Bank M&A Lessons Found in 2016's Regulatory Approvals

2016 marked an interesting year in Bank M&A, particularly at the Board of Governors of the Federal Reserve System (the Federal Reserve), which approved 13 bank and/or BHC merger/acquisition (M&A) applications.¹ Perhaps most interesting, the Federal Reserve considered, but never acted on, an application, resulting in the parties terminating the transaction. A review of the Federal Reserve approval orders, and other select agency approvals, reveals common themes that are instructive to industry participants considering testing the M&A market. Specifically, this article analyzes: (i) the importance of an institution's compliance history; (ii) consideration of CRA ratings, fair lending, and commitment to community development plans; (iii) consideration of potential job losses; (iv) consideration of anticompetitive effects; (v) timing of approvals; and (vi) expectations for the 2017 M&A regulatory climate.

Acquirers Face Significant Regulatory Scrutiny of Their Compliance History

In 2016, medium-sized and large transactions continued to receive greater scrutiny, and compliance history remained an essential element of the regulatory analysis for buyers of all sizes. While the banking regulators focused on a variety compliance issues beyond CRA and fair lending compliance—such as Bank Secrecy Act (BSA), overdraft policies, residential servicing, commercial real estate concentration, and enterprise risk management—it seems that fair lending was one of the hottest compliance issues that arose in connection with the merger approval process.

In addition, agencies are reviewing applicants' collective compliance programs and controls to ensure that the resulting institution is properly suited to protect against the new risks created through the transaction, particularly when key regulatory growth thresholds will be crossed due to the transaction . Indeed, although New York Community Bancorp (NYCB) did not disclose the reasons for the lack of timely regulatory approval of its acquisition of Astoria Financial Corporation (Astoria), it was widely known that this transaction would have caused NYCB to cross and significantly exceed the US$50 billion asset threshold. Similarly, Bank of the Ozarks, Inc. (Bank of the Ozarks), which received regulatory approval for two transactions in 2016, crossed the lower threshold of US$10 billion in early 2016 while its two acquisition applications were pending. As evidenced by the Bank of the Ozarks approval order, CRA and fair lending compliance were significant factors for the Federal Reserve's evaluation of the transaction. The second half of 2016 also saw Investors Bancorp, Inc. add a risk factor to its Form 10-Q disclosing the potential for its pending acquisition of Princeton Bancorp to be delayed as a result of its corrective actions in the area of BSA compliance. Finally, in at least one transaction, the Federal Deposit Insurance Corporation conditioned its approval on the resulting institution implementing strategies to address compliance deficiencies.

Fair Lending, and Community Development Plans In Particular, Emerge as Factors Critical to Regulatory Approval

A common characteristic of institutions that obtained Federal Reserve approval for an acquisition in 2016 was their ability to demonstrate their commitment to fair lending compliance, despite "Satisfactory" or "Outstanding" CRA ratings. Nearly all approved applicants confirmed that they had designated a CRA officer and/or a CRA committee, and several applicants described detailed plans for improving community lending in particular assessment areas. For example, in the approval order for Bank of the Ozarks, the Federal Reserve noted that Bank of the Ozarks had identified specific nonprofit organizations with which to partner and had specific plans for its target's headquarters' area.

The 2016 M&A approvals also revealed the impact of community benefit plans, as most clearly demonstrated in KeyCorp's acquisition of First Niagara Financial Group, Inc. (First Niagara) and Huntington Bancshares Incorporated's (Huntington) acquisition of FirstMerit Corporation (FirstMerit). These transactions received a considerable number of public comments focused on CRA and fair lending, and the parties utilized community benefit plans as an effective tool for these large financial institutions to demonstrate their fair lending compliance.

As one example, in response to comment letters received on its merger application, KeyCorp held community outreach meetings and worked closely with various community organizations to develop a community development plan (the KeyCorp Plan), which was announced in March 2016 prior to KeyCorp's receipt of regulatory approval for its merger. In connection with the KeyCorp Plan, KeyCorp made the following commitments:

• To direct US$16.5 billion in lending toward low- and moderate-income (LMI) communities over a five-year period, with up to 35% of the total commitment targeted for the areas where KeyCorp and First Niagara overlapped in New York.
• To open an additional branch in an LMI community in East Buffalo and to keep open four other branches in LMI communities that had originally been slated for closing.
• To convert First Niagara's existing headquarters in western New York into KeyCorp's post-merger Northeast regional headquarters.

