Recent transactions, including notably the direct acquisition of BankUnited by a private equity consortium immediately upon its closing by the FDIC, may signal the potential for expanded recognition of the role of private equity (PE) investors in providing needed capital to the banking industry.
Other transactions, including the sale of IndyMac to a PE group, the granting of “shelf charters” for acquisitions of troubled institutions, and various levels of participation by other PE groups in industry-related capital infusions, may suggest that the involvement of PE investors is becoming more acceptable and palatable to both the PE market and to regulatory agencies. With the BankUnited approval, the FDIC indicated that it intends to issue further guidance for PE investor consideration of failed institutions. Of course the relative scarcity of public capital for banks and the desire of the government to perhaps spread (or share) the current economic risk in the industry may also be somewhat of a catalyst for expanded acceptability of PE investors by agency decision makers.
Outside of the obvious investment risk, one of the primary obstacles to PE investor participation involves issues pertaining to what constitutes “control” of the entities for regulatory purposes. That “control” can bring with it additional potential financial liability for the PE investor, limitations on other non-bank investor activities and investments and the potential for being subject to regulatory examination and enforcement activities.
None of which is a particularly desirable outcome for most PE investors.
Issues with “Control”; GMAC
In terms of “control” issues, some interesting agency interpretations can be found in recent March 2009 Federal Reserve Board determinations relating to the conversion of GMAC from a Utah industrial loan company to a bank. In those interpretations, the Fed followed precedent by taking into account a variety of changes in “control” activities including reduced investor voting equity participation, passivity commitments and related limitations to dilute indicia of “control” by individuals and organizations. The GMAC interpretations serve as an example of the types of issues that arise in the context of addressing investor “control” of banking organizations and the type of restrictions on activities and ownership that the Fed will look for in structuring PE investments where “control” may be an issue or concern.
Cerberus and an individual that “controlled” or advised Cerberus, together with related investment companies, owned 51 percent of the equity voting interests of GMAC LLC. Upon GMAC’s recent conversion from a Utah industrial loan company to a bank holding company, important and complex “control” issues under the Bank Holding Company Act (BHCA) arose prompting the investor and its related interests to seek an exemption from the control provisions of the BHCA.
While not inconsistent with prior Fed “control” interpretations, the GMAC interpretive letter is a good illustration of the extent of required PE investor limitations. The Fed interpretation includes detailed required commitments by the investor and related entities to divest of certain holdings, to limit voting authority, to reduce and limit director representation, to eliminate employee interlocks, to terminate advisory agreements and to enter into lengthy and detailed passivity commitments regarding ongoing influence and activities involving GMAC.
On the same day, the Fed issued another interpretive letter with regard to “control” issues relating to the ongoing relationship between GMAC and General Motors Corporation (GM). As with the foregoing PE investment interpretation, the GM issue arose as a result of GMAC converting to a “bank” from a Utah industrial loan company under the BHCA. GM indirectly controlled 49 percent of the voting equity of GMAC, and the relationship between GM and GMAC had clearly been one of “control” since the formation of GMAC. Similar to Cerberus and other PE investors, GM did not desire to be deemed a “bank holding company” under the BHCA.
Under the GM interpretation, GM entered into a number of similar commitments and limitations on activities involving GMAC including reducing direct ownership to less than 10 percent (by transferring the balance to an independent trustee), surrendering GMAC board representation, modifying contractual limitations on the business of GMAC with non-GM organizations and generally changing the business relationship with GMAC to provide for greater business and product diversification by GMAC in the marketplace. GMAC will be free to make loans to any third-parties and will use its own underwriting standards as a result of the commitments. Like Cerberus, GM also entered into detailed passivity commitments with regard to the ongoing relationship between GM and GMAC.
Recent regulatory pronouncements intended to expand opportunities for PE investing without triggering “control” concerns under the BHCA (see the Fed’s September 2008 guidance), the Fed’s GMAC interpretations and recent approvals of PE investor consortiums for acquisitions of troubled institutions can be construed to evidence a move in the direction of increased flexibility with regard to, and regulatory acceptance of, expanded PE investor participation in the banking industry. As noted previously, in the BankUnited transaction the FDIC has indicated that it intends to issue guidance to PE firms for use in considering acquisitions of failed institutions. While the complexities and limitations involved in structuring investments to avoid “control” determinations (coupled with the unknowns and general concerns of governmental dealings in light of recent administration experience with TARP issues) provides that caution remains appropriate, it appears that expanded PE investor opportunities in the banking industry are likely to continue.
Enhanced definitive agency guidance with regard to “control” and related PE issues, clear direction and clear commitment with regard to bank oversight and capital issues would likely result in encouraging further PE investor involvement in the banking sector and perhaps reduced need for governmental intervention and support.