Banks have accelerated their mergers and acquisitions (M&A) activity over the past six months, with the announcement of several big regional banking deals. Many believe M&A in the sector could pick up later this year, and are wondering how big a deal we could potentially see in the space. The large U.S. banks are flush with capital, and could have more excess capital when they likely release the reserves they've been holding for potential loan losses later this year. Could one of the largest banks in the U.S., like, say, Citigroup (C 0.20%), buy another big commercial bank? Let's take a look.

Would Citigroup consider it?

Citigroup is in a unique position. While the four largest banks in the U.S. are flush with capital, JPMorgan Chase and Bank of America are not allowed to buy another depository institution. U.S. banking laws prohibit one bank from acquiring another if the acquisition would push that bank over 10% U.S. deposit market share. And Wells Fargo, which really would be at or above the limit if not for regulatory issues, is still close to the 10% threshold.

Bank % of U.S. Deposits*
JPMorgan Chase 10.5%
Bank of America 10.1%
Citigroup 4%
Wells Fargo 8.3%

Data source: Bank financial reports, Federal Reserve. * = as of Dec. 31, 2020

Citigroup, which runs a more global operation, has plenty of room to grow in the U.S. through inorganic opportunities. With $16.8 trillion in U.S. commercial bank deposits as of March 17, Citigroup has enough room to purchase any of the bigger regional banks below it and stay under the 10% threshold.

The interior of a Citigroup branch.

Image source: Citigroup.

Now, would Citigroup even consider a meaningful U.S. depository bank acquisition? Analyst Gerard Cassidy of RBC Capital Markets actually asked this very question on Citigroup's latest earnings call, which new CEO Jane Fraser more or less avoided answering. However, Fraser did say, "We do see important growth opportunities and our home market is an important one for it." Citigroup also had about $21 billion in excess capital over its regulatory minimums at the end of 2020, so it does have some cash to work with.

The obstacles

There are currently a few roadblocks standing in Citigroup's way. Last year, regulators hit the bank with a $400 million civil penalty for the bank's failure to address and improve internal controls related to compliance, data, and risk management.

The U.S. Office of the Comptroller of the Currency (OCC), which regulates national banks, also issued a cease-and-desist order requiring Citigroup to receive the OCC's "non-objection" before making important acquisitions. So Citigroup might need to address the order before thinking about acquisitions. This is not uncommon, as banks typically need to be in good standing with their regulators before doing things like expansion.

Even if Citigroup had the blessing of its regulators, the bank may have trouble anyway because the regulatory issues have hurt its stock price and valuation. The bank currently trades around $73 per share, slightly below tangible book value, a valuation that is toward the bottom of the industry right now.

Bank valuations are important for acquisitions if the acquiring bank is doing an all- or part-stock deal, which is common. The higher the acquirer's valuation is compared to the target, the less dilutive the purchase price will be to the acquiring bank's shareholder equity -- shareholders typically do not like to see a deal result in dilution that takes too long to earn back. At its current valuation, Citigroup would not be in a position of strength for an acquisition.

Is it a possibility?

I would be somewhat surprised to see Citigroup make an acquisition in the near term. The bank has a lot of work to do in terms of correcting its regulatory issues and getting back into good standing with its regulators. As I mentioned, its valuation is not strong right now, and the bank just installed a new CEO, who is in the process of refreshing Citigroup's strategy. That seems like enough to keep the bank busy right now.

But I wouldn't completely rule out an acquisition, because many expect Citigroup's stock price to recover further, boosting its valuation. Plus, if the bank puts a big focus on its U.S. consumer franchise, an acquisition could be a great way to jump-start the revamp. It will be interesting to see what Fraser says about the bank's new strategy on its upcoming earnings call, and when the bank unveils its implementation plan in May.