Federal Reserve Board s Approval of Capital One's Acquisition of ING Direct Discusses Financial Stability Factor INTRODUCTION Late yesterday, the Federal Reserve Board ("FRB") issued an Order (the "Capital One Order") approving the acquisition of ING Bank, fsb ("ING FSB") by Capital One Financial Corporation ("Capital One"). ING FSB is a leading internet-based depository institution and operates under the name "ING Direct". This decision followed a highly unusual series of public hearings and an unusually long processing period. The Capital One Order represents the second time the FRB has analyzed a proposed bank acquisition transaction under the financial stability factor added to the Bank Holding Company Act of 1956 ( BHC Act ) by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act ). The FRB s first articulation of its methodology for analyzing the financial stability factor was included in its December 23, 2011 order approving the acquisition of RBC Bank (USA) ( RBC Bank ) by The PNC Financial Services Group, Inc. (the PNC Order ). 1 In the Capital One Order, the FRB expands upon the financial stability analysis set out in the PNC Order, which we believe will have significant implications for bank expansion through merger and acquisition transactions in the United States. Although the overall analysis, including the factors considered by the FRB, is generally the same as that set out in the PNC Order, the Capital One Order includes some additional explanation of how the FRB evaluates the individual factors that support its financial stability analysis and the relationship among those factors, and provides additional guidance as to the limited types of transactions that, in the FRB s view, are not likely to present financial stability concerns. IMPLICATIONS Overall, the Capital One Order confirms that the FRB will devote substantial attention to the financial stability factor in evaluating future applications under the BHC Act by, or that would create, organizations New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney www.sullcrom.com
of significant size or complexity. Although the FRB describes in the Capital One Order certain types of transactions that it believes are not likely to present financial stability concerns, for larger acquirors only the smallest transactions of under $2 billion in assets are likely to avoid significant FRB scrutiny. In addition, as with the PNC Order, the fact that both Capital One and ING FSB are predominantly engaged in traditional banking activities seems to have been a significant factor in alleviating financial stability concerns, particularly as they relate to the potential resolution of the combined organization in the event of its failure. Consequently, it appears that organizations that are much larger than Capital One, or that are significantly engaged in more complex activities such as investment banking, securities underwriting and dealing, insurance or provision of core clearing and settlement services, may experience more difficulty in persuading the FRB that major acquisitions do not present significant financial stability concerns. Moreover, the length of time the FRB required to make a decision on both the Capital One/ING FSB and PNC/RBC Bank (USA) transactions indicates that any merger or acquisition transaction of size requiring approval under the BHC Act will undergo an even longer and more far-reaching review by the FRB than has been the case historically. In addition, the Capital One Order reflects an unusually strong focus on consumer compliance matters. This indicates that all applicants to the FRB, regardless of size, should be prepared for significant scrutiny of their compliance records, particularly with respect to matters that have attracted public attention as a result of litigation or customer complaints. THE FRB S FINANCIAL STABILITY ANALYSIS Section 604(e) of the Dodd-Frank Act amended Section 4(j)(2) of the BHC Act to add to the list of possible adverse effects the FRB is required to consider when reviewing notices under Section 4 of the BHC Act risk to the stability of the United States banking or financial system. 2 The FRB s financial stability analysis in the Capital One Order is consistent with the approach it took in the PNC Order, but in the Capital One Order the FRB provides additional explanation of its approach to this analysis. The FRB states that it expects generally to find a transaction to have a significant adverse effect on U.S. financial stability if the failure of the resulting firm, or its inability to continue its regular-course-of-business transactions, would likely impair financial intermediation or the functioning of financial markets in a manner that would inflict material damage on the broader economy. As examples of such damage, the FRB references seriously compromising the ability of other financial institutions to conduct regularcourse-of-business transactions or seriously disrupting the provision of credit or other financial services. -2-
