JLL Finds Way Around Bank Ownership Limit

Target: FC Holdings Inc.

Price: $75 million investment (with option to invest $75 million more)

Sponsor: JLL Partners

Legal Advisers: Target: Bracewell & Giuliani LLP; Sponsor: Skadden Arps Slate Meagher & Flom LLP

JLL Partners assumed control late last month of a Texas community bank after finding a way around regulations that limit most investors to holding no more than a 24.9 percent stake in a U.S. bank.

With help from law firm Skadden Arps Slate Meagher & Flom LLP, the firm carved out a separate vehicle from its $1.5 billion fifth fund to function as a bank holding company. Doing so allows the firm to comply with federal safe harbor regulations that limit outside investor participation in banks.

Under the terms of the deal, closed Nov. 30, JLL Partners has invested $75 million of equity in FC Holdings Inc., the parent of a start-up community bank in Texas run by industry veteran Nigel Harrison. FC Holdings will use some of the money to purchase First Crockett Bancshares, a small Texas bank, part of Harrison’s plan to create a network of business-focused banks in the geographic triangle formed by Dallas, Houston and San Antonio. With the purchase of First Crockett, FC Holdings will have about 20 branches that do business under the name First Community Bank. The goal is to expand the number of branches to more than 50, mainly by focusing on commercial lending to small and medium-sized businesses.

“We wanted to build a bank focused on small-business relationships in an attractive market,” said Frank Rodriguez, the JLL Partners managing director who led the deal. “Texas has great growth dynamics for small and medium-sized businesses.”

The initial $75 million infusion gives JLL Partners ownership of 55 percent of FC Holdings, as well as control of the board. JLL Partners has the right to kick in $75 million more to FC Holdings, which would raise its stake to 80 percent. The deal pushed JLL Partners past the 75 percent commitment threshold for its fifth fund, setting the firm up for a $3 billion fundraise in 2008 (see related story, p. TK).

JLL Partners’s total investment in FC Holdings values the company at 1.4x tangible book value, Rodriguez said. Banks typically trade at more than 3x or 4x tangible book value, and the sale down the road to a strategic buyer or a public offering could lead to a large cash-on-cash return, justifying the equity-heavy deal, he said.

Led by Rodriguez’s work in the specialty finance sector, JLL Partners had identified community banking as a good opportunity for investment, especially since regulators require banks to be well-capitalized and protected from downside risk. The only stumbling block was the regulatory hurdle.

Indeed, LBO shops have largely avoided the banking sector, and any investments they do make are typically small because federal safe harbor regulations generally limit bank investors to 24.9 percent ownership; any investment larger than that requires the investor to be a bank holding company. To surmount the obstacle, JLL Partners carved out a piece of its fifth fund to create JLL Partners Fund FCH LP, a vehicle that serves as a bank holding company and that shields all other pieces of JLL Partners’s portfolio from federal regulation.

While working out the legal framework to make the deal happen, JLL Partners talked to 30 management teams in the banking sector before settling on Harrison. At the time, Harrison had approached Bear Stearns about raising capital to fund his expansion strategy. Ted Huffman, a Bear Stearns investment banker, brought Harrison and JLL Partners together, knowing that Harrison preferred to work with a single partner and that the buyout firm wanted to enter the banking business.

In the 1990s, Harrison built up a community banking network in Texas before selling it to Wells Fargo in 2004. Wells Fargo didn’t need the back-office functions of Harrison’s old banking network, so Harrison kept it as a subsidiary and used it as the backbone to start up this new network of community bank branches, Rodriguez said.

The investment in FC Holdings marks JLL Partners’s fourth deal in the finance sector. The buyout firm owns ACE Cash Express, a diversified provider of financial services that cashes checks, issues debit cards, provides international moneygrams and writes short-term loans.

JLL Partners also owns J.G. Wentworth, which purchases structured settlements of insurance policies and annuities. Since buying the company in 2005, the shop has taken out 2x its initial investment through two recapitalizations, and over the summer it sold $145 million worth of equity on a private exchange run by Bear Stearns. The private placement paid off J.G. Wentworth’s second-lien debt and valued JLL Partners’s remaining equity position at $450 million, generating a 6.1x return on its original $125 million investment, Rodriguez said.—J.H.