A Foot In The Door

Out-of-state banks are buying their way into the Tar Heel Market. More to come . . .

 By Frank Maley

After 32 years in Tar Heel banking, Bob James had reached the pinnacle. The CEO of Charlotte-based First Charter Corp. was elected in June to a one-year term as chairman of the North Carolina Bankers Association. But by the time that term ends, he probably won’t even have the top job at his own bank. About two months after his election, First Charter, the state’s fifth-largest bank, agreed to be bought by Cincinnati-based Fifth Third Bancorp, the nation’s 19th-largest and perhaps its most awkwardly named. “We told them we’d merge with them if they called it Fifth Third First,” James quips. “That didn’t go over too well.”

Lots of other things did. In addition to a bridgehead between its operations in the Midwest and Florida, First Charter will give Fifth Third the fourth-largest share of the growing Charlotte metro market and launching pads in two other desirable ones: Raleigh and Atlanta. Fifth Third gives First Charter a way to broaden product lines quickly and gracefully exit what has become a rocky road for banks. It also provided something Tar Heel banks couldn’t — minimal impact on employees because there’s no overlap between the two banks’ territories. “We were looking for as much of our company to survive in the merger as possible,” James says. “And that was only possible with an out-of-state company that wasn’t in the market.”

Two weeks after the First Charter deal was announced, Columbia, S.C.-based SCBT Financial said it would buy the holding company of The Scottish Bank in Charlotte, the 75th-largest financial institution in the state. SCBT sees it as a way into the Charlotte market; Scottish Bank, which will keep its name, can improve its product offerings.

In light of history, two deals within a month constitutes a small run on Tar Heel banks by outsiders, and Scottish Bank likely won’t be the end of it. “Within a year or two, we’re going to see another out-of-state entrant in this market,” says Tony Plath, associate professor of finance at UNC Charlotte. “As long as we still have an in-migration of people, we have a growing labor force, we have a growing number of jobs, the Carolinas will continue to be an attractive point of entry into the Southeast.”

And Fifth Third sees it as a good place to expand, James says. “We would very much like to continue to do acquisitions in North Carolina, South Carolina and Georgia to build our franchise and our affiliate under the Fifth Third flag.” Acquiring banks is a quick way to build market share, but as a handful of other out-of-state banks have found, taking market share from the hypercompetitive North Carolina banks isn’t so easy unless you buy it, Plath says. “I haven’t seen anybody come in and light this market on fire, pretty much because it’s already on fire when they get here. And it’s a bigger fire than they’re used to.”

In the 1980s and ’90s, North Carolina banks got used to preying on those in other states. Permissive statewide branching rules gave Tar Heel banks experience with expansion and more heft than banks in some other states — big advantages as federal restrictions on interstate banking eased. Some North Carolina banks, led by what are now Bank of America and Wachovia, began aggressive acquisition sprees. By the end of the ’90s, Bank of America had branches in 21 states and Wachovia’s predecessor, First Union, was in 12.

In 2000, Memphis, Tenn.-based National Commerce Financial turned the tables when it acquired Durham-based CCB Financial, the seventh-largest bank in the state. (National Commerce later was bought by Atlanta-based SunTrust Banks.) Royal Bank of Canada followed that a year later, buying Rocky Mount-based Centura Banks, the sixth-largest. That was the last purchase of a top 10 Tar Heel bank. The First Charter deal is expected to close early next year. Those out-of-state companies won’t show up on The Financial 100, Business North Carolina’s list of the largest banks, thrifts and credit unions based in the state. But they do have a large presence here, and if experts such as Plath are right, it will increase. As of June 30, 2006, SunTrust and Royal Bank of Canada ranked fifth and sixth in Tar Heel deposits, and Fifth Third will likely rank seventh when its purchase of First Charter closes. Charlotte-based Wachovia is the market leader by far with $81 billion and a 42% share.

Other out-of-state banks do business but don’t hold deposits in North Carolina. San Francisco-based Wells Fargo, for example, is the state’s top mortgage lender, with $4.9 billion in loans closed in 2005, the latest year for which numbers were available. Six of the top 10 mortgage lenders that year were based outside the state.

There are several reasons to think more out-of-state banks will buy into North Carolina — and thin the top echelons of The Financial 100 — in the next few years. The gross state product grew 4.2% in 2006, compared with 3.4% for the nation. And Tar Heel banks, like others around the U.S., might come more cheaply than they have in the past. For much of the last two years, banks, which borrow at short-term interest rates and lend long-term, have seen profits pinched by daily U.S. Treasury yield curves that have been flat — with short-term yields about the same as long-term ones — or inverted — with short-term yields higher than long-term ones.

