recapitalization and acquisition of financial institutions

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RECAPITALIZATION AND ACQUISITION

OF FINANCIAL INSTITUTIONS:

EVOLVING STRUCTURES

AND REGULATORY GUIDANCE

February 2012

INDEX

Section Page

I. INTRODUCTION ................................................................................................................ 1

II. STRUCTURING ALTERNATIVES FOR BANK RECAPITALIZATIONS .............................. 2

1. Investments into Bank Holding Companies ................................................................. 2

2. Investments Directly into Banks that are Subsidiaries of Bank Holding Companies.................................................................................................................. 4

A. Good Bank / Bad Bank Structures....................................................................... 5

B. Bank Acquisitions as Part of a Section 363 Reorganization of the Bank Holding Company................................................................................................ 7

III. KEY REGULATORY CONCERNS.................................................................................... 10

1. Principal Regulators and Their Roles ........................................................................ 10

2. Control and its Definition ........................................................................................... 11

3. Cases Where Prior Approval Will Be Required – Irrebuttable Presumptions of Control ...................................................................................................................... 14

4. Cases Where Prior Approval May Not Be Required – Rebuttable Presumptions of Control and CIBCA Filings..................................................................................... 14

5. Safe Harbor – No Prior Approval Necessary ............................................................. 17

IV. REGULATORY ISSUES IN STRUCTURING INVESTMENTS.......................................... 18

1. Acting in Concert and its Consequences................................................................... 18

2. Rebutting Control / Passivity Commitments............................................................... 19

3. Consequences to an Investor of a Finding of Control ................................................ 20

4. FDIC Statement on Failed Bank Acquisitions ............................................................ 21

APPENDIX A OVERVIEW OF KEY THRESHOLDS FOR CONTROL UNDER THE FEDERAL BANKING LAWS

APPENDIX B THE FDIC’S STATEMENT ON FAILED BANK ACQUISITIONS

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RECAPITALIZATION AND ACQUISITION OF FINANCIAL INSTITUTIONS:EVOLVING STRUCTURES AND REGULATORY GUIDANCE

FEBRUARY 2012

___________________________________________________________________

I. INTRODUCTION

As depository institutions have attempted to recapitalize, they have found the path to success difficult due to increasingly pessimistic investor sentiment about the near-term prospects for the banking market. In addition to a host of market and macro-economic reasons for this sentiment, many investors who have traditionally looked to recapitalize depositories through an investment in the holding company have found that liabilities at the holding company, whether litigation-related or in the form of outstanding debt instruments or trust preferred securities, are a significant impediment to the investment. In situations where investors are willing to make an investment through a bank holding company (BHC), such a transaction is often highly dilutive to the BHC’s existing stakeholders, including creditors, shareholders, and trust preferred securities holders, which makes it difficult for a BHC to garner the requisite support from its existing stakeholders for the transaction.

Even BHCs that have the support of their existing stakeholders are finding it increasingly difficult to consummate highly dilutive transactions because potential investors do not see the desired level of investment returns as their investment effectively recapitalizes, at least in part, existing liabilities of a BHC. Similarly, a proposed acquirer of a BHC with a subsidiary bank in need of recapitalization will substantially discount the amount it is willing to pay the target BHC’s shareholders due to the substantial stake that creditors and trust preferred securities holders have in the target BHC. These discounts often make it difficult for a BHC to seek the approval of its shareholders for such a sale.

Furthermore, even if a BHC desires to negotiate a discount with its trust preferred securities holders, many are unable to do so as these holders are very difficult, if not impossible, to ascertain and contact. Many of the trust preferred securities that were issued in the five plus years leading up to the financial crisis were sold to alternative investment vehicles that packaged the trust preferred securities and sold securities with various maturity terms and distribution rates to investors based on the underlying trust preferred securities. These securities are commonly known as collateralized debt obligations, or CDOs. Often, once the CDOs were sold, the sponsor would no longer actively manage the assets underlying the CDOs (i.e., the trust preferred securities) and, therefore, no longer have the ability to negotiate the terms of the trust preferred securities on behalf of the CDO holders. Alternatively, the terms of the CDOs do not permit the issuers of the trust preferred securities holders to have access to the CDO holders.


Accordingly, if bank recapitalization investments are structured at the holding company level, holders of debt instruments and trust preferred securities would not suffer dilution comparable to the dilution that the common shareholders would experience and therefore would, in essence, be fully recapitalized. This materially lessens the return to investors, most often making the investment altogether unattractive. Similarly, financial institutions looking to acquire depositories by means of an acquisition of their holding company are often unwilling to assume the liabilities of the target BHC. As a consequence, investors and financial institutions alike are increasingly interested in pursuing a recapitalization of the depository institution directly at the bank level or, more aggressively, purchasing the stock of the bank through a bankruptcy of the holding company by means of a Section 363 reorganization.

Against this backdrop are the evolving regulatory standards for investments in depository institutions. Most of such investments are structured by investors (whether acting as individual investors, in conjunction with a group of other investors, or as part of a fund structure) as non-control investments. Typical structures that are used are becoming more of a well-worn path for regulators as private sources of capital have played a significant role in recapitalizing the banking industry over the past several years.

Regulatory positions and standards for non-control investments are evolving rapidly in the current economic cycle as an increasing number of significant non-control investors assess opportunities that are presented when banks seek capital infusions. This article sets forththe latest insight into the evolving structural and regulatory considerations that are applicable to bank and BHC recapitalization transactions.

II. STRUCTURING ALTERNATIVES FOR BANK RECAPITALIZATIONS

While there are many different structures that can be employed depending on the specific facts and circumstances of any given recapitalization transaction, there are two broad categories of structures that have very different considerations. Those categories are investments at a BHC level and investments directly into a bank which has an existing BHC parent. Those structures, and a few significant permutations of each, are discussed in this Section II.

1. Investments into Bank Holding Companies

A traditional recapitalization transaction for a bank that is a subsidiary of a BHC is, of course, for the holding company to issue securities to investors, raise capital, and downstream some or all of the net proceeds to the subsidiary bank. This type of transaction is the structure that regulators expect and it is generally their objective when they direct troubled institutions to raise capital. From a strictly regulatory perspective, BHC-level investments are “tried and true” and often do not raise special regulatory considerations beyond those arising in the context of control and “acting in concert” determinations


discussed in Section III “Key Regulatory Concerns” and Section IV “Regulatory Issues in Structuring Investments.”

In part, the regulatory bias toward BHC investments is because the vast majority of banks are subsidiaries of BHCs. In fact, the Federal Reserve’s Partnership for Progress indicates that “[c]urrently, about 84 percent of commercial banks in the U.S. are part of a BHC structure. More than 75 percent of small banks with assets of less than $100 million are owned by BHCs; this percentage increases to 100 percent for large banks with more than $10 billion in assets.”1

But the structure also has served as a traditional means of recapitalizing institutions because the regulators, particularly the Board of Governors for the Federal Reserve System (the Federal Reserve), prefer that the recapitalization take place at the holding company so that the BHC can continue to serve as a financial and managerial source of strength for the subsidiary bank in the future – notwithstanding the reality that many BHCs are so significantly distressed that they cannot legitimately serve as a meaningful source of strength. Moreover, while not an official policy, the Federal Deposit Insurance Corporation (the FDIC) has suggested in reviewing specific applications that it prefers the investment to be made at the holding company level so that all stakeholders are recapitalized. This is particularly true if the BHC has outstanding trust preferred securities as such securities are often held by other depositories. While the FDIC readily admits it has no jurisdiction over BHCs, it justifies its view due to its natural concern about the overall health of the banking system.

From a fiduciary perspective, management of a BHC may also be pressured to seek recapitalization at the holding company level so as not to dilute the BHC’s ownership of the subsidiary bank and to ensure that all stakeholders are, in effect, recapitalized.

