August 28, 2009
Gibson, Dunn & Crutcher LLP is closely monitoring risks and opportunities arising from the recent and dramatic reshaping of our capital and credit markets. We are providing updates on key transactions as well as regulatory and other legal developments that we believe could prove useful to financial institutions, investors, financial sponsors and other entities.
On August 26, 2009 the Federal Deposit Insurance Corporation (the "FDIC") adopted a final Statement of Policy on the Acquisition of Failed Insured Depository Institutions (the "SOP"), which sets the standards "private investors" must meet in order to qualify to bid on failed institutions seized by the FDIC.
The SOP finalizes the Proposed Statement of Policy on Qualifications for Failed Bank Acquisitions, dated July 2, 2009 (the "Proposed SOP"). The SOP follows vigorous industry debate and a 30-day public comment period on the Proposed SOP during which the FDIC held a roundtable discussion and received 61 individual comment letters. See Gibson, Dunn & Crutcher Client Alert "Release of FDIC Policy Statement on Qualifications for Failed Bank Acquisitions by Private Capital Investors", July 7, 2009, for a discussion of the Proposed SOP.
The SOP retains most of the provisions of the Proposed SOP. However, it eliminates one and alters several other provisions that were highly criticized by industry participants. The provision removed was the "Source of Strength" provision that would have required private capital investors to serve as financial backstops in the event an acquired depository institution faced financial trouble. In addition, the highly controversial enhanced capital commitment provision of the Proposed SOP was altered, but, as discussed further below, altered in such a way as to largely preserve the FDIC’s enhanced capital cushion goal. Importantly, the scope of the investors and firms covered by the SOP continues to be unclear. As a result, the standards set forth in the SOP remain robust and are likely to be broadly applied by the FDIC.
A complete copy of the FDIC’s Final Statement is available.
Purpose of SOP
In the SOP, the FDIC is attempting to balance two concerns, both of which relate to the FDIC’s primary objective of protecting the Deposit Insurance Fund (the "DIF"). First, the FDIC wants acquirers of failed banks and thrifts to have the "experience, competence, and willingness" to effectively and prudently operate such institutions, and the FDIC believes that investors with short term investment horizons are less likely to provide these attributes. Banks that are operated ineffectively, or without sufficient capital support, are more likely to fail again, impacting the DIF. Consequently, the FDIC wants private capital investors without a prior track record of successful operation of financial institutions that acquire a failed institution to commit to maintain higher capital levels and to hold the investment for at least a three year period. On the other hand, the FDIC is aware that the banking industry requires significant new capital and is reluctant to enact policies that may inhibit capital formation and investment in the industry. Fewer bidders for FDIC assets would likely mean lower initial auction bids and, again, a greater impact on the DIF.
The following summarizes the standards "private investors" must satisfy to bid on failed bank assets.
The SOP generally applies to (a) "private investors" that invest in a company proposing to assume the deposit liabilities (or liabilities and assets) of failed insured depositories and (b) applicants for deposit insurance for a de novo bank or thrift issued in connection with the resolution of a failed insured depository.
No Clarification Provided on Meaning of “Private Investor”: Many commentators sought clarification of the term "private capital investor" used in the Proposed SOP, particularly given that the term has no generally understood meaning. However, the FDIC declined to provide guidance on the types of firms to be covered, citing the "multiple variations in the structures" of bidders it observed bidding on failed banks. The final SOP uses the even more generic term "Investors," which it defines in terms of the types of transactions in which an entity engages rather than in terms of how the entity is structured, managed, or raises capital. Thus, the FDIC appears to be preserving its option to apply the SOP broadly to any "private investor" as well as to any investment structure it views as requiring enhanced scrutiny.
Exceptions and Limitations: The SOP applies only prospectively. In addition, the FDIC has broad authority to waive any provisions of the SOP if it deems waiver to be in the best interest of the DIF. Moreover, a depository subject to the SOP may petition the FDIC for the termination of restrictions if it maintains a composite CAMELS rating of 1 or 2 continuously for seven years, although the standards the FDIC will apply in granting "approval" of such petitions remain unclear. 
Partnerships with Holding Companies. The FDIC encourages private investors to invest with established financial institution holding companies. To this end, the SOP specifically does not apply to private investors that enter into a partnership with a bank or thrift holding company where the holding company has a strong majority interest in the acquired bank or thrift and an established record for success operating insured banks or thrifts.
Less than 5% Holders. Investors with 5% or less of the total voting power of an acquired depository institution are exempt, provided there is no evidence of concerted action by these investors. This exemption may offer structuring possibilities, particularly given the trend toward club deals, but the FDIC has created uncertainty as to what constitutes "concerted action". It is also worth noting that many industry participants had urged the FDIC to adopt a 10% threshold, although the FDIC clearly declined to do so.
