Flawed FDIC Guidelines May Block Funding for Failed Banks
The proposed guidelines published by the Federal Deposit Insurance Corporation for private equity investments in failed banks were in line with what was expected, though they did not fail to displease private equity firms. The guidelines require that investors maintain a 15% Tier 1 leverage ratio in the failed bank for three years. This compares with the 5% Tier 1 leverage ratio required for healthy banks. The obligation to “maintain” this capital ratio means the private equity firm would have to ante up more capital if the numbers slip. And the fuse would be running – the guidelines say the sponsor must “immediately facilitate restoring” the capital.
The private equity sponsor must also act as a “source of strength” to the bank, suggesting they would have to inject additional capital if trouble arises. At a minimum this would require a commitment to raise new capital if necessary.
Also, there is a significant expansion in the cross guarantee requirement. Under the proposed guidelines, a sponsor would have to pledge its investment in each institution in which it “individually or collectively” has a majority interest to cover the FDIC against potential losses. The guidelines would sweep up each participant in a club deal, whether or not it owns a majority stake. For example, a firm that had a 10% club investments in 2 failed banks would somehow have to pledge its investment in both deals to the FDIC. That requirement alone will likely rule out club deals for failed banks. The requirement raises big practical concerns, as each participant in the club would have to cross pledge its interest in different banks to other club-owned banks, all to make the FDIC more secure.
And there are other problems, such as the 3 year holding requirement. All in all, the guidelines are not friendly toward private equity sponsors, and will go a long way toward dissuading them from investing in failed banks. This may come under political fire, as the FDIC will sooner or later be pressed to support new capital for failed banks, if faced with the prospect of nationalization.
The FDIC’s approach is similar to the one adopted by federal regulators in Blackstone’s failed acquisition of Alliance Data System. That deal broke up when the Office of the Comptroller of the Currency insisted that Blackstone backstop the credit card unit of ADS, which Blackstone was not contractually obligated to do. The banking regulators do not seem to have learned their lesson from that – private equity may walk away again.
Related Posts:
Revised FDIC Policy Clears Way for Experienced PE Firms
FDIC Adopts Strict Rules for Private Equity Investment in Failed Banks
