Pennsylvania’s lukewarm bank M&A activity is poised to heat up.

In many ways, the state would be a logical market for accelerated consolidation. Pennsylvania is home to 154 banks, and many of those have potential succession issues and heightened regulatory costs.

Still, activity has stalled in recent years.

Only 19 banks in Pennsylvania have agreed to sell themselves since the end of 2015, according to data from Keefe, Bruyette & Woods and S&P Global Market Intelligence. Bank M&A activity trails behind a number of less-populated states including Georgia, Illinois, Missouri, Tennessee and Wisconsin.

While Pennsylvania is home to Philadelphia and Pittsburgh, there is a growing belief that consolidation will hinge on sellers in rural markets, particularly as rising interest rates push acquirers to pursue institutions with low-cost deposits.

“Pennsylvania is overbanked,” said T. Alexander Spratt, president and CEO of consulting firm Ardmore Banking Advisors. “There are targets. I would not be surprised if people are talking, but these talks just haven’t matured yet.”

The M&A market in Pennsylvania has been hot in the past. Fourteen banks were bought in the state in 2015.

Several developments could explain the drop-off in activity, including a need by previous buyers to press pause to integrate their acquisitions.

Buyers may also be more motivated to pursue organic growth in recently acquired Pennsylvania markets, said Frank Schiraldi, an analyst at Sandler O’Neill who just returned from visiting banks around Philadelphia.

Many banks were eager to poach business from BB&T in Winston-Salem, N.C., when it bought Susquehanna Bancshares in 2015 and National Penn Bancshares a year later. BB&T, which has been sidelined from bank acquisitions due to regulatory actions tied to anti-money- laundering compliance, was recently freed from most of those orders.

“When you talk to banks, the No. 1 priority is to grow organically,” Schiraldi said. “It is probably more that than trying to digest something.”

Philadelphia, meanwhile, lacks some of the stronger economic and demographic attributes behind deals in cities such as Atlanta, Chicago and Denver. While the city’s population is growing after decades of decline, it is increasing at a much slower rate than other markets. Its median household income of roughly $41,000 is about 28% below the national median.

Another snag could be pricing. There is still a likelihood that sellers in the Keystone State want higher premiums before agreeing to sell, industry experts said.

In the past 18 months, the average seller in Pennsylvania has received a premium equal to 165% of its tangible equity, based on data from S&P Global. That compares to 172% nationally and more than 195% in Colorado and Georgia.

“Sellers might have an inflated idea of their franchise," Spratt said. "Every time there’s a high-priced deal, other banks value themselves equally or higher."

There are signs that M&A could rev up in Pennsylvania.

Scale could be a factor; more than two-thirds of the banks in the state have less than $1 billion in assets, according to data from the Federal Deposit Insurance Corp. As a result, more banks could look at deals as a quick way to get bigger.

Succession vacuums could also lead to bank sales.

“Some may not have succession of management,” said Bob Kafafian, CEO of the consulting firm Kafafian Group. “When they run out of gas, they look for partners.”

Pennsylvania has few urban centers beyond Philadelphia and Pittsburgh, which can further complicate succession planning. It is often challenging to convince a qualified candidate to move to a rural market, said Alan Kaplan, CEO of the executive search firm Kaplan Partners.

A need for cheap core deposits could also spur M&A. In general, banks in rural areas have more limited lending opportunities and lower-cost deposits. That could motivate a rural bank to sell, particularly if it received an offer from a urban-focused bank that needs to reduce its funding costs.

“There will always be a desire to get into higher-growth markets, but banks won’t be able to support growth without a strong deposit base,” said Richard Quad, head of financial institutions at Griffin Financial Group in Reading, Pa. “Some of the markets in the central part of the state may end up being more valuable and sought after.”

Obtaining low-cost deposits has been a goal of Mid Penn Bancorp in Millersburg, Pa., an active acquirer that had bought two banks since 2015. The $1.4 billion-asset company also has a pending deal for First Priority Financial that is expected to close in the third quarter.

Scottdale Bank & Trust, which Mid Penn bought earlier this year, had $3 in deposits for every $1 in loans on its books. First Priority also presents Mid Penn with more lending opportunities, said Rory Ritrievi, the company's president and CEO.

A perfect storm of conditions, including higher regulatory expenses, prompted more Pennsylvania banks to sell a few years ago, Ritrievi said, adding that he believes this could happen once again.

“The regulatory relief is good — but not a windfall,” Ritrievi said.

“The economy is strong but not infallible," Ritrievi added. "Succession planning is weak, at best, in the community bank space. I think all of those [factors] that stimulated deals in 2014 and 2015 might do so again.”

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