United States: FDIC Adopts Modified Policy Statement on Private Equity Investments in Failed Banks

Last Updated: August 31 2009

Originally published August 26, 2009

Article by Scott A. Anenberg , Thomas J. Delaney , Charles M. Horn , David R. Sahr and Jeffrey P. Taft

Keywords: FDIC, private equity, failed banks, failed thrifts, de novo banks, de novo thrifts, Tier 1 capital, prompt correction action, cross-guarantee obligations

By a vote of 4-1 (with OTS Acting Director John Bowman dissenting), the board of the Federal Deposit Insurance Corporation (FDIC) adopted a final policy statement establishing guidelines for private equity investors in failed banks or thrifts. The "Final Statement of Policy on Qualifications for Failed Bank Acquisitions" (Policy Statement) (available at http://www.fdic.gov/news/board/Aug26no2.pdf) reflects a few important modifications to the FDIC's controversial July 2, 2009, proposal (Proposal) (see our Client Alert, "FDIC Proposes a Hard Line on Private Equity Investments in Failed Banks"), but retains many of the elements of the original proposal.

A brief summary of the significant provisions of the Policy Statement, including highlights of the key modifications to the Proposal, follows.

Scope: Consistent with the Proposal, the Policy Statement applies to (i) private investors in a company seeking to acquire deposits (or deposits and assets) of failed institutions from the FDIC, and (ii) applicants for FDIC insurance for de novo banks or thrifts issued in connection with the resolution of failed banks or thrifts. However, the Policy Statement now makes clear that it does not apply retroactively, and it does not apply to investments of less than 5 percent of "the total voting power" of a bank or thrift (or its bank or thrift holding company), provided, in the latter case, that there is no evidence of "concerted action" by the investors.

In an effort to encourage private equity investors to partner with established (and regulated) holding companies, the Policy Statement also excludes investors that invest in failed banks or thrifts together with bank or thrift holding companies that have "strong majority interests in the resulting bank or thrift and an established record for successful operation of insured banks or thrifts." Finally, the Policy Statement adds a provision permitting the FDIC to approve an application for relief from the restrictions, but only after the bank or thrift has continuously maintained a composite supervisory rating in one of the two highest categories for seven years.

Source of Strength: The Policy Statement eliminates what was arguably the Proposal's most controversial provision—the requirement that the "investor organizational structure" serve as a "source of strength" for the subsidiary bank or thrift, including a specific agreement by the investing holding company to raise any necessary capital.

Capital: The Policy Statement requires the target institution to maintain a 10 percent leverage ratio of Tier 1 common equity to total assets for at least three years, and to remain at least "well-capitalized" (i.e., leverage ratio of 5 percent, Tier 1 risk-based ratio of 6 percent, and total risk-based ratio of 10 percent) thereafter. Significantly, while the 10 percent requirement is lower than the 15 percent ratio contained in the Proposal, the Policy Statement's requirement that capital be in the form of "Tier 1 common equity" is more restrictive than the reference to "Tier 1 capital" in the Proposal and precludes the ability to rely on items such as perpetual preferred stock and certain hybrid capital instruments that are treated as Tier 1 capital. In addition, failure to meet these heightened (as opposed to regular) capital requirements would result in the institution being treated as "undercapitalized" for prompt correction action (PCA) purposes. That treatment would subject the institution to a range of mandatory and discretionary supervisory actions, including, for example, requirements to submit a capital restoration plan, restrictions on asset growth, and prohibitions on payment of cash dividends.1

Cross-Guarantee Obligations: Investors that own 80 percent or more of two or more banks or thrifts must pledge their stock in each institution to the FDIC to cover losses to the deposit insurance fund caused by the other. The policy statement thus represents a rather modest liberalization of the proposal, which would have imposed this requirement at the majority (rather than 80 percent) ownership level. The Policy Statement also permits the FDIC to waive this requirement if the pledge "would not result in a decrease in the cost of the bank or thrift failure to the Deposit Insurance Fund."

Minimum Holding Period: The Policy Statement retains the Proposal's general prohibition on investors selling any of their shares in the institution or its holding company for three years, unless the FDIC approves. However, the FDIC modified the requirement slightly to clarify that in the case of transfers to affiliates, FDIC approval will not be unreasonably withheld, and that the retention requirement does not apply to mutual funds.

