FDIC Final Policy Statement Onerous and Unclear

At a meeting of the Board of Directors of the FDIC on August 26, 2009, the FDIC adopted a Final Statement of Policy on Qualifications for Failed Bank Acquisitions. The final policy statement establishes standards and requirements for private investors acquiring or investing in failed insured depository institutions, including through holding companies formed for that purpose. While the final policy statement is a substantial improvement over the proposed policy statement issued on July 2, 2009, it nevertheless subjects private investors to more onerous requirements than those applicable to existing banks, thrifts and their respective holding companies, which explicitly remain the FDIC’s preferred buyers of failed insured depository institutions. Just how onerous these requirements will be is unclear, as the final policy statement leaves a number of terms and concepts undefined and thus subject to the discretionary interpretation of the FDIC. The FDIC Board of Directors has not only reserved the right to modify the policy statement in specific situations, but also agreed to revisit the policy statement in six months.

Highlights

Scope. The policy statement will not apply to private investors with 5% or less of total voting power; nor will it apply to pre-existing investments in failed depository institutions.

Term. Upon application to the FDIC, investors may seek relief from the policy statement if the institution invested in has maintained a composite CAMELS rating of 1 or 2 continuously for seven years.

Capital. The FDIC backed off its proposed 15% Tier 1 leverage requirement, but instead imposed a minimum 10% ratio of Tier 1 common equity to total assets. While the 10% requirement probably will not eliminate private capital bids for failed banks, at least in the near term, it represents a financial penalty that will reduce any potential bid, thus hindering private investors.

Cross Guarantee. The FDIC backed off its initial proposal to impose cross-guarantee liability where there is majority common ownership, increasing the common ownership threshold to 80% and clarifying the intent to impose that liability on common owners directly. While the 80% test is a significant improvement, it still represents a deterrent for prospective private investors.

Source of Strength. The FDIC completely eliminated the proposed source of strength requirement, but underlined the source of strength obligations of a depository institution’s holding company by deeming an insured depository institution “undercapitalized” for purposes of prompt corrective action if its Tier 1 common equity ratio drops below 10%.

Transactions with Affiliates. The final policy statement goes well beyond Section 23A of the Federal Reserve Act by flatly prohibiting transactions with private investors, their investment funds and any of their respective affiliates and by defining affiliates by reference to a 10% level of ownership.

Bank Secrecy Jurisdictions. The FDIC retained the ability to refuse to allow investors from so-called bank secrecy jurisdictions to participate.

Holding Period. The FDIC retained the minimum three-year ownership requirement, although it will permit transfers to affiliates that agree to the provisions of the policy statement, subject to FDIC consent, and it excluded mutual funds from this minimum holding period requirement.

Prohibited Structures. The FDIC retained the ability to preclude ownership structures that the FDIC determines to be “complex and functionally opaque.”

Precluded Investors. The policy statement retains a prohibition on investors that hold 10% or more of the equity of an institution in receivership from bidding on that institution.

Disclosures. Investors subject to the policy statement are required to provide substantial information to the FDIC in connection with any proposed bid.

Despite the compromises reflected in the final policy statement, the FDIC Board was unable to achieve unanimity, with the final policy statement being approved by a 4-1 vote. John Bowman, Acting Director of the Office of Thrift Supervision, cast the opposing vote, stating that the lack of empirical data supporting the policy statement made it impossible to evaluate its benefits.

In the memorandum, FDIC Extends Cautious Welcome to Private Capital Investments in Failed Banks, Davis Polk analyzes the final policy statement in greater detail. Because of the ambiguities in the final policy statement and the FDIC’s discretion to interpret and apply the statement, it will be more important than ever for prospective investors to engage the FDIC very early on in the process of any proposal to acquire a failed insured depository institution.