Wells Fargo's ( WFC) plan to acquire Seattle-based Pacific Northwest ( PNWB) may not be the kind of big merger that bank investors have been hoping to see. But it's the kind of niche deal that investors should get used to, analysts say. Wells announced Monday its planned $591 million all-stock merger with Pacific Northwest, a bank with $3.1 billion in assets and 58 branches. "Right now everyone is doing niche acquisitions that fill in pockets of coverage, but there are no blockbusters," said Tom Burnett, president of Merger Insight, a corporate advisory firm and an affiliate of Wall Street Access. Even though many bank stocks have outperformed the overall market this year, Burnett said a megamerger in the banking sector is unlikely as long as the economy continues to limp along. Burnett's assessment of the outlook for bank mergers comes at a time when there has been lots of on-and-off merger speculation surrounding a number of big regional banks, such as FleetBoston Financial ( FBF) and Bank One ( ONE). It also comes on the heels of recent comments from top executives at Citigroup ( C) and J.P. Morgan Chase ( JPM) about their willingness to get back into the acquisition game. But to date, those remarks largely have been nothing more than empty words. Through the end of April, there were just 77 announced bank deals in the U.S. valued at $6.6 billion, according to Thomson Financial. And most of those deals have been small, with the average sale price totaling $86 million. Last year there were 204 domestic banking deals for a combined value of $16.6 billion. Analysts say there are a number of things keeping a lid on merger activity in the banking sector. One is a concern that a buyer may be acquiring a bank with too many bad loans buried in its portfolio. For instance, skeptics say potential buyers likely will shy away from Fleet until the Boston-based bank offers a full accounting of its troubled Latin American loan portfolio.
Another obstacle is an unrealistic assumption on the part of some sellers, especially executives at small banks, about the value of their operations. The recent big gains posted by many bank stocks have deluded some bank executives into thinking they can command sky-high premiums. Indeed, Wells' planned deal with Pacific Northwest might only fuel those unrealistic expectations. The planned $35-a-share purchase price represents a 23% premium to Monday's closing price for Pacific Northwest's stock, and is $2 more than the stock's 52-week trading high. Shares of Pacific Northwest were up 22%, or $6.28, at $34.72 in afternoon trading Tuesday. Robert Lacoursiere, a small-cap bank analyst at Lehman Brothers, said potential sellers may have to lower their expectations in the coming months, because (he believes) much of the rally in the banking sector is unsustainable, particularly the gains of small banks. And that could lead to a slew of deals involving smaller regional banks. Another event that could prompt some smaller regional banks to put up "For Sale" signs is another rate cut by the Federal Reserve. The problem for many banks is that they already are making less money from their lending operations, as the margin between the income they make on loans and interest they pay out to depositors narrows. That situation is expected to worsen if the Fed brings interest rates even closer to zero because banks can't afford to make any further reductions in their interest payments to depositors. In addition, a Fed rate cut would also reduce the income that banks generate from investing money in mortgage-backed securities.