Silo Structures: Like the Proposal, the Policy Statement generally prohibits the use of "silo" structures in which beneficial ownership cannot be ascertained, decision-making responsibility is not clearly identified, and/or ownership and control are separated. However, in response requests for clarification, the Policy Statement describes a "silo" structure as "typified by organizational arrangements involving a single private equity fund that seeks to acquire ownership of a [bank or thrift] through creation of multiple investment vehicles, funded and apparently controlled by the parent fund."

Extensions of Credit to Investors and their Affiliates: The Policy Statement continues to prohibit all extensions of credit to investors, their investment funds, and any affiliates (defined at the 10 percent ownership level, but, in a modest change from the Proposal, only if held for at least 30 days), by a bank or thrift acquired by those investors. Despite the minor modification, this condition continues to go well beyond the traditional restrictions imposed on affiliate transactions under Section 23A of the Federal Reserve Act. The Policy Statement also adds an express requirement that investors provide periodic reports to the bank or thrift identifying their affiliates.

Secrecy Jurisdictions: Like the Proposal, the Policy Statement prohibits the use of entities domiciled in "secrecy jurisdictions" within the ownership structure unless (i) the parent company has been found by the Federal Reserve Board to be subject to "comprehensive consolidated supervision" in its home country, and (ii) the investors satisfy additional regulatory requirements, including executing a consent to jurisdiction and agreement to provide certain information. Recognizing that this exception will rarely be met, the FDIC simply states that "investors can organize efficient and functional ownership structures in the U.S." The Policy Statement adds a broad and somewhat amorphous definition of "secrecy jurisdiction" to include countries that limit US bank regulators' access to certain information, lack information exchange authority with US regulators, fail to "provide for a minimum standard of transparency for financial activities," or permit offshore companies to operate "shell companies without substantial activities within the host country."

Ability of Existing 10 Percent Owners to Participate: The Policy Statement adopted, without change, the Proposal's prohibition on existing 10 percent shareholders of a bank or thrift from joining an investor group seeking to acquire the assets and/or liabilities of that institution upon its failure.

Disclosure: Under the Policy Statement, like the Proposal, prospective investors must provide significant information to the FDIC about the investors and all entities in the ownership chain (including, e.g., size of the capital fund, its diversification, return profile, marketing materials, management team and the business model). However, the Policy Statement clarifies that "confidential business information" submitted by investors will be "treated as confidential business information and shall not be disclosed except in accordance with law." Presumably this language contemplates a process similar to the current regime of submitting requests to protect confidential information from disclosure under the federal Freedom of Information Act, which does not protect against disclosure in all circumstances.

Waivers: The FDIC board may waive any or all provisions of the Policy Statement, but only if it determines that it is "in the best interests of the Deposit Insurance Fund and the goals and objectives of [the Policy Statement] can be accomplished by other means."

Six-Month Review: In response to a suggestion by Comptroller of the Currency John Dugan, the Policy Statement also includes a requirement that the FDIC review the Policy Statement six months after it is issued to evaluate its effectiveness and consider any appropriate modifications.


Although deletion of the source of strength requirement represents a significant liberalization from the Proposal, the other modifications are more modest, and it remains to be seen whether the overall impact of the final Policy Statement will in fact discourage private equity investors from aggressively bidding for failed institutions. One possible impact of the Policy Statement may be to encourage some private equity investors to join with traditional bank and thrift holding companies in bidding on failed institutions and thus avoid the Policy Statement's restrictions altogether.

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1 FDIC's authority to impose this requirement appears somewhat unclear in light of the fact that the PCA regime is generally administered by the primary federal regulator of the bank or thrift, which may not be the FDIC.

Mayer Brown is a global legal services organization comprising legal practices that are separate entities ("Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP, a limited liability partnership established in the United States; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales; and JSM, a Hong Kong partnership, and its associated entities in Asia. The Mayer Brown Practices are known as Mayer Brown JSM in Asia.

This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.

Copyright 2009. Mayer Brown LLP, Mayer Brown International LLP, and/or JSM. All rights reserved.

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