When two tiny banks merge to form a slightly less tiny bank, which institution really reaps the efficiencies: the merged entity — or a larger acquirer down the road?

This year, 23 bank deals where the seller had less than $1 billion in assets have been announced. Of those, more than a third involved targets with less than $100 million in assets, with many of them agreeing to sell themselves to similarly sized buyers.

The bankers involved in these small combinations say that they are motivated by higher capital levels, cost-cutting and creating opportunities for future growth in an environment of rising regulatory burdens. But analysts say these deals are only buying time before the banks are gobbled up by bigger rivals. Acquisitive community banks would prefer gaining more assets in a single deal than spend more time and expense cobbling together a series of smaller institutions. The smallest banks may be too small to attract attention on their own, but combinations are creating more attractive targets.

"That $100 million in additional assets is probably a target for a billion-dollar bank," Mark Fitzgibbon, an analyst at Sandler O'Neill & Partners LP, said.

Last week, the $83 million-asset Coronado First Bank in California said it would sell itself to nearby competitor Embarcadero Bank, with $73 million in assets.

Bruce Ives, Coronado's president and CEO, said that his bank is joining Embarcadero to gain efficiencies and boost capital by $17 million without selling stock to investors and risking dilution. "To be a small community bank, [it]… is extremely difficult to survive," he said.

Ives said capital generated from the transaction "gives us the ability to take advantage of opportunities and comply with what we need to comply with." He added, "It's no secret that the regulatory environment and burden on small community banks is greater than it has ever been and it's going to get even worse."

Outsiders view the deal differently. Bigger banks will take notice of the Coronado-Embarcadero combination as way of "picking up more assets in one transaction," said Rick Levenson, the president of Western Financial Corp., a San Diego investment bank. "Coronado by itself might fly under the radar screen of anyone that's a billion in assets."

The Coronado sale announcement followed a handful of other small-bank deals unveiled this month. Stonegate Bank in Ft. Lauderdale, Fla., bought the $115 million-asset Southwest Capital earlier this month. The $581 million-asset Grandpoint Capital Inc. in Los Angeles agreed to buy the $224 million-asset Orange Community Bancorp.

Grandpoint and Stonegate bought other, smaller banks prior to these deals, inching them closer to $1 billion in assets, which analysts say is a sufficient level of scale to effectively spread out costs.

David Seleski, Stonegate's president, said he believes there is more to success than sheer size.

"There are banks that have been around for 20 years that are $200 or $300 million in size and surviving in this economy," he said. "Size is not a direct correlation into profitability. It's how efficient[ly] you operate."

Stonegate bought three failed banks in 2009 but Seleski said it has shrunk each one by 30% to 40% to be more efficient and profitable. Before its first acquisition in July 2009, the bank had $375 million in assets, with return on assets of 0.2% and return on equity of 1.7%. By the end of last year, Stonegate had $636.8 million in assets, its return on assets had climbed to 0.6% and its return on equity had increased to 3.98%.

Stonegate also bought Southwest Capital in Ft. Myers this month in a traditional stock deal valued at $9.4 million. Seleski said Southwest shareholders "felt they were better off" owning Stonegate's stock.

Most observers said that size will matter now more than ever, with some analysts predicting that $1 billion in assets will be needed for a bank to flourish. "Banks around $100 million or up to $300 million or so have challenges they didn't have in the past," Levenson said. "You either have to learn how to be very efficient at that size" or consolidate. "The general consensus is, you have to be bigger."

The highly anticipated wave of consolidation does not mean the smaller banks will disappear, especially in rural areas that depend more on small-town banks. And hitting $1 billion in assets does not mean a bank is "safe" from external pressure. "It makes things less painful but it's not completely painless," Fitzgibbon said.

Dan Bass, an investment banker and managing director at FBR Capital Markets, said most small community bank deals will likely involve a stock exchange because of the currently low bank values.

"If you see banks under $2 billion in assets merging, you can assume the seller's shareholders will want more stock than cash because they may not make a premium on this deal but they will make more money in the next deal," Bass said.

Little to no premium was a major factor why traditional sales of community banks with less than $1 billion in assets fell off drastically, to 112 in 2009 from 252 in 2007, according to SNL Financial. The totals have since recovered somewhat, to 150 last year and 23 through March 23.

Uncertainty about the impact of the Dodd-Frank Act and where capital ratio requirements will officially end up should fuel a ramp-up in transactions. "I don't see any revenue benefit from Dodd-Frank, and I don't see any revenue benefit from the higher capital requirements," Fitzgibbon said. "It looks like it's all on the expense side."

Fitzgibbon said he knows of a community bank with about 60 employees that is looking at adding eight people to its two-person compliance department because of the regulatory environment. "It's going to be overwhelming for many small institutions to do that," he said. He estimated that by next year, dealmaking will return to its peak of more than 400 transactions in 2007, after banks faced increased costs from provisions of the Bank Secrecy and Sarbanes-Oxley acts.