Changing Conditions May Drive More Community Bank Mergers in 2025

After a triple whammy of high rates, underwater portfolios, and an administration skeptical of mergers, community banks may see improved prospects for building scale through M&A next year. What could derail their chances? Three regulators and a Justice Department who have all decided to follow their own roadmaps.

Could community bank merger and acquisition activity accelerate in 2025 after a multi-year lull? A special report from Fitch Ratings says it’s quite possible, with the pace of that acceleration depending on how many factors that could favor M&A pan out.

On the eve of the presidential election, it would be tempting to put all the chips on the future of bank mergers on who wins the White House. And although that is a factor, it’s not that simple.

Broadly, the Federal Reserve’s plan to reduce interest rates, which began with a 50-basis point cut in September, has started a positive shift in the value of both banks’ investment portfolios and their loan holdings, according to Fitch.

This comes on top of the urgent need felt by many institutions to catch up or keep up with banking technology. From improved mobile banking apps to new core processing systems, many institutions have to gain tech ground to compete. Spreading costs over a bigger bank via merger eases the pain, Fitch points out in its late October report.

At the same time, a potential wild card — a handful of wild cards, in a sense — arises in the regulation and supervision of banking mergers at the federal level.

In mid-September, two federal banking regulators issued new policy statements on how they will review mergers on antitrust and other grounds. Those statements, while similar, differ in several important ways. Meanwhile, the Department of Justice at the same time shook up the way that it will review banking mergers. Meanwhile, the Federal Reserve has not changed its merger rules, beyond some changes to application instructions, and Michael Barr, vice chairman for supervision, has said it doesn’t plan to issue any new policy.

Economics Versus Politics: Both Moved the M&A Needle

Bank mergers, including those involving community banks, have faced multiple barriers in the last few years, according to Fitch. The chart below tracks the decline in deals from year to year over the last decade, and a late October analysis by S&P Global Market Intelligence suggests that total deals for 2024 will also be down.

FDIC-approved merger applications 2013-2023

Several factors have slowed the pace of deal making. Fitch says that the pandemic, and then the rate hikes that followed subsequent inflation, drove the change.

Economic factors that Fitch cited include “tightening liquidity, significant changes in the mark-to-market valuations of banks’ securities portfolios, and greater uncertainty on credit quality, particularly around commercial real estate.”

As Fitch explained it in its report, the Fed’s rate hikes, intended to fight inflation, hit bank portfolios that had been filled with longer-dated securities. As rates rose, unrealized losses kept rising.

“These unrealized losses created a significant barrier to M&As since they would have to be realized at the close of a merger, which in turn greatly curtailed the pool of attractive targets,” said Fitch. “Similarly, banks with large proportions of longer-dated and/or low-yielding loans were also less attractive to potential acquirers.”

In the middle of 2023, unrealized losses began to ease. Fitch projects that the Fed will reduce rates by a cumulative 250 basis points by the end of 2026. Fitch said this will address the impact of mark-to-market accounting on both the investment portfolio and the loan portfolio, notably commercial real estate.

The impact on CRE is especially important for M&A because those loans have been a heavy component of community bank portfolios for decades as volume in other categories, such as consumer loans, got snapped up by major banks and large fintechs such as Rocket Mortgage.

Fitch said that banks with $5 to $15 billion in assets are the most concentrated in CRE. The rating agency said that rural and suburban institutions are often sitting better than urban community banks because they tend to lend on owner-occupied CRE. This could push more mergers among urban players.

Read more: CRE Outlook 2025: How a Bust Could Become a Boom

Bank Mergers Collide with a Broad-Based Attack on M&A

Politics has also played a role. In mid-2021, the Biden administration issued an executive order on mergers of all kinds, including banks, an effort that was of a piece with the later push, also via executive order, on “junk fees” in multiple industries.

The merger executive order ignited both increased scrutiny under existing rules as well as a policy revamp that reached its culmination in September when the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp., and the Justice Department announced their moves. (The OCC and FDIC finalized policy statements and related materials that had been through the comment process. DOJ withdrew from the 1995 Bank Merger Guidelines — for nearly 30 years the guideline for competitiveness analysis — in favor of its general 2023 Merger Guidelines, with an added bank merger addendum.)

