It appears that "activist" investors are turning to banks because they, like many of the rest of us close to the banking sector, think that there will be continued consolidation of the banking industry in the U.S., and what better way to make yourself some hard-earned profits than buying shares in a business and then pushing its board to sell the family farm so you can cash out. Some of you may remember that this model business plan was why the FDIC apparently soured on relying on "private equity" investors to help it clean up the mess after the last banking meltdown.

According to reporters in the St. Louis Post-Dispatch, "[a]ctivist investors are putting the U.S. banking sector in their crosshairs, betting that headwinds whipping through the industry will accelerate consolidation among lenders." The authors cite the rapid uptick in such "activist campaigns" in the financial sector last year, and observe that the "activists" are turning their attention from insurance companies and other non-bank financial businesses to commercial banks.

Hedge funds such as Ancora Advisors, Clover Partners and Seidman & Associates are buying up stakes in lenders across the U.S., from community banks to large regional lenders.

Driving these investments is the view that ultra-low interest rates, lagging returns on equity and tough regulations will push more banks to merge, with buyers willing to pay a hefty multiple to a bank’s tangible book value. Activist investors interviewed by Reuters say another factor is exposure to energy-related loans, which is driving down the valuations of certain banks and making them all the more vulnerable to a takeover.

“Bigger banks are back in the market doing deals,” said Ralph MacDonald, a partner at law firm Jones Day, who specializes in mergers and acquisitions.

U.S. bank mergers and acquisitions volume rose 58 percent last year to $34.5 billion, according to Thomson Reuters data.

The authors think that Zions and Comerica are likely targets. Both "Systemically Important Financial Institutions" had under performing returns on equity last year. That alone makes them prime targets for "activists."

The firm believes that any bank earning a 12 percent or less return on tangible common equity needs to consider whether it can prosper as an independent institution, PL Capital co-founder Richard Lashley said in an interview.

A bank’s exposure to falling energy prices makes it even more vulnerable, he noted. But another key factor is a bank’s ability to maneuver through a climate where low rates are compressing net interest margins, and stricter regulations are increasing costs.

“Management teams and boards are just exhausted,” said Lashley, who is based in New Jersey. “It’s not fun to run a bank anymore.”

However, the article also contains a quote from a community bank chief that indicates that the trend to consolidate is not just for SIFIs.

“My phones are ringing off the hook with calls coming in from banks wanting to sell,” said Pat Hickman, the CEO of Happy State Bank, a lender in the Texas panhandle. “And one of the primary reasons is regulation.”

Yes, it's not fun to run ANY bank anymore, not just the large ones. Whether your a big bank or a small one, publicly traded or privately held, pressured by "activist" investors or simply by the facts of life: as we said a few weeks ago, 2016 will very likely be the year of the bank merger.

After an entire summer blissfully not blogging, what better way to ease back into the humdrum routine of enraging and/or boring my jaded readership than by letting my friend, former community banker Pat Dalrymple, do the heavy lifting for me with a guest post.

Pogo Possum, in Walt Kelly’s classic comic strip, once intoned, “We have met the enemy, and he is us”.

In 1973, I was lucky to be hired to run a de novo thrift in Aspen Co. Our chairman was a young guy, a graduate of the Wharton School of Business at Penn, who was fortunate enough to retire at 40 and fill his time with interesting projects.

While I was getting the doors of the business open, he attended the Colorado state S&L convention. Upon his return, my friend Mike paraphrased Pogo: “I’ve met the enemy, and it’s us”.

Not much has changed in 42 years, especially at the community banking level.

But, some leaves are rustling. We’ll see if it develops into a wind of change.

It’s noteworthy that, almost to a man (and there are precious few women in the job) all of the CEO’s of small banks were comfortably ensconced in the position before the Great Recession. Now, they’re riding off into the sunset, or going to that Great Loan Committee in the Sky. Maybe traditional bank think will go with them.

Here are a couple of revealing conversations I’ve had in the past month or so:

A banker that I respect who’s at the top of the depth chart for his position recounted an anecdote from the security line at Denver International Airport. Going through this procedure is an experience that he detests, so he was miffed to see a young man ahead of him in line chatting up and laughing with the TSA agent. “Who has a friendly tete a tete with a TSA apparatchik?”

