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AN ADDRESS BY FEB 2 4 "~-ssssr* STANLEY C. SILVERBERG, DIRECTOR DIVISION OF RESEARCH AND STRATEGIC PLANNING FEDERAL DEPOSIT INSURANCE CORPORATION WASHINGTON, D. C. PRESENTED TO THE THIRD ANNUAL BANK ACQUISITION AND MERGER CONFERENCE BANK ADMINISTRATION INSTITUTE WASHINGTON, D. C. OCTOBER 25, 1983 October 25, 1983 BANK ACQUISITIONS AND REGULATORY POLICY ON CAPITAL by Stanley C. Silverberg I have been asked to provide an FDIC perspective on a number of issues related to bank mergers: interindustry combinations; interstate transactions; forced mergers of troubled institutions, etc. I will touch on those issues, but I would like to concentrate on the financial aspect of bank and industry mergers and how that relates to the FDIC's role. intei— Ithink you will find that is where the FDIC will have the most to say in the future and it's where we are apt to have the most discretion. as straightforward as differ I can, giving my own views, from current FDIC policy and I’ll try to be indicating where they indicating those areas where policy appears to be most in flux. Bank regulators have always been concerned about the capital structure of banks and, companies. have been or to varying degrees, the capital In an markets impose Acquisitions result in Financial restraints by capital on leverage debt frequently than the charges display management of and All involving banks private sector mergers considerations because financial and involving too much stretching, markets that considerations. are affected increasing acquisitions noticed increasing number of instances, mergers limited by capital acquisitions structure of bank holding risk too much poor more in stock all leverage frequently price skepticism acquiring in response to a proposed South corporations. firms. Carolina toward Just performance. aggressive last week acquisition, I the stock price of the apparent high bidder declined whereas the stock price of the "loser" increased. 2 - Bank regulators - impose their own capital standards. These are not always tougher than those of the marketplace, but frequently they are. in my talk I will try to suggest where Later it may be appropriate for bank regulators to impose tougher standards and where it is not. When of book, the stock of it's impairing possible overall stockholders. acquiring institutions to pay for acquisitions capitalization or per share at a through high multiple stock without of existing earnings Under the right set of circumstances, where the market pays a high premium for size and diversification, actually improve exchange of its capital stock. part that for institution can hasn’t been the prevailing The majority of the stocks of large bank holding -companies have sold below book value. paid an acquiring position and per share earnings through an For the most situation in recent years. premiums sells acquired banks While there is some evidence that have been declining, they still are genera IIy pos it ive. Current Capital Policies Capital policy at the bank regulatory agencies currently is in flux. However, some general izations can be made. AI I of the agencies have moved to specific minimum ratios for banks. At the FDIC, there is no distinction made between The Fed and the Comptroller appear large and small banks. to permit some distinction, but it's less than generally prevailing practices and less than what used to be the case. for large banks to buy up everything. That makes it much more difficult Just a few years ago, discussions of interstate banking reflected concerns that the ability of money center banks to operate with smaller capital ratios would facilitate their gobbling -3up of smaller banks throughout the country. have lower capital standards isn't clear. Whether large banks should It's noteworthy that the shift in regulatory policy has not been accompanied by any convincing analysis one way or the other on this issue. Another issue related to measuring bank capital intangibles. is the treatment of This has been particularly important in connection with cash premiums paid by acquiring banks. After wavering some, current FDIC policy is not to include core deposit or other intangibles in calculating minimum bank capital certain requirements. intangibles so bank's equity. for long as they don't exceed 20 or 25 percent of a If acquiring banks are already close to their minimum capital position they will basis, The Comptroller and the Fed apparently include not be able to bid aggressively, acquisitions. This may also at least on a cash impact the value of small bank franch ises. On subordinated debt the FDIC policy for some time has been not to include it in meeting minimum capital requirements. The Comptroller and the Federal Reserve give it some weight, making a distinction between primary and secondary capital. has been popular All three agencies do include preferred stock which in the last year or so. While accountants and lawyers may see a substantial distinction between preferred stock and subordinated debt, I personally see no important, substantive distinction, particularly where acceleration clauses are not permitted in the debt instrument. These hard-line so restrictive bank positions on if bank supervisors holding companies. However, bank capital definitions would not be did not attempt to while policy limit leverage in is very much in flux in this area, agencies appear to be moving toward imposing tight restrictions -4on holding company leverage — I want to come back to this issue later. Let me suggest, however, that in some recent decisions the FDIC has insisted on five percent equity in bank holding companies. I don't think the Fed or the Comptroller are inclined to be quite as restrictive in this area as the FDIC. Impact on Acquisitions What are examples of a restrictive capital policy on bank acquisitions? In its handling lists banks that two did not meet its capital standards. This has bidding included instances where out-of-state acquisitions of failing commercial were permitted under the of bank failures the FDIC has excluded from excluded the provisions of Garn-St Germain. institutions were strongly interested Whether in the banks any of failed bank franchises, I don't know. It is no secret that the high bidder in the United American Bank P&A was an out-of-state national bank that met the FDIC bid Iist restrictions, but was not permittedto undertake the transaction by the Comptroller because the capital structurewould be too stretched after the transaction. The FDIC has a rejected merger proposals where the nonmember whose capital did not meet FDIC standards holding company did not meet FDIC capital standards. surviving bank was or where the parent Had these transactions involved a surviving national bank or had they been effected as a holding company acquisition, they might have been approved by one of the other Federal banking agencies. The FDIC has rejected savings and loan appl ¡cations to acquire banks and