Private equity groups seeking to buy failed U.S. banks would have to maintain very high capital levels and remain owners for three years under tough guidelines proposed on Thursday that some bank regulators fear could deter needed investment.
At a meeting of the Federal Deposit Insurance Corp, the heads of the Office of the Comptroller of the Currency and the Office of Thrift Supervision agreed to issue the proposals for public comment, but said they may need to be scaled back before final approval.
I do fear that the current articulation of the proposal has standards that go too far, said Comptroller of the Currency John Dugan. There is real money and real capital that can provide savings to the deposit insurance fund.
Bank regulators are increasingly looking to nontraditional investors to nurse failed banks back to health as the number of failed institutions continue to rise, draining the FDIC's deposit insurance fund.
But experts said the burdensome proposals could easily have a chilling effect on a large pool of potential investors. As one of my partners put it, I can't imagine it being more inhospitable to private equity, said Alan Avery, a banking lawyer at Arnold & Porter LLP.
The proposals call for private equity groups to maintain capital at troubled banks at levels that far exceed current regulatory standards for well capitalized institutions.
It would require a Tier 1 leverage ratio of 15 percent, for three years. Generally, well-capitalized banks must have Tier 1 capital of at least 6 percent of risk-weighted assets.
That's going to change the economics of a lot of deals. It could make it less attractive for private equity firms to acquire banks because they are going to have to pay more, said Joseph Vitale at law firm Schulte Roth & Zabel.
Private equity groups would also have to maintain the investment in a bank for three years, unless they get special approval from the FDIC.
Further, the requirements call for private equity groups to provide a contractual cross guarantee, meaning that, if one firm owns two banks, the healthier institution must provide support for the weaker bank if it falters.
The proposed guidelines would prohibit private equity groups from using the acquired bank to extend credit to their investment funds, affiliates or portfolio companies.
They also would require the private equity groups to make extensive disclosures, specifically about their ownership structure, so regulators could determine who is behind an investment in a failed bank.
On balance, it is far off the scale in terms of striking the right tone at a very difficult time for depository institutions that clearly need capital, said Kevin Petrasic, a lawyer at Paul Hastings and a former counsel at the OTS. It's not clear to me why any investor would want to put itself in that position.
The FDIC has faced increasing difficulties when trying to find buyers for failed banks as loan portfolios continue to deteriorate following the bursting of the housing bubble.
So far this year, 45 U.S. banks have failed, compared to 25 last year, and just three in 2007.
FDIC Chairman Sheila Bair defended the strict proposals, saying they need to include strong capital requirements and other provisions to ensure the safety and soundness of the banks.
But she is open to comments on the proposal and the FDIC has scheduled a July 6 roundtable discussion on the topic. I'm not sure we have it right here, but we do have a solid document.
Bair has said she is comfortable with the private equity deals the agency has struck so far for failed banks such as IndyMac and BankUnited, but said there needed to be a more structured process.
Firms including WL Ross & Co, Carlyle Group
(Reporting by Karey Wutkowski in Washington and Megan Davies and Paritosh Bansal in New York; editing by Lisa Von Ahn, Andre Grenon, Tim Dobbyn)