Big fish with a dollar badge wants to eat small fish

Companies across a variety of industries are expecting larger deals and a pickup in merger and acquisitions in 2018 – but in the banking world, experts expect the opposite.

“Most community banks that may have been considering selling previously may not sell,” said Arthur Loomis, president of Loomis & Co., a New York-based investment bank that has worked with community banks in the Northeast on stock conversions and mergers and acquisitions. “We are expecting less M&A activity in New England in 2018. … The same for mutuals, too.”

One major explanation is continuing favorable macroeconomic trends; the country likely has another year or two of vibrant economic growth before the business cycle turns, Loomis said.

And as banks expect to pay much less in taxes and regulatory compliance costs in the near future, they can also expect to boost earnings, making themselves more attractive purchases in a year or two.

“The astute seller probably does not sell now, unless it is for cash,” said Loomis, while noting that there are always exceptions.

Recent analysis from the American Bankers Association found that bank M&As, unlike other industries, have not been as active as of late. Bank deal activity in 2017 was similar to 2016, with about 200 deals, representing roughly the same 3.5 percent to 4 percent annual shrinkage of bank charters that has occurred since the financial crisis.

The ABA anticipates a steady, but not over-heated environment in 2018, with activity mostly concentrated in the community bank sector.

Wait and See

Demand for acquisition is strong, but banks are typically sold and not bought.

Independent Bank Corp. and Rockland Trust have made six acquisitions since 2009, and CEO Christopher Oddleifson has made it clear the bank is still very interested in making a purchase.

According to Loomis, target banks should be able to grow their earnings between 8 percent to 15 percent per year for the next two years.

This increase, combined with a typically smaller correction or decline in their change of control value, is expected to result in more favorable stock exchange ratio for sellers when the ultimate economic recession occurs. Based on past precedent, acquirer stock prices will tumble more than the change of control value to sellers when the next business cycle bottoms and begins to improve, said Loomis.

On the mutual side, banks will be focusing on regulatory relief, which has been a driving force behind a number of mergers that have taken place since the financial crisis.

Mergers and acquisitions by U.S. banks surged to about $18 billion in 2015, the highest level since 2009. That figure was even larger in 2016, according to data compiled by Bloomberg.

Nationally, 1,106 community banks were acquired between 2010 and 2016, and the number of banks in Massachusetts shrank from 171 in 2009 to 128 at the end of the third quarter of 2017, according to the FDIC.

Regulation is a primary contributor to the consolidation, specifically the Dodd-Frank Act, which lawmakers created after the financial crisis. The bill was geared toward the larger banks mostly responsible for the crisis, but it impacted community banks in unintended ways.

For instance, the Dodd-Frank Act instituted the Volcker Rule, which prohibited banks from conducting certain investment activities such as short-term proprietary trading of securities, derivatives, commodity futures and options on their own accounts.

While most small mutual banks did not engage in these activities, they still had to prove it by implementing policies to comply with the 950-page bill – not an inexpensive proposition.

Constant adjustment of regulations requires increasingly burdensome time and effort to revise regulatory processes, Massachusetts community bankers said in a 2017 national survey conducted by the Federal Reserve and Conference of State Bank Supervisors.

“Personnel involved in these processes are not revenue generators and, to that extent, limit a bank’s ability to remain profitable,” survey respondents said.

Now a new bill pending in Congress would provide relief from Dodd-Frank to smaller banks – for example, exempting banks with less than $10 billion in assets and total trading assets and liabilities that are 5 percent or less of total consolidated assets from the Volcker Rule.

“In addition to the rising tide of macroeconomic elements, regulatory burden is easing. Up to now, regulation has been analogous to a very small pipe with a lot of water pressure. There were enormous regulatory compliance costs, which small banks, mutual or stock had difficulty absorbing, thereby creating an urge to merge,” said Loomis. “Now, all this pressure to affiliate is going to go away… It’s not going to be as attractive or mandatorily necessary.”