Regulatory compromise

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

The final rules are somewhat more lenient than the FDIC’s original proposal, which indicates that the FDIC actually does want to encourage private capital to boost ailing banks. But private equity bank buyers are still going to have to clear a much higher regulatory bar going forward than in the past.

A detailed analysis of the new rules appears on Private Equity Manager this week. Briefly: under the modified rules, an acquired financial institution must be capitalised at a Tier 1 leverage ratio of 10 percent, rather 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 was removed altogether. But 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, and the rules still require private equity firms to hold their bank investments for at least three years.

“The revised FDIC guidelines represent an improvement over those originally proposed,” the US lobbying group – Private Equity Council – said in a statement. However, the PEC added that it still questions the “onerous capital requirements”.

But the rulemaking process sets a valuable precedent: the FDIC solicited public comments, and the industry got to speak its mind. The FDIC then amended its proposals to address some of private equity’s biggest areas of concern: a group of private equity investors including The Blackstone Group, Centerbridge Partners and TPG 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. Not all of those requests were met, but the FDIC took steps to meet private equity in the middle.

Bank investing is just one of many areas where private equity firms face “onerous” new regulatory requirements. If governments around the world follow the FDIC’s example and meet the industry halfway, the new regimes might not be a cataclysm for the industry.