United States: Federal Reserve Board Confirms Template For Financial Stability Test: Board's Way Or The Highway

Last Updated: March 1 2012
Article by Michael E. Bleier and Lauren A. Abbott

On February 14, 2012, the Federal Reserve Board ("Board") announced its approval of Capital One Financial Corporation ("Capital One") to acquire the shares of ING Bank, fsb ("ING"). In its order approving the acquisition, the Board reaffirmed its test for determining financial stability in light of the new criteria required by Dodd-Frank to the analysis of expansion applications pursuant to the Bank Holding Company Act (12 U.S.C. §§ 1842 and 1843) ("BHC Act"), which was first utilized by the Board in its order approving the merger of PNC Bank and RBC Bank. The Capital One order reiterated the template of criteria the Board would examine to determine financial stability. It also illustrated that nonbank acquisitions would be subject to the same test for financial stability as bank acquisitions. In addition, in the Capital One order, the Board specifically distinguishes itself from the Basel Committee in its analysis of global systemically important banks ("GSIBs").

The Parties Involved

Capital One, headquartered in McLean, Va., will acquire ING of Wilmington, Del. and, by doing so, indirectly acquire ShareBuilder Advisors, LLC and ING Direct Investing, both of Seattle, Wash. At the time of application, Capital One had total consolidated assets of $200 billion and was the 24th largest depository organization in the United States, controlling deposits of $127 billion. At the time of application, ING had total consolidated assets of $90 billion and was the 17th largest depository organization in the United States, controlling deposits of approximately $82 billion. As a result of the acquisition, Capital One will become the fifth-largest depository organization in the United States and the 20th largest depository organization by asset size.

Financial Stability

On December 19, 2011, the Board issued its first order under the new Dodd-Frank regulatory requirements approving the acquisition by PNC Bank of RBC Bank. The PNC Bank order set forth a framework for analyzing the financial stability of proposed acquisitions between financial institutions. In that order, the Board set forth a template of six factors to analyze relating to financial stability. The PNC Bank order was discussed in Reed Smith's Client Alert No. 2012-012. A copy of that analysis is attached.

The Capital One order confirms that the Board will analyze financial stability criteria for both bank and nonbank acquisitions. The Capital One acquisition involved a thrift and, therefore, the Board issued its approval pursuant to sections 4(c)(8) and 4(j) of the BHC Act.

The Capital One order is more comprehensive than the PNC Bank order. This is in part because of the fact that the Board received a significant number of public comments regarding the proposed acquisition.1 In total, the Board received 915 public comments from individuals and organizations regarding the proposed acquisition, a large number of which were opposed to certain aspects of the proposal and expressed concern about the impact the proposed acquisition would have on the financial stability of the U.S. banking system.2 In determining whether to approve a bank or nonbank acquisition under the BHC Act, the Board's decision must set out the rationale for its decision in sufficient detail so that its ruling is not overturned on appeal by a court of law. Section 9 of the BHC Act (12 U.S.C. § 1848) provides that any party that has been aggrieved by an order of the Board may appeal to the U.S. Court of Appeals.3 A court will uphold the Board's decision so long as the Board's decision is "supported by substantial evidence."4 Therefore, the Board must take the time to analyze and respond to the comments so that there is a thorough record that sets forth the basis for the Board's decision, which would be upheld if it was ever subject to judicial review.

Community Impact

As part of the approval process for the proposed acquisition of a nonbank entity by a banking institution, the Board must examine the benefits to the community as part of section 4(j)(2)(A) of the BHC Act, as well as section 604(e) of the Dodd-Frank Act. The commenters that opposed the approval were critical of the performance of both Capital One and ING under the Community Reinvestment Act ("CRA").5 Specifically, 575 individuals and groups expressed concern with the mortgage, small business, and consumer-lending records of both Capital One and ING. In evaluating the CRA performance of both companies, the Board analyzed the comments, supplemental filings by the companies, and confidential information obtained from other federal agencies. Upon completion of its analysis of section 4(j)(2)(A) of the BHC Act and the impact on the community, the Board determined that the CRA performance records of both companies were such that the proposal should be approved.

Risk Management

The Board determined that Capital One needed to improve its "risk-management systems and policies to account for the size, complexity, and diversification of the business lines that would result from the acquisition [of ING]." The Board instructed Capital One to adopt and submit a plan to make these improvements to the Federal Reserve Bank of Richmond within 90 days of the order, as well as (1) provide for periodic reporting to management and the Audit and Risk committee of the board of directors for Capital One, (2) provide improved employee training, and (3) require an annual review through an internal audit of the implementation of these new policies and procedures for the next three years.

