PE Unmoved By Initial Bank Investing Proposal

There’s still a good bit of wooing to be done before the federal government can get buyout firms to the altar with regard to investment in the ailing banking industry, but there are indications that compromise is in the offing.

The Federal Deposit Insurance Corp. issued its proposed guidelines for private capital investments in failed banks and thrifts on July 2. While the first step towards clarity was probably appreciated, the first draft got a fairly raw reception.

“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, speaking with Reuters shortly after the rules were revealed. In a client briefing, the firm said it viewed the requirements as “very harsh.”

The Private Equity Council, an organization backed by most of the biggest names in the business, gave a clear picture of its view, saying the guidelines would likely deter future private investments in the industry, although it reserved final judgment.

“We hope that the comment period yields changes that facilitate the flow of private capital into the banking system, consistent with the [Obama] Administration’s other efforts to address the financial crisis,” said Douglas Lowenstein, president of the Washington, D.C.-based group, whose twelve members include Bain Capital, The Blackstone Group, Kohlberg Kravis Roberts & Co., and TPG.

The main objections from buyout professionals were focused on the requirement for banks owned by buyout firms to have a Tier 1 leverage ratio of 15 percent for at least three years following the investment. Others that have drawn complaint are the provision calling for cross guarantees over commonly-owned depository institutions and a stipulated minimum holding period of three years.

Since that initial swipe at the ground rules, however, FDIC Chairwoman Sheila Bair has moved to get better read on the concerns of private equity players. A five-hour meeting was held July 6 in the wake of the release of the guidelines where Bair and other FDIC officials discussed the situation with lawyers, bankers, academics, and even a few buyout professionals, according to published reports. At that meeting, Bair reportedly indicated the 15 percent Tier 1 ratio requirement was a “high proposal” and that the FDIC was looking for ways to bolster investor interest.

“I am very open on many, if not most, aspects of this proposal,” Reuters quoted Bair as saying at the meeting.

One of the buyout voices in the room was Wilbur Ross, whose firm WL Ross & Co. was part of the private equity group that assumed control of BankUnited, a failed Florida bank, in late May. Ross told, the sister Web site of Buyouts, following that meeting that he believed Bair was genuine in her efforts to gather peoples’ views about what the guidelines should be.

“I think it shows that the proposals really are still proposals at this point, and that she and others at the FDIC are serious about wanting input from people in the private equity industry,” Ross said.

How this all shakes out is up in the air. The 15 percent Tier 1 ratio requirement seems likely to crumble, however, as it imposes a standard on private equity ownership that’s much higher than existing rules for other banks.

“In effect, this subjects a private equity-owned bank that holds 14.9 percent of Tier 1 Capital to the same activities and other restrictions and limitations as an undercapitalized bank that holds only 4.9 percent Tier 1 capital,” law firm Paul Hastings LLP said in a client alert. “Aside from the inequities of this approach, the merits of imposing this type of super-capital requirement are unclear.”

The cross-guarantee rule is also likely to see some alteration since the terms of most partnership agreements governing private equity funds would prohibit requiring one portfolio company to support another. And although three years is a fairly short holding period from a private equity standpoint, it’s debatable if limiting an investor’s ability to make an exit will stand up. Realistically, buyout firms investing in failed banks won’t have an opportunity to flip those investments that soon anyways.

The open-comment period for the guidelines runs into early August and Bair and the FDIC will surely be getting an earful from buyout professionals until then. Regulators will have to give serious thought to making some concessions If they expect that multi-billion dollar overhang of dry powder held by private equity to play a substantial role in getting failed banks back on their feet.