How to Buy Banks
By “Shopping” for Regulators, Private Equity Firms Have Discovered How to Buy Banks – Leaving
Taxpayers With All the Risk
The financial Barbarians are at the gates of the U.S. banking sector.
“Regulatory arbitrage” – sometimes called “regulatory shopping” – has emerged as
the favorite strategy for these Barbarians, otherwise known as private equity firms, to get around the federal
rules that kept them from owning banks.
Why the sudden interest in banks? Like legendary bank robber Willie Sutton is
famously (and probably falsely) remembered for saying: “That’s where the money is.”
Like so many of the businesses in the financial sector, the private equity business
is right now reeling – and littered with its own bankrupt leveraged buyout deals. So now these LBO firms are
shrewdly targeting failed banks, playing regulatory arbitrage, and shopping around as they search for ways around
the regulations that were designed to keep companies with their motives out of the U.S. banking industry’s
The new twist on acquisition leverage is to have taxpayers, through the Federal
Deposit Insurance Corp. (FDIC), backstop losses on acquired banks if the economy continues to falter. And as soon
as they can leverage depositors and the FDIC as a source of funds, these private equity firms will go back to
buying leveraged-up targeted companies with cheap borrowed money – to which they’ll have easy access, since they’ll
actually own the
The Background on Banking Regs
Banks are regulated at the federal level by a number of agencies. The regulators
include the Federal Reserve Board (FRB), which oversees national banks chartered by the government, the Office of
Thrift Supervision (OTS), a U.S. Treasury Department office that oversees thrift institutions, savings and loans
and credit unions, the Office of the Comptroller of the Currency (OCC), and the FDIC, not to mention various state
banking regulatory bodies.
Lately, approval actions by the OTS and FDIC are at odds with the U.S. Federal
Reserve, which has not authorized the acquisition of controlling interests in any banks by any private equity
players. The FDIC has expressed its acquiescence as a way of more-quickly offloading insolvent banks in the hope
that doing so might help limit its exposure to depositor claims. And the OTS, after being somewhat hesitant – and
with its future as a regulator now in jeopardy – seems to be doing what it can while it still has the power to
grease the wheels for private equity interests.
For a case in point, consider billionaire investor Wilbur L. Ross Jr., an expert
purchaser of so-called “distressed” assets who is known by some as “The King of Bankruptcy.”
Using his recently acquired American Home Mortgage Servicing Inc. – one of the
nation’s largest mortgage servicing companies, with about $100 billion on its books – as his investment vehicle,
Ross sought to buy bankrupt American Home Bank – at one time a would-be Countrywide Financial Corp.
The OTS denied the sale on the grounds that Ross’ firm wasn’t already a bank, and
AHB was subsequently sold to The Bancorp Inc. (Nasdaq: TBBK), a federally chartered online bank based in
Wilmington. But in a classic example of “if-at-first-you-don’t-succeed” strategic resolve, the
Ross-led WL Ross & Co. LLC-headed
a consortium of private equity giants and investors that included including Blackstone Capital Partners
(NYSE: BX), Carlyle Investment Management, Centerbridge Capital Partners LP, LeFrak Organization Inc., The Wellcome Trust, Greenaap Investments and East Rock Endowment Fund –
and with the full blessing of the OTS and FDIC just acquired BankUnited Financial Corp. (OTC:
BKUNQ), a Coral Gables, Fla.-based savings
and loan that had been shuttered by federal banking
The “Silo” Sidestep
The vehicle that was used to acquire BankUnited is called a “silo.” In a neat
little end-around the bank-holding-company laws separating bank owners from controlling other commercial businesses
– and control of multiple businesses is one of the keys to success for a private-equity player – the so-called silo
arrangement theoretically establishes a walled-off vehicle to acquire and manage the bank separately from the
firms’ other investments. Who knew it was that simple? The Fed has said that it has yet to determine the validity
of the silo-structure vehicle approach.
