What's driving surge in sales of larger community banks

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Larger community banks are in the sweet spot for industry consolidation.

Overall last year, 34 banks with $1 billion to $10 billion in assets agreed to be sold, a 26% increase from 2016 and more than double the number that were bought in 2011, according to data from a Deloitte study and numbers compiled by Keefe, Bruyette & Woods.

These deals are happening for a variety of reasons reflecting both the buyers' and sellers' circumstances, industry experts said. The trend provides hope that there will be more mergers among bigger institutions, though disagreements over pricing can always delay or derail some deals.

“There is a natural inclination to continue to move up the food chain,” said Jason Langan, who leads the financial services M&A practice at Deloitte. “There’s a lot of franchise value when you get to $5 billion [in assets] … and there are a lot of banks that wouldn’t mind partnering with you.”

The average bank is also getting bigger. Since 2013, the number of banks with $1 billion to $10 billion of assets has increased by nearly 11%, according to data from the Federal Deposit Insurance Corp.

The are several factors behind this M&A surge.

Banks may find it challenging to grow organically, said Vincent Hui, who leads the M&A and risk management practices at Cornerstone Advisors.

Financial institutions, especially the smaller banks in this asset-size class, may need additional services such as specialty financing, treasury management and trust offerings to compete more effectively, said Steve Nelson, a managing director of investment banking at D.A. Davidson. While banks can build those platforms on their own, doing so carries a risk and involves an upfront investment of time and money, he added.

In certain markets, the opportunity to do acquisitions may be diminishing, said Matt Veneri, who co-leads the investment banking team at FIG Partners. That could cause some institutions who have been active acquirers to consider selling.

North Carolina, for instance, has seen a dramatic decrease in banks after a wave of acquisitions by out-of-state buyers. The number of banks in the state fell by 42% since 2012, to about 50 at Dec. 31, according to FDIC data.

“You see some of these banks look for an exit themselves,” Veneri said. “Part of their growth strategy has been growth through acquisition and those are just not as prevalent.”

Banks with $5 billion to $7 billion in assets generally get the best multiples because they can usually be buyers or sellers, Veneri said. Those banks also tend to have more private equity and institutional investors that are interested in cashing out, he said.

The valuation gap has also widened in recent years.

Banks with more than $1 billion in assets sold at an average premium of 210% of tangible book value last year, or 58 percentage points more than institutions below that threshold, according to data compiled by KBW.

In 2013, the bigger group sold at an average premium of 164% of tangible book value, or a difference of 48 percentage points.

Larger banks “have a lot of good stuff going on with their businesses,” Nelson said. “Sometimes as it relates to any deal there’s a transaction with market synergies or a target has developed a nice niche that the buyer didn’t have. You have those types of dynamics, too.”

The $10 billion asset threshold continues to fuel consolidation between bigger community banks, industry experts said. There is still the belief that banks must jump, rather than crawl, over that mark to offset higher compliance costs and caps on interchange fees.

As a result, banks that close to the threshold may pursue a big acquisition. Absent a deal, those institutions could instead look to sell.

“As I described to our investors, as you get closer to $10 billion [of assets], there’s a fork,” said Claude Davis, CEO of First Financial Bancorp in Cincinnati. “You need to acquire and go across or you need to sell and go across that way.”

The $8.9 billion-asset First Financial is set to close its purchase of the $4.7 billion-asset MainSource Financial Group in Greensburg, Ind., on April 1. Crossing $10 billion of assets will cost First Financial $15 million a year in lost interchange revenue and added expenses, Davis said.

Still, the MainSource deal made strategic sense even if the $10 billion threshold hadn’t been a factor, Davis said.

Buyers could look to significantly expand their footprints and add deposits with bigger deals, said Martin Webster, the director of business development for Integrated Legacy Solutions.

“Since the recession, these banks have run their banks more efficiently than they have in a long time,” Webster said. “They’re in a position to buy. Their infrastructure supports a larger bank. There has been pent-up demand for growth.”

Activity among bigger banks has been slow this year; only four sellers had more than $1 billion in assets, according to data from S&P Global Market Intelligence.

One snag has been the difference between what buyers are willing to pay and what sellers are expecting, said T. Alexander Spratt, president and CEO of Ardmore Banking Advisors. Still, Spratt said, deal activity could pick up later this year as an equilibrium is reached.

“Without any clear problems like loan losses, sellers … believe they have a value that is greater than what the buyers want to pay,” Spratt said. “Sellers think they have something good to sell. Buyers are interested, but not quite at that the prices sellers would like. It is just one of those things.”

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