The Prude Courts the Shark: FDIC Releases Final Statement of Policy on Qualifications for Failed Bank Acquisitions

September 1, 2009 at 7:48 pm Leave a comment

On August 27, the Federal Insurance Deposit Corporation (FDIC) released its Final Statement of Policy on Qualifications for Failed Bank Acquisitions (Final Statement), which establishes the FDIC’s framework for private equity firms seeking to acquire failed (or failing) FDIC-insured depository institutions.  Although less restrictive than that the guidance proposed in July (Proposed Policy Statement), the Final Statement will probably not soothe private equity concerns over the FDIC’s posture toward private equity investments in failing financial institutions. 

Capital Commitment

Under the Final Statement, private equity investors must provide enough capital to give the failed institution, for the first three years of ownership, a Tier 1 common equity ratio of 10 percent to be considered “well-capitalized” (down from a 15 percent Tier 1 leverage ratio provided for in the Proposed Policy Statement).  After three years, the depository institution must remain “well capitalized.”  Further, a failure by the depository institution to satisfy these capital standards will cause the institution to be treated as undercapitalized for purposes of Prompt Corrective Action. 

To ease this burden, the Final Statement does contain a provision that would exempt private equity firms from complying with the higher capital standards if they partnered with a traditional bank buyer when acquiring the failed institution.

Three-Year Holding Period

The Final Statement retained the requirement, first set forth in the Proposed Policy Statement, that private equity firms hold their ownership interest for at least three years.  Given the shorter-term ownership periods preferred by many private equity investors, this requirement epitomizes the disparate cultures of private equity investors and the FDIC. 

Source of Strength and Cross Guarantee Provisions

Citing FDIC concerns about its ability to apply the source of strength doctrine to private equity firms, the Final Statement does not contain any requirement for private equity investors to serve as a source of strength to depository institutions.  Instead, the FDIC intends to use the 10 percent Tier 1 common equity ratio to shield the DIF from losses. 

The Final Statement also scales back on the “cross-support” provisions floated in the Proposed Policy Statement, creating a cross support obligation that will apply where two or more depository institutions are owned by a group of investors subject to the rule and the institutions are at least 80 percent owned by common investors.

Affiliate Transactions

The Final Statement prohibits investors and their affiliates (defined as entities in which an investor holds at least a 10 percent ownership interest for a minimum of 30 days) from receiving extensions for credit from a depository institution acquired pursuant to the Final Statement. and imposed restrictions barring the acquired bank from lending to companies affiliated with the private equity buyer.

Application and Review of Final Statement

According to the FDIC, the guidelines established by the Final Statement will apply only to future deals.  And the FDIC further noted that it intends to review the impact of the Final Statement in six months.

Conclusion

The prudence of the Final Statement is impossible to gauge.   The typical private equity firm lacks many attributes—e.g., significant banking experience, long-term commitment to a banking enterprise and willingness to contribute additional cash to a fledgling enterprise—the FDIC prefers.  But beggars cannot be choosy.  And while the FDIC is far from a beggar, the DIF is already running short on cash.  With dozens, and possibly hundreds, of bank failures looming, the FDIC would be reckless not to attempt to court some of the billions of dollars in private capital currently standing on the sidelines.

Entry filed under: Uncategorized.

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