Justice Dept. Could Hinder Consolidation

The banking industry is poised on the brink of a massive consolidation that will rationalize the industry. Unfortunately, judging by the Justice Department's actions when Fleet/Norstar Financial Group acquired Bank of New England, the agency is prepared to go against the tide.

The possible implications are important for any depository organization contemplating a major in-market expansion, of either a failed or a healthy organization.

Fleet was the successful bidder for Bank of New England over Bank of America and Bank of Boston. The Federal Reserve Board elected to consider Fleet's proposal in a two-step procedure:

It first approved - on an emergency basis - Fleet's entering into an interim management agreement for the BNE banks. The Fed then required an application with public participation to be processed on a quasi-emergency basis for Fleet's actual acquisition.

Jumping In

The Justice Department accepted Fleet's arguments that the anticompetitive effects would be much less than in the acquisition of a healthy organization.

Nonetheless, the department concluded that the transaction would raise significant competitive problems in the Bangor, Pittsfield, and Presque Isle-Caribou banking markets of Maine.

The Federal Reserve Board approved on a 3-to-2 vote. The Fed argued that though there would be anticompetitive effects in Bangor and Pittsfield as well as in Willimantic, Conn., any anticompetitive effects would be clearly outweighed by the convenience and needs of the communities involved.

The Maine superintendent of banking also approved, but on condition that Fleet divest $50 million in deposits in Bangor, and $10 million in Pittsfield.

(There is a substantial argument, which Fleet decided not to raise, that a state official has no authority to order a greater amount of divestiture than results from the federal process for resolving antitrust concerns.)

Competitive Concerns Raised

After reviewing the orders of the Fed and the Maine superintendent, the Justice Department advised Fleet that it continued to have competitive concerns. If Fleet did not agree to a consent judgment, the department's staff members stated that the agency would probably sue - and the statute puts the transaction on hold automatically on the mere filing of a suit.

The consent judgment would involve divestiture of offices holding $57 million in deposits in Bangor, $20 million in Pittsfield, and $8 million in Presque Isle-Caribou.

In the context of a $15 billion acquisition, Fleet decided it could not risk imposition of the automatic delay, and it agreed to a consent judgment.

The Justice Department's position bears repeating.

While Fleet's action meant that the Justice Department never had to decide whether it would take action, the agency appeared ready to scuttle the third-largest bank resolution in history in order to obtain:

* Divestiture of an office with $8 million in deposits in the Presque Isle-Caribou banking market.

* Divestiture of $7 million in deposits in Bangor beyond that ordered by the Maine superintendent.

* And the ability of the department to control the offices to be divested. This position has important ramifications for the acquisition of both failed and healthy institutions.

Effect on Unassisted Deals

An analysis of the competitive effects of a transaction subject to the Bank Holding Company Act or the Bank Merger Act proceeds in several steps:

* Determining the relevant geographic market or markets.

* Determining the relevant product market or markets.

* Determining the likely effect of the acquisition on competition in the relevant geographic and product market or markets.

* If the transaction would be likely to have a substantially adverse effect on competition, determining whether that effect is clearly outweighed by considerations relating to the convenience and needs of the communities involved.

* If divestitures are contemplated, determining whether the anticompetitive effect is eliminated by the divestitures proposed.

In Fleet/BNE, the Fed and the Justice Department differed on the resolution of most of these issues.

The Supreme Court has stated that the relevant product market in which to analyze the consequences of a bank merger is the "unique cluster of services" known as commercial banking. Over time, changes in federal and state law have permitted many thrifts to offer these services; accordingly, they are competitors in that product market. Generally, deposit size is a first approximation of competitive capabilities.

Measuring Deposit Share

The Federal Reserve Board considers the extent to which the average thrift in a particular market offers all banking services, and it then weights the deposits of all thrifts in that market accordingly.

For example, the Fed might conclude that the deposits of all thrifts in a market are to be considered the same as those of the market's banks or, alternatively, that thrift deposits should count at 50% or 75% of commercial bank deposits.

In the Maine markets in question, where thrifts have three times the national average in commercial loans, the Fed decided that thrifts were the full equivalent of commercial banks and that thrift deposits should not be shaded to reflect a reduced competitive capability.

The Justice Department adopted a different approach. It argued that one relevant market for purpose of this analysis is those organizations that offer the cluster of commercial bank services to small and midsize businesses.

