European governments will have to step in to back more private equity investments in troubled banks, American financial services investor J. Christopher Flowers warned the ICBI SuperInvestor conference in Berlin on Thursday as the prospects for the stability of the euro zone remained in doubt.
In a stark warning to the private equity industry's biggest annual international event, Flowers said Europe faced what he called "two futures, one where the euro continues, and one where it doesn't."
If the core of the euro zone stayed together, even if Spain or Italy were to default but remain in the euro, Flowers would judge that a "success," although there would be a risk of a domino effect on other countries. But if either country were to default and leave the euro zone, the ensuing crisis would be utterly catastrophic, ultimately leading to the complete destruction of the interbank market and interbank liquidity. Whichever banks went down would take others with them, not only in Europe but around the world.
That said, however, Flowers was convinced that if the euro zone stayed together, there would be an appetite for private equity purchases of some European banks, provided these were government-assisted deals, in which the state offered support to the investor.
Bank investments that had come with government assistance had been one of the better opportunities for investment in financial institutions for his investment firm, J.C. Flowers & Co. LLC, he said, "and in Europe today there are going to be, certainly, quite a few assisted deals."
"We're going to see a wave of this in Europe," he added. "The core proposition is that the government takes most of the risk on the loan book. Governments resist doing this. But it's like the phases of coming to terms with an illness. There's denial and ultimately acceptance.
"European governments are doing this. They will have to do this and it's ultimately the cheaper alternative for the government. These transactions arise in circumstances like you have in Europe today where the outlook is fundamentally uncertain and investors really cannot estimate future loan losses no matter how much due diligence they do. And even if they could they can't afford to take the risk anyway."
Flowers pointed to the deals his own company had done in Japan at Long-Term Credit Bank of Japan Ltd. and at IndyMac Bancorp Inc. in the U.S., which had gone on to do other assisted deals under Flowers' ownership.
But he also admitted there were issues in Europe that had not existed in either Japan or the U.S. that left him feeling uncomfortable.
"In Europe, three points which make this more exciting," he said. The first was sovereign risk, the second, the risks of limited liquidity, and the third, which derived from the others, is that liquidity guarantees that one might get from a national government, which itself might make one worry about the sovereign risk.
Nevertheless, he urged governments to "embrace rather than resist assisted deals, get the Brussels bureaucracy to help liquidity assistance, and to accept capital from all legitimate resources," including private equity, banks, hedge funds, institutional investors and sovereign wealth funds.