Dennis Merkley is a member at Howard & Howard. He advises banks, credit unions, and other financial institutions on the many constantly changing regulations directed specifically at financial institutions. Mr. Merkley also advises financial institutions and other businesses on corporate governance matters as well as asset, stock, and real estate transactions. In addition, he represents commercial developers from land acquisition throughout the development process.
Will Lower Interest Rates Stimulate the Bank M&A Market?
2024 could be marked by more dealmaking than previous years.
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At the meeting of the Federal Open Market Committee on Dec. 13, 2023, the Federal Reserve announced its decision to keep the overnight federal funds rate steady in its range of 5.25% to 5.5%. This announcement, coupled with a sharp drop in inflation, has led analysts to predict major central banks, including the Fed, will make earlier and more aggressive rate cuts. Analysts are predicting anywhere from three to nine rate reductions by the Fed in 2024 and that the reductions may start as early as January 2024.
Will the drop in inflation and projected rate reductions positively impact the banking industry mergers and acquisitions market in 2024? The answer is almost certainly yes. After over a year of slower than usual M&A activity, decreased inflation and impending rate reductions should stimulate deal activity. Pent-up deal demand, market confidence from decreased rates and overall positive economic impact from rapidly dropping inflation numbers should keep loan demand high or push loan demand higher.
Home loan demand remained steady despite high interest rates. Home loan demand should remain at current levels or increase with the anticipated interest rate reductions. Consumer credit should also increase with falling interest rates. Business loans, either for expansion or acquisitions, should start to increase with falling rates. This will increase the importance of finding new deposits, either organically or through acquisitions. Deposit growth in 2024 was already a consideration for many banks.
If deposits cannot be grown organically, which is increasingly difficult in a competitive banking environment, an alternative is to locate an acquisition target. Identifying a target with steady or increasing non-interest-bearing deposits or at least low-cost deposits within insured limits and across diverse industries will be ideal. Acquiring a target with such a deposit base may be the quickest way to address a robust demand for loans. Banks can avoid some of the issues we saw with bank failures in early 2023 by avoiding targets with deposit bases that are highly concentrated in a small number of industries along with high levels of deposits that exceed Federal Deposit Insurance Corp. insurance limits.
A difficult hurdle for both targets and acquirers will be lessened if interest rates drop. A drop in interest rates will erase some unrealized losses on available-for-sale securities. Banks must classify securities as held-to-maturity or available-for-sale. For securities that are available-for-sale, changes in valuation affect equity levels, as well as banks’ capital and liquidity. Longer maturity, government-backed debt, which some banks invested heavily in during the pandemic, is more sensitive to interest rate changes. When interest rates increased quickly, those banks had to report significant unrealized losses on their available-for-sale securities. As rates decrease, those unrealized losses will also decrease.
Unrealized losses on available-for-sale securities were an impediment to getting deals done because an acquiring bank would have to book the target’s available-for-sale securities at their value on the day of closing. The target had to accept a discount on its value based on unrealized losses or the acquirer had to pay a premium and show a loss on book value immediately post-closing.
We anticipate banking industry mergers and acquisitions in 2024 will be busier than the last couple of years, at least in part because of the anticipated interest rate reductions.