M&A in 2019: Banks will keep paying up for deposit-rich sellers

Bank acquirers are paying higher premiums for core deposits.

It has become commonplace for banks to pay a deposit premium of at least 10% in recent deals, based on data compiled by Keefe, Bruyette & Woods. That compares with 9.7% a year earlier and just 3.4% in 2013.

Premiums for over half of all bank acquisitions announced last year exceeded 10%, according to FIG Partners.

The trend punctuates a renewed interest in deposits, an area that long went overlooked after the financial crisis, at a time when interest rates have been steadily rising. It also highlights the intense competition among banks for cheap funding and the increasing value of deposit-rich franchises.

“Deposits are the life blood of the banking industry — and good core funding is critical to successful banks,” said Chris Marinac, an analyst at FIG Partners.

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An increase in deposit premiums comes at a time when community banks are struggling to hold onto low-cost funding.

Recent data from the Federal Deposit Insurance Corp. shows that deposits at banks with $10 billion or less in assets fell 3% in the 12-month period that ended June 30, while bigger banks’ deposits rose by 6%. The loan-to-deposit ratio at those banks has risen to 86% at Sept. 30 from 78% five years earlier.

Cheap deposits allow banks to be more competitive with loan pricing. They also give banks more overall flexibility, especially in a flat yield curve environment with tepid loan growth.

To better compete, smaller banks are beginning to offer more competitive CD and money market rates. But big banks have top-shelf technology on their side when it comes to landing deposits, said Brian Buckingham, senior vice president of services at Nomis Solutions, a financial pricing firm.

“Deposits have real value within the industry and that's reflected in what banks have to pay for deposits,” said Aaron James Deer, an analyst at Sandler O'Neill.

A need for low-cost deposits is one of the main factors driving bank M&A, industry observers said. BSB Bancorp in Belmont, Mass., which recently agreed to sell itself to People's United Financial in Bridgeport, Conn., cited the competitive landscape for deposits and loans as a factor behind the sale.

Expect acquirers to keep paying higher deposit premiums as alternative sources of funding become more expensive, said Cheryl Pate, an analyst at Angel Oak Capital Advisors.

“It has a to do with where we are in the rate cycle," Pate said. "The value of core deposits increases as rates go up, particularly the noninterest-bearing portion. Buyers are generally wiling to pay a premium for core, sticky, low-cost deposits.”

Some banks have been slower than others to ramp up deposit origination. With rates rising substantially for the first time since the crisis, there is pressure on those institutions to do more, said Collyn Gilbert, a KBW analyst.

“When there is greater need and more limited supply, that drives pricing," Gilbert said.

Deposit premiums fell slightly towards the end of the year, largely reflecting depressed stock prices, industry observers said. Still, there is a belief that premiums will again rise as deposits become more important.

"Over varying cycles, a deposit account still has much more profit potential than" relying on federal funds, Gilbert said. "You have a little more control."