Similarly, following the submission of its merger application, Huntington adopted its own community plan (the Huntington Plan), under which it committed to invest US$16.1 billion in the communities it serves, including LMI communities, over a five-year period. The Federal Reserve approval orders acknowledge that the KeyCorp Plan and the Huntington Plan were adopted, at least in part, in response to the comment letters received on the merger applications and that the Federal Reserve shared some of the commenters' concerns.

KeyCorp and Huntington are not the only banks to adopt community plans in connection with a proposed merger. A review of other applications revealed community plans that included commitments to invest funds in communities in which the acquirer and the target have overlapping operations and/or to divest branches in order to address market concentration-related antitrust concerns. The Royal Bank of Canada (RBC), in connection with its acquisition of City National Corporation (City National), represented to the Federal Reserve that City National had adopted a new community development plan to help meet the credit needs of the communities it served, detailing its commitment to achieve a minimum of US$11 billion in qualified lending, investment, and charitable contributions. Perhaps serving as guidance to applicant in 2016, the Federal Reserve's 2015 approval of the RBC merger noted that a number of community groups that initially opposed the merger application subsequently withdrew their comments following adoption of the plan.

Notwithstanding these successful approaches, the Federal Reserve likely will not require a bank to make any community investment pledge to any organization in the absence of significant negative comments or, more importantly, adverse examination findings or a pending enforcement action. Despite the Federal Reserve's reliance on the KeyCorp Plan and the Huntington Plan in concluding that the relevant institutions are meeting the credit needs of the communities they serve, the Federal Reserve noted in the Huntington approval order that it "has consistently found that neither the CRA nor the federal banking agencies' CRA regulations require banks to make pledges or enter into commitments or agreements with any organization." Nevertheless, given their apparent benefits, both for Federal Reserve applications and for general community and regulator relations, community plans likely will remain a factor in the approval process for bank mergers that attract the attention of community groups.

Political Pressures, Not Regulatory, Underscore the Importance of Attention to Job Losses

Although commenters frequently expressed concerns over potential job losses, it was political pressures, not the Federal Reserve, that drove some applicants' decision-making. Indeed, despite high-profile public officials publicly raising the prospect of job losses as the result of transactions, and comments echoing such concerns, the Federal Reserve did not substantively opine on the issue. Instead, the Federal Reserve noted in both the KeyCorp and Huntington orders that "this concern is outside the limited statutory factors that the [Federal Reserve] is authorized to consider when reviewing a merger application."

In the KeyCorp merger, both Governor Andrew M. Cuomo and Senator Charles E. Schumer, as well as many other New York public officials, publicly opposed the merger on the grounds that the branch closures and consolidations contemplated by the proposed merger would result in significant job losses. During the pendency of the merger, KeyCorp directly engaged with public officials to alleviate their concerns, and Senator Schumer and Representative Brian Higgins released a statement in July 2016 noting that they had for months been discussing with KeyCorp concerns regarding potential job loss and that, pursuant to an agreement reached with the bank, KeyCorp would not lay off any branch employees and would employ at least 6,117 people in Upstate New York by 2021.

Similarly. facing similar criticism regarding potential job losses in Akron, Ohio, where FirstMerit is headquartered, Huntington stated publicly that it is committed to maintaining a stable employment level within the city.

Institutions Are Taking Strategic Measures to Alleviate Anticompetitive Concerns

Consistent with prior years, the Federal Reserve continued to receive comments objecting to merger proposals on the grounds that the proposed mergers would have significant anticompetitive effects in certain banking markets, but applicants were able to successfully assuage such concerns through strategic branch divestitures. In 2016, for example, KeyCorp and First Niagara had subsidiary depository institutions that competed directly in 12 banking markets in New York State, which led the Department of Justice (DOJ) to express antitrust concerns regarding the merger. To alleviate these concerns, KeyCorp and First Niagara entered into an agreement with DOJ in April 2016 pursuant to which KeyCorp agreed to sell 18 of First Niagara's branches in and around Buffalo. In connection with that agreement, DOJ publicly stated the following:

[DOJ] will advise the Federal Reserve Board that it will not challenge the merger provided that: the parties divest the branch offices, associated loans and deposits and the entire customer relationships associated with the divestiture branches; the parties commit to the Federal Reserve Board that they will comply with the agreement with the department; and the parties' commitments to the department are included as a condition to any order the Federal Reserve Board enters allowing the transaction.

