In the upscale suburban Dallas community of Highland Village, four shopping centers recently opened at the intersection of Long Prairie and Justin Roads. These big-box anchored properties offer residents all the retail conveniences they could possibly want—including, count them, six bank branches. In fact, sitting in a car at a single intersection, one can see all six: a JP Morgan Chase, a Washington Mutual, a Wells Fargo, a Bank of America, a Capital One and a regional bank.

This is certainly a sign of the times—there are now nearly 100,000 bank branches in the U.S. But is it sustainable? JP Morgan recently acquired Washington Mutual. Does it need two branches facing each other? Meanwhile, Wells Fargo recently bought Wachovia meaning it too will need to examine its national network of retail bank branches and decide which ones must stay and which will have to go.

The intersection is emblematic of the race that’s taken place over the past two decades during which commercial banks, community banks and credit unions have raced to build market share and generate all important deposit bases. Even as the number of financial institutions has decreased due to consolidation, the number of branches has increased.

Retail landlords and investors have been able to make the most of this trend. For years, banks—many with drive-throughs—could be counted on to take corner pad sites at shopping centers. In some cases it provided a reliable tenant. In other cases, banks became extremely popular options for single-tenant net lease investors. Now, a coming wave of consolidation triggered by the ongoing credit crunch threatens to turn the tide on the wave of expansion leaving both landlords and investors exposed to a wave of risk.

The credit crunch has triggered a wave of forced mergers, leading to overlaps in banking networks. Moreover, the industry is dealing with an increased number of outright failures. In 2008, 40 banks failed, according to the Federal Deposit Insurance Corp. (FDIC). In most cases, these were small regional banks. But the FDIC also was involved in seizing Washington Mutual and passing the assets to JP Morgan Chase. In a typical bank failure, the FDIC moves in—typically over a weekend in order to minimize disruption—takes over a bank and passes the assets along to another bank so it can re-open on Monday under its new banner. Overall, 170 banks currently sit on FDIC’s watch list. In a typical year, 10 percent of the banks on the watchlist fail. However, in the current credit crisis, estimates are that failures could be much higher with as many as 200 banks failing before all is said and done. This could lead to further consolidation and adjustments to bank branch networks.

As a result of all of this, fewer banks will be looking to expand their footprint organically, says Mike Purchia, vice president of strategic market intelligence for BrandPartners, a Rochester, N.H.-based consulting firm that specializes in bank branch site selection, design and construction. Purchia says most bank consolidations result in a 5 to 10 percent overlap of branches, which means that sector could see at least a couple hundred bank branches go dark in 2009. However, Purchia also believes that there remain a large number of healthy banks ready and able to backfill the empty space. For example, Morgan Stanley and Goldman Sachs, the last two remaining Wall Street investment banking titans, both converted to bank holding companies and are exploring ways—either through organic growth or acquisition—of building deposit bases.

Ultimately, experts think the number of bank branches could drop in 2009, but the effects could be minimized with less than 5 percent of existing bank branches going dark for good. Purchia says the national and super regional banks will be occupied for some time sorting through their new networks and identifying the branches they need to close. Meanwhile, regional banks are looking to restructure their leases because of the downturn in the market. That could create some pain for landlords. For non-urban new pad sites, banks might pay more than $35 per-square-foot for rent. For in-line or end-cap space, the rents would be between $25 per-square-foot and $35 per-square-foot. In today’s market, it would be difficult to find replacement tenants to fork over those kinds of rents.

At the same time, however, Purchia thinks the ultimate effect of bank branch closings will be diluted. Regional players are keeping their eyes open for opportunities to pick up the branches that other banks have abandoned. The other banking segment—community banks and credit unions—haven’t missed a beat, Purchia says. “This segment is very strong financially and still selectively looking for expansion opportunities,” he adds.

Miami-based Union Credit Bank is an example of a community bank that is expanding. The bank, which currently has one branch and another under construction in West Miami is looking for existing banks and branches to acquire, says president and CEO Fernando Capablanca. “It’s a good time for my bank to expand,” he says, adding that he’ll be able to take advantage of opportunities created by the closure of other bank branches, either from consolidation or weak economic conditions. “We think this is an opportunity to gain market share.”

Branch offshoots

Overall, between 2000 and 2008, the number of financial institutions decreased by 14 percent (from 9,904 to 8,494), while the number of bank branches increased 14 percent (from 85,492 to 97,274), according to the FDIC. Meanwhile, over the past 20 years, the number of bank branches in the U.S. has risen by roughly 40 percent, according to the Federal Reserve Bank.

With the exception of a brief stall in the early 1990s, the rise had been relatively consistent at about 2 percent annually with some acceleration in that pace over the last three to four years. The bank branch expansion mushroomed nationwide. However states including Arizona, Florida, Nevada and Texas—those that have experienced strong population growth—saw the largest spike in the number of branches. Between 1994 and 2004, the number of bank branches increased 43 percent in Texas, 37 percent in Nevada, and 20 percent in both Arizona and Florida, according to the FDIC. And, urban areas experienced the biggest boom—a 43 percent increase since 1988, according to the Federal Reserve.

