The road to $10 billion in assets may seem a bit scary for community banks, but a couple of them recently found partners to join them on the journey.
Sterling Bancorp in Montebello, N.Y., agreed on Wednesday to buy Hudson Valley Holding in Yonkers, N.Y.; that deal would form a company with $10.5 billion in assets. Later that day, on the opposite side of the country, Banner Corp. in Walla Walla, Wash., announced a deal to buy AmericanWest Bank in Spokane, Wash., which would put it at $9.7 billion in assets.
The deals are an example of how banks are managing a desire for scale and efficiencies, while maneuvering through the delineations regulation has created around asset sizes. Essentially, bankers have the potential to earn more for investors with increased size, yet crossing $10 billion in assets creates more costs.
The challenge involves crossing over the threshold in a way that brings in enough revenue to offset the costs of additional compliance infrastructure, oversight from the Consumer Financial Protection Bureau and caps on interchange fees.
"For the average company, going over $10 billion in assets by just a little bit doesn't make sense," said Christopher Marinac, an analyst at FIG Partners. "But if you have the cost saves out there like a bag of goodies, it could be worth the additional brain damage. I think the analyst community has put a lot of attention on what happens if you barely go over, but deals like the Sterling one could make it more normal."
Executives at Sterling and Hudson Valley believe their deal's dynamics will allow the combined company to thrive even with slightly more than $10 billion in assets. Sterling projected that it can strip out 40% of Hudson Valley's annual operating expenses, while the deal is also expected to boost the company's earnings by 7% next year and 19% in 2016.
Sterling also believes it can earn back the acquisition's tangible book dilution in 1.2 years, which is much faster than the industry's standard of about four years.
"If they can hit those targets, the costs of going over $10 billion become just a nuisance," Marinac said.
Sterling did not make an executive available for comment.
The story is a little different for Banner. The deal is transformational and gives Banner some added heft to compete in a quickly consolidating region. During a conference call Thursday, Banner Chief Executive Mark Grescovich said the additional scale was the transaction's main draw.
"Scalability is required to continue to advance the needle," Grescovich said in an interview following the call. "Our customers are increasingly sophisticated, and we have to invest to have additional products and delivery channels that they demand. In order to do that, you need scale."
Analysts had long argued that Banner needed to do something to boost its earnings and, absent a reduction in expenses, it seemed like a large acquisition would be the way to go.
"They were not willing to lower their expense base," said Tim Coffey, also an analyst at FIG Partners. "If they wanted to improve profitability, they needed to grow into their expense base by adding a lot more revenue."
Banner is forecasting that it can trim 13% of the overall expense base, while projecting that the deal should boost 2016 earnings by 13%. It is expected to take five years for Banner to earn back the deal's tangible book value dilution.
For now, Banner is planning to manage its assets to remain below the $10 billion threshold, Grescovich said. A key feature of the deal is bringing in AmericanWest's excess liquidity to complement Banner's loan generating capabilities. To take advantage of that dynamic, yet stay below the asset threshold, Banner plans to tinker with its balance sheet to find the most profitable mix. For instance, management plans to shed $275 million in securities at closing.
Still, going over $10 billion is the eventual plan, Grescovich said, adding that Banner will have to do so "in a larger way."
Marinac calls that mentality the "Mitch Feiger rule" referring to the chief executive of MB Financial in Chicago, which hovered just below $10 billion until it agreed in July 2013 to buy the $4.5 billion-asset Taylor Capital Group.
Companies are getting better at determining the costs associated with going beyond $10 billion, industry observers said.
Sterling pegged the cost at about $7.5 million annually. Banner expects those costs to be $10 million, with $8 million coming from the lost revenue from interchange fees and $2 million coming from building the infrastructure. The ability to identify the cost could be a major positive for ambitious banks.
"I think that $10 billion mark has gained some clarity," said Jeff Rulis, an analyst at D.A. Davidson. "Before, banks wondered what it would cost, but now they seem to clearly know what they need to do and the fear of the unknown is being peeled away."