Small banks lead in buyouts

July 06--The economy may still be stuck in low gear, but the merger-and-acquisition market has accelerated in the first half of this year with a string of high-profile announcements, including large deals made by Facebook, Comcast and AT&T.

In the banking sector, however, the days of such mega-deals seem like a bygone era with regulators less open to the idea of big financial institutions getting even bigger. JPMorgan Chase, Bank of America and Wells Fargo have made no major acquisitions since the financial crisis of nearly six years ago.

Big bank deals aren't happening in New Jersey, either, with regulators holding up the pending purchase of Paramus-based Hudson City Bank by M&T Bank Corp. of Buffalo, N.Y.

But it's a different story in community banking. The merger Tuesday of Union Center National Bank and Englewood Cliffs-based ConnectOne Bank is the latest in a string of smaller North Jersey community bank deals that may represent the leading edge of a long-anticipated wave of small-bank consolidation. Deals among smaller banks, with less than a couple of billion dollars in assets, are on the rise, and not all of them are fire-sale acquisitions of troubled institutions.

In North Jersey, Lakeland Bank in Oak Ridge signaled the arrival last year of this new stage in the community bank merger-and-acquisition cycle with its $64.4 million purchase of Somerset Hills Bank, a small but well-capitalized and profitable lender with few problem loans. The price represented about a 30 percent premium over Somerset Hills' stock price the day before the deal announcement.

In May, The Provident Bank in Jersey City completed, through its holding company, the acquisition of Team Capital Bank in Bethlehem, Pa.Team Capital had about $1 billion in assets, comparatively few problem loans and made $6.5 million in profit last year. Provident paid about 1.9 times Team Capital's book value.

Wayne-based Valley National Bancorp recently announced a deal to acquire 1st United Bank in Boca Raton, Fla., and is awaiting regulatory approval. "That is not a troubled bank by any means," said Gerald Lipkin, chief executive officer of Valley National.

"[The community bank merger-and-acquisition market is] a lot more active since the fourth quarter of last year," said Parsippany lawyer Michael T. Rave of Day Pitney LLP, which advised Valley National on the Florida bank deal. "A lot of the larger banks are looking at small to midsize banks as a way to grow the franchise, especially in markets they see as important and fruitful," Rave said. Those would-be buyers are increasingly willing to pay more than the market value of a company's stock, which means potential sellers are more willing to talk, he said.

"It's hard to say whether there is going to be a wave," Rave said. "But banks are realizing they need some sort of critical mass to succeed these days."

Lawrence B. Seidman of the investment firm Seidman & Associates in Parsippany agrees.

"Today a bank needs at least $1.5 billion in assets," said the activist investor at the center of the former Center Bancorp's negotiations to merge with ConnectOne.

With Center Bancorp's$1.67 billion in assets and ConnectOne Bancorp's$1.24 billion, the combined bank has about $3 billion. Center Bancorp adopted the smaller bank's more modern name.Statistics from the state Department of Banking and Insurance show four community bank acquisitions involving New Jersey-chartered institutions were completed during the first five months of this year. Last year, a total of five deals were closed, and in the two previous years combined, there were only three.

The financial crisis and housing market collapse were particularly hard on small banks. More than 800 small lenders, those with less than $150 million in assets, have failed or were bought out since 2005.

In New Jersey, private-equity firms WL Ross & Co. and JC Flowers & Co. acquired large stakes in New Jersey-based community banks -- Sun Bancorp and Saddle River Valley Bancorp, respectively -- to use as platforms for growth, in anticipation of a wave of consolidation.

The Saddle River Valley Bancorp deal did not work out. The bank was closed after regulators discovered that a high-volume international wire transfer business was poorly monitored. And Sun Bancorp in Mount Laurel has struggled with high levels of problem loans and financial losses, making it look more like a potential seller than a buyer. On Thursday, it announced it was restructuring, with job cuts and branch closings.

Nonetheless, the banking sector in New Jersey overall is showing signs of a rebound, even as the state's recovery from the recession lags behind that of the nation as a whole.

Stock is the main currency of bank mergers, and share prices have risen, giving potential buyers more purchasing power. In the past 18 months the Nasdaq Bank Index, which includes most of New Jersey's publicly traded banks, has risen about 40 percent.

In recent deals, buyers have been more likely to pay a premium above the sellers' market value, said Thomas R. Mecredy, director of the Vining Sparks Community Bank Advisory Group in Memphis. "Stock prices are better, and [buyers] are able to offer a little better price," he said. "We are looking at cleaner deals with better premiums. It's back to the old way we used to do deals. It goes in cycles."

The rising cost of regulatory compliance and slim profit margins on lending in a low-rate environment are pushing some community banks to seek merger partners, Mecredy said. Banks have had to dedicate more staff hours to regulatory compliance and, in some cases, hire outside professionals to help them stay in line with the new rules.

"They have to get bigger to offset the cost of doing business," Mecredy said.

Thomas M. Hoenig, Federal Deposit Insurance Corp. vice chairman, said last month in a speech to a bankers group in Palm Beach, Fla., that consolidation in the banking industry started with deregulation about 30 years ago, when branching across state lines was permitted. Merger activity was ramped up by the legislation that allowed commercial banks to combine with insurance companies, investment banks and securities brokerages. The abuses and excessive risk-taking by large diversified mega-banks led to the financial crisis, which in turn led to increased government requirements on all commercial banks and "a rising fixed cost of regulation," Hoenig said. The expense is especially burdensome to smaller lenders that must pay lawyers to interpret the regulations, hire and train staff to beef up compliance programs and to react to risks of violations as they come up, he said.

"The regulatory burden contributes to the trend toward consolidation as smaller banks work to control costs and to survive within a highly regulated industry," he said.

Lipkin, chairman and chief executive officer of Valley National Bank, says he expects to see the number of banks in New Jersey and throughout the country continue to decline.

Lipkin said in a phone interview Wednesday that more and more small banks will likely sell themselves to larger companies in the months ahead because of high regulatory compliance costs that can include higher-priced insurance from the FDIC and expenses related to increased government requirements.

The Patriot Act of 2001, which expanded the Bank Secrecy Act, an anti-money-laundering law, requires financial companies to closely monitor transactions for possible links to terrorists. The Dodd-Frank regulatory reforms of 2010, passed by Congress in response to the financial crisis, include increased mortgage loan underwriting responsibilities for all lenders.

"The regulatory cost is a real burden to banks' operations," Lipkin said, adding that a regional bank such as Valley National, with $16 billion in assets, can absorb the costs, but for smaller banks, "it's almost impossible to manage the costs."

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