Private Equity Seeking Out The Next Value: Banks

With banks trading at historically cheap valuations, private equity firms are now looking not only for bargains in the sector, but also for ways to get around regulatory hurdles (see FT article). Currently, federal rules prevent investors from holding more than 24.9% of a bank if they own other companies. The reason for the rules were to keep larger companies and conglomerates from buying banks simply to fund their other businesses. This has been a sticking point in the past given that many private equity funds like to have the flexibility to take large, and at times controlling positions. Furthermore, anytime you own a bank there is also the possibility that regulators will come in and require additional risk capital to be set aside, further reducing investment returns.

However, funds are looking for ways around regulations, and indications are that some are succeeding as regulators are starting to show flexibility. Some funds are launching new funds with different names and no direct ties with the home fund, allowing the isolated fund or investors to take a controlling stake in the banks. Can anyone say SIV? Other companies have been able to take stakes that are slightly larger than the 14.9% benchmarks that in the past have usually resulted in regulatory disapproval. Both moves seem to go against safety and transparency, and indicate not only more flexibility with the regulators, but maybe also a little desperation as well. Given the decrease in SWFs for being the capital provider of last resort for U.S. companies (see previous post regarding decreased sovereign wealth funding), some regulators may be forced with a choice between less regulation and transparency, or flat-out insolvency. Sometimes you just need to look for more choices. This may be one of those times.