How dealmakers will navigate the current bank M&A market

Today’s regulatory and economic environment has many bankers wondering if the industry will ever revert to the norm or has a seismic shift occurred?

Faced with margin compression, challenges managing capital and liquidity positions, increased regulatory risks, the need for enhanced technology and, in many cases, management succession challenges, board and management teams must solve for reducing risk while enhancing shareholder and stakeholder return.

During the pandemic, the bandwidth of many banks was consumed by meeting customer demands on an ever-evolving Paycheck Protection Program while assessing various government safety mandates and keeping remote employees productive. The uncertainty created by the pandemic left little room to consider M&A strategy. Unquestionably, pent-up demand exists to engage in M&A, but the question is how to execute.

When evaluating strategic options, bank boards should consider their goals for a transaction, what impact a transaction will have on the bank’s risk profile and whether the bank is optimized to pursue a transaction.

• What are your goals for a transaction?

From a sell-side perspective, banks need to assess their goals for a transaction. Most banks have cut as many costs as feasible; however, the expectation is that costs will continue to increase because of inflation and the necessity to invest in new technology in the race to capture tech savvy Millennial and Gen Z deposits. Many potential sellers are focused on finding a partner who can create economies of scale in the technology arms race that will translate into greater earnings per share for their investors going forward. Others may be facing an inflection point on succession planning and need to partner with a larger bank to take the reins.

For buyers, the initial inquiry is the same as for sellers, what does the bank want to achieve through the transaction. Buyers should consider whether the transaction allows the buyer to expand into a new market or constitutes fortress building in an existing market. Will the target facilitate greater scale and efficiency for the buyer and improve financial metrics?

Preparing a roadmap to achieve your goals before embarking on a transaction will help to ensure that you find the right partner and stay focused on the desired outcome.

• What impact will the transaction have on the bank’s risk profile?

Whether the bank is a potential buyer or seller, reducing the bank’s risk profile should be a paramount priority.

Smaller banks facing increased regulatory compliance costs may want to partner with a larger more sophisticated bank to mitigate both the cost of compliance and the materiality in the event of compliance issues. Recognizing increased regulatory focus on consumer compliance and an increase in aggressive litigation against banks, the parties’ goals should be to mitigate risk and not step into a transaction creating new risks.

• Is your bank prepared for a transaction?

Regardless of which side of the transaction the bank is on, it is critically important to ensure your house is in order. Growing political sentiment regarding bank merger review has led to increased regulatory scrutiny of mergers and enhanced standards of review. According to the NRF Global M&A Trends & Risks report, regulation stands out as the number one hurdle to M&A in the opinion of most respondents.

In December 2023, the Department of Justice and the Federal Trade Commission released updated Merger Guidelines describing the factors and frameworks the agencies often utilize when reviewing mergers and acquisitions. Of note in the updated Merger Guidelines was a lowering of the HHI increase threshold in concentrated markets from 200 points to 100 points and creating a new indicator to evaluate pro forma market share.

In January 2024, the Office of the Comptroller of the Currency issued a proposed rule change along with a policy statement regarding reviews of national bank mergers under the Bank Merger Act. The new rule proposes to eliminate entirely expedited review and use of the streamlined business combination application. The OCC went on to outline the general principles it uses in its review of merger applications. The OCC highlighted the buyer’s management, compliance and CRA ratings, as well as the effectiveness of the buyer’s BSA/AML program and an absence of fair lending concerns. While only recently published, when reviewing transactions terminated since 2022, we can see the major contributors to those terminations significantly coincide with the OCC’s recent policy statement.

This enhanced scrutiny requires that all parties to the transaction review their compliance records both in the preparation and diligence phases of a transaction to mitigate the risk the regulators will not take an adverse position.

While there is unquestionably pent-up demand for deal making, the importance of finding the right partners is now more paramount than ever before.

Parties to transactions should fully understand the rationale for the transaction and be able to articulate those reasons to their various constituents. Once the rationale is determined, banks need to stay committed to their game plan and not agree to a transaction that is not aligned with their goals.

Deal activity may increase in 2024 but doing a bad deal can be far worse than doing no deal at all.

Michael Keeley is a Partner with Norton Rose Fulbright US LLP.