Banking Law

Reporter J. Scott Trubey of the Atlanta Business Chronicle thinks that recent deals in Georgia "could prove to be a model path to health for larger struggling community lenders across the nation."

The deal, "essentially a play on the 'bad bank model' from the savings and loan crisis, involves the purchase from Georgia third-largest commercial bank, United Community Banks, of $100 million in nonperforming loans and REO by a private equity firm in return for the purchase by the investment firm of $65 million in convertible preferred stock and warrants to buy and equal amount of common stock, together with the placement by the investment firm with the bank of $10 million in deposits"in exchange for financing." We assume that that the last statement about financing means that the bank is financing the purchase.

That structure gets illiquid assets off the bank's balance sheet at something higher than fire-sale prices, while cushioning the bank from a fatal capital hit. It's what TARP should have done from Day One, instead of jacking around for months before deciding that purchasing assets was politically "impossible," then concocting a capital injection program that Congress promptly changed and then  publicly bashed. You wouldn't expect that evil private equity could be trusted to structure something so obviously beneficial to both sides without input from financial wizards like Chris Dodd, Richard Shelby, and everyone's favorite financial elf, Barney Frank. Yet, somehow, it miraculously occurred.

The deal appears to signal a growing willingness on the part of bank regulators to allow private equity to play a part in bringing the banking sector back to health. Thus far in the cycle, private equity has been limited ? players would argue extremely limited ? to backing management teams in the acquisition of failed institutions.

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The Federal Deposit Insurance Corp. has been generally wary of private equity investment in banks. The groups typically have higher hurdles to clear because of the perception of the industry that it?s only around for a quick buck.

I'm not sure this indicates much of an attitude change for the FDIC regarding control of banks by private equity firms. Although the article doesn't discuss the control aspects, I assume that the convertible preferred stock is non-voting and otherwise doesn't contain features that would give the holder "control" of the bank, and I also assume that the exercise price on conversion is more than 50% of the price paid for the preferred stock so that it cannot be held by the regulators that the "preponderant economic risk" in the underlying common (voting) stock lies with the preferred shares holder. Thus, the "private equity" investment company isn't exercising "control" and doesn't have to worry about being qualified as a bank holding company. I don't think this type of transaction really indicates a fundamental change in the attitude the FDIC will take toward private equity players who plan to acquire control of failed banks from the FDIC through use of a shelf charter or otherwise. I think the FDIC is going to continue to proceed with caution.

While Trubey quotes other private equity firms that state that they are eager to engage in similar transactions in Georgia, he also cautions that this is not a cure-all (any more than would be the 10-year loss amortization plan we've been discussing in prior posts).

Such a transaction won?t work for all banks. Investors want scale, a stock that is publicly traded at volume and a franchise free from the most onerous regulatory restrictions. They also want a bank with a plan to go on offense.

"Publicly traded at volume" takes a whole slew of community banks out of the mix. Moreover, many are under "onerous regulatory restrictions" which the regulators aren't going to automatically release simply because some capital is being invested (although that's a case-by-case determination). Also, the bank has to be "realistic" in setting a price for both the assets and the capital. The private investment company has to have faith that the existing management of the bank (which might be burdened with some of the same officers who drove the bank into the ditch) can execute a revised business plan going forward, and while at least one investor representative stated that he was "agnostic" about the types of toxic waste that it would be holding (as long as the bank's business plan going forward looked sufficiently "dynamic"), I suspect that there are some assets so toxic that they won't recover within in the half-life of plutonium-239. As a number of the commentators quoted by Trubey correctly observe, the investors are in the game for the long haul, because it's going to take years to work out the assets. Some banks' assets might be too toxic to take at any price.

Notwithstanding all the caveats, seeing private equity recapitalizing banks without the siphoning off of FDIC funds, and without the failure of a bank, is encouraging.