Additionally, a BHC can issue debt securities as a form of less expensive capital relative to equity, and downstream the proceeds of those debt securities into the subsidiary bank as Tier 1 capital. We note that the Collins Amendment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), enacted into law on July 21, 2010,imposes risk-based and leverage capital standards on BHCs consistent with those currently applicable to insured depository institutions. While the Collins Amendment eliminates Tier 1 capital treatment for BHC-issued trust preferred securities and other hybrid debt and equity instruments, that option remains for certain small BHCs. To the extent that a BHC has less than $500 million in assets and therefore is not subject to the Federal Reserve’s Small Bank Holding Company Policy Statement, debt or hybrid instruments may serve as a less expensive way to provide capital to the subsidiary bank if, in fact, credit is available for the BHC.

1

Source: www.fedpartnership.gov/bank-life-cycle/grow-shareholder-value/bank-holding-companies.cfm.


Investors historically preferred investing at the holding company level because the BHCs are created under state corporate codes rather than banking statutes and provide greater specificity and flexibility to the rights and preferences of security holders at the BHC level. As economic conditions have deteriorated over the last five years, many BHCs have amassed various liabilities at the BHC level, and as described below, the preference to invest directly into the BHC is no longer a given.

2. Investments Directly into Banks that are Subsidiaries of Bank Holding Companies

In today’s environment, many BHCs are not in a financial position to serve as a source of strength for their subsidiary banks. Many have amassed significant liabilities in prior efforts to financially strengthen their subsidiary banks or have substantial outstanding hybrid debt and equity securities in the form of trust preferred securities, likely issued many years prior, and often in CDOs where the actual owner or holder of the securities is difficult to identify. As the financial condition of a bank and BHC declined, many were prohibited from making periodic dividend payments on trust preferred securities and, as a result, holders of such trust preferred securities are owed dividend payments from prior quarters in amounts that, in aggregate, can be daunting. In some cases, these liabilities are sufficient to deter investor interest in a recapitalization transaction at the BHC-level notwithstanding the fact that the subsidiary bank may have substantial franchise value.

These factors, which appear to exist in a number of banking organizations in the current environment, have resulted in efforts to recapitalize a subsidiary bank by investing directly in the bank and diluting the ownership interest of the BHC in its subsidiary bank. From a regulatory perspective, these types of transactions are viewed as potentially novel and raise unique considerations, some of which are discussed below.

De-registration of a Bank Holding Company. As noted, a BHC’s interest in a subsidiary bank is necessarily diluted when investors invest directly at the bank level. Pricing, the amount of capital needed and the financial condition of the subsidiary bank lead to complicated discussions among the BHC and investors as to exactly how much dilution the BHC must assume. Possibly in an effort to escape enforcement orders from the Federal Reserve and then be permitted to make payments on outstanding liabilities, including trust preferred securities, or perhaps due to the severity of the financial troubles experienced by the subsidiary bank, some BHCs may be so significantly diluted in a proposed transaction that they may not be in a control position for the bank following the transaction. Generally, one would expect that a BHC looking to de-register as a BHC to follow the same standards and guidelines discussed herein for bank investors. However, the Federal Reserve has not previously accepted a de-registration of a BHC that reduces its ownership interest in a subsidiary bank but retains a non-control position. We understand that the Federal Reserve’s general position is that de-registration may be accomplished only if the BHC retains less than 5 percent of the voting interest in the bank and does not have ongoing shared management or other relationships with the


bank. In essence, a BHC seeking to de-register must meet the safe harbor requirements for non-control of a bank as discussed herein and not be within the rebuttable range for control as a result of the transaction.

Objections of Bank Holding Company Creditors. Third parties looking for repayment from a BHC may object to a proposed transaction that dilutes the BHC’s relative ownership interest in the bank, sometimes merely as a means to gain information and may not realize the proposed transaction may ultimately benefit them as well. We note that publication of a notice or application with the bank regulatory agencies typically begins a formal comment period during which members of the public or interested parties may comment in favor of, or opposition to, a proposed transaction. Any meaningful, formal comments filed in opposition of a notice or application will often cause regulators to pause their review, and the agencies may in fact expect the applicant to vet the issues with commenters and report back on the outcome. Further, in the case of certain trust preferred securities issuances, the indentures related to such issuance may provide that a BHC’s reduced ownership interest in the subsidiary bank is an event of default. Regulators are both aware of, and concerned about, potential litigation exposure and related costs for the BHCs (and potentially their subsidiary banks) as a result of transactions that dilute a BHC’s ownership of its subsidiary bank.2

Within the broader category of bank-level investments, two specific structures appear to be gaining industry and regulatory attention and increasing in their consideration by investors and financial institutions alike. Those are good bank / bad bank structures and Section 363 reorganizations, each of which is discussed below.

A. Good Bank / Bad Bank Structures

Often, bank acquirers do not want to invest in, or acquire, a subsidiary bank that has a significant amount of non-performing loans and other real estate owned. Acquirers may attempt to solve this problem by agreeing to acquire the “good bank” through a purchase and assumption structure (similar to a branch acquisition transaction) and leave the “bad bank” in the subsidiary bank. This structure is possible if the acquirer is willing to assume all of the deposits of the subsidiary bank, which will allow the subsidiary bank to liquidate itself upon consummation of this transaction and to distribute the remaining assets (and liabilities) to the BHC. The BHC can then de-register as a BHC, sell or manage such assets, and attempt to satisfy the claims of its creditors as it winds down its operations. This structure is also possible where the subsidiary bank has an affiliate bank that can assume any remaining deposits as well as the remaining assets after the completed acquisition of the

2

By way of example, we reference the recent lawsuit filed by Hildene Capital Management in opposition to the proposed sale of BankAltantic from BankAtlantic Bancorp to BB&T Corporation announced on November 1, 2011. Hildene Capital Management purports to hold trust preferred securities of BankAtlantic Bancorp.


good bank. These transactions are often difficult to accomplish due to both valuation issues and regulatory concerns, but they are possible to complete.

Other options available to recapitalize banks with a significant non-performing asset portfolio (through a sale of the bank or a direct investment in the bank) involve an asset sale of many, if not all, of the non-performing assets. This sale is usually conducted by a third party advisor for the bank and the non-performing assets must be sold at a discount to their then-current book value. Such a discount has an adverse impact on the capital of the bank and, therefore, the amount of this negative capital impact needs to be considered when the parties are deciding on the amount of capital to be infused as part of the bank investment. Regulators will closely review any scenario where the purchaser of the non-performing assets is either related to the bank, its management, or a proposed investor in the bank or otherwise exposes the bank to some ongoing economic risk for asset performance following the transfer. By way of example, the Office of the Comptroller of the Currency (the OCC) has issued guidance that affirmatively rejects structures where a bank distributes non-performing assets in exchange for performing assets that are reliant on the original assets for their continued performance because the bank retains the risk of performance for the transferred assets.3

Another option is for the subsidiary bank to dividend many, if not all, of the non-performing assets to the BHC. Effecting such a dividend can have tax implications on both the subsidiary bank and BHC and requires that the transaction be structured in multiple steps for it to be tax efficient, including a purchase of subsidiary bank stock directly from the BHC by investors or an acquirer to provide the BHC with sufficient cash to manage the non-performing assets until it is able to liquidate them. Bank regulators do not look favorably on this structure for a number of reasons, including that it appears to be a circumvention of the affiliated transactions rules with the economic result being the sale of assets to the BHC without consideration. However, this is not the case, as the BHC is agreeing to reduce its ownership in the subsidiary bank and receive non-performing assets (and some cash from investors) to allow the subsidiary bank to be recapitalized by the investors. In instances where the bank is in troubled condition and has an existing order with its regulators that prohibits dividends without regulatory consent, the bank will find it very difficult to convince the agencies to waive that restriction. Further, where the transaction involves a direct investment in the bank rather than an acquisition of the bank, regulators may not look favorably on this transaction structure as it leaves the subsidiary bank without a BHC to act as its source of strength. Notwithstanding these concerns, we believe that this transaction structure is viable in certain circumstances.

