We have been hearing (and writing) for some time now about the wave of consolidation expected to ripple through the banking industry, especially with respect to the community bank sector. Although the pace of mergers and acquisitions has been healthy, the industry has yet to see the anticipated wave of consolidation. However, legislative, regulatory, and economic changes are creating an environment ripe for mergers, acquisitions, and other strategic transactions in the banking sector. As we examine in this article, the changes that have occurred in the last year are opening the gates for consolidations, but it remains to be seen whether such consolidations are pursued and can successfully overcome the challenges of deal making.
Congress recently passed the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018 (the Crapo Act), which provides regulatory relief for many banks, and will have a substantial effect for the community bank sector. The Crapo Act grants relief to community banks on a few important fronts. Relief from the Crapo Act includes capital simplification, extended examination cycles, reduced reporting requirements, and increased simplicity for small bank holding companies to finance bank acquisitions.
Specifically, the Crapo Act raised eligibility thresholds for an extended examination cycle from $1 billion to $3 billion in assets and made short-form call reports available for banks under $5 billion. Community banks, generally those banks with assets less than $10 billion, are also granted relief from the prohibitions on proprietary trading and relationships with hedge funds and private equity funds under the so-called Volcker Rule, at least to the extent that they were actually engaged in those relationships.
In addition, with the Democratic takeover of power in the U.S. House of Representatives in the 2018 mid-term elections, Representative Maxine Waters (D-CA) has taken the helm of the House Financial Services Committee. The banking sector generally should expect heightened scrutiny from the new chair, but this is likely to focus at least initially on the larger banks with more publicized regulatory challenges. This also means that the relief granted by the Crapo Act is likely the only legislative relief for the banking sector for the foreseeable future.
For bank holding companies, the Crapo Act amended the asset threshold for applicability of the Federal Reserve’s Small Bank Holding Company Policy Statement (the Policy Statement), which was implemented in August of 2018 and became effective the same day the interim final rule was released. Through the legislation, the asset threshold was raised from $1 billion to $3 billion in total consolidated assets. The Policy Statement also applies to savings and loan holding companies with less than $3 billion in total consolidated assets.
In 1980, recognizing the challenges of small bank holding companies accessing the capital markets through equity financing, the Federal Reserve adopted the Policy Statement to permit small bank holding companies to assume debt at levels higher than typically permitted for larger bank holding companies.
Under the Policy Statement, holding companies meeting the specific qualitative requirements may use debt to finance up to 75 percent of an acquisition, subject to the following ongoing requirements:
- Small bank holding companies must reduce their parent company debt consistent with the requirement that all debt be retired within 25 years of being incurred. The Federal Reserve also expects that these bank holding companies reach a debt-to-equity ratio of .30:1 or less within 12 years of the incurrence of the debt. The bank holding company must also comply with debt servicing and other requirements imposed by its creditors.
- Each insured depository subsidiary of a small bank holding company is expected to be well capitalized. Any institution that is not well capitalized is expected to become well capitalized within a brief period of time.
- A small bank holding company whose debt-to-equity ratio is greater than 1:1 is not expected to pay corporate dividends until such time as it reduces its debt-to-equity ratio to 1:1 or less and otherwise meets the criteria set forth in Regulation Y.
This update to the asset threshold is the third time the Policy Statement has been amended. When the Policy Statement was first adopted in 1980, there were more than 14,000 commercial banks according to the FDIC’s Historical Bank Data. Today, there are less than 4,800 commercial banks. Bank failures have played a role in the decline in the number of banks, but so have mergers and acquisitions. For example, in the past decade there have been approximately 2,300 bank mergers in the United States. This increased asset threshold for small bank holding companies to take advantage of the Policy Statement should encourage further consolidation in the community bank sector.
In addition to the legislative and regulatory changes over the past year that have further opened the gates for bank consolidation, the economic climate also appears to be a significant factor; however, it is perhaps a challenge for some banks as well. Banks are making money and growing. With rising interest rates, solid earnings, and healthy valuations, it would appear that the market is ripe for deals. Despite the healthy economy over the last few years, however, banks and investors are searching for deals at the right price with long-term sustainability. Some would-be acquirers are sitting out until valuations come down or a clearer path to long-term deposit and earnings growth emerges.
Overall in 2018, the underlying theme for bank deals involved “sellers in high-growth markets finding buyers willing to pay healthy premiums for market share. The average premium paid was 172 percent of tangible book value of the seller, which was an increase over the 165-percent average premium from 2017. Acquirers continue to search for core deposits and low loan-to-deposit ratios, even in remote markets. For example, earlier in 2018, Trinity Capital in Los Alamos, NM, sold itself to Enterprise Financial Services in Missouri after going to market to sell itself. In that deal, Trinity Capital’s strong core deposits and loan-to-deposit ratio of 65 percent rewarded the bank with a price that was 202 percent of its tangible book value.
