While today's treasurers are expected to make a concrete contribution to shareholder value, taking on a raft of strategic roles, it's still rare to see a treasury team take center stage in a $15 billion acquisition–the way Capital One's team did when the financial services company bought North Fork Bank last year. The deal was a key part of the company's strategy to add branch banking to its existing portfolio of consumer financial services, says Capital One CFO Gary Perlin: "By acquiring North Fork Bank in 2006, we not only added a leading institution in one of the most attractive deposit markets in the U.S., we also achieved the balance in funding and business mix we had been targeting."
The deal made strategic sense–but only if certain risks could be managed. Foremost among these was the real possibility that a shift in interest rates could affect the way stakeholders would view the deal. Simply put, if North Fork's market value fell after the acquisition was announced, Capital One would have been forced to record additional goodwill on its balance sheet at deal's end; if goodwill increased, the company's capital ratios and return on equity would have fallen. As a mortgage lender and deposit taker, North Fork's revenues and market value were sensitive to changes in rates and, during the eight months it took to close the deal, there was enormous uncertainty about the outlook for rates. "Creativity, collaboration and hard work were needed across multiple areas of the finance function," says Perlin.
As soon as the deal was announced, a core team of seven within treasury set to work stabilizing the economics of the acquisition. Led by Vincent Pennisi, head of Capital One's financial risk management group, they first analyzed the sensitivity of North Fork's $50 billion balance sheet to different rate scenarios–a task they ploughed through in a single week. "I don't think anyone slept much that week," Pennisi jokes. "It was an extremely aggressive timetable. Even though we had experience with similar dynamics from the Hibernia acquisition, and we had a good sense of the questions we needed to answer, the whole team needed to show great dedication and analytical rigor to actually get the work done in the short timeframe we had."
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Once they understood how changes in rates would affect North Fork's value, and ultimately Capital One's ratios, a decision was made on exactly how great a swing the company would tolerate. Anything more than a 75 basis-point rise in rates would have been too great. The rest of the risk had to be hedged away. The team ruled out using swaps: Although the company would have been protected against rising rates, falling rates would have hit the company's financials hard. Instead, the company used swaptions, giving them the option to purchase swaps if rates rose to a certain level. Finally, the maturity of the options needed to address uncertainty around the closing date of the acquisition. Although never triggered, Pennisi says that having peace of mind in an uncertain rate environment was more than worth the outlay for the options: "Ultimately, we knew that whatever happened to rates during that period, we were protected, and it was great to be able to communicate that to our stakeholders."
The team's work didn't end there. As part of the acquisition announcement Capital One had committed to downsizing the combined balance sheets by $14 billion. Treasury was given a mandate to sell the assets and liabilities, but it had to limit net interest margin impact to 10 basis points. "We analyzed the market conditions in late 2006, worked out which assets offered the lowest risk-adjusted returns, and made our decision based on that," says Treasurer Steve Linehan. He describes the team's contribution to the deal as its ability to "solve a highly complex problem in a short time with a creative solution which met all our objectives."
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