FDIC Eases Rules on Private Investors Buying Failed Banks

By Marcy Gordon
Associated Press
Thursday, August 27, 2009

The Federal Deposit Insurance Corp. approved rules Wednesday aimed at making it easier for private investors to buy failed banks, a move that comes as the agency is squeezed by a surge in bank failures.

The FDIC's board voted 4-1 to reduce the cash that private-equity funds must maintain in banks they acquire. Private-equity funds tend to buy distressed companies, slash costs and then resell them a few years later. They have been criticized for excessive risk-taking. But the depth of the banking crisis has softened the FDIC's resistance to them.

The agency's deposit insurance fund, which insures customers' deposits, has shrunk under the weight of collapsing banks. Analysts warn it could fall below zero by year's end. The FDIC is scheduled to reveal on Thursday how much was left in its reserves at the end of June.

At least in theory, having private investors buy failing banks would allow the FDIC to reduce the losses it would have to cover at a failed bank.

Under the new rules, a buyer would need to maintain the bank's capital reserves equal to 10 percent of the failed bank's assets, down from 15 percent under an earlier proposal. That compares with a 5 percent minimum requirement for banks that buy other banks. And the new policy limits the circumstances under which private investors must maintain assets that could be provided if needed to bolster banks they own.

But the FDIC sought to guard against private-equity funds that might want to quickly buy and sell at a profit: It required the acquiring investors to maintain a bank's minimum capital levels for three years.

Eighty-one banks have failed so far this year, compared with 25 last year and three in 2007. The closings have drained billions from the FDIC's deposit insurance fund, which insures regular bank accounts up to $250,000 and is financed with fees paid by U.S. banks.

"The FDIC recognizes the need for new capital in the banking system," the agency's chairman, Sheila C. Bair, said before the vote.

John E. Bowman, acting director of the Office of Thrift Supervision, was the lone holdout Wednesday. He said the new policy was still too strict and "could chase potential investors away." Rising loan defaults, fed by falling home prices and worsening unemployment, have hammered banks.

The FDIC estimates bank failures will cost the fund around $70 billion through 2013. The fund stood at $13 billion -- its lowest level since 1993 -- at the end of March. It's slipped to 0.27 percent of insured deposits, below a congressionally mandated minimum of 1.15 percent.

The FDIC seizes failed banks and seeks buyers for their branches, deposits and soured loans. The agency says private-equity firms can inject needed capital into the system, especially with fewer healthy banks looking to acquire failed institutions.

"There's an enormous need for private money to do this," said Josh Lerner, a professor of finance at Harvard Business School. "There's the sense that you have a lot of money which is currently sitting on the sidelines."

The 2,000 private-equity firms in the United States have around $450 billion in capital to invest, according to the Private Equity Council, the industry's advocacy group.

Douglas Lowenstein, president of the Private Equity Council, said in a statement the new policy is an improvement over a proposal floated by the FDIC last month. "But we continue to question the need to impose more onerous capital requirements on private equity firms," he said.

Organized labor still denounces the private-equity industry as being full of vultures and job-killers.

The industry is exploiting the economic crisis to enrich itself, said Stephen Lerner, director of the private-equity project at the Service Employees International Union. "They are trying to use their political and financial sway to get into what they see as bargain basement prices for very little risk."

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