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Hovde says ingredients remain in place for more bank M&A

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Hovde says ingredients remain in place for more bank M&A

The near-termoutlook for community banks is for more of the same modest economic growth, low interest rates and heavyregulation that leaves lenders fiercely competing for market share, prominent investmentbanker Steven Hovde says.

"Allof you are beating the tar out of each other, trying to steal others' best customers,"he told bankers who gathered this week in Scottsdale, Ariz., for a conference hostedby the investment banking firm that bears Hovde's name. He is chairman and CEO ofHovde Group.

Few bankscan emerge from such battles as winners, leaving many to contemplate selling toescape the pressure or buying to gain scale and market share quickly. That, he said,should drive M&A in 2016.

Hovde,who along with his brother owns controlling interests in a number of banks, detailedhis reasoning:

Hovdenoted that estimates for first-quarter economic expansion have been anemic. TheFederal Reserve Bank of Atlanta on April 8 pegged GDP growth during the first threemonths of 2016 at just 0.1%. While many economists anticipate a pick-up in the currentquarter, few are projecting a robust take-off, and as such, Hovde and others atthe conference say activity will likely not be strong enough any time soon to driverobust organic loan growth, leaving banks fighting for gains in market share.

And suchgains are important in a protracted low-rate environment that dates to the 2008financial crisis. Federal Reserve policymakers lifted rates by a modest 25 basispoints late last year, marking its first move off a zero-bound range in years. Butamid global economic vulnerabilities and worry about a domestic energy slump, theFed has yet to tack on the additional rate increases banks need to make lendingmore profitable.

Manyobservers have said rates need to move up roughly 100 basis points to make a notabledifference. Hovde and others at the conference were doubtful that the Fed wouldmove that much on rates this year.

Hovdeasked a conference room full of bankers what they expect on Fed action this year,and the vast majority raised their hands when asked if they expected just a single25 basis-point increase.

Againstthat backdrop, banks need high levels of loan volume to generate strong interestincome and, by extension, offset pressure to their net interest margins. That isvital, because at the same time, regulatory burden continues to mount, pressuringsmall banks the most — those under roughly$1 billion in assets — and making it difficult for many to contain costs.  A need to grow share in order to build up loanbooks and to gain scale to better absorb compliance costs, Hovde argued, has andwill continue to motivate community banks to partner up via M&A.

Hovde said that, for community banks, there is an"ideal sweet spot" in size — about $5 billion to just under $10 billion.At $5 billion or more, he said, banks have large enough bases over which to spreadout compliance costs and operate efficiently enough to generate solid profits. Andyet, these banks often want to stay under $10 billion because at that point moreregulatory requirements and scrutiny kick in.

If anything, regulatory challenges are only goingto intensify this year, Jeffery Hare, a financial services attorney and partnerat the law firm DLA Piper, said at the conference. He said that regulators are increasingly"anxious" about fast-developing financial technology companies. Thesefintech firms, which are increasingly partnering with banks, are often not directlyregulated at the federal level. But Hare said regulators are beginning to overseefintechs via their relationships with banks. And this in turn could add a layerof regulatory complexity for banking companies.

That possibility adds weight to Hovde's case for morebank M&A.

Hovde Group bank analyst Kevin Fitzsimmons remarkedthat investors are motivating banks to consider M&A as well. In the face ofregulatory headwinds and slow organic expansion, he said, investors favor banksthat make the most of what they can control, with M&A being a chief item onthis front. Deals give banks scale to manage costs and, if done well, greater marketshare, Fitzsimmons, who is co-head of research at Hovde Group, said at the conference.

Bank stocks took a beating early this year when itstarted to sink in with investors that interest rates might stay low for considerablylonger. That pushed some buyers and sellers to the M&A sidelines as buyers'deal currencies — their stocks — weakened.

But Fitzsimmons said deal talks continue to simmerfor many of the same reasons that stocks took hits: Banks that had held out forhigher rates as their "last remaining hope" for earnings expansion aregrowing tired of waiting for such a development to materialize and are looking tosell or buy.

"We think M&A will remain a positive catalyst"for community bank stocks for at least a few more years, he said.