Consolidation of small banks on the rise

August 27, 2012

A growing number of small and medium-sized banks are merging as shrinking profit margins, tepid loan demand and low interest rates place pressure on their operations. Conditions are unlikely to improve as the Federal Reserve contemplates another round of stimulus that could push rates even lower.

Community banks also are contending with the added cost of complying with new regulations stemming from the Dodd-Frank financial reform law. Industry watchers say all of these factors will spur buying activity in the coming quarters.

On Monday, M&T Bank, with $81 billion in assets, became the latest bank buyer, with a $3.7 billion deal to acquire Hudson City Bancorp, a $43.6 billion community bank in Paramus, N.J. The transaction, the largest bank merger this year, is slated to close in the second quarter of 2013, subject to regulatory approval.

Buffalo, N.Y.-based M&T will gain an additional $25 billion in deposits, $28 billion in loans and 135 branches. Once the acquisition is completed, the bank will boast 870 branches stretching from upstate New York to Virginia.

M&T has actively pursued deals coming out of the recession. The bank last year picked up Wilmington Trust Corp. for more than $400 million to expand its wealth management services, one of the most lucrative segments of the industry. In 2008, M&T purchased Baltimore-based Provident Bankshares for $401 million.

Despite emerging from the financial crisis relatively unscathed, Hudson City has watched profits wane in the face of record- low interest rates. Acting chief executive Denis Salamone earlier this year said the interest rate environment was making it difficult for Hudson to profitably grow its business.

By lowering long-term interest rates, while keeping short-term rates low, the Fed effectively squeezed the spread that banks such as Hudson depend on to make money, said banking analyst Terry McEnvoy of Oppenheimer & Co. He said a prolonged period of paltry profits, coupled with rising regulatory expenses, has made mergers more palatable to regional and community banks.

“Banking is becoming more and more about economies of scale to overcome the challenges posed to profitability from financial reform,” McEnvoy said. Whereas large national banks have little trouble hiring more accountants and lawyers to manage compliance with new regulations, community banks find it difficult to absorb those costs.

Banking analyst Bert Ely said Dodd-Frank legislation places the heaviest burden on banks with less than $500 million in assets, which will likely be the primary source of deal activity.

Small banks, he said, will be especially taxed by new requirements to keep 5 percent of the loans they issue through mortgage-back securities on their books. He also thinks smaller banks will be discouraged by higher and stricter capital requirements.

“People decry the growth of big banks, but that’s exactly where regulation is pushing things,” Ely said. “It’s going to lead to a much more concentrated and ultimately less competitive banking industry.”

There have been 108 bank deals in 2012 announced through August, compared with 72 deals for the same period a year earlier, according to Oppenheimer.

Community banks in the Washington area have been active buyers. In June, Fairfax-based First Virginia Community Bank announced a $3.7 million deal to acquire Arlington’s 1st Commonwealth Bank. A month earlier, Reston-based WashingtonFirst Bank agreed to buy Alliance Bank of Chantilly for $24.4 million.

Kip Weissman, partner with the law firm Luse Gorman Pomerenk & Schick, said banks with more than $50 billion in assets are generally staying out of the market because of merger-and-acquisitions limits imposed by Dodd-Frank. The law requires the Federal Reserve to block deals where the risk outweighs the benefits of the transaction to avoid creating more institutions that are “too big to fail.”

“A lot of banks in the $40 billion area are also going to be reluctant to pull the trigger on a deal that would get them above $50 billion, as they are trying to avoid being classified as systemically risky,” said Weissman, who has engineered a number of bank acquisitions. “A lot of the action will come from the smaller guys.”

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