Click here for printer friendly page
Investment in financial institutions20/08/2008. Source: Pepper Hamilton LLP. J Bradley Boericke and Timothy R McTaggart.
This article first appeared in the August 1, 2008 issue of The North American Brief, mergermarket.com. It is reprinted here with permission.
 Financial institutions of virtually all stripes have been hit hard by the subprime crisis and its related fallout. To some this will seem like a potential investment opportunity, but the regulatory framework applicable to various types of financial institutions can seem daunting. This is particularly true for investments in financial groups that include a bank, which are heavily regulated through complex federal and state statutes and regulatory authority.
For a private equity group considering an investment in a bank, the foremost consideration is the federal Bank Holding Company Act (BHCA), which regulates any company (broadly defined) that directly or indirectly “controls” a bank. Not only does this framework require prior approval for acquisition of such control, but any such company would thereafter be subject to regulation as a bank holding company. This regulatory framework restricts the activities of the bank holding company to only permissible financial activities, and requires compliance with consolidated capital requirements. In addition, the Federal Reserve has broad authority to review acquisitions and ongoing activities in terms of overall safety and soundness. One critical principle asserted by the Fed is that a bank holding company must serve as a “source of strength” for the banks controlled by it.
To date, nearly all private equity and sovereign fund investments in banks and bank holding companies in the U.S. have been structured to remain below U.S. control levels. Even in a situation like the investment in Doral Financial led by Bear Stearns Merchant Banking, where the aggregate investment was approximately 90 percent of the outstanding equity, the ultimate ownership was held by different investors, each with less than 10 percent. And, as in that transaction, significant investors will generally enter into passivity commitments to assure regulators that the investor will not seek to assert a controlling influence over the management or policies of the bank.
The BHCA has some exceptions, most notably relating to industrial loan companies, certain credit card banks and institutions that are limited to trust activities. In that circumstance, the capital requirements and activities limitations under the BHCA do not foreclose a diversified investor from acquiring control. However, regulatory authority exercised under the Change in Bank Control Act may nonetheless become an impediment. Applying “holding company”-type principles, the OCC has required capital and liquidity maintenance agreements in connection with such transactions, such as in the case of the 2005 acquisition of The Private Trust Company by a group including TPG and Hellmann & Friedman. More recently, the level of the OCC’s demands along these lines were why Blackstone aborted its acquisition of Alliance Data Systems.
For sovereign wealth funds, the passivity requirements under the BHCA generally are not a significant issue – they are passive economic investors and have no interest in asserting a greater level of operational control. For many private equity groups, however, this is a significant departure from their usual model.
What remains to be seen is whether the investment opportunity appears sufficiently attractive for a private equity group to push forward and seek regulatory approval for a more aggressive structure, and whether the bank regulators will be inclined to cooperate in light of the capital needs of the institutions in their charge. Some specialist funds, such as Belvedere Capital, are devoted exclusively to bank investments, so that their activities are consistent with those permitted for a regulated bank holding company. Any such fund would have to abide by the resulting consolidated capital requirements, and regulators would need to be satisfied from a safety and soundness and “source of strength” perspective. We believe there is some room for structuring proposals, consistent with U.S. bank regulatory requirements, to achieve the objectives of investor groups who see opportunity in the current environment.
In that regard, we along with the rest of the U.S. banking industry eagerly await the proposed updates to the “control” provisions under the Fed’s banking rules, expected to be released later this year. We expect the Fed will continue to rely on its bedrock principles in determining when a controlling influence is present, but the proposal likely will also endeavor to confirm the permissibility of “side-by-side” investments by a specialist fund devoted exclusively to bank investments which is subject to all BHCA regulatory requirements. The proposal also will likely seek to codify the result reached in the Doral Financial/Bear Stearns Merchant Banking transaction, including the accepted “passivity” commitments as well as to continue to allow some degree of flexibility regarding board positions.
Of course, even before such rules are finalized, the Fed will be available to discuss novel deal structures for private equity investors, merchant banking transactions and other entities not presently invested in the financial service sphere.
Pepper Hamilton LLP is a multi-practice law firm with more than 500 lawyers in seven states and the District of Columbia. The firm provides corporate, litigation and regulatory legal services to leading businesses, governmental entities, nonprofit organizations and individuals throughout the nation and the world. For more information go to www.pepperlaw.com
|
