This is a real conundrum, because while the FDIC’s vote to lower Tier 1 capital requirements for private equity purchasers of banks from 15% to 10% appears to be a capitulation, there is a twist in these regulations, in that the regulation does not call for 15% Tier 1 common equity, not just Tier 1 assets:

Under the rule that was adopted, such banks will have to maintain a 10% capital ratio, but the definition of capital isn’t Tier 1, it’s Tier 1 common equity.

Tier 1 common equity is close to tangible common equity, which is a stronger measure of capital than simple Tier 1.

…

Common equity is the best cushion of all because it sits in the first loss position. Preferred equity — which is included when calculating Tier 1 but excluded when calculating Tier 1 common — failed totally last year. Banks had issued a bunch in late ‘07 and early ‘08 in order to boost Tier 1, but because common was nearly overwhelmed with losses, investors higher up the capital structure panicked.

To be sure, the switch to common won’t have any effect on the day-one economics of these deals. Subordinated debt is wiped out when FDIC takes failed banks into receivership.

But this will discourage private equity guys from polluting the capital structure down the line. Hybrid debt issuance that would qualify as capital under Tier 1 won’t qualify under Tier 1 common.

Additionally, they will require that this level of capitalization be maintained for 3 years, and be audited more frequently to ensure that necessary capital is maintained.

I think that it is still an undeserved win for private equity pirate types, but it’s better than it appeared at first glance.