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highlights

 

Making a Difference with the Mass Affluent

While banks have long offered wealth management services to their high net worth customers, this business line has received renewed emphasis in the wake of the financial crisis.



Innovation in Payments

No area of banking has arguably seen more innovation in recent years than payments. Ever since the Check 21 legislation of 2003 allowed the digitization of checks, there has been an explosion of new technology in this space that radically transforms how consumers and businesses pay their bills.


Related Content
Spectrum of Choices

Private Equity: The Banker’s Perspective
Private equity firms can partner with banks in several ways; bankers need to weigh the pros and cons. by CHARLES B. WENDEL
Nov 1, 2009  |  0 Comments

Has private equity (PE) investment in the banking industry proven a positive force or not? Up to this point, the evidence has been mixed. Texas Pacific Group suffered a well-publicized $1.3 billion loss in its involvement with Washington Mutual Inc. More recently, the press has reported positively about FDIC-sponsored PE deals involving the purchase of IndyMac (now OneWest Bank) and BankUnited.

However, bank management needs to look beyond the headlines to understand the investment approaches pursued by private equity and how these firms might provide value to their institutions. For some banks, PE firms may be a “partner” to avoid; for others, they can provide much-needed capital, expertise and strategic direction.

The amount of total PE capital available for investment has been estimated by the Carlyle Group at about $400 billion. Recent FDIC regulatory decisions clarify how PEs can compete and have effectively removed some of the question marks that previously served to dampen investor enthusiasm. The issue now for bank management is whether private equity is appropriate for their individual institution.  

The common view among bankers is that PE investment is largely linked to failed banks and smaller community players. Yet larger players, such as Webster Financial Corp. and Boston Private Financial Holdings, have recently teamed up with PE firms in order to create fortress balance sheets and position themselves for growth.

PE investment in banks can take varied forms, which can be plotted on a spectrum indicating different levels of investor financial commitment and degrees of willingness to operate under regulatory constraints. At one extreme are the one-off loan purchases seen in FDIC resolutions; at the other, more complex transactions where the PE firm agrees to operate under the rules of a bank holding company (see chart, “Spectrum of Choices”).

As PE firms move along the spectrum, they gain greater control over a bank and begin to operate in a more intense regulatory environment. There are only a few options that provide the opportunity for banks to partner with PEs while remaining fully independent entities. They are: portfolio purchases, minority and 24.9% investments and FDIC Shared-Loss transactions.

Portfolio purchase – This involves a private group purchasing part of a loan portfolio, typically distressed assets. While this type of transaction can involve purchases from an ongoing bank, few deals of this type have occurred because of the inability of buyers and sellers to agree on portfolio valuations.

The focus of PE firms will probably center on opportunities to work with the FDIC on “toxic asset” transactions related to banks that are in receivership. Last month, for example, the FDIC completed its first auction involving residential assets from Franklin Bank, a $4.9 billion Houston-based bank. In this deal, Residential Credit Solutions Inc. purchased a portfolio with the agency’s funding assistance.

These types of deals are likely to remain scarce unless buyers and sellers close the significant asset valuation gap that exists today or unless the capital needs of currently well-capitalized banks increase.

Minority investment and 24.9% Voting Share: Rather than purchasing a loan portfolio, these transactions involve investors taking equity in an existing bank.

There is certainly demand on the buyer side for such deals. I recently met with a PE investor who said his firm had approached over 30 banks with the offer of an equity injection of between $50 million and $100 million. Donald Marron, who heads Lightyear Capital, recently stated on CNBC that his group had visited over 100 banks pursuing a similar mission.

As might be expected, PE firms are looking for a sharp upside to their investments in these deals. Their targets are generally undervalued companies or companies that need capital to stabilize and grow – what one investor called “eagles with broken wings.”

From a bank point of view, such deals can provide needed capital. But bankers also need to consider what the PE firms can bring in addition to dollars. At a conference last year, the chairman of Boston Private discussed the process that led to his company deciding to work with the Carlyle Group rather than other firms. He spoke of the extensive due diligence that Carlyle performed, which included visits made to various operating divisions in order to understand Boston Private’s key businesses in depth. Carlyle even allowed the bank input regarding the PE member who would join its board.

Collegiality, expertise, and commitment to the bank’s growth were key characteristics valued by Boston Private, according to the chairman. On Carlyle’s part, there was the opportunity to invest at the 24.9% level (above which the firm would be subject to bank holding company regulations) in an institution that needed capital to stabilize and take advantage of longer-term growth opportunities. Similarly, the July 2009 investment by Warburg Pincus in Webster Financial Corporation of Waterbury, Connecticut increased tangible common equity from 4.0% to 4.9% and, in management’s view, set the bank on a growth path.

Both Webster Financial and Boston Private had suffered from some loan deterioration and, arguably, needed a capital infusion to put the past behind them and focus on growth. One of the very practical stumbling blocks that PE firms face results from the recent rise in bank stock prices, which has reduced capital concerns at many banks.

However, our view is that the industry’s commercial real estate loan problems are still emerging and the ultimate scope of the hit to bank capital remains unclear. For many community and regional banks, commercial realty losses could represent a greater threat than they have already experienced in the residential area. Therefore, banks should continue to be open to approaches from PE firms. Beyond that, they should be actively evaluating these firms to assess their potential “fit” with the bank and the value they bring beyond capital.

One of the major challenges facing banks working with PE firms is the investors’ need to ask direct and sometimes difficult questions related to current and expected performance. Typically, PE investors operate with a relatively short time frame in mind, usually no more than three to five years. Such an intense focus on the bottom line is, frankly, not shared by all bank managers.

FDIC Shared-Loss Transactions: At their core, these deals involve an investor (whether a PE firm or a bank) entering into an agreement to purchase a failed bank that has been taken over by the FDIC. During these five plus-year agreements, the FDIC agrees to make the investor whole for between 80% and 95% of documentable loan losses. Similarly, the FDIC shares in any upside from recoveries. The expectation is that the length of the agreements allows time for market improvement to occur, as the overall economy improves.

In most cases the FDIC has selected banks as its partner for these deals. Most notably, BBVA was chosen to take over Guaranty Bank in Texas and BB&T was selected to take over Colonial Bank of Alabama. However, Shared-Loss transactions may be the opportunity of greatest interest to PE firms.

The IndyMac and BankUnited transactions appear to offer models for many in the PE industry. These deals featured a consortium of investors, none of whom owns more than 24.9% of the bank, thereby, avoiding issues related to bank holding company regulations. The attractiveness of these deals resulted, in part, from the ability of the investor to rely on the FDIC agreement while rebuilding the core bank for the future. Once the deal closes, the PE firm puts its designated “executive in waiting” in charge of the bank.

Banks have the opportunity to co-bid with PE firms for FDIC-assisted transactions. The primary benefit to the purchasing bank is that the partnership limits its capital requirements. The PE firm, meanwhile, benefits from being able to leverage the management capabilities of its deal partner rather than needing to build a team of bankers from scratch.

There is no question, then, that private equity can make a positive contribution to the stabilization of the nation’s banking system. The onus is on bankers (and regulators) to understand the conditions under which such an investment may be appropriate.

Mr. Wendel is president of Ridgefield, Conn.-based Financial Institutions Consulting. He can be reached at cwendel@ficinc.com.

 

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