Deposit Franchises Drawing Looks from Aspiring Acquirers

Deposits are regaining their status as a driver in dealmaking.

Once viewed as a key reason for M&A, deposit franchises became less relevant after 2008. For years, the right side of the balance sheet became an also-ran in consolidation talks as banks drowned in liquidity, leading buyers to covet assets.

A fundamental shift is taking place. Recent comments by Federal Reserve Board Chair Janet Yellen have sparked hope that interest rates could rise in 2015. And some banks are managing to book loans on their own, shifting their goals for M&A from asset generation to low-cost funding.

"From an M&A perspective, higher rates could make deposit liabilities more valuable and increase the attractiveness of banks flush with deposits but lacking an ability to lend," Deloitte declared in its annual report on bank M&A, released last week.

Small regional banks may buy deposit-heavy community banks this year "to expand their footprints and bolster liquidity," the consulting firm's report added.

The report is organized as a top-10 list of issues, and rising rates were runner-up to regulation. Concerns over regulation have been an industry mainstay in recent years, but the rate environment is making its first appearance on the list in at least three years.

The ranking is "a combination of flow of topics for the reader and priority," says Jay Langan, a partner in Deloitte's M&A transaction services team who co-authored the report. "We did think interest rates were a key issue to discuss."

The increasing attractiveness of banks with core deposits and low loan-to-deposit ratios echoes comments made by several bankers this year.

Core deposits are an "increasingly valuable" reason for deals, says Thomas Osgood, chief financial officer at Xenith Bankshares (XBKS), pointing to the Richmond, Va., company's recent agreement to buy the under-levered Colonial Virginia Bank. Xenith plans to use the Gloucester bank to enter the Hampton Roads area.

Chemical Financial (CHFC) in Midland, Mich., said earlier this month that it would buy Northwest Bancorp. Northwest, in Traverse City, Mich., has seen its loans shrink for the past five years. Still, Chemical is projecting double-digit loan growth in Northwest's markets once the deal is completed.

Northwest had a loan-to-deposit ratio of 65% at Dec. 31, compared to nearly 90% at Chemical, Lori Gwizdala, Chemical's chief financial officer said during a conference call to discuss the deal. "We don't anticipate that [Northwest's] loan-to-deposit ratio will remain at 65%."

Park Sterling (PSTB) in Charlotte, N.C., had a similar take on its pending acquisition of Provident Community Bancshares (PCBS) in Rock Hill, S.C. About 97% of Provident's deposits are core, James Cherry, Park Sterling's chief executive, said.

Provident "has a 45% loan to deposit ratio," Cherry added. "That's a healthy amount of liquidity and, with our double-digit loan growth, we think we can deploy it."

While mostly pessimistic about M&A, John Kanas, chief executive of BankUnited (BKU) in Miami Lakes, Fla., recently said that a deposit-rich bank would complement his bank's organic loan growth.

For sellers, a changing rate environment is perhaps a welcomed shift. As long as they have a strong core deposit base, a lack of loans could be an advantage. Selling could also serve as an alternative to having to find loans on their own.

"Management teams that realize this [organic loan growth] problem are faced with just two choices," Keefe, Bruyette & Woods noted in a bank M&A study released earlier this month. They must "either go on the offensive and expand into new markets or simply sell to an institution that is already generating loan growth ... and jump onto a faster-moving train."

Some focus on loan-to-deposit ratios might be driven by regulators' concerns that depositors could withdraw their cash from banks when rates go up, says Nishil Patel, a KBW associate and lead author on its M&A study.

"The surging quest for strong core deposits is based on the expectations of rising rates," Patel said in an interview. "Regulators are casting their gaze on high loan-to-deposit ratios and want to know that banks are preparing for the future."

To be sure, the pursuit of earning assets still exceeds current interest in deposits. "Loan growth still remains challenged, so finding a good origination platform is still the priority," Langan said.

The KBW study, based on a survey of 109 bankers across the country, yielded similar results. Like Deloitte's study, the KBW results show regulation was the main driver of M&A, with "growth is hard to find" in second place.

Still, some industry observers say deposits should always be the main event in M&A.

"Core deposits are the basis for all other accounts. It is the hook for everything else," says Ken Thomas, an independent bank consultant and economist. "The banking business is built around one thing: the deposit relationship."