FDIC Proposes a Hard Line on Private Equity Investments in Failed Banks

The Federal Deposit Insurance Corporation (FDIC) issued today for public comment its anticipated guidance for private equity investors in failed banks or thrifts.  The proposed policy statement, which will be open for public comment for 30 days following publication in the Federal Register, would impose significant and, in many cases, ambiguous restrictions on (i) private equity investors in a company (other than certain existing bank or thrift holding companies) seeking to acquire from the FDIC deposits (or deposits and assets) of failed institutions, and (ii) applicants for de novo bank or thrift charters in connection with the resolution of failed institutions. The restrictions would include:

• Prohibiting the use of “silo” structures in which beneficial ownership cannot be ascertained, decision-making responsibility is not clearly identified, and/or ownership and control are separated.
  
  
• Requiring the target institution to maintain a 15 percent tier 1 regulatory capital leverage ratio for at least 3 years, and to remain at least “well-capitalized” (i.e., leverage ratio of 5 percent, tier 1 risk-based ratio of 6 percent, and total risk-based ratio of 10 percent) thereafter.
  
  
• Requiring the “investor organizational structure” to serve as a “source of strength” for the subsidiary bank or thrift, with a specific agreement by the investing holding company to raise any necessary capital.
  
  
• Prohibiting investors from selling any of their shares in the institution or its holding company for 3 years, unless the purchaser agrees to the policy statement’s restrictions.
  
  
• Prohibiting use of entities domiciled in “bank secrecy jurisdictions” within the ownership structure unless (i) the parent company has been found by the Federal Reserve Board to be subject to “comprehensive consolidated supervision” in its home country, and (ii) the investors satisfy additional regulatory requirements designed to mitigate the FDIC’s risk, including executing a consent to jurisdiction and an agreement to provide appropriate information, and maintaining books and records in the United States.
  
  
• Prohibiting all loans by the acquired institution to the investors, their investment funds and their affiliates, a condition that goes significantly beyond the traditional  restrictions imposed on such transactions by Section 23A of the Federal Reserve Act.
  
  
• Requiring investors in multiple banks or thrifts to “pledge to the FDIC their proportionate interests in each institution” (so called “cross guarantees”) to reimburse the deposit insurance fund for any losses relating to another institution under common ownership.
  
  
• Prohibiting existing 10 percent shareholders of a bank or thrift from joining an investor group seeking to acquire the assets and/or liabilities of that institution upon its failure.

Absent a fundamental reversal of course—which seems unlikely—the policy statement, when it is adopted, will likely represent a disappointment to investors that were anticipating greater FDIC receptivity to private equity investments in failed institutions. 

This development, together with the rather modest changes previously made by the Federal Reserve Board to its “control” policies relating to equity investments in banks (see our Client Update, “Federal Reserve Board Policy Statement on Equity Investments in Banks and Bank Holding Companies”), the continuing hurdles to these types of investments posed by the requirements of the Bank Holding Company Act, and the recent reaffirmation of the separation of banking and commerce in the Obama Administration’s regulatory reform proposals (see our Client Update, “Obama Administration Proposes Comprehensive Changes to Financial Services Regulation”), suggest that private equity investors seeking to acquire banks and thrifts (whether operating or failed) will continue to face significant challenges in structuring those investments to comply with applicable regulatory requirements and expectations.

For a copy of the draft FDIC policy statement, please click here.