Why Fed Is Bound to Bless Capital One's Deal for ING Direct

Prediction: the Federal Reserve Board will let Capital One Financial Corp. buy ING Direct USA.

Why? Because blocking it would doom every financial firm larger than Capital One to a stagnant future and send a chilling message to any foreign firm with a presence here.

And on the flip side, denying the deal would be tantamount to preserving the very largest institutions' special status.

"Erecting a barrier to entry into that club is almost protecting them in a more insidious way by giving them an even stronger oligopoly and making each one of them even more systemically significant," said Neil Barofsky, the former special inspector general for the Troubled Asset Relief Program and among the most articulate critics of "too big to fail" policies.

Barofsky, now at New York University's Stern School of Business, agreed the Fed "should take a really, really close look under the hood" of Capital One's deal, "but there is some degree of incongruity here.

"If we are going to continue to have institutions as big and powerful and dangerous as JPMorgan Chase and Bank of America and Citigroup and Goldman Sachs, then it would seem a little odd to block an institution that is a fraction of their size on systemic grounds."

The Fed will hold the first of three public hearings on the Capital One/ING deal Tuesday in Washington. Dozens of people are scheduled to testify — roughly half in favor and half opposed. The other two hearings will be in Chicago on Sept. 27 and in San Francisco on Oct. 5. The extended comment period will close Oct. 12.

The Fed agreed last month to hold the hearings after the National Community Reinvestment Coalition objected, arguing that the government shouldn't let big banks get bigger. "Why rush to create another 'too big to fail' bank?" the group said in an Aug. 17 press release.

Rep. Barney Frank, D-Mass., also weighed in with questions about the "consolidation of banking assets, the provision of credit of the resulting bank and compliance with the Community Reinvestment Act."

Relatively speaking, the $9 billion acquisition will not make Capital One that big ($300 billion of assets and 1.5% of the nation's deposits) or that complex, interconnected or any other measure of systemic importance.

Blocking the deal on systemic grounds would raise questions about the largest firms' future.

"Denying this deal would clearly draw a line in the sand for the industry on what the Fed views as too big," said a former senior regulator. "And then what happens to the really large guys — will they be expected to shrink or will they ever be able to do another deal? We would freeze the market."

Karen Shaw Petrou, the managing director of Federal Financial Analytics, sees another huge ramification of denial. "Blocking transactions like CapOne/ING would send a clear distress warning to the entire global banking industry: if you do business in the U.S. and want to change the model through a sizable divestiture whether for strategic or regulatory reasons, forget about it," Petrou wrote in an American Banker BankThink piece recently.

ING Group's sale is not voluntary; the Netherlands' government told it to make the divestiture.

And what's a better solution — having the foreign parent company liquidate ING Direct's $80 billion of online deposits? Or perhaps one of the bidders that Capital One beat out with its $9 billion offer should get ING Direct? Those other bidders are reported to be General Electric and Ally Financial and neither is "less systemic" than Capital One.

Ironically, PNC Financial Corp., which is arguably more systemic than Capital One, is also in the midst of buying assets from a foreign seller. No one has yet objected to its June deal to buy 424 branches and $19 billion of assets from Royal Bank of Canada. (Capital One is also buying the domestic credit card business from HSBC of London.)

Fed Gov. Daniel Tarullo in a speech last week made it clear that at least he doesn't plan to vote against the ING deal based on systemic questions alone.

"It is important to note that, while Congress instructed us to consider the extent to which a proposed acquisition would pose a greater risk to financial stability, it clearly did not instruct us to reject an acquisition simply because there would be any increase in such risks," he said. "Instead, it appears we have been instructed to add any increased systemic risk to the list of adverse effects that could result from the merger and then determine whether the benefits to the public of the acquisition outweigh these adverse effects."

So it seems if the Capital One purchase is to be thwarted, the Fed will have to be persuaded that the adverse effects outweigh the benefits.

The NCRC's chief executive, John Taylor, remains ready to make that argument. In an interview Friday, Taylor said that Capital One expanded into the traditional banking business simply to feed its original focus on credit cards. "The model is to acquire banks to do more credit card business," he said. "If people are fine with that, OK, go ahead. But I am not fine with that."

Taylor thinks Capital One should do more Federal Housing Administration and Small Business Administration lending. "I do think they should participate in government programs since they have an affirmative responsibility to meet the credit needs" of the communities they serve, he said.

Meeting community needs is a squishy target, however. Countering Taylor's complaints are compliments from the likes of Newark Mayor Cory Booker who told the Fed his city was "lucky to have Capital One operating within its borders."

"Capital One has demonstrated a dedication to the low- and moderate-income residents of our city," Booker wrote.

The Fed isn't relying only on outside opinion.

In addition to the extended comment period and the hearings in three cities, the agency is building its own record.

In an Aug. 29 letter, the Fed gave Capital One a list of financial products and services and asked it to indicate which ones the companies offer.

Of course the Fed has been overseeing Capital One for decades so it already knew Capital One doesn't do the exotic things on the list like tri-party repo dealing or prime brokerage or high-yield bond underwriting.

In its Sept. 9 reply, Capital One told the Fed that the companies offer only four, plain-vanilla items: commercial real estate, construction lending, mortgage servicing and equipment financing. Capital One also noted that their combined share of any of those markets is tiny.

Capital One's argument for the deal is simple: it can better deploy ING Direct's deposits, mainly by making small-business and commercial loans that can create jobs.

The company claims it has created a net 3,000 jobs this year, and its capital position is strong: it raised $2 billion in equity and $3 billion in senior unsecured notes this summer.

(Capital One bolstered its arguments Monday with a 35-page submission to the Fed that lays out counterarguments to criticisms of the deal.)

Its critics will counter that Capital One took Tarp funds (which it repaid,) and its main banking subsidiary only has a "satisfactory" CRA rating.

The Fed, I suspect, will listen to both sides and conclude the benefits to the economy and to borrowers trump the costs of a larger company.

In addition to all the other reasons to approve the deal, the Fed knows it needs companies like Capital One and PNC that are large enough and healthy enough to absorb weaker institutions.

Barb Rehm is American Banker's editor at large. She welcomes feedback to her column at Barbara.Rehm@SourceMedia.com. Follow her on Twitter at @barbrehm.