FDIC eases rules for private buys of failed banks

Federal regulators have eased restrictions for private investors seeking to buy failed banks, as the tally of collapsed institutions mounts and well-funded buyers are scarce.

The Federal Deposit Insurance Corp.'s board voted 4-1 in a public meeting Wednesday to revise the rules it proposed last month in a way that lessens the amount of cash that private equity funds must maintain in the banks they acquire.

The minimum capital requirement was reduced to 10% of the bank's assets from 15%. The required capital must be maintained in the bank for at least three years, a mandate unchanged from the earlier proposal.

Private equity funds — which tend to buy distressed companies, cut costs and then resell them — have been criticized for their risk-taking and outsized pay for managers. But the depth of the banking crisis appears to have tempered the FDIC's resistance to private investors buying failed banks. That's partly because fewer healthy banks are willing to acquire other, ailing institutions with the financial crisis and recession causing banks to fail at the fastest pace since the height of the savings-and-loan crisis in 1992.

Eighty-one banks have failed so far this year. The closings have drained billions from the FDIC deposit insurance fund, which insures regular bank accounts up to $250,000 and is financed with fees paid by U.S. banks.

"The FDIC recognizes the need for new capital in the banking system," the agency's chairman, Sheila Bair, said before the vote.

The compromise struck among the FDIC directors — two of whom opposed the policy as proposed in early July — "is a good and balanced one," Bair said.

Banks need to be operated "profitably but prudently," she said.

One of the two original opponents, Comptroller of the Currency John Dugan, said the rules as originally written would have been "very costly" to the deposit insurance fund and the new ones "are a significant improvement."

The new policy also reduced the circumstances in which investment funds themselves would be required to maintain minimum levels of capital that can be provided to bolster banks they own.

John Bowman, the acting director of the Office of Thrift Supervision, was the lone holdout Wednesday, saying the new policy "could chase potential investors away."

Rising loan defaults, fed by tumbling home prices and worsening unemployment, have hammered banks. Eighty-one have failed so far this year, compared with 25 last year and three in 2007.

The FDIC estimates bank failures will cost the fund around $70 billion through 2013. The fund stood at $13 billion — its lowest level since 1993 — at the end of March. It's slipped to 0.27% of insured deposits, below a congressionally mandated minimum of 1.15%.

The FDIC seizes failed banks and seeks buyers for their branches, deposits and soured loans. Under the crush of failures, the agency says private equity can inject vitally needed capital into the system, especially with fewer healthy banks looking to acquire failed institutions.

"There's an enormous need for private money to do this," said Josh Lerner, a professor of finance at Harvard Business School. "There's the sense that you have a lot of money which is currently sitting on the sidelines."

A potential "sweet spot" for private equity buyers are banks with $5 billion to $20 billion in assets, said Chip MacDonald, an attorney at Jones Day in Atlanta. Falling within that range was BankUnited, a Florida thrift with $12.8 billion in assets that closed in May. BankUnited was sold for $900 million to a group of private equity investors that included billionaire Wilbur Ross' firm, without the new FDIC policy being in effect.

Private equity firms mostly buy distressed companies, slash costs and then resell them a few years later. They invest their own capital to buy a company and pump it up with money from other investors.

Such "leveraging" to buy companies amounts to, on average, three-to-one for private equity firms: They invest $3 in outside capital for each $1 they put up themselves. The roughly 2,000 private equity firms in the U.S. have around $450 billion in capital to invest, according to the Private Equity Council, the industry's 2-year-old advocacy group.

Investors in private equity funds include pension funds, university endowments and charitable foundations.

Organized labor still denounces private equity as vultures and job-killers. Unions got a sympathetic ear from many Democrats in Congress in 2007, when several key lawmakers pushed to raise taxes for managers of private equity firms as well as hedge funds. That tax campaign stalled.

The private equity industry is exploiting the economic crisis to enrich itself, said Stephen Lerner, director of the private equity project at the Service Employees International Union. "They are trying to use their political and financial sway to get into what they see as bargain basement prices for very little risk."