If successful, Guaranty Financial Group Inc.'s bid for open bank assistance could pique the interest of private-equity firms in other ailing companies — but that's a big if.
The Austin company said Monday that it is in discussions with regulators about a loss-sharing agreement that could facilitate a cash infusion from private investors. Without the government help, Guaranty said, its survival would be in doubt. It is facing such a significant writedown on its mortgage-backed securities that it would be left in a negative capital position.
Observers said Guaranty should be ready for its $14.4 billion-asset thrift unit to fail, because the government is unlikely to help.
"The odds are poor, and if they do get it, it will be a travesty," said William K. Black, an associate professor of economics and law at the University of Missouri-Kansas City and a former senior deputy chief counsel at the Office of Thrift Supervision. "This is an institution that destroyed itself."
Open assistance, rarely used, essentially allows a teetering bank to sidestep failure. The assistance can take different forms; one strategy is for the Federal Deposit Insurance Corp. to agree to share in future loan and investment losses. The intent would be to attract a buyer that would bolster the bank's capital.
Without government help, any new capital for Guaranty would first go toward plugging its massive deficit — which the company says has made it impossible to secure potential investors.
For open assistance to be used, the FDIC has to deem that it is the least costly solution, or that the bank is systemically important.
Guaranty said it meets the former test.
"We believe strongly that open bank assistance is in the best interest of our depositors, and that it meets the standard of being the least costly alternative for government regulators," said John Wessman, a spokesman for Guaranty.
Open bank deals were used in the last financial crisis during the late 1980s and early 1990s, peaking at 80 transactions in 1989, according to an FDIC spokesman.
But such deals have been harder to do since 1993, because of an amendment to the Federal Deposit Insurance Act that prohibits the deposit insurance fund from being used in any way that protects shareholders in a banking company from losses.
In the current downturn, open bank assistance has been provided only for large institutions. Bank of America Corp. received a package of guarantees, liquidity access and capital from the government to take over Merrill Lynch & Co.; Citigroup Inc. received such a package directly.
That's not to say community banks haven't tried to get it.
"I have actually sought open bank assistance for two different community bank clients and have been told that it isn't available," said Frank Bonaventure Jr., a principal at the Ober Kaler law firm in Baltimore and former senior counsel at the Office of the Comptroller of the Currency. "I don't know why they haven't used it, but it appears that the policy is that they'd rather liquidate."
If Guaranty's proposal were approved, he said, it could attract private-equity investors that have been on the sidelines to the banking sector.
"I think if this mechanism were to be instituted, it would open new sources of capital," Bonaventure said. "I would be very encouraged to see something like this granted."
Others disagreed, saying that even if it were to be approved in this case, open bank assistance is unlikely to become more common.
"I don't think that this particular situation would create a precedence for any bank to take comfort in open assistance solutions," said John Carusone, the president and chief executive officer of Bank Analysis Center Inc., a consulting firm in Hartford, Conn. "Open bank deals will only happen in unique situations where the bank has potential merit and is deemed worth saving, and most [proposals] will carry an uncertain probability of happening."
Guaranty raised $600 million a year ago from a group that included the financiers Carl Icahn and Robert Rowling.
It said in a Securities and Exchange Commission filing Monday that its proposed open assistance deal would wipe out the value of the company's equity.
Guaranty said the proposed FDIC loss-sharing agreement on a pool of its assets would be paired with a significant infusion from private investors — including existing principal stockholders.
It did not identify those investors. Calls to Icahn and Rowling were not returned.
Guaranty cautioned that though it is in discussions with investors, it does not have a commitment from any yet.
Patricia McCoy, a banking and finance law professor at the University of Connecticut, said that to invest in Guaranty a second time, a stockholder would need to have the utmost confidence in management or see some long-term value in the company. Or, she said, investors could see the deal as a way to shift losses to someone else.
"Why are they really going to pump money in there when their equity has already been wiped out?" McCoy said. "To me, this appears to be a desperate last-minute bid to maybe preserve management while shifting losses to taxpayers, and I don't think it is right."
Guaranty, which has yet to file its annual report for 2008, said in Monday's filing that it is facing $1.7 billion in writedowns, nearly all related to unrealized losses on its mortgage-backed securities.
Those hits would show up in the fourth quarter, increasing the company's preliminary 2008 loss fivefold, to $2.2 billion. It would also increase its estimated loss for this year's first quarter by 20%, to $308 million.
Those writedowns would leave the bank with a leverage ratio of negative-5.8% and a total risk-based capital ratio of negative-1.2% as of March 31.
Under a cease-and-desist order from the FDIC and OTS, the bank was supposed to have a leverage ratio of 8% and a total risk-based capital ratio of 11% by May 21. Mike Heller, the president of the bank rating firm Veribanc Inc., estimated it would take $3 billion to $5 billion to repair the thrift.
The OTS declined to comment.
Black, the former OTS lawyer, said open bank assistance for Guaranty would be a big risk since it is regulated by his former employer, whose other charges included some of the current downturn's biggest failures: BankUnited, IndyMac and Washington Mutual.
"The FDIC should have a healthy skepticism about OTS regulation," Black said.
"You really go out on a limb to do open bank assistance," he said. "You only do it when you have the fullest possible confidence about the bank and you have a really superb management team. Neither of those are here. It shouldn't be a difficult case."