Bank bailout may boost private equity opportunities

While its full impact remains unclear, the US goverment's intent to buy $250bn in bank equity stakes could create lucrative co-invesment opportunities for private equity firms.

Private equity insiders who invest in banks have many questions about the US government’s $250 billion bank bailout, but some believe the rescue, which Treasury secretary Henry Paulson has said will include co-invesment opportunities for private capital, will generate deal flow.

“This could create opportunities for private equity that without the programme might not exist,” said Don Edwards, chief executive of healthcare- and banking-focused private equity firm Flexpoint Ford. “Some institutions that get the capital combined with private investment are attractive, and without the capital are not attractive.”

The government said Tuesday it will use $250 billion of its $700 billion proposed financial rescue package to buy preferred shares in banks, especially large institutions. The largest payouts include $25 billion each to Bank of America, Citi, JPMorgan and Wells Fargo, as well as $10 billion to Goldman Sachs.

The plan also comes with regulations, including restrictions that prevent banks in which the government invests from providing golden parachutes.

The US plan mirrors those already being implemented in Europe, some of which have gotten a cool reception. In the UK, small investors have responded negatively to the government’s £37 billion bailout of the Royal Bank of Scotland, Lloyds TSB and HBOS, according to an article in The Times. The investors are concerned that Lloyds TSB and RBS will stop paying dividends until the bailout money is repaid. Investors also said the government will burden the banks with regulations.

Gerald Ford, who joined Flexpoint as a bank investing specialist, said he would be curious what sort of “strings” would come along with a bank that has received a capital infusion from the US government as well as how the government will pick banks to qualify for the bailout programme.

“It gets a little questionable as you go down the chain as to who is going to pick winners and losers and how will they allocate capital,” Ford said.

The government's actions could also make it more expensive for private equity firms to conduct deals in the banking sector. Ed Grebeck, chief executive officer of financial consultancy Tempus Advisors, believes that by selectively injecting capital into banks, the government “could set up a two tier banking system” with defacto higher cost of capital for banks that do not receive the funding, especially smaller, regional banks that have been the mainstay of private equity firms' foray into the banking sector.

Joseph Vitale, a partner in the bank regulation practice of law firm Schulte Roth & Zabel in New York, said the bailout could be a double-edged sword.

“The government taking a stake implies the government will be standing behind and providing some degree of support in the bank now that it has a vested financial interest,” Vitale said. “To the extent the investment is coupled with new regulatory requirements, depending on the requirements, it could make it harder for banks to make money.”

One industry source said banks are already heavily regulated and thus doesn’t anticipate government investment including new rules. In fact, the government eased rules for bank investing last month, allowing firms to buy up to a 33 percent stake in a bank without triggering bank holding company rules. Before the rule change, firms that bought a stake of 25 percent or more were considered controlling shareholders and had to become bank holding companies, subject to capital requirements, minimum leverage ratios and other regulations.

Robert Stewart, spokesman with the Washington, D.C.-based Private Equity Council, said the government's actions to open up investing in banks is a good thing.

“We've been supportive of increasing the opportunities for investment in banking institutions,” Stewart said.

Cezary Podkul contributed to this article