3

For example, see the OCC’s CEO Letter, OCC 2011-10, “Exchanging Other Real Estate Owned for Other Assets” (March 24, 2011).


B. Bank Acquisitions as Part of a Section 363 Reorganization of the Bank Holding Company

Given the financial condition of certain BHCs and the difficulty of obtaining approval from all of a BHC’s stakeholders, including shareholders, creditors and trust preferred securities holders, for transactions involving the structures discussed above, some investors may look to acquire a subsidiary bank through a transaction effected under Section 363 of the U.S. Bankruptcy Code as an alternative to a direct investment in, or acquisition of, a subsidiary bank from a BHC. A BHC that needs to recapitalize its subsidiary bank may, as a last resort, file for federal bankruptcy protection to facilitate a structured, court-approved sale of its subsidiary bank, and thereby avoid bank receivership and associated regulatory and civil liability considerations of a bank failure. The sale of a subsidiary bank by a BHC in a bankruptcy process eliminates the stigma of the subsidiary bank being placed in receivership and allows the purchaser to acquire the subsidiary bank free and clear of any outstanding claims and obligations against the BHC.

Below we outline the process for a Section 363 transaction and discuss the benefits and considerations of this type of transaction for the potential participants.

Mechanics of a Section 363 Transaction. Section 363 of the U.S. Bankruptcy Code is a broad provision that governs the use, sale, or lease of property held by the debtor (referred to as the “debtor in possession”) during the pendency of a bankruptcy proceeding. Generally, the sale of a subsidiary bank will be considered a sale outside the “ordinary course of business” which, under Section 363(b), can occur only after approval by the bankruptcy court following notice and a hearing. A Section 363 transaction can be completed relatively quickly and, if approved by the bankruptcy court and the appropriate state and federal bank regulators, closing may occur as soon as 45 to 60 days after the bankruptcy filing. The ultimate disposition of the debtor’s estate will take longer; however, the wind-down of the debtor is not the responsibility of an entity that acquires its subsidiary bank. Similarly, the bankruptcy process eliminates the risk of future claims by creditors or trust preferred securities holders of the bankrupt BHC against the acquirer or the subsidiary bank.

There are seven significant steps in a Section 363 transaction, each of which is described below.

First, the BHC identifies a stalking horse bidder to purchase the subsidiary bank. This process is typically accomplished in a manner similar to a traditional M&A sale process. The stalking horse bidder can be a BHC or a new entity formed by a management team or investors for the purpose of acquiring the subsidiary bank. For investors looking to participate in the acquisition of a subsidiary bank in a Section 363 transaction, it is easiest to do so through an entity specifically formed to act as the stalking horse bidder. Investors would make their investment in the subsidiary bank indirectly through this new entity. Without a new entity, investors would need to be separate stalking horse bidders for a portion of the subsidiary bank that would, for


all practical purposes, require the investors to act together to make a viable bid, which would give rise to acting in concert issues that investors typically want to avoid (see Section IV, 1 “Regulatory Issues in Structuring Investments ─ Acting in Concert and its Consequences” for a discussion of these issues).

Second, the stalking horse bidder conducts its due diligence on the subsidiary bank (and any other assets to be purchased from the BHC) and agrees with the BHC on the value of the subsidiary bank (and any other assets it intends to acquire from the BHC).

Third, the BHC and the stalking horse bidder negotiate and enter into a purchase agreement for the subsidiary bank, contingent on all necessary bankruptcy court and regulatory approvals. The purchase agreement will set forth the purchase price to be paid to the BHC for the subsidiary bank’s common stock (and other assets to be purchased) and the equity contribution from the stalking horse bidder to recapitalize the subsidiary bank. Given the nature of a Section 363 transaction and the expectation that the BHC will not survive the 363 transaction as a going concern, the purchase agreement typically has more limited representations, warranties, and covenants than a standard acquisition agreement.

The purchase agreement may include a break-up fee guarantee that protects the stalking horse bidder in the face of competing bids during the auction process for the bank required to confirm fair value as part of a bankruptcy proceeding. Additional terms in a typical Section 363 purchase agreement include expense reimbursement for the stalking horse bidder and minimum bid increments and deadlines for competing bids, all of which serve to protect the stalking horse’s interest and reimburse the stalking horse for costs in the event another bidder successfully obtains the bank. The bankruptcy court will need to approve the final purchase agreement, along with terms of the bidding process. The stalking horse bidder has advantages over other bidders, as other bidders will have a limited timeframe to conduct due diligence and offer competing bids and generally must bid based upon terms of the stalking horse bidder’s purchase agreement.

Fourth, the BHC files for bankruptcy protection and immediately files a motion for an order approving the bidding procedures for the auction of its subsidiary bank, setting forth the terms and conditions of the purchase agreement with the stalking horse bidder.

Fifth, the stalking horse bidder files for bank regulatory approval to acquire the subsidiary bank and the BHC files for all regulatory approvals necessary for the sale under any of its enforcement actions or letter agreements with the applicable bank regulators. In addition, if the stalking horse bidder is a new entity, investors in the new entity may be required to make certain filings with the applicable bank regulators (see Section III “Key Regulatory Concerns” for the potential filings that investors may be required to make).


Sixth, the bidding procedures are approved by the bankruptcy court and the bidding process is opened to other bidders who may conduct due diligence and make competing bids on the BHC’s assets. The bidding process typically takes 30 to 45 days.

Seventh, the sale is approved by the applicable bank regulators and the bankruptcy court. Approval by the bankruptcy court under Section 363 will transfer the stock of the subsidiary bank (and other assets purchased from the BHC) to the winning bidder free and clear of any claims, liens or encumbrances of the BHC. No approval of the BHC’s shareholders or debt holders is necessary to approve the Section 363 sale transaction.

Benefits of a Section 363 Transaction. The benefits of a Section 363 transaction for the BHC include allowing the BHC’s board of directors to obtain comfort as to the fairness of the purchase price for the subsidiary bank through bankruptcy court approval of the Section 363 transaction and obtaining releases through the sale process and the ultimate plan of liquidation of the BHC. In addition, the BHC can effectively recapitalize the subsidiary bank without the receivership.

The benefits of a Section 363 transaction for the acquiring entity include allowing the entity to dispose of executory contracts to which the BHC is a party, and potentially receive favorable treatment of net operating losses associated with the subsidiary bank under Section 382 of the Internal Revenue Code due to the application of Section 382(l)(6), which values the loss corporation (i.e., the subsidiary bank) post-recapitalization, thereby materially increasing the utilization of net operating losses which can be applied to the acquirer’s consolidated income.

The sale of a subsidiary bank through a Section 363 transaction is, currently, a highly unusual transaction for BHCs and subsidiary banks. As a result, all participants in the process should engage in dialogue with the applicable bank regulators early enough in the process to determine if the bank regulators will be supportive of the transaction. In addition, through dialogue and meetings with the bank regulators, the participants can ascertain the specific approvals that the bank regulators will require the participants to obtain prior to consummation of a Section 363 sale transaction and hopefully get some sense of the timeline available to execute the transaction before the bank is placed into receivership. Ultimately, if a Section 363 transaction is successfully consummated, it can be done expediently and can recapitalize a bank that otherwise may not be recapitalized due its BHC’s inability to otherwise raise capital or sell itself.


