Anyone running a bank in the asset neighborhood of $20 billion to $50 billion is caught between a rock (Wall Street) and a hard place (Washington.)

Lots of banks are under immense pressure to grow. None of them are expected to accomplish that with loans, interchange fees or much else anytime soon. Deal-minded Wall Streeters forcefully and repeatedly offer this answer: buy somebody else, or sell.

But the Dodd-Frank Act makes that an especially painful option to consider for midsize banks like First Horizon National Corp., USAA Federal Savings, Rabobank and New York Community Bancorp.

The act requires banks with assets of $50 billion or more — so-called systemically important financial institutions — to hold additional capital and submit to more intensive regulation. Worse yet, the rules are unfinished.

For banks hovering just below the threshold, or smaller ones that would entertain a combination with a like-size counterpart, uncertainty over the details of the rules could create a dead zone of merger and acquisition activity.

"Nobody wants to be the guinea pig," said Scott Siefers, a managing director in the equity research department of Sandler O'Neill & Partners LP in New York. "If someone is a $48 billion name right now, I am not sure they are going to hurry to put on new assets. Let someone else be the test case."

The Federal Reserve, which will perform the extra supervision mandated by Dodd-Frank, has made it clear that it wants to treat similarly sized banks as equally as possible.

Fed Gov. Daniel Tarullo said in a June speech that "while Dodd-Frank requires us to apply enhanced capital standards to all bank holding companies with more than $50 billion in assets, we would not want a big difference between the capital requirements for firms with assets just over that level and those just under that level. Thus the supplemental capital requirement for a $50 billion firm is likely to be very modest."

But the combination of a lack of formal proposals from the regulators and the assurance of at least some sort of change in regulatory treatment will be enough to keep prospective buyers or sellers in this asset class on the sidelines, according to analysts and others who closely follow bank mergers and acquisitions.

"It's hard to play a game when you don't know the rules," said Jason Goldberg, an analyst with Barclays Capital.

"You don't know, ultimately, where these designations will be for different capital levels, and you don't want to unknowingly cross a threshold and wind up in a higher capital bucket," he said. "If you're not already a SIFI, you will want to avoid becoming one."

Noncommittal comments by the heads of some regional banks seem to support that read — at least in part.

When Bryan Jordan, the chief executive of First Horizon, in Memphis, Tenn., took analyst questions after the bank's second-quarter earnings call in July, for example, the very first inquiry was about the market for new deals.

Jordan was noncommittal, noting that there was "building pressure" for consolidation in the industry, but he didn't go much further.

"It's hard to prove a negative," said David Hilder, a senior equity research analyst at Susquehanna Financial Group. "We on the outside don't see or hear about all the discussions that go on among CEOs of banks, so it is impossible to say whether there are more or less of those discussions than there would be without uncertainty about the SIFI capital buffer."

Though the absence of finished rules likely plants seeds of doubt, Hilder said, some regional banks have been active buyers. First Niagara Financial Group Inc. ($31 billion of assets) of Buffalo, N.Y., and Comerica Inc. ($54.1 billion) of Dallas recently signed substantial deals.

"It's not as though there is no merger activity taking place, though these are not what regulators would see as globally systemically important banks," Hilder said. "But they will certainly fall under the enhanced capital requirements of Dodd-Frank. The M&A transactions that are occurring are those where there is clearly a motivated seller."

Some observers say the pressure to increase revenues and profits in the slow economy ultimately will trump fear of the regulatory costs.

"Management believes size matters and investment bankers will continue to sell and create pressure for mergers," said attorney Ronald H. Janis, a partner with Day Pitney in New York.

Many bankers will view the added burden as inevitable, said Mal Durkee, a partner with Perella Weinberg.

"All banks are trying to grow and are thus headed to SIFI designation at some point or another," he said. "They can plan and prepare for it and the regulators can anticipate the designation. So acquisitions would just accelerate the timetable."

If there is an impact on merger and acquisition activity, it will likely be more indirect — like further complicating the pricing of deals, Durkee and other observers said.

"If there is uncertainty in what the capital levels are, then that puts pressure on your ability to price the deal, and it may lead to lower prices and fewer transactions," Durkee said. "In a very narrow sense, the higher SIFI capital requirements may put you at a disadvantage if you are competing against someone who might not become a SIFI designee."

Yet if the slow economy makes such deals inevitable, it also could contribute to postponement of the day of reckoning.

"Until we have a better sense of how the regulators behave toward those larger names, we are not going to have the comfort we are going to need for M&A to pick up in the $50 billion range," Siefers said.

Rob Garver is a freelance writer in Springfield, Va.


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