[This article was posted on August 19, 2008 on the home page of ABA Banking Journal, www.ababj.com, and is copyright 2008 by the American Bankers Association.]

 

It’s not that Joshua Siegel is a cockeyed optimist. He just prefers to go by solid research and experience, instead of media-driven crowdthink, and so his StoneCastle Partners, LLC, one of the largest private investment funds focusing on banks, continues to make investments in community banks.
    In spite of much-publicized implosions in selected real estate markets, he says, the markets where the vast majority of community banks do business haven’t had the same kind of wild swings in property values that the headliners have seen. And the typical community bank’s exposure to commercial real estate and construction lending isn’t nearly as severe or dangerous as some would believe. Sure, he says, some banks overdid it. “But we won’t see widespread failures,” he insists, and StoneCastle, where he is managing principal, puts its money where his mouth is, with investments in more than 220 community banks in 43 states.
    StoneCastle has been doing this for several years, and with the industry’s call for capital in the last year or so, it’s being joined by a growing throng of private equity investors, individuals and funds, who see good opportunities in banking.

Banking’s relief pitchers
There are over 75 private equity funds, “with north of $50 billion in assets,” with some interest in banking, says Tom Killian, principal at Sandler O’Neill and Partners, Inc. “That’s probably a very conservative estimate,” he adds.
    Banks of various sizes seeking capital have been aided by some household names in money—such as The Carlyle Group, which invested $75 million in newly issued securities in $6.6 billion-assets Boston Private Financial Holdings, Inc., a five-bank holding company, in late July, or Icahn Partners LP, which took part in a large investment made in $16 billion-assets Guaranty Financial Group, Inc., Texas, in June. They have also been helped by lesser-known, but active investor groups. Some groups come into the fray with ex-bankers and regulators on board, while others have money but not much banking knowledge.
    “We’ve been talking to a number of private equity firms about how to look at banks,” says Rick Maples, co-head for investment banking and head of the Financial Institutions Group at the investment bank Stifel Nicolaus, St. Louis.
    Some deals get done after regulators’ suggestions, some come about through word of mouth, and others rely on active management. Tom Killian is one of the matchmakers who get capital-hungry banks together with private equity investors. “Most of these types of investors are looking at what happened in the last cycle,” says Killian. As black as the late 1980s and early 1990s looked, he says, credit problems peaked in 1991 and investors who got in when the crowd was still in doubt did well.
    “The tricky part is to call the bottom,” says Killian.
    And today’s private investors aren’t settling for deal packages to determine if they ought to put money on a bank. “Most investors now want to do on-site due diligence,” Killian says, and this means delving as deep as individual loans, when warranted. From the banker’s perspective, these visitors aren’t generally just “lookers,” according to Killian.
    “There’s a reasonably good hit ratio, in some manner,” says Killian, “whether it is an investment being made or an M&A transaction taking place.” Confidentiality agreements are typical in due diligence mode.

“Meandering” through regulation
The quest isn’t over, even after general agreement is reached, however. Some private investors insist on having a seat on the board of the bank company their funds are invested in, for instance.
    But even more to the point is the issue of deal structure. There are various, somewhat complicated limits on investments in banking firms, some of which vary among regulators, that affect how much a nonbank investor will put into an institution and in what form. For example, holding more than 9.9% of the voting shares of a company triggers a Federal Reserve requirement to adhere to bank holding company reporting requirements. Coming into bank holding company status can affect what other investments a fund or investment group can make, legally.
    “A lot of venture funds don’t want to become bank holding companies and they don’t want to be reporting to the Fed and they don’t want to make small investments, either,” says Walter Moeling IV, co-chair of the Financial Institutions Practice Group at Powell Goldstein LLP, Atlanta. As a result, he says, large capital infusions are frequently structured “using every kind of instrument known to mankind,” says Moeling, “much of it to meander through the banking regulations.”
    Observers note that investment groups’ preference is to deploy large amounts of capital, both from the viewpoint of efficiency for the work put in on analysis, and for the sake of  significant entrée to a company and the industry.
    “There is an issue of ‘Return on Effort,’ here,” says Killian of Sandler O’Neill.
    As the industry’s overall needs for additional capital become more apparent, Moeling says “the Fed is receptive to the need to do something here.”
    Hints have leaked out, but as of mid-August the Fed had not shown any of its cards. ABA does not have a formal position on the matter yet, as no public details exist, according to a senior association officer, but it does support the Fed’s taking a fresh look at the options.


This article was posted on August 19, 2008 on the home page of ABA Banking Journal, www.ababj.com, and is copyright 2008 by the American Bankers Association.