A couple of articles on Friday's The Deal.com focused on how difficult it is for "private equity" investor groups to help the FDIC address the needs of commercial banks and thrifts for more capital and to increase the pool of bidders for failed banks. The first article is an excellent discussion of the problems that private equity firms have encountered not merely in successfully bidding on failed bank transactions with the FDIC, but with getting approval from the Federal Reserve Board to purchase solvent banks.
"What does private equity even mean to them?" says one annoyed private equity investor focused on banks.
The regulators refuse to be nailed down on the definition of "private equity." What they'll tell you when you talk to them about it is that the definition is a lot like the late Justice Potter Stewart's definition of "pornography": "I can't define it but I know it when I see it."
The article's author, Vipal Monga, asserts that banks are increasingly turning to public equity markets, and that solvent bank "strategic buyers" are "gaining confidence" in their ability to absorb their weaker brethren. Therefore, the regulators don't need private equity investors. Personally, I think that the public equity window will not survive long into the new year, and that the solvent banks' "confidence" will also take a hit in 2010. The commercial real estate market is going to hit the skids on a fast toboggan into the toilet next year and commercial banks are going to feel the effects much more than they have already. That's a subject for another post, however.
I agree with the article's author's view that Chris Flowers' impudent crowing earlier this year annoyed the regulators mightily. One private equity investor told me that Flowers should have been whipped with a wet noodle until he begged for his Mama to make them stop. On the other hand, I think that the regulators got over it. I think that their real problem with private equity is a fundamental distrust that is visceral and, in my view, is based on the fact that regulators are from Venus and private equity managers are from Mars. They come from completely different worlds. Regulators--especially within the FDIC and the Federal Reserve Board---think that "these Wall Street sharks" are not believable when they promise not to try to control the bank. The Fed is using the "common enterprise" doctrine to find "common control" and "interdependent courses of parallel action" across all kinds of structures where, previously, wise men feared to tread. A D.C.-based lawyer who has talked recently to responsible people at the Fed about structuring a private equity deal informed me that he/she was told, "We can't say that you couldn't theoretically structure a private equity deal that we'd approve; however, we haven't yet seen such a structure and we don't anticipate that we will see such a structure in the future."
Is that plain enough? Does anyone need to read between the lines?
The "blind-equity pool" scheme that's discussed in the article might pass muster. Certainly, on the surface it seems to meet the formal objections of the regulators concerning control. On the other hand, an unidentified "banker" opines in the article that such a scheme "will end badly" once a few banks that are purchased by the blind pool head south. At this point, who knows? It can't end badly if it never begins.
Some investors are pursuing other schemes where private equity plays some part, but not the major part, of the ownership of the bank. Others are pursuing joint ventures with financial institutions, in which the institution ends up with a failed bank's deposits and branches and the private equity investors end up with the bad assets and a loss-sharing arrangement with the FDIC. The FDIC is encouraging such ventures. Still other private equity investors figure that as bank failures accelerate and existing strategic buyers reach capacity (or suffer setbacks as the commercial real estate markets continue to deteriorate), private equity's turn at the table will come. The latter investors are standing pat, playing a waiting game. I hope cobwebs don't grow on their heads and shoulders as they wait for a phone call that never comes.
The Fed's hostility toward private equity merited a separate article by Mr. Monga. The speculation of the source of the hostility within the Fed focused on governor Daniel Tarullo. I'd heard that previously, as well. Mr. Tarullo's biography indicates that he never held a non-government, non-academic job in his life, so perhaps he believes everyone on Wall Street is the blood brother (or sister) of Gordon Gekko. Certainly, this can't be a case of familiarity breeding contempt. However, the article also points out that another "Dr. No" has been a fixture at the Fed for years. As one unnamed lawyer snidely observes, "It's not surprising they're making things difficult."..."They've been saying no forever."
"Forever" is a long, long time. As the crisis deepens and the need for buyers continues, we'll see how long this apparent wall remains standing. For the near term, at least, private equity seems to be running uphill.