In the PNC Bank order, the Board articulated the six criteria it would examine to determine if a proposed acquisition would cause a more concentrated risk to the "stability of the United States banking or financial system." These criteria were in addition to the other criteria the Board normally considered when analyzing an acquisition application under the BHC Act. The six criteria were size, substitutability, interconnectedness, complexity, cross-border activity, and financial stability factors in combination. The Board did note that certain transactions would only have a de minimis impact on an acquisition and therefore would not raise concerns about financial stability. The Board specifically referenced an acquisition (1) of less than $2 billion in assets, (2) that results in a company with less than $25 billion in total assets or (3) that represents a corporate reorganization, "may be presumed not to raise financial stability concerns absent evidence that the transaction would result in a significant increase in interconnectedness, complexity, cross-border activities or other risk factor." To summarize:

Size: The resulting size of an institution is an important indicator of the risk a transaction would have on the entire financial system. The Board noted that Congress imposed a "10 percent nationwide deposit limit and a 10 percent nationwide liabilities limit on potential combinations by banking organizations." In examining the assets, liabilities and leverage exposure of the resulting institution, as well as the deposits, the Board determined that Capital One "would fall well below the 10 percent limitations set by Congress."

Substitutability: This criterion evaluates whether there would be an adequate substitute service provider should the combined entity suddenly be unable to do so as a result of severe financial distress. The Board noted that Capital One engages in more traditional banking activities that overlap some of ING's service offerings. The Board determined that the resulting entity would "continue to have a small share on a nationwide basis and, numerous competitors would remain for each of the activities" should Capital One be unable to provide any of those services.

The Board specifically noted that with the acquisition of some additional credit card assets, Capital One would go from being the fifth-largest provider of credit cards in the United States to the fourth-largest, with an 11.8 percent share of outstanding credit card balances. The Board noted that other lenders have outstanding credit card balances that are one-third to two thirds larger than those of Capital One, and that numerous other credit card lenders operate on a national basis. The Board concluded that Capital One's resulting "share of credit card loans does not appear to be substantial enough to cause significant disruptions in the supply of credit card loans if Capital One were to experience distress, due to the availability of substitute providers that could assume Capital One's business."

Interconnectedness: The Board examined data to determine what the impact on other institutions in the U.S. financial system would be if the combined entity suffered financial distress. The Board noted that the resulting entity would use less than 1 percent of wholesale funding and that the intra-financial system assets and liabilities would be less than 1 percent. Based on this data, the Board determined that the risk to other institutions in the marketplace was not significant.

Complexity: The Board examined whether the resulting entity would contribute to the overall complexity of the U.S. financial system. The Board noted that neither entity engaged in complex activities that would cause a significant increase in the risk to the stability of the U.S. financial system.

Cross-Border Activity: The Board examined the businesses of each entity to determine if the cross-border presence of the combined entity would pose a risk to coordinating any resolution that would increase the risk to U.S. financial stability. Capital One has somewhat of a presence in the United Kingdom and Canada that is similar to its operations in the United States. ING is owned by a Dutch financial institution, but ING Bank, fsb operates exclusively in the United States. The Board noted that the combined institution is not expected to "engage in any additional activities outside the United States as a result of the proposed transaction." Therefore, the combined organization's cross-border activity would not create coordination difficulties.

Financial Stability Factors in Combination: The Board noted that the combined organization would not be highly interconnected. Significantly, the board considered the degree of "difficulty with which Capital One could be resolved in the event of a failure." The Board determined that Capital One would not be as complicated to resolve as other institutions in the event of a failure.

Basel Committee Distinction

Most interestingly, the Board distinguished its methodology for financial stability from that of the Basel Committee's in identifying GSIBs in three ways: (1) the Board will consider a broader and somewhat different set of metrics, (2) the Board will consider the systemic footprint of the resulting firm relative to the U.S. financial system, and (3) unlike the Basel Committee, "if a single category of metrics indicates that a resulting firm would pose a significant risk to the stability of the U.S. banking or financial system, the Board may determine that there is an adverse effect of the proposal on the stability of the U.S. banking or financial system." The Board also noted that each of these factors will be considered individually, rather than the Basel Committee's approach of focusing on the weighted average metrics. By making these distinctions, it appears the Board is allowing itself some flexibility in determining the risk associated with some potential acquisitions.

Implications

  • The Board has more definitively set out the template for how it will analyze the financial stability standard for bank and nonbank acquisitions under the BHC Act.
  • The Board is allowing itself some flexibility in approving bank and nonbank acquisitions by taking a broader approach to examining financial stability factors than the Basel Committee.
  • The Board has set out some of the acquisition parameters that will presumptively pass the financial stability test.
  • Both parties to a bank holding company transaction need to review in advance any CRA, consumer, or examination criticisms, and address as best they can the concerns before filing an application.
  • In acting on bank or nonbank expansion applications under the BHC Act, the Board's decision needs to set out, in sufficient detail, the basis or rationale for its decision so that its ruling is not overturned upon appeal.

Footnotes

1. In fact, the Board extended its initial deadline by which to submit comments to more than 85 days. In addition to soliciting written comments, the Board held public meetings in Washington, D.C., Chicago, and San Francisco, at which members of the public could provide comments on the proposed acquisition.

2. Actually, 425 of the commentators that opposed the proposal submitted comments in substantially identical letters.

3. 12 U.S.C. § 1848.

4. Id.

5. The CRA is a federal statute enacted to ensure that financial institutions meet the credit and deposit needs of the communities they operate in. 12 U.S.C. § 2901.

This article is presented for informational purposes only and is not intended to constitute legal advice.

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