Unfriendly Investments Under the Bank Holding Company Act
A look at Big Poppy and Summit State Bank
Poppy Bank is a $5.7 billion asset non-member bank based in Santa Rosa, California. A few weeks ago its parent company, Big Poppy Holdings, filed an application with the Federal Reserve Board seeking permission to acquire up to 24.99% of the shares of Summit State Bank.1 Summit State Bank, which operates without a holding company, also is based in Santa Rosa, California and has around $1.2 billion in total assets.
Following Big Poppy’s announcement, Summit State Bank issued a brief press release saying that it intended to review the application and “may comment on or respond” to it in due course.
Last week Summit State Bank did indeed comment on the application, sending in a seven-page letter expressing “grave concerns” about Big Poppy’s proposed investment.2 This post looks at some of the specific claims in the letter in the context of how the Federal Reserve Board has previously approached situations like this one.
General Principles
The Federal Reserve Board has made clear in a number of orders that, although it is “mindful of the potential adverse effects that contested acquisitions might have on the financial and managerial resources of the company to be acquired and the acquiring organization,” the mere fact that incumbent bank management opposes a proposal is not something the Board is permitted to consider under the Bank Holding Company Act.3
Instead, the Board’s review is constrained to an analysis of whether the statutory criteria set out in the BHC Act are satisfied. As a result, just like in the context of a more ordinary application where the target and the acquirer have agreed on the investment, the Board considers competitive factors, financial and managerial resources, convenience and needs, and so on.
The Board has also in certain precedent orders conditioned its approval on the acquirer agreeing to passivity commitments - i.e., promises that the acquirer will refrain from taking certain specified actions that could be viewed as exercising a controlling influence over the target bank.4
The Summit State Bank Letter
Consistent with the Federal Reserve Board’s precedents holding that opposition from incumbent management, standing alone, is not enough to require rejection of a proposed investment under the BHC Act, the Summit State Bank letter wisely does not simply express management’s unfavorable view of the investment and leave it at that.
Instead, the letter seeks to ground the bank’s opposition in the statutory factors under the BHC Act. Some of these arguments are more compelling than others, and honestly it is not clear that any of them are all that strong, but we only have the public record to go on.
Convenience and Needs
Summit State Bank is “concerned about the impact of Big Poppy’s proposed investment on the convenience and needs” of the Santa Rosa community. In particular, the letter focuses on Poppy Bank’s most recent Community Reinvestment Act evaluation.
For instance, although Poppy Bank’s overall CRA rating was satisfactory, the letter highlights certain areas where the FDIC thought Poppy Bank could have done better.
In its March 28, 2022 Community Reinvestment Act Performance Evaluation concerning Poppy Bank, the FDIC determined that Poppy Bank had a “Low Satisfactory” rating under the Investment Test and a “Low Satisfactory” rating under the Service Test. With regard to the Investment Test, the FDIC determined that Poppy’s performance in its Sacramento and San Diego Assessment Areas is below its adequate level of investments in the Bay Area and Los Angeles Assessment Areas. In fact, the FDIC determined that Poppy Bank’s responsiveness to credit and community development needs in its Sacramento and San Diego Assessment Areas was poor. The FDIC noted that Poppy Bank’s total Community Development (“CD”) service hours decreased compared to its previous exam, despite the bank’s growth. According to the FDIC, Poppy Bank managers struggled for bank staff to participate in CD activities.
All true, although it is also worth noting (and not mentioned in the letter) that on the Lending Test element of the evaluation, which is assigned a higher weight than the Investment Test and the Service Test, Poppy Bank received a “High Satisfactory” rating.
Every case is different of course, and maybe there will be additional opposition from community groups,5 but at least on the face of the letter I am not sure this moves the needle. It is not difficult to find Board orders from the past year or two approving applications from acquirers with a Satisfactory CRA rating, even if the acquirer received a “Low Satisfactory” rating on the Lending, Investment or Service tests.6
Competition
The letter contends that Big Poppy’s investment could have material and adverse effects on competition in the Santa Rosa, California banking market.
In particular, Summit State Bank argues that because there are “only 16” banks operating in the Santa Rosa market, and because the market is moderately concentrated, Big Poppy’s taking of a stake in its “fiercest local competitor” raises significant competitive concerns.
Again, the letter is not totally off base: the Federal Reserve Board has previously said that it may have competitive concerns in situations like this one where a company is making an investment in a competitor, even if the acquiring company would not control that competitor following the investment.7
Here though, again at least when looking at things superficially,8 it may be tough to make the argument that the Santa Rosa, CA market would be meaningfully affected by this transaction between its 5th and 7th largest players.
Managerial Resources
Summit State Bank also asserts that the way Big Poppy has sought to make this investment “raises concerns about Big Poppy’s management.”
We believe a bank holding company’s willingness to acquire up to 24.99% of another depository institution without conducting traditional due diligence should raise significant managerial concerns – as well as safety and soundness concerns.
But there is something worth mentioning here, not stated in the letter, that puts this claim in a slightly different context. Summit State Bank, unlike most small banks without a holding company, has publicly traded equity securities outstanding. It is one of 11 FDIC-supervised banks that make 8-K, 10-Q, 10-K, etc. filings with the FDIC, rather than via the SEC and EDGAR.
So here there is an investor seeking to acquire a significant minority stake in a target based on its public securities filings (and also, because this is a bank, its call reports). While not the most typical approach, an investment in a public company based only on its public filings and without additional diligence review of non-public materials is not all that far out of the ordinary.9
Nature of the Investment; Need for Passivity Commitments
Summit State Bank notes what appears to be a slip up by Big Poppy in the newspaper notice it was required to file giving notice of the application.
