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Banks May Need To Merge Given Slower Growth, Tighter Margins

A tough operating environment for U.S. banks, especially smaller ones, is likely to drive more of them to seek mergers this year in an effort to improve profits.

Through the second week of May, there were 21 U.S. bank and thrift mergers involving sellers with assets of at least $500 million in 2007, according to analysts at Keefe, Bruyette & Woods.

With internal growth opportunities limited for many banks and thrifts, experts say the lure of a merger that can provide opportunities for synergies and cost-cutting may prove too tempting in the months to come.

Many banks and thrifts are wrestling with increased competition and a difficult interest-rate environment that has hurt margins.

A prevailing "flat" or "inverted" yield curve, in which long-term rates are at or below short-term rates, has made it harder for banks to charge enough on loans to offset higher borrowing and deposit costs.

"We believe the reasons to consider mergers and acquisitions as a practical solution to the problem of improving profitability and earnings growth potential have intensified," Keefe, Bruyette & Woods analyst Jefferson Harralson said in a report.

KBW estimated that half of the banks and thrifts it covers would produce earnings-per-share growth of less than 2 percent in 2007.

The industry is on pace to reach 56 mergers by the end of the year, above the 54 transactions in 2006, itself a strong year for deals, KBW said.

"It's going to be busy," said William Hickey, co-head of investment banking at Sandler O'Neill & Partners. "I think you are going to see most of the activity at the smaller end of the scale."

Regulatory burdens and the inverted yield curve hurt smaller banks more because they have less fee income than larger competitors that have been better able to diversify their business, he added.

About three-quarters of bank and thrift deals so far this year were valued at less than $1 billion. Hickey said there were more sellers than buyers in most markets.

Suntrust

Even among the biggest banks, like Atlanta-based SunTrust Banks , there are issues that may cause a merger, albeit within a longer time frame of 18 months, according to KBW.

"SunTrust's earnings have been fairly stagnant since 2005, and its fundamentals do not appear to be mirroring the Southeast region's positive growth characteristics in recent periods," said KBW's Harralson.

KBW considers JPMorgan Chase & Co.and Wells Fargo & Co. as potential buyers of SunTrust, the seventh-largest U.S. bank. SunTrust, which has a current market value of about $31.5 billion, and JPMorgan Chase declined to comment. Wells Fargo was not immediately available.

Harralson believes SunTrust's board will give management a chance to succeed, but his firm nonetheless has added the company to its list of banks it believes may be taken over in the next 18 months.

Besides SunTrust, KBW has added six banks and thrifts, including Houston, Texas-based Prosperity Bancshares Inc. and Baltimore, Maryland-based Provident Bankshares Corp., to the list of 19 banks it considers potential takeover targets.

Banks that were already on the KBW list include Washington Mutual, Sovereign Bancorp Inc., Valley Nationaland Astoria Financial.

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Spain's Santanderowns 24.9 percent of Sovereign and has a right for one year starting in mid-2008 to buy the rest of the Philadelphia-based bank.

KBW said 15 of the 34 banks it identified as takeover targets over the past 2 1/2 years had been acquired.

This time around, banks and thrifts in lower-growth markets are likely to seek mergers, especially with companies in the same geographic region.

"You tend to see a lot of buyers in markets that are very low-growth," said Hickey of Sandler O'Neill.

"It's counter-intuitive," he added. "Why would companies selling in low-growth markets get so many bids? Because the other companies in those markets have no other alternative."

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