III. KEY REGULATORY CONCERNS

1. Principal Regulators and Their Roles

The Federal Reserve regulates BHCs and state-chartered banks electing to be Federal Reserve member banks. The FDIC regulates state-chartered banks that do not elect to be Federal Reserve member banks. The Dodd-Frank Act transfers responsibility for the regulation of savings and loan holding companies to the Federal Reserve from the Office of Thrift Supervision (the OTS) as of July 21, 2011, the transfer date. As of the transfer date, the role of the OTS was completely absorbed by other banking regulators. Federally chartered thrifts, previously regulated by the OTS, are now regulated by the OCC, the agency that also regulates national banks. State-chartered thrift institutions are now regulated on a federal level by the FDIC.

A corporation, fund, trust, or other entity that considers an investment in a bank must assess potential BHC status under the Bank Holding Company Act (the BHC Act) or, in the case of thrift institutions, the Home Owners’ Loan Act (the HOLA), in each case as interpreted and applied by the Federal Reserve.4 If an individual, rather than an entity, seeks to make a significant investment in a bank, a comparable review by the primary bank regulator under the Change in Bank Control Act (the CIBCA) will also be required. The Federal Reserve will make the CIBCA control determination in cases where the investment is made at the holding company level.5 To the extent an investment is made directly into a bank and not into a holding company, the primary regulator with jurisdiction over the bank will make the CIBCA control determination.

Regulatory determinations concerning these issues will turn on critical relevant factual and financial considerations, and are therefore often difficult to predict with certainty without specific review of the facts and circumstances present for a given investment. That said, useful guidance is available from these agencies on the regulatory and legal standards applied in their analyses, and should be thoughtfully considered by investors or investor groups when approaching a proposed investment.

The Federal Reserve reviews carefully every proposal by an investor to acquire control of a bank or BHC, and similarly reviews significant non-controlling investments to ensure that the investor will not be in a position to exercise a controlling influence over management or policies of the bank. The process can be detailed and lengthy; in the case of a finding of control a BHC application will be required that is not typically subject to expedited review and may not be subject to delegated review at the District Reserve Banks of the Federal

4

Relevant change of control statutes, under state law, also may need to be considered, as described below in Section III, 2 “Control and its Definition.”

5We note that the primary federal regulator for the subsidiary bank may also conduct a review of the investment under the CIBCA in such cases.


Reserve, meaning the staff of the Federal Reserve Board in Washington may be required to render the final determination.

In light of the above, it is suggested that, prior to agreeing to make a significant bank investment, a pre-filing meeting be organized with documents outlining the transaction delivered to the Federal Reserve for consideration and review prior to the pre-filing meeting. Significant departures from traditional approaches in the investment documents, whereby investors may be granted additional rights or powers (including veto authority) to control or influence the management of a bank, or significant departures from expected investment structures, may give rise to a control determination or lengthen the time necessary for the regulators to reach a decision on the proposal. In any case, the process will take several weeks for regulators to reach a determination. Appropriate foresight is necessary to ensure sufficient time is available to complete the review. Among the determinations that will be made is whether a Change of Bank Control notice will be required to be filed in accordance with the provisions of the CIBCA, as more fully described in Section III, 4 “Cases Where Prior Approval May Not Be Required ─ Rebuttable Presumptions of Control and CIBCA Filings.”

2. Control and its Definition

Among bank regulatory agencies, the Federal Reserve has developed an authoritative and elaborate set of guidance and principles on what constitutes control, as well as consequences of such a finding. These standards are of significance for purposes of evaluating the consequences of control under two very significant statutory regimes - the BHC Act (which requires the approval and registration of a BHC in the case of a finding that an entity has acquired a controlling influence over the management and business practices of a bank or its holding company),6 and the CIBCA (which imposes certain filing obligations and related notification requirements prior to an individual’s investment that constitutes a change in control of a bank). Because, in some cases, the statutory definitions in the CIBCA differ from those in the BHC Act, a regulatory agency may find a change of control to exist under the CIBCA without also finding that control exists for purposes of the BHC Act. One should also bear in mind that, if applicable, different state laws and regulatory regimes may follow different standards for what constitutes control.7

For reference purposes, we have produced a summary chart that outlines key regulatory thresholds under both the BHC Act and the CIBCA, and that summary is attached as

6

Note that the HOLA, as administered by the Federal Reserve following the transfer date for the Dodd-Frank Act, rather than the BHC Act, is the statutory regime under which entities with a controlling interest in savings associations are determined to be savings and loan holding companies, requiring prior Federal Reserve approval similar to BHCs.

7To this end, it should also be recalled that different states may have divergent standards and legislative tests for the concept of “control;” however, most follow the federal standards discussed above.


“Appendix A ─ Overview of Key Thresholds for Control Under the Federal Banking Laws.” Often, investors and institutions focus primarily on thresholds for acquisitions of voting interest, and those thresholds are set forth in the chart below:

Individuals Entities8

5% or morevoting interest

None File a passivity commitment with, and obtain acceptance from, the Federal Reserve, assuming the investor does not become a BHC


File a Change in Bank Control Notice with the appropriate federal banking agency

None, assuming a passivity commitment discussed above was filed at 5% or more voting interest, and the investor does notbecome a BHC


None File an application (FR Y-3) with the Federal Reserve to become a BHC

When reviewing these thresholds, please note that federal bank regulators have broad discretion to interpret the voting interest standards indicating control, and a specific review of the facts and circumstances at issue would be required for any significant bank or parent company investment. Also, other indications of control beyond voting ownership may cause a regulator to determine that an investor is exercising a controlling influence over the management or policies of bank or its parent, and thus is in a control position.

As noted, a finding of control for purposes of the BHC Act entails the conclusion that a legal entity having control over a bank will be deemed to be a BHC. The consequences of such a determination are significant for the BHC: it faces limitations on the scope of its non-financial activities and is required to serve as a source of managerial and financial strength for the depository institution it controls. Thus, such company must maintain consolidated capital levels consistent with regulatory standards for a BHC, as more fully set forth in Section IV, 3“Regulatory Issues in Structuring Investments ─ Consequences to an Investor of a Finding of Control.” Conversely, a change of control filing under the CIBCA does not rise to the level of a formal request for regulatory approval of the investment, but involves, instead, a notice filing with a finding of non-objection by the appropriate agency. Following an investment that is deemed to be a change of control for CIBCA purposes, but not an acquisition of control for BHC Act purposes, the investor is not subject to ongoing activities limitations and capital requirements.9 However, CIBCA review does call for background information on the

8

Entities generally include trusts (with the possible exception of certain estate planning trust vehicles), funds, corporations, partnerships, limited liability companies, limited partnerships, and other forms of legal entities, and exclude individuals.

9An investor that has filed for, and obtained, regulatory non-objection for a proposed investment under the CIBCA thereafter falls within the definition of an “institution affiliated party” for purposes


investor group and its overall business qualifications and objectives.10 Note that investments that are approved under the BHC Act are exempted from review under the CIBCA.

The most recent guidance offered by the Federal Reserve on non-control investments came in the form of a Policy Statement on Equity Investments in Banks and Bank Holding Companies, issued in September 2008. In this Statement, the Federal Reserve notes the standards for determining control under the BHC Act:

The BHC Act provides that a company has control over a banking organization if (i) the company directly or indirectly or acting through one or more other persons owns, controls or has power to vote 25 percent or more of any class of voting securities of the banking organization; (ii) the company controls in any manner the election of a majority of the directors or trustees of the banking organization; or (iii) the [Federal Reserve] Board determines, after notice and opportunity for hearing, that the company directly or indirectly exercises a controlling influence over the management or policies of the banking organization.