Then, he realized that the kid grew up with 21st century airport security. He’d never experienced wandering an airport at will, and greeting friends at the gate, so it never occurred to him to get all worked up over a normal situation. So it will be, my friend realized, with banking. The excessive angst of bankers over regulatory risk and oversight will fade with the older generation.

The second conversation involved a leading banking consultant who asked one of his small town bank clients if he was leaving the business, like many of his peers, in disgust as a result of Dodd-Frank and the CFPB.

“Why would I do that?” , was the response. “I’m hiring smart young people who never knew how it was. They’re taking the heat for me, and they think it’s just another day at the office.”

Whether us old fogies are riding into the west, or, more appropriately, sinking like mammoths into the swamp, there’s a new generation that will hopefully not be bound by the inherited thinking of several generations of bankers.

Maybe they’ll understand what community bankers have missed since Bonnie and Clyde were making premature withdrawals: The business of banking isn’t lending money; rather, it’s the function of making a profit on the movement of money.

Nothing illustrates this disconnect better than recent meeting I had with an account exec for a national factoring firm. His firm has been frustrated for years by the failure of the banking system to capitalize on his company’s ability to serve banking customers that either don’t meet the banks’ lending criteria or the financing format isn’t offered by the bank. He said he’s suggested setting up a consortium of banks to funnel un-fundable business to his firm, and has urged individual banks to use the resource, all to no avail.

Non-institutional lenders like this aren’t asking for freebies. They pay very well for referrals, and they do all of the work. It’s about the easiest way to make money on money movement imaginable.

At the end of the meeting, he casually dropped a comment that encapsulates the whole sad state of banking’s perception of itself. His company got a bank referral, and duly paid for it. But, he said, “We had to pay the fee to the banker’s wife, because it was against regulations for him to accept it.”

What?

Sure, this was motivated to some degree by greed on the gentleman’s part, but probably the situation was due more to a cultural mindset than to avarice. It simply didn’t occur to the banker that he had a profit center at his fingertips, nor, most likely, would it ever.

Every bank should have a Non-Conforming Lending Division to move money from other sources at a profit. When a customer doesn’t qualify, that potential source of revenue should be ushered across the hall to the bright young lady that runs the NLD, to tap one of a stable of non-institutional lenders.

And every community bank should have a robust mortgage brokerage operation (yup, I used the “B” word, right here in front of bankers). Today, the playing field is absolutely level; mortgage wholesalers have exactly the same rates and programs as the big players, such as Wells and Chase, and when the loans are funded by the lender, rather than the broker, there’s little regulatory risk, and, of course, no asset risk.

If a bank CEO would take the trouble to total up the money left on the table for, say, the prior 12 month period, it would be hard to explain to the stockholders why so much revenue was spurned. And, I assure you, it’s inevitably a big number.

We continue to hear about the mass extinction of community banks. Maybe it’s true.

After all, if you stand long enough in the swamp, you’ll sink into fossilization, no matter how big your tusks are.

While banks have complained about the crushing burden of regulations in a post-Franken-Dodd world, in one area they could use a little more regulation. Not of the banks, but of third-party service providers to banks.

I have yapped repeatedly on this rag sheet about how banks need to treat regulatory guidance seriously. While some regulators send confusing signals about the legal enforceability of guidance, they have also made clear that they expect banks to comply with it. Period.

One piece of guidance that we have discussed is OCC Bulletin 2013-29 regarding third party relationships, which is a reworking and expansion of guidance first issued in in 2001 (OCC Bulletin 2001-47). Other federal financial institution regulators have issued similar guidance. One portion of that guidance deals with provisions that the OCC expects to be incorporated into written agreements between banks and their service providers. Banks who take regulatory guidance seriously attempt to ensure that their written agreements with their significant vendors meet the regulators' expectations.

If some technology service providers are to be believed, not many banks take the guidance seriously.

