Washington Banks Continue March Toward Consolidation

For years, a prime criticism about American banks was that there were too many of them. Even in the era of interstate banking and megamergers, new banks seemed to appear as fast as old ones were gobbled up.

Problem solved, although probably not in a way anyone would like. From a national total of nearly 14,000 banks in 1992, and almost 10,000 as recently as 2000, the number of FDIC-insured institutions in the United States has been sliced to fewer than 7,500.

Washington state is no exception to this trend. The state had 100 banks headquartered here in 2003. At the end of the third quarter of 2011, Washington was down to 73 FDIC-backed institutions.

The reasons arent surprising. The mortgage and housing-finance debacle forced the closings of hundreds of banks and thrifts nationwide. Others found buyers on their own in order to escape that fate. Heres the prognosis for banks in Washington: More consolidation is coming.

Absent growth overall in the economy, theres just not enough business out there to warrant the current industry capacity, says Roy Whitehead, chairman, president and CEO of Seattle-based Washington Federal, which has absorbed a few smaller banks in the past decade and now has more than 100 offices stretching across eight western states.

Adds Melanie Dressel, president and CEO of Tacoma-based Columbia Bank, another company whose relative strength has allowed it to acquire several banks, Theres still more to go.

Banking consolidation dramatically remade the map of the industry in Washington. Gone are such longstanding institutions as Washington Mutual, Frontier and Horizon. And the shakeup brought some new names to the local market such as JPMorgan Chase and Umpqua. Others already here, like Union Bank and AmericanWest, beefed up their presence.

Bank wheeling and dealing in the state has been in a lull for a few months. An obvious reason is that the worst of the sick banks have been put out of their misery. Now, everyone is taking a breather, with the healthy banks consolidating their purchases and the weaker ones that are operating under close regulatory supervision (but were at least able to raise capital) hoping the economy will improve enough to lift them back to health.

Another reason for the lull is that potential sellers are holding out hope they can eventually get a better price. Theres less pressure on them to move right now because of declining credit costs, which have enabled many banks to report improving profits even though theyve had no top-line revenue growth and even though they have pressure on costs in other areas, Whitehead explains.

Buyers are willing to wait too. Were finding its cheaper to buy our own stock today than to buy [that of] others, Whitehead says, noting that in recent buybacks Washington Federal paid a price that was just 75 percent of book value. If we were to pay even book value, let alone a premium, for someone elses stock, when you look at the relative risk in those two transactions, it becomes almost a no-brainer to use the excess capital were generating through earnings to buy our own stock back.

But expectations are that the lull wont last. A major factor inducing more sales: Bank management and directors have been through a lot the past few years, theyre facing even more challenges in the coming years and they are, to borrow a frequently used term, tired.

Theres a class of tired bankers out there that are not having fun in the business any longer because they cant as freely do the things they want to do and that attracted them to the business to begin with, Whitehead notes.

Its been a very difficult time for a lot of banks from a regulatory standpoint, says Columbias Dressel. That takes its toll on boards and management. They might be a little bit tired and theyre thinking maybe now would be a good time to consider selling.

Increased regulation will hit all banks, not only the too-big-to-fail institutions. Even if we take out those potential regulations related to the very large banks that probably wont drift down to the community banks level, its just an awful lot of regulations, Dressel observes. Some people are saying it could be as much as 200 to 300 new regulations that could come out of the Dodd-Frank bill.

That additional compliance will cost money, as will the continued arms race in banking technology. People want all of the different ways to access banking services, she adds. It runs the gamut from your mobile phone to wanting a branch thats very convenient to you. Just being able to keep up with new technology and fill the demand for branch banking is a revenue-expense consideration for many banks.

Which leads to another potential headache: finding enough revenue to pay for all the new rules and higher expectations. Interest rates on loans are (for lenders, anyway) painfully low, and loan growth is tough for some banks to come by. Depending on whether the economy really does start picking up, the opportunity for revenue growth for many banks could be muted, says Dressel. If thats the case, the opportunity to grow revenue fast enough to accommodate the additional expenses is going to be tougher for some banks.

All told, those factors will begin to wear down the willingness to hang on, and force some consolidation, Whitehead predicts.

Its a view seconded by longtime Northwest banking analyst James Bradshaw, now senior equity analyst with Bridge City Capital in Portland.

It is going to be quiet on the traditional mergers-and-acquisitions front for the first half of the year, as banks with capital are being pretty picky about what they buy, Bradshaw says. I suspect that many Northwest banks with extra capital will begin to look more actively for growth via merger over the latter half of 2012 and into 2013. … A year from now, I suspect, we will have a pretty active M&A market out hereat least a handful of deals. Lots of sellers would be willing if prices are up over 125 percent tangible book value.

Who might be buying? Count Columbia and Washington Federal among the tire kickers.

Theres never been a time in our history when we werent actively looking, Whitehead says. There are a lot of conversations occurring. Very few of those conversations are gathering momentum. I think consolidation is inevitable. It may not happen in 2012. … [But] theres just not enough business out there for the banks still out there. These low rates are going to grind away with us, along with these much higher FDIC premiums were paying and the higher costs government at all levels seem willing to extract from us.

We certainly have the appetite to do more but were very disciplined in how we look at opportunities, explains Dressel, whose bank has more than 100 branches in Washington and Oregon. It has to make financial sense. It generally has to extend our geographic footprint in the Pacific Northwest. It has to make cultural sense. That means we are acquiring banks that have core deposits where you really develop a relationship with the customer. Its not just high-priced CDs where you see somebody today and then you dont see them for another nine months until their CD matures. It also means they understand how to deliver services to business.

Because we have a high capital level, obviously thats been very important to grow in the way we have. We still have capital we want to deploy and want to do that. But we want to do it in a disciplined and effective way.

Bradshaw speculates that midsize regional institutions will lead the way, perhaps followed by out-of-market regionals and private equity. I doubt the large-scale banks do much in this area, he says. They would have trouble getting enough scale to do a smaller bank acquisition.

Could some of the successful midsize players themselves be consolidation targets? Maybe, Bradshaw says, if they get to be larger and if theyre ready to sell. I dont think any of them are at that point yet, he adds.

Entry into this market from an institution not already here is also a possibility. The Pacific Northwest is an area that many banks want to be in because of the diversified economy or [they] want to expand [to], Dressel says. Weve heard from some of the very large banks.

For the time being, though, its quiet out there.

There is an absence of catalytic pressure on either side to do something because conditions are improving, Whitehead says. Its not improving fast enough to allow all of us to continue as going concerns over the long haul, but, nonetheless, [its] improving. Everyones feeling more optimistic, more durable than two or three years ago.