New FDIC Rule Proposals Would Restrict Private Equity Investment in Failed Banks

Earlier today, the FDIC voted to move forward a proposal that would place restrictions on private equity groups seeking to participate in restoring failed banks. The WSJ reports:

The Federal Deposit Insurance Corp.’s board of directors on Thursday voted to seek comment on a proposal that would set new limits on allowing private equity firms to purchase failed banks. The staff proposal calls for investors to maintain certain capital levels at the acquired bank—a minimum 15% Tier 1 leverage ratio for at least three years—and would put other restrictions on ownership changes and where credit can be extended.

Beyond the capital requirements, the proposal would prevent certain types of investment structures from purchasing a failed FDIC-insured institution. Specifically, agency staff said it would not be appropriate to allow firms “involving complex and functionally opaque ownership structures” to buy a failed bank. Bair said the FDIC has already received bids from some firms whose legal structures raised red flags, which is one of the reasons they want to put the new rules in place.

This proposal is troubling, especially considering there have been 51 bank failures in the past 18 months. When private equity very interested in investing in these failed banks to bring them out of bankruptcy, such restrictions threaten to extend the amount of time failed banks feed off FDIC life support. The WSJ report continues:

But critics were quick to suggest the proposal in its current form would be too prohibitive and would discourage private equity investment.

“It may be well intentioned but I think it could guarantee that there will be no more private equity coming into banks,” investor Wilbur Ross told Dow Jones Newswires. Ross’ investment firm was part of the private-equity consortium that negotiated with the FDIC to acquire failed Florida bank BankUnited FSB in May. […]

Comptroller of the Currency John Dugan said he was concerned that some of the restrictions are too onerous, and suggested they should be scaled back before a final rule is put in place.

Dugan was not alone in his concerns. The requirement to keep the bank “well capitalized” even after three years and other restrictions that could affect smaller shareholders could dissuade private equity firms from buying banks, said Lawrence Kaplan, an attorney at Paul, Hastings, Janofsky & Walker LLP.

“Even in proposed format, it’s very frightening to entities that are not used to dealing with the government,” Mr. Kaplan, a former attorney at the Office of Thrift Supervision, said of the proposal.

So the question becomes, why is the FDIC doing this?

“There is a significant need for capital and there’s significant capital out there…We want to accommodate that, but accommodate it in a way that is prudent,” FDIC Chairman Sheila Bair said in a statement. […]

Regulators, however, are wary that private investors may not be committed to the long-term ownership of a healthy bank and that allowing some firms into the market could just result in future bank failures.

“We are particularly concerned with the owners’ ability to support depository institutions with adequate capital and management expertise,” Ms. Bair said.

Thus is the problem with market regulation, it too often restricts opportunities to create wealth. It is understandable that the FDIC be prudent in who is sells the banks it has receivership power over too. Afterall, they have to clean up the mess if the bank fails again. But it is also imprudent to require three year interest stakes in a bank when dozens of banks are sitting around looking for buyers.