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FDIC Set to Open Bank Gates to Buyout Barbarians?

The FDIC today is expected to issue rules for private equity investors interested in buying banks. Here's why that matters: Buyout firms are sitting on an estimated $1 trillion, and banks desperately need some of it.

Apart from additional public financing, private investors are the best best for financial firms seeking the necessary funds to put them back on track. The FDIC faces a delicate balancing act. It needs PE investors to acquire ailing institutions, especially as the pace of bank failures accelerates, without giving these investors the kind of sweetheart deals that exposes taxpayers to potentially large losses. As my colleague Daniel Harrison notes, the agency is likely to err in favor of lowering the bar for buyout firms eyeing banks.

PE firms could play an important role in rehabilitating damaged banks, which obviously is key in reviving the U.S. economy. For one thing, with pension plans, mutual funds and other big investors still mostly cooling their heels, they're the largest source of capital with the risk appetite to invest in banks. For another, buyout shops move fast. These financial "barbarians," as critics deride them, are known for their aggression in restructuring portfolio companies, including throwing management out on its ear if it doesn't cooperate. Their goal is to fix broken companies as speedily as possible so they can be taken public or, more commonly, sold.

Quite properly, that's a source of concern for the FDIC. Under its original proposal, the agency would require PE firms to hold acquired banks for at least three years, a barrier to quick flips. PE investors are pushing for an 18 month limit.

A larger sticking point is how much capital PE-owned banks must keep on hand as a buffer against losses. The FDIC initially wanted such institutions to maintain leverage ratios of 15 percent, which is much higher than normal even for a well-capitalized bank (where a ratio of five percent is standard).

PE firms have squawked about the high threshold, and chances are the agency will reduce it. (I wouldn't be surprised if FDIC chief Sheila Bair, a shrewd operator, deliberately set a high leverage minimum so the agency had ground to give after buyout investors inevitably complained.)

Several PE firms have purchased banks of late. The results have been mixed. A consortium of buyout shops bought mortgage lender IndyMac in January for nearly $14 billion. The company, since re-named OneWest, has come back strong, reporting a $182 million profit in its most recent quarter. Of course, that profit came at an expense, draining some $11 billion from the FDIC's insurance fund after the agency agreed to absorb most of IndyMac's losses.

Other deals have been less successful. PE firm MatlinPatterson invested $350 million in FlagStar, a big mortgage underwriter, earlier this year. But FlagStar continues to struggle and faces pressure to sell a large chunk of its mortgage assets at a loss. In another transaction gone bad, a group of investors led by PE firm J.C. Flowers in 2008 bought a minority stake in German mortgage banking company Hypo Real Estate, only to see the company's shares plunge. The company has since been nationalized, with investors set to take a fat loss.

PE firms have their own reasons to be wary. In 2008, PE giant Texas Pacific Group notoriously invested $1.3 billion in thrift Washington Mutual, which promptly collapsed. Also last year, Corsair Capital pumped $7 billion into regional bank National City, subsequently sold to PNC Financial for $5.6 billion in another government-brokered deal.

In other words, a torrent of private money into banks won't cure the industry's ills. But it might help stem the tide of bank failures at a lower public cost than if the FDIC is left to soak up the damage alone.

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