Overcoming Regulatory Uncertainty in Bank Deals

Recent events have created turbulence in the bank mergers and acquisitions regulatory approval process and indicate that changes in approval standards are coming. Banks armed with a clear strategy and knowledge of potential potholes will be better equipped to execute a successful M&A strategy.

The current uncertainty gained steam in December 2021, when Democrats on the board of the Federal Deposit Insurance Corp. voted to release a Request for Information on the bank merger review process. Among other things, the RFI suggests the FDIC may begin presuming that any merger resulting in an institution with more than $100 billion in assets threatens financial stability. The RFI also foreshadows greater skepticism about whether a proposed transaction benefits the community, including when the acquirer proposes substantial branch closures.

In the coming months, it should become more clear how the relevant standards will change. Several key takeaways have emerged amid the recent turbulence.

Most Deals Can Still Be Approved
Most bank M&A transactions involve parties with total combined assets that are well below $100 billion. Further, even applications that appear to present issues under the FDIC RFI can be approved, especially if other agencies are performing the review. Shortly after the FDIC RFI was released, the Federal Reserve Board approved several transactions featuring issues that were discussed in the RFI. One of these transactions resulted in a bank with more than $100 billion in assets; another involved the closure of nearly a fourth of the parties’ combined branch network.

Scrutiny of Supervisory Issues
By law, the federal banking agency that is reviewing an M&A application must consider the parties’ managerial resources. As this factor has been applied, unsatisfactory supervisory ratings can disqualify a bank applicant from receiving approval, especially when the ratings relate to risk management, anti-money laundering or consumer compliance issues.

Under current leadership, it is likely that the agencies will adopt more rigid policies that keep banks with unsatisfactory supervisory ratings in the “penalty box,” unable to obtain approvals. Additionally, current agency leadership may be more disposed to assign banks unsatisfactory ratings that trigger the penalty box. Parties can mitigate this risk by engaging early with their supervisory contacts and gauging their regulators’ willingness to approve a transaction, notwithstanding outstanding supervisory issues.

Community Groups’ Influence May Grow
During the public notice period for a bank merger application, any interested person or group can protest the application and argue that the reviewing agency should deny the application. Public protests can lead to delays in processing. In the case of the Federal Reserve, a protest can require the Board of Governors, rather than a Reserve Bank, to decide the application, creating an extra layer of staff-level review.

Credence that the agencies may give to the views of community groups could give these groups greater power in determining the fate of a transaction. To mitigate this risk, acquirers may want to develop allies in their communities ahead of announcing transactions.

Mitigating Regulatory Risk
We expect that parties will more closely negotiate provisions in customary deal documents allocating risk that relates to regulatory uncertainty. Additionally, parties may be able to achieve their goals through different deal structures that require different sets of regulatory approvals. By carefully evaluating the options, the parties may be able to choose a deal structure that has the greatest likelihood of winning timely approvals.

Attractive Nonbank Acquisitions
Banks seeking value or growth in M&A are increasingly finding it in fintechs and other nonbank targets. Apart from the business reasons to consider these targets, there may be regulatory advantages. When a bank acquires a nonbank, it may not be required to obtain regulatory approvals, or any needed approvals may not involve the same standards or length of review as a bank acquisition.

Changes to the regulatory approval process are coming. In this environment, banks should continue evaluating M&A opportunities based primarily on business considerations, mindful of the risks presented by regulatory uncertainty and ways to mitigate them.