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Private Equity Bank Acquisitions Face Hurdles

Even though private equity transactions in banks are set to rise, deals in the sector will likely be dominated by foreign banks.



) -- There is a growing interest among both U.S. private equity and foreign banks such as

Banco Santander






Banco do Brasil


acquire and invest in U.S. regional and community financial institutions.

However, foreign banks are likely to make more acquisitions than private equity firms in the sector even though U.S. private equity has plenty of capital.

Interest from private equity firms to invest in and acquire banks is likely to increase as bank consolidation picks up, says Jonathan Rosenthal, a co-managing partner at Saybrook Capital, a Los Angeles-based private equity firm founded in 1990 that has made deals in the financial sector.

"There is absolutely, no question private equity is interested in getting deals done," Rosenthal says. "The opportunities will exist with smaller regional banks and some private equity investors are very focused on investing on community and regional banks."

At this moment banks are in dire need of capital. There are about 8,000 banks in the country and that number is expected to decrease significantly. There are published reports that bank closures could top 200 this year due to commercial real estate loans, and those bank failures are likely to continue for some time. The problem bank list has risen 53 banks to 829 since the first quarter of 2009.

Usually the industry would be ripe for private equity firms to jump into to make investments, especially now that some managers are under pressure to invest committed capital before the investment period ends. It's a situation where private equity firms stand to lose the money if they don't use it, says Rosenthal.

"There is a lot of dry powder out there and there are not a lot of great investment opportunities for traditional PE," says Rosenthal.

Recent private equity transactions in banking include

GrandPoint Capital

, which launched GrandPoint Bank in California in June 2010, through the acquisition of Santa Ana Business Bank. The bank holding company then acquired First Commerce Bank in July. Another recent deal was the $730 million investment from Warburg Pincus LLC and Thomas H. Lee partners in

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Transactions by private equity are trickling in, but would likely be greater if a number of hurdles were not holding the firms back from investing in banks.

"Part of the challenge is understanding the value of the underlying assets--the loans. It is very tough in the declining economy to understand what those underlying values are," Rosenthal said. "The other is quality of management. Then the regulatory environment is also questionable."

Similarly, Frank Aquila of Sullivan & Cromwell believes that uncertainty concerning the Dodd Frank legislation is keeping PE from making investments in banks at the moment.

"Private equity firms certainly have been trying to make acquisition of banks. It is difficult and complex," he said. "I'm sure that we will see some deals in that space inevitably, but you know it is not going to be easy. I suspect that everyone is going to have to take a deep breath and look at Dodd Frank and figure out what the implications are for the financial institutions themselves first."

Chip MacDonald of Jones Day adds that more foreign bank transactions are likely to occur due to restrictions placed on private equity firms investing in a bank.

"Regulators are having a cautious approach in the current environment. It is probably easier for domestic roots to buy domestic institutions, but unless the PE firm is a bank holding company they have keep their stake in a financial institution 24%," said Chip MacDonald of Jones Day. "I don't think there is any appetite for less regulation in the US."

So even though cross-border transactions by foreign banks are usually much more difficult to complete, they tend to be easier to complete than domestic private equity transactions because private equity will have to create club deals or do small investments in a bank. This, says MacDonald, limits private equity's control over management and the institution.

Regulators actually prefer bank acquisitions by foreign banks over private equity, says Bart Narter, Senior Vice President of Celent's banking group.

"The reason is because foreign banks already own a lot of U.S. banks. It is not a new thing. They have seen it and they are ok with it," says Narter. "Of course, it would be good for banks to have access to more capital."

--Written by Maria Woehr in New York.

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