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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