Starved for Capital, Lenders Call on Banks
Dan Freed
08/21/08 - 07:48 AM EDT
Lenders who had relied on now-choked debt and equity markets for financing are increasingly looking to good old-fashioned bank deposits as a cheaper and more reliable alternative.
Chevy Chase, Md.-based commercial lender
CapitalSource(CSE), which lends to mid-sized businesses such as health care companies by raising debt in the capital markets, last month acquired flagging California bank Fremont General. The deal was done in the belief that dampened investor appetite for these securities will make this way of doing business untenable.
Private-equity investor MatlinPatterson is pursuing a similar strategy with its investment in
Thornburg Mortgage(TMA), according to investment bankers, investors and a report in
The Wall Street Journal last month.
Scott Albinson, an investment banker at
JPMorgan Chase(JPM) who advised CapitalSource on its deal, says he is working with other lenders who were heavily reliant on the capital markets but are seeing new advantages to owning bank deposits.
"Even some companies that have depositories may decide they're not sufficiently optimizing that platform and may look to expand it significantly," Albinson says. Commercial financier
CIT Group(CIT) and GMAC, owned by Cerberus Capital and
General Motors(GM) are among other big lenders that use bank deposits to supplement the debt and equity they raise in the capital markets.
The new focus on deposits represents a return to its roots by the lending industry, which had increasingly relied on securitization -- a form of financing that involves pooling loans, chopping them up into pieces and distributing them to investors. Securitization is not going away, but it is being called into question in the current environment as having led to irresponsible lending practices.
One needs look no further than the billions in writedowns and losses due to structured finance holdings at major Wall Street banks such as
Merrill Lynch(MER) and
Citigroup(C) to see the damage done, as investor appetite for these securities disappeared in the credit crunch.
"All of these exotic securities that have been created in the last few years have been misunderstood, poorly underwritten, and people have lost significant amounts of money on them," says Richard Bove, an analyst with Ladenburg Thalmann & Co. "There has been a clear move away from them in the marketplace, because people simply don't trust them."
Early concerns over such a shift in investor sentiment and the effect it would have on the capital markets were what drove CapitalSource to begin a quest to buy a bank three years ago, according to CEO John Delaney. Last month, CapitalSource completed its acquisition of Fremont General, a Brea, Calif.-based bank that last year consented to a cease-and-desist order from the FDIC that forced it out of residential subprime lending.
Owning a bank gives CapitalSource access to $5.2 billion in deposits to put to work in extending new loans. Delaney believes that new regulations and stricter capital requirements by ratings agencies will take away many of the advantages enjoyed by the capital markets. The agencies greased the wheels of the securitization machine by bestowing high ratings on structured debt products that posed a serious risk of default. Now the banks, with their more secure deposit bases, are poised to return to the driver's seat once they get past their current difficulties, Delaney and others believe.
"Deposits will be our principal source of funding going forward," Delaney says.
However, many lenders will not be able to convince bank regulators to trust them with deposits, which in most cases are insured up to $100,000 by the FDIC. Indeed, that may be one of the reasons MatlinPatterson, a vulture investment firm that has reportedly been trying to acquire a bank for some time as an additional source of capital for struggling Santa Fe, N.M.-based Thornburg Mortgage, has not yet sealed the deal.
"Regulators will allow you to originate new, good, clean assets in a bank, but they are not going to let you use a bank to solve a problem," Delaney says.
Mark Patterson, a principal at MatlinPatterson, did not return calls.
The regulatory hurdle is not to be underestimated by any means. Though the banking industry's woes suggest regulators have been asleep at their posts, banks' struggles are not as severe as those of more lightly regulated financial entities.
"Even though we've seen a number of bank failures, that number pales in comparison to the number of capital markets vehicles that have failed," Delaney says. "Probably 2,000 securitizations have failed, and yet the press focuses on the handful of banks that have gone under."
Given the recent bank failures, one might expect regulators to be more cautious about approving new buyers for banks. On the other hand, banks need capital, and Delaney says regulators are interested in encouraging lenders to diversify beyond mortgages. That's one reason he believes CapitalSource was successful in getting approved to own a bank.
An FDIC spokesman declined to make anyone available to discuss the Fremont acquisition.