Although less remote compared to its current footprint, Delmar Bancorp in Maryland agreed in 2018 to purchase Virginia Partners Bank in Virginia, where the deal will bring Delmar its first branches in the neighboring state. In another deal announced in 2018, Cambridge Bancorp in Massachusetts agreed to buy Optima Bank and Trust in New Hampshire with a valuation of 191 percent of tangible common equity. In that deal, Cambridge indicated that the deal was consistent with its growth strategy because of the focus on growth in its wealth-management business line.
At the end of the day, increasing shareholder value is paramount, and whether that is accomplished through organic growth, partnerships, or acquisitions will depend on the institution’s board of directors and particular growth strategy.
Despite the encouragement for consolidation, challenges persist. Some banks are sidelined with compliance struggles, whereas others are finding it difficult to get to the right price for shareholders. Bank boards of directors are having difficulty in some cases determining the right price at which to buy another institution or sell itself. In many cases, the price targets for the buyer and the seller are just too far apart as sellers seek healthy valuations and buyers worry about the potential short-term devaluation in share price and, in many cases, the longer-term view of the economy.
Banks also continue to face the challenges of financial technology companies, both from competition and partnership opportunities. Financial technology firm Robinhood Financial, for example, recently announced that it would be offering a version of a bank account, Robinhood Checking & Savings, which promises a three-percent interest rate. Although not subject to the same regulations, banks are struggling to compete with these financial institutions nonetheless.
Finally, there are the ongoing challenges of the regulatory approval process after the deal is struck. Filing requirements, newspaper notices, and timing considerations present an entirely separate stage of challenges in the M&A process that must be managed with precision through consummation.
Although it is too early to tell whether 2019 will finally be the year of the merger wave, recent legislation, regulatory relief, and current economic conditions appear to have opened the gates to consolidation, as evidenced by the recent announcement of the proposed merger between SunTrust and BB&T. However, the market will ultimately tell us whether the challenges associated with successful deal making have been overcome by the many or the few.
 Economic Growth, Regulatory Relief, and Consumer Protection Act, Pub. L. 115-174 (hereinafter Crapo Act).
 Federal Reserve Statistical Release, Large Commercial Banks as of March 31, 2018; see also, Federal Reserve, National Information Center (there were 4,748 commercial banks, 489 savings banks, and 172 savings and loans chartered in the United States with assets less than $10 billion as of March 31, 2018).
 See Gregory J. Hudson & Joseph E. Silvia, Crapo Helps Community Banks, 135 Banking L. J. 456 (Sept. 2018) (discussion on how the Crapo Act reduces the regulatory burden for community banks).
 See Gregory J. Hudson & Joseph E. Silvia, Recent Legislation Encourages Bank M&A Activity, Bus. Law Today, Dec. 2018 (discussion on how the Crapo Act encourages mergers and acquisitions in the community bank sector).
 See Crapo Act, supra note 1, at § 203. On December 21, 2018, the federal banking agencies, as well as the Securities Exchange Commission and the Commodity Futures Trading Commission, released a Notice of Proposed Rulemaking to implement this section of the Crapo bill exempting community banks from certain prohibitions under the Volcker Rule. With the legislative revisions to the Volcker Rule, banks under $10 billion in assets will be exempt from the Volcker Rule’s restrictions if the bank’s total trading assets and trading liabilities are no more than five percent of the bank’s total consolidated assets.
 See Crapo Act, supra note 1, at § 207.
 Regulation Y, 12 C.F.R. § 225, Appendix C to Part 225 (Small Bank Holding Company and Savings and Loan Holding Company Policy Statement).
 See 12 C.F.R. §§ 225.14(c)(1)(ii), 225.14(c)(2), and 225.14(c)(7).
 The Small Bank Holding Company Policy Statement was previously amended in 2006 to raise the asset threshold from $150 million to $500 million. See 71 Fed. Reg. 9902 (Feb. 28, 2006). In 2015, the asset threshold was raised from $500 million to $1 billion, and the scope of the Policy Statement was expanded to include savings and loan holding companies. See 80 Fed. Reg. 20158 (Apr. 15, 2015).
 See FDIC Statistics at a Glance (Sept. 30, 2018).
 See FDIC Statistics at a Glance, Historical Trends (Sept. 30, 2018).
 See Davis, Paul, Top bank M&A deals of 2018, Am. Banker, Dec. 23, 2018.
 See Davis, Paul, Nobody saw this bank deal coming, Am. Banker, Dec. 13, 2018.