It’s no accident that those states were the same ones that experienced the greatest population boosts and the highest run up in prices during the housing bubble. For example, according to Standard & Poor’s Case-Shiller Home Prices Indices, housing values in Las Vegas rose from a baseline of 100 in January 2000 to 234.78 in August 2006. (The index has since dropped to 142.57 as of October 2008, the last month for which data is available.)

The growth in commercial banks and the housing bubble are indelibly linked. The commercial banking model is entirely based on generating deposits from customers that then can be rolled into secured and unsecured loans, credit cards and mortgage debt. The recent spike in branches coincided with the credit bubble that is now unwinding. Commercial banks were a central cog in the securitization machine that has now come to a screeching halt. Growing deposit bases allows commercial banks to originate more loans—most importantly, mortgages. The race for mortgages was in part driven by Wall Street—investment banks eager to turn mortgages into tradeable securities had a voracious appetite. This in turn was one of the factors that drove housing values up so precipitously.

Between 1989 and 2005—the same time frame in which the number of bank branches grew 40 percent—the amount of mortgage debt grew from $3.6 trillion to $12.1 trillion, according to the Economic Report of the President. Consumer revolving credit, meanwhile, grew from $211.2 billion to $826.6 billion. The percentage of household debt relative to GDP grew from 60.8 percent in 1989 to 94.0 percent in 2005.

As a result, much of the growth can be tied directly to the residential housing boom and the increased amount of new retail construction, according to Mark Newman, a senior vice president with Staubach Retail who handled Wachovia’s expansion into the Dallas-Fort Worth metroplex.

“We’ve had a phenomenon where there have been eight banks or so vying for the same pad sites,” Newman explains. “There was some defensive posturing from banks that wanted to protect their marketshare and new banks were aggressive in establishing a footprint.”

Charlotte, N.C-based Wachovia, for example, targeted Texas as an expansion market. San Francisco-based Wells Fargo, has 580 branches in the Lone Star State. It’s unclear how many of its 228 Texas branches will be closed as part of its acquisition.

Now, however, with the housing bubble gone bust and the ongoing credit crunch continuing to get sorted out, the race for bank branches has at least temporarily come to a halt.

Very little overlap

Yet, is it as bad as all that?

Despite the coming wave of consolidations, two banks merging won’t necessarily lead to large numbers of bank closures, depending on the existing branch networks. The effects will vary greatly from city to city. For example, Wachovia and Wells Fargo, despite operating nearly 11,000 branches combined, have very little overlap, except in Texas and California, according to Bart Narter, a bank analyst with Celent, a Boston-based financial consulting firm. In California, Wells Fargo may have to deal with some antitrust issues because it will own almost 30 percent market share. Wells Fargo has not announced how many overlapping branches it plans to close. However, the branches that are most vulnerable to closure are those that are within a quarter-mile of each other or those housed in older, smaller buildings, Narter says.

Wachovia’s branches are concentrated along the East Coast, with a large footprint in Florida, North Carolina, Georgia and Virginia. In contrast, Wells Fargo is concentrated in the western and southwestern U.S., and it doesn’t boast any branches in Florida, Virginia or Georgia.

Across the U.S, Wells Fargo’s $13.5 billion acquisition of Wachovia gives the company the most branches of any bank. The combined company will have $1.4 trillion in assets, $787 billion in deposits, 48 million customers, and 10,761 branches in 39 states and Washington, D.C., according to Wells Fargo’s financial statements.

JPMorgan Chase & Co., which acquired Washington Mutual’s assets and deposits for $1.9 billion from the FDIC, has announced that it plans to complete the integration and re-branding of Washington Mutual branches by 2011. The New York City-based firm says it will close less than 10 percent of its branches in the combined network, which includes 5,400 branches in 23 states.

The Seattle, Wash.-based Washington Mutual operated roughly 2,200 branch offices in 15 states, primarily along the West Coast. Its acquisition expands Chase’s footprint into California, Idaho, Oregon and Washington creating the nation’s second-largest branch network with locations reaching 42 percent of the U.S. population.

There is also very little market overlap for Pittsburgh-based PNC Financial Services Group Inc., and National City Corp. PNC agreed to acquire Cleveland, Ohio-based National City in October for $5.2 billion. While PNC is concentrated primarily in Pennsylvania and New Jersey, National City has a presence throughout the Midwest including Ohio, Illinois, Indiana, Kentucky, Michigan, Missouri and Wisconsin. It also has branches in Florida.

Together, the combined company will have 2,747 branches, according to PNC’s SEC filings. The only market where the two banks have significant overlap is Pittsburgh, where the banks have a combined 53 percent market share, says Narter.

