Private Equity Firms Call on FDIC To Lower Criteria for Acquiring Failed Banks

Source: BNA - Bankruptcy Law Daily
Date: August 14, 2009

Financial Institutions:

On behalf of seven major private equity firms—including Blackstone Group, Oak Hill Capital Partners, and TPG Capital—Simpson Thacher Aug. 7 urged the Federal Deposit Insurance Corporation to lower the proposed capitalization requirement and other terms and conditions that its clients and other private investors would have to meet to acquire failed banks and hold them as long-term investments.

FDIC introduced the acquisition criteria on July 2 in the form of a policy statement. At the time, FDIC Chairman Sheila Bair explained that the proposal aims to maximize private investors' interest in failed banks while also assuring that the banks remain safe and sound in the hands of new nontraditional owners. The comment period on the policy statement ended on Aug. 10.

Already this year, two banks transitioned from FDIC receivership to private equity owners. In March, for instance, FDIC sold IndyMac to One West Bank, a newly formed depository institution under the control of a fund underpinned by more than $1 billion in private equity capital.

Capitalized Beyond the Norm?

In its Aug. 7 comment letter, Simpson stated that clearer terms and conditions would encourage more such transactions. Noting that as of January 2009, private equity firms had approximately $470 billion in available capital, the firm said this is a “tremendous resource that … could be effectively used to resolve failed banks and thrifts” in a way that minimizes job loss, benefits consumers and local communities, and increases competition.

However, the law firm warned that as proposed, the FDIC's capitalization requirement could not only discourage private equity participation, but also adversely impact FDIC and the banking system. Under the policy statement, private equity investors would have to maintain the acquiring institution at a minimum 15 percent “Tier 1” leverage ratio for the first three years, and thereafter, at a “well capitalized” level of 5 percent.

Such a requirement, according to Simpson, is 65 percent greater than the median leverage ratio at large and mid-sized banks and thrifts, and 88 percent greater than the leverage ratio that FDIC has historically required for start-up banks, which are generally riskier than those emerging from receivership. Expecting capitalization beyond industry norms will force private equity investors to “significantly” reduce their offering price for failed banks. To acquire $10 billion in assets for an eight-year holding period, for instance, Simpson estimated that private equity investors would lower their bid by $1.8 billion in order to meet the capital requirement and still realize an acceptable rate of return.

Alternative Capital Test

FDIC should set the requirement according to the ratio of common equity to risk-weighted assets, rather than leverage to capital, Simpson recommended. Specifically, Simpson said its clients had agreed that a three-year requirement of a 6 percent Tier 1 common ratio would provide “robust additional capital cushion.” Moreover, this ratio would “more accurately reflect both actual level of risk on the resolved institution's balance sheet as well as the amount of core common equity freely available to absorb losses in the future.”

If FDIC prefers the leverage test, Simpson asked the agency to drop the requirement from 15 percent to 8 percent, in line with “historic practice.” FDIC should reserve to impose a stricter criterion on a “case-by-case basis taking into account the quality of the capital contributed, the strength and experience of the management team, the risks inherent in the business plan, and other similar factors.”

Simpson Thacher's entire comments and other letters on FDIC's proposed policy statement are available on the agency's website at http://www.fdic.gov/regulations/laws/federal/2009/09comAD47.html.