Thus, it excluded loan production offices of out-of-market banks, which do not offer deposit services, and it excluded thrifts and credit unions that are competitors only for retail customers.

It focused instead on the extent to which each thrift actually serves small and midsize businesses. The department included as competitors in the market those thrifts that do provide such services - but only to the extent that the thrift actually provides those services (known as "selective thrift inclusion").

The department's approach resulted in a market structure reflecting substantially less competition from thrifts than did the Fed's approach, thereby increasing the anticompetitive effect of a merger of two institutions in the market.

Screening Test

A second significant difference between the agencies concerns the method of determining whether a transaction will actually produce an anticompetitive effect. Both agencies use as a screening test the Herfindahl-Hirschman index of market concentration, which is derived by summing the squares of the shares of the institutions in a market.

The Fed has accepted a test originally proposed by the Justice Department that permits mergers in markets that are not exceptionally concentrated, as long as the index does not increase by more than 200 points as a result of the transaction.

Using such a test in the Presque Isle-Caribou banking market, the Fed found that, although market concentration would increase, the threshold level was not exceeded. In its advisory report to the Fed, the Justice Department concluded (based on the market structure resulting from selective thrift inclusion) that a competitive problem existed because the index increased by 196 points, without any real explanation why an increase within its 200 point guideline should be considered a violation of law.

One possibility is that the Justice Department is no longer using the 200-point standard for banking. Normally, the department finds increases of more than 50 points in the index objectionable in concentrated markets, but it allowed 200-point increases in banking in recognition of the amount of competition that was not reflected by considering only the deposits of in-market banks.

Action Went Unexplained

If the department is now focusing solely on the deposits of competitors offering the entire cluster of services to small business, then it may be returning to a 50-point standard for bank acquisitions (since only in-market banks and competitor thrifts actually offer the entire cluster of services). In any event, the department did not explain what it was doing, and the area will only be clarified by future Justice Department action.

The final significant difference between the Fed and the Justice Department concerns the question of divestitures. Both agencies have long held that divestitures can be used to correct an antitrust problem. The Fed, however, has permitted the applicant to choose which of its offices or those of the acquired bank within the market should be sold; the sole requirement was that the sale take place (in the normal case) at or before the time the applicant consummated its acquisition.

Perhaps because of limitations on the information that is generally available to it, the Fed's assumption has been that the deposits at any office are a proxy for the competitive pressure on the market that the office is capable of generating. Therefore, it is irrelevant to the Fed which offices the applicant chooses to divest.

The Justice Department refused to permit Fleet to choose the offices to be divested. The department instead asked Fleet for a list of the offices it planned to divest, and then objected to some of them.

Effect on Assisted Deals

As noted, the Bank Holding Company and Bank Merger acts contain a special defense: A transaction can be approved that violates the antitrust laws if the impact of the transaction on the convenience and needs of the communities involved would substantially outweigh the anticompetitive effects. In general, the agencies have used the defense in cases where a bank to be acquired was on the verge of failing.

The FDIC wrote two letters to the Federal Reserve Board urging that the board not require any divestitures. Echoing arguments made by Fleet, it urged that the anticompetitive effects were less than might otherwise appear, and more significant, that the imposition of divestiture requirements might set a precedent that would dissuade in-market bidders completely in future acquisitions, or reduce the amounts that they might bid. As noted, the Fed approved the application without requiring divestitures.

My understanding of the Justice Department's position is that:

* There is no special convenience and needs defense for the banking industry.

* The banking industry, like any other industry, can offset anticompetitive effects with efficiencies resulting from the transaction.

* Advantages to the FDIC fund are not relevant.

* Fleet, in any event, is not entitled to any "convenience and needs" credit for having acquired the failed BNE banks because Bank of America, which would have raised no competitive concerns, was also a bidder.

The agencies can structure emergency acquisitions so that the Justice Department has no role to play.

If the agencies adopt the Fleet/BNE procedures, however, the department has the time and apparently the inclination to play a major role.

In-market bidders should adjust their bids to take account of the divestitures that the department may require, since it, in effect, will consider the acquisition of the failed institution using the same standards as it uses for the purchase of a healthy one.

Mr. Greenspan is a lawyer with the firm of Thompson & Mitchell in Washington.

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