Community Bank M&A
The latest FDIC quarterly banking
profile shows that the banking industry continues to get back on its
feet. More than half of all institutions showed improvements in
their quarterly net income from a year ago, driven largely by improving credit quality. Headwinds are becoming tailwinds and the
downward spiral in credit quality seems to have stabilized.
One gets the sense,
from the industry dialogue, that merger and acquisition (M&A)
activity at the mid-size and community bank level is poised to
increase significantly in 2013. With recent news stories indicating
that the mega-banks have been sidelined by the Fed with regard to M&A
activity, the M&A focus moves to the mid-size and community bank
segments of the industry.
Three reasons contribute to this hunch. The first is the program of financial repression
created through the Federal Reserve zero interest rate policy and its efforts to push down long-term rates. A community
bank, in particular, has to have a reasonably wide positive carry
(net interest margin) to cover its overhead. Fee income helps, but with what looks like a public jihad against banking fees (think overdraft and interchange fees), there are limits to flexibility on that
With loan demand lethargic, options to offset financial repression
are few. Many community bankers are seeing the present Fed zero interest rate policy remaining for years to come. This is
pushing some to pursue classic “down and out”
banking - moving down the scale of credit quality and out
along the yield curve to squeeze out a few more basis points of
yield. But those practicing “down and out” banking know, in
the back of their minds, that a reasonable buyout offer tomorrow
would be preferable to the risky, and potentially mortal, balance sheet positions they
are building out of necessity and desperation today.
The second is the escalation in the
average community bank cost structure. Community bank cost
structures are creeping up faster than technology can lower them. Technology is a great way to lower unit costs of production, but
diminishing returns appear to be kicking in. The cost reduction curve
is being slowed by increased expenditures for cyber-security and
Then add in to the community bank cost
structure increases in personnel expenses associated with the
implementation of the Affordable Care Act, compliance costs
associated with the ongoing implementation of the Dodd-Frank Act,
Consumer Financial Protection Board regulations in the pipeline, and
the increased regulatory agency fondness for “guidelines” (which appear to be recommendations, but are enforced as obligatory through the examination process).
Not helping the cost structure
situation either, is the emotional attachment to
lightly-trafficked brick-and-mortar branches as monuments to territorial conquest and icons to the exercise of superior
generalship in days gone by. Cede turf to a competitor? Never!
Third, battle fatigue is showing up in
more and more community bank CEOs and boards of directors. Not only is this
economic recovery so frustratingly long and slow, but many of the true joys of community banking are being overshadowed by the aforementioned frustrations and obstacles. The
familiar five stages of adaptation are at work: denial, anger,
bargaining, depression and acceptance. This process tends to soften
opposition to market value buyout offers. Stock swaps may also become more
popular, as many shareholders may think that buying a ticket on a
winning horse may be preferable to being passengers on a foundering vessel.