Under pertinent Federal Reserve interpretations, a group of investors may be deemed to be acting in concert, and thus have their respective investments aggregated for purposes of a control determination, if the regulator finds “knowing participation in a joint activity or parallel action towards a common goal of acquiring control of a state member bank or bank holding company whether or not pursuant to an express agreement.”11 A significant point made by

of Section 8 of the Federal Deposit Insurance Act. As a result, the bank regulators have authority to impose orders and undertake enforcement actions against such investors for certain unsafe and unsound practices and legal or regulatory violations. 12 U.S.C. § 1818(b).

10For example, financial data on the part of the investor making such filing will be required, as will information on the business background and personal or corporate history of the investor and on the source of the funds being used for the investment. In addition, the CIBCA notice will be the subject of publication requirements in appropriate local newspapers, and the potential source of public comment as a result. Background verifications and fingerprinting for significant investors or their principal managers will be likely.

1112 C.F.R Section 225.41(b)(2). Similarly, the OTS has provided guidance on what constitutes control and what steps may be taken to rebut the presumption of its existence under the HOLA. These standards are generally consistent with the approach on control set forth in 12 C.F.R. Section 574.4, which notes as follows:

“An acquiror shall be determined, subject to rebuttal, to have acquired control of a savings association, if the acquiror directly or indirectly, or through one or more subsidiaries or transactions or acting in concert with one or more persons or companies, holds any combination of voting stock and revocable and/or irrevocable proxies, representing more than 25 percent of any class of voting stock of a savings association, excluding such proxies held in connection with a solicitation by, or in opposition to, a solicitation on behalf of management of the savings association, but including a solicitation in connection with an election of directors, and such


the Federal Reserve is that “[c]ontemporaneous minority investments in the same banking organization by multiple different investors also often raise questions about whether the multiple investors are a group acting in concert.”

3. Cases Where Prior Approval Will Be Required – Irrebuttable Presumptions of Control

An investor or group of investors acting in concert may, as a general matter, acquire an interest in a bank or a BHC below the thresholds discussed herein without obtaining the prior regulatory approval, unless the position in question is deemed to establish a controlling influence over the operation of the entity. Federal banking law establishes a number of parameters with respect to how much equity, and how many other management and related rights, may be acquired with respect to a bank before a controlling influence will be deemed to arise. As a general matter, the following are instances where control will be irrebuttably presumed to exist, thus mandating prior approval of the investor or group of investors:

An investment that equals or exceeds 25 percent of the voting shares of the banking entity will cause the investor that is acquiring such a position (whether acting individually or in concert with other investors) to obtain the prior approval of the pertinent bank regulatory agencies.

An investment that exceeds 33 percent of the total contributions to the equity of the banking entity, whether as a combination of voting or non-voting shares or through the holding of subordinated debt or other positions treated as equity for accounting or regulatory purposes, will also cause the investor acquiring such a position (whether acting individually or in concert with other investors) to obtain the prior approval of the pertinent bank regulatory agencies.

For purposes of these analyses, a class of non-voting stock, debt, preferred stock or other securities that is convertible into voting stock, may be deemed to represent the class of stock into which it is convertible, irrespective of conditions or time periods for conversion.

4. Cases Where Prior Approval May Not Be Required – Rebuttable Presumptions of Control and CIBCA Filings

Historically, the Federal Reserve has determined that an investment which equals or exceeds 10 percent of the voting shares of a banking entity, but which is less than 25

proxies would enable the acquiror to: (i) elect one-third or more of the savings association's board of directors, including nominees or representatives of the acquiror currently serving on such board; (ii) cause the savings association's stockholders to approve the acquisition or corporate reorganization of the savings association; or (iii) exert a continuing influence on a material aspect of the business operations of the savings association.”


percent of the voting shares and less than 33 percent of the total contributions to equity, creates a rebuttable presumption of control. More recently, however, the Federal Reserve has found that, in the case of certain investors that possess unique characteristics or raisespecial concerns from a regulatory perspective, a lower threshold of investments that equal or exceed 5 percent of the voting shares of the entity will result in a presumption of control. Such investors generally include private equity investors or funds, in light of perceived investment objectives, strategies for shareholder influence and involvement in the business of the bank. The lower threshold for review in these cases is designed, in part, to allow the regulators to collect information on such investors, and to allow for monitoring of the investors’ activities, timing of investments and divestitures and common investment decisions among multiple parties, particularly in light of potential acting in concert considerations.

Accordingly, it will be important for an investor that falls into this category, along with the banking entity that is the subject of the investment, to arrange for a pre-filing meeting with regulators to review the details of the anticipated investment structure before making the investment. Although such reviews are very fact-driven, the following general considerations may be helpful in analyzing whether the presumption of control may be rebuttable in the view of the regulators:

A Sliding Scale of Voting Interests. Lesser percentages of voting interests generally trigger a lesser likelihood for regulatory focus, as compared to larger voting positions. For example, an investor with a 24.9 percent voting position may find itself more likely to be deemed to control the bank than an investor with a 14.9 percent voting interest and similar ownership rights and rights and privileges.

Bank Interactions Outside of the Proposed Investment. Significant relationships or historic interaction between the investor and the bank may elevate the regulators’ concern that an investor within the range of a rebuttable presumption of control does, in fact, control the bank. For example, an investor that also has a long-standing, major credit relationship with the bank, that intends to acquire loans or real estate assets from the bank or that is a major service provider to the bank is more likely to be deemed to control the bank than an investor that has no relationships with the bank other than its equity investment.

Passivity Commitments. Rebutting a presumption of control will be predicated upon an investor entering into certain fairly standard passivity commitments, which are structured to avoid a characterization of control, and to refute an indication that such investor may be acting in concert with other shareholders. These undertakings are described in detail in Section IV, 2 “Regulatory Issues in Structuring Investments ─ Rebutting Control / Passivity Commitments.” In addition to mitigating potential control factors, the passivity undertakings are designed to minimize the effect of any prior relationships that may have existed between any investor and any members of current or proposed management of the bank. These commitments include direct limitations on the investor in exercising a controlling influence over the management


of the bank (including prohibitions on naming any management official or setting corporate business policies or compensation). With respect to potential acting in concert concerns, the commitments also impose constraints on agreements or voting arrangements with other investors, including by voting for a common slate of directors, acting upon the advice of a common investment advisor, or engaging in other banking ventures or investments with the same investors. In cases where prior or current relationships may exist among non-controlling investors and a proposed member of the management group, by virtue of consulting, employment, or investment arrangements, the regulators will likely require all such ties be severed so as to avoid any indirect exercise of influence by the investor. Any financial or other agreements (including salary, insurance or equity ownership arrangements involving the proposed investor and the executive) must be terminated. In some instances, the investor may be required to agree not to re-hire or re-engage any such executive for a period of two years after he or she leaves the management team of the bank.

Board Representation. A non-control investor may nominate one director to the board of the bank and one director to the board of the BHC, provided that the director representation does not exceed a proportionate percentage of the investor’s ownership interest and does not exceed, in all events, 25 percent of the voting members of the board or of any specific committee of the board of directors. An investor-nominated director will also be precluded from participation on a committee that has decision making authority on managerial matters for the bank. In the case of club investment structures involving a small number of significant private investment fund investors each such investor may be able to nominate a separate board member, provided that the majority of the members of the board remain independent. Under certain limited and unique circumstances, an investor that meets the criteria set forth above may be able to nominate a second director, provided the bank is controlled by a larger, unaffiliated shareholder registered as a BHC, and the number of director nominees does not exceed 25 percent of the voting members of the board and is proportionate to the investor’s stake in the bank. In addition, it may be possible, in certain cases, to designate a non-voting observer to attend directors meetings, although this option is carefully reviewed by most regulatory agencies to assure that the observer does not provide any investors with impermissible influence over the board.12

The Largest Shareholder Factor. Indicia of control by an investor are lessened if an unaffiliated shareholder has a larger position in the entity. The mitigating role of a larger, unaffiliated shareholder is further strengthened from a regulatory perspective when the larger shareholder is in a regulated control position as a BHC.

