M&A outlook gets bleaker in wake of bank failures

After bank merger-and-acquisition activity slowed substantially in 2022, it could reach a standstill following the failures of Silicon Valley Bank in California and Signature Bank in New York.

The sudden demise of the two banks — coupled with the self-liquidation of Silvergate Bank in California — injected hefty doses of uncertainty into the financial system and raised doubts about the veracity of regulatory oversight. The $209 billion-asset Silicon Valley Bank's reliance on deposits from risky technology startups brought it down, while the $110 billion-asset Signature and the $11 billion-asset Silvergate tumbled following forays into the dubious cryptocurrency market.

Regulators missed the extent of those vulnerabilities, and in the aftermath of the collapses observers say bank supervisors are likely to further ramp up reviews of banks' potential weaknesses to compensate. This likely will extend to bank M&A, including previously announced deals that are awaiting regulatory approvals, said Jacob Thompson, managing director of investment banking at Samco Capital Markets.

"Any time there is a failure or perceived problems in the system — a weakness in the banking sector's armor, if you will — the scrutiny level gets ratcheted up," Thompson said in an interview.

This could derail large bank mergers that already were struggling to clear higher regulatory hurdles imposed by the Biden administration, he said. Thompson emphasized that he had no inside knowledge of new challenges but said the likes of Toronto-Dominion Bank's pending acquisition of First Horizon Corp. in Memphis, Tennessee, could see new challenges. Canada's second-largest bank had already warned of new regulatory delays, just days before Silicon Valley Bank's failure. TD did not immediately respond to a call Monday. 

Last month, TD and First Horizon extended the deal's closing date from Feb. 27 to May 27. Then early this month, they said they wouldn't receive approval from regulators by the late-May date. Large deals have needed extra time to reach the finish line because of regulatory roadblocks as well as concerns created by rising interest rates, persistent inflation and recession fears.

"Now, these bank failures add another negative wrinkle on top of the issues already impacting bank M&A," Thompson said.

He added the vast majority of banks in the United States, including community lenders, have little to no exposure to cryptocurrency or Silicon Valley startups. "But when people get nervous about the overall banking system, that almost always seems to worry regulators, and approvals get slower and slower," Thompson said.

This could hold up relatively small but somewhat complicated deals such as Prosperity Bancshares' plan to at once acquire two West Texas community banks for $570 million in cash and stock. The $37.7 billion-asset Prosperity in Houston said last October it would pay $341.6 million for First Bancshares of Texas in Midland and $228.7 million for Lone Star State Bancshares in Lubbock. Prosperity had targeted a first-quarter close for both acquisitions. It did not immediately respond to a call seeking an update Monday.

"Again, I'm not seeing any performance reason for a delay here," Thompson said. "Prosperity is a high-performing bank and a proven acquirer, and both of the banks it is buying are solid. But, at least for a window of time when there are issues with bigger banks, it seems community banks tend to get painted broadly with the same brush, and that can create unfortunate side effects."

Mike Matousek, head trader at U.S. Global Investors, agreed. "In six or 12 months, we may all forget about this because I do think the issues with the failed banks are isolated. But for the near-term, yes, regulators tend to react with more scrutiny of everything, including M&A," he said in an interview.

Ratings agencies and some analysts also tend to react harshly and at least temporarily add to negative sentiment, he said. 

Moody's Investors Service, for example, changed its outlook on the entire U.S. banking system to negative from stable. Moody's said this reflected what it called rapid deterioration in the operating environment following deposit runs at Silicon Valley Bank, Silvergate and Signature.

These kinds of announcements contribute to downward pressure on bank stocks and add another impediment to M&A, Matousek said. He noted that banks often use their stocks to pay for acquisitions, but if share prices are beaten up, deals get sidelined.

The week ended March 10 — following the announced liquidation of Silvergate and the failure of Silicon Valley Bank — was the third-worst trading week for U.S. bank stocks since the 2008 financial crisis, according to S&P Global Market Intelligence. The S&P U.S. BMI Banks index lost nearly 12% of its value that week.

Ahead of the failures, bank stocks were already struggling to maintain momentum because of inflation and recession worries.

There were just 168 U.S. bank M&A deals announced last year, down from 205 in 2021, according to S&P Global. Only six deals were announced in January, the latest month for which S&P reported totals. It marked the lowest deal tally for the first month of the year since 2009.

Still, Matousek said, in bids for size, talent and new markets, M&A activity is likely to recover once failure worries subside and stocks recover. He said small banks need more scale to invest in technology and new business lines to meet customers' increasing demands for digital services and to compete with larger, more diverse lenders.

"From my view, this is a problem for M&A but not a long-term one," Matousek said. "Sure, there may be other banks to emerge with issues, but the system overall is well-capitalized and strong. After we get past some of this panic, I think the market will see that."