Following a slow year for mergers and acquisitions in 2023, community bankers face many of the same challenges that stifled activity last year. High interest rates, economic pessimism and regulatory uncertainty remain unabated. Yet industry experts expect the pace of M&A to rise this year, before returning to full strength in 2025 as bankers adjust to uncertainty and evaluate deals to effectively scale their operations.
Only 96 deals were announced last year, according to S&P Global Market Intelligence, the lowest number since at least 2000 and just more than half the 161 finalized in 2022. Expectations for M&A to bounce back this year have not yet been realized. The Federal Reserve has delayed rate cuts amid strong economic conditions and higher-than-expected inflation.
Twenty-eight deals were announced in the first quarter, including nine in the Midwest, noted Kirk Hovde, managing principal and head of investment banking at Chicago-based Hovde Group. He expects M&A will continue to lag historical trends until interest rate cuts begin. The firm is expecting 114 whole bank and thrift deals this year, before jumping to nearly 200 in 2025.
“So far this year, it is very slow,” said Craig Mueller, co-founder and managing partner at Lake Elmo, Minn.-based investment banking firm TruStar Advisors. “The most active participants in the M&A market are credit unions, and the banks continue to be hindered by … bond losses, and the bond losses are typically a direct deduction from the purchase price.”
Despite the slow pace of M&A, experts say the disproportionately high number of bank charters in the Upper Midwest means activity will pick up. Of the 4,500 FDIC-insured banks in the United States, more than 2,000 are based in the Midwest, including 251 in Minnesota, 161 in Wisconsin, 240 in Iowa and 358 in Illinois.
A couple hundred bank charters could disappear in the next decade, noted John Reichert, a banking and finance attorney at Milwaukee-based law firm Reinhart Boerner Van Deuren. Mueller predicted the pace of M&A will increase in 2025 as banks’ AOCI bleeds off or succession planning challenges cause a sale.
Ballard Spahr Partner Scott Coleman said the pace of M&A will “dramatically escalate” in the next 12 months as more bankers grow comfortable with current conditions and are more optimistic the economy will improve this year. Deal volume in his practice plunged 60 percent last year amid high inflation, elevated interest rates and caution following the spring failures of Silicon Valley Bank, Signature Bank and First Republic Bank.
Coleman said stable core deposits are again an attractive option for potential buyers. “There is a fair amount of pent-up buyer demand,” he added. “The tightening of liquidity has caused institutions to be more interested in transactions that will positively impact that side of the balance sheet.”
Although Coleman is bullish on M&A in 2024-25, he described his forecast as “fragile” and based on broader economic trends. He is also unsure of the impact a new presidential administration could have on M&A.
The rate of M&A over the next 12 months will depend on whether interest rates remain high, noted Howard Hagen, an attorney with Des Moines-based law firm Dickinson Bradshaw Fowler & Hagen. Hagen sees pent-up M&A demand amid a lack of succession planning, not stress on individual banks. More aging bank owners are looking to sell as fewer members of the next potential generation of ownership are interested in continuing in the industry, he noted.
Hagen advised banks looking to either buy or sell to go over their goals with their advisors, evaluate their bond portfolios and potentially be willing to trade a short-term loss for a long-term gain. Bank owners should have a fail-safe succession plan in place in case they don’t sell, Hagen noted.
Potential sellers are waiting to secure higher purchase prices, added David Heneke, principal at Minneapolis-based accounting firm CliftonLarsonAllen. Expensive core contracts, deferred pay packages and employee compensation plans are sometimes delaying deals on the seller’s end, he noted. Recently-finalized deals have involved banks strategically entering a market, Heneke said. Fewer have been for transactional value.
As of February, community banks were a majority of the 20 most recent mergers of equals, according to S&P Global. Buyers in those transactions had an average asset size of $8.0 billion, while the targets had an average asset size of $7.8 billion. More community banks shifted their focus to low- to no-premium MOEs from securing attractive premiums to gain scale as stock prices fell in 2023, according to S&P. Bankers see MOEs as especially attractive in raising their value for a potential future sale to a larger lender or to spread increasing costs for technology, talent and regulation over a larger asset base.
Mueller said the vast majority of transactions in recent years have involved banks with fewer than $1 billion in assets. Few potential investors are willing to face down the minimum $25 million needed to form a de novo charter. Mueller said investment groups are better off overpaying for an existing charter than meeting the stringent capital and regulatory requirements of a de novo. Twenty-six de novos were established from 2017-20, according to S&P. Of those, 20 had a positive return on average assets in 2022.
