Private equity recruits bankers

Private equity firms and hedge funds are banding together and recruiting bank executives, hoping to gain enough credibility with US regulators to get them to approve bank and thrift deals.

The strategy faces rising headwinds, though, as the friendliest of regulators to alternative asset management takeovers of banks, the Office of Thrift Supervision (OTS), faces potential demise under the Obama administration’s regulatory overhaul.

Private equity, hedge funds and other investors have increasingly turned their attention to banks and thrifts, which look cheap amid the financial crisis.

The United States has more than 8,200 banks and thrifts, some of which will fail, then be cleaned up and sold. Many smaller banks that are healthy also present an attractive investment opportunity as platforms for further deals and growth.

But private equity ambitions are dampened by regulators such as the US Federal Reserve and the OTS that jealously guard the gates separating banking from commerce.

So private equity firms are forming groups in club deals, where they can invest in a bank or thrift in a way that no one firm has a controlling interest in the institution, banking experts said.

They are also hiring former bank chiefs and other executives, hoping familiar names and people with banking experience will allay regulators’ concerns, they added.

“The last thing regulators want to do is take on most of the credit risk and then discover you are out of compliance,” said Seamus McMahon, chief executive of bank consulting firm McMahon Advisory LLC. “They really worry about who’s in charge.”

McMahon, who has held senior positions at HSBC Bank and Toronto Dominion Bank in the United States, said two groups scouring for deals have approached him as well as others.

“They are looking for people who have done a start-up or taken a bank from a small size to a larger size,” McMahon said. “’The play here is a clean balance sheet and a fresh start with a tight focus on credit quality.”

Already, this strategy has proven successful in some cases.

Last month, John Kanas, a veteran of the banking industry and former head of North Fork Bank, led a takeover of Florida’s BankUnited by a private equity consortium that included WL Ross & Co, Carlyle Group and Blackstone Group.

Rival bidders included a group involving Toronto Dominion Bank and Goldman Sachs.

The auction, which also saw a bid from private equity firm JC Flowers & Co, showed buyout shops could offer the Federal Deposit Insurance Corp a better deal than a strategic bidder like the TD-Goldman group.

The FDIC plans to provide general guidelines for how private equity investors can make investments in banks.

In another recent deal, three private equity firms – Fortress Investment Group, Crestview Partners and Lightyear Capital – agreed to invest in First Southern Bancorp in Florida and install former Bank of America Corp Vice Chairman Gene Taylor as its head.

As a longtime lieutenant to Bank of America CEOs, Taylor oversaw the integration of dozens of banks, especially in the US Southeast.

Still, even with credible management teams and capital, some experts say regulators remain wary of private equity and tend to prefer banks buying other banks.

Regulators worry about whether non-controlling private investors would be a source of strength for a bank and would pony up fresh capital in the time of need.

They are also concerned about the relatively short-term nature of private equity investments and the impact that might have on the health of the banking sector.

“There is still scepticism that private equity’s typical investment strategies are in the best interest of the banking system generally,” said Alan Avery, a bank regulatory partner at law firm Arnold & Porter LLP.

Arnold & Porter is working with five to 10 private equity consortia that have put together teams of bank executives and are looking for deals, Avery said.

Clearing regulatory hurdles could get even more difficult for private firms if the OTS is disbanded under the Obama administration’s overhaul of financial regulation.

Private equity firms typically do not want to become bank or thrift holding companies as that would bring all their operations under regulatory purview and restrict activities in unrelated sectors.

Some experts see OTS as more flexible than the Fed in allowing structures such as club deals.

“There is to some extent a level of forum shopping going on,” Avery said. ‘It’s an open question within the industry as to what would happen to the OTS deals if and when they go away.”