State, regional business lenders stay on top of trends
All signs are pointing to 2013 as a banner year for bank acquisitions and mergers in Wisconsin. What’s cloudy to most industry observers is whether Associated Bank will grow its own portfolio as a major buyer.
Industry analyst Scott Siefers, who tracks Midwestern banks with the New York firm Sandler O’Neill, says Associated is a good candidate to acquire additional properties.
“I think a name like Associated is an acquirer,” Siefers says. “It competes on service with community banks and then it competes with national institutions like Wells Fargo and Chase by using the local bank angle. At the same time, it’s big enough to offer a broader product suite than a community bank.”
Community banks are those with assets under $1 billion and generally provide banking services to a local geographic area with deposits, investments and loans. About 96 percent of Wisconsin banks, slightly more than 250, are considered community banks.
The number of community banks has declined nationally by more than 50 percent since 1985, according to research by the Federal Reserve Bank of St. Louis. Many struggled with the financial meltdown that began in 2007 and more than 417 banks failed nationally from 2006 to 2011.
While the pace of failures has declined, and the St. Louis Fed research cited many benefits of locally-focused community banks, industry watchers forecast that economic and regulatory pressures will prompt investors in smaller institutions to sell to larger banks.
Associated Bank, headquartered in Green Bay, has assets of more than $23 billion, and is one of the top 50 publicly-traded banks in the U.S. While the bank has been performing well since the damage inflicted by the financial crisis, CEO Philip Flynn won’t tip his hand whether the bank is in the market to buy.
“An acquisition takes two parties,” says Flynn, who joined Associated as president and CEO in 2009 and helped it dig out from $600 million in nonperforming loans, mostly in construction.
Flynn agrees market conditions favor consolidation and acquisition in the industry.
“As time goes on and the smaller banks realize they will have a hard time getting a reasonable return for shareholders, they will have to think whether it is better to trade their stock for the stock of a larger bank,” Flynn says. “In the older days, folks who started and owned community banks expected to grow and sell for three-times book value. The new reality is that bank stocks are trading barely over book.”
Banking analysts have been impressed with the steps Associated took in the wake of the financial meltdown and recover from the losses it sustained in real estate and construction lending. The bank accepted TARP funds, which have since been repaid, cleansed its portfolio and hired new management, including Flynn and Christopher J. Del Moral-Niles, who joined the bank as executive vice president and chief financial officer in 2010.
Flynn’s arrival in December 2009 triggered a blitz of activity at Associated. The bank sold off $600 million in nonperforming assets, closed its books for 2009 by Jan. 11, 2010 – nearly two weeks early – and did a $500 million secondary stock offering that got it out of trouble.
“It was fast action,” recalls Flynn. “I was impressed by how hard my colleagues are willing to work. To close the books two weeks early on a $20 billion bank – people just killed themselves to get this done. But that allowed us to turn the franchise around.”
Analysts and industry watchers have taken note.
“Associated today is in a very good place,” says Christopher McGratty, a banking analyst at Keefe, Bruyette & Woods, a New York-based investment bank that specializes in the financial services sector. “They had a lot of the assets (going into the financial crisis) that everyone else did, but it was a concentration issue. The street (Wall Street) really likes them and the bank is doing much better than in 2008.”
A lesson for others
McGratty says Associated’s ability to use the capital markets is an advantage that community banks just don’t have, making it harder for those institutions to repay TARP funds and fully recover.
“A lot of these community banks should be exploring their options,” McGratty said. “It’s a tough operating environment with interest rates at zero and regulatory pressures, but it’s an ideal environment for M & A.”
Other analysts suspect McGratty is overly optimistic about community bankers’ realism.
Robert Atwell, chairman and CEO of Nicolet Bank, says many community bankers are tired and looking for a buyer. While some community banks are strong, with more than 250 in Wisconsin, the state is ripe for consolidation, he says.
“The banks with a strategy that is durable and adaptable are perhaps 20 to 25 percent of the total in the state,” he says. “Then there are the tweeners with enough capital strength not to make a decision for several years, and then there are some banks that have no room to move.”
But before the expected wave of mergers and acquisitions can take place, community bankers have to recognize that the economy has changed, says Robert Cera, CEO of Baylake Bank. He agrees with Flynn that the prices community bankers expect are far too high.
“Some community bankers would like to get out, but there is a disconnect on ultimate valuation,” says Cera. “There is a cavern between buyer desire and seller expectations. Bankers remember when the price was two to three-times book and now prices are getting closer to book or book-and-a-quarter.”
In addition to an expected wave of consolidations, another key trend in the banking industry is finding the right business mix of asset balance. The days of plowing 12 percent of a portfolio into construction loans, and reducing the focus on retail banking, are over.
“We are more balanced in retail and business banking, with a trend toward the business side,” Cera says of Baylake’s business model.
Meanwhile, retail banking is changing and doesn’t require as many branches as it used to.
Associated closed about 20 branches last year and another 12 in January. Most of the closed outlets were within 3 miles of another branch. Associated held onto 90 percent of its customers and managed to place 60 percent of displaced staff internally, Flynn says.
“Consumer behavior is changing with technology,” says Flynn. Basic foot traffic has declined by 20 percent or more as customers access banking services online, through smart ATMs and mobile banking. Associated is investing in all those channels, he says.
On the commercial side, Associated is diversifying its portfolio with investments in oil and gas and power and utilities.
“For me, the important thing about managing risk in a bank is diversification, not allowing one segment to grow disproportionately,” Flynn says.
Specialized for success
Banks with a light retail footprint, such as commercial banks that limit personal banking services to their commercial clients, have done well in the new banking environment.
