Beginning with the financial crisis in 2008, bank mergers and acquisition activity slowed to a crawl in Wisconsin.
There are various reasons why deal activity is increasing and several noteworthy trends.
First, a few words on bank consolidation. Many industry "experts" are predicting massive bank consolidation over the next few years. These experts believe that banks cannot survive in the post-financial crisis environment if they are not large enough to absorb the additional costs and complexities of new regulations and capital requirements being thrust upon our nation's banks as a result of, among other things, the Dodd-Frank Act and Basel III. According to these experts, the threshold size for bank survival seems to be assets in excess of $1 billion.
The reality is, the decision for a bank to sell is much more nuanced than a simple calculation of its size. For example, several small community banks in Wisconsin—some well under $100 million in assets—have robust earnings and provide exceptional returns to their shareholders.
Moreover, bank directors (especially those from small community banks) tend to be fiercely independent and committed to their communities and the bank's employees, so the decision to sell is often very personal and not merely financial.
That said, consolidation is a reality for the banking industry—and it has been for decades. In 1921, there were 981 banks headquartered in Wisconsin. Now there are approximately 260, and that number is declining. Nationally, the trend is just as stark. Thirty-five years ago, there were approximately 20,000 banks and thrifts in the United States; today there are less than 7,000. The rate of consolidation appears particularly dramatic in recent years given that there are no new "de novo" bank charters being formed to take the place of charters being merged out of existence. There were only three new banks formed in the United States from 2010 to 2013, compared to 237 from 2007 to 2009.
So what are the key drivers for Wisconsin bank M&A activity in 2014? Here are a few of the significant ones:
Regulatory weariness. The fallout from the recent financial crisis has imposed significant regulatory compliance burdens on Wisconsin banks. The new burdens are simply becoming too expensive or too complex for some bankers. A number of experienced bankers often comment to me that banking just is not as much fun or as fulfilling a career choice as it once was. According to a recent survey of 200 U.S. banks under $10 billion in total assets, 93 percent of them reported that compliance with the Dodd-Frank Act has resulted in additional burdens, and 83 percent have seen their compliance costs increase by more than 5 percent since 2010.
Earnings pressure. The current low interest rate environment is causing banks' net interest margins (the difference between what funds costs and what is earned on loans) to be squeezed to historically low levels. This earnings pressure, coupled with increasing regulatory expenses, is making it more difficult for many banks to provide the shareholder dividend returns they expect.
Succession planning. Many bank boards and executive management teams are "baby boomers" and nearing retirement. Some banks are being forced to consider selling because they do not have a succession plan in place for these key individuals.
Liquidity. Most banks are privately held, and, thus, their stock is highly illiquid. Many shareholders who either made initial investments to form some of these banks decades ago or in many cases have inherited shares held by a parent or grandparent, are increasingly demanding that their boards find a "liquidity event" for retirement or other purposes.
Non-local ownership issues. Many privately held Wisconsin banks have been in existence for many generations — some for well over 100 years. As shares have been passed down through multiple generations upon death, these banks find that the majority of their shareholders no longer live in the bank's local community. These non-local shareholders often do not have the same commitment and pride of ownership in a smaller community bank that local shareholders do, and would rather have liquidity in the form of cash or publicly-traded stock.
Pricing expectations. Many buyers and sellers were too far apart on pricing expectations for the last several years. However, the gap is beginning to narrow as loan portfolios improve and more comparable deals get announced.
Growth. Organic growth is hard to come by in some Wisconsin markets due to soft loan demand and/or extreme competition. As a result, some banks wanting to grow need to consider acquisition opportunities in order to do so.
Desire for efficiencies. Some buyers and sellers — often competitors from neighboring communities — simply determine that they are better off working together than they are apart. A combination of talent and resources can help increase efficiencies and provide new products and services to each other's customers and communities.
Bank M&A trends
Here are a few of the trends the Wisconsin banking industry is currently experiencing in the M&A space:
Increased deal activity. Deal activity is on the rise, for both whole bank and branch transactions. The accompanying chart shows the number of whole bank and branch deals in Wisconsin since 2004 (excluding FDIC-assisted transactions).
Through April 9 of this year, there have already been eight bank mergers and branch sales announced in Wisconsin. If this pace persists (and there are indications that it will), 2014 will be the busiest deal year the Wisconsin banking industry has seen in the last 10 years.
Whole bank vs. branch transactions. 2013 saw increased branch transaction activity. In fact, branch transactions outnumbered whole bank mergers. So far in 2014, this trend is continuing. Banks selling branches are doing so to create efficiencies, exit certain markets, and increase regulatory capital ratios by shrinking their balance sheets. Banks buying branches are doing so to increase assets and deposits, enter new markets, or solidify their presence in existing markets. Branch transactions will continue to be a good strategic tool for both buyers and sellers. However, with industry research detecting a decrease in branch traffic due to internet banking, mobile banking, and other electronic means of doing business, the long term viability of some Wisconsin bank branches is up for debate.
The "little guy." Banks with less than $100 million in total assets make up approximately 30 percent of all bank charters in Wisconsin, but these small banks were targets in 58 percent of mergers from 2008 to 2013 (14 out of 24).That means small banks under $100 million in assets made up a disproportionate number of sellers over the last several years. Many of these small banks are feeling the pressures of increasing regulation, shrinking net interest margins, and a lack of diversified revenue streams. What does the future hold for these smaller community banks over the next three, five, and 10 years?
Private transactions. Traditionally, many selling banks "shopped" themselves to several prospective buyers (often with the help of an investment banker) in order to ensure the best price for shareholders. This formal marketing process protects the selling bank's board of directors from lawsuits alleging a breach of their fiduciary duties. However, more often than not, Wisconsin banks are now foregoing the formal marketing process, and instead buyers and sellers are finding each other informally. Often, they are longtime competitors from neighboring communities. Selling bank boards protect themselves from shareholder lawsuits by obtaining an opinion from an independent investment banker that the transaction is fair to shareholders from a financial point of view. In addition, selling bank boards are permitted to take into account not just the price offered to shareholders, but also the interests of employees, customers, and the community. These "non-financial" considerations are often key decision points for boards of the selling banks.
Predictions for 2014 and beyond
Wisconsin M&A activity will increase in 2014 compared to the last several years, but do not expect the dramatic consolidation that some pundits and investment bankers are predicting. The pressure to consolidate has existed for decades, and many Wisconsin banks have a long tradition of independently serving their customers and communities. As the banking industry in Wisconsin and the United States continues its slow process back to a "new normal," expect to continue to see a steady pace of bank M&A activity. However, as the number of bank charters continues to slowly decline, do not be surprised if over the next decade the Wisconsin banking industry sees a resurgence in interest from investor groups wanting to form new "de novo" banks to take the place of those being merged out of existence.
Peter Wilder is an attorney in the Banking & Financial Institutions practice group at Godfrey & Kahn, S.C. in Milwaukee.