US bank M&A activity fell to a record low in 2023 amid intense uncertainty, but the industry is poised for a strong rebound in 2024.

US bank M&A skidded to a near halt in 2023 with just 96 deal announcements — the lowest yearly total going back to at least 2000 — and a total announced deal value of $4.21 billion — the lowest yearly deal value since 2009 — according to S&P Global Market Intelligence data through Dec. 25, 2023. But with concerns over major bank failures fading, more clarity on future interest rates and recent bank stock rallies, advisers expect a wave of activity in 2024 similar to the surge of M&A in 2021 after a quiet 2020 due to the COVID-19 pandemic.

"A twinbill of recent market developments — a precipitous drop in interest rates and a sharp rally in bank stocks — may prove to be the collective matches that spark acceleration in bank M&A," Olsen Palmer managing partner Christopher Olsen wrote in a December 2023 report.

Interest rates

Rapidly rising interest rates kept US bank deal activity at bay over the last year by distorting deal math and dragging banks bond books underwater. But the Federal Reserve holding interest rates steady in the past three FOMC meetings and signaling rate cuts in 2024 is boding well for a return to dealmaking.

With a clearer outlook for future interest rates and a recent decline in medium-term interest rates, banks are feeling more comfortable with M&A, advisers said.

"High rates, low rates, it's not an absolute matter that either one of those is bad. What's bad is not knowing. ... Last year, there was just too much uncertainty," James Stevens, a partner at Troutman Pepper Hamilton Sanders LLP, said in an interview. "This year, there's just a lot more certainty, and clarity by the Fed adds to that. So I think 2024 is going to be a very busy year" for M&A.

Clarity of future rates is more important than the actual level of rates, Keefe Bruyette & Woods managing director and head of US bank research Christopher McGratty said in an interview.

Bank valuations have also been under pressure, which has contributed to the downturn in M&A as buyers have less buying power. But some recent rallies in November as Treasury yields declined and another uptick in December after the Fed signaled cuts in 2024 also helps future dealmaking.

"Movements in interest rates and a positive momentum in bank valuations, that sets the stage for more conversations," OceanFirst Financial Corp. Chairman and CEO Christopher Maher said in an interview. OceanFirst, which has closed seven whole-bank deals since 2015, is interested in M&A over the long term once the various headwinds seen in 2023 subside, Maher added.

Failure fallout

The tumult toward the beginning of the year with three of the largest US bank failures ever put a hard pause on M&A. But with those in the rearview mirror and concerns about more liquidity-related failures subsiding, banks are feeling better about pursuing M&A. However, the events of the spring are still on their mind, and giving them more reason to do deals, advisers said.

One of the recent drivers for M&A is diversification, specifically of liquidity sources, in order to improve safety and soundness.

"The need for diversification is tremendous," Stevens said. "Historically, it's been focused on diversifying your loan portfolio getting bigger and getting into new markets so you can have less concentration on the credit side. But I think these days, the big driver is to seek to have diversification on the funding side. So more branches that you can attract deposits from or consolidate with somebody that's got a fintech partnership or something that delivers deposits."

Regulatory environment

Another factor that has hindered M&A is the tougher regulatory environment, which has led to prolonged deal closing timelines for some banks. Advisers expect that dynamic to continue throughout 2024, but banks are more likely to bite the bullet and take a chance of a prolonged closing timeline as regulatory scrutiny increases, they said.

As regulators step up their scrutiny, banks will look to come together to gain scale and spread the costs associated with increased regulation over a wider asset base, advisers said. That need will be more acute for banks approaching $100 billion as that threshold "is the new line in the sand" following new rule proposals in 2023, such as Basel III endgame, McGratty said.

Heightened rules for banks with more than $100 billion in assets "further underscore the logic for consolidation in the regional and super regional bank sphere," Isaac Boltansky, managing director and director of policy research at BTIG, wrote in a Nov. 29, 2023 report.

Once a bank reaches around $80 billion, "scaling up or strategic conversations must occur," KBW analysts wrote in a Nov. 19, 2023, report. In the note, the analysts name Huntington Bancshares Inc., Fifth Third Bancorp, M&T Bank Corp., Regions Financial Corp. and East West Bancorp Inc. as "potential scale builders" and Comerica Inc., First Horizon Corp. and Zions Bancorp. NA as "potential 'sources of scale' for larger peers."

Credit quality

Economic uncertainty plagued 2023, and will persist in 2024. The investment community is waiting for the shoe to drop on credit quality, which has remained largely pristine since the generous stimulus that flowed into the economy during COVID-19. While credit quality is likely to normalize in 2024, that will more likely serve as a stimulus for M&A, rather than a deterrent.

"If there is an uncertain spike, you have a lot more incentive for companies to do a transaction because it might weaken capital positions to a point where folks need to do something. So credit in and of itself could be a stimulus to more deals for sure," PwC's US Banking and Capital Markets Deals Leader Dan Goerlich said in an interview.

In some cases, institutions might find regulators suggesting that the best course of action for a struggling bank is to sell, said both OceanFirst's Maher and Greg Cunningham, senior vice president at Donnelly Penman & Partners.

"There's going to be a number of institutions where the cumulative pressure of several things is going to push them to find a strategic partner. They may be doing it on their own. They may be encouraged by their board. They may be encouraged by the regulator to seek out a partner that can help them kind of bolster their position," Maher said. "I don't think we're going to see a wave of very troubled banks, but there will be banks under pressure. And one thing they may decide to do is to find a good partner to link up with."

Other ongoing drivers

Other ongoing drivers of M&A — like the need for scale, increasing expenses and succession planning issues — are still at play and more intense than ever, advisers said.

"There are these very significant forces around scale and efficiency," Maher said. "A wider asset base is a very helpful thing. So some of that will come from organic growth, people will continue to grow and get scale. But you can get a lot of scale from mergers and acquisitions as well."

All of these various factors are setting the next few years up for a wave of M&A.

"There is sort of this insatiable drive to consolidate within the banking industry," Stevens said.