Regulatory compliance issues are slowing down bank M&A approval processes and sometimes preventing them from closing altogether.

The total assets of US bank deal terminations surged this year following the fallout of The Toronto-Dominion Bank and First Horizon Corp.'s blockbuster deal — marking the largest US bank deal termination. Among the four US bank deals terminated so far this year, three cited regulatory issues as the cause.

In interviews with S&P Global Market Intelligence, industry experts said compliance deficiencies related to the Community Reinvestment Act (CRA) and fair lending as well as anti-money laundering (AML) and the Bank Secrecy Act (BSA) can often lead to prolonged deal closing timelines or even termination.

"We've had two transactions that were taken off the market, or stalled out, one or the other, because of BSA and CRA issues, and in one case, they've been given time to get their act together, and in the other case, they were told to just withdraw, get their act together and then come back to it," Craig Mueller, a managing director and co-head of the financial institutions group at Oak Ridge Financial, said in an interview.

CRA compliance

One issue of growing importance in regulators' reviews of M&A, especially as community group protests are on the rise, is CRA compliance. If banks have CRA and fair lending deficiencies, the deal could either be approved with conditions related to improving CRA or shut down by regulators altogether. Often, if regulators are not going to approve a deal, they ask banks to withdraw their application.

"If we're in the middle of our application process, and all of a sudden, a material deficiency is found in CRA ... at either institution, there's a pretty good precedent that the Fed Board won't allow for either organization to go through with the process," Bob Warnock, director of the senior leadership team at Curinos, said in an interview. "They're happy to kind of let it sit there in purgatory, it seems like."

Two banks, Oakwood Bancshares Inc. and Maple Financial Holdings Inc., announced a merger of equals in January 2022 but terminated the deal after withdrawing the deal application in August 2022. Less than a year after the withdrawal, the banks' subsidiaries each received "needs to improve" ratings on their latest respective CRA exams.

Neither company replied to requests for comment asking if CRA compliance had an effect on the previously proposed deal or if it came up in regulatory discussions regarding the deal, leading to the withdrawal.

Beyond the banks' regular CRA exams, fair lending issues have emerged in other aspects of Oakwood's growth plans with regulators. In 2021, the Federal Deposit Insurance Corp. approved a branch expansion application from the bank, but required it to develop an action plan to improve business lending in majority-minority and low- to moderate-income areas, the agency disclosed in the bank's latest CRA exam.

CRA issues can easily halt deals big and small, industry experts said. Often, those issues are uncovered after a CRA protest is brought to light during the public comment period, according to Stephanie Kalahurka, a partner at Fenimore Kay Harrison LLP whose work includes M&A for financial institutions.

"The investigation can become a fishing expedition, and that can raise issues that maybe weren't a focus prior to filing the application, and we've seen it cause deals [to] not close," Kalahurka said in an interview, speaking broadly and not about any specific deals.

But not all deals that face CRA issues fall apart. In the case of the merger of equals between Texas-based banks CBTX Inc. and Allegiance Bancshares, regulators approved the deal despite receiving a protest related to CRA issues, but under the condition that the combined company, Stellar Bancorp Inc., submit an action plan for extending more mortgage loans to African Americans.

BSA/AML compliance

Another compliance category that can easily axe a bank deal is BSA/AML deficiencies. That may have been the regulatory issue in Toronto-Dominion and First Horizon's approval process, according to a report in The Wall Street Journal, which claimed regulators' concerns about Toronto-Dominion's AML practices were the "biggest obstacle" to approval.

Regulators' compliance focus is often heightened for the largest bank deals.

"It's just going to become a continual aspect of, 'Have you invested in these capabilities once you've hit a certain size?'" Curinos' Warnock said. "The jury's still out if they allow some smaller deals to go through, but I think it's going to increasingly become a sticking point across all sizes of deals, especially the largest."

However, BSA/AML issues are not stopping deals as frequently as other compliance issues.

"It's certainly a hot button, but it's not a hot button that's causing multiple deals to not close," Kalahurka said. "It may affect a deal here or there. It may affect a big deal, but it's not something that we would expect on a frequent basis to prevent deals from closing."

Mergers can help with compliance issues

Ultimately, regulators' eventual approval or disapproval typically depends on whether the compliance issues lie within the buyer or seller.

"If the target bank has an issue, sometimes that can be resolved because it's being swallowed, effectively, by the acquirer, and so the acquirer's policies, procedures, standards [and] controls are going to be surviving and may actually resolve the issue by virtue of the merger," Kalahurka said. "But if the acquirer has the issue, that could be something that would prevent them from approving an application."

Regulators typically scrutinize banks more closely when they become acquirers, said Frank Sorrentino, managing director at Stephens.

"If you're a buyer, and you submit a regulatory application, the regulators are probably going to be holding you to a different standard than if you were ... not doing M&A," Sorrentino said in an interview.

Nonetheless, given regulators' increased focus on compliance issues, banks should take advantage of longer deal processing times to do more detailed diligence, according to Curinos' Warnock.

"If deals are taking longer to get done, why aren't we spending more time in the clean room?" Warnock said.