Bank M&A Seen Stuck in Limbo in 2014

While the world feared the worst about financial services in the summer of 2008, Randy Dennis was telling banks to suit up for a wave of opportunity.

Dennis' DD&F Consulting in Little Rock, Ark., became one of the go-to advisory firms for banks looking to buy failed institutions from the Federal Deposit Insurance Corp. His clients include George Gleason, the chief executive and chairman of Bank of the Ozarks (OZRK), and John W. Allison, the chairman of Home BancShares (HOMB).

Gleason was named a community banker of the year by American Banker in 2010, and Allison in 2013, partly because of their skills as failed-bank buyers.

(For full Countdown 2014 coverage, click here.)

Now failures have slowed to a crawl, and Dennis is looking to the future. The low-rate environment allowed more banks to survive than expected, and bank M&A in general will remain cool because it will take awhile for small banks to feel the full brunt of new regulatory costs, he says. For that reason, there appear to be more buyers than sellers at the moment.

Until things heat up again, Dennis says his firm will turn more to new services, including risk management and data-processing advice.

The following is an edited transcript from an interview in December.

How did you get involved in advising banks on bank failures?

It goes back to the 1980s when the savings and loans started failing. Until about 1993, we were doing failed savings and loans with the Resolution Trust Corp.

In the current wave of failures, we helped our clients bid on over 220 banks and we closed on 41. That represents 22 different buyers. We represented Mutual of Omaha when it bought First National Bank of Nevada and First Heritage Bank in the summer of 2008. It happened right after the failure of IndyMac, and the FDIC was scared there was going to be another run and CNN was going to be there. The tension was extraordinary.

After the closing, we saw that this was going to be a huge business going forward. We set up meetings with Bank of the Ozarks, Home BancShares, Arvest Bank, Simmons First National and others. We told them, 'We need to train you on how this works. You need to be prepared to do this.' As a result, that is one of the reasons why those banks were such good and aggressive acquirers. We worked with them on the front end, but some of these banks, you don't have to tell them a lot. They get the idea real quick, and before you know it they are way past you. Then we did it with other banks across the country, too. We helped our clients trust the FDIC, too, because in the beginning there was a natural suspicion that the FDIC was trying to put something over on the banks.

Bank of the Ozarks and Home BancShares went on to be two of the most prolific failed-bank buyers.

They were similar in that they sent a team to look at nearly every deal that came available, and we were involved in some of them. The great thing for me was that Home was primarily looking in Florida, and Bank of the Ozarks was looking in Georgia and the Carolinas, so there was no conflict.

What the biggest difference between S&L-era resolutions and the resolutions in the Great Recession?

What the S&L playbook didn't have was loss-share. It was all cash and deposits. I think they took a lot of what they had and improved it. The FDIC's division of resolutions and receiverships is not born in bureaucracy, it is born in deals. They are very creative, extremely responsive and when they hear a good idea, say one of the buyers proposes a good idea, they'll apply it. They added loss-share because of the asset issues, and I think that was a tremendous addition.

Nearly 500 banks have failed in the last six years. How many banks were you expecting to fail?

We were dealing with 600 to 700 troubled banks. What we didn't anticipate was the low cost of funds for so long. That had an amazing impact on the troubled banks out there. That saved the Deposit Insurance Fund a lot of money because the banks could afford to carry nonperforming assets, so long as they had enough capital, until things improved. Most banks say they want rates to jump up, but there are a whole lot who still have nonperforming assets and they would be hurt significantly by higher rates.

There are still more than 500 banks on the problem list. What happens to them?

Some are improving. A number are improving with time, and that will continue to happen. Julie Stackhouse from the Federal Reserve Bank of St. Louis put out a study recently of banks with Camels ratings of 4 or 5. [Camels ratings are from one to five, with one being the best.] There were 1,390 banks that had a Camels rating of 4 or 5 during the downturn. Of that, 161 were merged away, and 355 failed. But 120 recovered without being purchased.

The first loss-share agreements are approaching five years, when banks can no longer submit claims for losses on commercial assets. How is that going to affect the industry in 2014?

Those who were not aggressive in dealing with the problem loans in the first few years of loss share are going to get push-back from the FDIC with it saying, "How come all of a sudden you're getting real aggressive when you hadn't been up until this point? Don't you think you should have been paying attention?"

I also think the FDIC clearly sees that they have upside. Most markets are improving and while it is five years for losses, the FDIC has another three years for recoveries. Those who think they are out of their loss-share after five years are going to be surprised to know the FDIC is still their partner.

The FDIC will continue to buy out small ticket loss-shares, the ones that have $2 million or $5 million left in their portfolios. The FDIC and the banks will be amenable for buyouts if they can reach a price. One thing though, is that the FDIC doesn't trade price. It is not a negotiated process. You give them a price, and they'll look at it and if they think it is fair they'll take it.

What's going to happen to M&A next year?

It will continue at the slow steady pace, but it is not going to fall out of bed. Mainly because the community banks have not yet really seen the increased cost of the Dodd-Frank Act, because the regulations aren't in place. We are seeing a little bit of it, but you have just not seen that additional cost yet.

The Federal Reserve Bank of Minneapolis did a study on the cost of Dodd-Frank and they found that for a $50 million-asset bank it was going to cost them about 20 basis points on their return on assets because they are going to have to hire someone. For $500 million to a $1 billion, they are going to have to hire a few people, but it is only going to cost those about four points. There is going to be a fixed cost that is going to reduce profitability and will drive banks to sell eventually.

If you look, the price has kind of ticked up a bit this year and I think that is a reflection that there are more acquirers than sellers right now in my sense of the market. That will change as the cost goes up and age bears down on people.

Now the failed banks have slowed, what is DD&F up to?

We are broader than M&A; we also do risk management. We are gearing up our compliance and risk management businesses for things like loan reviews, audits and information technology audit.

The great thing about the FDIC failed-bank program to us was that it was like the NASA space program. You think about all the things that came out of the space program, it was a huge shot in the arm to Americans. The FDIC program was a lot like that to us. It allowed us to go in and look at the insides of these transactions. Things like contracts, integrations, core processors and all the other things.

As a result of that, the electronic side of our business has increased tremendously. We are now helping banks look at their core processors and other systems interactions, whereas three years ago we couldn't even spell "I.T."

We are looking at the possibility of setting up a cooperative that would provide data-processing and risk management services to help alleviate some of the costs and expertise level for some of the small rural banks.

Were you ever a banker?

No. I've been a used bank salesman practically my whole life.