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FDIC establishes rules for private equity bank buyouts

The US banking regulator scaled back its proposed rules, easing certain requirements that had attracted industry criticism including Tier 1 leverage ratios.

US private equity firms that want to bid on banks will face fewer impediments from the Federal Deposit Insurance Corporation, which voted 4-1 to ease leverage ratio and “source of strength” requirements it had initially considered imposing on private equity bank investors.

The final version of the rules call for an acquired financial institution to be capitalised at a Tier 1 leverage ratio of 10 percent, lower than the 15 percent originally proposed. The proposal requiring private equity owners to serve as a source of strength for the banks they invest in has been removed altogether.

The provision for cross guarantees, meaning that a firm that owns two banks must provide support to the weaker bank with capital from the stronger bank, remains a part of the rules, but now only applies for investors that own more than 80 percent of a bank – a higher stake than most private equity firms would likely take. Investors are still barred from using the acquired bank to extend credit to their investment funds.

The rules still require private equity firms to hold their bank investments for at least three years.

“I think they’ve made substantial progress in leveling out the playing field for this category of investors versus everyone else,” said Joseph Lynyak of law firm Venable. The FDIC clearly focused on the concerns raised by private equity firms, he said.

Given the well-documented track record of private equity firms in turning around troubled companies, it also makes little sense to deprive the banking system of needed expertise.

Douglas Lowenstein

“The revised FDIC guidelines represent an improvement over those originally proposed in July,” Douglas Lowenstein, president of the Private Equity Council, said in a statement. However, he added the PEC, which lobbies on behalf of a dozen or so mega-firms, said it still questions the “onerous capital requirements”.

Higher capital thresholds may deter private equity interest in failed banks, Lowenstein said. “At a minimum, it will reduce the value of any bids, increasing the resolution costs for the FDIC and creating greater likelihood that the agency will be forced to tap the $500 billion line of credit put up by American taxpayers,” he said. “Given the well-documented track record of private equity firms in turning around troubled companies, it also makes little sense to deprive the banking system of needed expertise.”

The FDIC will review the rules in six months time to judge their effectiveness, however, so there is still some risk to private equity investors that the agency will further modify them.

FDIC chairman Sheila Bair, vice chairman Martin Gruenberg, director Thomas Curry and Comptroller of the Currency John Dugan voted for the rules. Office of Thrift Supervision acting director John Bowman was the lone dissenting vote. He said the revised rules were too imprecise, but also noted that he had not reviewed the entire proposal until just before the meeting.

Several institutions governed by the OTS have been rescued by private equity owners in recent months: WL Ross, Carlyle, Blackstone and Centerbridge Partners in May backed a $900 million buyout of Florida-based BankUnited, and a group of private equity investors, led by private equity firm Dune Capital’s chief executive Steven Mnuchin, bought failed mortage lender IndyMac for $13.9 billion in January.

Those deals might not have occurred under the new rules, noted Harold Reichwald, co-chair of the banking and specialty finance practice at law firm Manatt, Phelps & Phillips.

One interesting idea brought up by several board members during the meeting was the possibility that private equity firms that invest alongside bank holding companies could avoid additional regulation, Lynyak said.

“I’m not sure that private equity wants to play with bank holding companies,” Reichwald said. “Private equity firms like to be the masters of their own fate. If they have to tie themselves to decision-making and other processes at a bank holding company, that might be less attractive to them than otherwise.”

The rules were proposed in July, and were subject to a 30-day comment period. During this time, investors such as WL Ross, Centerbridge, and Fortress Investments all criticised the proposals, along with public pension plans from Oregon and New Jersey.
 
A group of private equity investors including The Blackstone Group, Centerbridge Partners, TPG, Oak Hill Capital Partners, Lightyear Capital, Irving Place Capital and Corsair Capital sent the FDIC a letter proposing that the Tier 1 leverage ratio be lowered to 8 percent; the restriction on private equity firms using the acquired banks to extend credit to their portfolio companies be modified to apply only to investors with a 10 percent or greater ownership stake, and the three-year holding period be lowered to 18 months.