Dodd-Frank fatigue hampering PE investment structures

Author: Danielle Myles | Published: 22 Jul 2011
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The Dodd-Frank rulemaking burden may have dampened the Federal Reserve’s willingness to consider creative bank acquisition structures.

Attorneys say that over the past twelve months it’s been harder to have detailed conversations with the regulator about proposed investments in banks and the nuances of different structures.

They suspect this is because of time constraints caused by the regulatory overhaul law.

"I think the Federal Reserve staff, like most regulatory staff, are so overwhelmed by the demands of Dodd-Frank rulemaking requirements that they just don’t have the same appetite for novel structures," said Gregory Lyons, a New York-based partner with Debevoise & Plimpton.

"They seem to be getting more strict in their views as to what an acquisition deal needs to look like to pass muster with them," he added.

Another contributing factor could be staff changes including the 2010 departure of key figure Patricia Robinson, who oversaw M&A applications.

The Reserve’s new approach could be particularly problematic for private equity funds which look to maximise target-control while avoiding bank holding company-status.

Generally funds look to avoid being deemed a bank holding company because it would require them to divest from their other activities.

They stay below the 25% voting stock-threshold and make great effort to keep board representation, officer interlock, business relationships and other control factors to a level that helps them direct the bank’s operations, but doesn’t cause the regulator to designate it a bank holding company.

This becomes more difficult, however, when the Federal Reserve is reluctant to entertain novel structures.

It’s also unfortunate, as the credit markets have stabilised enough for private equity firms to make informed purchases. "I think private equity now feels more comfortable that it understands and can value the balance sheet of a bank," said Lyons.

An area where regulators may have to re-think this strict approach is failed banks.

The percentage of first losses which the Federal Deposit Insurance Corporation’s (FDIC) will accept under its loss share agreements declined last year, making failed banks less attractive for PE investors.

For now there are strategic acquirers looking to take on these assets, but this is expected to dry up eventually.

"They may be forced to show enhanced flexibility. There’s still a lot of problem banks out there and if the strategic acquirers stop buying, what happens then?" said Lyons.

"They have to find buyers to sure up the system otherwise the FDIC fund that is insuring these bank deposits takes the hit directly," noted Jay Cohen, a private equity partner with Duane Morris.

Another factor that could be contributing to regulators’ reluctance to permit large PE investments in failed banks is the public’s – sometimes inaccurate – perception of private equity. Failed banks are a politically sensitive topic, given the unfinished inquiry into the cause of the financial crisis.

"The FDIC gets a little backlash on letting these private equity funds acquire these failed banks," said Cohen.