Ongoing Regulatory Woes Could Trigger California M&A

The number of small banks in California operating under enforcement actions keeps growing, leading some industry observers to assert that the time is right for consolidation.

Last year, 116 California banks and holding companies operated under such orders, based on data from Trepp LLC. The total represents roughly a third of all banks based in the state and is more than double the number of banks with such orders in 2009.

While failures have cleared out some beleaguered banks, several industry observers believe regulators may soon start nudging remaining stragglers to find buyers.

"We're stuck with a bunch of banks with a couple hundred million dollars in assets [each]. It will take a couple of years to clean these up," says Edward Timmons, an analyst at Roth Capital Partners LLC in Newport Beach, Calif. "If you're under $1 billion [in assets], it's going to be tough to be independent and remain profitable."

Tim Coffey, an analyst at FIG Partners LLC, agrees. "If they have to, regulators will close them down," he says.

Others don't see impending doom and say things are gradually turning around for California banks. Only four banks failed there last year, compared with a dozen in 2010 and 17 in 2009, according to data from the Federal Deposit Insurance Corp.

"The issues that really hurt our banks dealt with land and development loans, and those have been worked through the balance sheet," says Rod Brown, the chief executive of the California Bankers Association.

"Commercial real estate is steadier in this environment, and I just don't think we have the concentration issues that we were contending with three to four years ago," Brown adds. "I'm just not seeing some kind of arbitrary sentiment that there are too many banks and that there ought to be consolidation."

California's economy has been hit worse than many other states. The state's unemployment rate was 11.3% in November; the U.S. rate was 8.5% in December, according to the latest data from the U.S. Bureau of Labor Statistics. Gov. Jerry Brown has projected it will have a $9.2 billion deficit in the upcoming fiscal year.

Only five of the California banks with enforcement actions have assets of more than $1 billion, including the $2.7 billion-asset Hanmi Financial Corp. in Los Angeles and the $1.5 billion-asset Metro United Bank in San Diego, according to Trepp. About three dozen have less than $200 million in assets.

Any bank with assets of at least $5 billion could be a buyer, Coffey says, listing City National Corp. in Los Angeles and TriCo Bancshares in Chico, Calif., as banks that could pursue deals.

Timmons says CVB Financial Corp. in Ontario, Calif., and PacWest Bancorp in Los Angeles could also be buyers. "They're sitting on a ton of capital, but buybacks have gotten tough because stock prices have gone up," he says.

Out-of-state banks could also look at deals, including Umpqua Holdings Corp. of Portland, Ore., and Sterling Financial Corp. of Spokane, Wash., analysts say.

Certain regions in the state carry extra appeal. Several banks have shown interest in the Silicon Valley, due to its technology firms and high-net-worth workers. Orange County is also on watch lists for growth. California United Bank of Encino in December agreed to buy Premier Commercial Bancorp of Anaheim, given attractive demographics in Orange County and a large number of midsize companies.

The Treasury Department is also giving not-so-subtle signals that banks that owe money under the Troubled Asset Relief Program need to pay back the funds or find a buyer. About two dozen California banks still owe Tarp funds, based on a report from KBW Inc.'s Keefe, Bruyette & Woods.

An enforcement action alone should not be viewed as a sign that a bank should sell, says William Haraf, the commissioner of California Department of Financial Institutions. "Unless the bank is in terrible condition, we'd try to work with them to raise capital and improve their business plan before we'd take a radical step," he says.

Credit issues have largely been addressed, but California banks are grappling with poor loan demand. "The biggest challenge today is less about credit issues for California banks and more about finding good earning assets to drive revenues and profitability," Brown says.

Brown notes that Martin Gruenberg, the FDIC's acting chairman, has emphasized a desire to address the long-term health of community banking, and that the number of failing banks has declined over the past year.

If these banks have time to recover, long-term signs are promising, Brown says. Some have raised capital, including Hanmi and North Valley Bancorp in Redding, Calif., and most are sitting on huge amounts of liquidity.

Managers of smaller banks "really need to evaluate their earnings power and be honest with themselves whether their earnings power is going to be stronger tomorrow than it is today," Coffey says.