The other common form of combination involves an existing bank holding company acquiring a bank. The Federal Reserve, as sole federal regulator of bank holding companies, must approve all of these transactions. Some states also require state approval of these acquisitions. In addition, some states require banks to have been operating for a minimum number of years before another bank or bank holding company can buy it—known as a “minimum-age requirement”—further restricting some transactions.
Regardless of the type of combination and which banking regulatory agency has primary responsibility for the transaction, all proposals must meet the following standards:
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Financial condition: An applicant must be in at least satisfactory financial condition, both before and after the transaction;
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Managerial resources: An applicant must have adequate managerial resources to operate the new, larger institution in a safe and sound manner;
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Anti-money laundering safeguards: An applicant must have in place adequate systems for preventing money laundering and must be capable of extending these safeguards to the new, larger banking organization;
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Convenience and needs of the communities served by the applicant and target: A proposed transaction must be likely to make banking services more convenient and to meet the financial needs of the communities served; and
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Competition: A proposed transaction must not reduce competition in any local banking market by an unacceptable degree.
Each application, therefore, goes through a multistep process that covers each of the above areas. The first four criteria ensure the safety, soundness and service orientation of banks and the banking system. The last requirement—competition—ensures that banks operate in locally competitive markets. We will cover competition in detail in Part IV of this essay.
Although it is true that the Fed approves nearly all proposals it evaluates—giving rise to the impression that we merely rubber-stamp banking merger and acquisition applications—approval comes only after an exhaustive process during which we keep a keen eye out for apparent and, sometimes, hidden weaknesses that could lead the proposal to fail one of the criteria. To avoid any unforeseen obstacles in the process, applicants often contact us before filing an application. Doing so enables us to point out areas that could be troublesome during the actual application process. Lesser problems most often can be addressed through committed actions documented in the process. If problems are severe or not correctable in a reasonably short time frame, then the applicant typically is asked to delay the proposed transaction until it has corrected the problem and demonstrated improvement. In this way, the Fed uses its “moral suasion” to discourage flawed proposals, which benefits us and applicants because it enables all parties to address weaknesses before the process officially begins.
So, what exactly is the Fed looking for when examining applications for each of the first four criteria? And how are we fulfilling our role?
Financial Factors
The applicant and the resulting combined institution of a proposed transaction must be judged as satisfactory with respect to relevant financial factors. These factors are the same as those reviewed during a bank examination—capital adequacy, asset quality, profitability, liquidity and sensitivity to market risk. Equally important for a transaction involving a holding company acquisition of a bank is cash flow. The company must demonstrate its ability to generate sufficient cash from operations to cover principal and interest payments on debt incurred from the acquisition, as well as its other operating expenses.
We develop an overall picture of the strengths and weaknesses of the combining banking organizations by reviewing examination reports, periodic financial reports, information provided in the application, and other available data. We project this information to portray the financial profile of the consolidated organization. Financial weaknesses or deficiencies that are determined in the analysis of the proposal must be addressed before the Federal Reserve approves the application. Some financial issues, such as a capital deficiency, might be addressed by raising more equity capital. Other weaknesses, such as poor loan quality or an imbalanced asset/liability mix, are not easy to fix in a short period of time. Banks can sometimes address deficiencies of this type with commitments to policy changes or specific actions focused on the weakness.
Notwithstanding a solid commitment that would be expected to improve a problem area, the Federal Reserve normally will require some evidence that the proposed action has had the intended effect. Improvement usually must be demonstrated before we approve a transaction.
That’s not to say that any weakness must be corrected or requires improvement before the Fed approves the proposed transaction. For example, when the acquiring institution is in satisfactory financial condition, but the target institution is financially weak, the size and financial strength of the acquiring entity is a favorable consideration that can offset weaknesses in the target institution.
Managerial Factors
As with the analysis of financial factors, each transaction involving the combination of banking organizations must undergo a management assessment, which considers the competence, experience and integrity of the officers, directors and principal shareholders of the acquiring organization. However, the process of judging officers and directors and their ability to operate the consolidated institution lacks the objectivity that comes with the review of financial data, including trend analysis and peer comparison.
We often can learn something about a bank’s management by reading previous examination reports. Feedback from other regulators, who may have knowledge of relevant factors not covered in reports, also helps to clarify the management picture. This information might come through a letter responding to a request for comments on a pending application, or informally through a telephone call. For some banking combinations, we may require certain officers, directors and principal shareholders to undergo a background check. In this process, we ask law enforcement agencies to provide any unfavorable information that they may have on an individual.
As with financial weaknesses, managerial deficiencies must be addressed or corrected before an application is approved. Again, this can occur through informal discussions and actions taken before the submission of the application or through an action plan as part of the formal proposal.
Occasionally, even though each institution involved in a proposed banking combination has effective management, the larger and more complex resulting institution could end up being beyond the managerial capacity of the existing officers and directors. In such a case, the Fed might require additional management staffing as a condition of approval.
Combating Money Laundering
The USA PATRIOT Act of 2001 introduced additional strong measures to prevent, detect and prosecute international money laundering. Among other things, the PATRIOT Act requires federal banking regulatory agencies to take into consideration a banking organization’s effectiveness in combating money laundering activities when that banking organization files a merger or acquisition application. This assessment involves a review of the banking organization’s policies and procedures to detect and prevent money laundering.
Minor weaknesses in an anti-money laundering program often can be addressed during the application process. However, if significant program weaknesses exist, then the acquiring banking organization may be required to demonstrate verifiable improvement over a period of time before being allowed to expand through combination.
Convenience and Needs
The Federal Reserve is required to assess whether a proposed banking combination would likely have any adverse effect on the convenience and needs of the communities served by the banking organizations. This assessment focuses on the availability and manner in which banks provide products and services to customers. Closing cost-inefficient branches of the resulting organization is one possible way in which customers’ convenience and banking needs could be negatively affected.
Assessing convenience and needs also involves taking into account the acquiring organization’s and the target institution’s records of meeting the credit needs of their communities, including low- and moderate-income neighborhoods, as required under the Community Reinvestment Act (CRA). The Federal Reserve expects an acquiring organization to have an established record of satisfactory CRA performance before it files an application. A satisfactory CRA record for the target institution is also important. A less-than-satisfactory CRA examination rating on the part of the acquiring institution or the target can present an obstacle to approval.
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