Community banks to prioritize restructuring, growth in capital strategy over M&A

Growing regulatory capital and external raises are paving the way for community banks to continue balance sheet restructuring and look for income opportunities.

In the second quarter of 2024, US banks' aggregate common equity Tier 1 (CET1) capital rose to $2.18 trillion from $2.14 trillion a quarter earlier, according to S&P Global Market Intelligence data.

For community banks, CET1 capital was $384.07 billion in the quarter, up from $379.44 billion a quarter earlier. The median leverage ratio of community banks, which measures capital relative to assets, rose to 10.67% for the quarter, its highest point since 10.96% in the first quarter of 2020, according to Market Intelligence data.

Community banks with excess capital will likely find organic growth more attractive than M&A, as many banks do not want to miss the time window to grow high-yield assets before rates drop back down, industry observers said.

"I think some banks with excess capital are actually, instead of doing M&A first, they're going to look at themselves and say, 'should I spend a little bit of my excess capital repositioning my balance sheet?'" said Scott Hildenbrand, head of depository fixed income at Piper Sandler.

Community banks have also been actively raising external capital in conjunction with balance sheet repositioning, and there is an appetite for more such transactions, said Frank Sorrentino, a managing director at Stephens' financial institutions group.

"I think what people are finding is that they're better off basically repositioning their own company, turning 'playing defense' into 'playing offense,'" Sorrentino said.

Among recent deals, on Sept. 27, Coral Gables, Florida-based Amerant Bancorp Inc. raised $165 million in common equity. Amerant will use the capital to resolve nonperforming loans and reposition securities.

Additionally, Dallas-based First Foundation Inc. moved to reclassify $1.9 billion of its multifamily portfolio from loans held to maturity to loans available for sale, after raising $228 million in July.

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Looking for growth

Unlike in 2023, when some banks were in dire need of capital after the March 2023 turmoil, banks' current capital considerations are driven by the pursuit of growth as interest rates trend downward.

"I think liquidity seems to have stabilized," said Brennan Ryan, a partner on the financial regulatory and corporate team at Nelson Mullins. "You really, in some cases, are looking for that income opportunity."

For many banks, there are opportunities to improve on both the liability and asset sides. Banks have been deploying capital to pay down high-cost funding sources, redeploy capital into higher-yielding securities and search for loan growth while the credit environment is relatively benign, Ryan said.

Amerant's capital raise and the balance sheet repositioning indicate its shift to growth, Piper Sandler analyst Stephen Scouten wrote in note after the capital raise announcement.

Amerant plans to transfer all of its $220 million securities designated as held-to-maturity to available for sale; sell all securities yielding under 2.75%; and sell all corporate debt securities including the bank unit's subordinate debt.

Navigate uncertainties

The moves to bolster balance sheets come as banks try to navigate political uncertainties, persistent challenges in M&A and dynamic capital market trends.

"I think it's really hard for folks to get M&A deals done right now anyways. And then also, you've got an election coming up," Hildenbrand said. "So I think everybody may wait that out, and get your balance sheet ready for 2025."

Commercial real estate exposure is also still complicating M&A considerations, especially if the CRE concentration ratio of the combined entity exceeds 300%, Sorrentino said.

"It's not that they won't transact. It makes it harder, and they probably need to raise equity as part of it," Sorrentino said.

Although community banks have faced a "rain delay" with subordinate debt due to the high cost, some banks have recently raised sub debt to put cash to work, Hildenbrand said. First Business Financial Services Inc. issued $20 million of sub debt in September and plans to use the proceeds to fund loan growth.

For the second quarter, banks in the Community Bank Leverage Ratio (CBLR) framework with the highest leverage ratios included Alma, Wisconsin-based Bank of Alma, Wyoming, Ohio-based Spring Valley Bank, and Fairfax, Minnesota-based First National Bank of Fairfax. Spring Valley Bank is under a consent order for weakness in consumer protection and compliance.