Banks’ $10 Billion Sweet Spot Sets Off Buying Spree for Lenders

Early last year Prosperity Bancshares Inc. surpassed $10 billion in assets after almost 30 years in business. For Chief Executive Officer David Zalman, it wasn’t yet time to celebrate.

The $10 billion threshold subjected the Houston-based bank to a variety of regulatory hurdles under the Dodd-Frank Act, including a cap on fees it can charge retailers for debit-card transactions. That alone would cost the bank $9 million in revenue. So to help absorb the regulatory burden, Zalman went on a shopping spree. He has spent $1.37 billion on six banks since the start of 2012, making Prosperity the most acquisitive U.S. bank. Now its assets total $16.3 billion.

“The regulations are getting more strict, more strict all the time,” said Zalman, who pointed to the bank’s spending $500,000 last month on software for a stress test. “We’re going to do more deals as they come along.”

The $10 billion sweet spot is proving a boon to regional-bank mergers and acquisitions as small institutions say they need to be bigger to swallow costs to comply with the new financial rules. About 57 banks with assets of less than $10 billion each have made acquisitions this year, data compiled by Bloomberg show. That’s the most activity among banks of this size since the same period in 2007 when 59 made transactions. More acquisitions may occur through the end of the year as rising bank stock prices give acquirers greater currency to consummate deals, according to bankers and analysts.

The Standard & Poor’s Small Cap Regional Banks Index has risen 27 percent this year through yesterday and trades at 1.43 times book value, near the highest level in six years, data compiled by Bloomberg show.

Sluggish Economy

“Most banks either want to stay right below that $10 billion mark or if they go over it, they want to go over it aggressively,” Brady Gailey, an analyst who covers mid-sized banks for Keefe Bruyette & Woods Inc. in Atlanta, said in a telephone interview. “We’ll see more banks that are right on the edge elect to go over.”

Some regional institutions may also look to merge as the only way to grow in an economy that remains sluggish, according to John Kanas, chief executive officer of BankUnited Inc., based in Miami Lakes, Florida.

“There’s a strong chance we’ll see activity in that space in the next year or two as people run out of other ways to improve their earnings picture,” said Kanas, who transformed BankUnited from a failing mortgage lender in 2009 into a profitable bank with about $13 billion in assets.

Total Assets

Of 66 potential bank acquirers identified last month by Keefe Bruyette & Woods, 51 have total assets that are less than $10 billion, according to data compiled by Bloomberg. Among the possible buyers: United Bankshares Inc., a bank holding company with $8.48 billion in assets, and Phoenix-based Western Alliance Bancorp with assets of $8.59 billion.

The M&A pipeline for regional banks is “very full,” according to Eric Lohmeier, managing director at NCP Inc., a Des Moines, Iowa-based investment bank focused on mid-market mergers and acquisitions.

United Bankshares, based in Parkersburg, West Virginia, and Phoenix-based Western Alliance Bancorp didn’t respond to calls seeking comments on merger speculation.

The largest banking deal this year, announced on July 22, was PacWest Bancorp’s $2.3 billion offer for CapitalSource Inc. PacWest has $6.71 billion in assets and CapitalSource $8.68 billion.

Last week, Umpqua Holdings Corp., based in Portland, Oregon, agreed to pay about $2 billion for Sterling Financial Corp. of Spokane, Washington. Both have about $10 billion in assets.

Good Environment

The transactions come amid a general increase in banking M&A, especially among smaller institutions. There have been 116 banking purchases this year that fetched a total of $10 billion, data compiled by Bloomberg show. That’s the most for the first three quarters of the year since 2007’s 155 deals, worth around $54.2 billion. The average transaction size is only about $90 million compared with $480 million in 2007.

“The overall environment for dealmaking is better now than it’s been at any time since Dodd-Frank has been passed,” Frank Cicero, global head of financial institutions investment banking at Jefferies Group LLC, said in a telephone interview. “The bank stock market has been pretty healthy, which has been an important catalyst for transactions.”

Stock Buys

Prosperity Bancshares paid for its most recent acquisitions mostly using its stock, which has surged 39 percent over the past year. It announced on Aug. 29 it agreed to buy Tulsa, Oklahoma-based F&M Bancorporation Inc. for about $245.1 million, according to data compiled by Bloomberg. Two months prior, Prosperity said it would buy FVNB Corp., which is based in Victoria, Texas, for $370.8 million, the data show. Stock accounted for about 80 percent of the purchase price in both transactions, according to data compiled by Bloomberg.

Banks with assets of $10 billion to $50 billion face rules that smaller banks are exempt from. One requires an annual stress test, where they assess the potential impact of scenarios on their consolidated losses, revenue, balance sheet and capital. To comply with the Bank Secrecy Act, Prosperity had to hire 15 new employees, Zalman said.

A federal court ruling in July may make the debit-card fee even more costly for banks. U.S. District Judge Richard Leon in Washington said that the Federal Reserve acted improperly in setting the cap on so-called swipe fees at 21 cents per transaction. Banks had said the rules would cost them 45 percent of the $16 billion it collected from the fee.

On Appeal

Unless overturned on appeal, the ruling may lead to a cap of even less than 21 cents, according to analysts. The Fed had first proposed cutting the sum to 12 cents before agreeing to 21 cents after bankers complained.

Tougher regulation isn’t the only driver of M&A activity. Rising home loan interest rates are squeezing banks with mortgage operations as applications fall, according to Justin Fuller, a director at Fitch Ratings Ltd.

“It certainly could spur some activity,” said Fuller, who analyzes the credit side of financial institutions. Banks with mortgages “may look to diversify through acquisitions.”

Targets may include banks that do more commercial real estate and industrial lending, said Fuller.

Once bank-holding companies grow beyond $50 billion in assets, they’re subject to even stricter regulations under Dodd-Frank. Capital standards are higher and banks may have less control over bonuses and dividends.

That’s why deals will happen at the lower end, with the “Prosperities of the world,” said Jeff Davis, managing director at Mercer Capital, a Nashville, Tennessee, advisory firm.

“The industry is going to consolidate,” said Davis in a telephone interview. “But the consolidation will be about smaller banks getting bigger, rather than big banks getting bigger.”