Randal Quarles Is Polishing His Presentation of Why Carlyle Group Should Takeover Banking

Oligarch of the future, Randal Quarles, spoke to FT recently and appears to have polished his presentation as to why private equity operator Carlyle Group should be allowed to plow into the banking sector with privileges allowed none other.

FT reports:

"Private equity really is almost tailor-made to solve the difficulties currently faced by financial institutions in a way that will cause less friction down the road," says Randal Quarles, managing director of the Carlyle Group's new financial services team.

"A number of investments by private equity will tend not to be majority investments, which make can them even more politically palatable," says Mr. Quarles, who is a former US Treasury undersecretary for domestic finance.

Quarles is clearly more sensitive to the political aspects of PE investing aggressively in the banking sector. This is the first time to my knowledge that he has publicly discussed the non-majority nature of investments PE plans to make in the banking sector and the political palatablity of such.

Mr Quarles says private equity is an ideal solution for politicians concerned at the cost of bailing out banks...

Any private equity group with more than 25 per cent is considered a "bank holding company" and required to make "source of strength" commitments to provide more capital if required.

Mr Quarles argues that these regulations should be relaxed to encourage capital to flow where it is needed. In any case, he says private equity is likely to find ways to invest consistent with the rules, such as by investing via separate vehicles.

The above is about limiting downside risk. If PE puts in chips to buy a stake in bank, they want to be protected against being required to ante up a second time.

Ben Bernanke, chairman of the Fed, last month promised to clarify bank holding company regulations. "Private equity is a very good source of capital. There are the issues relating to effective control . . . what constitutes control. We are looking at that and we will make a clear statement about that."

Mr Quarles says: "Private equity has become popular to demagogue unfairly but I don't believe that politicians are succumbing to that temptation."

"Private equity is really about standing between the taxpayer and these losses for a finite period, then returning the stake to the public markets once the problems are addressed."

"Private equty is about sttanding between the taxpayer and these losses for a finite period, then returning the stakes to the public markets once the problems are addressed." Hmm.

This nobility of Quarles to protect taxpayers means only one thing, Quarles sees the banking crisis as overblown . While fear runneth in the streets, Quarles is going to aggressively buy into the sector, add capital where needed, whip the banks into shape and then blow the shares out the door into the public's hand, again. What a play!!

As we have stated in the past, we have no qualms with any operator willing to step in and buy into the banking sector, however, we suspect that along with stepping up to the plate, PE will have government created special privileges that will ease its operation in the field. That said, PE, Carlyle and Quarles are going to make a fortune on the banking sector.

Watch wherever they put their money and if the stocks are still publicly trading and at a price close to the insider price they negotiate for themselves, then it is certainly an investment to take a look at. These guys know what they are doing. Why not go along for the ride if you can?

What Private Equity Can Do for Banking

In addition to the huge potential upside PE can experience from the leverage of buying into bank stocks in anticipation of an eventual turnaround in the real estate sector, there is also the fact that PE can bring its efficiency skills to banking.

Leo D'Acierno and Hugh MacArthur of Bain & Co. explain:

The subprime woes that have hit bank balance sheets with massive write-downs are helping to forge some unusual partnerships.

Private equity investors, with their well-honed talents for spotting opportunities to create value in troubled businesses, are buying big stakes in bank holding companies. In early April, groups led by TPG Capital and Corsair Capital Partners bought stakes in Washington Mutual Inc. and National City Corp., respectively. According to an analysis by Goldman, Sachs & Co., the 20 most stressed commercial banks need to raise between $25 billion and $35 billion in new capital. With the Federal Reserve Board's recent announcement that it would consider loosening regulations to make it easier for private equity firms to invest in banks, much of it will likely come from PE investors.

While welcoming the fresh equity infusion, bankers will be challenged to adapt to the hands-on management style of activist private equity shareholders. At a time when banks are under pressure to fundamentally rethink their businesses, learning to apply the winning formula of the top private equity firms may be just the tonic they need. According to Bain & Co. data, the top 25% of U.S. private equity funds raised between 1969 and 2007 have earned internal rates of return of 34%, on average.

Banks and their PE partners have their work cut out for them. Many banks have been too willing to stay in low-margin businesses that do not even earn back their true risk-adjusted cost of capital. This pervasive disease of "hidden underperformance" can be cured by embracing three time-tested private equity lessons.

