Mergers among the nation's community banks, already steaming along at a record clip, could well heat up further in the next five years, particularly in fast-growing markets that still have many small institutions. Consolidation activity across the banking industry has been steadily increasing for the last three years. Last year, there were 520 mergers in the country, with the largest amount occurring in the midwestern states, which have a number of small community banks. So far this year, 116 institutions with less than $1 billion in assets have announced that they are for sale. And exactly half of those were bought by other institutions with less than $1 billion in assets. Industry observers expect this pace to continue, and very likely to pick up. "We're seeing lots of activity," said Chris L. Hargrove, vice president of Louisville-based Professional Bank Services, an investment banker. "I haven't been home in 40 days. It's real busy." But it also needs to be noted that a brisker pace of dealmaking activity does not always mean higher prices for the banks being acquired. Midwestern community bankers are the most likely to find themselves riding the crest of the newest wave of acquisitions, as the onset of interstate banking unleashes a host of new players onto previously closed off markets, observers say. Some states in the Midwest, such as Illinois, long had restrictive banking laws on the books that prevented consolidation in their state's industry, leaving hundreds of tiny banks with less than $100 million in assets. But those ranks are expected to be thinned significantly in the coming years, as out-of-state banks that had been banned roll across the border and as in-state institutions seek to bulk up before the out-of-state buyers arrive, said Frank J. Barkocy, a veteran banking industry analyst at Advest Inc., Hartford, Conn. "States that until five years ago had unit banking and have excess banks will see a lot of mergers," said Arnold G. Danielson, president of Danielson & Associates in Rockville, Md. The problem in some states, however, is the lack of dominant public acquirers who would serve as the driving force behind consolidation. And the large superregionals don't have much of a presence yet in some of these states, notes Greg Anderson, bank and thrift analyst at the Chicago Corp. "What you need is not only to have a couple of big acquirers, but also to have some strong community banks on an acquisition binge," said Eric D. Hovde, executive vice president of Hovde Financial Inc. in Washington, D.C. In much of the Southeast, on the other hand, many of the states are already tightly consolidated, particularly North Carolina, because they've had interstate banking for years through the Southeast Compact, and because the region has had many active large players, observers say. In Louisiana and Kentucky, for example, the state's large banks are "buying everything in sight," said Martin Friedman, senior thrift analyst at Friedman, Billings, Ramsey & Co., Arlington, Va. Florida is the exception to the rule, however. With a few large players already controlling a big part of the market and more than 400 smaller institutions, many of which started in the last 20 years, the Sunshine State is ripe for renewed consolidation, said Gerard Cassidy, banking analyst at Tucker Anthony's Hancock Institutional Equity Services. "Florida is going to continue to be a hotbed of activity," Mr. Barkocy said. "We've seen a lot of activity in the Florida marketplace and that will continue as banks look to fill in franchises that they already have in the Florida markets." But Laurie K. Havener, senior thrift analyst at Friedman Billings Ramsey, noted that since many of the institutions in Florida are not publicly or actively traded, they won't be acquisition targets. "You are going to see consolidation in Florida, but I just don't think it's going to be to the same extent as somewhere in the Midwest," she said. Another merger site: California, which has seen little consolidation because banks have been licking their economic wounds. "There have been a lot of banks that were willing to sell, but because of loan quality problems, the market's been put on a hold," Mr. Danielson said. "Both buyers and sellers had asset-quality problems and it made it difficult to have acquisitions." But now that the community bank buyers and sellers are looking for willing partners, there are few medium-size institutions in the state that could buy them. So, they're turning to each other, albeit at lower premiums that what a larger, regional bank could pay. The lack of many medium-size institutions is also a problem for outside superregionals, which view the state as a highly desirable market but can't afford to buy the few remaining big banks. That leaves California's 400-plus community banks as targets for outsiders looking for a toehold in the state, Mr. Cassidy said. Even as the consolidation continues, new factors are likely to influence who buys and who sells, analysts say. The recent supermergers of Fleet Financial Group with Shawmut National Corp. and First Union Corp. with First Fidelity Bancorp. reflect the changing attitude of the large regional institutions. With consolidation in full swing, these medium-size institutions are jockeying for survival. That generally leaves community banks to feed on one another. And as the superregionals race to enter new states, they're also more likely to want to buy fairly large banks in order to get a sizable presence fast, said Elizabeth A. Summers, first vice president of Ryan, Beck and Co., West Orange, N.J. "It's very expensive to patch together a franchise with a series of small institutions," the New Jersey analyst said. "So your first choice is going to be the ones that have statewide coverage. You want as much bang for your buck as you can get." As a result, the traditional big buyers aren't likely to pay highly to buy small community banks simply because they're not as desirable, Mr. Cassidy said. Nor will small banks find their fellow community banks offering lofty purchase prices. "When you look around the country, we're going to see a slowdown in the large-bank acquisition of small community banks because of the megamerger trend that has started in the commercial banking industry," Mr. Cassidy said. "I would be surprised if the prices would continue to be as steep as they were in the past five to 10 years," he said. But instead of dampening the enthusiasm for selling, the declining premiums are expected to drive more deals, as banks that were holding out for better offers realize that the time to sell might be now, before the price drops further, Ms. Summers said. "A lot of community banks are trying to assess their prospects of staying independent," Mr. Hargrove said. "We've had more calls of people wanting to sit down and talk about their chances of survival than ever before." Also, growing shareholder activism among community banks could prompt new attempts at hostile takeovers, even though there have been few such successful deals in banking, Mr. Anderson said. "It has been a gentleman's market," Mr. Anderson said, adding, "If it can be shown that a hostile deal can be completed effectively and reward shareholders, the pace may quicken." And increasing pressure is coming from the investors of urban institutions that first opened their doors from 1986 to 1991 in cities like New York and Philadelphia, Mr. Danielson said. Now that the institutions are turning profitable, the investors want to collect on their investments, he said. "These are the institutions that are most likely to sell just because they don't have 150 years of history," Mr. Danielson said. "They have a lot of investors who are concerned and want to cash in in case the market isn't as hot in 10 years as it is today."

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