Sunday, August 10, 2008

The Players Have Settled On A Loophole

Bank stocks have been crushed and Private Equity is ready to step in and scoop up the pieces. And, it appears they have settled on a loophole du jour to do it.

First, we hear from HEC Private Equity/Venture Capital Club:

Considering that the private sector is always better at coming up with solutions to business problems than the public sector (i.e. government), there’s been ever increasing discussion that private equity should take a larger role in helping turn around the banks. The catch being pesky U.S. regulations. But as everyone should know, if there’s a law or rule then there is a way around it and private equity firms are beginning to find ways to bypass stipulations on bank ownership.

One method is to simply create a separate, unique fund without ties to a firm’s other funds which is what J. Chistopher Flowers of JC Flowers is doing. He’s created a fund under his own name that is not directly connected to his firm’s funds. This would
allow him to take controlling interest of a financial institution (at least greater than 24.9% in the U.S.) while permitting JC Flowers & Co. to own other businesses, which they wouldn’t be allowed to due if they controlled more than that percentile threshold in a bank. Nicely done.

And, FT is covering the story:

Executives of large private equity firms believe they have found ways of overcoming US rules that make it difficult for their funds to buy large stakes in banks. This would position them to bolster the faltering sector without changes in regulations.

Private equity firms have trouble buying banks because federal rules bar investors holding more than 24.9 per cent of a bank from owning other kinds of companies. This was intended to prevent conglomerates taking control of banks and using them to fund themselves.

Funds have also been skittish about bank investments because of fears that financial regulators could compel them to provide additional capital to such institutions in bad times.

However, with banks trading at historically low valuations, private equity firms have been scouring the sector for bargains, while their lawyers work on structures that would make such purchases palatable from a regulatory standpoint.

At the head of the pack isJC Flowers, a renowned investor in struggling financial institutions. The solution of its chairman, Christopher Flowers, has been to launch a fund under his own name - with no ties to his other funds - that would enable him to buy a controlling stake in a bank.Carlyle, the private equity group, could also consider establishing funds in the names of individuals, lawyers familiar with the matter say. Meanwhile, Carlyle has taken a 17.8 per cent stake - including 9.9 per cent of the voting stock - in Boston Private Financial Holdings, which has a subsidiary that is a private bank in addition to an asset management arm.

The Carlyle stake is of interest because the Federal Reserve does not usually sign off on private equity purchases of more than a 14.9 per cent stake in a bank. Carlyle has also been able to name a director at Boston.

Tony James, president of rival buyout house Blackstone, referred to the Fed rules as a problem in an earnings conference call on Wednesday. However, he hinted that Blackstone might try to back an experienced bank management team in raising a fund to buy bank stakes.

Will we be hearing of the formation of a Randal Quarles/Oliver Sarkozy Fund soon?

Whichever way Quarles decides to buy into the banking sector, keep an eye on the deals he makes. He is a SAP--Sharp, Aggressive and government Protected. If you can buy into a deal on the open market, at a price close to the insider price he cuts for himself, it is the best way I can think of to bottom fish the banking sector. BTW: The Boston Private Financial Holdings/Carlyle deal was his deal.

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