Private Equity Waits Out the Feds
The U.S. is making it tough for private equity firms to buy ailing banks. In late August the Federal Deposit Insurance Corp. imposed stricter rules for acquisitions, the latest move in a long game of chess between the banking regulator and the buyout giants. But analysts say the FDIC may back down. The number of troubled banks is rising, and the regulator's pot of money is dwindling.
For months private equity players such as Carlyle Group, Blackstone Group (BX), and KKR have been salivating over bad banks. That's because the FDIC has agreed to eat the bulk of the losses in most deals, leaving buyers with huge potential for profits. The FDIC says these "loss-sharing" pacts ultimately save taxpayers money, in part because it's costlier for the U.S. to take over the banks outright. For buyout players, the deals "are like licenses to print money," says a banking lawyer.
Despite the ready pool of capital, private equity has accounted for only a handful of such purchases. The most recent was in May, when Carlyle and a group of other investors bought Florida's failed BankUnited Financial (BKUNQ) for $900 million. Instead, established banks have bought most of the failed institutions from the FDIC, snapping up dozens since the start of 2009.
Dealmakers say the government is the biggest roadblock for private equity. Under the new FDIC rules, a bank acquired by private investors will have to keep an extra cushion of capital to protect against losses, roughly 10% of assets in the first three years of ownership. The buyout industry calls the requirement unfair. In similar situations, bank holding companies typically set aside capital that amounts to 8% of assets. "We're being held to a different set of rules," says a deal-maker at a large private equity firm.
The changes are less stringent than initially proposed, and FDIC Chairman Sheila C. Bair told BusinessWeek they are justified. The agency, she noted, has received several dubious bids for failed banks. One private equity firm proposed to flip the bank to another investor quickly. Another wanted an offshore company to own the bank, making it less transparent. Private equity firms "have greater risks to us than established banks," Bair said. "We want them in, but we want to set some ground rules that will address the heightened risk."
The FDIC can afford to take a tough stance for now. The stock market is way off its lows, and housing shows signs of stabilizing. As a result, banks, which have been suffering under the weight of bad loans, aren't as desperate to raise money from outside investors.
But the crisis isn't over. Since the start of 2008 the number of banks on the FDIC's "problem list" has jumped threefold, to 416, the highest in 15 years. If a double-dip recession occurs, the housing market fails to improve markedly, or commercial real estate crashes, those banks may need a fresh infusion of capital—and fast.
That's why industry experts figure the government will loosen the capital criterion. Bair expects private equity dealmaking will pick up despite the new requirements. But she acknowledges the banking system's hunger for capital and plans to revisit the rules in six months. "We'll see how [the new plan] works," she says. If too many banks sour, the FDIC may run out of cash and be forced to tap a line of credit from the Treasury. It has just $10.4 billion left in a fund to cover insured deposits, the lowest amount in a decade. The math, says Robin Maxwell, a banking lawyer at law firm Linklaters, favors private equity: "The FDIC just needs the money."