Fed Officials Deliver a Bank M&A Buzzkill

Footnotes can ruin a perfectly good party.

The Federal Reserve this week seemed to offer renewed hope for large-bank M&A when it finally approved the M&T Bank/Hudson City Bancorp deal — until everyone read an important caveat in the 40-page order that dampened the celebration.

Central bank officials went out of their way to say that they had taken the "highly unusual step" of shelving the application while Buffalo, N.Y.-based M&T addressed concerns around its anti-money-laundering and Bank Secrecy Act compliance. The application was pending for more than three years.

The Fed vowed not to be that generous again. Banks will have to formally withdraw their applications, resolve any outstanding issues, and then resubmit.

The warning (tucked in footnote No. 28) renewed anxiety that completing M&A transactions, especially ones involving large buyers and sellers, will remain difficult. It also underscored the message that acquirers must be completely prepared before signing a deal.

"I had anticipated that the approval of the merger would be a positive for larger size bank M&A," said Frank Schiraldi, an analyst at Sandler O'Neill. "But because it came with that caveat, it was less of a positive than I initially thought. What it tells you is that you better make sure everything is perfect and that's the bottom line."

Though the Fed's comments might have sounded technical, there is a distinction with a difference between a prolonged review and a withdrawal of an application. Having to withdraw a merger application presents acute risks to both parties of a deal, experts explained.

Buyers could lose out on future acquisitions as sellers view them as unreliable in getting the deal done, said Brian Klock, an analyst at Keefe, Bruyette & Woods.

Sellers face even greater dangers of a deal being withdrawn and possibly terminated, said H. Rodgin Cohen, the senior chairman at Sullivan & Cromwell, whose firm advised Paramus, N.J.-based Hudson City on its sale to M&T. Sellers have to worry about employee and customer defections and have to jump-start projects that had been put on hold once the deal was announced.

Changing regulatory sentiments were foreshadowed when BancorpSouth in Tupelo, Miss., withdrew applications for two acquisitions in 2014 over problems with its BSA compliance, Cohen said.

The $13.6 billion-asset BancorpSouth later resubmitted the applications to buy Central Community in Temple, Texas, and Ouachita Bancshares in Monroe, La., and is awaiting approval. There are some problems that can be resolved with a merger pending but not usually anti-money-laundering and BSA compliance, Cohen said.

M&T was allowed to continue because they had negotiated the deal in good faith and did not know about its looming BSA and anti-money-laundering issues, Cohen added. Additionally, withdrawing the application and having the deal potentially falling apart after such a long period would have been very harmful to Hudson City.

Plus, determination from chief executives on both sides — M&T's Robert Wilmers, Hudson City's Denis Salamone and Salamone's predecessor, the late Ronald Hermance Jr. — possibly encouraged the Fed to permit the application to continue, Cohen said.

The Fed declined to comment for this story.

To be sure, large banks have been able to complete deals in recent months. The industry has touted the recent success of BB&T in buying the $18.5 billion-asset Susquehanna Bancshares in Lititz, Pa., and CIT Group's purchase of the $22 billion-asset OneWest Bank in Pasadena, Calif.

Despite the long delay and the Fed's caveat, M&T's success should add to that momentum.

"This should give people comfort that the Federal Reserve is open for business," said Chip MacDonald, a partner with the law firm Jones Day in Atlanta. "But you've got to do it right and be prepared when you go in."

Still those other deals involved sellers that were significantly smaller than Hudson City, which had $43 billion of assets three years ago and $35 billion as of June 30. Additional regulatory scrutiny, including the Fed's warning, are likely to cause large banks to take more time in due diligence and look for targets that are below $30 billion of assets, Klock said.

"The closer you get to the [systemically important financial institution] threshold, the more that is expected," he added. "That brings an elevated level of risk."

M&T had the unfortunate timing of submitting its merger application right after Dodd-Frank-related rules for large institutions were being issued, Chief Financial Officer Rene Jones said in an interview with American Banker. This put M&T in a "unique situation," and a lot of the work the company did to complete the deal would have been necessary anyway, he added.

"At the end of the day it is important that we have a strong financial system and all members should focus on being safe and sound," Jones added. "That will be standard, and it's not a surprising message."

The long delay has not soured M&T's management on future deals, though the Fed's order requires the company to complete the Hudson City integration before pursuing future acquisitions.

M&T has "a long history of doing successful integrated transactions that have built the bank" and "likely there will be other opportunities" down the road, Jones said. He declined to speculate how the rest of the industry would read the outcome of the Hudson City deal.

Investors Bancorp in Short Hills, N.J., is viewing the Fed's comments as a warning to all banks, not just large ones, Chief Operating Officer Domenick Cama said. The $19.9 billion-asset company has acquired five banks since 2012 and it will remain cautious about future deals, he said.

"If this isn't an incentive to make sure banks have all of their issues resolved before doing a deal then I don't know what is," Cama said. "We will almost certainly call the Fed and present them the scenario, not to get a blessing but to make sure we don't get a 'don't do it.'"