Private Equity Briefcase

August 12, 2008

Financial-Services Buying Spree

The words couldn’t suggest a worse environment for shareholders of banks and financial institutions. But the old adage "one person’s trash is another’s treasure" couldn’t be truer when it comes to financial services, an industry many expect will produce its share of M&A investment bonanzas.

Large financial institutions are still working through a backlog of bad mortgage loans as a result of last summer’s subprime market route and, in some cases, offloading big chunks of debt through sales to financial buyers. Banks are expected to reorganize their operations, shedding assets or selling shares to replenish depleted capital reserves. Bulge-bracket houses, community banks and specialty-finance companies all could use a boost.

Large and middle-market private equity firms have been, and only continue to be, only happy to oblige. Large transactions like TPG’s participation in a $7 billion capital infusion into Seattle thrift Washington Mutual have commanded headlines and, against the backdrop of the mortgage mess impacting Wall Street and Main Street alike, prompted regulators to review bank holding company regulations.

The mid-sized market has also drawn investment, particularly involving mortgage-related plays of late. Take, for instance, The Blackstone Group’s minority stake infusion in Bayview Asset Management at the end of July or Lightyear Capital’s $400 million deal in May to back a newly-formed monoline mortgage insurance company through a transaction with Winston Salem, N.C.-based mortgage insurer Triad Guaranty.

All the activity suggests at first blush that the number of transactions should increase. But, new research by Jefferies Putnam Lovell, a division of Jefferies & Co., indicates that deal execution in financial services should remain about the same over the next 12 months as it has over the last six months. In the first six months of 2008, buyers committed $10.6 billion to acquire partial or full ownership of 104 fund managers, compared to $36.9 billion, or 115 deals, in the prior-year period. Even so, the aggregate deal sizes and the assets under management that change ownership is expected to increase because of capital-raising moves of troubled financial institutions, which have written down at least $400 billion and sought more than $300 billion in new capital.

That’s a given in the bulge-bracket segment of financial services because of the massive write-downs that have taken place. But, it’s notable that some middle-market investors have chosen not just to capitalize on mortgage servicing businesses, but fund the build out of community at a time when large banks remain mired in the credit morass. It’s what Paul Levy, founder of JLL Partners, had in mind when the firm invested $75 million to expand First Community Bank of Dallas' regional banking chain.

Meanwhile, as economic challenges and credit problems remain on the horizon the outlook for acquirers of financial-services assets should only continue to improve. Purchase multiples are only expected to soften, Jefferies Putnam Lovell notes, reflecting an increasing number of sellers that need to refuel capital reserves and, hence, will settle for lower bids.

For a financial-services acquirer that should mean three things: buy, buy and buy.