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Community Banks expected to face difficulty in Q3 2010
In the regional and community banking space, the third quarter (Q3) of 2010 is expected to show some improvement over previous quarters, but banks continue to struggle with slow loan growth, stricter regulatory standards, continuing losses and increased competition.
Revenue growth, which is generally considered to be the engine for success is still very limited, leaving investors with limited choices when seeking growth-oriented banks. The good news is that majority of the regional banks are expected to be in the black for the quarter and are showing a positive trend from previous quarters. Most are expected to maintain losses at current levels and according to a report by Howe Barnes, over half of the smaller players will likely show better performance as compared to Q2. The efforts to strengthen reserves continue, but the activity is expected to provide little relief, as credit cost remains high.
Existing loans in both raw land and non-owner occupied properties continue to add to asset quality concerns as banks struggle to workout or sell the assets in a slow real estate market. The prospect of organic loan growth remains low and is resulting in no-to-slow expansion in new assets. Although, interest rates remain at historic lows, the slow demand coupled with higher credit standards required by both regulators and secondary market participants is increasing competitive pressures for those borrowers with the ability to qualify for new loans. For most banks the return to normalized returns is expected to begin in late 2012 and early 2013.
The passage of the financial reform bill and the agreement on new Basel 3 standards is providing a more defined regulatory environment and has lifted some uncertainty about the overall regulatory sentiment. But considerable risk remains as the implementation rules for these standards are still unclear.
The impact of slower growth, increased competition and new regulatory standards is likely to clear a path for increased M&A activity in the coming quarters as banks struggle to cope with the changing macro and micro environments. Regardless of the decision to stay independent or to merge/acquire, most banks will find a need to raise additional capital.
For most bank investors, selectivity will be the key to longer-term success as the sector overall is expected to underperform when compared to broader indexes. Banks that have adequate capital, presence in growing markets, ability to conduct targeted acquisitions and a superior strategy/focus to steal Marketshare exhibit some of the best indicators for success. Additionally, banks focused on niche, ethnic or non- traditional markets are well positioned to outperform the pack as they face limited competition for customers in an improving economy.
Disclosure: I am a community banking consultant - no ownership
6 Easy Steps to Buying a Small Bank
Have you ever wondered what it takes to buy a small community bank? Thousands of investors across America have found community banks to be a valid investment vehicle and have acquired interest in community banks. Most bank investors acquire ownership by subscribing to Private Placements that are circulated to accredited investors by the selling bank.
Private Placement investments in banks are typically not listed on any exchange and are generally considered illiquid. The investors are rewarded only if the banks perform as expected allowing appreciation of the bank stock and/or via irregular dividend payments. These factors limit the overall appetite for bank investments to those few qualified investors that are comfortable with the associated risks and have a longer-term investment horizon.
The financial meltdown of 2008/2009 negatively impacted many community banks resulting in the failure of hundreds of such institutions. In the face of mounting bank failures, the FDIC decided to limit its exposure and effectively stopped the issuance of deposit insurance to new bank charters, also known as De Novo banks.
It is estimated that between 2008 and 2009 over100 investor groups in various phases of De Novo application were either asked to withdraw new bank applications or were rejected outright. Leaving many with hundreds of thousands in sunk cost that was incurred during the De Novo process. Although, there was no clear policy statement on this matter by bank regulators, in some cases the investor groups were given soft suggestions to seek existing banks for acquisitions.
For many De Novo groups, the path to bank acquisition was a major change in direction, and some abandoned the efforts all together. The reason was simple, for decades, filing a de novo application had been the preferred path to seeking new bank charters and most knew the process or could find affordable resources with experience in the process. Bank M&A had typically been the domain of larger banks who could afford to retain seasoned investment bankers to help close the deal.
As of this writing in October 2010, it is fair to say that de novo is dead. There may be some lucky investors that can convince the regulatory bodies to allow them new bank charters, but that is the exception to the rule.
The number of banks in the U.S has been declining since the 1980s when there were over 14000 banks in existence. Today the number stands at roughly 8000 banks and thrifts. It is conceivable that the total number can decline to 6000 banks in the coming years; much of the reduction will result from M&A activity in the space.
Simple economics of supply and demand have not kicked in yet, but they will. As a result of the financial collapse, most small banks trade below book value today. This is an artificial dip in valuations. The reduced supply should start to impact bank valuations in the coming years, and those that are fortunate enough to survive the downturn will be more valuable than ever before.
Buying a bank is not as simple as buying other companies. The bank regulations are much stricter today and in order to complete the acquisition process companies need to retain experienced legal, accounting and strategic advisory services. The following steps outline the acquisition process
1. Identify an institution
2. Negotiate a price
3. Conduct due-diligence
4. Negotiate a definitive agreement
5. Fund the acquisition
6. Seek approval from regulatory agencies.
For individuals ready to embark on the acquisition process it is important to understand the importance and value of skilled help, the process can take 3-6 months from start to finish.
Disclosure: I am a community banking consultant
How to buy a community bank?
Buying a community bank can be a complex and confusing process. For many investors seeking to acquire a bank, the complexity of the acquisition process can sometimes serve as a non-starter. I have put together a quick process overview to help would-be bank acquirers to understand the overall process.
Typical acquisition process consists of the following steps.
Step 1: Identify an Acquisition candidate
Step 2: Conduct Due Diligence
Step 3: Negotiate a price
Step 4: Negotiate a Definitive Agreement
Step 5: Fund the Transaction
Step 6: Apply for Change of Control approval
Step 1: Identify an acquisition target
Identifying a potential bank to acquire is the first step. Investors should seek a bank that fits their business needs and their capital ability. There are many factors that play a role in the bank identification process, these include geographic preference, charter type, number of branches, asset quality etc.
Step 2: Conduct due diligence
Know what you are buying. It is important to build a thorough due diligence checklist before starting the process. The checklist should include A/L, regulatory, governance and management due diligence.
Step 3: Negotiate a price
Before making an offer, it is critical to understand the various factors impacting bank valuations. Some of the key considerations in price determination can include the following items.
Step 4: Negotiate Definitive Agreement
The definitive acquisition agreement outlines all aspects of the acquisition terms and conditions and should include the following components
Step 5: Fund the investment
In order to fund the acquisition, the investor should establish an Escrow account. Select a stable bank to hold the escrow money. Prior to selecting an escrow agent, some financial due diligence may be necessary on the institution.
Step 6: Submit Change of Control Application
Once the Change of Control application is completed, it should be filed with the relevant regulatory bodies. Additionally, the new investors will be required to submit detailed personal and financial background information. Certain factors such as a criminal history, bankruptcies, foreclosures etc. may be considered as automatic disqualifiers by bank regulators. Typically a meeting will be scheduled between the investors and the regulating agency, at the meeting the investors must explain and defend their business plan to the regulators.
To learn more about the bank acquisition process please visit my company website at ownabank.com
Disclosure: I am a community banking consultant