Lesson of the ConnectOne/Center Deal: Deposits Are Hot Again

ConnectOne Bancorp (CNOB) and Center Bancorp (CNBC) in New Jersey, to adapt a line from native son Bruce Springsteen, were born to run… together.

The banks announced a merger-like deal Tuesday: the $1.7 billion-asset Center legally speaking is the acquirer and will own 54% of the combined company, but Frank Sorrentino 3rd, the leader of the $1.24 billion-asset ConnectOne, will be chairman and chief executive of the combined company, which will be called ConnectOne.

Deals resembling mergers of equals are on the rise as banks say pairing with a similarly sized peer is the perfect way to overcome a low-growth economy and heavy regulation. But they are among the most complicated because a delicate balancing of interests is necessary.

The ConnectOne/Center combination makes sense because they have complementary strengths and a clear mutual interest.

ConnectOne, which is based in Englewood Cliffs and went public in January 2013, has impressed investors by expanding its assets by roughly 30% annually since 2009. But that growth has left it with a funding imbalance. Its loan-to-deposit ratio was 119% at the end of 2013, Sorrentino says. Center's ratio was 71.6%. Their combined figure is expected to be 91.6%.

For the last few years M&A has been marked by buyers' pursuit of loans. In the biggest deal of 2013, PacWest Bancorp, frustrated with its inability to make use of its deposits, agreed to buy specialty lender CapitalSource. But as banks plot the near future, attitudes are shifting, says Christopher Marinac, an analyst at FIG Partners. The focus is now on finding deposits to serve as dry powder for the next few years.

"Bankers are thinking about the next two or three years and funding is quickly becoming an issue," Marinac says. "In a good way, it is a little scary. They have the currency, they are confident about loan growth and now are figuring out what they want to do."

Regulators might be playing a role as well, Marinac says.

"I am not saying the regulators are making these marriages happen, but I think they are making it known that they want more core funding," Marinac says. "They want that 1:1 ratio and if you're not there, they want to know how you're going to get there."

Jeff Marsico, executive vice president of the Kafafian Group, an advisory firm in New Jersey, says the deal is somewhat surprising given ConnectOne's proven ability to book loans. However, as the nine-year-old company gets bigger it would likely be harder to produce eye-popping loan growth year after year.

"Given that level of growth, I thought a merger was unnecessary, but in the strategic planning of future growth they must have figured there were not going to be able to meet their expectations on their own," Marsico says.

The combined company is expecting loan growth of 15% annually without accounting for possible revenue enhancements. However, executives said on a conference call that the projection is conservative and could end up being much higher.

It helps, too, that Center, based in Union, is known for being lean — its efficiency ratio was 46.6% in the fourth quarter.

But with only $7 million in cost cuts planned, the deal is not one built on stripping out redundancies.

"A lot of mergers take place because one or both companies don't know how to grow on their own, and they see a merger as a way to generate earnings through expense savings," Sorrentino said in an interview on Tuesday. "We are putting together two of the best performing banks in the state and will be leveraging both of our capabilities."

Anthony Weagley, the Center CEO who is set to serve as chief operating officer of the combined company, seemed to second Sorrentino and the analysts.

"The deal cements our ability to deliver the quality earnings performance on a go-forward basis," Weagley said in an interview. "This builds more value with the scale to handle the headwinds that banks are facing."