Bye-bye bulletproof credit

As the banking sector wades through consolidation, the credit crunch, and billions of dollars in capital infusions from the U.S. government, net lease and 1031 exchange buyers are struggling to understand what it all means for investment.

The financial crisis, subsequent bankruptcies of venerable Wall Street investment banks, and near failures of Wachovia and Washington Mutual have caused investors to be a little leery, says Jonathan Hipp, CEO of Calkain Companies, a Reston, Va.-based brokerage firm that specializes in net lease investments.

Net lease investors and real estate developers are increasingly concerned about the credit quality of banks. “Banks have shown themselves to be vulnerable, and that is the last thing that net lease investors want to see,” says Andrew Reeder, principal of Trade Commercial Group, a San Francisco-based investment sales firm.

That doesn’t mean there won’t be any new bank branches or financial institutions expanding. But, what it does mean is that banks are no longer willing to pay top of the market for pad sites, and net lease investors are no longer willing to pay low cap rates for bank branches.

Prior to the meltdown in the financial sector, investors considered net leased bank branches nearly “bulletproof”, says Michael O’Mara, director of investment sales in Braintree, Mass.-based Paramount Partners LLC’s 1031 exchange group. Investors were willing to pay a premium for bank branch credit, which was among the strongest credit available in the retail sector. Bank branches regularly traded at cap rates below the 6 percent range, cites Randy Blankstein, president of the Boulder Group, a Northbrook, Ill.-based investment brokerage firm. That’s similar to what a top credit drugstore like Walgreens might have fetched, but more expensive than the 7 percent cap rate typical of most retail net leases.

Not only didn’t investors differentiate between banks, they ignored the real estate in favor of the bank credit. For example, a regional bank branch in a secondary market would trade at a similar cap rate to a national bank branch in an urban market.

The financial crisis has caused many net lease investors to lose confidence in banks, and investors want to wait until they know for certain which branches will be shuttered before they make any decisions. “People aren’t sure they’re getting that foolproof credit,” Blankstein says. “It’s more suspect.” He notes that credit issues have pushed cap rates up—today, bank branches are listed at cap rates of 6 percent or higher.

For example, Ryan Butler of Stan Johnson Company has a Washington Mutual outside of Houston, in Sugarland, Texas, available at a 6.0 percent cap rate. Six months ago the property, which is listed at $1.5 million and features a 20-year ground lease, would have sold at a 5.5 percent cap rate. The property is still generating interest from investors because it’s new, has a lot of time left on the lease and there aren’t any Chase branches within a two-mile radius.

Nationally, very few bank branches traded in 2008 primarily due to the lack of availability of debt. But, Hipp says he hasn’t closed any bank branch deals in six months because the developer decided to pull them from the market. “Investors are not willing to pay the cap rates the developers think they should be getting,” he says. “Clearly they think there’s more risk than the developer believes.”

Hipp says investors are starting to pay more attention to location and the rental rate. During their height of the bank branch expansion, banks routinely paid 30 percent to 40 percent more rent than other retailers. “If the bank is paying $20 per square foot over market, you won’t be able to find a tenant to replace that rent,” he says.

Philadelphia-based Equity Retail Brokers, principal, Edward Ginn, cited developers and investors concern regarding bank strength, but said it’s worth noting that banks are the only ones within the retail sector that have the federal government’s backing. “Restaurants don’t have that and neither do drug stores; so you’ve got to think that banks are a better risk.”

SIDEBAR

What’s In Store?

Some banks look to expand in-store networks.

While a number of standalone bank branches are expected to be shuttered in the coming months as the banking industry works through the most recent round of acquisitions, retailers with bank branches in their stores can breathe a sigh of relief. Experts say in-store bank branches are safe from closures because these branches are inexpensive to operate and generate a lot of revenue.

“Consolidation is not going to limit banks’ interest because in-store branches bring in deposits and see a lot of traffic,” says to Bart Narter, a bank analyst with Celent, a Boston-based financial consultancy.

But, banks’ appetite for in-store branches will be curbed by a lack of new retail development and store openings, “After several years of robust growth, in-store branches have plateaued,” he notes, adding that much of the previous growth has occurred as existing grocery stores have been backfilled with in-store branches.

Today, in-store branch opportunities are limited to new grocery and discount stores like Wal-Mart, Narter says, and there are only so many that are opening. In fact, the slowdown in the residential housing sector means that even fewer in-store branches will open in the next few years since fewer grocery stores are under development. And the in-store bank branch concept doesn’t really work outside of grocery-oriented retailers, he adds.

The lack of new space has created a competition situation for banks, but Narter warns retailers against getting greedy with their lease terms. “Banks value their in-store branches, but they are not looking for any extra expenses right now,” he says. “If a retailer said it planned to double the bank’s rent, the bank would not be in the mood to hear that.” —J.P.