savings bank branches because FDIC capital standards were not met by -5the surviving institution, even though it would not be insured by the FDIC. (When an FDIC-insured bank is acquired by an "uninsured" institution, the FDIC must approve the transaction.) The bank FDIC denied insurance in South Dakota, to a proposed we II-capitaIized principally because its parent, nonmember a large midwestern bank holding company, did not meet FDIC capital standards. These decisions have mattered to individual institutions. they are of much significance from the standpoint of the overall I’m not sure. system, Most bank observers expect accelerated merger activity over the next few years, reduced. Whether Capital this activity, particularly if and when interstate restrictions are policy by the banking agencies could materially especially restrictive policies. if all the Federal If the Federal inhibit banking agencies adhere to Home Loan Bank Board continues to be less restrictive on capital, we may see Federal savings banks and savings and loan holding companies becoming increasingly used vehicles for acquisition and expansion. Why Do We Impose Bank Capital Standards? Let's go back now and take a hard by bank regulators. Why Do they make sense? do we regulate banks so much? look at capital standards imposed Should bank capital be regulated? Historically, the rationale has been that (I) banks deal principally with other people's or corporations' money and they (depositors) need some protection against excessive risk; and (2) bank failures adversely affect other parts of the economy, leading to contraction in the money supply and available credit. Federal deposit insurance was established in 1933 to deal with these - 6 - two issues and to provide an orderly mechanism for handling bank failures. While the FDIC establishment capital has has pretty provided standards. well another taken care of these reason to supervise banks and If a considerable portion of the bank insolvencies was to be borne by the FDIC, then banks and problems, its impose loss arising from it needed to examine impose standards on banks to protect its financial exposure in much the same manner that any private insurer needs to protect itself. We have three Federal bank supervisory agencies the way things have evolved historically. — that’s part of In principle, the FDIC can rely on other Federal or state supervisory agencies (or perhaps accounting firms) to provide information on its risk exposure and, possibly, to implement appropriate standards. The supervisory process has been confused by efforts to implement social policy, and protect potential bank limit competition, competitors in the industries. Some bad insurance, security, and other financially related interpretation of economic history dealing with the cause of the collapse of our banking system in the to confuse the supervisory process. (If you 1930s also has served interpret this to mean that I think GIass-SteagaI I makes no sense in the context of today’s environment if, indeed, it ever did — you are interpreting my thinking correctly.) More and more financial observers have come to accept the proposition that it is deposit insurance that makes banks special from the standpoint of safety and soundness, and supervision. it's why they are or ought to be subject to It is interesting to note that in the American Assembly Report this past spring on The Future of American Financial Services Institutions, a group of bankers, academicians, trade association representatives and Government officials agreed that supervisory authority over banks ’’should -7rest only in the insurer". Bank capital provides a protective cushion to assure solvency and, most important, to provide protection to the insurer. But how much capital? Should it be related to bank size, asset diversification, management? There is no scientific way to determine the appropriate or minimum capital ratio. The insurer-supervisor protection. requiring is likely to A very high number will high margins on bank favor a high number for its own impose costs on the banking system, services, possibly pricing banks out of certain markets. How should capital be calculated? If the purpose is to protect the insurer, then subordinated debt will serve as well as equity and probably reduce a bank’s capital cost. If the purpose of capital is to protect the insurer or even to keep the bank solvent, then why do bank supervisors need to fuss about the capital structure of bank holding companies? A Suggested Approach Let me suggest a reasonable way to resolve some of these issues. " Impose a minimum capital requirement on banks: perhaps five or even six percent. Try to enforce it. If a bank falls below the required acquisitions or branch expansion and, possibly, premium. insurance too far and has difficulty servicing its debt, bank subsidiary. Don't Let financial markets decide how leverage the holding company can carry. If a holding company goes it need not bring down the There are restrictions on financial transactions between banks and affiliates and these can be enforced. impose a higher At some point later on, seek to remove deposit insurance. attempt to regulate holding companies. much level, permit no - The attractiveness insurer-supervisor is of 8 this arbitrary in - approach setting is that, capital even standards, if the financial markets can adjust appropriately at the holding company level so that the market can make distinctions among banking organizations according to management, d ivers if icat ion, prof itab iIi ty, etc. There is no way that bank regulators can meaningfully regulate holding company capital using consolidated equity ratios. of Iine-by-1 ine consol idations Think of some of the perverse for What is the significance a diversified incentives. financial institution? A bank holding company would be encouraged to acquire poor quality institutions at less than book capital to dress up the holding company balance sheet. should not be a concern of bank regulators. That sort of consideration Hopefully, when capital policy is sorted out by bank regulators, focus will be concentrated on banks and why we regulate them. Now let’s come back to acquisitions and mergers. direction I have suggested, standards that will I think we can protect the insurer, If we go implement reasonable financial not be overly restrictive and provide for an important role by the financial marketplace. to move completely in the direction in the I have suggested? Are we about Unfortunately, not yet, although we may see some liberalization at the holding company level. In evaluating our policies it is important to note that we have been flexible in adjusting to market conditions, and further future adjustments are poss ibIe. In any case regulatory capital policy is going to matter and it will affect the pace of acquisitions, how they are structured financially and the premiums paid to acquired institutions.
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