As the dust of the financial crisis settles and the Federal Deposit Insurance Corp. bags and tags regional bank casualties, a new wave of acquirers is emerging. No longer are the biggest banks, brimming with deposits, getting bigger by swallowing the competition. Now midtier banks are starting to sop up core deposits, increasing market share and expanding regionally, thanks to the bevy of seized banks available cheaply and at minimal risk.

After these consolidators work through the FDIC's damaged goods and gain enough confidence in targets' balance sheets to make acquisitions without the agency as a backstop, healthy deals could follow.

The past decade or so of consolidation has created three retail banks of national scale -- Bank of America Corp., J.P. Morgan Chase & Co. and Wells Fargo & Co.--all of which are now digesting massive acquisitions and have hit or are near the 10% national deposit limits. BofA's is over the limit at about a 12% market share, Wells Fargo's is roughly 10% and J.P. Morgan is around 8.5%.

"All of these guys are pretty busy now -- Wells integrating Wachovia, J.P. Morgan integrating WaMu and Bank of America integrating Merrill and Countrywide," says a financial institutions group banker. Furthermore, seized and near-dead banks are too small for these giants to expend time and effort on. "These banks are huge -- a small-to-medium deal doesn't move the needle much," the FIG banker says.

That's not the case with midtier banks, however. Another banker says that if it were up to the FDIC, the new group of acquirers would be "very well-respected, well-capitalized operators" with between $200 billion and $500 billion in assets. "Those banks as consolidators create scale platforms without necessarily being too big to fail," he says. This second tier includes banks such as U.S. Bancorp, PNC Financial Services Group Inc., SunTrust Banks Inc., Regions Financial Corp., Fifth Third Bancorp and BB&T Corp.

Consolidation among this group may ultimately fill the gap between them and the biggest banks while stopping short of creating more TBTF institutions.

Because the biggest banks have gotten so much larger, the next tier feels it must consolidate to achieve competitive economies of scale and increase their bottom lines. And if a TBTF bank does fail, a consolidator from the next tier may have enough scale to step up and fill the void.

"The regulators want to create a middle rung of banks that can provide for a replacement of services of the larger tier if they run into a problem," says the banker. "I wouldn't be surprised to see the promotion of regional champions."

All this raises fundamental and unresolved regulatory questions involving the size of the banks and the wisdom of consolidation. While it's good to have banks that can rescue a failing institution, it's problematic to do so and simply create another TBTF institution.

That said, there are increasing pressures on the biggest banks to stop growing and, in some cases, to divest assets. "The big guys in most cases will have to shrink -- they don't have enough capital to support their businesses. Some larger institutions may have to be parceled up," says John Koelmel, CEO of Lockport, N.Y.-based First Niagara Financial Group Inc., which has raised just under $1 billion in the past year to fund acquisitions. "It's increasingly challenging to grow when you have to hold a higher level of capital."

Indeed, bank analysts expect regulators to raise "well-capitalized" requirements from a 10% total risk-based capital ratio to 12% or higher. Increasing capital would hit hard the biggest banks, with their range of capital-intensive trading businesses, particularly if regulators demand relatively larger capital cushions for TBTF institutions.

The lion's share of near-term acquisitions executed by this consolidator group and smaller banks down the food chain will come from FDIC seizures. Some experts do not anticipate measurable non-FDIC acquisition activity for 12 to 18 months as acquirers wait until the end of the credit cycle for potential targets' credit losses to materialize. "[Healthy] regional consolidation will come, but before it happens, people have to get more comfortable with the asset side of balance sheets," says Adam Chinn, partner with New York advisory and private equity firm Centerview Partners LLC. "Buyers must also get comfortable that they have enough capital."

Brian Sterling, managing director with New York-based Sandler O'Neill + Partners LP, concurs. "Buyers first need to be confident in their ability to handle their own credit issues and to analyze, price and manage the targets' credit issues," he says.

FDIC-assisted deals remove most of the credit uncertainty thanks to generous loss-sharing agreements. There is no shortage of deals; the FDIC has already seized 106 banks this year and has about 400 on its watch list.

Potential targets that have so far stayed out of the FDIC's clutches are playing a valuation waiting game before deciding to sell. For targets to consider selling, "they need stock prices to get back above book value," says Richard Thornburgh, vice chairman of New York private equity shop Corsair Capital LLC. Thornburgh was named a director of Cleveland-based National City Corp. after his firm led a $7 billion recapitalization of the struggling bank in April 2008. In October 2008, PNC acquired National City for $5.6 billion.

Some of these so-called healthy banks may have limited time to play this waiting game.

While they may have steered clear of the FDIC, many struggle to repay Troubled Asset Relief Program funds or find themselves coping with new credit woes, like commercial real estate. These banks may eventually have to sell assets or the entire bank, predicts Morgan Keegan & Co. analyst Robert Patten.

