PE ignores financial sector

The investment potential of financial services providers is being ignored by private equity says data published by German research and consultancy house, the Center of Private Equity Research (CEPRES).

Looking at 21,000 private equity portfolio companies between 1986 and 2008, the report found that only 486 of these operated in the financial services field. Of these, 249 could be classified as buyout deals (as opposed to venture capital), and averaged a return of 21.34%, compared to 17.47% for all buyouts in the same period.

Private equity has traditionally been a reluctant backer of the financial services sector, but as the economy falters, CEPRES argues it’s time for a change.

“Since the subprime crisis there has been a radical rethinking in this field. Earlier, banks and other financial service providers were more of a challenge than investment objects, because they have always been heavily regulated”, says Dr. Daniel Schmidt, managing director at CEPRES. “On one hand, there is now more money in the market that needs to be invested, and on the other hand lots of banks are in a precarious situation and need injections of capital.”

Historical returns demonstrate that for private equity firms that have taken the plunge, the rewards can be impressive, and with very little risk attached. In the US, the loss rate for buyout investments in the financial services arena over the last 22 years is 1.54% – the average for all sectors is 11.46% – and 26.15% of all investments received an IRR of over 100%, higher then any other market.

The European picture is less attractive – the loss rate is 3.57% (against a 7.72% average), and only 8.93% returned a plus 100% IRR.

However, the high returns in the US can be largely attributed to investments made between 1986 and 1991 during the Saving and Loan Bank Account Crisis.

“At that time, investors could buy banks at bargain prices, sometimes for one dollar. When the market had regenerated itself, they could then sell the investment objects on at higher multiples.”

Investments from this period generated a median gross return of 52.16% per annum. The median IRR of US buyout investments in the financial services sector from 1986 to 2008, gross of all costs, is 30.54% per annum.

With European undergoing something of a crisis in its banking sector, the local financial sector could do for European firms what the US banking crisis did for American funds in the 1980s.