Define full potential. No company can succeed when it divides its resources among too many initiatives. What sets PE leaders apart is their commitment to scrutinizing how money is actually made in each business in their portfolio. Only after taking stock of competitive trends, customers and demand to determine what the full potential of a business is do they commit to the few key initiatives.

Some institutions have already started taking a private equity lens to their business. For example, First Horizon National, the financial services holding company, recently turned to the capital markets to raise more than $600 million to replenish its balance sheet. It is using the capital to close peripheral branches in Atlanta and Washington and sell off its big mortgage lending unit to MetLife Co. The company will refocus on retail and commercial banking in its home state of Tennessee, where it is the dominant player.


Develop the blueprint. Once they've pruned their list to a handful of key initiatives, PE owners link them to specific activities and anticipated results that are spelled out in a detailed "blueprint" for action. Unlike traditional strategic plans, which focus on "what we want to be," blueprints spell out "how we are going to deliver."...

Accelerate performance. Because they typically hold their investments over three to five years, private equity owners create a sense of urgency about delivering results. They mold the organization to the action blueprint by setting up rigorous program management tools to drive implementation of the key initiatives. They track progress toward their goals by focusing on a few key metrics.

Outside the U.S., PE funds have applied this lesson to achieve remarkable turnarounds. In South Korea, for example, Newbridge Capital (now a unit of TPG) transformed Korea First Bank from a bankrupt commercial lender into a top retail bank, earning a nearly fourfold return on its equity investment in the process. Newbridge launched a bottom-up plan to revitalize the branch network. They consolidated corporate business into a handful of large-scale branches, stripped remaining office of low-value functions, and refocused the network on customer sales by retraining frontline employees and introducing performance-based compensation. The program resulted in $50 million of bottom-line improvements in the first year

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Bank Of America Basically Wrote the Bank Mortgage Bailout Bill

In posts below we detailed the curious meetings between the Federal Reserve and private equity funds such as Carlyle Group, on the attempts to change banking regulations to make it easier for private equity funds to buy large chunks of banks. We wrote:

While we have no problem with free markets being allowed to operate, as we asked in our earlier post, what's all this "dialogue" between the Fed and Carlyle Group and other private equity funds about?... There's a few lessons to be learned here about how the power elite operate. First, they always take advantage of crisis to make a grab...[And]They always make things complicated.

Always be suspicious of "dialogue" between a regulator and the regulated. It usually ends up being a plot by the regulated to carve out some benefit.

Indeed, the mortgage crisis is turning into a feast for the well connected power elite to take advantage of the crisis atmosphere and use it for their own benefit. Not only is private equity attempting to grab the banks, but the elite banks are writing the mortgage bailout bill to their benefit. Where's my proof. Here's my proof. My comments on private equity attempting to grab banks is here, here and here. As for the power elite banks, consider:

It appears that Bank of America essentially wrote the bailout section of the Dodd-Shelby mortgage bailout bill. National Review Online obtained a copy of an internal Bank of America's 64 page “discussion document” on the Dodd-Shelby bill.

Stephen Spruiell at NRO writes:

Almost all of BofA’s preferences are mirrored in the Dodd-Shelby legislation. The BofA document even offers PR tips, such as “We believe that any intervention by the federal government will be acceptable only if it is not perceived as a bail-out of the bond market.”... the similarities between BofA’s ideal bill and the bill before the Senate are obvious even to the layperson — read the document, then read David C. John’s analysis of the bailout and see for yourself.

The bill itself, as would be expected, is totally to the benefit of the likes of Bank of America and Countrywide. (Bank of America agreed in January to buy Countrywide.) MrMortgage writes:

This $300 billion Dodd-Shelby bailout is an absolute crime. It bails out the banks by limiting their loss to 10%; a joke since many of the problem areas like CA are down as much as 30% already on the median in the past 12-months and the rate of acceleration of the price declines are picking up steam. The subprime crisis is nearly over and now Prime, Alt-A, Pay Option ARMs and Home Equity Lines/Loans are failing. If they get this $300 billion passed, another $1 trillion+ will have to come on its heels for all of the other bailouts.

This needs to be fought and/or vetoed or it’s potentially $300 billion of taxpayer money down the toilet.

Timothy Carney reports:

We call it the 'Bank of America bill on steroids.'" A House staffer told me that, demanding anonymity, but speaking on behalf of aides to GOP members of the House Financial Services Committee.

