Mergers and the Justice Department

Competitive-impact analyses of the Fleet/Norstar and First Hawaiian mergers are the best guide to the U.S. Department of Justice's current approach to bank mergers.

A Justice Department task force is studying possible revisions. But this should not be viewed as a retreat from the merger analyses it has undertaken in connection with Fleet/Norstar Financial Group's acquisition of failed banks, from federal regulators, and First Hawaiian Inc.'s acquisition of a direct competitor in Hawaii.

Even mergers approved by regulators may require additional divestitures to avoid litigation with the Justice Department. Such divestitures can have significant ramifications for the economics of proposed mergers.

Banks contemplating such acquisitions should consider carefully, at the outset, the Justice Department's likely position on competitive implications.

Shared Responsibilities

Federal regulatory agencies share responsibility with the Justice Department, under the Bank Merger Act of 1966, for ensuring that proposed bank acquisitions will not undermine competitiveness.

In the recent First Hawaiian and Fleet cases, the Justice Department opposes an acquisition on the grounds of probable adverse competitive impact. But the responsible banking agency approves it, pursuant to its own competitive analysis.

The Justice Department may challenge the merger in federal court pursuant to Section 7 of the Clayton Act, which prohibits mergers that lessen competition.

The analysis spelled out in the Justice Department's 1984 merger guidelines delineates one or more relevant product and geographic markets. It measures the proposed transaction's effect on concentration in each relevant market.

The analysis also determines possible anticompetitive effects of other factors that are presumed to result from increased concentration.

According to Justice Department traditions, a relevant banking product consists of the products and services denoted by the term commercial banking. This "cluster" banking product market was approved by the Supreme Court in 1963, in United States v. Philadelphia National Bank.

More recently, the Justice Department has focused on a market of commercial banking services that small and midsize businesses may obtain only locally. This narrower concept has been rejected in United States v. Central State Bank, the only reported decision in which it has been addressed.

The Justice Department seeks to define the smallest geographic area in which collusion among depository institutions could be effective. In many cases, it uses markets defined by the Federal Reserve; in others, geographic banking markets are defined on the basis of Rand McNally Areas or county boundaries.

Measuring the Market

The department measures competitive impact of a proposed merger in each relevant market by use of a quantitative concentration formula, the Herfindahl-Hirschman Index.

Computation of market shares is based generally on total deposits at banks. But the Justice Department historically has included only 20% of thrift deposits in its market-share analysis; this recognizes regulatory limits on commercial lending by thrift institutions.

If the Herfindahl-Hirschman Index analysis indicates high concentration levels, the Justice Department will examine whether mitigating factors may offset the presumptively anti-competitive effects.

The Fed's analysis of competitive implications is somewhat different, focusing on the cluster-product market defined in CoreStates Financial Corp.s Philadelphia National Bank.

While the Federal Reserve also analyzes the Herfindahl-Hirschman Index, it measures market shares in geographic banking markets it has defined. And the Fed accords thrift deposits at least 50% -- often 100% -- weight in assessing market concentration.

The Fed generally is more receptive to potential mitigating factors. Some examples are the availability of banking services in contiguous banking markets and the financial difficulties of the banks seeking to merge.

First Hawaiian Challenge

The Justice Department's federal court challenge to the First Hawaiian acquisition, in December 1990, was its first since its unsuccessful 1985 challenge in the Central State Bank case.

It followed a decision by the Federal Reserve, authorizing the merger conditional on the divestiture of four commercial bank branches. The Justice Department had earlier submitted a competitive analysis to the Fed, arguing that the acquisition was likely to lessen competition.

To settle the Justice Department action, the banks agreed to divest six commercial bank branches (including the four the Federal Reserve required) and a financial services loan company.

The department also required the banks to terminate the First Interstate system franchise license, which First Hawaiian was to have acquired via the merger. The final judgment also limited possible purchasers to financial institutions that lack a significant presence in the relevant local markets.

The Justice Department's challenge to the First Hawaiian acquisition reflects concern over the availability of banking services to small and midsize businesses. The Herfindahl-Hirschman Index analysis differed significantly from the mechanical analysis the Justice Department has previously applied.

The Fleet Acquisition

It included the deposits of only one thrift, weighted at 100%, on grounds that other Hawaiian thrifts, credit unions, and industrial loan companies did not serve small and midsize Hawaiian businesses. The Justice Department noted that state regulations create "substantial barriers to entry into business banking services in the State of Hawaii."

The most recent Justice Department suit challenged the Federal Deposit Insurance Corp.'s proposed sale of New Maine National Bank to Fleet/Norstar. New Maine National was a bridge bank, comprising Maine banks previously owned and operated by the now defunct Bank of New England.

The Federal Reserve selected Fleet as the winning bidder, even though the Justice Department had expressed concern that such an acquisition was likely to diminish competition in specified banking markets throughout New England.

After the FDIC announced its approval of the Fleet bid, the Justice Department stated its intention to file suit to block the merger. And it entered into negotiations with Fleet over the scope and terms of divestitures that the Justice Department would require to drop its opposition.

On July 5, the department simultaneously filed a Section 7 complaint in federal court. It challenged the Fleet acquisition and a proposed consent decree. This decree would have resolved the suit through Fleet's agreement to divest six specified Fleet and New Maine National Bank branches in three Maine banking markets, to purchasers without a significant presence in those markets.

As in the First Hawaiian matter, the Justice Department defined the relevant product market for Fleet in terms of commercial banking services to small and midsize businesses.

In its complaint, the Justice Department states that the "relevant product markets in which this acquisition will affect competition include, either individually or collectively, transaction accounts, commercial loans, or other business banking services offered to small and medium-sized businesses in the relevant geographic markets."

The Justice Department again rejected a mechanical Herfindahl-Hirschman Index analysis of Fleet, in favor of one that reflected the dynamics of the marketplace. The Justice Department included only commercial banks and state-chartered savings banks, because it found that Maine savings and loans do not compete in the provision of business banking services.

The department found no mitigating factors to offset its conclusion that the merger would substantially diminish competition in several Maine banking markets. It found new entry unlikely and rejected Fleet's invocation of the failing-company defense -- noting that there were other bidders who did not present competitive problems.

Future Implications

The Justice Department's primary concern is the impact of a bank merger on banking services to small businesses -- particularly the availability of commercial loans.

It will no longer engage in a mechanical Herfindahl-Hirschman Index analysis. Rather, the Justice Department will examine the role of thrifts and non-bank institutions, on a merger-by-merger basis, in providing commercial banking services to small and midsize businesses.

In both Fleet and First Hawaiian, the Justice Department rejected the use of industry-wide weighting formulas as a proxy for market participation by such entities.

The Justice Department is not likely to disregard high concentration levels on the basis of potential mitigating factors, such as new entry or the competitive weakness of bank to be acquired.

Based on challenges to the First Hawaiian and Fleet deals, prospective parties to a proposed bank acquisition would be well advised to do their own competitive analysis at an early stage. This step would help them to assess the risk of Justice Department opposition and determine the scope of divestitures that may be necessary to satisfy the department. They can also use such an analysis to project the financial implications of such divestitures to the overall economics of the proposed merger.

Mr. Sandler is a senior associate with the law firm of Skadden, Arps, Slate, Meagher & Flom in Washington.

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