The FDIC's Proposed Statement of Policy on Qualifications for Failed Bank Acquisitions would impose significant burdens on bidders for failed banks that are backed by private-equity investors and would likely squelch the interest those funds have in injecting new capital into the banking system to fund acquisitions of failed banks. These burdens would both be inconsistent with the FDIC's mandate to resolve failed banks at "the least possible cost to the deposit insurance fund" and disregard the FDIC's positive experience with private-equity-backed bidders during the last banking crisis.
Four aspects of the proposed policy statement are especially problematic: the 15% Tier 1 leverage ratio requirement; the expanded source of strength doctrine; the requirement for cross guarantees when some or all of the investors in a holding company or bank that acquires a failed bank also hold a majority investment in one or more other FDIC-insured banks; and the three-year prohibition on selling or otherwise transferring securities of the investors' holding company or bank without prior FDIC approval.
These policy recommendations fly in the face of experience from the last banking crisis in the late 1980s and early 1990s, when New Dartmouth Bank acquired three failed New Hampshire banks and Fleet Financial Group acquired the failed Bank of New England franchise. These transactions were completed only with significant capital infusions from private-equity investors (and the FDIC).
Had the FDIC required New Dartmouth to maintain a Tier 1 leverage ratio of at least 15% for its first three years (versus the 4% ratio that it initially had), we know from firsthand experience, having been the president of New Dartmouth and counsel to the New Dartmouth investor group, that New Dartmouth would have been unable to raise sufficient capital, as the projected returns to common equity investors would have declined dramatically.
We suspect the outcome would have been similar for the Fleet transaction. Even with an infusion of private equity, Fleet's pro forma Tier 1 leverage ratio was only about 6%.
The FDIC's attempt to justify the greater Tier 1 leverage ratio by analogizing to the typical experience of a start-up bank is disingenuous. Unlike a conventional start-up bank, which can be expected to lose money for the first two to three years while it establishes its deposit base, a winning bidder acquires from the FDIC a deposit franchise that typically has a substantial, seasoned customer base and thus a more predictable funding source and earnings stream.
The FDIC's proposed expanded source of strength doctrine and cross guarantee would breach the corporate wall between minority private-equity investors and the holding company or bank that acquires a failed bank. These provisions would introduce substantial uncertainty for investors. In particular, the expanded cross guarantee would likely reduce if not eliminate the prospect of an investor participating in more than one "club deal" in which several private-equity investors provide capital to support the acquisition of a failed bank's franchise, but none of the investors is deemed to be a holding company.
The proposed three-year holding period is both arbitrary and ambiguous. More important, the holding period will likely chill the interest that private-equity investors might otherwise have in providing capital to support the acquisition of one or more failed banks.
The FDIC asserts the three-year holding period is needed to ensure that investors are "committed to providing banking services to the community served by the acquired institution" and to provide a continued link with the parties with which the FDIC has entered into a loss-sharing agreement. This rationale is specious. The FDIC's statutory mandate is to resolve failed banks at "the least possible cost to the deposit insurance fund," not to paternalistically seek to ensure that particular investors — as opposed to the bank itself — are committed to providing banking services to the community.
Again New Dartmouth is instructive. In March 1993, just 18 months after its transaction with the FDIC, New Dartmouth agreed to be acquired by Shawmut National Corp. There was no reason then why the FDIC or any other regulator should have treated that transaction differently than any similar proposed merger. There still isn't.
Several important aspects of the FDIC's proposed policy statement would create substantial disincentives for private-equity investors to capitalize bidders for failed banks. The inevitable consequence of those disincentives is that there will be fewer bidders for failed banks, and in turn that reduction in competition will necessarily result in the FDIC receiving less economically attractive bids for failed banks.