Last week, the Federal Deposit Insurance Corporation’s (FDIC) Center for Financial Research published a working paper examining how private equity helped to support and stabilize failed banks after the 2008 financial crisis by providing critical capital. According to Emily Johnston-Ross of the FDIC, Song Ma of Yale University, and Manju Puri of Duke University, FDIC, and the National Bureau of Economic Research, “PE-acquired banks performed better ex-post, with positive real effects for the local economy. Our results suggest that private equity investors had a positive role in stabilizing the financial system in the crisis through their involvement in failed bank resolution.” Copied below are some key takeaways regarding the critical role private equity played in stabilizing the financial system.
- Private equity delivered needed capital to local banks – “PE acquirers complement banks in this market by bidding and ultimately acquiring lower-quality and higher-risk failed banks. In doing so, PE investors help channel capital that can fill the gap created by a weak, undercapitalized banking sector and help meet the huge needs for new capital. The PE presence allows more failed banks to avoid being liquidated and the local financial system to be preserved.” – Page 3
- Private equity ensured quicker job recovery – “During the post-acquisition period, however, those counties with PE acquisitions experience stronger recovery from the crisis—faster employment growth and increased total per capita income. One potential channel for this is the sustained lending activities supported by acquired bank branches. Compared to bank-intervened counties, PE-intervened counties witness higher growth in small business lending, both in terms of the number and amount; those loans are made at a lower interest rate.” – Pages 4-5
- Private equity provided experienced turnaround leadership – “PE investors acquire failed banks that are too risky to acquire for incumbent banks who themselves may be in distress. Thus, PE investors fill the funding gap and turn around those banks with their hired expertise. These banks are later more suitable for a bank acquisition and return to traditional bank ownership.” – Page 28
- “Private equity investors hire ex-bankers to manage acquired banks. Those bankers, on average, have nearly 30 years of experience in the banking industry, and more than half of them were CEOs of other banks before being appointed at the failed banks. More than 60 percent of the CEOs had experience in the local area of the failed bank, more than a third specialized in turnaround management and troubled and distressed assets.” – Page 29
- Private equity played a positive role – “We find that PE investors acquired failed banks that were generally underperforming and riskier than bank-acquired banks were. PE investors also acquired failed banks when the neighboring banks were also in distress and therefore had a lower ability to make failed bank acquisitions. Thus, our finding suggest that PE investors fill the capital gap in scenarios the natural local bank buyers are themselves distressed or capital constrained. Using a quasi-random empirical design, we find that PE-acquired failed banks recovered as well as those banks despite underperforming ex-ante, and we show some evidence of them outperforming distressed banks in various dimensions. Our quasi-empirical design further shows positive real effects on the local economy of PE failed bank acquisitions. Overall, our results suggest a positive role for PE in helping to stabilize the financial system in the crisis through their participation in failed bank resolution.” – Page 30 (Conclusion)
Click here to read the full paper.