How Will Tomorrow’s Financial Regulation Announcements Affect Private Equity?

Tomorrow, President Obama will announce his proposal for financial regulation reform, which is expected to include elimination of the Office of the Thrift Supervision.

So will the new financial regulations affect private equity? Technically, they won’t. Indirectly, they will.

The Office of the Thrift Supervision (OTS) is the agency known for being more lenient on private equity investments in banks. It’s the agency responsible for approving acquisitions of both Indymac and BankUnited by consortiums of buyout firms. With the elimination of the OTS, it’s possible that approval for these types of transactions could fall to the Fed, which currently regulates bank holding companies. Notably, the Fed has yet to approve a bank buyout by private equity.

If the OTC is eliminated, it’s not clear which regulator would handle the regulation of thrift holding companies, but it is likely to be the Fed, said Larry Kaplan, of counsel at Paul Hastings and former general counsel to the OTS.

The Fed may be less likely to approve a club deal like that of BankUnited, where the private equity firms combine forces to buy a bank but stay within regulations with stakes of less than 25%, he said. Further, under the Fed’s rules, a buyer can own up to one third of a bank without being a bank holding company, but the buyer can only own 15% of voting stock. OTS rules mandate a 25% ownership ceiling with a 24.9% voting stock ceiling.

After the regulation is proposed, it will need approval from Congress. According to Kaplan, it won’t happen anytime soon. Since every district has a bank, every member of Congress will have constituents affected by the rules.

The real fight-or-flight moment for private equity will come when the FDIC announces its own set of guidelines for private equity investments in banks. Earlier this week FDIC Chairman, Sheila Bair disclosed more details on what that guidance could include in an interview with Forbes. Bair outlined three main areas of concern for private equity investments in banks:

  • Anti-flipping provisions, which will prevent buyout firms from earning a quick profit and may involve required hold times.
  • Affiliate transactions, or more narrow definitions of existing rules which prevent deals between a bank and its investor. This may come down to the definition of “shareholder.”
  • Cross-Guarantees, which means if a buyout firm invests in more than one bank, even if they are in separate holding companies, those banks can or should guarantee each other.

These are all areas not currently regulated by the FDIC and when they’re finally announced, they’ll be created specifically for private equity. Tomorrow, buyout shops won’t be the focus; they’ll just deal with the side effects.