To assess the likelihood of these results, the FRB explains, it uses a combination of quantitative metrics and qualitative factors. The metrics and factors described in the Capital One Order are the same as were used in the PNC Order: size of the combined firm; any reduction in the availability of substitute providers for the services offered by the combining firms; the extent of interconnectedness of the combining firms and the rest of the United States financial system ( USFS ); the extent to which the combined firm would contribute to the complexity of the USFS (including an assessment of the complexity of the combined firm s organization and anticipated difficulty of resolving it); and the extent of cross-border activities of the combining firms. In the PNC Order, the FRB noted that these factors and metrics correspond to those used by the Basel Committee on Banking Supervision to assess the systemic importance of globally active banking organizations. In the Capital One Order, by contrast, the FRB takes care to say that its methodology is compatible with the Basel Committee s approach but draws three distinctions between its methodology and the Basel Committee s: (1) the FRB will consider a broader and somewhat different set of metrics, (2) the FRB s analysis considers the systemic footprint of the combined firms relative to the USFS, and (3) under the FRB s approach, it is possible that it could deem a proposal to have an adverse effect on the stability of the USFS even if only one category of metrics indicates that the combined firm would pose a significant risk to the stability of the USFS. The FRB distinguishes its approach of considering each metric both individually and in combination from the Basel Committee s focus on a weighted average of all its metrics. The Capital One Order also includes some discussion of transactions that, in the FRB s view, would not raise financial stability concerns. The FRB states generally that transactions likely to have only a de minimis impact on an institution s systemic footprint are not likely to raise such concerns, and then offers three specific examples of transactions it may presume, absent other evidence, not to present financial stability concerns: (1) an acquisition of less than $2 billion of assets, (2) a transaction resulting in a firm with less than $25 billion in total assets, or (3) corporate reorganizations. These examples are obviously quite limited and thereby suggest that a broad range of transactions will be subject to special scrutiny. The Capital One Order then analyzes each of the metrics and factors listed above, and concludes that financial stability considerations associated with Capital One s acquisition of ING FSB are consistent with approval of Capital One s notice. Although the manner in which the FRB analyzes each of the factors and metrics is consistent with the approach taken in the PNC Order, in discussing some of them in particular, size, interconnectedness, and complexity the FRB has expanded upon the analysis set out in the PNC Order. -3-
Size In the Capital One Order, the FRB explains its view of the relationship between the analysis of a financial institution s size under the BHC Act financial stability factor and the other provisions of the Dodd-Frank Act and BHC Act providing for enhanced supervision of larger financial institutions. By doing so, the FRB appears to be responding to the argument that the size of a resulting institution should not be a principal focus of its analysis under the financial stability factor in light of (1) the enhanced prudential standards that Section 165 of the Dodd-Frank Act requires the FRB to apply to bank holding companies with $50 billion or more in consolidated assets (and to any nonbank financial company designated by the Financial Stability Oversight Council for supervision by the FRB), 3 and (2) the prohibitions in the BHC Act against the FRB s approval of any transaction that would create an institution holding more than 10% of total U.S. insured deposits, or of any transaction (whether or not subject to FRB approval) that would create a financial company with more than 10% of the liabilities of all financial companies in the U.S. 4 The FRB states that, despite these additional safeguards against systemic risk posed by large financial organizations, the fact that the FRB is required under the BHC Act to consider the financial stability factor when reviewing proposed transactions likely indicates [these other safeguards] were not meant to substitute for an analysis of size as part of the financial stability factor. The impact of this position on future merger and acquisition transactions by larger (and certain systemically significant) bank holding companies, or nonbank financial companies supervised by the FRB, could be serious. The FRB appears to be saying as it suggested in the PNC Order that regardless of the strength of the Section 165 enhanced prudential standards that it may impose on such companies, the size of the resulting institution alone may provide sufficient basis for it to disapprove a transaction, even if the resulting institution would be underneath the statutory deposit and liability caps. Whether this position evolves as the FRB develops and refines the Section 165 enhanced prudential standards, and becomes comfortable with their effectiveness at mitigating systemic risk, remains to be seen. Interconnectedness The discussion of interconnectedness in the Capital One Order largely parallels that in the PNC Order, but it also includes an interesting response by the FRB to assertions by public commenters that Capital One is materially interconnected with the USFS because it securitizes credit card receivables which are sold to institutional investors including pension funds, insurance companies, and other financial institutions. The FRB concludes that any systemic risk from these securitizations is mitigated for the following reasons: (1) Capital One s credit card securitizations represent a small (under 10%) portion of the total credit card securitization market; (2) recent changes to accounting and capital rules act to align Capital One s interests with those of investors in its securitizations; 5 (3) Capital One s retention of an interest in its securitizations that exposes it to losses on a pari passu basis with other investors; and (4) enhanced disclosure and reporting obligations imposed on securitizers by the Dodd-Frank Act. The -4-