12

It should be noted that both the director, as well as the individual or company investor that nominates the director, will be subject to background checks and informational reviews.


Contractual Rights. Bank regulators may find control to exist in situations where an investor has certain rights to approve key business decisions of an institution, despite the fact that such rights may be solely prudential in nature. For example, providing an investor the right to approve entering into new banking activities or markets, to consent to the sale, transfer, or encumbrance of a majority or all of the voting shares of the institution, to dictate management compensation, or to otherwise provide anti-dilution protection, may cause the agencies to find that an investor with such rights obtained control of the bank. These issues will be subject to regulatory scrutiny on a case-by-case basis. While informative of the types of influence and rights that raise control concerns for the agencies, these determinations are typically made in individual instances and may not always have precedential consequences for future investments structured on a comparable basis.

Filing of Change of Bank Control Notice. In cases where an investment equals or exceeds 10 percent of the voting securities of a particular class of equity (5 percent where funds or similar investors are involved), the staff of the Federal Reserve will likely require, even in the absence of a formal finding of control, such investor to file an Interagency Notice of Change in Control under the CIBCA.13 In the case of a club investment structure, not all the investors will be required to effectuate such a filing; only the largest investor among such acquirers will be required to submit a formal Notice.

5. Safe Harbor – No Prior Approval Necessary

Federal banking law indicates that a position which represents less than 33 percent of the total contributions to capital (inclusive of voting and non-voting interests), and less than 5 percent of the voting interests of a banking entity for an entity investor (or less than 10 percent of the voting interests for an individual investor), should not engender a controlling influence. In such cases there is a presumption that no control exists; however, even these cases must be structured carefully because the regulators may determine that facts and circumstances exist to override the presumption. Thus, it is advisable that investors approaching even these relatively small investment levels should be careful to address the following considerations:

Avoid any characterization that the investor may be deemed to be acting in concert with other proposed investors or current shareholders, and

Eliminate any special veto or other rights over the management of the banking entity that would be inconsistent with a non-controlling investment as outlined in the passivity commitments referenced above.

13

Similar Change in Control Notices may also be required by the OCC and FDIC, depending on the structure of the investment transaction.


We also note that in cases where all investors stay below the designated thresholds, collectively take a significant portion of the banking entity’s equity, and invest in a banking entity that intends to undergo significant changes in either management or board composition in connection with the recapitalization, federal banking agencies may require an Change in Bank Control Notice to be filed under the CIBCA. Often, the appropriate parties to file such notice are the new management and director teams because none of the investors individually reaches a large enough position to warrant a filing.

IV. REGULATORY ISSUES IN STRUCTURING INVESTMENTS

1. Acting in Concert and its Consequences

The provisions of the BHC Act make clear that a group of investors, each of whom holds a position of less that 5 percent of the voting shares of a bank or BHC, may nevertheless be presumed to have acquired control if the investors, taken together, hold an amount in excess of the stated thresholds and if such investors are held to be acting in concert. The term “acting in concert” includes, but is not limited to, a knowing participation in a joint activity or parallel action towards a common goal of acquiring control of a bank or BHC, whether or not an express written or oral agreement exists.

The following persons or entities are presumed, under federal banking law, to be acting in concert:

A company and any controlling shareholder, partner, trustee, or management official of the company, if both the company and the person own voting securities of the bank or BHC;

An individual and the individual's immediate family, which includes spouse, father, mother, stepfather, stepmother, brother, sister, stepbrother, stepsister, son, daughter, stepson, stepdaughter, grandparent, grandson, granddaughter, father-in-law, mother-in-law, brother-in-law, sister-in-law, son-in-law, daughter-in-law, or the spouse of any of the foregoing;

Companies under common control;

Persons that are parties to any agreement, contract, understanding, relationship, or other arrangement, whether written or otherwise, regarding the acquisition, voting or transfer of control of voting securities of a bank or BHC;

Persons that have made, or propose to make, a joint filing under Sections 13 or 14 of the Securities Exchange Act of 1934; and

A person and any trust for which the person serves as trustee.


These principles have led the Federal Reserve and other banking regulators to conclude that a number of affiliated entities acting in concert may be deemed to have established the functional or legal equivalent of a new entity or association, and this new association may be deemed to be a de facto partnership or association that has acquired control of the bank or BHC. This outcome was determined to exist in a dated, but illustrative, Federal Reserve decision referred to as the Dinsdale case where a single person’s control of multiple investors in the same banks gave rise to a finding of a de facto partnership or association which controlled the subject banks.14

Further, an interesting illustration of these doctrines is contained in a final enforcement decision issued by the Federal Reserve on June 7, 2005.15 In this proceeding, penalties were imposed on a large group of individuals that were found to have acted in concert to acquire a controlling interest in a financial institution. The basis for this conclusion turned on the judgment that the individuals were affiliated with a church organization that had intended for some time to acquire operational control of a bank. The individuals were advised by a key officer of the church to acquire the shares, and in some instances were reimbursed for the purchases. Of significance is the fact that no formal agreements, undertakings or contracts memorializing such arrangements existed, and in some cases the individuals were apparently not fully aware of how their own actions were linked to steps taken by other participants. The decision suggests that where prior affiliations exist, even among a group of individuals who may not be members of one family or associated with entities under common control, actions taken in furtherance of a common objective or under the direction of a leader or spokesman, may rise to the level of concerted action and bear on control determinations.

2. Rebutting Control / Passivity Commitments

As noted, the Federal Reserve has articulated a series of undertakings that may be entered into by prospective investors in cases where a finding of control might otherwise be the conclusion. These undertakings include that the proposed investor will not, directly or indirectly:

take any action causing the bank to become a subsidiary of the investor;

acquire or retain shares that would cause the combined interests of the investor and its officers, directors, and affiliates to equal or exceed 25 percent of the outstanding voting shares of the bank, or to exceed 33 percent of the total contributions to capital(both voting and non-voting interests) of the bank;

14

66 Fed. Res. Bull. 782 (1980).15

In the Matter of Carl V. Thomas, et al. (66 Federal Reserve Bulletin 446 et seq. (Summer 2005)).


exercise or attempt to exercise a controlling influence over the management or policies of the bank;

seek or accept representation on the board of directors of the bank, or of any committee of such board, unless in conformity with the passivity rules articulated by the Federal Reserve, as noted above;

have or seek to have any representative serve as an officer, agent or employee of the bank;

propose a director or slate of directors in opposition to a nominee or slate of nominees proposed by the management or board of directors of the bank (with the caveat that, as noted above, a non-control investor may have one director nominee);

solicit or participate in soliciting proxies with respect to any matter presented to the shareholders of the bank;

attempt to influence the dividend policies or practices of the bank;

attempt to influence the loan and credit decisions or policies of the bank, the pricing of services, any personnel decisions, the location of any offices or branches, the hours of operation or similar activities of the bank;

enter into any other banking or nonbanking transactions with the bank, except that investor may establish and maintain deposit accounts with the bank, provided that the aggregate balances of all such accounts do not exceed $500,000 and that the accounts are maintained on substantially the same terms as those prevailing for comparable accounts of persons unaffiliated with the bank; or

dispose or threaten to dispose of any shares in the bank in a manner designed to influence or exert control over bank policy.

Although developed by the Federal Reserve in the context of BHC regulation, these principles are of general applicability to investments in savings institutions, nonmember banks and national banks regulated by the FDIC and the OCC.

