Private Equity Briefcase

June 30, 2008

Uncharted Territory

The notion of additional private equity investments in banks gets more interesting by the day.

When news surfaced in the Wall Street Journal that the Federal Reserve may ease investment regulations in the banking industry one could almost hear trumpets heralding the arrival of a new age in Wall Street’s lower downtown canyons.

An additional source of capital for mortgage finance-depleted balance sheets is, without a doubt, music to the ears of bank executives. It too must be similar for private equity firms since present rules akin to the separation of church and state deter the vast majority of leveraged buyout firms from investing in banks.

Ownership restrictions imposed by the Bank Holding Company Act of 1956, not to mention increased Fed oversight, aren’t exactly unsubstantial reasons for why many LBO investors have shied away from investing in the highly regulated industry. A handful of private equity firms like Castle Creek Capital, though, have taken another route by focusing exclusively on financial services and allaying regulatory concerns.

The buyout industry’s financial services watershed moment may not be too far off if the editorial penned by big wheel Carlyle Group managing directors and dealmakers Oliver Sarkozy and Randal Quarles is right. In their editorial, they noted existing regulations can be amended to provide the financial services industry with the necessary access to capital while maintaining structural safeguards.

Some might wonder what sort of structural safeguards Sarkozy and Quarles were referring to? Perhaps, it’s the not-too-unbelievable idea that LBO firms will turn to their bank portfolio company to access cheaper debt financing to fund new acquisitions, or that these same firms will allow non-financial portfolio businesses to work out lucrative lending relationships with other portfolio companies.

The Service Employees International Union, as usual, didn’t mince words on the topic. The SEIU said its members and Seattle area residents donned HazMat suits and protested TPG’s $7 billion “toxic” infusion in Seattle bank Washington Mutual. The transaction, it said, will only encourage “risky behavior and more abusive [banking] practices.”

Industry observers, though, tout a different line, saying buyout firms are interested in banks as businesses rather than sources of funding.

Meanwhile, buyout groups and the law firms that counsel them are eagerly waiting to see what adjustments the Fed might make to existing ownership limitations or if it will address the “source of strength” doctrine as Sarkozy and Quarles reference should a private equity firm be required to prop up a failing bank.

Anyone remember the Blackstone Group’s highly publicized tussle with Dallas credit transaction and marketing services company Alliance Data Systems over that topic?

Just how long it will take the Fed to revise regulatory requirements for banks is uncertain. But, with the global financial industry facing up to $1 trillion in losses by some economists’ estimates, one thing is certain: the Fed better not take too long.