More banks also are having problems with loan losses than before. In early October, New York-based Citigroup said increased loan losses would help cut third-quarter earnings. “As you look out for the next year to two years, it’s a tough operating environment for banks,” James says. “It’s still a flat yield curve, which means margins are continuing to decline. Core deposit growth is almost nonexistent. Asset-quality trends are declining, and regulatory costs continue to increase.”

On Aug. 6, less than two weeks before First Charter’s buyout was announced, its stock hit $17.78, a four-year low. That same day, the Nasdaq Bank Index, which includes First Charter, hit its lowest point in three years. The day before First Charter’s announcement, the NYSE Financial Index, which includes Bank of America and Wachovia, closed the lowest it had in more than a year.

Harry Davis, professor of finance at Appalachian State University and economist for the North Carolina Bankers Association, says a slowdown in the nationwide housing market means banks will write fewer mortgages and a slowing national economy will mean fewer commercial loans. “Bank profitability overall will probably decline some next year.”

Depressed earnings will keep a lid on stock prices, so shareholder value won’t increase much, James says. “That will put added pressure on some managements to look at alternative ways to increase shareholder value. One is to partner with a larger company, where your shareholders, like First Charter’s, get an immediate pickup in price and a significant increase in dividend.”

Fifth Third’s 42-cent quarterly dividend is more than double First Charter’s. First Charter stock jumped 38% the day of the announcement and finished September above $30 — about 50% higher than before the deal was announced. “The question is: How long would it have taken for the stock price to get to that point on its own?” Davis says. “In this economic environment, quite a while.”

And First Charter had no guarantee it would be able to find a buyer if it took a wait-and-see approach, James says. “The worst thing that could possibly happen is that your board elects to remain independent for the next three or four years and then decides to sell and nobody shows up for the party. And that has happened already in a couple of instances that I know about.”

A bank like First Charter, with a respectable share in Mecklenburg County, has an advantage over banks in smaller metro areas. “If you’re going to be in North Carolina, you need to be in the Research Triangle area and you need to be in Mecklenburg County,” Davis says. “Those are the two high-growth areas. That’s where most out-of-state banks like to get to.”

Tighter margins and weak stock prices cut both ways: Tar Heel banks also can find deals here and abroad. In July, FNB Financial Services and LSB Bancshares — each with assets close to $1 billion — closed a merger that left LSB, the smaller bank, the survivor with a new name: NewBridge Bancorp. More such deals could follow as banks try to cut costs and bolster earnings.

Despite tough economic conditions, some North Carolina banks grew quickly in 2006. Hendersonville- based Mountain 1st Bank & Trust moved up 11 notches on the Financial 100 and ranks 41st this year. Charlotte-based NewDominion Bank, which failed to make the list last year, crashed the party at No. 53, and Durham-based Square 1 Bank debuted at No. 54.

Plath expects Winston-Salem- based BB&T to move into the Ohio River valley and the Midwest eventually but admits that the troubles of the domestic automobile industry, vital to much of that region, make it a less desirable territory than before. Some parts of the Southeast, including Alabama, Tennessee and Virginia, offer attractive markets that are still unconsolidated compared with North Carolina, he says.

But with deposits typically growing faster than the national total, North Carolina is more attractive to out-of-state banks than many other parts of the country are to North Carolina banks, Plath says. “From a demographic standpoint, it’s really hard to duplicate in another region of the country the attractiveness of the economic fundamentals that you get in this market.”

Before long, though, the North Carolina market might meld with its neighbor to the south. “That I-85 corridor in the upstate of South Carolina looks an awful lot like the North Carolina Piedmont,” Plath says. “Banks are going to consolidate that into one financial-services market that will be a Carolinas market, and an out-of-state entrant from the West Coast or the Midwest is going to look at that North Carolina-South Carolina market as an attractive territory.”

What isn’t always apparent to outsiders salivating over the growth potential here is how difficult it can be to compete in a region with two of the nation’s five biggest banks and a deep pool of banking talent. Big full-service banks that have bought into the North Carolina market haven’t exactly been showing up the locals. RBC Centura’s deposit market share has dropped from 5% in 2001 to less than 4% in 2006. SunTrust’s share slipped from 4.74% to 4.04% during the same period.

Plath doesn’t expect Fifth Third to do any better at stealing North Carolina market share from homegrown banks. “I think they’re going to run into Wachovia and BB&T and First Citizens and Bank of America and realize they’re not in Cincinnati any more.”


Below is a partial breakdown of the top Financial 100 listing in the November 2007 issue of Business North Carolina.

To see the entire chart, click here to purchase a copy of the November 2007 issue.