Widening digital divide forcing more community banks to find buyers

When Allegiance Bancshares and CBTX agreed to a merger of equals this week, the two Houston banks said the deal was motivated by a demand for better technology and need for scale. They are far from alone in citing these factors as prompting their consolidation.

Many small lenders simply do not have the resources to keep up with deep-pocketed megabanks and a growing field of fintechs. Small banks increasingly find themselves on the wrong end of a digital divide that keeps getting wider.

What small lenders can offer — a physical presence in their market — might be more appealing to an acquisitive rival than to prospective customers.

“With the increased size and scale, we'll be able to invest in improving technology, explore additional revenue-generating areas, continue to recruit and develop high-performing talent all while we seek to deepen our existing relationships with our customers,” CBTX Chairman and CEO Bob Franklin, who will helm the combined company, said on a call with analysts.

The merger would create a bank with $11 billion of assets should it close as planned in the second quarter of next year. Larger, tech-savvy banks are better able to attract talent in a tight labor market, the banks said.

“The tech demand is real, it’s expensive and it takes a lot of time and focus to stay on top of it,” Robert Bolton, president of the bank investor Iron Bay Capital, said in an interview. “Some of the smallest banks can’t keep up. A lot of bigger guys really want that scale, and they are waiting to buy up these small guys.”

While an independent future grows less likely, sellers have a healthy array of merger-and-acquisition opportunities. Larger community banks and regionals are on the prowl for more assets over which to spread out rising technology costs of their own.

This makes selling palatable on one side and appealing for buyers on the other side, Bolton said.

Stock Yards Bancorp in Louisville, Kentucky, for example, is buying crosstown rival Commonwealth Bancshares as part of an ongoing push for scale. The $153 million deal, expected to close by next month, is the second M&A play for Stock Yards in 2021. The company closed its $190 million buyout of Kentucky Bancshares near Lexington in May.

Between the two deals, Stock Yards would gain $2.5 billion of assets and become a $7.4 billion-asset company. “In today’s financial world, you need scale to keep up with necessary technology spend” to stay relevant, James Hillebrand, chairman and CEO of Stock Yards, said in an interview.

U.S. bank M&A activity surged in 2021, with 180 deals announced as of Nov. 4. That compared with 111 in all of 2020, according to S&P Global data.

Acquisitions are also getting larger and more expensive. Total deal value through early November reached $58.58 billion, according to S&P. That far exceeded the $27.84 billion for all of last year and put the industry on track for the most lucrative year for M&A since 2008, when the financial crisis touched off a wave of consolidation.

Though the current market is incomparable to the crisis, increasingly more lenders are looking to join larger banks with cost-efficient digital offerings and other growth opportunities, said Jacob Thompson, a managing director of investment banking at SAMCO Capital Markets. This should continue to drive both volume and prices through 2021 and into next year, he said.

“I think we’re only going to see even more for some time to come,” Thompson said.

Deal drivers

Allegiance's example is one of many. South State Corp. in Winter Haven, Florida, tells a similar story.

Its deal to acquire the $3.8 billion-asset Atlantic Capital Bancshares in Atlanta for $545.8 million, slated to close early next year, would give it heft and help it expand into Georgia’s largest market. The $41 billion-asset South State said the pandemic punctuated the necessity of robust digital platforms, as social distancing pushed branches out of favor and brought online banking to the forefront. But it also emphasized the importance of expanding in heavily populated growth markets to offset light loan demand overall.

“Every day, technology becomes more important in banking,” said Chris Nichols, a strategist and head of capital markets at South State. “Growth is the best way to keep up with it.”

OceanFirst Financial closed two bank deals early in 2020 that gave it roughly $2 billion of additional assets. It used its greater size following the deals to invest in tech as well as talent it describes as key to cultivating new lending relationships in a highly competitive era.

The Red Bank, New Jersey-based OceanFirst most recently agreed to buy Partners Bancorp in Salisbury, Maryland, for $186 million. Announced last week and slated to close next year, the deal would enable OceanFirst to deliver its expanded tech capabilities to a retail footprint in the Washington, D.C., suburbs and nearby areas. The combined bank would have assets of $13.5 billion.

Chris Maher, chairman and CEO of OceanFirst, said that in the wake of the coronavirus, adoption of digital services and products among the bank’s customers grew two to three times faster than prior to the pandemic.

Digital demand

All banks need both digital tools and skilled people to capitalize on the change and win new business, he said, as well as footholds in growing markets.

With the deal for Partners Bancorp, “we’re buying a very good bank,” Maher said in an interview. “But what they needed and couldn’t fund on their own was a substantial improvement in technology. We can and will provide this, and as we spread our capabilities across a wider base, it makes us more efficient.”

He estimated that OceanFirst’s tech spending accounts for 20% of its expenses. Mobile payments, for example, have quadrupled in the past year alone, he said. The bank sees similarly rapid digital adoption rates across its customer base and the industry.

“It is a massive amount of money … but this is what you have to do to keep up. Our customers have embraced digital like never before,” Maher said. “If you are unable to keep up, you are going to lose customers.”

Maher estimates that some of his rivals are spending half as much on tech as OceanFirst. He predicts those competitors will be sold in coming years, if not sooner.

“The most important strategy is growth,” he said, “and M&A is one very important way to get there.”