VIEWPOINT: Easy Way to Get Private Equity to Banks
Bush, Derek M., American Banker
Byline: Derek M. Bush
A simple fix, sitting right on the shelf in Congress, would make it easier in important ways for the vast pools of capital in private-equity funds to be put to good use in the banking sector.
Of course private-equity firms can and do structure acquisitions of banks within existing legal and regulatory constraints. The recapitalization of Doral Financial and the Federal Deposit Insurance Corp.'s sale of IndyMac's banking operations to a private-equity consortium led by Dune Capital are but two examples of how existing techniques can be adapted to make such acquisitions possible.
Regulators are doing what they can to make bank acquisitions and investments easier for private equity. They have adopted procedures to preclear bidders for failed institutions, and the Federal Reserve has loosened somewhat the "control" rules for private-equity investments in banks.
Still, basic statutory limits designed to separate banking from commerce continue to hamper traditional private-equity investments in banks. Recent experience proves that the obstacles can be cleared, but some private-equity firms have balked at the requirements to structure a consortium deal, form a separately "siloed" bank fund, or make a noncontrolling investment.
As uncertainty persists in the financial markets, and leading private-equity firms stand by with available capital, the time has come to revisit more fundamentally the rules for private-equity investments in banks. And the good news is: A simple solution is just waiting to be adopted.
Nearly a decade ago, in the Gramm-Leach-Bliley Act of 1999, Congress authorized qualifying bank holding companies to make private-equity investments in commercial firms under a new "merchant banking" investment authority. This authority also applied by extension to thrift holding companies and to foreign banks operating in the United States.
As a result virtually all major banking organizations can legally own up to 100% of a commercial firm (whether an automaker, a winery, or a hotel chain). They can elect a majority of the portfolio company's board of directors and can otherwise "control" the company.
But restrictions remain. For example the banking organization generally may not "routinely manage or operate" the portfolio company. It cannot, for example, install one of its employees as CEO of the portfolio company or make routine business decisions. And the investor generally must sell its investment within 10 years (unless it obtains a regulatory extension). Most portfolio companies bought under this authority are treated as "affiliates" for purposes of regulations that limit a bank's ability to lend to or otherwise do business with its affiliates.
These restrictions, promulgated jointly by the Federal Reserve and Treasury, were designed not only to maintain a separation between banking and commerce but also to promote the safety and soundness of insured depository institutions. The restrictions are meant to insulate the insured institution from the risks of merchant banking investments while letting its holding company diversify its investment activities in prudent ways.
Which leads to the simple fix that the current environment cries out for. If banking organizations can make private-equity investments in commercial companies, why not let private-equity funds make investments in banking organizations under exactly the same restrictions? …