In late August, the US banking regulator voted to approve an amended final version of rules it proposed earlier in the summer to govern private equity participation in the acquisition of failed banks. The Federal Deposit Insurance Corporation (FDIC) eased certain requirements that had attracted industry criticism, including Tier 1 leverage ratios and “source of strength” provisions, while leaving others intact.
So far, it looks as though the new rules will not drive private equity firms away from the strategy entirely. In the wider press and in interviews with PEI, GPs which target investments in banks have admitted the rules are bearable, though they will hurt returns. A common complaint from GPs is that they do not understand why they are being singled out by FDIC.
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 demand that private equity owners serve as a “source of strength” for the banks they invest in has been removed altogether. A “source of strength” obligation means an investor with a majority stake in a bank has to put more capital in if the institution is struggling.
I don't understand why… banks with private equity investors should be subject to higher capital standards than banks without private equity investors
The provision for cross guarantees, meaning that a firm owning 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 bank investments for at least three years.
Wilbur Ross, founder of private equity firm Wilbur Ross & Co, told the Wall Street Journal that his firm would not have made any bids on failed banks if subject to a 15 percent Tier 1 capital ratio requirement, but would consider investing under a 10 percent requirement. He added that had the new rules been in effect during bidding on Florida's BankUnited, the buyout consortium's offer would have been a couple of hundred million dollars lower.
“While I'm pleased that the FDIC listened to private equity and other industry sources during the comment period, I don't understand why the FDIC feels that banks with private equity investors should be subject to higher capital standards than banks without private equity investors,” William Spiegel, a managing director at private equity firm Pine Brook Road Partners, told PEI.
Like Ross, he pointed out that that when a bank with a private equity investor bids on an assisted deal against a bank that doesn't have private equity investors, it either has to bid a lower price or ask for assistance from government in order to get an equal projected return to the other bidders.
“Private equity firms might conclude that it will be too difficult to participate in buying banks from the FDIC and redirect their scarce resources, their people, to other industries,” Spiegel said. “That means the healing process for failed banks will take that much longer.”