The silo structure was first tested and approved back in January, when the OTS
approved New York-based MatlinPatterson Global Advisers
LLC’s purchase of Flagstar Bancorp Inc. (NYSE: FBC) in Troy, Mich. But as a precaution – and to address
the early OTS denial of Ross’ attempt to buy American Home Bank (based on the fact that he didn’t already own
a bank), Ross that same month personally bought a controlling
stake in tiny Indiantown, Fla.’s First Bank and Trust Co.
At the time, Miami Banking expert Ken Thomas told the
Palm Beach Daily News that Ross “[isn’t] buying a bank as much as he's buying a bank charter. Once you have a bank
charter, you can go statewide, region-wide, or nationwide. That may be just the beginning of his endeavors. It
could be Bank of Indiantown or Bank of America (NYSE: BAC) – it doesn’t matter.”
As for why Ross bought the stake personally, Mark Tenhundfeld, director of regulatory
policy at the American Bankers Association, a Washington-based trade association, told
Bloomberg News that
“an individual cannot be a bank holding company. If the OCC approves a change in bank control proposal by an
individual, then that person may avoid bank-holding-company regulations.”
The Flowering Inferno
Being the cautious type, however, Ross wasn’t the first to personally buy a bank.
That distinction goes to billionaire investor J. Christopher
Flowers, who personally bought tiny First National Bank of Cainesvill in Missouri in order to
keep his own private-equity shop from becoming a bank holding company. It seems that both Ross and Flowers are
determined to “backdoor” their way into owning and controlling banks, while at the same time limiting the larger
exposure of their principal investment vehicles. How that turns out for the banks, or for their depositors, remains
to be seen.
J.C. Flowers & Co. LLC. is no stranger to
banking, at least not outside the United States. J.C. Flowers bought a 24% stake in Hypo Real Estate Holdings AG, Germany’s second-biggest
commercial property lender and a company that’s in such deep trouble that it’s 90% owned by Germany’s national
stabilization fund – which wants to “squeeze out” Flowers, according to news
Flowers & Co. also owns a third of Shinsei
Bank Ltd., a Japanese bank in which it has invested hundreds of millions of
dollars. Too bad Shinsei is in dire straits and has had to be supported by the Bank of Japan.
But in another “if-at-first-you-don’t-succeed,” Flowers is looking
to merge Shinsei with another failing Japanese bank, Aozora Bank Ltd.,
which itself happens to be majority controlled by none other than the three-headed dog from Hell,
Cerberus Capital Management LP – the
same Cerberus that wouldn’t support its Chrysler LLC investment with any additional capital. One of the reasons Aozora isn’t doing so well
is that it invested its depositors’ money in its master’s LBO deals, and in the case of lending to Cerberus’
51%-owned, struggling and technically insolvent GMAC LLC (NYSE: GMA), has lost hundreds of millions of
The two failures are now telling Japanese regulators they intend to merge the two
banks. The deal is actually being orchestrated by Japan’s banking regulator, the Financial Services Agency, and
according to a recent Wall Street
Journal article, is the second time that the government has
aided the two banks.
Back here in the United States, J.C. Flowers – along with hedge fund
Paulson & Co. and others –
also bought defunct IndyMac Bancorp Inc.
(OTC: IDMCQ) bank out of receivership
from the FDIC.
Allowing private equity players to replicate the failures of their recent history and
leverage going concerns with layers of debt by now granting them access to FDIC-insured depositor funds to do more
of the same is a mistake of massive proportions. In a recent letter to U.S. Treasury Secretary Timothy F. Geithner,
U.S. Sen. Jack Reed, D-R.I., expressed “serious concerns” about this potential problem, stating that “private
equity firms are not transparent. There are potential conflicts with their other holdings, investors, management
and sources of funding, much of which is not disclosed.”
Desperate times don’t always require desperate measures. While it’s true that banks
need to be recapitalized and that private-equity firms have plenty of dry powder at the ready, we should welcome
banking-sector investments from these private-equity players only if it’s passive in nature. After all, why should
we give the quick brown financial fox access to our already-plucked-to-death hen house?