Fed May Give Private Equity More Leeway to Help Banks

The Federal Reserve may soon make it easier for private-equity firms and others to invest in the nation's ailing banks, according to people familiar with the matter. With bank stocks crumbling and the second quarter drawing to a close Monday, the changes could offer a lifeline to cash-strapped lenders desperate to secure capital. "This would be a bit of a sea change for the Fed," said Gregory Lyons, head of the financial-services practice at law firm Goodwin Procter LLP. "A number of banks would love to access the private-equity pool. It's a clean slug of money." The move comes as regulators grow increasingly worried about the ability of many banks to replenish capital amid the worst banking crisis in decades. Small and regional lenders are expected to have a tougher time lining up new investors, particularly since some recent capital infusions have stuck banks' new shareholders with big losses. The Fed and other banking regulators historically have resisted unregulated entities' exerting control over banks, and tough enforcement of federal rules has often prevented private-equity firms from pumping much cash into banks. Instead, banks recently have drummed up cash from a combination of government investment funds, mutual funds and other investors, often through public offerings of stock or other securities. But there are signs that the capital pool is starting to dry up at a time when many financial institutions are still ailing. "We are looking at ways we can make those things more workable and gain from the experience we've had over the past few years," Federal Reserve general counsel Scott Alvarez said. Fed officials recently have met with big buyout firms -- including J.C. Flowers & Co., Carlyle Group, Kohlberg Kravis Roberts & Co. and Warburg Pincus -- and banking lawyers to discuss the obstacles, according to people familiar with the matter. Under federal law, to own more than 24.9% of a bank, an entity must register as a bank holding company, which is subject to heavy regulation and can be forced to serve as a "source of strength" for the bank. Ownership of more than 9.9% of a bank also subjects the entity to regulatory scrutiny to ensure that it isn't controlling -- or even influencing -- the bank's operations. The Fed can't change those laws, but it has wiggle room in how it interprets them. For example, the Fed recently has been reluctant to approve deals involving private-equity firms' owning more than 9.9% of a bank unless the buyers agree to limit their voting power and not have more than one seat on the bank's board. That tends to make bank deals much less attractive to private-equity firms, which crave large positions and control over their portfolio companies but don't want to fall under federal regulation. The Fed has been trying to determine whether private-equity firms are demanding more board representation than is currently permitted in bank deals, one person said. And would-be investors are pressing their case for an expanded role in the industry. "If we don't facilitate private equity's role in that, that's one less pool of capital to stand between these losses and the taxpayer," said Randall Quarles, a managing director at Carlyle and a former senior U.S. Treasury official, who has been in discussions with the Fed. Private-equity infusions are looking increasingly important because stronger banks are still averse to snapping up peers with damaged balanced sheets. Accounting rules also have inflated the price tags on many such deals. Even if private-equity firms are permitted to take a more active role, it isn't clear that they will jump headfirst into the banking sector. For one thing, most of the recent capital infusions have lost money. That could temper enthusiasm as private-equity firms examine opportunities. Some banks need cash quickly. When lenders report second-quarter earnings next month, many are expected to show steep declines in capital levels. One of the banks that could benefit from looser rules is BankUnited Financial Corp., based in Coral Gables, Fla., that is currently seeking some $400 million in capital. A number of private-equity firms approached the small lender earlier this year, but bank executives rejected their interest, says a person familiar with the situation. Some of these firms are probably still interested in the bank, and with other investors expressing reluctance about pumping more money into small and regional lenders, the Florida bank may welcome that interest.