Credit Unions, nonbanks remain active acquirers
Credit unions and nonbanks remain active bank acquirers as sellers remain hindered by bond losses, Mueller noted. Several credit union-bank buys have already been announced this year in the Upper Midwest. Oshtemo, Mich.-based Advia Credit Union plans to expand further into Illinois by acquiring Chicagoland-based NorthSide Community Bank. Wabash, Ind.-based Beacon Credit Union announced its pending acquisition of Salem, Ind.-based Mid-Southern Savings Bank. Moline, Ill.-based Empeople Credit Union plans to acquire Lomira, Wis.-based TSB Bank.
Still, state regulators in some states have prevented credit unions from acquiring state-chartered banks. In Minnesota, the Department of Commerce blocked a 2021 deal between Royal Credit Union and Lake Area Bank. The deal was eventually called off, before the groups announced in March 2023 that Royal would acquire Lake Area’s mortgage division and three of five Twin Cities-area branches. The modified acquisition closed in August.
Hagen and fellow Dickinson Bradshaw attorney Bradley Kruse are not expecting an active year for bank-credit union deals in Iowa, as the state has resisted credit union acquisitions of state-chartered banks. Banking regulators in Iowa and Colorado have vowed not to approve credit unions acquisitions of state-chartered banks. Heneke said there could be momentum to enact similar bans in other states. “It’s becoming a more-known issue, where it was kind of under the radar over the last few years,” he added.
Credit unions can generally pay more than a bank due to their tax-exempt status and ability to pay cash, both attractive options for potential sellers. Nonbanks have also emerged as major players in acquiring community banks with less than $500 million in assets. More than half of the deals Reinhart was working on as of April didn’t include a bank buyer, Reichert noted. A couple acquirers were credit unions, while the rest were nonbanks — a mortgage company, broker-dealer, investor groups and private equity firms.
“A lot of the banks, at least in the Upper Midwest, still have an interest in selling,” Reichert said. “What is changing is the buyer profile.”
Nonbanks and credit unions will continue to be major players in M&A, noted Karen Grandstrand, chair of the bank and finance group at Minneapolis-based law firm Fredrikson. Her firm is seeing a mix of nonbank and bank buyers for smaller community banks as larger bank M&A has slowed. More deals are occurring between banks with traditional business models and no adverse examination findings, Grandstrand noted.
Regulations sparking, hindering M&A
Regulations are both placing pressure on community banks to grow through an acquisition and making deals harder to complete, Grandstrand said. In 2021, the Biden administration issued an executive order calling on the attorney general and heads of federal banking regulatory agencies to update merger guidelines and oversight under the Bank Merger Act and Bank Holding Company Act.
Early this year, the Office of the Comptroller of the Currency proposed ending the default approval of certain merger applications after a given time period. The OCC is also proposing adding transparency to standards consistent with merger approvals and denials, and signaled it will not approve deals in which the selling bank is rated in less-than-satisfactory condition. Whereas regulators previously viewed the acquisition of a bank in unsatisfactory financial condition favorably to avoid a failure, Grandstrand said the proposal will likely create insolvent banks kept alive by government support.
The FDIC has historically allowed banks to either refile or completely withdraw their applications when it identifies regulatory issues. Grandstrand said a new proposal would enable the FDIC to issue a statement outlining its concerns with the application when the bank withdraws an M&A application. Banks looking to avoid the reputational risk might decide to instead move forward with the deal, she noted.
Regulators are especially concerned with banks that have rapidly grown through a series of transactions, Grandstrand said. Other regulatory considerations include whether the buyer has a firm integration plan, if the seller and buyer have clean regulatory examinations, and whether any Bank Secrecy Act-related issues exist.
The influx of proposed regulations leaves uncertainty and a lack of clear interagency regulatory standards, neither of which are positives, she added. To combat heightened uncertainty, Grandstrand said bankers must undertake more pre-planning before embarking on M&A activity. Buyers and sellers should work with professional advisers on how to best position the deal for approval.
Kruse said there has been an uptick in the amount of information requested by federal regulators in M&A deals along with an increase in approval times. Hagen said selling banks are more likely to secure regulatory approval by acquiring an existing bank, as regulators are intensely scrutinizing fintech-bank deals.
Reichert said sellers still cite a lack of succession planning, desire for shareholder liquidity and rise in cyber fraud as major considerations. “Cybersecurity is becoming increasingly expensive as banks are forced to play defense against fraud and play offense through increasingly digital and complex offerings,” he said.
“The fraudsters are really hard to keep up with, and if you are a small bank that can be a challenge,” Reichert added. “Even if you have the appropriate insurance and everything, it’s a significant cost and disruption.”
Coleman said banks should prepare for a deal to take 12-18 months as regulators more closely scrutinize competitive factors. Last June, Department of Justice Assistant Attorney General Jonathan Kanter announced the DOJ would expand its M&A competitive review process to include fees, interest rates, branch locations and the potential to further consolidate power in an already dominant bank.
Some of the deals Reinhart is working on date back to 2022. “In the next decade, we will continue to see significant consolidation,” Reichert added. “The pace depends on the economy and the regulators.”