Under the shadow of credit clouds, the U.S. banking industry may face a wave of consolidation

Concerns about credit losses in the U.S. banking sector are intensifying expectations for mergers and acquisitions. Media reports, citing four senior industry insiders, suggest that large banks may accelerate the absorption of smaller or weaker competitors.

This dynamic comes more than two years after the collapse of Silicon Valley Bank. In recent weeks, bankruptcies in the automotive sector and bad loans have pressured bank stock prices, raising market fears of more pain to come. The KBW Regional Banking Index in the U.S. plummeted over 6% on Thursday but partially rebounded on Friday, having fallen nearly 5% year-to-date.

Last Thursday, Zions Bancorporation disclosed losses related to two commercial and industrial loans, while Western Alliance announced it had filed a fraud lawsuit against Cantor Group V, leading to a broad decline in bank stocks. The recent bankruptcies of automotive companies such as First Brands and Tricolor have triggered a ripple effect in the credit market, exposing the risk exposures of some of the world's largest banks to scrutiny.

Concerns about credit quality will make acquirers more cautious as they pursue deals. However, the uncertainty highlights the importance of scale in absorbing market and credit shocks, which will support the M&A outlook in the long run.

Improved Regulatory Environment Drives Deal Discussions

Media reports cite an industry insider revealing that, based on interactions with multiple banks, bank executives have been discussing M&A matters due to an improving regulatory environment for transactions. Dan Hartman from the law firm Nutter stated:

"Market activity and valuations have been driving M&A conversations, so the current market volatility may accelerate these discussions."

He added that banks were already open to M&A due to the Trump administration's more favorable stance on transactions:

"The larger the bank, the better prepared it is to absorb significant credit losses."

In recent months, a broader positive economic environment has also made it easier for institutions to decide that the time to sell has come, another industry insider noted. S&P Global Market Intelligence data shows that 51 bank transactions announced in the third quarter set a record for the highest number in three months in four years.

Key Differences Between Current Credit Concerns and the 2023 Crisis

A senior industry executive, who wished to remain anonymous, stated that current concerns differ significantly from the regional bank crisis of 2023. He added that concerns about credit quality are amplified because information about banks' loan exposures is often confidential.

The securities mismatches that led to bank failures in 2023 were visible to shareholders, while credit losses are aggregated and only disclosed to bank shareholders once a significant threshold is reached.

Michael Driscoll, a credit rating officer at Morningstar DBRS Global Financial Institutions Ratings, stated:

"In most cases, bank loan performance has exceeded expectations. Losses have been low, so recent issues with large loans have raised concerns about broader deterioration. However, one of the lessons from the 2023 regional bank failures is that if significant problems arise, the collapse of bank funding may happen faster than in the past "This industry executive and another source said that growing concerns about small banks may drive merger and acquisition activity. The executive noted that boards are likely to feel worried when they see continued weakness, making them more inclined to urge management to consider a sale, although he did not mention any specific target banks.

Potential Deal Targets Emerge

An investment banking source told Reuters earlier this month that, based on their internal analysis of the banking industry—rather than any information based on specific transactions—banks such as Zions, Flagstar, First Horizon, East West, Popular, Western Alliance, and Webster Financial may become attractive deal targets. These banks did not immediately respond to requests for comment.

However, the higher risk of taking over potentially troubled banks may cause some buyers to hesitate. Stock price volatility is often seen as detrimental to deals, as it makes reaching an agreement on valuation more difficult. Early-stage merger and acquisition considerations may be put on hold until the broader market calms down in the coming days or weeks.

Greg Hertrich, head of U.S. interest rate strategy at Nomura Securities, stated that the latest sell-off will restart strategic deal negotiations rather than attract new buyers or sellers:

"If the market's perception of the value of these franchise businesses changes, that could accelerate the timeline."

For small banks, credit difficulties may prompt boards or shareholders to pressure them to sell to mid-sized lenders. An industry banker noted that despite the uncertainty, this underscores the importance of scale in helping absorb market and credit shocks, supporting the long-term outlook for deals