FDIC Issues Final Policies on Investments in Failed Banks

On August 26, 2009, by a vote of 4 to 1, the Federal Deposit Insurance Corporation’s Board of Directors approved a Final Statement of Policy of Qualifications for Failed Bank Acquisitions (the “Policy”). The Policy requires private equity groups to maintain a capital to asset ratio of 10% when investing in failed banks.

The Policy was first proposed on July 2, 2009 and public comment was open for 30 days following its publication. The proposal sparked strong industry reactions. Many commentators argued that it imposed significant and, in many instances, vague restrictions on (i) private equity investments in companies (other than certain existing bank or thrift holding companies) that sought to acquire from the FDIC deposits (or deposits and assets) of failed institutions, and (ii) applicants filing new bank or thrift charters in connection with resolving the status of failed institutions. Members of the investment industry raised concerns that the FDIC’s proposed rules would suppress the desire of private equity funds to commit their capital, instead of encouraging investments in the increasing number of distressed banks. The FDIC Board’s action indicated that it took heed of the comments.

Tier 1 Leverage Ratio Set at 10%. The proposal would have set the Tier 1 ratio of “common equity” (Tier 1 capital less non-common equity elements, i.e., qualifying perpetual preferred stock, plus minority interests and restricted core capital elements not already included) to total assets at 15%. The Policy reduces this leverage ratio to at least 10% for a period of 3 years from the time of acquisition. Thereafter, depository institutions must maintain a level of capital adequacy no lower than the “well capitalized” standard during the remaining period of the investor’s ownership.

To be “well capitalized” (defined in Section 325.103(b)(1) of the FDIC’s Rules and Regulations) requires minimum ratios of 6% Tier 1 capital and 10% Tier 1 and 2 capital to total risk-based assets and a leverage ratio of 5% Tier 1 capital to total assets. If the depository institution fails to meet this standard it would have to immediately take action to restore its capital to the 10 percent Tier 1 common equity ratio or the “well capitalized” standards, as applicable. If a bank fails to maintain the required capital level, it will be treated as undercapitalized.

Cross Support. If one or more investors own 80 percent or more of two or more banks or thrifts, the stock of the commonly-owned banks or thrifts must be pledged to the FDIC. If any one of those banks or thifts fail, the FDIC may exercise pledges to the extent that it needs to recoup any losses that it incurs as a result of the failure. The FDIC may waive this pledge requirement where the exercise of the pledge would not result in a decrease in the cost of the bank or thrift failure to the Deposit Insurance Fund.

Transactions with Affiliates. The Board decided that it would prohibit all extensions of credit to investors, their investment funds if any, and any affiliates of either, by an insured depository institution acquired by such investors. Existing extensions of credit by an insured depository institution acquired by such investors would be exempt from the prohibition. The term “affiliate” means any company in which the investor owns, directly or indirectly, at least 10% of the equity of such company and has maintained such ownership for at least 30 days. Investor must provide regular reports to the insured depository institution identifying all of the investor’s affiliates.

Secrecy Law Jurisdictions. Investors employing ownership structures that include entities domiciled in a country that applies a bank secrecy law (i.e., limits U.S. bank regulators from determining compliance with U.S. laws or prevents them from obtaining information on the competence, experience and financial condition of applicants and related parties, lacks authorization for exchange of information with U.S. regulatory authorities, does not provide for a minimum standard of transparency for financial activities, or permits off shore companies to operate shell companies without substantial activities within the host country) would not be eligible to own a direct or indirect interest in an insured depository institution unless the investors are subsidiaries of companies that are subject to “comprehensive consolidated supervision” (“CCS”) as recognized by the Federal Reserve Board. They must also (i) execute agreements regarding the provision of information to the primary federal regulator about the non-domestic investors’ operations and activities; (ii) maintain their business books and records (or a duplicate) in the U.S.; (iii) consent to the disclosure of information that might be covered by confidentiality or privacy laws and agree to cooperate with the FDIC, if necessary, in obtaining information maintained by foreign government entities; (iv) consent to jurisdiction and designation of an agent for service of process; and (v) consent to be bound by the statutes and regulations administered by the appropriate U.S. federal banking agencies.

Continuity of Ownership. Investors will be prohibited from selling or otherwise transferring their securities for 3 years following the acquisition, unless they obtain the FDIC’s prior approval. The approval shall not be unreasonably withheld for transfers to affiliates, provided the affiliate agrees to be subject to the conditions applicable under this policy statement to the transferring Investor. This requirement does not apply to mutual funds.

Prohibited Structures. The proposal provided that investment vehicles featuring “silo structures” would be ineligible to acquire failed banks. The Policy indicates that the FDIC may determine that complex ownership structures in which the beneficial ownership is difficult to ascertain with certainty, the responsible parties for making decisions are not clearly identified, and ownership and control are separated, would be “substantially inconsistent” with the Policy and inappropriate for approval for ownership of insured depository institutions. The Policy also clarified that a silo structure typically involves a private equity firm (or its sponsor) creating multiple investment vehicles funded and apparently controlled by the private equity firm (or its sponsor) to acquire ownership of an insured depository institution.

Special Owner Bid Limitation. The proposals restrictions on limitations on bids were retained. Investors that directly or indirectly hold 10% or more of the equity of a bank or thrift in receivership will not under any circumstances be considered eligible to be a bidder to become an investor in the deposit liabilities, or both such liabilities and assets, of that failed depository institution.

Disclosure. An investor subject to the Policy is expected to submit to the FDIC information about itself and all entities in its chain of ownership. This includes information such as the size of the capital fund or funds, its diversification, the return profile, the marketing documents, the management team, and business model. In addition, investors and all entities in the ownership chain will be required to provide such other information as the FDIC staff determines to be necessary to assure compliance with this policy statement. Confidential business information submitted by investors to the FDIC in compliance with the disclosure provisions will be treated confidentially and will not be disclosed except in accordance with law.

“Source of Strength” Provision. The proposed rule triggered concern by stating that investors would be expected to serve as a “source of strength” for their subsidiary depository institutions (i.e., the private equity group would be responsible for adding more funds into the bank if it continued to struggle). The Board eliminated this vague concept.

If you have any questions on the FDIC Policy and its impact on investors in failed banks and thrifts or wish to receive a copy of the Policy Statement please contact Michael Lubben.