Wells Fargo: US banking is expected to usher in a “wave of mergers and acquisitions” within the next two years

The Zhitong Finance App learned that Wells Fargo expects bank mergers and acquisitions in the US to accelerate over the next 18-24 months, mainly due to changes in the regulatory environment, the reduction in the “score” of balance sheet assets due to the low interest rate environment, the “burning” of low-interest assets, and the ability of some large banks to increase profitability through economies of scale.

M&A activity is expected to accelerate

Wells Fargo expects bank mergers and acquisitions to accelerate over the next 18-24 months, mainly due to the need for some banks to increase profitability through economies of scale. Wells Fargo believes mergers and acquisitions may be easier under Trump's second administration compared to the regulatory environment of the previous four years. As the election comes to an end, Wells Fargo believes mergers and acquisitions will accelerate, and the downward trend in the number of US banks and savings institutions will continue. In the early 1980s, the US banking system had approximately 18,000 banks and savings institutions. Today, the number is close to 4,500, of which around 600 (about 13%) are publicly traded; it is expected that the main drivers behind the consolidation will be: 1) a more supportive regulatory environment; 2) strategies to increase profitability through economies of scale; 3) mitigating the “market-based” challenge; and 4) increasing the value of core deposits.

The regulatory landscape is about to change

During Trump's first administration, we saw several regulatory changes that, in general, reduced the burden on banks. After going through this period of relatively relaxed banking regulations, political pressure and a few special bank failures in early 2023 prompted regulators to shift and adopt a regulatory tightening strategy. As we enter 2025, Wells Fargo expects the regulatory environment to relax again, as recent election results will lead to changes in the leadership of banking regulators (FDLC, OCC, and CFPB) and could change the trajectory of key rulemaking plans.

Economies of scale

Scaling up for the sake of scale is not what banks seek to achieve through mergers and acquisitions. Instead, economies of scale provide opportunities for increased efficiency and growth, such as through technology and brand marketing, which should all lead to higher profitability. Furthermore, it is important that the scale should lead to a better portfolio of core consumer deposits, which will drive the value of bank franchises. By providing digital solutions to customers, technology continues to provide banks with greater efficiency and revenue growth, which is more important than ever. As the number of branches in the industry dwindles, banks continue to optimize their branch footprint, and this trend is expected to continue over the next few years. Recently, this trend has slowed as a few select banks have begun implementing new branch strategies to supplement their existing branch footprint. National brand marketing is also becoming increasingly important for large banks seeking to expand their market share.

The challenge of pricing by market capitalization

One of the biggest barriers to bank mergers and acquisitions is the “price by market value” issue, which is driven by rising interest rates and their impact on the asset-side interest rate indicators on the balance sheet. Assuming lower interest rates, this barrier is expected to weaken in the future. Furthermore, as each quarter passes, more low-yield assets placed on bank balance sheets in the context of low interest rates from 2020 to 2021 will be “burned”.

Core deposit value-added

According to Wells Fargo, low-cost core consumer deposits are where the real value of banking business lies. As interest rates have risen over the past few years (which are unlikely to return to 0 -0.25% in the near future), low-cost core deposits have become very valuable, and the bank expects institutions with cheap core consumer deposits to be highly sought after. In an environment with higher interest rates, deposit premiums paid are higher, which confirms the value of cheap core consumer deposits to buyers.

Peer to Peer Merger (MOE) vs. Acquisition

Compared to MOE, affordable bank acquisitions work much better for the acquirer and its shareholders. In an acquisition, the acquirer makes all the difficult but necessary decisions to make the acquisition a success. Phu Quoc believes that in the MOE, it is difficult to break the “we against them” culture that initially formed after the MOE. This made it more difficult to meet the goals set at the time of the merger announcement, leading to poor stock performance, and in some cases, extremely poor stock performance.

Banks that may participate in mergers and acquisitions

Wells Fargo anticipates mergers and acquisitions across the banking industry. Today, only Bank of America (BAC.US) and J.P. Morgan Chase (JPM.US) are prohibited by law from buying deposits (fair trade) because their share of the deposit market exceeds 10%. Here are the different bank categories where M&A activity is likely to occur in the next two years:

Wells Fargo believes that banks with assets between $10 billion and $50 billion will continue to integrate to form economies of scale or be acquired by larger banks; banks with assets between $50 billion and 90 billion US dollars are expected to evaluate the pros and cons of assets exceeding $100 billion due to increased associated costs and regulatory burdens. The bank also believes that some of these banks will choose to sell rather than exceed the $100 billion threshold. Other companies may cross the $100 billion mark by buying their own companies to manage the higher costs of more than $100 billion in assets. Furthermore, the bank believes that low-debt banks with assets of $100 billion to $750 billion or more (excluding custodian banks) will seek acquisitions or mutual mergers.

Federal Reserve Regulatory Report

The Federal Reserve publishes an industry regulatory report every six months. In the report, large financial institutions (LFIs) are assessed using three criteria: 1) capital planning and positions, 2) liquidity risk management and positions, and 3) governance and control. According to the latest report in November 2024, two-thirds of banks received unsatisfactory ratings, which Wells Fargo believes prohibits them from carrying out depository acquisitions. Unsatisfactory ratings are driven by weaknesses in governance and compliance issues, such as mRAs (matters requiring attention) and mRLA (matters requiring immediate attention). The bank believes that under the Trump administration's banking supervision policy, as banks correct outstanding regulatory issues, they will see the number of banks with poor ratings decline over the next 12-14 months, which means there will be more acquirers.