California Has Potential for More M&A, Stronger Pricing

Smaller banks in California could be feeling pressure from a new breed of regional players that are aggressively expanding.

Banc of California (BANC) and Opus Bank are leading a growth charge, either by acquisitions or by poaching talent. This could spur smaller banks to consider their options to gain scale and compete more effectively.

"The market place for buyers continues to expand," says Richard Levenson, president and chief executive of Western Financial, an investment bank in San Diego. "You have some serial acquirers … but you also get other institutions that perceive they should be doing deals as well."

Seven California banks have agreed to sell themselves this year, compared to six by this time last year, according to KBW. Overall, 14 deals were announced in California in 2013.

The median deal premium in California, while on par with national pricing in the past two years, is lagging behind levels seen in several states such as Texas, Ohio and Florida.

California's pricing has been muted by deals with relatively unhealthy sellers, says Ken Siegman, a director in the banking practice at West Monroe Partners. He says the state is primed for more activity and stronger pricing as more banks pursue acquisitions.

"The economy continues to improve and there are some banks that are growing very quickly, which can drive up prices," Siegman says.

External and internal issues are spurring consolidation across the country, particularly for smaller banks. Regulatory costs have risen and it is still difficult to generate loan growth.

Banks must get bigger to handle the "cost of infrastructure" needed for a sound institution and to "provide the quality of service customers want," says Steven Sugarman, president and chief executive at the $4 billion-asset Banc of California in Irvine. "It will continue to be difficult for small banks to compete successfully with their larger counterparts."

The possibility of rising interest rates could also lead to more activity, says Timothy O'Brien, an analyst at Sandler O'Neill. Higher rates could "unlock the earnings power" of acquirers, he says, while forcing other banks to take a hard look at the composition of their balance sheets.

California, especially the southern part of the state where most recent deals have taken place, has experienced a new group of regional banks that are playing an important role in their markets. This could lead to more consolidation as smaller banks try to compete, Siegman says.

Many publicly traded banks in California "are market leaders in their niches, sectors or local footprints," with larger institutions serving as "premier franchises," Julianna Balicka, an analyst at KBW, wrote in a note to clients earlier this year. Smaller banks "have a weaker growth and profitability outlook because of scale" but the "possibility of an M&A exit provides potential upside."

"There's a clear distinction between the haves and the have nots" in California, says Stephen Gordon, chairman and chief executive of Opus Bank in Irvine.

"The equity markets are rewarding those growing at healthy rates," Gordon says. "The highly valued institutions are looking at potential acquisitions and using their currency. That's starting to create an atmosphere of more deals."

The $4 billion-asset Opus, which bought two banks in 2011, is looking for potential acquisitions, Gordon says. Still, the company, which recently went public, has also been aggressively hiring talent and expanding into new business lines. As a result, it doesn't feel pressure to make a deal, he says.

A willingness on the part of past acquirers to take breaks from deals could stymie activity, causing the pace of M&A to slow, Sugarman says.

Banc of California, which bought three banks since 2012 and recently agreed to buy 20 branches from Popular (BPOP), will likely focus its near-term efforts on integration and building out its current operations, Sugarman says.

"I think there could be an adjusting phase," Sugarman says. "You have a number of acquirers who are consolidating and integrating their assets and the pace of M&A could be slowing down for a period."

Regardless of the overall pace of consolidation, smaller institutions are likely to be bought by other banks that are roughly their size or slightly larger, Sugarman and Gordon say.

It doesn't make sense for larger banks to go through the distraction of buying smaller institutions, Gordon says. "We need to be pretty disciplined" with acquisitions, he says.

"That means we don't look at the smallest institutions because it is the same amount of work as it is to look at larger deals," Gordon adds. "We don't want to be dependent on acquisitions because you never know what you will get."