Key Depository Markets for Banks... A Texas Perspective
Source: Stephen's INC.
Within the state of Texas, 1,567 financial institutions compete for $274 billion in consumer, business and public (government) deposits. From 1997 through 2001, deposits grew at a rate of 5.75% annually,the third fastest rate among large states (see Table 9). Due to the economic environment, not demographic trends, we are projecting deposits to grow at a CAGR of 5.25% from 2001 thru 2006, somewhat below the previous four years' growth rate.
Despite our more conservative estimates, some $80 billion in new deposits will be added to the state's total. To truly grasp this increment, recognize that this amount of new deposits would exceed the current deposit totals of banks in 32 states. Or consider that this figure is equivalent to adding the deposits of another Houston (4th largest U.S. city) and Dallas (8th largest U.S. city) to the state's total."
Our forecast for deposit growth is based on our expectation that the national economy will experience moderate growth going forward after the long and prosperous economic boom experienced over most of the past decade. Nonetheless, a 5.25% CAGR in deposit growth for Texas is very attractive on a relative basis. In fact, this rate of growth would exceed the results experienced by 75% of all states during the most recent five years.
From an investment perspective, three of the best states for banks are California, Texas and Florida as these states exhibit the most attractive demographics (e.g., population growth, income growth, home ownership). While many out-of-state banks have acquired/developed significant presence in these markets, new bank formation has not been stymied. Rather, it has flourished. Texas was second in the nation in new bank formation, with 74 de novo banks established during the past five years.
Continued Market Share Gains by Commercial Banks
Currently, commercial banks control 76% of the deposits in the state. Thrifts and credit unions each
control 11% of the total, and savings banks account for 1% (see Table 10 and Figure 6). The share of
deposits held in banks in Texas is comparable to that of banks in other large states. While all financial
institution types experienced deposit growth between 1997 and 2001, commercial banks were the
only group to grow its market share in a meaningful manner during this period.
We believe that commercial banks will persist in taking share from other financial institutions as they a) continue to win deposits on a head-to-head basis due to higher service levels and broader product offerings, b) add more branches than thrifts and credit unions will, and c) benefit from more robust de novo activity relative to other institution types. However, the more progressively run thrifts and savings banks should continue to be afforded attractive growth opportunities, in our view.
For these reasons, we are projecting commercial banks to grow their share of statewide deposits. We look for an increase of 94 basis points between 2001 and 2006 (See Table 11). The incremental market share gain equates to $3.3 billion in deposits.
Fewer, Bigger Texas Banks
Consolidation among banks has occurred at a faster clip in Texas than in the rest of the U.S.
The number of banks in the state has declined from nearly 2,000 in 1986 to just over 700 at
the end of 2001. Yet, the banking industry in Texas remains more fragmented than in both
California and Florida.
We believe that acquirers' interest in Texas banks remains keen. During the last decade, out-of-state banks crossed the state boundary "early and often," purchasing more banks in Texas than in any other state. Despite expected strong de novo activity, we look for a net decrease of about 180 banks over the next five years, reducing the state's total to 525 banks (see Figure 7 and Table 12). Since statewide deposits are projected to grow by $80 billion over this period, the average institution size should increase.
Though the number of banks in the state continues to shrink, the number of interested acquirers is expanding, particularly local (in-state) buyers. This intrastate merger alternative may provide greater flexibility, growth and capital appreciation opportunities to local community bank owners than what out-of-state-controlled banks have offered to date. It appears that sellers agree. Our analysis of over ten years worth of merger statistics reveals that nearly three-quarters of transactions are between two "local" banks. This type of transaction occurs more frequently, in spite of the fact that Texas banks pay lower multiples than NLO banks do.
While not reflected in current transaction activity, the macro-environment for bank M&A is beginning to improve, particularly for high-growth states like Texas. In total, we are projecting in excess of 200 mergers/acquisitions in Texas between now and 2006 (see Figure 8). About the same number of deals were consummated between 1997 and 2001, though activity slowed in late 2001/early 2002.
Why do we expect deal activity to increase? The 2001/2002 period has proven to be good for U.S. bank earnings, thanks to good spreads and fee income as well as modest loan losses (the Enron and/or telecom exposure at some banks aside). Thus, war chests for acquisitions are expanding. Yet, banks face stagnating commercial loan growth in a number of markets. For many of the commercial banks that strayed into the capital markets, the downturn in investment banking has served to refocus those institutions. Most have reached the conclusion that commercial banking is a safer way to grow, and they have renewed their pursuit of banks in high-growth markets. Furthermore, sector rotation in the stock market has resulted in very good relative performance for bank stocks, translating into higher P/Es that improve the economics of stock transactions. Of course, higher stock prices reduce the accretion from share repurchases, making more cash available for deals. For banks that are "bank buyers," the logical growth path is apparent: acquisitions in high-growth markets. We come to this conclusion because the use of capital for acquisitions is increasingly attractive relative to alternative uses of capital (e.g., reinvestment in existing, stagnant markets, de novo expansion, share repurchases, dividends).
In addition to the large nationwide banks, regional expansion-driven banks like Compass, South- Trust and BOK Financial are interested in increasing their presence in Texas. These banks, having outgrown their own slower-growth markets, would like to double or triple their footprint in Texas.
It is well known that plenty of banks not currently operating in Texas would like to be (e.g., SunTrust, Zion's, Trustmark, and some Canadian banks). We cannot say whether it will be stagnant loan growth in their core markets, or fear of getting left behind that move these banks off the sidelines. Inevitably, we believe, competition for the acquisitions of quality Texas banks will increase. To say that interest in Texas banks is high would be an understatement. In the last 10 years, out-of-state banks purchased more banks in Texas (143) than in any other state according to figures from SNC Financial.
Most of the recent acquisition activity has centered on the urban markets. However, we expect bank M&A activity to increasingly follow the population growth to the suburban and outlying markets. And these markets are even more fragmented than urban areas. Multiple transactions in a market may be necessary in order to impact an acquirer's results. It follows, then, that the sheer number of transactions will increase because these community banks, though highly profitable, are small. New bank formation in Texas has been strong over the past three years, though it has tapered off in recent quarters (see Figure 9). Looking ahead, we believe that strong local economic growth, as well as ongoing population migration shirts, will sustain a reasonable level of de novo activity. Expected increases in mergers should bolster new starts as well, since new bank formation is often preceded b/heightened merger activity. From 1997 through 2001, 48 new banks were formed in Texas; we expect about 50 new banks to be launched in the state during the next five years.
