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— Industry Insight —
The Federal Deposit Insurance Corp.'s Proposed Statement of Policy on Qualifications for Failed Bank Acquisitions would impose significant burdens on bidders for failed banks that are backed by private equity investors and would likely squelch the interest those funds have in injecting new capital into the banking system to fund acquisitions of failed banks. These burdens would both be inconsistent with the FDIC's mandate to resolve failed banks at "the least possible cost to the deposit insurance fund" and disregard the FDIC's positive experience with private equity-backed bidders during the last banking crisis. There are four aspects of the proposed policy statement that are especially problematic: Enhanced leverage ratio commitment. A bank, which is backed directly or indirectly by private equity investors and acquires a failed bank, would be expected to maintain for at least three years a Tier 1 leverage ratio of not less than 15%.
Expanded source of strength doctrine. The holding company through which private equity investors have made their investments would be required to sell equity or engage in capital qualifying borrowing, if necessary, to support the subsidiary bank. Expanded cross guarantees. When investors in a holding company or bank that acquires a failed bank also hold majority investments in one or more other FDIC insured banks, the investors would be expected to pledge to the FDIC their proportionate interests in each such bank to pay for any potential losses to the deposit insurance fund. Three-year holding period. Private equity investors in a holding company or bank that acquires a failed bank would be prohibited from selling or otherwise transferring securities of the investors' holding company or bank for three years absent the FDIC's prior approval. These policy recommendations fly in the face of experience from the last banking crisis in the late 1980s and early 1990s, when Fleet Financial Group acquired the failed Bank of New England franchise and New Dartmouth Bank acquired three failed New Hampshire banks. These transactions were completed only with significant capital infusions from private equity investors (and the FDIC) and demonstrate that significant private equity investment in a bidder for a failed bank is not incompatible with the FDIC's interest in efficient and cost-effective resolutions. Had the FDIC required New Dartmouth to maintain a Tier 1 leverage ratio of at least 15% for its first three years (versus the 4% ratio that it initially had), New Dartmouth would have been unable to raise sufficient capital, as the projected returns to common equity investors would have declined dramatically. We suspect the outcome would have been similar for the Fleet transaction. Even though, with the infusion of private equity from Kohlberg Kravis Roberts & Co., the FDIC and others, Fleet became one of the better capitalized banking companies of its size in New England, Fleet's pro forma Tier 1 leverage ratio was only about 6%. The FDIC is attempting to rationalize the requirement for a minimum 15% Tier 1 leverage ratio by analogizing to the typical experience of a startup bank, but this comparison is disingenuous. Unlike a conventional startup bank, which can be expected to lose money for the first two to three years while it establishes its deposit base, a winning bidder acquires from the FDIC a deposit franchise that typically has a substantial, seasoned customer base and thus a more predictable funding source and earnings stream, as well as mature operating systems and many experienced managers. The FDIC's proposed expanded source of strength doctrine and cross guarantee would breach the corporate wall between minority private equity investors and the holding company or bank that acquires a failed bank. These provisions would introduce substantial uncertainty for investors and would likely have a dramatic chilling effect on private equity investments in failed banks generally. In particular, the expanded cross guarantee would likely reduce if not eliminate the prospect of an investor participating in more than one "club deal" in which several private equity investors provide capital to support the acquisition of a failed bank's franchise, but none of the investors is deemed to be a holding company. As the FDIC has itself acknowledged, club deals have played an important role in the resolution of two large banks during the current crisis -- the sale of IndyMac to One West Bank FSB, a newly formed federal savings bank, which was funded by a consortium of private equity investors, and of BankUnited FSB's operations to a newly chartered federal savings bank owned by a group of private equity investors. If the cross guarantee is not eliminated, the effect will be to discourage private equity investors from taking large, but noncontrolling stakes, in more than one acquirer of a failed bank. The proposed three-year holding period that would restrict investors in a bank that acquires a failed bank's deposits from selling or otherwise transferring securities of the investors' holding company or depository institution, absent the FDIC's prior approval, is both arbitrary and ambiguous. More important, the holding period will likely chill the interest that private equity investors might otherwise have in providing capital to support the acquisition of one or more failed banks. The FDIC said that the three-year holding period is needed to ensure that investors are "committed to providing banking services to the community served by the acquired institution" and to provide a continued link with the parties with which the FDIC has entered into a loss-sharing agreement. This rationale is specious. The FDIC's statutory mandate is to resolve failed banks at "the least possible cost to the deposit insurance fund," not to paternalistically seek to ensure that particular investors -- as opposed to the bank itself -- are committed to providing banking services to the community. And if a creditworthy party assumes the acquirer's obligations under the loss-sharing agreement, what more of a "link" to the parties to the loss-sharing agreement does the FDIC need? Again New Dartmouth is instructive. In March 1993, just 18 months after its transaction with the FDIC, New Dartmouth agreed to be acquired by Shawmut National Corp. This was an economically rational decision for both banks, and there was no reason in 1993 why the FDIC or any other regulator should have treated the New Dartmouth-Shawmut transaction differently than any other similar proposed merger. There still isn't. Several important aspects of the FDIC's proposal would create substantial disincentives for private equity investors to capitalize bidders for failed banks. The inevitable consequence of those disincentives is that there will be fewer bidders for failed banks, and in turn that reduction in competition will necessarily result in the FDIC receiving less economically attractive bids for failed banks. Robert P. Keller was the president and CEO of New Dartmouth Bank and now is the co-head of Triumph Investment Funds. Michael K. Krebs, a partner at the Boston-based law firm Nutter McClennen & Fish LLP, was counsel to New Dartmouth in its transaction with the FDIC and subsequent acquisition by Shawmut National Corp. |
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