Texas banking could be in for the most consolidation the industry has seen in a decade—the product of a perfect storm of factors that have largely appeared since the 2016 election, experts say.
“Strategic mergers can improve our company and build shareholder value,” says Kevin Hanigan, president and CEO of Plano-based LegacyTexas Bank. “Our interests are in Dallas-Fort Worth and Houston. We are only interested in Texas.”
The $8.7 billion (in assets) institution is one of a half-dozen public banks in North Texas looking to expand in the state by combining with other players, according to Craig McMahen, Austin-based managing director in the investment banking department of Keefe, Bruyette & Woods Inc. Including the six locals, McMahen counts 18 public banks in Texas that are kicking tires within Lone Star borders, thanks partly to their own high stock prices. “Bank mergers and acquisitions will be strong for the next two years,” McMahen says.
Institutions on McMahen’s list are sometimes looking beyond Texas. Independent Bank Group Inc., a McKinney shop with assets of $9.6 billion, agreed to pay $1 billion for Denver-based Guaranty Bancorp in May. Like most of these six area banks, Independent declined comment.
The wild card in this deal frenzy is oil. Texas bank mergers and acquisitions roughly tracks its per-barrel price, revving up when (as in June) black gold is fetching at least $60, dropping off when below that. Bank deals dwindled statewide when oil hit the $50 range in 2015, according to Chet Fenimore, managing partner of Fenimore, Kay, Harrison & Ford LLP, an Austin-based law firm focusing on independent banks across the U.S.
That was partly because of declines in public banks’ stocks, which in good times serve as currency for doing transactions, according to Fenimore, whose firm opened a Dallas office in April. Lower oil prices can also hurt the financial performances of the many small and mid-sized banks across Texas, even if the bank doesn’t work directly with the oil and gas industry, he adds.
That’s because the customers of those banks often do work with the industry in fields such as hospitality and commercial real estate. “In 2015, we saw several transactions that were in the early stages of discussions that were ultimately abandoned when the oil and gas market began to struggle,” Fenimore says.
New Freedom for Deals
In May, banks gained new latitude in how they run their businesses—and in doing transactions—when President Donald Trump signed a law that reduced regulation largely imposed through 2010’s Dodd-Frank Act.
The new law is called the Economic Growth, Regulatory Relief, and Consumer Protection Act. It raises the threshold at which banks get greater regulatory scrutiny by virtue of being considered “systemically important” from $50 billion in assets to $250 billion.
“This could result in increased activity by regional and super-regional banks acquiring attractive mid-sized competitors,” says Scott Reed, partner at Dallas-based BankCap Partners, one of the country’s few private equity firms focusing on financial services.
Before the change in the law, many large regional banks were wary of doing transactions that would put them over $50 billion, experts say. In the last 10 years, Texas has had only three bank transactions with announced values of at least $500 million, Keefe, Bruyette data show. For small banks, the Economic Growth Act raises a regulatory threshold, from $1 billion in assets to $3 billion, at which point it becomes easier to use “subordinated debt” to finance M&A.
Holders of subordinated debt stand further back in line in the event the party who owes them money has to liquidate. The new $3 billion threshold means that 416 institutions nationwide, and 38 in Texas, have greater latitude to use subordinated debt to be considered “small bank holding companies,” according to Robert Flowers, a partner at Kay, Harrison & Ford LLP. “This in turn may drive additional M&A activity,” he says.
Public and private banks also benefited disproportionately from last year’s tax overhaul, which lowered the corporate income tax rate businesses pay from 35 percent to 21 percent. Banks tend to pay nearly the full tax rate because they don’t get write-offs that other industries receive for, say, new facilities. “The lower federal income tax goes right to the banks’ bottom line,” says Dan Bass, Houston-based head of investment banking at Performance Trust Capital Partners.
Even before President Trump signed tax legislation last December, banks enjoyed some of the strongest financial cushions against calamity in the industry’s history. Those backstops were the result of deposits consumers had parked in banks during a decade of near-zero interest rates.
Scale Remains Necessary to Play
The flip side is that deposits—which banks take in for one rate and loan out at a higher one—are one of several factors pressuring community banks to sell. Through a series of small interest rate hikes starting in late 2015, the Federal Reserve has, for the first time in a decade, forced banks to compete for deposits—a battle the largest players usually win. “It could become more of an issue and might slow loan growth because the banks don’t have deposits to fund new loans,” Bass says.
And while recent deregulation has helped, compliance with byzantine government rules remains costly and difficult for smaller institutions. “Though we’ve made progress in pushing it back, the reality is: you have to be bigger today,” says David Baty, president and CEO of Frisco-based Texas Republic Bank.
Since helping lead an investor group’s 2011 purchase of the bank, Baty and company have grown the 127-year-old institution’s assets from $23 million to $242 million. “We’re interested in [M&A] opportunities,” he says. “But the reality is we’re still a small player.”
Community banks are also struggling to match the technology bells and whistles available to customers of both money-center banks and emerging players like San Francisco-based RSF Social Finance, which is free of many bank regulations.
Regional institutions in particular may also see competition from a checking account-type product Amazon is considering, according to Bloomberg. But companies like Amazon and Microsoft are less likely to offer financial services that compete with the biggest banks. The reason: money center players are potential customers for tech companies’ cloud computing services, according to The Wall Street Journal.
“Technology is another issue that’s causing small banks to feel like it’s too tough to compete,” says Robert Hulsey, president and CEO of American National Bank of Texas, a Terrell-based institution with $2.8 billion in assets and roots dating back to 1875.
Software and hardware upgrades are the order of the day at mid-sized players such as Dallas-based Hilltop Holdings Inc., the Dallas parent of a group of financial services firms that includes PlainsCapital Bank. “Our technology investments and operational expenditure in digital service channels is one of our fastest-growing areas of spend,” says Jeremy Ford, Hilltop’s president and co-CEO.
“Financial technology and payment innovation is a global issue for our industry,” adds Ford, whose business has a combined $13.3 billion in assets. “While these innovations are often challenging, keeping pace with a changing world is not an option. It’s a necessity.”
Eyeing the Sunset
Community banks also face a shortage of young executive talent. “The average age of a community bank CEO across the U.S. is 64 years old,” Fenimore says. “With the baby-boomer generation at or well into retirement, there has been an increased demand for shareholder liquidity, given that most community banks are not publicly traded.”
For now, investment capital is abundant, prompting many banks to weigh going public. “Our firm has announced seven [M&A] transactions thus far in 2018, all of which are in Texas or adjacent states,” Flowers says. And more are in the pipeline.
Most recent bank mergers or acquisitions have aimed to solidify an institution’s presence in at least one large metro area of Texas. Since agreeing to buy PlainsCapital Corp. in 2012, Hilltop has snapped up institutions in the Rio Grande Valley (First National Bank) and Houston (Bank of River Oaks).
“Since starting in Lubbock 30 years ago, PlainsCapital has expanded into every major market in Texas,” says Alan White, Hilltop’s vice chairman and co-CEO. “We are excited about opportunities to increase our presence in Houston and other areas in the state.” And they’re not the only one.
Jeff Bounds is a freelance business writer in Garland.