First Niagara's Koelmel argues that the clock may be ticking on sellers as the "regulatory environment becomes progressively stringent," particularly in terms of capital requirements. "[Sellers] are walking a tightrope, if not a slippery slope," he says. He does not expect bank multiples to increase for another two to three years.

In an industry battered by bad real estate loans and other credit-related problems, acquirers look to return to the stable business of building core deposits. "There is a lot more focus on quality of deposits than has been historically, because what banks are buying right now are deposit franchises in seizure deals," says Credit Suisse Group managing director Neil Carragher, who advised BB&T on its acquisition of FDIC-seized Colonial BancGroup Inc. "In seizure deals, the targets' lending is questionable -- the buyers are not interested in the bad loans or franchises and the people that made those loans," but rather in taking on stable funding sources.

Branch networks tend to accompany core deposits. Acquirers seeking to expand branch networks will likely stay closer to home to boost local market shares. "If a bank has a subscale position, increasing share to get economies of scale is most important," says Thornburgh. Buying close to home also provides an opportunity to cut costs by eliminating overlaps.

Banks may also avoid acquisitions in unfamiliar markets to avoid repeating the mistakes of many of their go-go peers. "Banks that did deals in high-growth out-of-markets in 2006 and 2007 got killed there," says Patten, citing Colonial, Fifth Third and Synovus Bank.

First Niagara has stayed away from "far-flung franchises," says Koelmel, adding that banks outside its core geographic markets are "tougher to manage." But he warns that out-of-market deals may prove extremely tempting, given "the weekly drip of assisted deal opportunities."

While the real estate meltdown has hit nearly every part of the country, it's been particularly devastating in the Southeast, Midwest and West Coast. Sterne, Agee & Leach Inc. analyst Jim Schutz expects acquisition activity in the Southeast and parts of California due to the number of banks that wrote residential construction loans. Atlanta, one of the fastest-growing metropolitan areas in the U.S., should be a particularly hot zone, he says. Acquiring banks willing to wait for Atlanta's overdevelopment to "work itself out over a long time period" may stand to benefit from snatching up troubled franchises, he says.

BB&T, which has maintained strong capital levels, "is sitting in the captain's seat now" in the Southeast, Schutz says. The Winston-Salem, N.C., bank largely avoided significant out-of-market construction loans and resisted acquisitions of smaller banks in high-growth markets in 2006 and 2007, says Morgan Keegan's Patten.

BB&T this year raised about $2.75 billion through stock offerings and roughly $2.3 billion from debt, in part to fund acquisitions. Patten says BB&T, which has a roughly $17 billion market capitalization, "raised capital above tangible book value, so it was accretive, not dilutive." The bank deployed some of this capital to buy $22 billion in assets and $20 billion in deposits of Colonial for a roughly $500 million deposit premium.

A Louisiana bayou bank with a Spanish name, IberiaBank Corp., looms as another potential Southeastern consolidator. "Iberia has already done assisted deals, paid off TARP and raised capital for the explicit reason of doing deals," says Sterne Agee's Schutz.

The Lafayette, La., bank repaid its TARP borrowings in March and in July raised just over $173 million, which helped fund the August acquisition of Birmingham, Ala.-based CapitalSouth Bank's $546 million in deposits, $589 million in loans and 10 branches.

Iberia is positioned to expand from within the Southeast's slower-growth markets that did not experience explosive homebuilding, Schutz says. Banks in its core market had "little in the way of asset-quality problems," he says, which could limit the number of FDIC deals available to Iberia at home. Iberia has 101 branches scattered throughout Louisiana, Arkansas, Tennessee, Alabama, Texas and Florida.

In contrast to the Southeast, the Midwest saw slow real estate growth but is primed for consolidation because of a weak local economy and overbanked landscape. Corsair Capital's Thornburgh expects the Midwest to be rife with acquisitions over three to four years because of its many banks with "subscale market positions." Potential consolidators include Huntington Bancshares Inc., Fifth Third, KeyCorp, PNC and Marshall & Ilsley Corp., he says.

Credit Suisse managing director Doug Simons, who also worked on the BB&T-Colonial deal, says Ohio is particularly overbanked. "There are more larger regional banks headquartered in Ohio than in New York City or California." However, because the Ohio and Michigan economies are in such disarray, "there is no obviously very strong credit name" poised to capitalize on these opportunities," he says.

Cincinnati's Fifth Third, which encountered its own problems due to out-of-market acquisitions, may eventually be able to key in on bank deals. "Fifth Third has taken some steps to improve its capitalization relative to its peers," the banker says.

One analyst says nearly every acquisition Fifth Third completed in Florida in recent years has taken a toll on its bottom line because of the real estate implosion in the state. One of the larger deals it completed in the Sunshine State was its $1.58 billion acquisition of Naples-based First National Bancshares of Florida Inc. in August 2004. More recently, Fifth Third purchased Casselberry, Fla.-based R-G Crown Bank for $288 million.

With about $116 billion in assets, Fifth Third in June completed a $1 billion stock offering to pad its capital and repay TARP. The bank took over $250 million of deposits of Bradenton, Fla.-based Freedom Bank in October 2008.

