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Federal Deposit Insurance Corp. aids failed-bank buyers

| Thursday, Aug. 27, 2009

WASHINGTON — Squeezed by rising bank failures, regulators made it easier Wednesday for private investors to buy failed institutions.

The Federal Deposit Insurance Corp.'s board voted 4-1 to reduce the cash that private equity funds must maintain in banks they acquire.

Private equity funds tend to buy distressed companies, slash costs and then resell them a few years later. They have been criticized for excessive risk-taking. But the depth of the banking crisis has softened the FDIC's resistance to them.

The agency's deposit insurance fund, which insures customers' deposits, has shrunk under the weight of collapsing banks. Analysts warn it could fall below zero by year's end. At least in theory, having private investors buy failing banks would allow the FDIC to reduce the losses it would have to cover at a failed bank.

Under the new rules, a buyer would need to maintain the bank's capital reserves equal to just 10 percent of the failed bank's assets, down from 15 percent under an earlier proposal. And the new policy reduces the circumstances under which private investors must maintain minimum levels of capital that might be needed to bolster banks they own.

But the FDIC sought to guard against private equity funds that might want to quickly buy and sell at a profit: It required the acquiring investors to maintain a bank's minimum capital levels for three years.

Eighty-one banks have failed so far this year, compared with 25 last year and three in 2007. The closings have drained billions from the FDIC deposit insurance fund, which insures regular bank accounts up to $250,000 and is financed with fees paid by U.S. banks.

"The FDIC recognizes the need for new capital in the banking system," the agency's chairman, Sheila Bair, said before the vote.

The compromise struck among the FDIC directors "is a good and balanced one," Bair said.

Banks need to be operated "profitably but prudently," she said.

John Bowman, acting director of the Office of Thrift Supervision, was the lone holdout yesterday. He said the new policy was still too strict and "could chase potential investors away."

Rising loan defaults, fed by falling home prices and worsening unemployment, have hammered banks. The closings have drained billions from the FDIC deposit insurance fund, which insures regular bank accounts up to $250,000 and is financed with fees paid by U.S. banks.

The FDIC estimates bank failures will cost the fund around $70 billion through 2013. The fund stood at $13 billion — its lowest level since 1993 — at the end of March. It's slipped to 0.27 percent of insured deposits, below a congressionally mandated minimum of 1.15 percent.

The FDIC seizes failed banks and seeks buyers for their branches, deposits and soured loans. Under the crush of failures, the agency says private equity can inject vitally needed capital into the system, especially with fewer healthy banks looking to acquire failed institutions.

Private equity firms invest their own capital to buy a company and pump it up with money from other investors. Such "leveraging" to buy companies amounts to, on average, three-to-one for private equity firms: They invest $3 in outside capital for each $1 they put up themselves.

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