March 5, 2014

Smaller banks merge as TARP deadline looms

Two Charlotte bank mergers in two days have at least one root in common – the federal bailout of the financial system.

Two Charlotte bank mergers in two days have at least one root in common – the federal bailout of the financial system.

On Wednesday, Park Sterling Corp., the largest regional bank based in Charlotte, said it would buy 80-year-old Provident Community Bancshares of Rock Hill.

That news came a day after Charlotte-based Bank of Commerce said it would end its seven-year run by selling to HomeTrust Bancshares in Asheville.

Both Provident and Bank of Commerce said the deals made sense for a variety of reasons. But both cited the fact that investments in their banks stemming from the financial crisis were about to get much more expensive.

Here’s how. At the height of the crisis in 2008 and 2009, the U.S. Treasury made preferred stock investments in hundreds of banks across the country under the Troubled Asset Relief Program, known as TARP. The banks got capital, sorely needed as a buffer against losses. In return they had to pay the government an annual interest payment.

By now, most banks have paid the money back. But the investments were designed in a way that penalizes banks that haven’t repaid their obligations five years later.

As that deadline rolls around this year, the impending changes have prompted small banks across the country to explore a sale to bigger banks that are better able to repay the government or private investors who have bought the securities. That includes the two Charlotte-area banks announcing sales this week.

“It’s sort of been an 800-pound gorilla in the room,” said B.T. Atkinson, a partner with Nelson Mullins Riley & Scarborough LLP in Charlotte. “I think there’s no question it’s a factor.”

Park Sterling gets a significant boost in its South Carolina presence through the Provident deal, worth a total of $6.5 million.

Park Sterling will pay $1.4 million in cash to Provident shareholders, or about 78 cents per share. The deal also includes paying the U.S. Treasury $5.1 million to redeem preferred stock stemming from TARP – a 45 percent discount from what the government was owed.

It’s not unusual for the Treasury to sell some of its TARP investments at less than original value as it unwinds the program. The government says it has made a profit on the bailout program overall.

Bank of Commerce shareholders will get about $10 million in its acquisition by HomeTrust. The transaction includes paying off $3.2 million in preferred stock once held by the Treasury. It had been sold to private investors in a 2012 auction.

In both deals, the banks being acquired were staring down the deadline for repaying the preferred stock investment. For the first five years, banks were to pay a 5 percent annual dividend. After that, the dividend becomes 9 percent.

For community banks, that difference can add up to hundreds of thousands of dollars – an amount that could easily push a year-end report from the black to the red.

“It makes you think about how you’re going to pay it off over time,” said Jefferson Harralson, an analyst with Keefe, Bruyette and Woods. “If it’s going to be very difficult to pay off over time, you might choose to sell your bank.”

Repaying TARP certainly isn’t the only factor propelling mergers of smaller banks these days. Many banks with the bailout-era investments still on the books have struggled financially. Low interest rates and increasing regulatory costs have also spurred a wave of small-bank consolidation across the country.

But industry experts say the deadline has given bank executives a new reason to take a look at the future of their banks. It’s one more factor in a shrinking community banking industry that has left some small business owners with fewer choices for loans.

Not the only factor

In the Park Sterling deal, the chief executives of both banks said the merger makes geographic and economical sense on both sides.

Park Sterling CEO Jim Cherry said the deal will increase the bank’s position in the upstate and midlands regions of South Carolina and boost its deposit base as the bank expands into Virginia.

On the other side, Provident CEO Dwight Neese said his bank has struggled with credit issues through the recession, and faces significant risks as interest rates begin to rise.

“We just don’t have the capacity to solve that problem as a standalone bank,” he said. The bank had been looking for an investor or buyer for a while, Neese said, but the preferred stock deadline gives an added incentive.

“With this increase in rates, banks are motivated to do something,” he said.

For HomeTrust, the foothold in the Charlotte market was a primary driver in doing a deal. Acquiring Bank of Commerce was one of the last ways for a regional bank to get into the heart of the Charlotte market without building an infrastructure on its own, Atkinson said.

Wes Sturges, Bank of Commerce’s CEO, said the preferred stock on the books was a factor in the decision to sell, but not the final decision-maker.

“It was nice to have it gone, but it wasn’t pushing us to panic,” he said.

And a sale isn’t the only way to avoid the increased payments. Gary McNorrill, a Charlotte-based managing director at Atlanta’s Banks Street Partners, said banks that are not looking to sell have found other ways to repay preferred stock investments as the deadline approaches.

While his investment bank has seen an uptick in merger and acquisition activity, “I don’t know that the increase in the rates is really driving it,” he said. “We’ve been fortunate to see multiple alternative funding sources as the rate increase comes into play for most of these banks.”

A Treasury spokesman did not respond to a request for comment.

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