Spurring financial institutions to take credit risk in these tough economic times may require consolidation. Larger financial institutions with greater investment diversity will have more tolerance for default risk, and thus will be more willing to extend mortgages, home equity lines, and revolving credit to consumers.
With many banks having sustained heavy losses of late, some observers say a wave of financial institution consolidation may be upon us. Any such deals could involve regional banks that are direct competitors as well as national banks with relatively large mortgage and card issuance portfolios. This could result in substantial market concentration, which in turn could cause antitrust enforcers to oppose a given merger.
The question thus arises whether antitrust maxims will permit mergers of "weakened" financial firms even where the combination produces a firm with dominant market share. The answer is that, historically, antitrust enforcers have considered permitting such a merger only where the target is "failing" — set to liquidate or exit imminently.
Such an enforcement posture at this time is unwise. Buyers in the financial services sector that are substantially weakened but not failing should be permitted in the current economic climate, particularly if they and the sellers can show that the proposed merger would stabilize the buyer's long-term prospects or otherwise facilitate lending.
The Department of Justice and Federal Trade Commission's Horizontal Merger Guidelines, which govern the prosecutorial discretion of our nation's antitrust enforcers, state that a merger should be presumed to be anticompetitive — meaning it would likely result in higher prices for consumers. In such a scenario, according to a strict interpretation of the merger guidelines, a transaction should clear antitrust review only when the merging parties can establish that the target is a failing firm or that the transaction would likely result in cost savings and other efficiencies. But it is not easy to demonstrate the likelihood that such efficiencies would override any pricing concerns.
The failing-firm defense also faces high legal hurdles. It will only permit a merger that results in substantial market concentration and where the target has been so diminished that it will immediately exit the market unless it is sold. In other words, a target cannot be characterized as failing unless it has filed for bankruptcy protection and there is no reasonable prospect for reorganization under Chapter 11. The rationale for this merger defense is simple: anticompetitive concerns are not raised by the acquisition of a failing firm, because, whether or not the transaction is completed, the firm will ultimately cease to exist.
A weakened firm is one that will not imminently exit the market but nonetheless has incurred consistently poor financial results as a stand-alone entity. Banks that have been weakened by writeoffs of mortgaged-backed securities debt or that otherwise have applied for funding from the government's Troubled Asset Relief Program would be, in our view, examples of weakened competitors. The acquisition of a weakened firm may raise anticompetitive concerns where it leads to substantial consolidation in the short term because the buyer would be better able to raise prices, particularly in a market with high entry costs. However, the long-term benefits generated by such a merger, particularly an increase in output, may override these short-term detriments. It is the long-term benefits that we believe antitrust enforcers should consider when evaluating deals for weakened firms.
While a strict reading of antitrust statutes and case law generally does not recognize a weakened-firm defense, there is some precedent that arguably permits the acquisition of weakened firms even if market concentration is substantially increased, to account for poor market outlook.
During the Great Depression, the Supreme Court in Appalachian Coals Inc. v. United States allowed competing coal companies to form an otherwise anticompetitive joint sales agency where the industry as a whole was suffering.
More recently, a federal district court in Washington, D.C., permitted a merger — also in the coal industry — to clear when it considered the target's weakened financial condition.
Even the relatively restrictive merger guidelines provide a party room to argue that weakened market conditions are relevant to its merger application. They acknowledge that the FTC and Justice Department "will consider reasonably predictable effects of recent or ongoing changes in market conditions in interpreting market concentration and market share data."
Given the need to loosen credit markets, it is critical that the agencies and courts take a less categorical approach to merger review. They should be more receptive to a weakened firm defense in order to spur a financial recovery and create an entity that is more inclined to extend credit.
