NEW YORK ( TheStreet) -- Private equity firms, which played a role in some of the biggest bank rescues, now are looking to bring capital to the remaining smaller banks by buying up common and government owned shares at a discount. Since the financial crisis hit, there's been a multitude of deal activity oftentimes brokered or guaranteed by Uncle Sam. Among them are the Federal Reserve supported weekend marriages of Bear Stearns and J.P. Morgan ( JPM) and Merrill Lynch with Bank of America ( BAC), as well as hundreds of institutions seized by the Federal Deposit Insurance Corporation and sold to other banks or private equity investors. But despite the government-assisted deals, a majority of banks that needed the crutch of public capital to make it past the financial crisis, still do. While the U.S. government data shows that over 90% of the $204.9 billion used to capitalize banks under the Troubled Asset Relief Program (TARP) has been repaid, a majority of the banks that received bailout funds -- 55% -- haven't repaid a dollar of Treasury money they received. That works out to roughly 412 banks still don't want to operate without government capital. Through TARP's Capital Purchase Program, the Treasury injected capital in banks in exchange for mostly preferred stock and warrants carrying a 5-to-9% dividend. Normally, small regionally-focused banks with capital needs would be the target of larger regional and national banks. Times are not normal. The nation's largest banks like Bank of America ( BAC), Wells Fargo Bank ( WFC) and Citigroup ( C) were recently downgraded by Moody's ( MCO) and are trading at historically low price-to-book multiples. Robert Spass a veteran private equity investor specializing in financials says that large banks don't have the capital to buy smaller players, making now a great time for the private market to step in. "You put two companies together that both have issues, you still have capital issues. At the end of the day, they
large banks don't have the capital bases to get deals done," he says. Spass and the buyout firm Capital Z Partners he co-founded in 1990 have a solution: Private equity investors can buy banks with TARP capital at a healthy discount. The private equity firm's strategy is to find a region of focus where there will be long-run economic growth and banks with assets that are manageable. Capital Z Partners are focusing on states like Alabama, Texas and California and cities like Atlanta and Dallas.
They then hire outside experts to provide a valuation of loan portfolios, finding the assets they'll want to keep and those they'll dispose of. Spass says in a recent deal that's soon to close, "we came up with a subset of loans we couldn't live with. As part of the transaction, we're selling to loans and taking a loss, but getting the bad assets off the balance sheet." Spass adds that private equity firms can handle the loss of loan sales if they're buying a bank's common shares at less than the book value of its assets, a level of valuation many banks are frustrated to be so familiar with. Historically, small regional lenders trade at 1.7-to-2.5 times their book value, he says. For private equity investors, the sweetener to a deal involving a TARP funded bank is that the Treasury is willing to sell its preferred shares at a discount to have the banks privately capitalized. He says that discounts for preferred shares can be close to 50 cents on the dollar and adds, "Treasury wants to see capital to come into these institutions to be repaired and so they are willing to do things to attract private equity capital." The other key is to find partners. The Federal Reserve mandates that anyone holding more than 24.9% of the voting shares of a bank be subjected to regulation as a bank holding company, the last thing a private equity firm would want. The result, Spass says, is that private equity can fix the balance sheet of a bank that's still living off of survival cash from the crisis and inject it with the capital to make loans and restore its value. Currently, the process is done at an attractive discount because when larger banks return to health, Spass says, "They are going to be back in the acquisition market." Private equity investors can also play a wider role in large U.S. and European financial institutions "in small amounts," says Hamilton
Tony E. James, president of The Blackstone Group ( BX). Though Blackstone partnered on a $900 million recapitalization of BankUnited ( BKU) in the last crisis, James says there are two impediments to adding similar or larger sized investment now. He says, "The regulators have to stop discouraging private equity investment in banks," and adds, "If you are talking about $200 billion euro's for European banks, private equity's pockets aren't nearly deep enough." -- Written by Antoine Gara in New York
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