In 2021, mergers and acquisitions in the banking industry surged to the highest levels in 15 years. Based on early indications this year, it looks like we can expect a similar story in 2022. The 2021 increase in M&A activity was largely the result of pent-up demand after virtually no deals closed during the early phases of the pandemic. There are several factors that will continue to encourage consolidation, but the banking industry faces headwinds that could curb it.
What is driving M&A activity?
Banks are feeling pressure to grow, and organic growth for many institutions is difficult to achieve. Competition is increasing and it is coming from more sources than ever as fintechs and other nonbank financial service providers continue to encroach on space that has traditionally been occupied by banks. And a downward pressure on traditional sources of fee income that the Biden Administration is exerting is only beginning to be felt. As a result, banks are seeking attractive M&A partners to increase their market share, expand into new markets and acquire new business lines, management and technology.
Efficiency drives a lot of deals — the most attractive transaction will be the one that will quickly deliver cost and operational efficiencies to the greatest extent. Due to the ever-increasing burden of regulations, the expense associated with operating a bank is making size matter more than ever before.
With these motivators as the driving force, we have seen several “mergers of equals” and other acquisitions of larger, established institutions since deal activity kicked into high gear after the initial shutdown associated with the pandemic. In Texas, for example, the public filings associated with the larger deals that were announced and closed in 2021 demonstrate that the factors set forth above played a major part in the thinking of both the buyer and the target — BancorpSouth Bank, Simmons Bank and Home BancShares, Inc. each became more geographically diverse by entering (or significantly increasing its presence in) the Texas market, and Allegiance and CommunityBank each expressly emphasized the need for size and scale to compete in today’s market, particularly with technology and digital banking offerings.
Deal term considerations
Deal pricing and consideration mix can vary widely depending on the specifics of a particular transaction. Mergers of equals tend to be lower-premium transactions because both parties are usually motivated to build long-term value by combining successful franchises. For similar reasons, the acquiring institution usually pays all or a significant portion of the purchase price in stock in both mergers of equals and most acquisitions of larger, well-managed community or regional targets. When a target is concerned with maximizing purchase price, publicly traded banks usually have a significant advantage over privately held banks that will use cash or relatively illiquid stock as consideration in the merger. Generally speaking, publicly traded banks can use their highly valued stock to meet a seller’s premium expectations.
In the current environment, smaller community banks are not garnering as much attention from larger bank buyers as in times past. A smaller, rural community bank has traditionally been an attractive target because it can provide an acquiring institution with a wealth of low-cost and stable core deposits. However, with liquidity at an all-time high throughout the industry, this funding source does not carry the same weight as it once had, and many of these smaller institutions do not provide the scale, product diversification, market entry or talent acquisition that established buyers require in this environment.
However, smaller community banks still attract plenty of attention from investor groups seeking to enter the banking market, particularly in a strong market like Texas. While the de novo route is open and available for investor groups, many investor groups prefer to identify an existing bank charter because it already has infrastructure, employees, leadership, earning assets and technology in place, and it provides an existing balance sheet and customer base upon which the new team can build.
From the seller’s perspective, an investor group transaction may be more desirable than selling to an existing bank because the seller can likely negotiate a higher purchase price, and key employees, directors and shareholders may continue to play important roles in the bank after closing. However, investor groups may not provide the same degree of deal certainty as an existing bank purchaser because the investor group may face issues raising the necessary capital, putting together the appropriate leadership team or obtaining regulatory approval.
... banks must be prepared to demonstrate to federal regulators exactly how a proposed merger will benefit, rather than harm, the communities where merger partners operate.
Headwinds curbing M&A activity
While there are plenty of reasons to expect banking M&A to remain active for the foreseeable future, there are factors that may slow or potentially stifle some transactions. Uncertainty caused by significant inflation and expected rising interest rates could dampen deal volume over the coming months. More importantly, we are now in the second year of President Biden’s Administration, and it is likely that the Administration’s philosophy and agenda could impact bank consolidation. In July 2021, the Biden Administration issued an executive order encouraging the Department of Justice and the federal banking regulators to update guidelines for banking mergers and to provide more robust scrutiny of these deals.
Interestingly, under the Trump Administration there was momentum to revise the bank merger competitive effects review to lessen restrictions on bank mergers. However, in December 2021, the Department of Justice released a statement seeking public comment of its merger review process to ensure that Americans have choices among financial institutions and to “guard against the accumulation of market power.”
In perhaps history’s most dramatic financial regulatory drama to play out before the public, the three Democratic-appointed members of the FDIC’s board, against the wishes of Republican FDIC Chair Jelena McWilliams (who has since resigned), released an FDIC request for information and comment on bank merger transactions that promoted President Biden’s call for heightened scrutiny of bank mergers. We do not yet know the full effect of these regulatory actions, but it is reasonable to expect that merger approvals will face significant delays and certain transactions may not be approvable in the current political and regulatory climate.
All institutions should expect a trickle down of the Administration’s renewed scrutiny of consolidation, and banks must be prepared to demonstrate to federal regulators exactly how a proposed merger will benefit, rather than harm, the communities where merger partners operate. A less obvious effect of the Biden Administration’s philosophy may be delayed regulatory approvals and the return of CRA protest letters that can send even the best M&A transactions to the penalty box or even the graveyard.
Banking continues to be a great business, but the pressure to be more efficient is likely to motivate more banks to seek a dance partner that will assist in achieving their objectives in a safe, sound and expeditious manner.