Fed, not FDIC, should regulate a merged BB&T-SunTrust

There’s a big question that neither BB&T nor SunTrust answered about their merger last week: “Who will be the primary regulator of the resultant bank?”

While they have billed this as a “merger of equals,” it is anything but that for their primary regulators, namely the Federal Deposit Insurance Corp. for BB&T and the Federal Reserve for SunTrust.

American banks, unlike banks or regulated companies elsewhere, have the luxury of choosing their own primary federal regulator. Importantly, they can switch them, if desired, to find the friendliest regulator, often referred to as “competition in laxity.”

Having followed both banks for decades, I believe the resultant bank will choose the FDIC — even though the merged entity would be better overseen by the Fed.

BB&T, the decision maker in this deal, with greater assets, market value and 57% ownership of the new bank, is comfortable with their existing regulator. BB&T is by far the largest bank regulated by the FDIC, but this is not the case with SunTrust and the Fed. And using Comptroller Joseph Otting’s reference to regulated banks as the Office of the Comptroller of the Currency’s “customers,” it is harder to say “no” to your far and away largest customer, whether you are a regulator, bank or any business.

Of the 30 banks with assets over $100 billion, the $216 billion BB&T is one of only two state-chartered Fed nonmember banks whose primary federal regulator is the FDIC, the other one being the $104 billion Discover Bank. Of the remaining 28 banks, 19, including the very largest, have the OCC as their primary regulator and nine, including SunTrust, have the Fed.

The FDIC demonstrated that it was friendlier than the Fed when it (and North Carolina’s state regulator) terminated BB&T’s joint anti-money laundering order from December 2016 this past June, while the Fed still has not terminated that order.

Most importantly, based on my detailed research, the FDIC has displayed continued favoritism toward BB&T on the industry’s most subjective regulation, namely the Community Reinvestment Act. The two most blatant cases of regulatory favoritism involved BB&T’s 2009 acquisition of the failed Colonial Bank in Alabama and BB&T’s most recent CRA exam.

BB&T’s biggest and most important deal prior to SunTrust was the purchase of the failed Colonial Bank in Alabama from the FDIC. The FDIC did not make public in a timely fashion material data about BB&T's fair lending and CRA performance — that information could have scuttled the deal if it had been brought to light earlier. BB&T was downgraded from an outstanding rating in 2004 to satisfactory in 2008 because of a serious fair lending violation, namely a “pattern or practice of discrimination on the basis of race” in violation of the Equal Credit Opportunity Act and the Fair Housing Act.

The FDIC withheld public notification of the downgrade and the finding of serious racial discrimination until September 2010, well after the agency accepted BB&T’s winning bid for Colonial Bank in August 2009. In contrast to this unprecedented delay of nearly three years, the FDIC released BB&T's two previous CRA exams in 2004 and 2001 just eight months after they were completed, and the two previous exams before that were released within four and five months.

Had the FDIC disclosed this material information in a timely manner, the predictable outcry from community groups, Congress and the general public could have stymied BB&T's bid on the failed Alabama bank or inhibited the FDIC's ability to accept that bid. In that case, Colonial would have gone to the runner-up, TD Bank, which had put forth a fairly close bid. I documented this argument to the regulators in a 2012 when BB&T bought BankAtlantic, one of Florida’s largest thrifts, but it was readily dismissed.

In an unusual case of déjà vu all over again, BB&T’s most recent CRA performance evaluation, released in May 2018, resulted in an outstanding rating, despite the fact that they were once again found to have engaged in a “substantive violation of Regulation B, which implements the Equal Credit Opportunity Act.”

The problem this time was not a delay in the FDIC’s release of the rating but rather an outright inflated rating. Having read thousands of CRA performance evaluations since 1990 — when I coined the term “CRA grade inflation” — I concluded that the FDIC inflated BB&T’s current CRA rating from a satisfactory to an outstanding one for several reasons.

The cited fair lending violation in the exam should have resulted in a one-rating downgrade as was the case in BB&T’s 2008 exam, and most other FDIC exams, consistent with FDIC examination procedures. However, in an apparent accommodation to its largest “customer,” the FDIC stated that “a downgrade of the CRA rating to less than Outstanding was not warranted” based on the bank’s “CRA performance, extent and impact of the finding, and immediate corrective actions taken.”

BB&T received a “high satisfactory” rating on the 50% weighted lending test and outstanding ratings on the 25% weighted investment and service tests. Many banks receiving such a “50-50” ratings mix from the FDIC receive an overall satisfactory rather than outstanding rating, because of the importance of the lending test, especially when there is a serious fair lending violation.

BB&T received an inflated outstanding rating on the investment test, since qualified investments during the review period amounted to only 0.7% of total assets — below the 1% of assets outstanding guideline determined from a review of thousands of published CRA exams and below the comparable percentage of many other banks receiving outstanding ratings from the FDIC. BB&T also received an inflated outstanding rating on the service test, since their cited 5,728 community development services is about 2,000 services below the outstanding guideline from my same CRA research. (These guidelines, which are not endorsed or accepted by any federal bank regulator, are summarized in my recent CRA reform comment.)

Had the FDIC made the proper downgrade, BB&T would still be a satisfactory rated bank, like 90% of all banks, and this would most likely not be an obstacle to the SunTrust merger. However, we should expect our biggest banks, especially those engaged in major M&A deals, to have outstanding ratings and certainly not to have any substantive Reg B violations.

I previously argued that BB&T was “too big to regulate” for the FDIC based on regulatory favoritism on the Colonial Bank deal. This was similar to a much earlier argument I made that the now defunct Washington Mutual was too big to regulate for the now-defunct Office of Thrift Supervision.

If BB&T was too big to regulate then, their roughly doubling of size and the FDIC’s recent regulatory favoritism makes this argument even stronger.

The FDIC is primarily a regulator of small banks, whereas the OCC and the Fed have much more experience in overseeing very large banks. Under the supervision of the Fed, BB&T would just be another large bank rather than the dominant one under the FDIC.

Good public policy therefore dictates that the resultant bank from the BB&T-SunTrust merger have the Fed as their primary regulator.