Spate of banking mergers may be just the beginning

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First Merchants Corp. CEO Michael Rechin thinks a wave of bank mergers is coming—driven by financial institutions’ quest to increase profits in an environment where super-low interest rates continue to squeeze margins.

Rechin Rechin

“I think the interest rate cycle is going to be the driver of more deals than the credit cycle was,” Rechin said, referring to the massive loan losses many banks suffered in the wake of the financial crisis.

First Merchants, in fact, pulled off its own deal this month, announcing it is acquiring Munster-based CFS Bancorp and its Citizens Financial Bank subsidiary for $115 million in stock.

The deal expands Muncie-based First Merchants into the northern reaches of the state. It’s expected to add to profits immediately—in part because of an anticipated $11.5 million in cost savings.

Rechin said the greater efficiencies that come with scale are a big deal at a time banks are facing substantial headwinds, including increased government regulation and increased investments to upgrade technology.

He noted that First Merchants runs its back-office functions out of an operations center in Daleville that could support a bank 50 percent larger than First Merchants with little additional investment.

Similar dynamics helped drive a very different deal announced this month involving a similarly named institution—Carmel-based Merchants Bank of Indiana.

Merchants’ eight shareholders will receive stock valued at $189 million in return for merging their institution into Mooresville-based Citba Financial Corp., parent of Citizens Bank. The buyer, which will adopt the Merchants name, gains ownership of Merchants’ P/R Mortgage and Investment Corp., a fee-generating powerhouse that leaves Citba less exposed to the vagaries of interest rates.

In explaining the deal, Citba CEO Lynn Gordon said, “Margin compression is really impacting all traditional community banks. All community banks are looking for non-interest income revenue streams.”

Indeed, these days, bankers in Indiana and across the nation are racking their brains trying to figure out how to grow and reward their shareholders amid a humdrum economy made worse by a prolonged stretch of low interest rates and thin profit margins.

Banks generally are set up to increase earnings when interest rates increase—and a stronger economy would push rates higher. But that more favorable operating environment could be years away.

In normal times, the solution might be to expand profit margins by paying less for deposits. But bankers say those rates already are almost nothing and can’t go lower.

“You cannot offset this margin pressure with a corresponding reduction in your price of funds. It’s what they call the classic squeeze, and we are all getting squeezed,” said Morris Maurer, CEO of The National Bank of Indianapolis.

NBI managed to post a record 2012, and many other banks also are seeing improved results, in part because losses on soured loans have subsided.

However, banking experts say the earnings boost institutions will get from healthier loan portfolios will only take them so far. What they need is a return to robust load demand and vibrant economy.

The lack of a clear path forward, experts say, often will lead executives to explore merger opportunities.

Carmel banking consultant Mike Renninger doesn’t expect a deluge of deals, “but the constant pressure of improved earnings in this economic climate is certainly going to wear on people.”

Forty-seven bank deals were announced in the United States in the first quarter, and 226 were struck last year, according to SNL Financial. Experts expect this year’s activity to eclipse 2012, in part because the rally in bank stock prices has given buyers a stronger currency to do deals.

First Merchants has a long history of using dealmaking to develop a beachhead in growing markets. In 2008, for instance, it acquired Lincoln Bancorp of Plainfield, and last year it bought the loans and deposits of the failed SCB Bank of Shelbyville. With each acquisition, First Merchants positions itself as a service-driven alternative to super-regional banks.

Even in disappointing environments like this, hunkering down and waiting for better times is not an option, Rechin said. “Customer preferences drive a need to reinvest in technology. If you can’t meet customers’ expectations, your company runs the risk of losing relevance.”•

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