A Quarter of Community Banks Expect to Sell Next Year: KPMG

A growing number of community bank leaders are finally expressing a willingness to sell.

That long-awaited sea change is evident in a new survey by KPMG, an audit, tax and advisory firm. The findings provide evidence that more deals might be struck in the coming year.

"There has been a lot of discussion about M&A and all of the reasons it could happen," says John Depman, KPMG's national leader of regional and community banking. "Part of the disconnect … has been that everyone wanted to be a buyer and there were not enough sellers."

KPMG conducted its survey in October, gathering responses from 105 CEOs and senior executives at banks with $1 billion to $20 billion of assets.

One-fourth of respondents told KPMG that they expect to sell next year, while 40% still plan on being acquirers. Last year, 15% of participants expected to sell within two years; 42% planned to pursue deals.

This year's results indicate that the gap between buyers and sellers is starting to close, Depman says. The changing attitude is the culmination of many factors, industry experts add.

Executives planning for 2014 don't expect substantial improvement in business conditions, says Thomas Rudkin, a principal at FIG Partners. And there is an overall sense of fatigue among executives and directors, says Chip MacDonald, a lawyer at Jones Day.

KPMG found that 85% of bankers believe revenue will increase next year, though most expect revenue to rise by 10% or less.

"People are tired," MacDonald says. Banks are "having a hard time generating sufficient profits in this low interest rate environment. Those are certainly factors that will lead to more consolidation."

Stock prices have increased, giving potential buyers a stronger currency for deals. Improved asset quality is giving potential sellers a chance to command a better price, industry experts say.

Respondents to the KPMG survey said a seller's customer base was the most important criterion for making an offer. Buyers may select a bank with a similar customer profile since they already know how to serve them, Depman says. Still, buyers are also interested in banks that serve other customer groups or offer different products, he says.

In recent years, "we've seen mutual thrifts that convert and want to get away from their traditional residential mortgage base to include commercial loans," Depman says. "That's a different reason to get into M&A."

Rising regulatory costs could strong-arm banks to sell. More than three fourths of respondents said banks must reach $1 billion of assets to stay independent. Nearly a third said regulatory changes and reform are important drivers of deals.

"Regulatory uncertainty and its burdens and costs are driving the process," Rudkin says. "Bankers are realizing that is only going to increase."

More than a third of executives said 5% to 10% of operating costs are tied to regulatory compliance; 37% said the figure ranges from 11% to 20%. Besides spending dollars on compliance, executives are forced to devote time to this area, says Pam Perdue, chief compliance strategist at Continuity Control. Unfortunately, this could lead to regulation fatigue.

"Some banks are sort of becoming numb to the regulatory response," she says. "If you are in a boxing match, you can only get hit so many times until you don't feel it anymore."

Small banks need to hire more employees to handle regulation and compliance, taking resources away from other areas, says Shaheen Dil, managing director of risk and compliance at Protiviti.

Dil says she recently attended a conference were small bankers frequently discussed the pressures of regulation, stress testing and compliance reporting. There is a trickle-down effect, where regulation originally meant for big institutions is being applied to smaller banks, Dil says.

"Regulators are saying 'You aren't required to do this, however, this is an industry best practice so if you do it, we would be very happy,' " Dil says.

First Sound Bank in Seattle decided to avoid mortgages because of the qualified-mortgage rule, says Patrick Fahey, the $106 million-asset bank's chairman and chief executive. The bank was unlikely to build enough scale to justify the additional risk, he says.

Regardless, First Sound is feeling the pain of more regulation, hiring a compliance consultant and completing an external compliance audit to make sure the bank is "on track," Fahey says.

Still, Fahey likes to take a pragmatic view when it comes to handling regulation. Fahey says he accepts regulation, though he believes small banks have an opportunity to succeed by being responsive to customer needs.

"I don't particularly like the additional regulation, but I don't get fired up about it, either," Fahey says. "This is the business that we're in. We adapt. We can continue to do what we need to do. We can still meet the needs of the customer, but we just have to be more careful about it."