FRB s citation of the Dodd-Frank Act requirements in this context contrasts with its analysis of the size and complexity factors, where Section 165 s requirements are not cited as mitigating any concerns raised by the size of the combined Capital One/ING FSB organization. Complexity and Difficulty of Resolution The relative difficulty of resolving a combined Capital One/ING FSB organization is discussed several times in the Capital One Order, including in connection with the complexity and cross-border activity factors, though it is not, in the FRB s methodology, a stand-alone factor in its financial stability analysis. The FRB determined that neither Capital One s structure nor its activities, which are and would remain focused on standard retail and commercial banking and credit card lending, would make it difficult to resolve quickly without causing significant market disruption. Although the FRB noted, as in the PNC Order, that Section 165(d) of the Dodd-Frank Act requires bank holding companies with $50 billion or more in total assets to submit a resolution plan to the FRB, the FRB still has not indicated whether or how the existence of such a plan would mitigate any concerns over the difficulty of resolving an institution raised in connection with the review of a transaction under the BHC Act s financial stability factor. 6 It may be that, once affected bank holding companies have begun submitting such plans and the FRB has had the opportunity to review them, difficulty of resolution will become a less prominent part of its financial stability factor analysis. COMPLIANCE TESTING CONDITION Another noteworthy element of the Capital One Order, unrelated to the financial stability factor analysis, is that the FRB conditioned its approval on Capital One s adoption, within 90 days, of a plan to enhance its compliance transaction testing program. The FRB specifically stated that this condition was not imposed because of any identified deficiencies in Capital One s current compliance program. The FRB s decision to impose this condition on a well-managed banking organization like Capital One likely signals a much stronger focus by the FRB on consumer compliance matters, which may impact the application and approval process for all organizations, regardless of size. * * * Copyright Sullivan & Cromwell LLP 2012-5-
1 2 3 4 5 6 ENDNOTES The financial stability analysis set out in the PNC/RBC Bank order is more fully described in our Memorandum to Clients of January 18, 2012, available at http://www.sullcrom.com/bank- Mergers-Acquisitions-01-18-2012/. Sullivan & Cromwell LLP represented ING Groep, N.V. in the sale of ING FSB and Royal Bank of Canada in the sale of RBC Bank (USA). 12 U.S.C. 1843(j)(2)(A). 12 U.S.C. 5365. See 12 U.S.C. 1842(d)(2)(A), 1843(i)(8) and 1852(b). Sections 1843(i)(8) and 1852(b) were added to the BHC Act by the Dodd-Frank Act. Specifically, the FRB cited accounting rule changes that require a securitizer to consolidate its credit card securitizations on to its balance sheet in many circumstances, and capital rules that require a capital reserve to be held against such securitizations. See 12 U.S.C. 5365(d). The deadline for the initial submission of such plans by bank holding with $250 billion or more in nonbank assets is July 1, 2012. See Resolution Plans Required, 76 Fed. Register 67,323 (Nov. 1, 2011). As of December 31, 2011, Capital One reported total assets of $200 billion. According to the FRB, following the acquisition of ING FSB, it would have assets of approximately $292 billion. -6-
ABOUT SULLIVAN & CROMWELL LLP Sullivan & Cromwell LLP is a global law firm that advises on major domestic and cross-border M&A, finance, corporate and real estate transactions, significant litigation and corporate investigations, and complex restructuring, regulatory, tax and estate planning matters. Founded in 1879, Sullivan & Cromwell LLP has more than 800 lawyers on four continents, with four offices in the United States, including its headquarters in New York, three offices in Europe, two in Australia and three in Asia. CONTACTING SULLIVAN & CROMWELL LLP This publication is provided by Sullivan & Cromwell LLP as a service to clients and colleagues. The information contained in this publication should not be construed as legal advice. Questions regarding the matters discussed in this publication may be directed to any of our lawyers listed below, or to any other Sullivan & Cromwell LLP lawyer with whom you have consulted in the past on similar matters. If you have not received this publication directly from us, you may obtain a copy of any past or future related publications from Jennifer Rish (+1-212-558-3715; rishj@sullcrom.com) or Alison Alifano (+1-212- 558-4896; alifanoa@sullcrom.com) in our New York office. CONTACTS New York H. Rodgin Cohen +1-212-558-3534 cohenhr@sullcrom.com Elizabeth T. Davy +1-212-558-7257 davye@sullcrom.com Mitchell S. Eitel +1-212-558-4960 eitelm@sullcrom.com Michael T. Escue +1-212-558-3721 escuem@sullcrom.com C. Andrew Gerlach +1-212-558-4789 gerlacha@sullcrom.com Andrew R. Gladin +1-212-558-4080 gladina@sullcrom.com Mark J. Menting +1-212-558-4859 mentingm@sullcrom.com Camille L. Orme +1-212-558-3373 ormec@sullcrom.com Donald J. Toumey +1-212-558-4077 toumeyd@sullcrom.com Marc R. Trevino +1-212-558-4239 trevinom@sullcrom.com Mark J. Welshimer +1-212-558-3669 welshimerm@sullcrom.com Michael M. Wiseman +1-212-558-3846 wisemanm@sullcrom.com Washington, D.C. Andrew S. Baer +1-202-956-7680 baera@sullcrom.com Eric J. Kadel, Jr. +1-202-956-7640 kadelej@sullcrom.com William F. Kroener III +1-202-956-7095 kroenerw@sullcrom.com J. Virgil Mattingly +1-202-956-7028 mattinglyv@sullcrom.com Andrea R. Tokheim +1-202-956-7015 tokheima@sullcrom.com Samuel R. Woodall III +1-202-956-7584 woodalls@sullcrom.com -7-
Los Angeles Patrick S. Brown +1-310-712-6603 brownp@sullcrom.com Stanley F. Farrar +1-310-712-6610 farrars@sullcrom.com Tokyo Keiji Hatano +81-3-3213-6171 hatanok@sullcrom.com DC_LAN01:268439-8-