Opinion

Felix Salmon

When private equity funds try to get around bank-ownership rules

By Felix Salmon
May 8, 2009

The NYT sent Eric Lipton all the way to Cainsville, in the middle of absolutely nowhere, to visit what used to be called the First National Bank of Cainesville and is now called Flowers Bank, after its brand-new owner, Chris Flowers. Lipton has filed a great story of attempted regulatory arbitrage, where Flowers is personally buying this bank just so that he can get its national banking charter — his private equity shop being considered by the Fed to be not boring enough to own a bank.

The Fed is right, as Lipton shows — he even quotes Flowers talking about how “lowlife grave dancers like me will make a fortune” from the bank crisis and bailout. Which is not really the attitude that one wants bank owners to have: they should be boring and conservative, not greedy Masters of the Universe who happily drop $53 million on buying an Upper East Side townhouse.

Incidentally, the NYT’s picture caption is very wrong: it says that the value of the Cainsville bank is “about a third” of the value of Flowers’s townhouse. Not even close. As of the end of last year, the bank had $16.699 million in assets and $12.492 million in liabilities, for a book value of $4.2 million. Even if Flowers paid 2x book (unlikely, but possible, given that what he really wanted was the banking license rather than the bank) he will only have shelled out about $8 million for the bank, or about 15% of what he paid for his townhouse. More likely he paid less than a tenth of what he spent on his home.

If Lipton wants to follow up on the subject of regulatory arbitrage among private-equity shops which own banks, he might want to take a look at MatlinPatterson, a distressed debt fund right here in New York which has been going through all manner of contortions to avoid breaching rules preventing it from owning more than 24.9% of banks such as Flagstar Bancorp in Michigan. When it wanted to buy Flagstar, it couldn’t do so directly. So it asked its limited partners to send more money to a new entity it set up for the purpose, and as soon as it got that money, it refunded an identical amount back to those partners in a deal which looked very fishy to John Hempton back in April. (One of the limited partners was Nicola Horlick’s Bramdean Alternatives.)

I think it’s about time that we move from a rules-based system where private-equity types spend vast amounts of time and effort trying to get around rules preventing them from buying banks, and move to a principles-based approach where anybody attempting something as blatant as this (“it’s not my private-equity shop buying this bank, it’s me personally, so that’s fine”) gets slapped down sharpish. And that goes for MatlinPatterson, too.

Comments
6 comments so far | RSS Comments RSS

As not-okay as this kind of rule-bending ought to be, I rather like the idea of someone investing money in an old-fashioned bank these days.

In particular, the nutcases throwing $8 billion at Wells Fargo might perhaps be better served using that money to capitalize a new bank, no?

Rather than recapitalize the institutions that have failed so miserably, investors with that kind of money to burn should really be replacing them.

Posted by Jacob | Report as abusive
 

I don’t follow, Felix…do you oppose private ownership of banks in general, then? Should Beal Bank go public? Not to mention the Rothschilds? I don’t get why JC Flowers can’t invest a small amount of his substantial fortune in a bank…

Posted by Jay | Report as abusive
 

Jay, that’s the whole point. Beal and the Rothschilds clearly want to personally own banks, and under a principles-based approach they’d be allowed to do so. But when Flowers personally buys a bank just to get around rules banning his fund from doing so, you can crack down on that.

 

What is not clear in this piece is why private equity or other investors want to avoid breaching the 24.9% ownership line. To do so requires that they apply to the Fed to become a bank holding company (BHC). At that point they are subject to the “source of strength” rules which in effect put 100% of the investor’s assets at risk. These rules have kept significant private capital from being invested in the banking industry at exactly the time they most need it. The problem is especially acute within the smaller community bank arena. It is my understanding that with Flagstar the regulators actively sought a workout that would wall off Matlin’s other assets beyond the $250 million they committed to the deal. There is not a truly healthy bank in Southern Michigan and absent some loss limit agreed to in advance by the regulators, recapitalizing these institutions with non-public funds will be extremely unlikely.

Posted by Mark | Report as abusive
 

that’s like trading a bedroom for a bank.

Posted by CB | Report as abusive
 

Regarding your fraction-of-a-townhouse calculation for how much Flowers paid for his bank: Note that of the $4.2 million book value, it appears that $2.6 million was new paid-in capital from Flowers himself (per the FDIC link, that’s the amount of equity attributable to “business combinations”; it was zero in ’07). Applying your 2x book estimate to the remainder, in all likelihood he paid only around $3 million — excuse me, I mean one-eighteenth of a townhouse — for his bank.

Posted by Matt | Report as abusive
 

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