Private equity has been bitten once, but it doesn’t do shy. Though some of its better-known names were left scarred after investing too early in troubled banks and thrifts-remember TPG’s disastrous foray into Washington Mutual-buy-out shops are lining up for a second shot at finance as confidence picks up again.
For much of 2008 dealmaking was dead. But since the sale of IndyMac, a collapsed Californian lender, to a group of private buyers in January, “the logjam has broken,” says Josh Lerner of Harvard Business School. In recent weeks Blackstone, Fortress, Carlyle, Wilbur Ross, and others have bought stakes in banks, among them Florida’s First Southern and BankUnited, the state’s largest home-grown lender. Several other deals are said to be in the works, including the possible sale of Atlanta-based Silverton Bank, seized by regulators in May, to a group that includes Carlyle. Bidding wars are even breaking out.
Private equity has piles of unallocated capital, although it has become much more difficult to wrest undrawn funds from investors. It also has a lot more raw material to work with, as the pace of bank failures accelerates. Hundreds of lenders will need help to survive but most large banks are too capital-constrained to step in. Those that have raised fresh equity, such as JPMorgan Chase, will use it to repay taxpayers.
Hence the focus on private equity. The favored strategy is to snap up a small bank, healthy or not, and turn it into a vehicle to scoop up failed local rivals. John Kanas, a veteran banker charged with reviving BankUnited, sees in it the foundation of a regional powerhouse. The Florida market is particularly attractive, he says, as many competitors there are shackled by regulatory or government restrictions.
Investing is still risky. Smaller banks are riddled with commercial-property loans, which are going bad at an alarming rate. American banks’ loan-loss reserves are falling ever further behind actual losses and now cover just 70% of the total, according to Moody’s, a rating agency. But buyers are growing cannier, pouncing only once a bank has been seized and insisting the government shoulders much of the downside in loss-sharing agreements.
The bigger problem for buy-out firms is posed by long-standing restrictions on bank takeovers by non-financial firms. Those unwilling to become bank-holding companies, with the extra regulation that entails, have to make do with a maximum stake of 33% (and voting rights of less than half that). Acquisitions are thus only possible via “club” deals, in which several buyers band together and regulators police the arrangement to ensure they are not acting in concert thereafter.
Alternatively, investors can use their personal wealth to buy entire banks. Christopher Flowers, a specialist in bank buy-outs, did just that, splashing out on a small Missouri lender and rebranding it Flowers Bank. But these solo buyers are barred from tapping their firms’ funds for expansion, greatly limiting the appeal of such moves.
As the crisis has rumbled on, regulators have reluctantly ceded some ground to the barbarians at the banks’ gates. They can now, for instance, appoint more directors without this being deemed to constitute control. Clubs of investors are being pre-cleared so they can pick up bank charters quickly when opportunities arise. The Office of the Comptroller of the Currency, which regulates nationally chartered banks, has even developed a “shelf charter,” which such groups can secure in advance of deals. It has already handed out two. The Federal Deposit Insurance Corporation, which handles failed banks and is expected to release new guidelines on private-equity investment soon, has also softened its stance. Sheila Bair, its chairman, believes buy-out firms should be considered eligible bidders if they show they can run a bank prudently and are “good corporate citizens.”
The Office of Thrift Supervision, which watches over lenders with around $1 trillion of assets, has gone even further. It recently permitted a single buy-out shop, MatlinPatterson, to take over a thrift in Michigan and has indicated that it will wave through similar deals.
This puts it at odds with the more cautious Federal Reserve, which oversees the holding companies that sit atop most banks. The Fed will not permit a firm that is not regulated as a bank to own a controlling stake in one, even if the investment is ringfenced. The central bank worries about mixing commerce and finance, which have been legally separated for decades in America.
Most investors accept that banks, unlike thrifts, are out of bounds to lone buyers. Some complain that not being able to control a bank forces them to demand a higher return, which will raise the cost of recapitalizing the industry. But there will still be money to be made, says Mr. Kanas, because even minority investors will be able to meet their hurdle rates of return if the government is generous enough in its risk-sharing. Mr. Flowers, unable so far to make much progress at home and licking his wounds from setbacks abroad, believes riches lie ahead. As he colorfully predicted earlier this year: “Lowlife grave-dancers like me will make a fortune.”