FDIC Backs Off Slightly, As PE Firms to Buy Troubled Banks

Includes: BX, XLF
by: Zachary Scheidt

The FDIC voted Wednesday to approve guidelines for private equity firms interested in buying failed banks. You may remember in early July the governing body came up with a proposal to place tighter restrictions on these transactions effectively shutting out some much needed capital for these troubled institutions.

After the initial announcement, The Blackstone Group LP (NYSE:BX) traded off sharply as investors worried that the company would be kept from participating in some of these lucrative deals. Since that time the stock has rebounded as it became clear that private equity firms clearly had the upper hand in this negotiation. The FDIC needs PE firms to help with the orderly transition for failed banks much more than PE firms need the opportunities (there are plenty of other attractive takeover candidates in many other sectors).

The final ruling showed that the FDIC was willing to give up some ground as private equity investors are now only required to maintain 10% Tier 1 capital instead of the proposed 15%. This means that as PE firms take on the balance sheet of a bank and theoretically bring it back to life, the amount of capital required to stick with the bank is a bit less restricting than previously proposed. This will result in much larger profits for such transactions and while it likely means banks will eventually be sold to the public with more debt on their books, the liquidity need for today will likely lead to more help from the PE community.

New regulation is aimed at Private Equity firms who are seen by many as preying on troubled companies and turning a quick profit by selling these banks into public markets – often before they are truly viable on their own. The argument seems to miss the vital role Private Equity firms play in taking on risk through these transactions and providing capital that is often cheaper than alternatives – or even not available elsewhere. The important thing for the overall economy is making sure that the system is truly set up to incentivize buyers of these troubled banks to build new stable institutions that can withstand the difficult environment that is our current economy.

The FDIC recognizes the need for additional capital in the banking system… We want to maximize investor interest in failed institutions… We do want people who are serious about running banks.

~Sheila Bair, FDIC Chairman

Yesterday’s decision was a step in the right direction as it allows free market transactions to take place, but still requires a reasonable amount of care when dealing with some of the most important institutions in our economic system. We certainly need to ensure that these failed banks are not resurrected, spun off on their own, and wind up failing again simply because private equity firms were too quick to turn their profit. At the same time, the FDIC (which is eventually funded by all of us who hold deposit accounts through insurance premiums paid by banks) needs to have access to the deep pools of capital offered by private equity investors.

It’s important for industry and governing bodies to figure out ways to align their interests and offer our economy a more stable foundation from which to grow.