Fortune magazine online posted a recent analysis of the bidding in the FDIC's resolution of Guaranty Bank of Texas, and came to the conclusion that the FDIC favored a foreign bank (BBVA) over large private equity players like TPG, Blackstone and Jerry Ford. The author, William Cohan, gave a laundry list of roadblocks thrown in the path of private equity bidders, including the late approval of Blackstone and TPG as bidders, so that they couldn't participate in full-blown due diligence on Guaranty Bank.
The odd thing was, of course, that TPG and Blackstone were well known to D.C. regulators, since TPG had bought a stake in Washington Mutual and Blackstone was part of the private equity consortium that bought BankUnited in Florida when no commercial bank expressed interest in that bank earlier this year. "We can't figure out why it took so long for us to be approved," a person at one of the investment firms said in an interview.
Here's an idea: the FDIC wanted to stack the deck in favor of BBVA and other non-private equity bidders. Does that sound like a possibility?
The real disadvantage, as noted by Cohan, is the higher capital requirements imposed upon private investors by the FDIC.
Since the private equity investors would have had to use at least double the equity of Banco Bilbao, its bid -- by definition -- would have to be lower to get the same return on that equity as could Banco Bilbao using less equity.
Think of it this way, if Banco Bilbao and Ford were both bidding on the same house, Banco Bilbao would be able to get a mortgage for 96% of the purchase price and Ford could only get a mortgage for 90% of the purchase price. Naturally, Banco Bilbao would be able to pay more for the house, all else being equal, with the same amount of equity. "The math just produces a different price," Ford told Fortune. The FDIC therefore severely stacked the deck against the bid from the private-equity players and made their bid less competitive than it otherwise could have been.
In a webinar last Tuesday that was sponsored by Source Media, investor Wilbur Ross (who participated in a group that acquired the deposits and assets of the failed BankUnited in Florida and has bid on other FDIC failed bank transactions) made the same point. To Ross, the policy of the FDIC that requires private equity investors to maintain 10% Tier 1 capital for the first three years makes it hard for him to “be a player.” While Ross said he intends to continue to "be a player,” when his competition (existing banks) is required to maintain, for example, only 7.5%, he can’t be as aggressive with his bids as can his bank competition. You have 3% capital that is being "inefficiently deployed." It’s tough to make a bid that makes sense in terms of return on invested capital when your competitors have a lower capital requirement and, therefore, greater leverage opportunities. As a consequence, Ross believes that this uneven treatment of bidders will drive private private equity investors toward asset acquisitions rather than whole bank deals.
Ross doesn't understand why the FDIC is uncomfortable with private equity. He does not believe that the FDIC can't point to specific examples of abuse by private equity investors that justifies the FDIC's attitude. Nevertheless, he (and other private equity investors) accept reality. If it's the intent of the FDIC to ensure that private equity doesn't participate in buying failed bank deposits from the FDIC, it's doing a great job of driving it away. Of course, the folks who will ultimately suffer by not having more bidders in the game to potentially make bids that maximize the FDIC's return on failed bank resolutions are the banks that fund the FDIC through assessments.You know, the banks that are prepaying three years of assessments so the FDIC doesn't go broke (dream on).
To me, the FDIC's position makes sense not from a business or economic standpoint, but from a political one. The public, stoked by demagogues in Congress, is righteously upset with "Wall Street," and in the mind of the average citizen, private equity investors are part and parcel of the same cesspool. Therefore, if your major method of decision making is licking your index finger and sticking it in the air to determine the wind's direction, dumping on private equity investors, even at the cost of increasing your ultimate losses, is perfectly "rational." Rather than leading the American public where it needs to go, it's simply so much easier to simply find out what rouses the herd's ire and play to it.
The FDIC has promised to revisit its private equity policy in six months. If it doesn't change the policy, Ross said he believes that private equity will abandon the failed bank acquisition game altogether and concentrate instead on the acquisition of the "bad assets" of failed banks from the FDIC. When it comes to these matters, I'd never bet against Mr. Ross.