Texas Bankers Are Engaging in M&A Standoff

Maybe Texas' banks just aren't the marrying kind.

With its numerous attractive institutions and robust growth markets, the state could kickstart a round of traditional deals nationwide, analysts say. The only problem is that Texas bankers also know they're attractive, and the most comely banks aren't interested in low-priced dates.

George Lee, the president and chief executive at MetroCorp Bancshares Inc., recalls an analyst comparing his bank to an attractive young adult who insists on staying single despite repeated overtures from interested suitors. "Sure, it's nice to have people look at us, but at same time, it's annoying," he says.

The annoyance resonates with many Texas bankers who consider themselves buyers but have become targets of larger banks looking to enter markets like Houston and Dallas. Talks end quickly; buyers won't come off post-recession prices while would-be targets, content with organic growth, want twice their book value.

"The buyers are going into this for … maybe 1.5 times book and the sellers are looking for" more, says Geoffrey Greenwade, president and chief executive at Green Bank in Houston, which has made two acquisitions since 2010. "We'd love to do two deals this year; it's just a matter of finding those that are easy, willing and able to do the deal."

Despite higher regulatory costs and more competition from outsiders such as BB&T Corp., Hancock Holding Co., and IberiaBank Corp., consolidation in Texas fell last year to its 2008 level. There were 14 deals in Texas last year, compared to 21 in 2010, according to FBR Capital Markets.

So far this year only one banking company has announced an acquisition in the state; Prosperity Bancshares Inc. in Houston said last month that it would buy Bank Arlington at roughly 131% of the seller's tangible book value.

"Last year, the deals were mostly among little banks that were either tired or distressed," says Dan Bass, managing partner at FBR. "Banks in Houston are neither of those."

Greenwade says bidding prices began to "creep up" in the last six months as buyers became more comfortable with asset quality. He is hoping potential sellers will re-evaluate their organic growth strategy as competition heats up and interest rates remain low until 2014.

"The longer interest rates stay down, the more it will put pressure on small banks with heavy expense loads," Greenwade says. Sellers "keep thinking six months from now it will be better timing, and I'm not sure they know what happens in six months when I ask them. … I just call it denial."

It's a tough call on who should budge next, because the state's publicly traded banks have some of the nation's highest price-to-book valuations. At Feb. 2, those banks had a median price to tangible book value of 1.84% — the highest among states with at least five banks studied by Mercer Capital.

Some bankers say that their markets are producing enough growth to outlast years of low interest rates and heightened competition.

"Clearly, the community banks have done well" in a state that is dominated by JPMorgan Chase & Co., Wells Fargo & Co. and Bank of America Corp., says Jim D'Agostino, the chairman and CEO of Encore Bancshares Inc. in Houston. "The fact that we are local and Texans are somewhat provincial in that we like to deal with other Texans."

Last month, Encore reported 10% loan growth from a year earlier, earning $1.3 million in the fourth quarter. That marked a rebound from the $1.8 million loss the company reported a year earlier. The performance impressed Matt Olney, an analyst at Stephens Inc., who recently included Encore and MetroCorp on a list of 19 banks in Texas that could emerge as good targets because of the potential sellers' scale and market franchise.

"Houston … is one market where we could see M&A relatively soon," Olney says. "I'm bearish about M&A prospects nationwide this year … but if there is a market where they can make that case, it's Houston."

Industry observers say Houston is attractive because of its business diversity largely in growth coming from the oil, port and health care industries. Olney noted that the state is also more business-friendly, which produces more entrepreneur lending opportunities for banks.

D'Agostino remains adamant that his company's focus on independence and organic growth will continue. He says Encore plans to use fee-based revenues that were untouched by the Dodd-Frank Act and other new regulations, including wealth management and insurance services, to offset lower revenues associated with interest rates.

"We had terrific growth in loans and that translated into reasonable profits for the year, so I'm very pleased to be here and be in an environment where there's good loan demand," D'Agostino says. "We're growing nicely and organically, and we want to continue that."

MetroCorp's Lee may not be actively looking to sell his company, but he says the pricing that investment banks are floating out are not too far off to eventually spur some consolidation. "I don't see the market ever going back to three to four times book [value], but I think we may see more M&A, including us and other people, if we ever get to two times tangible book," Lee says.

Lee says he expects consolidation activity to accelerate during the second half of this year and into 2013 when banking companies get "braver" about doing deals. "Keep in mind that everybody just got their head above water not too long ago and like everything else, when there's enough smoke, there's fire," Lee says. "There's a lot of smoke going on right now, but there has to be a few fires."