3. Consequences to an Investor of a Finding of Control

An entity that is determined to acquire control under the BHC Act will be deemed to be a BHC and will be required to obtain approval as such from the Federal Reserve and possibly the applicable state regulator. Some of the most salient consequences of BHC status are outlined below.


If the consolidated assets of a BHC exceed $500 million, certain capital requirements will apply, along with associated quarterly financial reporting to the Federal Reserve to demonstrate the ongoing financial condition of the BHC.

Activity requirements will be imposed on the BHC that generally limit activities to those “closely related to the business of banking.” Fundamentally, these limitations impose constraints on the ability of such BHC and its controlling investors to engage in activities that are not financial in nature, unless the Federal Reserve is willing to approve the undertaking or has previously authorized such activities for a BHC and its affiliates.

Consistent with the capital requirements, a BHC must serve as a source of financial and managerial strength to its subsidiary bank(s). In practical terms this source-of-strength doctrine may require controlling investors to commit to contribute additional capital to the bank during times of financial distress for the bank as may be necessary to render the bank financially solvent at all times.

In the event of the receivership of a subsidiary bank, other banks that are commonly controlled by the BHC may be liable under the provisions for cross-guarantee set forth in the Federal Deposit Insurance Act for any amount of loss not otherwise recouped by the FDIC in connection with the liquidation.

BHCs are subject to periodic examination by the Federal Reserve to confirm compliance with bank regulatory requirements, including those discussed in the previous bullets.

4. FDIC Statement on Failed Bank Acquisitions

Banks and BHCs seeking to acquire failed banks from the FDIC face unique issues and regulatory considerations in connection with capital raises for such efforts. Those issues areoutlined in the FDIC’s public Statements of Policy on this topic, and are discussed in some detail in attached “Appendix B ─ The FDIC’s Statement on Failed Bank Acquisitions.”

DLA PIPER LLP

Rusty Conner Jeffrey HareDavid KrohnAnn LawrenceMichael P. Reed

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APPENDIX A

Overview(1) of Key Thresholds forControl Under the Federal Banking Laws(2)

Change in Bank Control Act

An investor is required to provide 60-day prior notice to the applicable federal bank regulator under the Change in Bank Control Act in the following circumstances. The Change in Bank Control Act applies to entities (including trusts, funds, corporations, partnerships, etc.) and individuals.

Acquisition of 10% or more voting interest in a bank or its parent and (i) the bank or its parent is an SEC registered company; or (ii) no other shareholder of the bank or parent owns a greater voting interest.

Acquisition of 25% or more voting interest in a bank or its parent.

The investor has otherwise been determined by the applicable federal bank regulator to be acquiring the power to direct the management or policies of a bank or its parent.

No Change in Bank Control Act notice is required if the investor is approved as a BHC for the subject bank.

Bank Holding Company Act

An investor is required to obtain prior Federal Reserve Board approval under the Bank Holding Company Act in the following circumstances. The Bank Holding Company Act applies to entities (including trusts, funds, corporations, partnerships, etc.) but not individuals.

Acquisition of 5% or more voting interest in a bank or its parent; may be rebutted if voting interest is below 25% by filing a passivity commitment with the Federal Reserve that enumerates certain actions indicative of control that the investor will not take.

Acquisition of 25% or more voting interest in a bank or its parent.

Contribution of 33% or of the total equity in a bank or its parent.

Controlling in any manner the election of a majority of the directors or trustees of the bank or its parent.

The investor has otherwise been determined by the Federal Reserve Board to be exercising a controlling influence over the management or policies of a bank or its parent.

1

Note that federal banking regulators have broad discretion to interpret these laws and requirements, and a specific review of the facts and circumstances at issue would be required for any significant bank or parent investment.

2Note that these charts do not address state banking laws which, in many cases, require prior approval from or notice to the state banking department of the state in which the bank is located; however, state laws often parallel the federal laws discussed here.

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APPENDIX B

The FDIC’s Statement on Failed Bank Acquisitions

On July 2, 2009, the FDIC authorized publication of its “Proposed Statement of Policy on Qualifications for Failed Bank Acquisitions” (the Proposed Statement).1 The Proposed Statement set forth certain standards for bidder eligibility in connection with the resolution of failed insured depository institutions that would affect the way private equity and other investors acquire a stake in failed banks. With some modification, the Proposed Statement was adopted in final form on August 26, 2009 (the Statement). The FDIC has further clarified its interpretation of the Statement to provide an indication of how these important regulatory objectives may be achieved by specific investors. In particular, on December 11, 2009, the FDIC issued frequently asked questions (FAQs) regarding this Statement, which were subsequently withdrawn by the FDIC on December 14, 2009. On January 6, 2010, the FDIC released revised questions and answers (the Revised FAQs),2 replacing and superseding the original FAQs, and providing the FDIC the opportunity to set forth additional interpretations of its Statement. These Revised FAQs were, in turn, amended and amplified by the FDIC on April 23, 2010, by its issuance of new questions and answers (the New FAQs), which expanded upon the Revised FAQs, and which provide additional clarity on the applicability of the Statement.

Reflecting the regulatory concerns alluded to above, the New FAQs provide additional clarity on the principal safe harbor exemption from the consequences of the Statement, reflecting those instances, as noted above, where a strong majority institutional investor continues to hold a significant position in the failed bank in question. Such an investor is seen as a basis for providing guidance and continuity in the ownership and management of the specific bank.

Applicability of the Statement

In issuing this Statement, the FDIC evidenced concerns about non-institutional sources of investment acquiring significant holdings in failed banks. These considerations reflect the view that such investors may not be able to ensure that the ownership and management of a particular bank remain stable, nor be able to provide guidance and continuity for safe and sound operations of the bank. As the FDIC noted in the Introduction to the Proposed Statement:

The ability of the owners to provide financial support to depository institutions with adequate capital management expertise are essential safeguards. These safeguards are particularly appropriate for owners of insured depository institutions given the important benefits conferred on depository institutions by deposit insurance….The FDIC is particularly concerned that

1

A copy is set forth at http://www.fdic.gov/regulations/laws/federal/2009/09FinalSOP92.pdf.2

A copy is set forth at http://www.fdic.gov/regulations/laws/faqfbqual.html.

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owners of banks and thrifts, whether they are individuals, partnerships, limited liability companies or corporations, accept the responsibility to serve as responsible custodians of the public interest that is inherent in insured depository institutions and will devote the efforts to assuring that banks or thrifts acquired with assistance from the deposit insurance fund do not return to the category of troubled institutions.

Accordingly, to enhance the policy objectives identified above, the Statement, as issued, provides a number of restrictions and constraints to be undertaken by:

Private capital investors in a company that is planning to assume deposit liabilities or other liabilities and assets from a failed insured depository institution, and

Applicants for insurance in connection with the resolution of failed insured depository institutions.

Notably, the Statement does not apply to:

Investors in partnerships or similar ventures with bank or thrift holding companies (excluding shell holding companies) where the holding company has a strong majority interest in the resulting bank or thrift and an established record for successful operation of insured banks or thrifts,

Investors with 5 percent or less of the total voting power of an acquired depository institution or its bank or thrift holding company, provided there is no evidence of concerted action by these investors, or

Investments in troubled or non-troubled institutions or entities that have not been placed in receivership.

Instead, it applies only to the acquisition of failed banks from the FDIC. Nevertheless, the Statement’s provisions are indicative of the approach that may be followed by the FDIC more generally in the context of these other investments. In addition, we understand that in cases where investors have an existing position in a troubled institution that is not subject to the restrictions set forth in the Statement, should an additional investment be made in such institution by these investors, the terms of the Statement will only be potentially applicable to such additional invested amounts and resultant ownership related to these new sums.

