Navigating the Applications Process
Applications Update - June 2017
Published June 30, 2017
Organizations filing applications or notices, such as proposals to acquire other banking organizations or engage in nonbanking activities, with the Federal Reserve System (System) often ask how they can best ensure timely and favorable action. In 2014, the System issued SR letter 14-2/CA letter 14-1 (Enhancing Transparency in the Federal Reserve’s Applications Process), which outlines the issues that have slowed or prevented favorable action on proposals. Each proposal can raise unique issues, so this list is not exhaustive. However, applicants can improve their chances of success by addressing the matters outlined in this article.
First and foremost, before submitting a proposal, applicants should resolve any significant issues that resulted in a less than satisfactory composite, management, consumer compliance or CRA rating or an enforcement action against their organization. Applicants should also address significant findings related to Bank Secrecy Act/Anti-Money Laundering compliance. Preferably, the applicants’ banking regulators will already have confirmed that the institution has satisfactorily addressed the issues.
Applicants should also address other weaknesses identified in their most recent examination or inspection reports or targeted reviews. For example, they should be prepared to discuss the steps they are taking to address a less than satisfactory rating assigned to a subsidiary bank’s asset quality or criticisms of the information technology or consumer compliance function. Applicants should also be prepared to demonstrate that the proposed change or acquisition will not result in the diversion of managerial or financial resources needed to correct existing weaknesses.
Additionally, applicants should be prepared to discuss the due diligence they have conducted of the target organization, the actions they plan to take to correct any identified weaknesses and the sufficiency of the resources available to correct issues. If weaknesses exist in the asset quality of both the applicant and the target (or their subsidiary banks) and the acquisition involves or anticipates a merger, the applicant should provide current and pro forma nonaccrual, noncurrent and past-due asset quality information for the combined organization. The applicant should also provide (internally) classified asset information for the combined organization and should outline plans to reduce problem assets.
Applicants should also consider how they will structure the funding of an acquisition. Generally, the System will not view favorably an application that proposes to use short-term debt (i.e., less than three years) to fund an acquisition. If applicants anticipate that they will need to rely significantly on income from their subsidiary banks to repay acquisition debt, they should consider additional sources of funding (e.g., capital contributions from shareholders) if the financial obligation would erode the banks’ capital or otherwise strain the banks’ financial resources. Applicants should also take into account existing financial obligations, such as trust preferred securities or other instruments; these obligations, in combination with acquisition debt, could represent a significant burden. In the same context, applicants should consider personal debt that their principals are repaying with proceeds provided by the organization’s dividends. While the System will not uniformly attribute shareholder debt to applicants for analytical purposes, in some circumstances the personal debt of one or more principals may be treated as if it were an obligation incurred by the applicant.
Applicants should also ensure that their organizations’ capital (its level as well as its composition) is in compliance and will remain in compliance, on a pro forma basis, with the System’s regulations, policies and guidance. Applicants should be able to demonstrate that they are well capitalized and will continue to be well capitalized after consummation of the proposed transaction. For applicants subject to the Small Bank and Savings and Loan Holding Company Policy Statement, this means they should be able to demonstrate that their subsidiary banks are and, after consummation, will remain well capitalized. For applicants subject to consolidated financial reporting, the demonstration should be on both a consolidated and a subsidiary bank level. Moreover, applicants that are bank holding companies subject to the Board of Governors’ capital adequacy guidelines should ensure that they have a capital composition in which voting common equity is the predominant element.
In this article, I have identified only some of the matters that applicants should consider and address before filing with the System. If applicants have specific questions concerning the application process, they should contact the applications staff at the Federal Reserve Bank of Minneapolis. They can also use the pre-filing process outlined in SR letter 12-12/CA letter 12-11.1
1 SR letter 12-12/CA letter 12-11 (Implementation of a New Process for Requesting Guidance from the Federal Reserve Regarding Bank and Nonbank Acquisitions and Other Proposals.