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Of the 575 official complaints against Capital One's plan to buy ING Direct, only one stuck: The credit card lender has been a serial screw-up when it comes to getting delinquent borrowers to pay up, the Fed found.
February 15 -
After nine months of consideration, the Fed said the merger of Capital One with ING Direct USA did not pose a systemic threat, but placed conditions on the deal to ensure the combined institution did not become one.
February 14
WASHINGTON — Although the Federal Reserve Board ultimately signed off on Capital One Financial Corp.'s deal to buy ING Direct USA, the grueling 9-month long process to get there is a warning to other large would-be acquirers.
Banks are likely to face tougher standards and a lengthier approval process than ever before, according to industry experts.
"The application was approved, but the Fed I think took the opportunity to send clear policy messages about its approach to future applications," said H. Rodgin Cohen, a partner with Sullivan & Cromwell and one of the nation's top banking lawyers. "You can certainly see the very largest banks facing substantial uncertainty as to whether the Fed will approve any material acquisition."
Capital One closed its deal Friday with ING for $6.3 billion in cash and 54 million shares of the McLean, Va.-based company's stock after an unusually long approval process.
Although critics charged the deal would make Capital One a systemic threat, the Fed-and many observers-disagreed. Still, the fact that the central bank took 9 months of deliberation on the issue, and held three public hearings, indicates the Fed is viewing large mergers with a more skeptical eye than in the past.
To many, the central bank's 40-page order sent a strong signal that the Fed will only get tougher and more rigorous as it reviews future applications.
"The most important message, which comes at least from the process with which this was reviewed as from the actual approval, is that once routine transactions among even mid-sized regional bank holding companies are no longer at all routine," said Karen Shaw Petrou, a managing partner at Federal Financial Analytics. "They've become political and subject to a much more stringent standard under this new financial stability criteria."
Like Capital One, observers said the next institution to seek a merger will have to make a strong case to regulators on the public benefit of the deal. They will also have to be persuasive to regulators that the new entity can be safely and quickly unwound. Their biggest hurdle will be something more nebulous: proving that the merged firm won't be a risk to the system.
That doesn't mean all potential mergers will be subject to such scrutiny. Larger firms seeking relatively smaller transactions — under $2 billion of assets, for example — would likely avoid scrutiny from the Fed. Two other examples offered by the central bank include deals that would result in a firm with less than $25 billion in total assets and corporate reorganizations.
The Fed is also likely to favor deals with institutions, such as ING, that are largely engaged in traditional banking activities.
In its order, the Fed found that neither ING nor Capital One were engaged in complex activities such as core clearing and settlement organization, which could potentially complicate the resolution process.
"If you want to do an M&A you need to have a resolution plan clearly developed and ready to present to the Fed to persuade it on that criteria that you are not systemic," said Petrou.
While that was good news for Capital One, other acquirers may not be so fortunate.
As a client memo by Sullivan & Cromwell points out, firms that are involved in "investment banking, securities underwriting and dealing, insurance or provision of core clearing and settlement services" will have a much tougher time convincing the Fed that a major acquisition doesn't raise any financial stability concerns.
It's possible, the memo says, that the Fed's concerns may wane as firms submit detailed resolution plans.
"Once affected bank holding companies have begun submitting such plans and the Federal Reserve Board has had the opportunity to review them, difficultly of resolution will become a less prominent part of its financial stability factor analysis," the memo says.
The Board also makes clear that size alone won't be a sole indicator of systemic risk.
By law, the Fed must block any merger that would give an institution control of 10% or more of domestic deposits or 10% of U.S. banks' liabilities.
But in its Capital One order — which noted that the credit card bank didn't come close to either threshold — the Fed indicated that even institutions below those metrics will attract extra scrutiny.
The Fed also examined whether any activities engaged by Capital One were critical to the functioning of the financial system, and if there were substitutes that could step in and perform those activities if there was any financial distress.
While the Fed's order offered some glimpse into its thinking of financial stability, it's not the final word. The Fed has previously said it plans to issue a proposal on exactly what "financial stability" means as required under Dodd-Frank.
"Until it does, I think the answers are if you're retail bank, you're probably not going to be systemic," said Petrou. "If you are a specialized bank, or a complex, larger one, you may well be."
The irony of the Capital One deal, which was deemed by many as the Fed's first "test case" of systemic risk, is the fact there seemed to be little indication that its purchase of ING's online banking unit would ever put the U.S. financial system in harm's way.
"What was odd about it — Is it really systemic?" one banking lawyer said, who requested condition of anonymity. "What's happened with Dodd-Frank is we have a highly cautious view of what it is to be systemic."
Regulators are now required under Dodd-Frank to go through additional regulatory hoops to ensure that any sizable institution won't have an impact on the banking and financial system alike.
Yet, because of the scrutiny it faced by both the Fed — and publicly — the question on observers' mind is what will happen when a systemic bank proposes an acquisition.
"It's a clear signal to the larger banking organizations that any acquisitions are going to be tough," said Ernest Patrikis, a partner with White & Case LLP and former general counsel of the New York Federal Reserve. "There are larger banks who clearly the Fed would say are institutions that are potentially systemic. They're going to go through a lot of hoops."
The rigor of the Fed's new oversight could make the M&A environment even tougher.
"For the next group of banks, the concern is what are the size limits the Fed will ultimately impose," said Cohen.