The Strong Majority Investor Provision

As already discussed, the Statement does not apply to holding companies that maintain a strong majority interest in the acquired bank and an established record of successful operation of insured institutions. In fact, such a structure is the asserted preference of the FDIC for investments in failed banks. In the New FAQs, the FDIC indicated that such an interest will generally require the holding company to have at least two-thirds of both the voting and total equity of the institution in question. While the New FAQs do not require the strong majority interest to be held for a minimum period of time prior to acquisition of the

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failed bank, the FDIC is concerned that such a strong majority interest not have been recently established in anticipation of effectuating the failed bank investment. The FDIC will take into consideration whether a significant portion of the total equity shares or voting equity shares held by such investors was recently acquired or was part of a recapitalization of the existing institution. Although recapitalizations do not technically fall within the application of the Statement, a recapitalization will be examined by the FDIC to determine whether the additional capital was provided contingent on completion of subsequent failed bank acquisitions. Such a conclusion would likely render the Statement applicable in the case of a recapitalization, as would be true for any acquisition of one or more failed banks that exceed, in the aggregate, 100 percent of the recapitalized institution’s total assets within an 18-month period following the recapitalization.

The Concept of Concerted Action

As also discussed above, the Statement will not apply to investors that alone or in concerted action with others hold 5 percent or less of the voting power of the acquirer. However, the Statement will apply to less than 5 percent investors if such investors are deemed to evidence concerted action, allowing them greater power in connection with the operation and management of the entity in question. While the concept of concerted action in the Statement was initially presumed to have the same meaning as the term acting in concert, which is the subject of an existing interpretation by the Federal Reserve and discussed previously, the FDIC has indicated that it will undertake its own analysis, and Federal Reserve precedent may not, in fact, be determinative. Although the Federal Reserve guidance should and likely will inform an FDIC decision, the FDIC will independently investigate the facts and circumstances surrounding a given relationship among investors in reaching its conclusion. Notably, pursuant to the New FAQs, such minority investors will be presumed to be engaging in concerted action if they hold in the aggregate more than two-thirds of the total voting equity. This presumption may be rebutted if facts allow.

The Role of the Anchor Group

If the Statement is otherwise applicable to an investment, investors holding a minimum of one-third of the total voting equity or total equity of an acquired institution or its bank or thrift holding company (including, potentially, less than 5 percent holders) may need to structure an exemption for the majority of the investors in question by agreeing to constitute an anchor group bound by the provisions of the Statement. Without such an anchor group, the risk exists that the terms of the Statement would apply to the larger group of shareholdings in the acquired bank. To qualify for this status, this anchor group test must be met at the time of the proposed acquisition, with the anchor group investors agreeing to subject their equity in the acquired bank to the three-year continuity of ownership requirement contained in the Statement. In this way, the FDIC will assure that the anchor group will provide the requisite guidance and continuity over the entity’s ownership and management to address the FDIC’s policy concerns on this point.

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Consequences of the Applicability of the Statement

Once it is determined that the Statement applies, investors should be aware that the following conditions and criteria will govern the role of the investors:

Capital Commitment

An investor group in a failed institution must initially capitalize the institution at a minimum 10 percent Tier 1 leverage ratio for a period of three years, and maintain well-capitalized status for the institution throughout the period of time the investor group maintains its ownership interest. That same requirement applies to investors in an institution that acquires assets or deposit liabilities from a failed depository institution.

Continuity of Ownership

Investors in the failed bank are prohibited from selling or otherwise transferring securities of the institution or its holding company for a three-year period of time following the acquisition, absent the consent of the FDIC.

Cross Guarantees

Investors that, individually or collectively and directly or indirectly, acquire an 80 percent or greater interest in a failed institution and any other insured depository institution must pledge to the FDIC their proportionate interests in each institution as a potential source of reimbursement of any loss to the Deposit Insurance Fund caused by the failure of, or assistance provided by the FDIC to, either institution. The pledge is waivable by the FDIC if waiver would result in decreased cost to the Deposit Insurance Fund. While Section 5(e) of the Federal Deposit Insurance Act creates liability among commonly controlled depository institutions, the Statement’s mandatory pledge of stock in a commonly held institution poses concerns beyond potential cross-liability exposure.

Transactions with Affiliates

The Statement prohibits all extensions of credit, as that term is broadly defined in Regulation W, by the acquired failed institution to the investors, their respective investment funds (if any), and any affiliates thereof, as well as any portfolio companies. For purposes of these prohibitions, an affiliate will be deemed to include any entity in which an investor owns 10 percent or more of the equity. For compliance purposes, investors are required to give periodic reports of covered companies, which requirement may present concerns for those investors whose relative percentage stakes in companies change frequently as well as those who do not publicly disclose portfolio companies.

Secrecy Law Jurisdictions

Ownership vehicles established by investors in bank secrecy jurisdictions would be ineligible to own a direct or indirect interest in a failed insured depository institution, absent, among other things, a commitment to or the existence of comprehensive consolidated supervision

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for the investor group in question, as well as a consent to provide information to federal banking regulators, consent to jurisdiction in the United States and agreement to be bound by the statute and regulations administered by such pertinent federal banking regulators. This provision has proven particularly troubling for certain investors with parallel domestic and off shore funds. To address concerns raised by offshore investors that may be seeking to invest in failed institutions through vehicles organized in “secrecy law” jurisdictions, the FDIC has said that certain funds, including potentially those in the Cayman Islands with domestic advisers, will be permitted to invest if they establish a domestic pass-through subsidiary to hold the investment and disclose the identity of their investors. To this end, in the New FAQs, the FDIC has indicated that entities will be in compliance with the “secrecy law” jurisdictional constraints so long as each offshore investor makes its investment in the bank or holding company through at least one wholly owned subsidiary established under the laws of any state of the United States, and such entity agrees to maintain, within the control and disposition of such subsidiary, certain key books and records concerning the vehicle’s operations and its investors. All such records would be made available, if required, to the FDIC, and would support the transparency of the operations of the investor entity in question.

Special Owner Bid Limitation

Investors that hold, directly or indirectly, 10 percent or more of the equity of a bank or thrift in receivership are ineligible to invest in the acquirer of the deposit liabilities of that failed institution.

Disclosure

Investors will be required to submit to the FDIC complete information concerning the investor group as well as all entities in the ownership chain, including the size of the capital fund or funds involved in the proposed acquisition, the return profile, the marketing documents, the management team and the business model. The Statement expressly provides, as well, that additional requirements may be imposed in connection with the general character, fitness and expertise of management, the need for a thorough and reasonable business plan, satisfactory corporate governance structures and any other supervisory matter deemed pertinent.

Practical Observations Resulting from these Criteria

Recognizing the use of the term voting power in the Statement, structures are in the market where a non-voting class of securities is being offered to investors that will hold a 5 percent or less voting interest. These structures are being carefully considered by the FDIC to confirm that the non-voting class truly lacks voting power in all cases and that their equity interests are not convertible into voting securities. For example, if the non-voting equity interests are convertible into voting shares at the election of the investor, these non-voting interests would be aggregated with voting equity positions held by such investors.

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In practice, the FDIC and other regulators that oversee the proposed acquirer will also carefully consider the financial strength of the proposed acquirer and the potential risks of integration that the acquisition may present. For those investors seeking to roll up multiple failed banks that have successfully acquired one failed bank from the FDIC recently, the FDIC typically imposes some waiting period (e.g., six months) for integration before the investor can acquire a second institution. All investors contemplating transactions that may fall within the scope of the Statement are advised to consult with FDIC staff as early as possible in the structuring process, so that potential exemptions, as well as the consequences of the Statement’s applicability, may be considered carefully and appropriate planning be effectuated.

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recapitalization and acquisition of financial institutions

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