A depository acquired by private capital investors must maintain a ratio of Tier 1 common equity to total assets of at least 10% for 3 years from the time of acquisition and afterwards remain "well capitalized" for as long as it is owned by the initial investors. To remain "well capitalized" under current regulations a bank would need to maintain a minimum total risk-based capital ratio of 10%, a Tier 1 risk-based capital ratio of 6% and a Tier 1 leverage ratio (defined as the ratio of Tier 1 capital to average total consolidated assets) of 5%.
The Proposed SOP suggested a 15% Tier 1 leverage ratio. Thus, while the SOP reduces the ratio to 10%, it counts only common equity in the numerator (excluding, for example, other categories of Tier 1 capital such as certain classes of senior perpetual preferred stock and trust preferred stock). The FDIC has explained that the final capital standard of common equity to total assets is "a better measure of the capital available to absorb losses." The Proposed SOP also provided for an extension of the three year holding period, which extension was eliminated in the SOP with the FDIC suggesting it views the perpetual "well capitalized" requirement as sufficient.
If one or more investors own 80% or more of two or more banks or thrifts, the stock of the banks or thrifts commonly owned by these investors must be pledged to the FDIC. If one of the institutions fails, the FDIC may exercise such pledges to recoup its losses.
The FDIC made an effort to clarify the circumstances in which the cross support obligation would apply. Whereas, in the Proposed SOP, investors that individually or collectively owned a majority interest in two or more depositories were required to pledge "proportionate interests" in each bank to the FDIC, the SOP applies only where two or more depositories are at least 80% owned by the same investors.
Transactions with Affiliates:
All extensions of credit to investors (or their affiliates) by an insured depository institution acquired by them are prohibited. Existing extensions of credited are exempted from the prohibition.
The SOP is similar to the Proposed SOP, but clarifies that an affiliate, defined as a company in which the investor owns at least 10% of the equity, must hold that ownership position for 30 days.
Secrecy Law Jurisdictions:
Investors cannot use entities in bank secrecy jurisdictions to own a direct or indirect interest in an insured depository institution unless the investors are subsidiaries of companies subject to comprehensive consolidated supervision as recognized by the Federal Reserve Board and they agree to provide information to federal regulators.
Continuity of Ownership:
Investors are generally prohibited from selling or transferring their securities for three years following the acquisition, absent FDIC approval.
The SOP is similar to the Proposed SOP, except that the FDIC will not unreasonably withhold transfers to affiliates and mutual funds are exempted.
Complex and functionally opaque ownership structures will generally not be approved for ownership of insured depository institutions. This provision is unchanged from the original proposal, with guidance suggesting the FDIC has in mind structures in which a private investor creates multiple investment vehicles that it funds and controls and uses to acquire the depository.
Special Owner Bid Limitation:
An investor that directly or indirectly holds 10% or more of the equity in a bank or thrift in receivership is not eligible to be a bidder for the deposit liabilities, or liabilities and assets, of that failed depository institution. This provision was not changed from the original proposal.
Investors are expected to submit information to the FDIC about themselves and all entities in the ownership chain, including the size of the capital fund (or funds), fund diversification, fund return profile, fund marketing documents, the management team and the business model. Investors are also broadly required to provide the FDIC any other information the FDIC decides is needed to "assure compliance". This is largely the same as the original proposal, with an assurance added that confidential business information will be treated confidentially.
 This seven year period is consistent with other recent FDIC actions. On August 28, 2009 the FDIC released a Financial Institution Letter titled Enhanced Supervisory Procedures for Newly Insured FDIC-Supervised Depository Institutions (the "Letter"). The Letter extends the time during which newly insured depository institutions must meet higher capital requirements and more frequent examinations, from the first three to the first seven years. The reasoning in the Letter is identical to the reasoning in the SOP. Specifically, since the FDIC found depository institutions insured less than seven years are overrepresented in the list of institutions that failed in 2008 and 2009, the FDIC considers that such "de novo" institutions offer heightened risks to the DIF. The Letter provides that during the seven-year de novo period newly insured institutions will remain on a 12-month risk management examination cycle and be subject to enhanced supervision for Compliance examinations and Community Reinvestment Act evaluations.
Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work or any of the following:
Dhiya El-Saden – Los Angeles (213-229-7196, [email protected])
Kimble C. Cannon – Los Angeles (213-229-7084, [email protected])
Stewart L. McDowell – San Francisco (415-393-8322, [email protected])
Douglas D. Smith – San Francisco (415-393-8390, [email protected])
Howard B. Adler – Washington, D.C. (202- 955-8589, [email protected])
Christopher J. Bellini – Washington, D.C. (202-887-3693, [email protected])
Michael D. Bopp – Washington, D.C. (202-955-8256, [email protected])
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