As a commercial and industrial bank, Nicolet escaped the worst of the downturn when it hit. While it had $25 million in chargeoffs during four years, earnings always exceeded losses during that same time.
Atwell says Nicolet competes against big players like Associated, BMO Harris and Wells Fargo. After Nicolet completes its merger with Mid-Wisconsin Bank, the $1.1 billion bank will have a $17 million lending limit, the highest in Brown County, he says.
“At other banks, when you hit $2 million someone in a distant location, someone you will never see, is signing off on that deal,” he says. “In our organization, everybody involved lives here.”
In addition to new economic realities, Wisconsin’s community bankers are also dealing with the challenge of finding quality talent to fill key roles.
At a Federal Reserve conference for community bankers, Atwell asked how many were encouraging their children to go into banking. Amid some nervous laughter, no one raised a hand, he says.
“Where is the talent going to come from? Here are these $250 million not-very-well-run community banks who thought they were doing well up to 2008, but what they thought they were doing right blew up in their face,” Atwell says. “Their boards are tired, and if they didn’t have a regulatory near-death experience they had a pretty scary time. People used to get onto community bank boards because they were a nice social club, paid a few hundred for a meeting and they got to see what other businesses were doing. Now the boards are sick of the game and management is aging and tired.”
The Too Big to Fail banks, or those regulators have deemed systemically important (think Chase, Citi, Wells Fargo, US Bank, Goldman Sachs, Bank of America), have an interest rate advantage over smaller banks, because people know they won’t be allowed to go bust. (Bloomberg cited an IMF study that the implicit guarantee gives the top 10 banks a .8 percent pricing advantage, or a hidden subsidy of $83 billion a year.)
In a crisis, the advantage goes beyond interest rates to survival.
What that implicit guarantee looks like in Wisconsin showed up during the financial crisis. Atwell says his customers were trying to decide if they should draw down their lines of credit with Nicolet and transfer all their money to a TBTF firm like Wells Fargo.
“If people like a community delivery system, they have no problems with their deposits being there. But in a crisis, they may move their funds to Chase because they know the government won’t let them fail,” he says.
So Nicolet invited its top 100 to 150 customers to the lobby for a chat and explained where the bank was financially and how management was handling the crisis.
“It kind of worked, but I don’t know if it would have worked if the Feds hadn’t gone all in on the financial safety net,” Atwell says. “We were verging on a run on the whole structure of our financial system.”
Community banking attraction
Community banks do have an edge in service and customer trust, if they know how to use it well.
Big banks were the catalyst for the creation of Investors Community Bank, founded in 1997 by Bill Censky, Tim Schneider, Wayne Mueller and Mark Binversie in Manitowoc.
The four left a large institution in Manitowoc because they believed the bank was not taking care of customers as well as it should, says Schneider, co-CEO and co-founder. The founders raised $6.5 million to open; now it would probably take more than $20 million to start a bank, he says, which is the reason for little de novo banking activity in the state.
Schneider agrees the regulatory burdens are heavy; the bank has just hired a full-time compliance officer to keep up with legal changes. Unlike many community banks, Investors has a specific focus on the agriculture and commercial sectors, which it tries to keep roughly balanced.
“We provide retail services to our commercial clients and farm owners, but it is not a market we pursue directly,” Schneider says.
The bank has nine agricultural specialists who cover the entire state, making it Wisconsin’s largest farm lender.
“Every one of them grew up on a farm, several of them on large dairy farms,” Schneider says. “They have conversations with clients on a regular basis. Customers see our lenders as a valued advisor to them.”
The bank continues to build its commercial business with growth in manufacturing and lending to medical clinics. It also continues to hire staff from larger banks.
“Probably 70 percent of our staff joined from a larger institution. They enjoy our culture as a community bank,” Schneider says. Investors plans to add 10 new positions this year.
While bad as a whole, the financial crisis helped prove the business model for institutions like First Business Bank in Madison, says Mark Meloy, president and CEO.
A business bank was a relatively new concept when the bank started 23 years ago by taking over a charter from Kingston State Bank. Meloy left First Wisconsin, now US Bank, where he felt that changes in the big bank model moved decision-making further away from clients and their needs.
In the last four or five years, centralized decision-making at large banks led them to drop customers in certain industries, Meloy notes.
“We picked up a client who had a more than 30-year relationship with one of the country’s top five banks,” Meloy says. The client, in the construction business, was getting vibes the big bank wasn’t interested in continuing the business.
“I can think of three other clients with over 25-year relationships with big banks who moved over to do business with us because they saw that as the economy got tough, they got bullied by their long-term provider,” Meloy says. “It wasn’t because of anything unique about them and their performance, but because of the herd mentality. They were in a specific industry and because of that they were treated the same as everyone else in the industry.”
First Business was ready to take them on because it had been prospecting those very companies for years.
“They were very consistent performers,” Meloy says. “We look at the people who are going to sign the documents, people we will work with in good times and bad. We see it as a partnership. We want to know how their business is going and we need to communicate how things are going in the banking world.”
Baylake’s CEO Cera says that Baylake acquired a large business customer who had been with a major bank for more than 30 years and was doing fine, but the bank tried to put more discipline into its credit structure, adding new covenants.
“The way they did it was annoying,” Cera says. “We talked to the company and put in place the same kind of discipline in our proposal, but the way we delivered the message was so much more positive that we won the business – although what we were doing wasn’t really anything different from the large bank. It was the way we did it.”
It also helps, he said, when the bank CEO is part of the community and can speak to customers directly.