Regional Banks Headed for Buyout Boom

Most industry observers agree that 2011 will likely go down as the year of consolidation for the banking sector. This anticipated shakeup will likely result in not only fewer independent players, but in the emergence of “super-regional banks” which will hold significant sway over geographic markets.

While the last two years have seen the sector plagued by nonperforming assets and loan defaults which have sucked up working capital in terms of loan loss reserving, the biggest challenge will be securing top- and bottom-line growth, industry watchers observe. How to deliver adequate return on equity and achieve sustainable growth — particularly in the face of new regulative constraints — is going to be foremost in the minds of top management.

This pressure will be particularly acute for regional banks relying on traditional interest (loans) and non-interest (fees) income derived from concentrated customer bases or product types. The smaller players with less than $500 million in assets and those still subject to capital constraints (namely those banks with outstanding TARP loans) will be hard-pressed to survive in the new banking landscape.

For many such entities, the only solution would be to either merge operations to maximize marketshare and cut costs, or put themselves on the selling block, “…a more palatable emergence from TARP for some weaker banks may be to sell the institution, thereby having the acquirer repay TARP as part of the purchase price,” Fitch Ratings notes.

For investors not shy of taking a speculative position, the expected M&A activity among the regional and mid-cap banks presents some good buying opportunities, analysts say. The bigger regional entities with TARP commitments – such as KeyCorp (NYSE:KEY), SunTrust Banks (NYSE:STI) and Regional Financial (NYSE:RF) – have long been at the top of the list of likely takeovers, the analysts observe, but they don’t necessarily offer good value based on fundamentals or current pricing.

Fifth Third Bancorp (NASDAQ:FITB) recently paid off TARP and is showing signs of loan growth says Erik Oja, U.S. banking analyst at Standard & Poor’s Equity Research Services. “Fifth Third is well poised for growth, and is one of the better ones [regional player that may be a good M&A candidate].”

“It’s tough to make a call on M&A opportunities, they tend to come out of nowhere. KeyCorp has been rumoured forever,” Oja points out. However, of the more attractive regional players, he has his eye on Sterling Bancshares (NASDAQ:SBIB), First Horizon National (NYSE:FHN) and Associated Bankcorp (NASDAQ:ASBC). Only the latter still has to retire its TARP commitment.

S&P also recently lifted its 12-month fundamental outlook on “U.S. diversified banks” to positive based on improved prospects for loan growth. This list comprises of Wells Fargo (NYSE:WFC), U.S. Bancorp (NYSE:USB) and Comerica (NYSE:CMA).

While he is unable to mention which banks might make a good fit for M&As, Oja adds, “mergers of equals make more sense”.

Burt White, chief investment officer at LPL Financial, concurs that the mid-cap and regional bank segment is ripe for M&As. The big banks are increasing their attention in areas like investment banking and wealth management services while the regionals have to focus on a different strategy while still dealing with capital constraints. As such, mergers look like an attractive option to secure capital and the means to grow, he adds. He particularly favours commercial regional banks with exposures to Midwestern markets which he believes will produce faster loan recovery.


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