Well, it’s almost Spring and the flowers and deal talk are starting to bloom. We hear and see a lot of activity going on in the Western United States. Our sense is that this activity is being fueled by a confluence of factors: continuing low interest rates and skinny margins; loan concentration concerns and fears of another real estate bubble and uncertainty as to the economic recovery; undue regulatory burden; the pending Presidential election; instability in foreign countries; and a lingering hangover from the recession. Let’s briefly address these factors below:
Low Interest Rates
Given what has been going on in Europe, as well as China, it looks like the Fed is reluctant to raise interest rates again immediately. Guessing the Fed’s next move is a fool's errand. However, it seems pretty clear that a rapid succession of interest rate rises is not on the horizon for the foreseeable future. Hence, margin compression should continue, and particularly impact the smaller community banks which are so interest rate sensitive. Obviously, the Fed’s action on interest rates is driven by concerns about stimulating a continuing economic recovery.
Loan Concentrations and the Bubble Risk
With home real estate values climbing and building booming in many cities, particularly in the Western United States, there continue to be concerns about another real estate housing bubble. A repeat of the meltdown experienced in 2008 doesn’t seem likely, but if housing prices are overinflated, there could be further pain felt in the real estate market. In addition, concerns about real estate lending concentrations, whether owner-occupied or not, seem to be growing.
Let’s face it, the cost of compliance, especially for community banks under $1 billion in assets, has grown exponentially post-Dodd-Frank. We now see small community banks having to staff with two to three compliance people to meet regulatory expectations. This is a huge expense, say, for example, a $100 million community bank making 1% on assets or $1 million a year in net income. And all of the regulations under Dodd-Frank still haven’t been adopted. Unless true regulatory relief is on the horizon, this disproportionately high regulatory burden will continue to fall on the community banks.
The Pending Presidential Election
Without taking a political side, the unprecedented dynamics of our pending Presidential election are sure to have a destabilizing effect on our economy. Regardless of party preference, the stated positions of some of the candidates, or the volatility of others, is sure to strike economic uncertainty and fear in our markets. And the election is still nearly eight months away.
The negative interest rate policy in Europe and the instability in China and other significant trade partners continue to have an unsettling effect on our economy. Until these are stabilized, I suspect our economy and the actions on interest rates taken by the Fed will be in a wait-and-see mode.
Hangover from the Recession
The good news is that the banks that are still around survived the recession. The bad news is that there are still scars remaining. Management and boards are tired. It’s been eight years folks, and lingering low interest rates and relatively tepid loan growth are still prevalent. Even though banks have recovered and are not at risk, they are frustrated with their inability to grow and increase profitability to acceptable levels.
How Does All This Shake Out?
Not surprisingly, with all of the above going on, many boards and their management teams are frustrated by their inability to gain real traction and earn significant returns for shareholders. This has added to a continuing level of frustration for many community banks, combined with the host of uncertainties mentioned above, creating a fertile environment for merger and acquisition discussions. Potential buyers are open to deals as they seek ways to grow their footprint and earnings through strategic acquisitions.
No Crystal Ball
I don’t have a crystal ball, but I do expect that a number of deals will come to fruition in 2016. While perhaps not at the same pace as 1996, when our firm did nine deals in a year (four alone in each of two months), I expect healthy activity to continue through the that reflect the unusual confluence of factors addressed above.