Some community banks celebrate their recovery by selling themselves. Heritage Oaks Bancorp (HEOP) is opting instead to buy itself something nice.
The $1.1 billion-asset company in Paso Robles, Calif., recently agreed to acquire the $445 million-asset Mission Community Bancorp (MISN) in San Luis Obispo, Calif., for $56.4 million in cash and stock.
The deal would take out its next largest rival and allow Heritage Oaks to leapfrog over Bank of America (BAC), JPMorgan Chase (JPM) and Wells Fargo (WFC) to second place in deposit share in San Luis Obispo County.
Expected to end up with 17.69 percent of the market, Heritage Oaks would be comfortably above Wells' 13.93 percent, but still well below Rabobank's 26.14 percent.
For Simone Lagomarsino, the chief executive of Heritage Oaks, the acquisition was a chance to cement her company's place in the county less than two months after the Federal Reserve released it from an enforcement action.
"We are the largest community bank in the central coast, and they are the second," Lagomarsino says. "If we didn't buy them, someone else possibly would have."
The deal is about more than gaining market share, though. If all goes according to plan, Heritage Oaks will make a lot of money. The branch networks have significant overlap, and the buyer anticipates it will be able to halve Mission's expenses. The combined company is expecting a 20 percent boost to earnings as a result of the combination in 2015.
"As net interest margins have compressed, it takes the same energy, effort and people to run the bank, but earnings are less than they were," Lagomarsino says. "We've all done everything we can to operate more efficiently."
The trend lately has been toward transformational deals — ones that turn banks into puzzle pieces. Their markets or business lines complement each other, and together they can create powerhouses.
Such recent deals include Heritage Financial (HFWA), which skirts Seattle to the south, pairing up with Washington Banking Co. (WBCO), which operates north of the city. PacWest Bancorp (PACW) in Los Angeles is solving its loan demand woes by acquiring CapitalSource (CSE), a specialty finance company with an industrial loan charter that had long wanted to become a bank.
Deals for in-market rivals that are heavy on cost cuts — but low on the long-term strategic benefits of, say, entering a new market or a new business line — are the safer option, observers say.
"The risk perspective is lower. You get to stay in the neighborhood," says Christopher Raffo, a managing director at Caldwell Securities in Sausalito, Calif. "It's beautiful. It is hard to argue with a classic overlapping deal."
If dealmaking is a progression, the in-market deal is level one.
"If you're skittish and don't want to stretch, you do a deal with plenty of cost saves," says Tim Coffey, an analyst at FIG Partners. Cost savings "are like an insurance policy in case you got the math wrong. We are starting to see more transformational deals — that's the next stage of M&A."
Lagomarsino says Heritage Oaks is adding loans organically, but it could look to do a deal that would take it into a new market.
The worry in in-market deals is the execution of the branch reduction, but Lagomarsino gets high praise from analysts in her ability to win over customers. Meanwhile, James Lokey, the chief executive of Mission, said in a conference call that the deal would be a positive for his depositors because Heritage Oaks has 12 branches across San Luis Obispo and Santa Barbara counties, where his bank has five branches and a loan production office.
For Heritage Oaks, the deal comes less than two months after the Fed released it from a 2010 memorandum of understanding that ordered the company to overhaul its operations. Over the summer, the company also redeemed the $21 million in preferred shares it issued the Treasury Department's Troubled Asset Relief Program.
Heritage put its defensive playbook "emphatically … well behind it" with the deal, says Tim O'Brien, an analyst at Sandler O'Neill, in a research note. "And it picks up its competitive offense game along the central coast."
Heritage's decision to buy right after its recovery is a bit of a break from the pack of banks this year that have looked to sell right after being freed from orders. Heritage Oaks is still in the bucket of banks that could likely sell, Coffey says, and improving its profitability with an in-market deal may only make it look more attractive. Lagomarsino also isn't ruling out a sale at some point.
"There is not the need to sell, but that doesn't mean we won't sell," Lagomarsino says. "We'll continue to seek out ways to improve our shareholder value."