Why Private Equity Shops Are Recapitalizing Banks

Many banks are raising capital these days; the latest to hit the headlines are Washington Mutual (WM), raising $7 billion from TPG, and National City (NCC), which is getting something north of $7 billion from a syndicate led by Corsair Capital. Such bilateral deals seem to be more common than the alternative route, taken by Wachovia (WB), of going to the public markets.

Why would banks choose to limit themselves to a small number of sovereign wealth funds or private-equity shops, rather than the millions of potential investors in the stock and bond markets? After all, it's not as though the big investors can't subscribe to a public offering if they're so inclined.

Roger Ehrenberg has a theory on this: that the big funds are jumping in too early, desperate to justify their existence.

I applaud the guts-of-steel necessary to invest in the face of financial panic. The problem is, I just don't see the panic reflected in the U.S. stock market, notwithstanding all the issues with the global credit markets. And I know that these private equity firms and the SWFs say that they are getting quality assets on the cheap. But I worry about the conflict between the ability and desire to write a big check and the best time to write such a check...

It takes incomprehensible amounts of discipline to let ok deals (from a risk/return perspective) go by in order to wait for the truly great deals with solid margins of safety to present themselves. Because it can get pretty embarrassing sitting on $10 billion (or in the case of SWFs, $100 billion or more) of commitments, getting paid management fees and not putting money to work. There is a natural pressure to pull the trigger, because it may be more painful waiting for the right deal to come along than doing a deal that ends up being mediocre but being busy in the process. And it certainly is impossible to raise a fund V, VIII or XII if one can't even get past 50% of committed capital for the current fund. This would bring the whole asset gathering operation to a screeching halt. And we can't have that, can we?

I'm not sure how much this argument works in the case of SWFs, but it does make a lot of sense with respect to the private-equity shops. The bank recapitalizations are one of the few areas where it's possible to invest multibillion-dollar sums right now on a leveraged basis (all banks, by their nature, are leveraged) without having to actually borrow money from someone. It might even be the case that the private-equity funds need these bank investments more than the banks need the funds - with the implication that the funds are overpaying.

This, of course, is great news for the financial-services industry as a whole: It is being recapitalized by private-equity shops at a time when the public markets are very reluctant to throw good money after bad. The only losers are likely to be the limited partners in the PE funds, and no one's going to shed too many tears for them.

Comments

[DSX Lover:]

Banks should be re-capitalized at the right price. There's no market panic, and no guts from Private Equity for being early. This is just simple stupidity by the part of Management in these large financial institutions, and irresponsible behavior, so that they can maintain their Jobs. The Deal with WM, was horrible, and its all the fault of management for relying in just Mortgages. What we're seeing this morning from NCC is a total Disgrace, Current shareholders are better being served through liquidation of the company, or a takeover by JPM rather than accept this offer. What a joke, is becoming the issue of raising capital. Management of NCC and its advisor Goldman Sachs should be ashame. At the close of Q1, NCC had $13.2 Billion in Equity, and $20.61 of Book Value, . The Allowance for Loan Losses is over 2.23% of All outstanding Loans at $2.6 Billion, these are loans written off the Books, that are still earning money. Loans past due 90 even decreased by 100 Million at end of Q1 from Q4 to $1.8 billion, from $1.9 Billion, which is 1.6% of all Loans, reflecting that the worst credit conditions have peaked. With 8.5% of Capital over total assets. and 6.65% Tier 1 capital, NCC has more than enough capital to be above the "the well-capitalized" threshold of 6%, and with the worst 2 quarters in the the Bank's history, there are no signs, that it will fall below 6%. With 13.2 Billion equity, and a good Loan Loss allowance that has taken care for possible deteriorating conditions. Why does it need to raise $7 Billion at $5 dollars (.25 of existing Book Value), $6.3 Billion of those on Preferred Stock convertible at $5 (well below market price) at what interest? There's no risk here for Private equity, and these shows management's irresponsability and stupidity. All Directors and Managers of NCC should be fired, and NCC should be allowed to be taken over by anyone in an open auction, instead of these joke from Corsair Capital.

2008 Apr 21 11:08 AM

[Voice of Re...:]

"At 6.65% Tier 1 capital, NCC has more than enough capital to be above the "the well-capitalized" threshold of 6%". I don't know how anyone with a straight face can claim .65% about the threshold is well capitalized. NCC as painful as it is needed a capital infusion which in my view in the main reason for the stock's recent sharp decline. Now that they are about to get 7B they have it. The irony is that now makes them more likely to find a suitor down the road.

No arguement NCC management can best be compared to a bunch of clueless monkeys more worried about keeping their fat paychecks than anything else. Still in my always humble opinion long term, NCC not only will survive but again prosper. Think at least 18 months down the road.

The rumor mill has it several banks liike FifthThird, Key and BOM DID take a look, all saying thanks but no thanks. Just be patient. ;-)

2008 Apr 21 11:55 AM

[DSX Lover:]

Yes they have enough capital Voice of Reason. They aren't growing assets, so they don't need extra capital. They can survive fine with what they have because they are not going to take a charge off of more than 2.5% on all earning assets, and they have already put 2.23% of Loans on Reserves. Now giving it away to P/E is joke, if they want in they should pay accordingly to what the risk is. Paying for convertible stock convertible at $5, is no RISK at all, Even a Monkey would take that.

2008 Apr 21 12:02 PM

[Alex Filonov:]

Oh well. My only problem with these investments is that it's impossible now to short bad banks. You never know what idiot would save unsolvent bank you are shorting... Now, if only more money from oil market go into these deals, economy will be in great shape.

2008 Apr 21 12:17 PM

[Voice of Re...:]

Uncle Sam is doing pretty good. He's "just" 9.3 trillion in the hole and counting.

www.brillig.com/debt_c.../

2008 Apr 21 01:59 PM

[globalmacro:]

I'm sure you've seen the article in the WSJ about the two founders of TPG and their previous successful forays in to this sector during a past crisis. It probably takes alot of foresight to do deals like this and I don't expect the average member of the general public to think it's a good idea. Yet, when they're clearly successful at some undetermined point in the future, they'll be labeled genuises by the same people that write blogposts like this today when the waters are still murky.

2008 Apr 21 02:04 PM

[globalmacro:]

Oh and I forgot to mention that I think it's highly unlikely that you have anywhere near the same mindset as the TPG guys do. Nor do I think you understand how they think and work. Because if you did, you would understand that they hardly feel the need to justify their existence. I thought that was a particularly laughable assumption. If you have made billions of dollars with 40-50%+ IRRs over the last 10 years, would you feel the need to justify your existence?

2008 Apr 21 02:09 PM

[test:]

DSX Lover's quote: "they are not going to take a charge off of more than 2.5% on all earning assets"

how do you know?

with $115.4 billion in outstanding loans, the allowance for loan losses of $2.6 billion reflects expected probable losses on residential real estate loans.

the company expects more loan losses. if the economy takes a shit, the charge offs won't be more than 2.5% on all earning assets???

i doubt it

2008 Apr 21 05:05 PM

[Voice of Re...:]

With the 7B injection of capital NCC went from one of the lower Tier 1 captialized banks to now one of the highest with a percentage North of 11%. As to the "why" that would imply to protect their bond ratings which are still good all things considered and who knows, perhaps because the regulators were sniffing around and hinting a half a percent over minimum wasn't enough padding.

No argument from me, NCC's management and board did a piss poor job the last 9-12 months. Of course they're not alone in that regard.

2008 Apr 22 03:14 PM