Watching The Power Elite As They Grab Some Power and Money

Earlier this year, April 6, to be exact, I attended a luncheon meeting of the Washington D.C. National Economists Club. The guest speaker was Randal Quarels.

Quarles was former Under Secretary of the Treasury who led the Treasury Department’s effort in the coordination of the President’s Working Group on Financial Markets (aka, The Plunge Protection Team) and he is currently a Managing Director at Carlyle Group.

Plunge Protection Team coordinator? Managing Director at Carlyle Group? Folks, this is what is known as a major league insider.

At the time, I posted on the luncheon meeting and wrote in part:

In his talk, Quarles said that estimates go into the hundreds of billions in terms of capital that will be required by the financial industry because of losses sustained as a result of the current crisis. He said there will be more financial institutions that will go under in coming months.

He said that public markets will not supply the necessary funds because they don’t have the capabilities to study in detail the risks and potential rewards of the complex financials of financial institutions. He said private equity firms have the capabilities to do so and to supply the necessary funds. (N.B. Carlyle Group is a private equity firm).

Quarles stated that some changes in the structure of regulations that Paulson proposed were necessary but would take time to develop. He specifically stated that one regulation that needed to be changed is the limitation on the size of positions that non-banks can take in banks. (Note: Limitations in the size of non-banks positions in banks now limits Carlyle Group from taking large positions in banks).

It sounded to me like a power grab was being set up, and I titled my post:

Carlyle Group's Plan to Takeover the Banking Industry

Lo and behold, three months later Bloomberg is reporting that the Carlyle Group, and other private equity firms, have been meeting with the Federal Reserve to discuss removing limitations on the size of positions equity funds can take in banks.

Writes Craig Torres at Bloomberg:

Federal Reserve officials are reviewing regulations that limit investment firms' stakes in banks in an effort to channel more capital into the U.S. banking system....Fed officials have met with the Washington-based buyout fund Carlyle Group, spokeswoman Ellen Gonda confirmed. ``There is an ongoing dialogue,'' she said. ``It's not unusual for regulators to seek private sector input on policy.''

There's a few lessons to be learned here about how the power elite operate.

First, they always take advantage of crisis to make a grab. Notice how Quarles in his talk at the luncheon mentions Treasury Secretary Paulson's call for reform in financial regulation and structures.

Of course, Paulson made his comments about financial reform under the guise of changing things because of the current mortgage crisis. Nowhere did Paulson specifically state, "As part of this reform we are going to allow private equity funds, such as Carlyle Group, to buy bigger stakes in banks."

Quarles at the luncheon also mentioned that he picked the topic of financial reform way back in January. So we now have something of a timeline. Quarles had financial reform on his mind in January. Thus, one can assume, with a large degree of confidence, that the plotting was certainly going on at Carlyle back then. Paulson doesn't come out with a speech about the need for financial reform until late March. And, viola, here we are in late June and meetings between the Fed and the Carlyle Group are leaked to the press.

Which brings us to point two, of how the elite operate. They always make things complicated. Just what exactly are the Fed and Carlyle Group meeting about? It's "an ongoing dialogue" says the Carlyle Group.

If the Fed simply wanted to increase the amount of capital that banks could take from any one investor or investor group, the problem is fairly simple and could be solved with a Fed statement as follows:

Restrictions are hereby removed that prevent investors from increasing their stake in a financial institution above a specified level.

or

Restrictions on what individual investors or investor groups can invest in a financial institution have been increased to X.

Anytime a regulation is more than one sentence long, special interests are carving up little slivers for themselves and putting up barriers to entry that make it difficult or impossible for others to play the game.

The barriers to entry come in the form of complex regulations that require teams of lawyers to understand. Unless, of course, you are "in dialogue" with the regulators and help design the regulations so you know where the loopholes are, and in fact probably suggested some of them.

Taking advantage of crisis and making things complex is how the elite play. The current crisis is the mortgage crisis. They are taking advantage of the crisis to sweep up and buy into banks on the cheap, and they are sitting in a conference room with the Fed to create regulations so onerous that only the elite will be able to play.

When do you as an individual investor come in? Three to five years down the road when the banks stocks are prettied up and sold to the public at a price somewhere between 5 to 20 times what the elite paid for them.