Repeatedly, attorneys who advise banks on such agreements will hear a common complaint: the bank asking for such a contractual provision is the only bank that has ever asked the vendor for the same. Putting aside my stock response ("You'll never be able to say that again, will you?"), let's take them at their word and see what this means.

Let's pick two provisions, access by the bank's regulators to the service provider's records concerning the services it provides to the bank, and a binding agreement by the vendor to provide the bank with a disaster recover plan and modifications to it. These aren't the only provisions. There are many more, but I don't make a living off this blog, so they'll have to do for now.

OCC Bulletin 2013-29 provides in part as follows:

In contracts with service providers, stipulate that the performance of activities by external parties for the bank is subject to OCC examination oversight, including access to all work papers, drafts, and other materials. The OCC treats as subject to 12 USC 1867(c) and 12 USC 1464(d)(7), situations in which a bank arranges, by contract or otherwise, for the performance of any applicable functions of its operations. Therefore, the OCC generally has the authority to examine and to regulate the functions or operations performed or provided by third parties to the same extent as if they were performed by the bank itself on its own premises.

That's pretty clear. Yet, we have repeatedly encountered service providers, including one of the major technology service providers in the United States, who have resisted such a contractual "stipulation". In one discussion, a service provider that was providing an online banking system and related customer-facing services asked the bank to cite the provision of the law that gave the OCC the right to have such access. When we gave it the citation to 12 USC 1867(c), it responded that its inside counsel did not agree with the OCC's interpretation of the Bank Service Company Act, and that examinations that it had permitted the OCC to make were purely voluntary and could be terminated at any time. We responded that we didn't give a flying fig in a rolling donut what its in-house counsel thought about the OCC's interpretation, since the law was clear on its face. In that case, we compromised on language that required such regulatory access "as is required by applicable law." However, we were told by that vendor that other banks did not insist on such a provision in the agreement.

With respect to business continuity plans, OCC Bulletin 2013-29 provides the following:

Ensure that the contract requires the third party to provide the bank with operating procedures to be carried out in the event business resumption and disaster recovery plans are implemented. Include specific time frames for business resumption and recovery that meet the bank’s requirements, and when appropriate, regulatory requirements. Stipulate whether and how often the bank and the third party will jointly practice business resumption and disaster recovery plans.

Recently, we have encountered a technology service provider who provides a critical online banking service that absolutely refuses to agree to any provision in the agreement that addresses business continuity plans or procedures. While it states that it has such a plan and that the bank can review it, it will not agree to put anything in the contract regarding such plans. Again, the bank was informed by the vendor that it has never agreed to provide such contractual protection to a financial institution, and that no other bank has insisted upon it. Again, this is a critical service provider whose service, if it went "offline" for any length of time, would cause intense heartburn to the bank.

These are only two examples. There are many, many more. It's as if not only are many vendors unaware of requirements that their bank clients must meet (and that have been required for over a decade), but that many banks do not care about complying with regulatory guidance. In the case of smaller institutions, there is also the problem that they lack the expertise to negotiate, or perhaps they believe that they do not have sufficient importance to the vendor to bargain effectively. Whatever the reasons, many of them are rolling over with their paws in the air instead of trotting in the other direction.

This leaves those banks that take regulatory guidance seriously in a tough position. Some of them are simply walking away and trying to find vendors who "get it," even if they are not the first choice from a purely business standpoint. Others end up negotiating with themselves to arrive at less-than-reasonable contractual compromises.

I have a couple of suggestions for the regulators. First, try enforcing the guidance across the board. There are financial institutions who are trying to "do it right," but who are being undercut by those who aren't. Moreover, use your authority under the Bank Service Company Act and otherwise to bring home to the vendors directly that if they want to play in this arena, they need to play by your rules. Some of them are not getting the message. Perhaps it would be helpful to start naming names on both ends of the spectrum. Perhaps that would get some attention.

In fairness, there are technology service providers who are doing it right. They understand the guidance, and while they are not willing to fall over and play dead, they are willing to make a reasonable attempt to accommodate what is essentially appropriate risk allocation between the parties, and appropriate accommodation to their customers' regulators' expectations. They "get it." Here's hoping that more of them eventually get the message, as well.