Corsair's National City Deal Concerns Fed - TheStreet

Corsair's National City Deal Concerns Fed

Measures that protect private equity firms from having their stake diluted may make it more difficult for banks to raise money in the future, sources familiar with central bankers' thinking say.
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Updated from 1:05 p.m. EDT.

A recent amendment to

Corsair Capital's

investment in

National City

(NCC)

has brought to light concerns among

Federal Reserve

officials about private equity investments into flagging banks.

New York-based Corsair in April led a $7 billion cash infusion into Nat City. Under the terms of the original agreement, Corsair and the other investors were protected from having their stakes diluted should Nat City seek to raise additional capital. Nat City and Corsair

revised the provision

last month after Fed officials balked at it, because they fear these provisions will make it more difficult for banks to raise additional capital down the road, sources familiar with central bankers' thinking say.

Corsair, however, is not the only private equity firm to have such protections in its investment agreements.

TPG

, which in April invested $7 billion in

Washington Mutual

(WM) - Get Report

, had a similar provision. The Fed may issue guidance on the subject in the next few days, either prohibiting such investments, or clarifying its position, say banking attorneys.

"Federal Reserve staff have expressed concern about the 'reset' provisions of recent capital raising transactions that enable investors to claw back some of their investment in the event that the financial institution raises further equity capital ... at a share price below the original investment," write Richard Kim and Lawrence Makow, partners at law firm Wachtell, Lipton, Rosen & Katz, in a memo distributed to clients Wednesday. "The concern on the part of the Federal Reserve is that this feature, particularly when combined with other investor protections, may deter additional capital raises by the bank holding company."

A Fed spokeswoman declined to comment.

In agreements governing both the Nat City and WaMu capital infusions, if the bank issues new equity at a price below what the private equity firms paid, it must compensate the private equity firm.

"The Fed clearly feels that when private equity firms put these anti-dilutive provisions into these capital raises, they're constraining the ability of the

bank to raise capital in the future," says Richard Bove, an analyst at Ladenburg Thalmann.

Private equity firms came to the rescue of banks amid a first-quarter earnings reporting season soaked in red. Nat City reported a loss of $121 million, or 27 cents a share, while WaMu lost $1.1 billion, or $1.40 a share.

If the firms thought they had caught a bottom in the stocks, however, it turns out they were sorely mistaken. Shares of WaMu have plummeted more than 50% since the day before TPG's investment was announced on April 8. Nat City's stock has nosedived more than 40% since April 18, the Friday before the Corsair investment was made public.

In a complicated

Securities and Exchange Commission

filing on June 30, Nat City amended its agreement with Corsair, limiting the anti-dilution provisions which compensate Corsair if Nat City issues new equity at less than the $5 per share Corsair paid. The Fed pushed for the amendment, according to a person involved in the deal.

While Fed officials are said to be similarly concerned about TPG's WaMu deal, that agreement has not been amended. The reason may have to do with the fact that WaMu is a thrift, and so is regulated primarily by the Office of Thrift Supervision.

OTS spokesman William Ruberry declined to comment on whether the regulator will require an amendment to the WaMu deal. He said the OTS is not currently planning to issue any guidance addressing deals of this nature, noting private equity investments in thrifts are "a new phenomenon." The office has seen "a large increase in interest, potential issues and questions in the last nine months to a year" from private equity firms considering investing in thrifts.

The OTS may consider issuing new guidance on the issue if the interest continues, Ruberry says.