Middle Tennessee banks make good consolidation targets

Friday, July 18, 2014, Vol. 38, No. 29
By Jeannie Naujeck

Prevailing wisdom says community banks need to reach about $1 billion in assets to absorb new regulatory and compliance costs imposed by the Dodd-Frank Act and Consumer Financial Protection Bureau. Not all bankers agree.

While more Tennessee community banks will reach that benchmark this year through mergers or organic growth, remaining small is still a viable alternative for some small banks with good assets and tight management.

The July 1 merger of Franklin Synergy and MidSouth banks, with combined assets of $1 billion+, is the latest in about a half-dozen deals announced this year, most in urban and suburban markets.

Expect more to come, says Colin Barrett, president of the Tennessee Bankers Association.

“We’re going to continue to see some consolidation between now and the end of the year,” he says. “There are still a good number of deals in the works.”

On a national level, 2014 is likely to be the biggest year for bank mergers since 2008, with small bank deals accounting for the majority of the transactions, according to SNL Financial data.

Tennessee currently ranks about fifth in the nation in its rate of bank mergers and acquisitions, Barrett says.

Middle Tennessee’s growing economy puts it in the sights of regional and national banks looking to expand through acquisition, and investment bankers say it is one of the most attractive markets in the country to enter.

For an out-of-state bank looking to make a splash in Tennessee, a profitable, well-managed bank like Pinnacle, CapStar or the merged Franklin Synergy Bank would be an attractive target for acquisition, says banking attorney Dan Small, who represented MidSouth in its merger. And for the same reasons, those banks are also positioned to acquire.

For small banks – about half of Tennessee-based banks have less than $200 million in assets – frequently-cited reasons to merge include the increasing costs of regulation and compliance, which some believe are becoming too burdensome to absorb without scaling up.

With data breaches and identity theft becoming more common, regulators also recently announced they’ll be placing greater scrutiny on community banks’ online security measures.

The economy has also brought clarity to banks’ books, with most questionable assets cleared away, Barrett says.

“A lot of them are gone – or at least everyone has a full understanding of what they are – which makes it easier for banks to get real valuations out of other banks for the purposes of acquisition,” he says.

“People like to know what’s on the books and have a good understanding before they’re ready to make a purchase.”

Many banks that merged during the recession – because they didn’t want to or weren’t able to raise the capital that regulators wanted them to have – were bought for low prices but the value of their assets were uncertain, Small says.

“The problem is you didn’t know what the assets were worth. There were loan problems and you didn’t know how deep those problems were,” he says.

“Now things have changed. Most of the banks have come out of this and are starting to show earnings. Now the question is, ‘What multiple of earnings should we pay you? What can I do with your assets?’

“You’ve now cleaned up your loan portfolio but haven’t had a lot of time to build your earnings, so now is the appropriate time for me to come in and buy. I know your assets are probably okay and your shareholders are probably tired of having stock that they can’t sell. Your directors may have regulatory fatigue. So it’s the perfect time to strike.”

Not all bank directors feel that way. Civic Bank & Trust CEO Bob Perry is one of those bankers who not only doesn’t have a problem with staying small, but also doesn’t think the new regulatory costs are particularly onerous.

“There’s a lot of talk about the regulatory environment driving this, but I don’t see any banker I know letting the cost of Dodd-Frank drive them into a merger,” Perry says.

“Unless the cultures match up, unless the money or share offer is adequate, nobody’s going to let the regulatory environment drive a bad deal.”

Civic has about $145 million in assets, and Perry notes that half the banks in Tennessee have less than $200 million.

Over the years, he says, costs like FDIC insurance have been much more burdensome, yet banks have absorbed it.

“If you take a rifle shot at Dodd-Frank, sure, it’s expensive and compliance is expensive and the rules have changed, but I don’t know anybody who says ‘I’m going to fold up my tent and take whatever money I can get and merge with any culture because I can’t pay the Dodd-Frank regulatory costs.

“If you’re making money and doing right by your shareholders, you don’t have to run off just because some costs come along you hadn’t planned on that you will adapt to eventually.”

Banks of Civic’s size stay profitable for shareholders through lean management and intense underwriting of business loans, Perry says.

And there are plenty of customers who still support small banks.

“Will we merge? I don’t know,” Perry adds. “Probably at some point in time. Soon? I don’t know. If something comes along, and it’s in the best interest of our shareholders to do so, yes.”