"We would continue to look at [FDIC] opportunities and are most interested in opportunities in our current 12-state geography," a Fifth Third spokeswoman says. "But we understand the importance of capital at this point in time -- capital is king." Fifth Third operates about 1,300 branches across Ohio, Kentucky, Indiana, Michigan, Illinois, Florida, Tennessee, West Virginia, Pennsylvania, Missouri, Georgia and North Carolina.

Minneapolis-based U.S. Bancorp, with $264 billion in assets and nearly 2,900 branches in 24 states, tacked on a few more in April with the acquisition of seven branches and $225 million in deposits of the shuttered First Bank of Idaho. In October, the Minneapolis bank acquired $800 million in deposits and an undisclosed number of Nevada branches from BB&T, which it acquired in the Colonial deal. U.S. Bancorp's 13% risk-based capital ratio exceeds the well-capitalized threshold, thanks in part to its $2.4 billion May stock offering.

Widespread California bank failures have been driven by "outsized exposures to [residential] construction and land loans," says Sandler O'Neill analyst Aaron Deer.

The pain may be far from over for these banks, as they face potential commercial real estate losses over the next year, as do other banks throughout the country. Many of California's regional banks with less than $10 billion in assets have loan portfolios made up of as much as 60% of commercial real estate, he says.

CVB Financial Corp. of Ontario, Calif., is one of a handful of West Coast banks positioned to snap up ailing peers. CVB cut a deal with the FDIC in mid-October to buy $775 million in assets and $631 million in deposits of Bakersfield, Calif.-based San Joaquin Bank. Earlier in the quarter, CVB executed a roughly $133 million stock offering to reinforce its balance sheet and build an acquisition war chest. CVB has the makings to be a "serial acquirer" in the state, Deer adds.

When prospective buyers gain enough comfort in target balance sheets and clarity about credit losses, the FDIC may begin to fade from bank deals. Banks that have stayed just out of its grasp while struggling to repay TARP will be forced to eye exit strategies, namely, asset sales or whole-bank sales, says Morgan Keegan's Patten. Acquirers will then have to assign valuations to targets rather than simply paying the FDIC modest deposit premiums or nothing at all.

Thornburgh speculates that when healthy bank deals return, the acquisitions will be at premiums to book value. However, if acquirers take on banks with significant unrealized losses, they may bid at discounts to book value, potentially at around 50%, says Bert Ely, a banking consultant at Ely & Co. in Alexandria, Va. "They must buy at enough of a discount to absorb all losses that are not recognized yet," he says.

Healthy strategic acquisitions will likely be stock-for-stock transactions, enabling buyers to preserve capital, Thornburgh says. "Capital ratios [requirements] will be raised across the globe, which means all transactions will be subject to purchase accounting."

Publicly traded banks are likely the first to be sold in the early round of non-FDIC deals, Ely says, adding that privately held banks are "unrealistic about their pricing."

Once healthy deals return, one banker expects the second-tier banks to acquire both smaller competitors and merge among themselves.

A select few banks have already mustered up the bravado to make purchases without the FDIC. First Niagara's participation in non-FDIC deals is largely a function of slow-growth markets in which it operates. First Niagara's upstate New York and western Pennsylvania markets did not experience the high levels of housing growth as other parts of the country, and bank failures have been rare. "In the footprint where we sit, there has been one assisted deal," says First Niagara's Koelmel.

First Niagara raised about $115 million in September 2008, "just before the [capital markets] window pretty much slammed shut," he says. "We could see at the time that things were more than soft, and we had the opportunity to continue to grow organically within our own footprint."

After securing $184 million in TARP funds, which it quickly repaid, the bank "shuffled a tad from thinking about organic growth," he says. "We found our relative position became one of absolute strength, as we were well capitalized while everyone started to go south."

First Niagara began tapping capital markets again to fund acquisitive growth with a $380 million stock offering in April, ahead of a $3.2 billion all-cash purchase of 57 Pennsylvania branches, $3.9 billion in deposits and $757 million in performing loans from PNC. The bank in July announced an all-stock $237 million deal to buy Harleysville, Pa-based Harleysville National Corp. In late September, it priced a $460 million stock offering.

First Niagara would consider FDIC deals if they presented themselves within its core region or geographic adjacencies in which it seeks to expand, including New England, southeastern Pennsylvania, the Midwest and the mid-Atlantic, Koelmel says. Potential acquisitions must be accretive to earnings to be considered, he adds.

The desire for earnings accretion is in no way unique to First Niagara; it's a primary driver of bank consolidation. Cutting costs will be one of the few ways to achieve earnings growth over the next five to six years as regulators boost capital requirements, says Thornburgh. Building scale and gaining market share in core markets is one of the most "efficient ways to cut costs," because it allows banks to eliminate overlapping distribution synergies, adds Centerview Partners' Chinn. So if midtier banks want to build bottom lines, they will have to try to grow -- at least at home. Let the feeding frenzy begin.