Strange bedfellows

Western governments' emergency measures to buy bank equity stakes may have wide-ranging implications for financial services-focused private equity firms, writes Cezary Podkul.

The US Treasury has reportedly decided to allocate $250 billion of the US government’s $700 billion bailout bill towards taking equity stakes in US banks, a move that could dramatically alter the landscape for private equity firms hoping to invest in the troubled US banking sector.

Details are pending, but US Treasury secretary Hank Paulson, said on Friday that the financial sector recapitalisation programme would be designed in a way that would “encourage the raising of new private capital to complement public capital”.

This suggests that the US government may seek to co-invest in banks alongside private equity investors who have poured record amounts of capital into the sector in recent months.

But at $250 billion, the government’s investment would dwarf the approximately $6 billion that private equity firms have invested in the sector year to date.

Cezary Podkul

As a result, private equity firms that have earmarked funds for financial services investing could now find a strong new partner for their investments, albeit undoubtedly with restrictions typically associated with private uses of public funds that may make the investment less attractive financially.

The increased moral hazards posed by the use of public funds toward private investments may also provide private equity groups with more ammunition for lobbying the government to ease long-standing limitations on how large of an interest they and other non-banking investors can acquire in banks before they have to register as bank holding companies.

Regardless, a welcome side effect, may be that recapitalised banks will see through their leveraged loan obligations to buyout firms. After the UK government recapitalised the Royal Bank of Scotland, the banking giant is again standing behind its financing obligations for the $52 billion leveraged buyout of Canadian communications giant BCE Group.

Other countries have struggled with similar issues. Earlier today, the German government announced a €500 billion financial rescue plan for its struggling financial sector. Similar plans in France, the Netherlands and Spain total €650 billion.

Although terms and conditions on deploying the rescue capital differ from country to country, for the private equity investor, perils and opportunities abound.