Sunday, July 18, 2010

FDIC ‘Balancing Act’ Addresses New Approach To Bank Deals

The FDIC and private equity firms seem to be playing a cat-and-mouse game.
After the FDIC put in place restrictions last year on private capital’s involvement in failed-bank acquisitions, PE firms tried various alternatives to pursue such transactions. One alternative is to inject capital into existing banks and use those as platform to purchase failed banks.
Several firms are pursuing or contemplating this approach. Once its pending $500 million investment in Pacific Capital Bancorp is complete, Ford Financial Fund LP plans to use the bank as a platform to buy banks including failed institutions. Late last year, Corsair Capital LLC invested $131 million in East West Bancorp to support the bank’s acquisition of failed United Commercial Bank. And in October, Warburg Pincus LLC invested $115 million in Webster Financial Corp., a potential platform for rolling up failed banks in the Northeast.
Now, that approach may be harder to execute due to a group of questions and answers the FDIC posted on its Web site in response to inquiries about its guidelines.
According to the Q&A, firms are able to acquire failed banks in partnership with or as the majority investor of an existing bank. And recapitalization of an existing bank, in general, is not subject to the FDIC guidelines.
But the agency made it clear that it would examine the timing and purpose of the recap, as well as the amount of roll-up acquisitions the bank does subsequently.
“The FDIC will take into consideration whether a significant portion of the total equity shares or voting equity shares held by Investors in the established bank or thrift holding company pre-dating the proposed failed institution acquisition was recently acquired or was part of a recapitalization of the existing institution,” the Q&A said.
The FDIC will review whether the new capital was provided contingent on completion of failed bank acquisitions, the Q&A said. “The Statement of Policy will apply if any acquisition of one or more failed institutions occurs that in combination exceed 100% of the recapitalized institution’s total assets within an eighteen-month period following the recapitalization.”
In other words, if a PE firm recapitalizes an existing bank, and within a year and a half of the recap, use the bank to buy failed institutions from the FDIC whose total assets exceed that of the existing bank, the firm would be subject to the FDIC’s guidelines.
Doug Landy, head of the U.S. bank regulatory practice at law firm Allen & Overy LLP, said the additional restrictions are part of a “balancing act” that reflects the FDIC’s concern about destabilizing the existing bank.
The 18-month provision, for instance, may be a compromise made to accommodate recap deals, Landy said. In an outright acquisition, firms are forbidden from selling their interest in failed banks within three years of the purchase.
“A recap is not a full investment but has some elements of it,” Landy said. “So [the FDIC said] let’s split the baby and call it 18 months.”
Other provisions of the Q&A call for investors that combined hold at least one-third of the total voting equity of the acquired bank to be bound by the FDIC guidelines. The so-called 1/3 test needs to be met at the time of the failed bank acquisition, the FDIC said.
“There is significant amount of discretion on the part of the FDIC as to what works and what doesn’t, and who are included in the guidelines and who are not,” said Chip MacDonald, head of the financial services practice at law firm Jones Day.
The Q&A means investors must “chin up for the test,” MacDonald said. It also means a consortium will now consist of a larger number of investors, with each holding a smaller stake, he said, meaning it will take longer to put together an investor group and to get a deal approved.
Michael Krimminger, deputy to the chairman for policy at the FDIC, said the Q&A, like one released in January, was in response to questions received during review of the agency’s guidelines.
“We want to send a strong message that we strongly support recapitalization, which is less costly than closure of the bank,” Krimminger said.
“We want to make sure action is taken alongside the capital injection. There need to be changes to management and the bank’s asset and liability structure, in addition to the new capital.”
Krimminger said he doesn’t believe potential investors would view the Q&A as additional impediment. “It is intended to clarify the statement of policy, and make it more predictable and understandable.”