Regional bank M&A expected to get a boost from Fed rating proposal

A recent Federal Reserve proposal is expected to make it easier for regional banks, whose dealmaking appetite is on the rise, to engage in M&A.

The Fed's proposal is set to alter the regulatory rating system for banks with over $100 billion in assets, making it easier for them to obtain a "well managed" rating. Currently, just one "deficient-1" rating, the next-to-last on a scale of four, would deem a large bank "not well managed." However, under the proposal, a bank would need two or more "deficient-1" ratings to be handed a "not well managed" rating. The proposal would maintain the current standard in which a bank with any "deficient-2" rating, the bottom of the scale, would be deemed "not well managed."

Since a favorable regulatory rating is a key component in obtaining a green light on growth initiatives like M&A, the proposal is expected to open the door for large banks to merge, said advisers and analysts.

"It definitely shows you that there's a willingness to entertain M&A at the $100 billion and above level," Klaros Capital Managing Director Kevin Stein, a former associate director at the FDIC who worked on resolutions and a bridge bank, said in an interview. "Under the prior administration, they weren't invited," he added. "It was frowned upon."

The proposal comes at an opportune time for regional banks, who are feeling more confident in dealmaking after the change in administration and recent large bank deal announcements.

Last month, Huntington Bancshares Inc. announced its $1.84 billion acquisition of Veritex Holdings Inc., making Huntington the largest bank buyer in four years. Less than two weeks later, Pinnacle Financial Partners Inc. and Synovus Financial Corp. announced their merger of equals that will create a bank with over $115 billion in assets. It is also the largest US bank deal announced in nearly four years.

More large deals will come down the pike if the proposal is finalized, advisers said. Regulators are "trying to be a little more facilitating rather than obstructing," John Gorman, partner at Luse Gorman PC who represents financial institutions on M&A, regulation and other topics, said in an interview.

In particular, the M&A door will open back up for some banks considered unsatisfactory under the current standards. In the Fed's most recent Supervision and Regulation Report, it revealed that only one-third of large financial institutions, or those with total assets of $100 billion or more, maintained satisfactory ratings in the first half of 2024.

"In theory, if you've done everything else correctly, and you're otherwise in good financial condition, and you're in the process of remediating, you could be allowed, in some circumstances, under this proposal, to pursue certain expansionary activities," Michael Lewis, a partner at Sidley Austin LLP who advises financial institutions on regulatory aspects of M&A, said in an interview.

Assuming the Fed's proposal is finalized, it could take time before banks see changes to their ratings.

It will take regulatory "examiners a while to get through these assessments and for ratings to change," Cliff Stanford, partner at Alston & Bird LLP advising banks and more, said in an interview. "So it's not like it will happen overnight. But over time, it could be that this is removing, or at least lowering, one of the obstacles, for M&A."

The proposal is a "recalibration of a supervisory approach that in the right instance could result in an institution that was otherwise sort of in the penalty box suddenly not being in the penalty box," Stanford said.

The Federal Reserve Board of Governors was split on the proposal, with one governor voting against it, one abstaining and another voicing concerns. The Fed will accept public comments until Aug. 14.

Concerns expressed by Fed Governor Michael Barr, former vice chair for supervision, who voted against the proposal, were that banks who are truly poorly managed could be deemed "well managed," and "if we permit firms that have significant management weaknesses to acquire other firms, it would increase the likelihood and cost of their failure."

In a June speech, Fed Vice Chair for Supervision Michelle Bowman advocated for changes to the rating system for large banks, stating that the majority of the two-thirds of the large banks deemed unsatisfactory through the first half of 2024 met "all supervisory expectations for capital and liquidity."

The proposal is unlikely to harm safety and soundness, Klaros' Stein said.

The Fed is "still going to be supervising institutions," Stein said. "I think it just takes care of some of the somewhat more subjective elements of the ratings, and it certainly eliminates all of the social policy aspects of it."