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Banks Still Merging: When Will the Cycle End?

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Recently, there were two bank mergers involving banks based in the Corridor.

While those mergers, which involved Revere Bank, of Laurel, and Bay Bank, of Columbia, were newsworthy, they were also part of a trend that isn’t showing any signs of slowing in the near future.

On that note, know that, according to the Maryland Banker’s Association (MBA), at the beginning of The Great Recession, the state served as headquarters to 95 banks; at the start of 2016, that number had plummeted to 60.

While mergers aren’t unusual, those numbers are proof that relatively few new banks have been established in a vast and lucrative market with various needs.

The next questions in the banking industry concern the number of consolidations that are still to come and what barriers to entry need to fall before new institutions once again enter the market.

A Few Reasons

Kathleen Murphy, president and CEO of the MBA, offered some historical perspective on the market and how it’s evolved to its current state.

“As long as banks have been around, there has been consolidation. When I entered the industry in the mid-’80s, just before the savings and loan crisis, there were about 14,000 banks in the country,” Murphy said, with today’s figure north of 5,600, according to the Federal Deposit Insurance Corp. (FDIC).

At that point, “banks in many states could not establish a branch in separate states and [sometimes] even other counties, which is interesting, because not one point in Maryland is more than 45 minutes from another state,” she said.

Whether a bank could make the interstate move depended on its charter. “So that evolution started happening when the interstate banking laws changed around that time,” Murphy said.

Fast forwarding, the 2010 Dodd-Frank Act, which was created after the mortgage loan meltdown, “added a significant number of regulations in the banking industry,” Murphy said, though adding that “some have still not been applied” to the banking industry.

“If you look back several years to the start of The Great Recession, we still had the 95 banks [there are 112 in Maryland, including those not headquartered in state] here. The bulk of that decline was spurred by banks that had multiple charters in the state, which have been consolidated into one bank,” Murphy said. “That has resulted in greater efficiencies” for a number of organizations.

Also, she said, there have been several banks that have disappeared from the market that didn’t end up with enough capital to satisfy the FDIC and were bought by other institutions.

More Reasons

What we’re are also seeing, said Murphy, are high compliance costs that spiked after the recession that have not only made it tougher for some of the smaller banks to stay afloat, but have prevented new banks from acquiring enough funding to enter the market.

“If a bank had two people working on compliance in its IT [information technology] department, they now have four,” said Murphy, “so technology has also been a strong driver of consolidation. People want their money and information protected, so banks need a robust security system to stay ahead of the bad guys. So, institutions are deciding that merging allows them to achieve economies of scale on that front, too.”

Brian Walter, group vice president for M&T Bank, also talked about what’s driving consolidation, pointing to “Complex, still-evolving regulatory requirements that continue to drive heightened investment in compliance, risk and capital management infrastructure.”

Walter said the “slow and uneven economic recovery, an unusually persistent low-rate environment and rising competition from outside the regulated banking industry [have] all placed further performance and consolidation pressures on small and mid-sized banks.”

As did Murphy, he noted that consolidation is nothing new.

“It’s been going on for decades, at [both ends] of the spectrum. In 1983, of the 100 largest banks that were in existence, only 23 are still around today,” Walter said. “There is nothing that would indicate consolidation will be stopping.”

‘Three Main Reasons’

Joe Thomas can talk, first-hand, about why banks consolidate, as Bay Bank, which was founded in 2010 with $26 million in equity financing, already has acquired four institutions and has $700 million in assets to show for it. He offered a short case study.

“There are three main reasons,” said Thomas. “After the recession, you had banks that had credit and capital problems. Some had been taken over by the FDIC and we bought two of those: Slavie Federal Savings Bank and Bay National Bank.

“Other banks don’t have a succession plan, such as Hopkins Federal. [Chairman] Alvin Lapidus did not have a successor, so he sold it to us,” said Thomas. “Lastly, with the low interest rates, lots of new regulations and IT setup costs, as well as dealing with the entry of non-banks into the market, their boards elected to sell. Carrollton Bank is in that category.”

All told, the operating environment in banking has “gotten much more difficult, so the small banks’ boards have concluded that shareholders are best served by selling,” Thomas said, “not just in Maryland, but nationally. This means a huge opportunity for banks like ours that focus on small business and can provide a skilled banker, with a sufficient legal lending limit.”

Revere Bank also has come up big in the consolidation game, having acquired Blue Ridge Bank in 2015, which put Revere above $1 billion in assets; Revere also bought Monument Bank in May and is in the midst of its due diligence; if the deal settles, Revere will shoot up to $1.7 billion in assets.

“As far as new banks go, BlueRidge was the last to start in Maryland,” said Revere Co-President and CEO Drew Flott. “They were founded in April 2008; we started in November 2007, and Monument and Howard banks both started in 2005. De Novo [new] banks are few and far between now, but prior to The Great Recession, there were 30–50 a year started across the country.”

It used to be that investers would start a bank to help the community, but it’s more expensive and more complicated after the recession and the associated loan problem,” said Flott. “With the Sarbanes-Oxley Act, there’s a certain cost to comply with federal and state regulations. A bank will generally have to expense $250,000 a year in compliance expense, no matter the size.

“As a bank grows, compliance expense does not grow in direct proportion; therefore, it has a reducing impact with the growth.” The concern is that there is a big need for people to finance small businesses, and a community bank that knows the individuals involved is much more likely to be in that space than a big regional,” Flott said, “like M&T, Citi and JPMorgan Chase & Co.”

Just why are these smaller banks crucial? Because “[many] people don’t understand that small businesses create most of the jobs in a given market, and community banks finance small business,” he said.

Still More Reasons

Reiterating that the consolidation trend “is normal ebb and flow,” Mary Ann Scully, president and CEO of Howard Bank, offered her observations.

“What Kathleen Murphy and Joe Thomas said is right; this is a much more difficult regulatory environment, for three reasons: all the regulations, notably the Bank Secrecy Act requirement; the second is the FDIC saying more banks need to hold more capital; and the trend for investors the last several years has been to stay away from small banks, due to difficulty they have getting started,” Scully said.

And, she said, Thomas is right about succession planning issues, too. “That has to do with demographics, since not only are people in the market getting older, so are long-time members of boards, along with all of the other pressures.”

All of these factors mean that, while small banks used to grow more organically and move “in a straight line, there is no straight line anymore,” Scully said. “It’s a much more demanding environment.”

However, these trends “run in cycles,” she said.

“Regulators have said that they want new banks, so they are going to soften some of the rules. Hopefully, that will be within the next six months, but I think it will take more than a year. Meanwhile, some smaller banks that are not positioned well may still see a merger is the best way to make shareholders happy. That’s what drove Patapsco Bank to merge with us last year.”

All told, the successful community bank of the future “has to be a little bit bigger, have better talent and have the capacity to invest in technology to be successful,” said Thomas, adding, “Will we look for a new deal in the new year? Sure.”