Private Equity to the Rescue of Banks?
The Economist has an interesting analysis of the prospects of private equity riding to the rescue of beleaguered financial institutions.
“Buy-out firms are unlikely saviours, but private equity’s $450 billion war chest is big enough to fill Western banks’ capital shortfall,” the magazine notes. “There are few other sources of ready capital. Sovereign-wealth funds have been badly burnt; banks cannot easily raise equity in public markets; and the atrophy in many of the biggest lenders leaves them in a poor state to buy the weakest.”
“On one side of the financial system are buy-out firms with ambition, long-term capital, discretion about how to invest it, and a dearth of opportunities to invest in industrial companies. On the other are banks, desperately short of capital and liquidity.”
It does not take a billionaire buy-out barbarian to put two and two together.
Most buy-out firms have started by buying the distressed loans that banks issued to fund LBOs, many of which trade at 70-80% of face value. Only a few big deals have been made public: Citigroup’s sale of $12 billion of debt to TPG, Blackstone and Apollo, for instance. But behind the scenes the activity has been frenzied.
One alternative to buying banks’ loans is to buy their holdings of the securities at the heart of the crisis—structured-credit products backed by mortgages. Blackstone is talking to “several institutions” about buying mortgages. Last month Merrill Lynch offloaded a pile of collateralised debt obligations at a knock-down price of $7 billion, or 22% of their face value, to Lone Star, a private-equity firm.
But Lone Star has a history of specialising in finance and such deals are unusual. When UBS auctioned a portfolio of securities backed by “Alt-A” mortgages in May, it received little interest from private-equity firms. This may be because these securities are highly technical. In addition, they are passive investments that do not call for the operational management where private equity thinks its skills lie.
For mainstream private-equity firms, the promising business may lie elsewhere: buying into banks themselves.
The Economist recognizes that “before private equity takes the plunge, the rules may need to be tweaked. As early as next month, the Fed is expected to offer more guidance on the grey area of the ownership thresholds, probably relaxing its stance.”
The Bank Holding Company Act, which governs most big deposit-taking institutions (although not broker-dealers), stipulates that a voting stake in a bank of 25% or above constitutes control, whereas a holding of less than 5% does not. “Between these two thresholds is a grey area that the Federal Reserve has interpreted conservatively, taking into account, for example, whether the owner can appoint directors or owns non-voting capital too.”
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