The financial services community and the media have devoted considerable attention in recent months to efforts by private equity and other firms to acquire banking organizations primarily for investment purposes, including deals such as MatlinPatterson’s recently announced acquisition of a majority stake in Michigan-based Flagstar Bancorp and the reported sale by the FDIC of assets of IndyMac Bank to a limited partnership that includes private equity investors. (The May 27, 2008 edition of the Alert includes a more complete discussion of private equity investing in banking organizations, and the following is a link to an audio re-broadcast of a seminar Goodwin hosted in New York in October entitled, “Private Equity Investing in Banks: Opportunities in a Perfect Storm”).
However, as discussed below, the extended turmoil in the credit markets and the resulting lack of liquidity has led many nonbank financial services firms, as well as private equity and other fund firms that own financial services firms as portfolio companies, to reevaluate their business models and to consider acquiring a full service bank or thrift charter, not for investment purposes, but instead to gain access to the strategic benefits that a bank or thrift can provide. GMAC’s move to become a bank holding company is only the latest in a series of similar strategic decisions to seek bank holding company status made last year by financial services firms, including Morgan Stanley, Goldman Sachs, and American Express. Similarly, several insurance companies, including The Hartford, Genworth and Lincoln National recently sought OTS approval to become thrift holding companies. In other cases, nonbank firms have been incented to align with a commercial bank. This Alert article discusses some of the considerations behind these developments, namely the greater access to liquidity, products and licensing benefits that banking organizations, and their affiliates, enjoy.
Liquidity. With respect to funding, historically, nonbank lenders, including credit card companies, mortgage lenders and servicers and commercial and small business lenders, have obtained funding through securitization and other structured finance arrangements, commercial paper facilities, repurchase agreements, and other mechanisms to finance their business. However, the credit crisis has significantly reduced these funding mechanisms, or, where funding remains available, the costs are often uneconomically high.
Clearly the access to current and possible funding being made available by the federal government is often part of the incentive for seeking a charter at this time. As described in numerous past issues of the Alert, the U.S. Treasury, the FRB, the FDIC and other regulators have taken substantial steps to provide liquidity to bank and thrift holding companies through the Capital Purchase Program (most recently used by GMAC and several insurance companies), the Temporary Liquidity Guarantee Program and other government programs.
However, these short-term government programs are not the only sources of liquidity banks/thrifts make available. Banks and thrifts can also access funding through the ability to take insured deposits (in the form of brokered CDs, sweep programs, and other types of consumer and business accounts) and obtain advances from the Federal Home Loan Bank System, the FRB’s discount window and other sources. For example, both Morgan Stanley and Goldman Sachs have signaled that they are seeking to build deposits through retail deals (brokered deposits as the predominant source of funding can be problematic from a regulatory perspective) and Morgan Stanley has hired an executive formerly in charge of Wachovia’s retail and small-business operations to head its commercial banking efforts.
Moreover, these financial institutions are using banks to fund more than bank-originated activities. As a result of substantial limitations on transactions between insured depository institutions and their sister and parent affiliates, banks and thrifts are generally not able to transfer to their sister and parent affiliates access to the additional liquidity a depository institution charter provides. However, banks/thrifts can provide capital support to many activities, such as brokerage, without violating these affiliate transaction rules by reorganizing existing businesses as operating subsidiaries of their bank/thrift institutions.
Products. Because it is possible to offer deposit and lending products and even fiduciary and asset management services within a bank or thrift charter, a banking organization also provides an opportunity to offer customers a significantly wider range of products and services over time and to obtain a larger share of customers’ assets and a more diverse revenue base. In many cases, nonbank financial services firms were already offering fiduciary and asset management services through limited purpose trust companies and registered investments advisers, but they can now consider the possibility of streamlining their corporate structure by integrating those operations within a bank or thrift charter that also takes deposits, makes loans and conducts other businesses, and is not subject to certain rules, such as the cash solicitation rule, to which registered investment advisers are subject.
Licensing Benefits. Federally chartered banking and thrift institutions also offer the substantial advantage of preemption from state laws. Although commercial and small business lenders have tended to worry less about state requirements than other types of lenders, firms with a consumer focus, such as credit card and mortgage lenders, have long recognized the substantial advantages of federal preemption, which makes it possible to operate a nationwide consumer lending business largely free from state by state restrictions, a factor some industry observers have cited as a possible reason mortgage servicer Ocwen Financial Corp. may have decided recently to seek regulatory approval to acquire a bank. Indeed, as a practical matter even state-chartered full service banks are able to avoid many of the licensing and other requirements to which nonbank providers of similar products and services are subject.
Caveats. As the foregoing indicates, a bank or thrift charter can provide strategic benefits by providing liquidity, increasing relations with customers, and enhancing an enterprise’s overall operations. However, any firm considering acquiring a bank or thrift charter or converting an existing limited purpose institution into a full service charter for strategic or other reasons must carefully consider the advantages and disadvantages of various charter options available (e.g., federal vs. state, bank vs. thrift, etc.). (The March 5, 2002 issue of the Alert presents a general discussion of these charter choice considerations.) In addition, this year in particular, close scrutiny of regulatory developments will be critical to ensure time and effort are not wasted pursuing an ineffective or even disappearing charter.
Finally, even though there are significant benefits to conducting a lending business through a bank or thrift charter, depository institutions are subject to significant regulation, and indeed many of the firms that have recently sought bank holding company status for years conducted business through specialized charters in order to avoid extensive oversight by the FRB and other regulators. The banking industry is among the most highly regulated industries in the United States, and operating through a depository institution charter involves oversight from federal and, possibly, state banking regulators, depending on the charter type. Bank and thrift holding companies are also subject to extensive limitations on permissible activities and, in some cases, some of the firms that have recently become bank holding companies will need to restructure or discontinue some of their current business activities in order to conform to these limitations. Accordingly, as discussed above, it is crucial that an organization and its business and legal advisers evaluate carefully both the advantages and the disadvantages of a specific charter and whether use of the charter is consistent with the organization’s overall business model and objectives.