Private Equity and the FDIC: Why Must It Be The Forbidden Dance?

One of the sharpest snubs to the private equity industry during the credit crisis has been the FDIC’s refusal to let private investors own banks outright. The more the agency tried to set boundaries for private equity acquisitions of banks, the more offense it caused.

The FDIC improved the relationship somewhat over the past year, by reducing punitive leveraged ratio commitments and abandoning a cross-guarantee proposal. Still, its extensive pre-nuptial agreement showed that the agency remained distrustful and wary. A review was kicked off in March, and the results were flagged yesterday by Shasha Dai.

Somehow, it turns out that the FDIC has put police tape around a favorite PE method of buying banks: Recapitalizing an existing bank and using it to make acquisitions in order to avoid the 10% leverage-ratio requirement and the three-year holding period. Rolling up a recapitalized bank would put PE firms under the thumb of the FDIC once more.

Them’s the breaks, right? Sorry, David Bonderman? Play again?

Not so fast. The FDIC should be looking forward to a time when its options are running out, which won’t be far in the future. The agency should examine why it’s playing favorites with bank buyers as compared to private equity buyers. Consider, for instance, that there are very few banks who came through the credit crisis strong enough to buy rivals. Most of the others have terrible toxic assets, and the FDIC is spending a lot of its own money offering various guarantees and stock-sharing agreements trying to convince other banks to buy them.

And even if they’re bought, the FDIC is still stuck, as the Wall Street Journal pointed out:

The Federal Deposit Insurance Corp., and by extension the U.S. taxpayer, owns more than 250 collateralized debt obligations that were purchased by small institutions that later failed. Although the bonds have a book value of more than $400 million, they are a headache for the agency as it grapples with the toxic assets flowing from many banks around the country.

The issue of CDO exposure is bigger than the usual one that many troubled banks (and their acquirers) carry, including exposure to failing home loans, commercial loans, and the problem of “hot money,” or depositors that abandon banks who lower their interest rates. The financial-reform bill seems to acknowledge this because it will prevent banks from counting trust-preferred securities in their tier-1 capital. That will make banks even less well-capitalized. Private equity firms may have a lot of issues – excessive debt among them – but they do seem to be better managed than many banks. The FDIC’s arms should be more open.