Banking: Growing New Deals

“It is not the strongest or the most intelligent who will survive, but those who can best manage change.”

This quote from Charles Darwin, the 19th century evolutionary scientist, describes his theories on natural selection among animals and wildlife, but it could certainly apply to banking.

In the five years since the financial collapse that triggered the Great Recession, Arkansas banks have shrunk from 134 to 120, a 10 percent decline between 2009 and 2013 according to FDIC statistics.

Yet in that same time frame, fathom this:

• Net income has nearly tripled for those 120 banks to $708 million;
• Total assets and deposits have both experienced 19 percent growth;
• Total return on equity has risen 36 percent; and
• Bank employment in Arkansas has climbed by nearly 1,500 workers, up eight percent.

It has taken a “survival of the fittest” mentality to plow through the aftermath of the economic downturn and the banks that are still standing confide that the next five years may be even more dramatic than the last five.

George Makris, the new CEO of Pine Bluff-based Simmons First National Bank Corp., just led his bank through two big buyouts – Little Rock-based Metropolitan National Bank and Delta Trust and Bank – spending a whopping $119.6 million on the deals.  In early May, Simmons First and Makris announced another blockbuster deal with the acquisition of one of Tennessee’s largest banks, Community First Bancshares for $243 million.

Makris said market share is driving Simmons’ acquisition strategy these days.

“In central Arkansas, our share was obviously not where we wanted it to be. So as we take a look at acquisitions, it is to build our franchise in those growth markets,” he said.

That includes out-of-state markets, such as Missouri and Kansas where Simmons previously conducted FDIC-assisted transactions. Tennessee is now a new growth target for the Pine Bluff-based bank.  Makris said Simmons First is now positioned for organic growth and acquisition growth in the future with a host of new products.

“We really would like to fill in our footprint in Missouri and Kansas. We have a strategy now for de novo growth. We’ve got some really good bankers in those markets,” he said. “We need a little more scale in those markets to be able to do some of the things that we really want to do.”

Makris said for the private banking sector, especially small community banks, there are several factors likely to lead to more merger and acquisition (M&A) activity in the coming years.

“There are a lot of private banks that are just tired of what’s going on in the industry today,” Makris said. “In many cases, we see private banks that have aging management and not a real good succession plan.”

Those banks typically have boards of directors who must contribute money into a local bank’s capital in order to help in maintain sufficient margins. Of course, they’d prefer to be receiving dividend checks, Makris said.

He also said recent regulatory burdens stemming from the Dodd-Frank reform bill is also impacting community banks and forcing many of them to reconsider their long-term futures.

“Management that may not have a great succession plan, boards who have changed their focus for their wealth, and regulatory fatigue are the three main drivers of a lot of the M&A activity we see today,” said Makris.

One of Simmons’ biggest competitors, Bank of the Ozarks, has also been on an acquisition tear in recent years. Since 2009, the Little Rock-based publicly-traded financial holding company has purchased 10 different banking outfits. Most recently, it closed on a small bank buyout in Houston and $216 million acquisition of Arkadelphia-based Summit Bank.

While expanding its footprint and beefing up its market share is important to Bank of the Ozarks CEO George Gleason, the bigger driver is return on equity.

“Our foremost metric is we want to be able to generate a 20% return on equity with an 8% capital allocation. If the transaction can’t be structured in a way that meets that test, it’s probably not going to be something we’re interested in doing.”

Gleason’s bank has done a number of FDIC-assisted transactions over the last several years, but many banks on the bubble have battled through the worst part of their challenges and now are faced with selling from a healthier position or carrying on. While Gleason doesn’t see the FDIC driving deals like it once did, he does think the sluggish economy is putting big-time pressure on many of his potential targets.

“The big picture is we’re in a very slow growth economy and we’re probably going to be in a very slow growth economy for a long time,” he said. “There was a tremendous amount of banking capacity built from the mid-90’s through 2007. There’s simply more capacity out there than is needed in the economy that we’re in today. If you combine that excess capacity in the industry with a growing regulatory burden, you have an environment that is ripe for consolidation.”

Gleason warns that two factors could change the current M&A environment – one government driven, one market driven.

Too much regulation or a decline in the economy could lead marginally healthy banks back into the FDIC’s purview, Gleason says – a development that could “chill” bank acquisitions as buyers wait to get deals for pennies on the dollar.

Or, the market could return to the pre-recession days when it overpaid on bank acquisitions.

“We could get back to an environment like we saw in 2006 where acquisitions were being done at unreasonably high prices that didn’t make economic sense,” said Gleason. “We could possibly evolve into an environment where the buyers become so determined to make transactions that they overpay for them and that will end the game in a very unpleasant way.”

Darwin spent his life observing what happens when animals and humans “end the game in a very unpleasant way.” Bankers could take a note or two.