Hopes that the bank dealmaking cool front could break in 2023

Mitch Eitel, managing partner in the financial services group at Sullivan & Cromwell, said many banks have asked whether they can get deals done because it has taken so long to close transactions, particularly larger deals. Eitel said some buyers have remained on the sidelines because they are fearful that they could be waiting for regulatory approval while another, more attractive target becomes available.

"There's not just concern about how long it will take. There actually has been a concern about whether an approval can be obtained at all," Eitel said.

Mark Menting, a partner at Sullivan & Cromwell, added that consumer-related issues have particularly drawn attention from regulators. Menting said there is an enhanced focus on discrimination and discriminatory lending.

"I think the heightened focus on that, the heightened scrutiny on that can ultimately have an impact on somebody's regulatory standing and rating and ultimately, their ability to get a transaction done," Menting said. "It's no great secret that the [Consumer Financial Protection Bureau] is very, very active in this space as is the [Department of Justice]."

Eitel said he is hopeful that the recent, regulatory approval of USB's acquisition of MUFG could help readjust expectations. That transaction was announced in September 2021, with an expected closing date in the first half of 2022. However, regulatory approval was not received until mid-October and came with a list of conditions, including regular updates from U.S. Bancorp on how it plans to meet additional regulatory requirements facing larger banks. Among other provisions, large banks like U.S. Bancorp are required to maintain resolution plans to show they would wind themselves down in the event of failure.

Eitel noted that had been some push for larger regional banks — which he thinks likely means institutions with more than $250 billion in assets — to hold more total loss-absorbing capital, or TLAC, in the form of long-term debt like their larger, globally systemically important bank, or G-SIB, counterparts. Regulators raised that issue when approving the U.S. Bancorp/MUFG deal but simply requested comments on whether an extra layer of loss-absorbing capacity would help with any resolution.

"There is no sweeping statement that TLAC is going to be required in GSIB-like amounts," Eitel said.

Beyond concerns over obtaining regulatory approval, David Sandler, co-head of financial services investment banking at Piper Sandler, said the spike in interest rates this year has complicated deals. Bank M&A accounting requires buyers to mark a seller's balance sheet to market at close. With the sharp increase in rates, Sandler said the required mark that a buyer must take could substantially reduce tangible capital at the pro forma company and possibly require a capital raise to facilitate the transaction.

"Deals with some exceptions are effectively capital hungry," Sandler said. "This isn't a conversation about desire. It's a conversation about getting deals done and limiting uncertainty."

Sandler further noted that the marks require greater explanation to the Street when announcing a deal.

KBW's Anderson also noted that more buyers have included provisions that would adjust the deal's price if the target's tangible book value changed notably between announcement and close.

"If you go back two or three years, it was about one-quarter of the deals that were announced that had some provision in there regarding either credit or capital-related thresholds. It grew to about 30-something percent a year ago. It's about 37% now," Anderson said.

The myriad complications facing bank M&A are unlikely to change very soon, Sandler said, as liquidity and credit pressures have not been felt yet. Sandler said deposit costs had only risen modestly thus far but he expects that to change given the significant increase in interest rates. He further noted that banks have not shown any real signs of credit deterioration yet but believes liquidity will drive some level of credit erosion over the next six months.

"We're seeing the need to increase rates and tighten liquidity that is demonstrably going to lead to some level of erosion in credit so I don't think we have that stability yet. I can tell you that next year is going to be a busy year," Sandler said. "Next year is either going to have the kind of stability that we're talking about, in which case, we'll see a big ramp-up in the execution on the deals that are being discussed or we'll see a big round of capital raising, but it's going to be a very active year in 2023."

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This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.