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 (C) 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 (MER) 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 (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.

Comments

[Mr Mortgage:]

They can't come 'riding to the rescue' until there is some transparency to their books with respect to the valuation of their assets. For example, WaMu has $55 billion in Pay Option ARMs, $60 billion in Home Equity Lines and $16 billion in Subprime. Performing, these loans types might fetch 10 cents to 50 cents on the dollar on a great day! Non-performing or as REO, you may get 30 to 50 cents of the new value of the underlying collateral. That would means WaMu is looking at a write down of $10s of millions yet to come. With the housing market continuing to fall and defaults now surging in Alt-A, Jumbo Prime and second mortgages, there is not enough clarity. Most of these banks that hold such large amount of mortgage paper are deep underwater if you were to sell assets to pay off liabilities and 'settle up'. I highly doubt if any private equity will be as foolish as BofA was with CFC or as foolish as TPG was with WaMu for years to come. Just my opinion.

2008 Aug 28 11:20 PM

[Theo O'Brien:]

Interesting article, I've been hearing a lot about this potential rescue by private equity firms but frankly I just don't see it happening. I do believe that private equity will play a major role in recovering AFTER the banks hit bottom. It seems that there is still a lot of fallout remaining and the private equity industry probably sees that. If anything, a few private equity groups will be unable to restrain themselves and buy some big shares in a few banks now that the SEC has relaxed some rules that previously restricted a private equity firm's purchase in a bank to under 25%. But overall I think this one is up to the Fed.

2008 Sep 28 09:18 PM