Colonial Virginia Bank in Gloucester, chose to hitch a ride to a higher growth market by agreeing to sell itself to Xenith Bankshares (XBXS).

Xenith, from Richmond, Va., agreed to pay about $10 million in stock for the $115 million-asset Colonial, which operates in a bedroom community just a bridge away from the bustling Hampton Roads area.

Colonial's efforts to enter a bigger market were thwarted by regulators' expectations. Given Colonial's earning stream and lingering credit woes, the qualifications it needed to expand were too great, says Robert Bailey, the bank's chief executive. That barrier, along with the overall operating and regulatory environment, convinced directors to consider a sale.

"It was the best path for us given the circumstances we find ourselves in," Bailey says. "We had a hard time painting a picture where remaining independent was the right decision."

Colonial received an unsolicited offer from another bank that Bailey declined to identify. It then hired Sandler O'Neill to help the board weigh its options.

Xenith, which began in 2008 as an investment vehicle looking to build a dominant commercial lender in Virginia, entered the fray. Colonial determined the two parties' interests were in line, Bailey says.

Hampton Road was on Xenith's list of markets it wanted to enter. The company already had operations in nearby Suffolk.

"Colonial is adjacent to a key market for us and [Bailey] is very capable to lead the effort into greater Hampton Roads," says Thomas Osgood, Xenith's chief financial officer.

Bailey is expected to join Xenith's management team and will lead the push into the greater Hampton Roads area. Whether the company opens a loan production office, a branch, or does another acquisition to truly enter the market is to be determine, Osgood says.

Besides serving as a beachhead, the acquisition gives the $680 million-asset Xenith another way to leverage its capital. The deal will increase its assets to just less than $800 million.

"We built the infrastructure to be a larger bank," Osgood says. Becoming a bank with more than $1 billion in assets "is readily in our sights with this deal."

Banks spend considerable time talking about the size and scale needed to reach targeted returns, often saying they need to double in size. Osgood says he believes having more than $1 billion in assets will help, though having $2 billion to $4 billion seems like the right size to become a "formidable" competitor.

"The bad news about the banking industry is the fixed costs, but the good news is the fixed costs, too," Osgood says. "If you can get past that leverage point, you can really have adequate returns."

M&A activity has been heating up in Virginia, especially after United Bankshares' (UBSI) purchase of Virginia Commerce and Union First Market Bankshares' (UBSH) acquisition of StellarOne. Industry observers say they expect Xenith to continue to be a buyer as the state consolidates.

"Xenith certainly had success with creative acquisitions," says Derek Ferber, a senior analyst at FJ Capital, a Washington hedge fund focused on banks with a very small position in the company. "The acquisition of StellarOne was a game changer ... and it brought more attention to the market. I see Xenith as continuing to be a consolidator."

Colonial Virginia is Xenith's fourth acquisition, following the purchase of its target bank, a failed-bank deal and a branch acquisition. Growth by acquisition was not what the company intended when it organized with $47 million in capital. It wanted to create a bank and grow organically. With de novo actively practically dead, organizers bought their way in and have kept buying. Still, Xenith also has produced noteworthy organic growth — total loans increased 16% last year.

Xenith is looking for more opportunities, Osgood says. While content with deals the size of Colonial Virginia, management thinks a game-changing deal could be out there.

"We could do numerous deals like this and still be in good shape," Osgood says. "But it would be exciting to go from $800 million to $2 billion overnight. We are examining a whole spectrum of strategies."

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