When BankUnited went into Federal Deposit Insurance Corporation (FDIC) receivership on May 21, it didn’t take long for a group of new owners to step up to the plate. The Coral Gables, Florida savings and loan group was picked up by a consortium of private equity heavyweights—including W.L. Ross, Carlyle, and Blackstone. The $900 million price tag may have removed a significant burden from the shoulders of both the FDIC and the American taxpayer, but the ramifications of the PE-bank deal will prove a topic of contention for the many regulators caught in the mix.
The established regulatory view is that private equity, with its risky plays, secrecy-at-all-costs culture, and vast pool of dollars, does not mix well with the staid thrift banks that are the humble base of the economic pyramid. The overarching rule, as enforced by the Federal Reserve—and as mandated by the Bank Holding Company Act of 1956—is that bank holding companies cannot engage in non-banking activities. “A conglomerate that owns a bank cannot be engaged in traditional commercial pursuits,” says University of Connecticut law professor Patricia McCoy. “The Fed’s concern here is that by allowing private equity into the banks, they’re eroding the traditional wall that exists between banking and commerce.”
PE firms, which generally have their eyes set on many industries beyond commercial banking, of course would prefer to run thrifts with the same iron grip they use on other riskier ventures. To prevent this, the Fed limits non-bank holding companies to controlling positions of under 25 percent, which requires the type of private equity group-deal seen in the BankUnited takeover. “Banking is a fairly high-risk venture these days,” says McCoy, “and being able to control management and make investment decisions and handle risk is essential for PE firms.” However, as is often the case, the promise of profit can persuade buyout firms to adjust their expectations.
Though the credit climate is gradually thawing, capital is stillrelatively scarce, and regulators would love to see some of the $1trillion in dry powder that global PE firms have collected inanticipation of a healthy investment climate, go into the banking sector.
“I’m not sure [PE firms] need control of the banks,” says Lawrence D. Kaplan, general counsel at Paul Hastings and a former regulator with the Federal Home Loan Bank Board (now the Office of Thrift Supervision [OTS]). “I think most firms view the banking sector as underpriced, and financial institutions now have terrific opportunities to get returns for investors.”
The introduction of PE firms into the banking sector is also advantageous for regulators eager to get commercial banks back on track. Though the credit climate is gradually thawing, capital is still relatively scarce, and regulators would love to see some of the $1 trillion in dry powder that global PE firms have collected in anticipation of a healthy investment climate. Says Walter J. Mix III, managing director of consulting firm LECG, “The size of the banking and savings and loan problem exceeds the FDIC funds’ capacity, and the banking sector will need private as well as government capital in order to improve credit availability.”
In order for that money to make its way through the thousands of U.S. commercial lenders, regulators are going to have to come to an agreement on just how PE firms interact with small banks. “The issue for the regulators is that they want a well-qualified board of directors and management with the requisite banking experience,” says Mix. “In this type of market, that especially means experience with credit and liquidity.” While the Fed has so far taken a hardline stance, the OTS has proven itself more willing to allow leeway among the approximately 800 thrifts it regulates. Earlier in the year, the OTS approved the takeover of thrift Flagstar Bancorp by distressed assets specialist MatlinPatterson Global Advisers. For $350 million, MatlinPatterson got a 70 percent stake in the Troy, Michigan bank, going against the Fed’s opposition to PE firms taking majority stakes.
The FDIC, too, has shown its willingness to cooperate with private money. Says Kaplan, “We may see a willingness of the FDIC to allow private equity buyout deals, and if this happens, it’s going to put pressure on the Fed to hammer out a deal with other regulators to determine when such buyout deals would qualify as sound.” Besides the BankUnited deal, the FDIC approved the sale of $13.9 billion worth of IndyMac assets to a group of private equity investors that included J.C. Flowers and Paulson & Co. Following the close of the BankUnited deal, the regulator pointed to an upcoming policy shift: “Due to the interest of private equity firms in the purchase of depository institutions in receivership, the FDIC has been evaluating the appropriate terms for such investments. In the near future, the FDIC will provide generally applicable policy guidance on eligibility and other terms and conditions for such investments to guide potential investors.”
Clearly, the tide is shifting in favor of more and more private equity firms that want a stake in the banking sector. With trillions in banking assets on its books, the Fed may need to reevaluate the merits of PE buyouts as apply to the heretofore sacrosanct area of commercial banking. Says Kaplan, “The Fed’s going to have to look at potential buyouts on a case-by-case basis, and to look through the legal precedents, but they can’t ignore that PE has the cash and because of that we can’t rule them out.” Mix says that it’s possible for private equity to make a bigger footprint in the banking industry without a complete overhaul of the rules: “I wouldn’t foresee a policy change unless Obama or Congress specifically directs such a change. Regulators are going to try and make it work with the tools they have.”