| ||||||||||
| ||||||||||
— Industry Insight —
On Aug. 26, the Federal Deposit Insurance Corp. issued a Final Statement of Policy on Qualifications for Failed Bank Acquisitions. The statement offers guidance to private capital investors seeking to acquire or invest in failed banks on the terms and conditions that such investors could expect from the FDIC, in its role as receiver or conservator. The release of the statement was greeted with significant gloom and doom from private capital investors, negative reporting from the press and a myriad of slightly hysterical law firm memoranda. According to these naysayers, the statement's terms are sufficiently onerous to dissuade otherwise interested private capital investors from investing capital into the banking system. Among the most vocalized complaints is the belief that private capital investors are being treated differently than traditional strategic bank investors due to the increased risk that the regulators believe such investors may introduce into the banking system. This belief is largely incorrect. In fact, the statement offers private capital investors an attractive path toward noncontrolling bank investments, especially as compared to traditional investors. A brief comparison of certain critical factors is below.
Source of strength. In the statement, the FDIC removed the proposed requirement that private capital investors serve as a "source of strength" for the institutions in which they invest. This represents a sea change in the FDIC's attitude toward investment in banks, and the magnitude of this win for potential investors should not be overlooked. Some historical context is helpful here. The board of governors of the Federal Reserve System amended Regulation Y in 1984 to provide that a "bank holding company shall serve as a source of financial and managerial strength to its subsidiary banks." This "source of strength" doctrine was originally only considered by the Fed during the bank holding company application process. Then, on April 24, 1987, the Fed issued a policy statement that it would consider a bank holding company to be engaging in unsafe and unsound banking practices, or to be in violation of Regulation Y, if it failed to provide appropriate assistance to a failing bank. Since then, the Fed has regularly required applicants for acquisition of control of financial institutions under the Bank Holding Company Act to confirm their commitment to serve as a source of strength to the institution they seek to acquire. In cases where the controlling owner of a financial institution is not a bank holding company subject to Fed jurisdiction (for example, in the context of credit card banks), other federal bank regulators have also insisted that the controlling owners agree to provide support to maintain the bank's minimum capital and liquidity levels if and when necessary. A source of strength requirement, in other words, has been the norm for acquisitions of financial institutions for better than two decades. This requirement obligates covered owners to provide virtually unlimited support to a bank subsidiary upon an order by the Fed. Under the Final Statement of Policy on Qualifications for Failed Bank Acquisitions, private capital investors will not be subject to this obligation. Thus, as compared with traditional investors, private capital investors are in a significantly advantaged position. Capital. Private capital investors have bemoaned the statement's requirement that depository institutions subject to the statement maintain a ratio of Tier 1 common equity to total assets of at least 10% for a period of three years following an acquisition. While the 10% requirement is a significant reduction from the 15% Tier 1 capital to total assets requirement initially proposed, it is, nonetheless, significantly higher than the Tier 1 and total capital requirements applicable to traditional investors in banks. When viewed in light of the general regulatory trend toward higher capital requirements and compared to the more onerous range of capital requirements imposed on de novo banks, however, the statement's requirement seems remarkably reasonable. The FDIC generally requires de novo banks to maintain an 8% Tier 1 capital to assets ratio, which is higher than that required of established banks. The FDIC recently increased the period for which de novo banks are required to meet this capital requirement from three to seven years. In essence, the FDIC seems to be viewing a failed institution acquired by a conglomerate of private capital investors as analogous to a de novo bank -- with the same untested management and higher likelihood of failure in the initial period -- but with a slightly different risk profile. In each case, a higher capital requirement is required to deal with the greater likelihood of failure during the defined period. In light of recent history of bank failures, the FDIC appears to be acting reasonably in imposing such a regime. In any case, the general trend among regulators is to increase capital requirements. While the requirements for "well-capitalized" institutions call for a total risk-based capital ratio of 10% and a Tier 1 risk-based capital ratio of 6%, most banks now maintain ratios well above those minimums. Widespread support for a worldwide increase in bank capital requirements was a theme at September's G-20 Summit in Pittsburgh, and the Basel Committee on Banking Supervision is expected to calibrate the new requirements in the near future. In addition, the comprehensive regulatory restructuring plan proposed by the Obama administration contemplates higher capital requirements for riskier bank activities, a sentiment President Obama echoed recently. It seems the FDIC is just one step ahead of what will be an across-the-board increase in bank capital requirements. Cross support. If a group of private capital investors owns 80% or more of two or more banks, the Final Statement of Policy on Qualifications for Failed Bank Acquisitions requires those private capital investors to pledge their stock in each bank to the FDIC, to be exercised if necessary to recoup losses as a result of one of the banks' failures. This requirement is softened from the FDIC's initial proposal, which required a cross-guarantee when a majority of two or more banks was commonly held. It also represents a less burdensome standard than the one applicable to traditional investors. Ordinarily, a bank is liable for any loss to the FDIC in connection with the default of a "commonly controlled" bank. It is fair to expect that if two or more banks have 80% or more overlap in ownership, private capital investors in the ownership group share some responsibility toward the institutions in which they invest. Control. Regardless of the specific requirements of the statement, private capital investors should keep in mind that the FDIC (with the Fed) rarely permits a group of private investors to buy a financial institution without "controlling" it, as defined in the Bank Holding Company Act. On Sept. 22, 2008, the Fed issued guidance to permit private capital investors to invest in banks without controlling them. When combined with the statement issued in August, the FDIC and the Fed now permit -- for the first time -- an organized approach by private capital investors to own, but not control, banks. This is an historical "give" by the federal regulators to private capital, and it reflects the present conditions of emergency need for capital in the banking system. The Final Statement of Policy on Qualifications for Failed Bank Acquisitions received a lot of bad press. In fact, in it the FDIC offers what both now and historically is a good opportunity on fair terms for private capital investors to invest in banks. We understand that the industry desired better terms from the FDIC and was disappointed in the results. However, in our view the industry should take a step back and realize that those investors within it are being provided a once-in-a-lifetime chance to acquire valuable bank properties at attractive terms. Douglas Landy is a banking partner and head of the U.S. regulatory group at Allen & Overy LLP. Jillian S. Ashley is a banking associate at Allen & Overy. |
|
|
|
|
|
