Barbarians at the banking gates

Private equity firms appear to be a little more willing to invest in banks again. But regulatory hurdles could keep a lid on how many deals get done.

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By David Ellis, staff writer

Buyout firms have a bigger appetite for banks, but few deals have materialized partly out of caution as well as regulatory hurdles.
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NEW YORK ( -- There are plenty of ailing banks out there. But there are also lots of big investors with plenty of cash. So why haven't there been more deals between the two?

Despite the severe slump in the banking industry since last fall, private equity firms have made only a handful of plays for U.S. banks. It's a bit of a surprise since many private equity firms are known for "vulture investing" -- picking through the carcasses of beaten-down firms to find hidden value.

But that may be slowly changing. Buyout shops, which rose to prominence in the 1980s as the so-called "barbarians at the gate," are starting to take a closer look at some struggling financial firms.

Last week, the failed Florida lender BankUnited (BKUNA) was bought by a group of well-known buyout shops, including WL Ross & Co., Carlyle Investment Management and Centerbridge Capital Partners.

Top executives at Blackstone Group (BX), another participant in the BankUnited deal and a major private equity player, have outlined their interest in investing in the financial services sector in recent weeks.

A source close to the New York City-based firm said that the company considered upwards of 40 other bank deals before agreeing to team up with others to buy the assets of BankUnited.

At first glance, it would seem that now is a great time for buyout firms to go shopping for banks.

While fundraising levels are down from the pre-credit crunch days, private equity firms, as a group, have a lot of cash that could be used for more investments. U.S. buyout shops alone currently sit on an estimated $605 billion in unallocated capital, according to the London-based research and consultancy firm Preqin.

Banking regulators have even begun to relax some rules in order to encourage buyout shops to invest in banks that still face a severe shortage of capital.

Last week, the Federal Deposit Insurance Corp. signaled its willingness to play matchmaker, pledging to soon offer "policy guidelines" for buyout shops looking to take stakes in ailing lenders.

"It is definitely an important recognition that good capital from outside the banking industry is very useful at this point in time," said Gerard Comizio, senior partner in the financial services practice group at the law firm Paul Hastings.

Still, private equity investors remain extremely cautious. And for good reason.

Several buyout firms were burned badly by investments in troubled banks. TPG and Corsair Capital poured a combined $14 billion into Washington Mutual and National City a little more than a year ago, only to watch their respective investments get wiped out just months later.

Uncertainty about the direction of the U.S. economy and continued loan losses, particularly in areas like commercial real estate, have also tempered investor interest.

Sensing that, regulators agreed to share in some of the losses as part of the BankUnited deal. They did so as well in the sale of the California-based mortgage lender IndyMac to a group of investors earlier this year.

With that in mind, experts contend that similar loss-sharing arrangements may need to be part of any other future private equity-banking deals.

Washington roadblock

Banking regulators have already made a lot of concessions to private equity investors in recent months to keep capital flowing to banks that need it.

The Federal Reserve, for example, deemed in September that non-banking firms can control as much as a third of a bank and also allowed them a greater presence in the boardroom. Previously, non-banking entities were restricted from owning more than a 25% equity stake in a bank or thrift.

At the same time, the Office of the Comptroller of the Currency and the FDIC rolled out programs late last year aimed at making it easier for willing buyers to acquire failed banks.

"It is easy to lose sight of the fact that the government has made tremendous progress in opening doors to private equity to own banks," said Jaret Seiberg, policy analyst for Concept Capital's Washington research group.

Nonetheless, some believe regulatory restrictions remain the biggest hurdle for private equity investors looking to bet big on the U.S. banking sector.

Many experts contend that policy is rooted in the long-standing notion that U.S. companies should not be allowed to engage in both commercial activities and banking.

Among other things, regulators fear that a non-banking institution, namely buyout firms, could use an acquired bank to limit credit to competitors or plunder the bank's deposit-gathering resources to fund their commercial operations.

Since some private equity firms own hundreds of other businesses at any given time, experts said there could be such a conflict if they were allowed to control a bank.

Some buyout shops have managed to make an end-run around these restrictions through a so-called "silo" structure, in which its investment in a bank is walled off from its other investments. Private equity firm Matlin Patterson, for example, won over the Office of Thrift Supervision with such an approach when it acquired Michigan thrift Flagstar earlier this year.

But that transaction has raised eyebrows among some lawmakers and fellow banking regulators.

The Federal Reserve, which oversees a portion of the nation's banking industry, has indicated that a firm that buys a bank should be willing to abide by the "source of strength" concept, meaning that the acquirer would agree to marshal all of its resources to help a bank get out of financial trouble.

"No private equity firm wants to do that since it is an unlimited call on capital," notes Hal Scott, a Harvard Law School professor who also serves as director of the Committee on Capital Markets Regulation. That group published a series of regulatory recommendations this week, including removing restrictions on private equity firms owning banks.

Other experts place the possibility of such changes as slim, even as regulators continue to coax buyout shops to invest more in the nation's banking industry.

As a result, capital hungry banks and the buyout world may just have to make due with the status quo. There may be more deals here and there, but not the glut that both industries are hoping for. To top of page

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