U.S. bank regulators may have placed a number of hurdles for private equity investments in failed banks, but that has not stopped the firms from taking a shot at weaker banks.
The U.S. Federal Deposit Insurance Corp (FDIC) has crafted tough guidelines for private equity groups seeking to buy failed U.S. banks, which include maintaining very high capital levels and remaining owners for three years.
However, private equity players are trying to dodge the restrictions by offering distressed banks an option to sell themselves before they get sucked into the FDIC's vortex.
"These PE players are coming to the realization that the FDIC route may not be the most efficient way, so now they are going the open bank route and I think we'll see more of them," Keefe, Bruyette and Woods FDIC analyst Juliana Balicka said.
The deal pipeline is beginning to swell, with billionaire banker Gerald Ford buying a 91 percent stake in Pacific Capital Bancorp, and Thomas H. Lee Partners and Warburg Pincus saying they would invest $139 million each in Sterling Financial Corp.
Cash infusion in the struggling lenders is being seen by private equity firms as a great opportunity to enter into the banking space.
LIMITED UPSIDE SEEN
With few private-equity deals being struck, most firms are trying to take advantage of the upheavals in the banking industry.
"Ultimately (PE firms') goal is to make money on their investment, which would imply that they would like to turn around the bank, get it back to stability and profitability and hopefully generate a respectable return," analyst Terry McEvoy of Oppenheimer & Co said.
But netting a troubled bank without FDIC backing is fraught with risks and there are questions about the gains to be made from such deals.
"There is the expectation or belief that in acquiring a failed institution there may in fact be a lot of upside that can be picked up, at an institutional level or in the process of aggregating or acquiring multiple failed institutions," analyst David Moffat of Huron Consulting said.
But industry watchers believe that the purchases may not be as lucrative as they look, with returns being limited in case of most deals.
"The private equity guys are used to probably a 20 percent to 30 percent rate of return and I think if they get a really good deal they may hit that target," Professor Lawrence White of the Stern School of Business at New York University said. "But more likely I think they'll get 10 percent to 15 percent return on capital."
Additionally, these banks will be raising a lot of equity and investors may be concerned about their ability to earn their cost of capital.