FDIC Restricts Private Capital Investments In Failed Banks

Qualified Buyers Only

Despite 52 failed banks in 2009 and many more to follow, Sheila Bair, FDIC Chairman, has wisely chosen to restrict private capital investments in failed banks to qualified buyers only.  In mid May of this year, Ms. Bair had made the following comments:

I am particularly concerned with new owners’ ability to support depository institutions with adequate capital, management expertise, and a long term commitment to provide banking services in a safe and sound manner. Obviously, we want to maximize investor interest in failed bank resolutions. On the other hand, we don’t want to see these institutions coming back.

I support the transactions we have completed to date which have involved sales to private equity owners. We have imposed some special restrictions on these, including higher capital requirements. However, some have suggested that capital requirements should be even higher, given the difficulties in enforcing source of strength obligations outside the initial capital investment made by the acquirers in so-called “shell” structures. I know that this will be a contentious area, and we are opening high, with a proposed 15% requirement.

I am also troubled by the opacity of some of the ownership structures that we have seen in our bidding process, though these have not been winning bids. We have seen bids where it has been difficult to determine actual ownership. We have seen bidders who have wanted permission to immediately flip ownership interests. We have seen structures organized in the secrecy law jurisdictions. So based on the experiences we have gathered, I think it is prudent to put some generic policies in place which tell non-traditional investors that we welcome their participation, but only if we have essential safeguards to assure that they will approach banking in a way that is transparent, long term, and prudently managed.

Today, the FDIC issued a proposed policy statement listing specific bidder standards for private investors in order to be eligible to purchase failed banking institutions.  The proposed standards include:

• capital support of the acquired depository institution;
• agreement to a cross guarantee over substantially commonly owned depository institutions;
• limits on transactions with affiliates;
• maintenance of continuity of ownership;
• clear limits on secrecy law jurisdiction vehicles as the channel for investments;
• limitations on whether existing investors in an institution could bid on it if it failed; and
• disclosure commitments.

The FDIC is particularly concerned that owners of banks and thrifts, whether they are individuals, partnerships, limited liability companies, or corporations, have the experience, competence, and willingness to run the bank in a prudent manner, and accept the responsibility to support their banks when they face difficulties and protect them from insider transactions.The FDIC is keenly aware of the need for additional capital in the banking system, and the contribution that private equity capital could make to meeting this need provided this contribution is consistent with basic concepts applicable to the ownership of these institutions that are contained in our banking laws and regulations, and now summarized in the proposed Policy Statement.

The FDIC seems to have its eye on preventing another series of costly banking failures in the future.  Implementing sound regulations based on capital adequacy and management expertise is a step in the right direction towards establishing a sound banking system going forward.