Wednesday, September 15, 2010

Banking Market Gains Strength

SEPTEMBER 15, 2010, 10:52 AM ET

Why Banking On The FDIC Has Been A Less-Than-Sure Bet

By Shasha Dai, Wall Street Journal

In the spring of 2009, a golden age for private equity bank investment appeared to be in the offing.

The banking sector downturn was nowhere near the bottom, with many more expected to fail. The Federal Deposit Insurance Corp., facing soaring costs in its insurance fund, was eager to bring in private capital. The economics of buying closed institutions looked attractive, with the FDIC sharing the banks’ future losses.

In reality, the number and pace of FDIC-assisted deals has fallen far short of expectations, with only two outright acquisitions–IndyMac Federal Bank and BankUnited FSB–being done so far.

Potential buyers of FDIC-backed assets have found the deals harder than they expected because of regulatory scrutiny and rising valuations of bank assets. Many investors have therefore turned to recapitalizing existing banks.

“Six months ago, every private equity firm was looking to do FDIC deals,” said a partner at a New York firm, which has yet to do such transactions. “But look who has actually done them? They are very hard deals to do, and they caused a lot of brain damage.”

The FDIC maintains a higher standard for de novo banks, or start-up banks, and shelf charters, or institutions that have obtained bank charters but have yet to acquire assets, than that for an existing bank, said Brad Oates, co-managing partner of advisory firm Stone Advisors, who also heads a shelf charter, Stone Bank. Start-up banks are subject to strict vetting of their management’s track record and the banks’ financial strength.

“An assisted deal has a very high hurdle,” said Oates. “It is not just the FDIC, but the Federal Reserve is also carefully vetting such transactions.”

Michael Krimminger, the FDIC’s deputy to chairman for policy, admitted that de novo banks are subject to higher standards. “It is a historical fact that de novo institutions have a higher failure rate and a higher problem rate than existing institutions in any type of financial institutions, particularly in banks,” Krimminger said.

Rising bank valuations, the result of interest from financial and strategic bidders, led the FDIC this year to reduce the level of guarantee to a flat 80% of potential losses from the acquired banks. Before that, the FDIC typically offered to guarantee 80% of potential loses up to a certain threshold, and 95% thereafter.

As a result, many firms have turned their attention to recapitalizing existing banks, and using those as platforms to buy closed institutions. Firms such as Corsair Capital LLC, Ford Financial Fund LP, Warburg Pincus LLC and Thomas H. Lee Partners have done such deals.

And the FDIC said it welcomes that.

“We certainly have preference for new capital coming into existing banks or bank holding companies,” said the FDIC’s Krimminger. “New capital and an already proven management is a stronger combination.”