Fitch’s report noted that the then-new administration “created an additional headwind, as the Biden administration’s focus on consumer access for banking services brought greater scrutiny to proposed deals, which notably increased the time for deal approvals.” The chart below from the Fitch report illustrates the falloff in volume and the increase in the time taken to obtain approval.

Fewer bank mergers and more time for approval

“While no proposed mergers have been formally denied since the directive took effect, approval times have increased markedly and, in some cases, to the point of making deals non-viable, as market conditions turned during the review period,” said Fitch.

From the archives: How Mixed Messages from Biden Regulators Are Muddying M&A Waters in 2024

Red, Blue and Green: Will a New Presidency Change Bank M&A?

What impact will a change in President have? Fitch outlined both possibilities:

A Trump victory: “A second Trump administration will likely assume a similar stance to the first, with relaxation of regulations a key plank of the Trump platform.”

A May 2021 article on The Financial Brand noted the gearshift going on into the Biden years: “… while the past administration’s Department of Justice was calling for a review of merger policy with an eye toward liberalizing it, a Democratic DOJ would be seeking to crack down on alleged past laxity in merger approvals and toughening standards.”

A Harris victory: “The outlook for a Harris administration is somewhat less clear. Specific pronouncements relating to bank regulation have been vague but would seem to align with other pronouncements on economic policies with a focus on social equity.”

Added Fitch: “The most likely assumption relating to bank M&As is that a Harris administration will continue the increased regulatory scrutiny of the Biden era.”

Read more: How Are Banking Industry Experts Handicapping the Impact of the Election?

Meanwhile, the FDIC, OCC and DOJ Moved Forward

Over the last few decades, much — not all — federal banking rulemaking of all sorts has been done on an interagency basis, with at least the three prudential banking regulators working out common rules in this or that area. (When it comes to mergers, which agency does the actual review depends on the type of institution — state-chartered Fed member, state-chartered nonmember, or national bank, as well as holding companies — that would be in control after the proposed merger.) But the regulatory approach has been shared.

For the time being, however, that longstanding approach has gone by the boards, raising concern.

“A lack of interagency coordination in this critical policy area furthers the uncertainty for industry participants and has a chilling effect on bank merger transactions,” wrote Sarah Flowers, SVP and senior associate general counsel for regulatory affairs at the Bank Policy Institute in a recent blog. One point of objection is that the FDIC policy indicates that parties to a proposed merger be able to demonstrate that the deal will better meet the convenience and needs of the community the merged entity will serve. The blog hinted that lawsuits could be in the offing.

One of the goals of the two regulatory agencies, especially the FDIC, is to expand the factors that are looked at to evaluate competition in a market. Historically deposits in a market were used as a proxy for competition, but with the internet and other channels competition hasn’t just been about local brick and mortar competitors for some time.

However, Fed Governor Michelle Bowman, who occupies the designated community banking seat at the central bank, expressed concern with the new FDIC approach in a recent speech. Widening the factors in the evaluation of a merger “seems likely to promote inconsistency in the analysis among firms, and even longer delays in processing times,” said Bowman. She believes that community banking needs both easier formation of new banks and the ability to do mergers for efficiency’s sake.

In an analysis of the approaches of the two agencies and DOJ, Covington & Burling LLP said the efforts “demonstrate that the current leadership of these agencies is, and has been, adopting a more skeptical view of bank mergers than in the past.”

In its own analysis, Skadden, Arps, Slate, Meagher & Flom LLP said that the moves by the agencies and DOJ “raise more questions than answers, not least of all because the Federal Reserve Board — the principal agency that approves mergers of bank holding companies — was not part of these actions.”

Much in the revamped approaches will hit larger institutions harder, such as mandatory public hearings for megadeals. In a company newsletter, Gerrish Smith Tuck, PC, a law firm specializing in community banks, downplayed the changes vis-à-vis those institutions: “It will add some nuance to the application process, but we certainly do not classify it as wholesale change.” How those “nuances” play out remains to be seen, as interest in deals picks up.

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