Similarly, as a condition to the consummation of the Huntington merger, to mitigate the potentially adverse competitive effects of the proposed merger in the Akron, Ohio market, where Huntington is the fifth largest bank and FirstMerit is the largest bank, Huntington committed to divest one branch office. Huntington also committed to divest 10 branches in Canton, Ohio and two branches in Ashtabula, Ohio.

Pursuant to joint FAQs published by the Federal Reserve and DOJ in October 2014, the number of branches required to be divested in the face of competitive concerns will vary due to the presence of mitigating factors; however, there are no general guidelines for determining the level of divestiture that would be necessary to allow the Federal Reserve to approve a potentially anticompetitive application. Although branch divestitures are not a new remedy to address antitrust concerns, the recent merger approvals make clear that the Federal Reserve and DOJ are carefully scrutinizing large bank acquisitions to consider and mitigate the potentially adverse competitive effects of a proposed merger. If the Federal Reserve and DOJ determine that branch divestitures are necessary for approval of a transaction, such divestitures will likely be conditions to the proposed merger's closing. Therefore, banks submitting applications for approval of a merger involving geographic overlap should consider preempting antitrust concerns raised by the Federal Reserve, DOJ, or any commenters by preparing a strategy of potential branch divestitures.

Impact of Regulatory Delay

When both the KeyCorp and Huntington mergers were announced, questions were raised in the marketplace regarding whether the bank regulators would have the appetite to approve additional large acquisitions considering the other large M&A deals that were previously announced, including deals announced by BB&T Corporation and NYCB. Despite skepticism regarding whether and how quickly the Federal Reserve would approve the mergers, the Federal Reserve released its orders approving the KeyCorp and Huntington transactions seven and one-half months after KeyCorp announced its plans to acquire First Niagara and six months after Huntington's announcement to acquire First Merit. These timeframes for approval are relatively fast for large deals, which typically take six to 12 months from announcement to regulatory approval.

In contrast to the KeyCorp and Huntington applications, the Federal Reserve took three years to approve the proposed merger between Hudson City Bancorp, Inc. (HCBK) and M&T Bank Corp (M&T), which is the longest review period ever for a US deal valued at more than US$1 billion. In its order approving the HCBK–M&T merger, however, the Federal Reserve noted that it "expects that a banking organization will resolve all material weaknesses identified by examiners before applying to engage in expansionary activity." M&T's issues largely arose during the processing of its merger application, and the Federal Reserve "took the highly unusual step of permitting the case to pend while M&T addressed its weaknesses." The Federal Reserve's order warned that "[t]he [Federal Reserve] does not expect to take such action in future cases. Rather, in the future, if issues arise during processing of an application, the [Federal Reserve] expects that a banking organization will withdraw its application pending resolution of any supervisory concerns."

Perhaps in an example of this policy in action, NYCB's proposed merger with Astoria, which was announced a day before the KeyCorp merger, still was awaiting Federal Reserve approval when the merger's termination was announced on December 20, 2016, a month after NYCB announced that regulatory approval was not expected by the end of 2016. Another test of the policy expressed in the HCBK–M&T approval order may be the Investors Bancorp–Princeton Bancorp transaction. Arguably, a much smaller transaction, it may provide some clues as to whether compliance issues will continue to overwhelm the financial and strategic benefits of a transaction

Outlook

Recent merger approvals make clear that a well thought-out consolidation plan, a strong compliance plan, and a comprehensive fair lending strategy (which may or may not include a community benefit plan) is likely to be well received by the regulators and considered in applicable approval analyses.

Further, although significant changes in the bank-regulatory environment are anticipated in light of the results of the 2016 presidential election, such changes typically do not occur overnight. We expect the regulatory staff of each of the federal banking regulators to continue to focus on compliance issues, particularly those areas most impacted by significant and immediate growth (i.e., fair lending, CRA, and BSA compliance). Over time, the change in the administration and resultant policy impact on bank regulation may allow the agencies' staffs to allow for commitments from the buyers and non-standard approval conditions to reduce the regulatory delays that have resulted in recent years from compliance issues. In any event, we expect BSA, risk management, and cyber security issues to continue to be M&A stumbling blocks. We also expect community groups, as well as politicians, to continue to comment actively on the consumer compliance issues of buyers in bank merger transactions and attempt to influence the activities of those buyers. Finally, we expect institutions with outstanding enforcement actions, unresolved systemic compliance issues, and supervisory issues related to risk management to continue to be sidelined from merger activity by the regulatory agencies.