Under the cloud of credit concerns, a wave of consolidation may be coming for U.S. banks.

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

This development comes more than two years after the collapse of Silicon Valley Bank. In recent weeks, bankruptcies in the automobile industry and non-performing loans have depressed bank stock prices, sparking market fears that more pain is on the way. The KBW Nasdaq Regional Banking Index plunged more than 6% on Thursday before partially rebounding on Friday, and has fallen nearly 5% so far this year.

Last Thursday, Zions Bancorporation disclosed losses related to two commercial and industrial loans, while Western Alliance revealed it had filed a fraud lawsuit against Cantor Group V, sending bank stocks down across the board. Earlier, the bankruptcies of auto industry companies such as First Brands and Tricolor triggered a chain reaction in the credit market and put the risk exposure of some of the world’s largest banks under the spotlight.

Concerns over credit quality will make buyers more cautious in pursuing deals. However, this uncertainty highlights the importance of scale in absorbing market and credit shocks, supporting the long-term outlook for M&A.

Improved Regulatory Environment Drives Deal Talks

Media, citing an industry insider, report that based on interactions with several banks, bank executives have been discussing M&A, as the regulatory environment for deals is improving. Dan Hartman, of law firm Nutter, says:

"Stock market activity and valuations have always fueled merger discussions, so current market volatility may accelerate these conversations."

He adds that banks were already open to M&A because the Trump administration is friendlier to deals:

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

The broader positive economic environment in recent months has also made it easier for institutions to decide that the time to sell has come, another industry source said. S&P Global Intelligence data shows 51 bank deals were announced in the third quarter, the highest three-month total in four years.

Key Differences Between Credit Concerns and the 2023 Crisis

A senior industry executive, who asked not to be named, said current concerns differ in key ways from the 2023 regional banking crisis. He added, worries over credit quality are being amplified because information about banks’ loan exposure is typically confidential.

The securities mismatches that led to the 2023 bank failures were visible to shareholders, but credit losses are aggregated and only disclosed to bank shareholders when they reach a significant threshold.

Michael Driscoll, a credit ratings officer at Morningstar DBRS Global Financial Institutions Rating, said:

"In most cases, bank loan performance has been better than expected. Losses have been very low, so recent issues with large loans have triggered concerns of more widespread deterioration. But one of the lessons from the 2023 regional bank failures is that if major problems emerge, bank funding can unravel faster than in the past."

This executive and another source said growing concerns about small banks could drive M&A activity. The executive said boards tend to become anxious when they see ongoing weakness and are more likely to nudge management to consider a sale, but he did not mention any specific target banks.

Potential Deal Targets Emerge

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

However, the heightened risks associated with acquiring possibly troubled banks will make some buyers hesitate. Stock price volatility is usually seen as negative for deals, because it makes reaching an agreement on valuation more difficult. Early-stage M&A considerations may be put on hold until the broader market calms in the next few days or weeks.

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

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

For small banks, credit troubles may prompt boards or shareholders to put pressure on them to sell to mid-sized lenders. One industry banker said that despite uncertainty, this actually highlights the importance of scale in helping to absorb market and credit shocks, supporting the long-term outlook for deals.

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