The main reasons why banks sell themselves are timeless.
Management is ready to retire. Shareholders want liquidity. Buyers offer the banks a price per share that would take them a few years to attain on their own.
But there are also several nontraditional forces that could drive M&A in 2014. Many of them are already starting to take hold, and their influence could build in the coming year.
Here are the ones to watch for in 2014 in our opinion, based on interviews with dealmakers and advisors.
PE Ready to Move On
Private-equity investors circled 2014 on the calendar years ago five years ago, in most cases.
Back in 2009, PE's appetite was whetted by the chance to enter into banking at its low point. Some set out to string together a collection of failed and distressed banks, while others decided to focus on using their cash to save institutions that still had latent value.
But private equity at least the traditional, diversified funds works by cashing out somewhere around five years into an investment and moving on to the next investment.
In 2013 several cashed out by selling their stock, but Brian Sterling, principal and co-head of investment banking at Sandler O'Neill, says that as valuations increase some private-equity funds might see a sale of the whole banking company as the better option.
Even if the PE firms are not pressured to sell by covenants in their agreements with investors, others might push for a sale because the bulk of the profit has already been made, says Rick Maples, co-head of investment banking at Keefe, Bruyette & Woods.
"It's not that it has become a bad investment, but the internal rate of return is averaging down," Maples says. "The big gains have already happened."
Hangover from Failed-Bank Deals
Banks that stepped up to absorb failed banks from the Federal Deposit Insurance Corp. were rewarded handsomely. If bid correctly, the deals were highly accretive, created mounds of capital and added a layer of insulation from the environment of low loan growth and low interest rates.
Those banks are now floating back down to reality.
Their margins are narrowing because the accounting benefits are running out as covered assets decline, and they are joining the pack in having a hard time finding loans, Sterling says. Meanwhile, fewer banks are failing, and the FDIC isn't offering the generous deals of several years ago.
Investors are also noticing.
"Shareholders and boards of directors very much enjoyed the type of returns they realized from failed-bank transactions," says Lori Buerger, a partner at Schiff Hardin in Chicago. "Whenever you show them that sort of return, they want to look for that in future years."
More banks could follow the lead of Home Federal Bancorp (HOME) in Nampa, Idaho, which agreed to sell itself in September.
But others are longtime acquirers that will likely now go back to their roots of open-bank M&A. In 2013 that was the case for Bank of the Ozarks (OZRK), Home BancShares (HOMB), and SCBT Financial (SCBT), which acquired and adopted the name of First Financial Holdings.
New Regulatory Costs
The Dodd-Frank Act tightens the regulatory scrutiny of large community and regional banks as they cross certain asset thresholds.
At $10 billion in assets, banks have to comply with the Durbin Amendment, which caps interchange fees. The Consumer Financial Protection Bureau begins regulating banks at that point, too.
As a result, some larger community banks have to balance the potential benefits of acquisitions with the new regulatory costs that come with passing certain asset milestones.
Once they decide to cross the $10 billion line, the thinking is to go over it with a big acquisition that will take them to at least $15 billion, if not $20 billion, of assets.
"There is a real fear of the thresholds," Sterling says.
The effect is palpable, too. David Zalman, the chief executive of Prosperity Bancshares (PB), said during an investor conference in September that his company saw as much as $8 million of annual earnings evaporate by going over the $10 billion-asset threshold.
Prosperity embarked on a buying spree and, should all the deals close as planned, the company will have $21.2 billion in assets. That compares with $9.8 billion at the end of 2011.
Trying to stay below the limits is infeasible, Maples says. "That's just working against the forces of nature."
The other threshold is $50 billion. There banks are deemed systemically important and that designation comes with a slew of new regulations. There are few banks at that range eyeing M&A; New York Community Bancorp (NYCB) is one of the more vocal in the group about its aspirations to surpass that threshold.
Markets Bolster Buyers
The sexiest part of bank M&A in 2013 was the stock market's embrace of buyers.
Traditionally, the stock of the buyer falls following a deal announcement, but in 2013 several buyers saw big pops or at least only small dents. Dealmakers seemed to have cracked the code for now: pay in stock, promise double-digit accretion, project cost saves of 30% or more and earn back tangible-book dilution in about three years.
The deals were often for competitors or a similarly sized rival in an adjacent market. In many cases, the deals were years in the making, giving credence to their strategic rationale.
For now, the market is willing to give credit to the buyers, says Michael Barry, a managing director and head of depository M&A for Sterne, Agee & Leach. However, a couple of undelivered promises could temper investors' enthusiasm.
"So long as bank stocks have the wind on their back, it is going to be conducive to M&A. Investors are now convinced that size matters and if you can announce a deal with great cost saves, the market will love the deal," Barry says. "The market will readjust if those promises aren't delivered, but it seems like now companies are doing deals that make a lot of sense. They are not slapping companies together. They are making the tough choices."
Too Small to Survive
The advantage of being a small community bank should be nimbleness, but the leaders of some of those banks see things differently.
Some believe they can't survive on their own. The banking industry is often criticized for its herd mentality, and it may be evident in the idea of "too small to survive." Even if the changes in regulatory oversight have affected few banks yet, they fear future regulation.
"Regulators hate to hear it, but small banks are absolutely putting themselves on the block merely because of the schizophrenic nature of modern community bank regulations and regulators," says Philip Smith, president of Gerrish McCreary Smith Consultants.
Directors are seeing the world similarly, too, Smith says. They believe the national landscape is slanted against small business and see now as the last good window to sell.
Other banks acknowledge that the industry is changing, but they have either refused to respond or failed in attempts to adjust their cost structures and product offerings to suit today's operating conditions.
Smart buyers are looking to capitalize on banks in both of those camps, Smith says.