Since the start of the recession, Beach Business Bank has bucked industry trends by growing its assets almost 50 percent and turning a profit nearly every quarter.
But the sharply rising costs of regulations recently drove the small Manhattan Beach lender to consider a dramatic decision that many of its peers may soon face: whether to sell. The board opted to make a deal, and Beach is merging with a larger bank.
“We made a strategic decision that we either had to be an acquirer or … be acquired,” said Chief Executive Robert Franko. “Compliance costs are going up. I don’t think that smaller banks can remain competitive for the long run.”
The move reflects the dire situation facing many community banks today: As the costs of complying with new and forthcoming regulations are rising at the same time that profit margins are being squeezed, many small banks are struggling to remain competitive. As a result, many bankers say, the industry is beginning a period of consolidation that could reshape the landscape.
Already, small banks in Los Angeles County have entered more than a half-dozen merger deals since last summer, including the pending combination of Professional Business Bank in Pasadena and Bank of Manhattan in El Segundo. Franko estimated that as many as one-quarter of California’s community banks – including profitable, growing institutions – could be forced into mergers in the next three years.
That expectation has larger banks lining up in the hopes of cashing in on a profitable acquisition. City National Bank, the largest local commercial bank, has said it is looking for potential acquisitions in the community banking space.
“You’ve got a lot of bigger banks looking for deals,” said Richard Levenson, president of Western Financial Corp. in San Diego, an investment banking firm that caters to community banks. “I think we’re going to see an accelerated rate of bank acquisitions.”
First PacTrust Bancorp Inc. in Chula Vista reached an agreement in late August to buy Beach for $37.4 million, a 53 percent premium on its stock price. The deal, which is expected to close in the next few months, came shortly after First PacTrust announced the acquisition of another small institution, Gateway Business Bank in Cerritos.
For Beach’s board, the decision centered on projections of revenue and expenses.
In the current environment of low interest rates and with demand for lending down, many smaller banks are finding it difficult to grow their loan portfolios organically. As a result, revenue remains suppressed.
“As that happens, cost control becomes more important than ever,” Franko said.
And costs are going up as regulators place additional compliance burdens on banks, he said.
The Dodd-Frank Act alone is adding several hundred regulations and rules. While small banks are exempt from many of them, the banks still are facing many more tasks and higher compliance costs.
For instance, Franko said, the process to originate a simple mortgage loan has become much more complex, requiring additional paperwork, more time and an exact sequence of events to complete the loan.
In the past, one nonexpert staffer might have been able to handle the loan, but Franko said banks now have to have at least one and oftentimes multiple specialists to originate the loan within the new regulatory guidelines. Of course, the specialists cost more.
The costs are also rising in other areas, including more information technology support to ensure that websites are secure and more consulting support to handle merger transactions.
Since most of those compliance procedures are essentially fixed, smaller banks face a proportionally higher cost than bigger banks – even much bigger banks. Franko estimated that a bank with $300 million in assets would have operating expenses comparable with a bank five times larger.
That notion has been behind a number of recent mergers in the local market.
Mary Lynn Lenz, chief executive of Professional Business Bank, complained about the “static expenses” that are weighing down small banks.
“It’s becoming increasingly daunting for community banks to produce positive earnings and continue to grow those earnings year after year when you have certain static expenses,” she said during a recent interview.
Lenz engineered a merger in 2010 that helped the bank recover from heavy loan losses it incurred during the downturn and boosted its assets to nearly $400 million. But once that task was complete, she said she knew that the bank still could not compete in the long term. So she helped arrange the deal with Bank of Manhattan, which was announced in November.
“We have taken a lot of expense out of this company,” she said. “We have done a really good job of bringing in new business and developing new relationships, but it came a point in time where I really believed as the CEO that we needed a merger.”
Opportunities abound
A number of larger banks are angling to take advantage of the situation and grow through acquisition.
First PacTrust has already acquired Beach and Gateway, and it plans to do additional deals.
Grandpoint Bank in downtown Los Angeles has acquired a series of institutions since it launched in 2010. Those pickups include Escondido’s California Community Bank and Phoenix’s Bank Capital Corp.
In a recent conference call to discuss City National’s quarterly earnings, Chief Executive Russell Goldsmith said the bank is “waiting, watching, looking for opportunities” to acquire a small bank that can no longer remain competitive at its size.
“We fully expect that there will be banks … that will realize that they’re better off merging with the right partner and getting the benefits of some scale that a bank like City National can provide,” he said.
Joseph Gladue, a bank stock analyst for West L.A.’s B. Riley & Co., said with loan growth sluggish at all levels, larger banks need to look at acquisitions in order to build business. He cited City National and PacWest Bancorp, a midsize Century City bank, as institutions that he expects will look for deals.
“A lot of the banks I follow have been very open that they are very eager to find banks to buy,” he said.
