| ||||||||||
| ||||||||||
— Analysis —
But there's a new tonic on the market, peddled by top private equity funds. Flush with capital, PE managers have been eager to settle roiling bank balance sheets with well-timed infusions, just as depositary institutions head into what is expected to be a miserable second half. Fund managers are offering to bail out troubled banks but are telling Washington they first need relief from restrictive bank ownership rules. The private equity industry is actively pressing the Federal Reserve Board to relax requirements that in some cases could require PE funds, not just the banks they buy, to submit to the Fed's intrusive holding company supervision.
For the past three years, the funds and banking industry lawyers have been negotiating with the Fed to liberalize ownership rules to better accommodate investment firm buyouts. Carlyle Group recently took the fight public with an op-ed article in The Wall Street Journal. Fed Chairman Ben Bernanke acknowledged the discussions in a July 10 appearance before the House Financial Services Committee. "We are looking for banks to raise capital, and private equity is a very good source. There are issues related to effective control," he told lawmakers. "We're currently looking at that in the hope we'll make a clearer statement about when PE can come in and add capital." But there have already been several bank buyouts by funds in the past year despite the ownership restrictions. In April a group led by Corsair Capital LLC acquired a 70% stake in Cleveland's National City Corp. for $7 billion. Also that month, a TPG Capital-led group invested $7 billion in Washington Mutual Inc., giving TPG a 13% stake. Those deals managed not to hit the holding company trigger, so what more do PE buyers need? They're frustrated with the existence of the Bank Holding Company Act, a federal law requiring that stakes of 25% or more of a bank's voting stock be viewed as a controlling interest and requiring the owners to submit to Fed supervision. The decades-old restriction is intended to keep banks separate from conventional commercial businesses. Stakes of less than 5% are viewed as passive, but between that safe harbor and 25%, regulators have discretion to decide what level of investment and degree of involvement in a bank's management will be deemed as control. For instance, the Fed views investors as gaining control if they own only 10% or more of the voting stock. Receiving board seats may also trigger holding company oversight. But for PE investors who may have pumped billions of dollars into a bank, remaining completely passive is an unattractive option. Instead, many opt for a second approach: creating a separate fund solely to control the bank. The new fund becomes a bank holding company subject to regulators' oversight, but the parent funds are insulated. Bank lawyers say this will likely be the most popular option for future buyouts, but the structure has problems. The Fed's leverage ratios limit how much money a bank owner may borrow, while the PE business model calls for closing deals with as little of the funds' own money as possible and borrowing the rest. A third option for PE buyouts is to diversify control among investors so no single fund triggers holding company thresholds, though with this option it's essential the investors sit alongside each other without acting in concert. Shortcomings of the available options prompted Carlyle managing directors Olivier Sarkozy and Randal Quarles to write the op-ed piece in June, arguing that ownership restrictions are the main impediments to bringing the billions their industry has at the ready to bail out federally insured banks. Of course, their investments so far have produced only losses. Declines in the banks' stocks have been compounded by leverage restrictions that forced the funds to put more of their own money into the deals than they'd like. Since the TPG stake was announced, WaMu shares have dropped from $13.14 on April 7 to just over $5. Similarly, National City shares have fallen roughly 25% since the Corsair deal was announced April 23. Nevertheless, the funds blame the ownership rules for discouraging PE investment in banks. "In addition to increasing the industry's cost of capital, these limitations increase the risk that taxpayers will ultimately be called on to assume some of these burdens," the Carlyle authors argued. Contacted by The Deal, Carlyle officials would not discuss what changes they seek, but bank regulatory lawyers, some of whom have discussed the issue with the Fed, were willing to spell out what changes would facilitate PE buyouts. "It's clear they are now thinking about how to facilitate private equity investments into financial services businesses," says Thomas Vartanian, chair of the financial institutions and electronic commerce transactions groups at Fried, Frank, Harris, Shriver & Jacobson LLP. "We're going to see real strain and turmoil in the banking business in the third and fourth quarters of this year." Private equity is flush with capital, he says, and the regulators have "got to ask themselves how they can marry those two ends of the spectrum." Vartanian says there's little chance the 25% statutory trigger will be raised, but the regulators have a fair amount of discretion to ease the guidelines for investments that fall below that level. For example, the Fed can raise the level of voting stock that triggers its own definition of control. It also can better define what constitutes "acting in concert" while recognizing that flexibility is necessary to encourage multifund investments. Also, rules are needed that spell out what role a fund's general partner can play, including what services the GP can provide, what ownership level the GP is limited to and what carried interest it can take without triggering control. "New deals necessarily raise new issues and nuances," he says. "The more flexible those new interpretations are in light of these new deals and in the interest of encouraging them, the better for PE firms and banks that need capital." Douglas Landy, partner in the New York office of Allen & Overy LLP, agrees. "The amount of capital banks are going to need is significant and it has to come from somewhere. The Fed often says banks need more capital but never where it is supposed to come from." Landy, a former attorney for the Federal Reserve Bank of New York, says this wouldn't be the first time regulators relaxed ownership limits to pull the industry out of a mess. At the height of the savings and loan crisis in the 1980s, when "no one wanted to buy thrifts," regulators had to ease limits to draw in buyers. "There is a history of loosening restrictions when the industry needs capital and tightening them again when capital is abundant." The biggest question may not be whether the Fed is willing to facilitate PE buyouts, but how fast. Gil Schwartz of Washington firm Schwartz & Ballen LLP says easing up on ownership rules isn't something regulators take lightly. "These requirements were developed over many years because of concerns about conflicts between bank owners and their outside interests." Speaking at bank industry conferences, Fed staffers have indicated proposed changes can be expected later this year or early next. But wait that long, Vartanian worries, and bank stocks might be unattractive even for private equity. "If they're going to do it, they ought to do it now," he says. "One thing drawing potential investors is that bank prices are right. That won't always be the case." |
Bad mortgages, cratering construction loans and rising consumer delinquencies have caused a pandemic of sour stomach among commercial bankers and their regulators. 
|
|
|
|
|
