Banking On 'Smart Money'

By HEIDI N. MOORE Private equity is known as "smart money," but in recent years it made some less-than-bright investments. In 2006 and 2007, firms spent billions of dollars in deals many considered overvalued and that burdened the targets with too much debt. Now, private-equity firms have before them a potential feast of cheap assets that could be acquired, rolled together and eventually sold for big profits. There is just one problem. These cheap assets are banks, and U.S. laws prohibit any company or investor except a bank from owning more than 10% to 24.9% of a deposit-taking bank. Yet some buyout funds are proceeding, finding ways to comply with the letter -- if not the spirit -- of U.S. ownership laws. The latest exhibit: Last weekend, a group of seven private-equity firms led by Dune Capital Management bought the carcass of failed Pasadena, Calif., mortgage lender IndyMac. The private-equity firms plan to rebuild it and use it to acquire other financial institutions. Since each of the firms are pitching in some money, no one firm owns more than 10% of IndyMac. In August, J.Christopher Flowers bought a little bank in Missouri called First Cainsville Bank. The bank, with $14 million in assets and just two branches, probably wouldn't normally be considered worthy of the attention of a financial sophisticate like Mr. Flowers, who kicked the tires of such massive potential M&A targets as Bear Stearns and Washington Mutual. Mr. Flowers saw the Cainsville deal as a way to get a foothold in the banking business and make it easier to buy other banks. And instead of buying the bank as part of his private-equity firm, J.C. Flowers, he bought it under his own name. Federal regulators have been amenable to such solutions thus far. Perhaps that has something to do with the fact that roughly 25 banks already have failed, and more are expected. The benefit to the private-equity firms of participating in federal auctions for failed banks is the chance to own cheap assets and gain a toehold in a consolidating banking industry that they already know well. Private-equity firms plowed $23 billion into financial-services deals in 2008, and that is down 69% from the $74 billion of 2007, according to data from Freeman & Co. This is something of an echo of the late 1980s and early '90s, when some private-equity firms snapped up assets from the government's Resolution Trust Corp. amid the savings & loan crisis. They also are willing buyers, which is no small comfort to the government. Federal regulators looked for a buyer for IndyMac for five months before finally handing it over to a private-equity consortium. Still, private-equity firms must accept federal bank regulators as highly involved overlords, something all haven't been willing to do. Blackstone Group abandoned its proposed $6 billion acquisition of Alliance Data Systems -- which owned a bank -- saying that it wouldn't be able to meeting the changing requirements of federal regulators. Success is this arena isn't, of course, guaranteed. Investment fund Corsair Capital did nicely on its investment in National City, but TPG was hardly as lucky with its investment in Washington Mutual, which was nearly wiped out entirely when WaMu was seized by regulators.