Big Poppy’s public notice states “We [Big Poppy] intend to acquire control of Summit State Bank, Santa Rosa, California.” This conflicts with Big Poppy’s application, which states “there would be no change in control of any insured depository institution.” Summit State Bank is an insured depository institution.
I am guessing what happened here is that Big Poppy just took the standard form language made available by the FRBSF for newspaper notices under Section 3 of the BHC Act and forgot to tweak it to more accurately describe the nature of its investment.
More substantively, Summit State Bank asks the Federal Reserve Board, if it does approve Big Poppy’s application, to impose conditions on Big Poppy.
We believe that any approval should impose conditions providing that, among other things, Big Poppy, and members of its several control groups and their affiliates:
Shall not have or seek to have a representative serve on the board of directors of Summit State Bank.
Shall not become or seek to become a management official, director, or other senior executive of the Summit State Bank.
Shall not take any action to control, influence or direct the operations of Summit State Bank.
Shall agree that with respect to any matter presented for action by the shareholders of Summit State Bank, they shall vote their shares of Summit State Bank in the same manner as the holders of a majority of the outstanding shares.
Shall not enter into any banking or nonbanking transactions with Summit State Bank, other than transactions or business relationships already in existence.
Some of these go beyond the passivity commitments the Board has traditionally imposed in prior orders involving minority investments of this kind.
An interesting side question, though, might be whether the Board would see the need for passivity commitments in this situation at all. The Board’s 2020 revisions to its control rule include several rebuttable presumptions of control. These rebuttable presumptions, combined with other changes to the rules, were intended to increase transparency “by describing the combination of factors that would and would not trigger control concerns.”
Accordingly, the Board said in 2020 that, in light of these changes, it “does not intend to obtain the standard-form passivity commitments going forward in the ordinary course.” The Board will, however, “continue to obtain control-related commitments in specific contexts,”10 as well as in “special situations.”11
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This application is necessary because the BHC Act says that prior Federal Reserve Board approval is required before a bank holding company may acquire more than 5% of the voting shares of a bank.
I first saw this situation written about in an article by Rica Dela Cruz at S&P Global Market Intelligence. The local newspaper has also covered the story.
See, e.g., the Board’s orders on applications by Juniata Valley Financial Corp., C-B-G, Inc., and Central Pacific Financial.
The letter says, “we believe that a well-publicized public hearing is necessary to ensure that the Federal Reserve receives and considers the views of affected community members before making a decision on the application.”
See, e.g., the Board’s orders approving applications involving Umpqua and Brookline Bancorp.
See, e.g., the Board’s 2003 order in S&T Bancorp:
The Board previously has noted that one company need not acquire control of another company to lessen competition between them substantially. [citing orders] The Board has found that noncontrolling interests in directly competing depository institutions may raise serious questions under the BHC Act, and has concluded that the specific facts of each case will determine whether the minority investment in a company would be anticompetitive. [citing orders]
Summit State Bank in its letter makes the case that this is in fact too superficial a view, and that once you take into account other factors the market is less competitive than it appears.
Of the 16 organizations, only three institutions, Poppy Bank, Summit State Bank and Exchange Bank are headquartered in the market, assuming the pending acquisition of Luther Burbank Savings is completed. And of the 16 banking organizations, four are large, national banking organizations without meaningful ties to the community and six are not particularly competitive, each with less than 2% market share.
Earlier in 2023, the market lost a competitor when First Republic Bank was placed into receivership and acquired by in-market competitor, JPMorgan Chase Bank, increasing market concentration. In addition, during 2020 – 2023, the Santa Rosa, CA Banking Market has lost nine branch offices closed by eight different banks, or roughly 10% of the branch offices in the market. With fewer competitors, these developments indicate that the current market is already increasingly less competitive than the Herfindahl-Hirschman Index of 1,263 (which is based on historical data) indicates.
Admittedly the most prominent recent example I can think off the top of my head is Elon Musk’s acquisition of a 9% stake in Twitter, but that is probably not an example Big Poppy wants to cite for a number of reasons.
Also, if Big Poppy really does go all the way up to 24.99% that may be a little more unusual. Often there are other constraints that weigh against a non-friendly acquirer amassing that significant of a stake.
Specific contexts given as examples included “commitments from employee stock ownership plans and mutual fund complexes.” On that latter point, see for example the commitments given to the Board by Vanguard.
To my knowledge, this is the first non-friendly minority investment requiring Board approval under the BHC Act since the 2020 control rule changes, so it is not clear if this would count as a special situation.
This was a very different context as it was downstream from a friendly deal in which Schwab used its shares as acquisition currency to acquire TD Ameritrade, but the Board did not require passivity commitments from TD in its acquisition of more than 5% of the voting shares of Schwab, although the Board did rely on certain representations made by TD.
These representations include that (i) TD would have the power to designate two of fourteen total directors on the board of directors of Schwab, and TD’s director representatives would not have the power to make or block major operational or policy decisions of Schwab; (ii) TD would have no officers or employees in common with Schwab; and (iii) TD would not have any limiting contractual rights with respect to Schwab, as that term is defined in the Control Rule. TD and Schwab would have substantial business relationships with each other following the proposed acquisition, including a large deposit sweep arrangement. TD represents that these business relationships would not account for 10 percent or more of Schwab’s annual revenues on a rolling basis following the proposed transaction. Based on these representations and other information provided by TD, TD would not trigger any of the presumptions of control under the Board’s regulations with respect to Schwab.
There is also this 2021 letter in which the Board provided relief from 2018 passivity commitments in the context of an investment that did not trigger a presumption of control under the revised control rule, but the publicly available version of the letter is too high-level to base any conclusions on.