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Late last week, the FDIC announced it had rescinded a 2009 statement of policy that restricted non-bank entities’ participation in failed-bank auctions. This Sullivan & Cromwell alert notes that this change was previewed in a speech by the FDIC chairman earlier this month and follows other recent FDIC actions with similar motivations. Here’s some background from the alert:

The Policy Statement prospectively imposed terms and conditions on covered “private investors” in a company seeking to acquire any part of the deposit franchise of a failed bank. These terms and conditions included:

– a prohibition on private investors utilizing “complex and functionally opaque ownership structures,”
– a requirement to disclose to the FDIC information relating to the private investor’s chain of ownership and affiliates,
– a requirement that private investors maintain their investment for a three-year minimum term, and
– a requirement that the investors undertake in certain circumstances to pledge the stock acquired in one depository institution to the FDIC as a form of “cross-support” in the event of the failure of any other depository institution under common ownership by the investors.

The Policy Statement also imposed conditions on the acquiring institution in which a private investor invested, most notably a requirement to maintain a ratio of Tier 1 common equity to total assets of at least 10% throughout the first three years from the time of acquisition and an outright prohibition on extensions of credit to affiliates of the private investor.

The rescission notice states:

The FDIC recognizes that nonbank entities such as private equity firms can play a significant role in the resolution process, given their ability to access and
deploy significant pools of capital. Because the Statement of Policy is more restrictive than certain statutory requirements, and also introduces another point of approval and uncertainty for nonbanks in the failed bank acquisition process, the FDIC believes that continuing to apply the Statement of Policy may have a deterrent effect on private capital investment and inhibit the infusion of a potentially significant flow of capital into failed institutions.

Given the increased speed with which a bank failure may occur, in part driven by the advancement of technology and ongoing evolution of the financial system, these impacts could, in turn, result in considerably increased costs of resolution and risk to the Deposit Insurance Fund. Potential investors willcontinue to be required to comply with existing laws and regulations—including those governing capital, control, affiliate transactions, and antimoney laundering/countering the financing of terrorism requirements— and will be expected to operate in a safe and sound manner following an acquisition. Rescinding the Statement of Policy will improve the ability of nonbanks to participate in the resolution process.

– Meredith Ervine