Investment bankers bet on California to gain on other states in M&A derby.

Earlier this month, Comerica Inc. bought a small business bank in Palo Alto, Calif., the midwestern company's fourth acquisition in the Golden State in six years.

Though the deal attracted little attention, some investment bankers are saying it could foreshadow more acquisitions by out-of-state banks.

"The state offers an economic opportunity that is very powerful, and as a result of the economy continuing to stabilize and improve, bank acquisitions will become more plentiful," said Murray G. Bodine, a managing director at Hoefer & Arnett Inc., a leading investment banking adviser to the state's community banks.

"Any institution with a national banking strategy is no doubt attempting to analyze how to get here," he said.

To date, the lingering recession and a deposit market controlled mostly by a cabal-like group of banks and thrifts have turned acquirers away from California. The Bass brothers' inability to sell American Savings Bank in January reinforced the view that the bank merger and acquisition wave could miss California altogether.

But more and more investment advisers are banking on the expectation that California is about to play catch-up in the M&A derby.

Alex. Brown & Sons Inc., long a fixture on the East Coast, opened a financial institutions office in San Francisco last month and hired an experienced Merrill Lynch & Co. officer to run it.

And earlier this year, Natwest Securities hired five investment bankers away from Oppenheimer & Co. to staff a West Coast office.

At the same time, the stocks of California's thrifts and community banks have risen all year on takeover rumors. (See chart.)

Takeover Targets Sept. 30 Rise share since price Jan. 1City $11.00 49%NationalCoast 17.75 28SavingsGlendale 11.75 65FederalImperial 16.75 32BancorpVallicorp 14.75 23HoldingsWestamerica 32.50 20Bancorp

Source: Rodman & Renshaw

While First Interstate, Wells Fargo, and Great Western Financial are frequently mentioned as attractive entry vehicles, other institutions may be better plays, analysts said.

Thrifts like Glendale Federal Bank, Coast Federal Bank, and California Federal Bank are seen as likely takeover targets, said Campbell Chaney, an analyst in Rodman & Renshaw's San Francisco office. They have more than $30 billion in assets between them, he said.

Buying both Home Savings of America, the main unit of H.F. Ahmanson & Co., and Great Western Financial Corp. would give a bank an immediate 12% of the state deposit market, said Charlotte A. Chamberlain of Wedbush Morgan Securities in Los Angeles.

Assuming an acquisition premium of 175%, both could be bought for roughly $6.7 billion, she said.

Another view is that those two thrifts are likely to be the acquirers of other thrifts in the upcoming consolidation, said Philip Erlanger, a Lehman Brothers investment banker based in Los Angeles.

Smaller banks that are commonly mentioned as acquisition targets include City National Corp., dubbed the bank to the stars for its Hollywood business, and Westamerica Bancorp., San Rafael, with assets of $2 billion.

The big national players, meanwhile, remain coy about their intentions in the state.

One bank commonly mentioned as a natural for California is Norwest Corp. It is expanding; it already has extensive western operations; it has excess capital; and its mortgage, finance, insurance, and venture capital subsidiaries are already operating in the state.

But Norwest's chief executive officer, Richard M. Kovacevich, said recently that California "is not our highest priority." He conceded the time is ripe for entry into California but said his bank avoids large metropolitan areas and would stick to that policy.

Roughly 80% of California's deposits are concentrated in San Diego, San Francisco, and Los Angeles.

"It is such a vast state that in order to do well there you need a fairly significant market share and a statewide branch system," Mr. Kovacevich said, "and there aren't many of those left." He also pointed out that the kind of agricultural lending practiced in northern California is much more of a big-business game than the ag lending Norwest specializes in elsewhere.

Talk also continues to swirl around NationsBank Corp. as a potential acquirer, despite its denials last year that it was headed to California.

NationsBank currently takes the same position as Norwest, though adding -- as with any question about acquisitions -- that it does not rule out expansion anywhere.

Also weighing against a surge of out-of-state acquisition is the increasingly prevalent view that it is not cost-effective for banks to amass bricks and mortar at the dawn of the era of electronic banking.

Given the current prices bank sellers are demanding -- often well in excess of 2 times book value -- it does not makes a lot of economic sense to acquire more branches, said Louis F. Coleman, chief financial officer of BankAmerica Corp.

Reflecting this sentiment, NationsBank and Banc One Corp. have idled their M&A motors for the time being.

An even bigger problem for California M&A aspirations is the structure of its banking industry.

As with a 500-piece jigsaw puzzle in the box, there appears to be little logic in how the industry is organized.

After BankAmerica Corp., Wells Fargo & Co., First Interstate Bancorp, and Union Bank, the next-largest bank in the state is City National Corp., with $2.8 billion of assets, hardly an attractive entry vehicle for the likes of NationsBank or Banc One.

The more than 400 community banks used to make a healthy living out of the state's real estate market before it crashed.

And thrifts control roughly half the state's deposit market. Many of these thrifts are in the southern part of the state, where the real estate recession stubbornly lingers.

In addition, managers of many of the thrifts and banks stubbornly refuse to sell, despite encroaching competition and disappointing shareholder returns.

"Out-of-state banks aren't convinced these are good entry vehicles," one investment banker said. However, he added, with 13% of the U.S. economy here, the banks must come.

Comerica has roughly $2 billion of assets in the state but is geared toward business lending, not retail operations.

"A lot of banks make money off retail banking, which is a mass-market and scale-sensitive business," said Jon Lewis, vice chairman of Comerica. "But market leaders in California are very large and difficult to acquire."

Citicorp owns 95 branches through its thrift in the state but recently sold some operations.

But there are other reasons to expect new entrants in the market expect new entrants in the market shortly.

If Japanese banks that control the likes of Union and Sumitomo Bank were willing to sell, said Kathy Smythe, an investment banker at Montgomery Securities, more opportunities would arise. The returns to the Japanese have been disappointing, and they may be ready to sell and shift their focus to domestic operations, she said.

What's more, consolidation has quickened in this state, as investment bankers seek to piece together franchises large enough to attract outside interest.

Last year, there were only 13 deals in the state, this year, there have already been 24, with an average price to book value, ratio of 135%, according to Rodman & Renshaw.

One investment banker is even working on a four-way merger of equals that would produce a $600 million-asset bank -- a paltry franchise perhaps but one that could be more attractive to the next bank up the food chain.

Mr. Chaney of Rodman believes most M&A activity will take place in-market, with the community banks and First Interstate doing the buying.

But like others, he expects at least some nationwide banks' to make a play in the state.

And there is always the possibility of First Interstate or Wells Fargo's merging with an outside bank. Another force driving the expected M&A boom would be the rapidly shrinking supply of Resolution Trust Corp. assets, which will force acquirers to look to the private sector.

But for now, Comerica looks to be the only active out-of-state acquirer after completing its purchase of University Bank and Trust, which is renowned for its annual gifts of Walla Walla sweet onions to customers.

Of course, out-of-state acquirers are interested not in onions but in plums.

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER