Last night The Bank Lawyer--blogger Kevin Funnell--offered a theory about why the Independent Community Bankers of America is supporting the Federal Deposit Insurance Corp.’s plan to raise capital requirements for private equity investors buying failed banks. He said it seemed that the ICBA expected the rule-change to steer more private equity firms toward stakes in troubled-but-still-standing institutions. Would it work? Funnell didn’t think so. But private equity bidders may find deals with still-operational banks to be sweeter and easier to get.
In June, for example, a Virginia-based private equity firm, Comstock Partners, LC, formed a new bank holding company and bought the troubled Greater Atlantic Financial Corp. for just 10 cents a share. The total cost of the deal came to about $1 million, while Greater Atlantic had $190.2 million in deposits and $218.6 million in assets, with a book value of negative $10.4 million. Sound similar to an FDIC deal with a loss-sharing agreement? We thought so too. Except Comstock wouldn’t face any exceptional capital requirements—not even if the new FDIC rules were passed.
Funnell’s point, though, was that there may not be much demand for any kind of bank. “It’s not as if there’s a large pack of salivating private investors howling at the gates of the community banking business, demanding entry,” he wrote. “Private capital flows to investments where the reward justifies the risk… If there’s one thing that Washington Mutual and Guaranty Federal have taught private equity investors, it’s that in the midst of the worst recession of the post-World War II era, dumping a ton of private capital into a troubled bank or thrift and expecting to “work it out” over time without government assistance is like commandeering a cigarette boat to overtake the Titanic and jumping on board right before the ice berg looms out of the fog.”
For the record, Chris Cole, the ICBA’s vice president and senior regulatory council said changing the course of private equity interests wasn’t the trade organization’s motivation. But Cole did acknowledge that the organization’s support of higher capital standards for private equity was indeed limited to the cases of failed banks, and emphasized that the ICBA didn’t want to prevent private equity firms from taking stakes in banks that were still operating.
“We’re not trying to say that private equity firms in all cases, whether they’re buying banks or failed banks or starting banks should be subject to abnormally high capital standards,” he said. “Our position only had to do with the failed bank situation.”
Cole said the ICBA’s main reason for supporting the proposal was to keep opaquely organized consortia of private equity buyers away from failed banks. “The FDIC often doesn’t know who the true principals are behind the deals and we could see that when, for instance, there was a consortium of private equity firms that took over BankUnited. You’re bewildered, who really owns, who’s really backing these private equity firms?” Cole said. “It appeared to us that you didn’t know who was ultimately liable and there were concerns about whether the private equity funds had the resources to operate the bank. We were not only concerned about that but also about do these firms have any commercial interests out there? Are we slowly allowing commercial interests to get into banking through the sale of receiverships, particularly large ones?“
Cole added that after the ICBA submitted its comment letter to the FDIC on the proposal, the organization received worried calls from a few bankers. “They were confused about the whole issue. They were thinking we were taking the position that in all instances we wanted higher capital requirements for all private equity funds in any investment that they had whether it was a healthy or failed bank. We had to clarify that point to them. Some of those calls came from banks that were in some trouble or had some concerns and were seeking private equity capital. We said ‘no no no, you’re confused our position was just on this failed bank investment.’ We weren’t taking a position on a healthy bank or on a bank that has some trouble and has to recapitalize.”
Given this distinction, it isn’t hard to see why observers could view the ICBA as trying to encourage firms to look at operational banks instead of failed ones.
Kip Weissman, a partner at Luse Gorman Pomerenk & Schick PC, dissected the two sides to the argument. On the one hand, he said, making it more strenuous for private equity firms to buy failed banks wouldn’t necessarily divert their attention. The FDIC’s model for receiverships could still be too tempting to resist. Buyers of failed banks are getting lots of help these days, and tough new capital requirements may not dissuade them. “The FDIC made a policy decision supported by the Treasury and others to make receiverships very attractive and unless that decision is reversed all the other incentives that they’re trying to build are going to be at the margin,” Weissman said.
On the other hand, there are advantages to taking over banks before they fail. “There’s a balancing act,” Weissman said. “There are two things that you evaluate: One is the quality of the deal and the pricing and the asset support which in most cases is better after a receivership. The other thing you’ve got to look at is the likelihood of getting the deal. There were a lot fewer buyers for Colonial [Bank] before they went under than after they went under. I’m sure there were quite a few people standing in line for that one.”
BB&T bought Colonial on Friday, he noted, crowding out potential private equity bidders who would have had more of a shot if they had tried to bid before Colonial failed. “Private equity probably looked at that deal and said ‘you know we just can’t make it work before they failed.’ But after they failed they just didn’t have a good chance at getting it.”
There are other upsides, too, Weissman added. “Obviously from the point of view of the bank itself if you’re taken over before you fail, people don’t lose as many jobs, there are fewer lawsuits, the government spends less money.”