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The effect of regulatory reviews on US financial M&A



The US financial sector is turning to increasingly creative and innovative strategies to seal mergers and acquisition (M&A) deals, as a result of the tightening of the regulatory processes that has been an effect of the global financial crisis.

Writing for Thomson Reuters, M&A expert, Jessica Toonkel, said that regulatory reforms have had a major effect on the practices of the lawyers and financial professionals who deal with the buying and selling of businesses between banks, insurers and other financial service firms.

Last September's $912 million stock deal that saw FirstMerit Corp buy out Citizens Republic Bancorp was a clear example of such creativity, according to Toonkel, particularly regarding the generous terms that FirstMerit offered in order to secure the $250 million of subordinated debt funding that supported the deal.

She explained, “FirstMerit needed the funds to repay the US government for bailing out Citizens in 2008, so the Akron, Ohio-based financial services company promised bond investors that it would buy back their subordinated debt at $1.01 for every dollar if the acquisition received no regulatory approval within nine months.”

The move was the first time such a financing clause had been used by a US bank. Observers have said FirstMerit’s actions proved to be an effective way of hedging against the regulatory risk, which is increasingly causing long delays in major deals, due to the high levels of scrutiny now in place.

Rodgin Cohen, a senior chairman at law firm Sullivan & Cromwell, told Toonkel that another strategy that financial institutions are using is to ask for reverse break-up fees when engaged in such deals. These deals see the buyer agree to pay compensation to the seller if the deal falters, and were used 24 times in 2012, nearly double the 13 times they were used in 2009, according to figures from Thomson Reuters.

Cohen added that the size of the fees has also increased – in response to the financial crisis – with many deals featuring reverse break-up fees of greater than 5 per cent, as opposed to the more usual 3-5 per cent. He explained, “The increase in reverse break-up fees in financial services is directly related to greater concern about the regulatory environment.”

Another tactic that is being employed by financial institutions is the use of ‘holdback clauses’ in the deal contracts, through which they are able to retain a certain portion of the amount they will pay for a company in order to provide for any regulator issues that might arise once the deal has been completed.

In terms of the potential risks that financial institutions are having to be prepared for in M&A, they stem from the need of regulators to drive down systemic risk in the financial markets, which require them to explore deeper than the usual antitrust matters that must be addressed in finance M&A. These include examining systems and unearthing any compliance violations, as well as taking into account the durability of combined institutions.

The true effect of the increased regulatory requirements on the overall financial M&A landscape remains to be seen. The volume of deals carried out among financial services firms in 2012 showed a 20 per cent decrease from the volume in 2007, according to Thomson Reuters' figures. The fall could be as a result of the increased scrutiny or from companies being unwilling to take risks in the still faltering economic climate. Many companies, however, are still finding that M&A is the best way of increasing profits, due to low interest rates and the weak economy, but insiders have said that terms previously uncommon – like holdback clauses and reverse break-up fees – in finance M&A will soon appear more and more frequently, as the business environment evolves.  

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