Right Time, Right Place, Right PriceGeoffrey Smith
On Mar. 25, Terrence Murray and four aides flew from Providence to New York. The chairman of Fleet/Norstar Financial Group Inc. and his companions dropped their bags at the University Club and hustled around the corner to the offices of Kohlberg Kravis Roberts & Co. With just four days before the government's deadline for bids on the failed Bank of New England, Murray still faced plenty of hurdles. Chief among them: money.
Both KKR and Providence-based Fleet knew they wanted to make a joint bid. KKR, a master of leveraged buyouts, longed to set up a joint venture that would grant it greater influence. Fleet demanded that KKR remain a passive partner. The standoff lasted for days. "KKR is tough," says a Fleet executive. Finally, an investor group led by KKR agreed to buy $283 million worth of Fleet preferred stock--without any voting rights. With five minutes to spare, the group submitted its bid to the Federal Deposit Insurance Corp.
It was a fortuitous agreement. On Apr. 22, the FDIC awarded the BNE franchise to Fleet and the KKR group. In return for $625 million, Fleet and KKR got control of one of the largest retail-banking franchises in New England. Even better: Fleet and KKR investors, which are mostly pension funds, will receive nearly $12 billion in loans and other earning assets, with a guarantee that they can return any bum ones to the FDIC within three years.
And by selecting a bid that includes a nonbank, regulators have set a precedent for dealing with a failed commercial bank. Already, investment bankers are scrambling to learn the bid's details to duplicate it. "This has got to encourage the astute institutional investor to pick and choose among the rubble," says Brian W. Smith, a former counsel to the Comptroller of the Currency.
The selection of a winner ends the Bank of New England's tortuous saga. Weighed down by acres of bad real estate loans, BNE was seized by regulators last January. It was the third-largest failure in U. S. history, and it sent the FDIC searching for a buyer willing to take BNE off its hands.
LOTS OF BIDDERS. The FDIC didn't have to look long. A dozen banks expressed interest in the BNE franchise. A leading contender was BankAmerica Corp., which boasted a strong capital position. Although weakened by bad real estate loans itself, Bank of Boston Corp. stepped up as another contender and managed to find several investors to shore up its capital.
Eager to join the bidding, Fleet's Murray knew he needed outside investors. While well-managed, Fleet had also been wounded by New England's recession, losing $48 million in 1990 (charts). Murray then thought of KKR. Everyone knew the firm had a long list of clients with deep pockets. And KKR realized it couldn't buy BNE without a bank to run it. KKR had lost a 1989 attempt to purchase the failed units of Dallas-based MCorp even though it made the highest bid. Analysts suspect that regulators cringed at the thought of awarding the bank to an LBO firm.
The relationship started coolly. The first meeting was arranged by Fleet's investment adviser, Salomon Brothers Inc., a few weeks after BNE failed, says Fleet Executive Vice-President H. Jay Sarles. Murray talked with KKR executive Michael Tokarz, who had handled KKR's 1989 bid for MCorp. Yet as a few weeks passed, it became clear that if either were to succeed, they would need each other. In early March, Murray flew alone in Fleet's private jet to Henry R. Kravis' Vail (Colo.) ski lodge to meet with KKR's partners--Kravis, George R. Roberts, and Paul Raether. Over dinner, they agreed to pursue a joint bid.
Each side then took a microscope to BNE's books. Even Kravis showed up at BNE's Boston headquarters to ask questions. What did they find? "An attractive deal," says Sarles. "It's one of the preeminent banking franchises in New England." Moreover, Fleet thought it could save $350 million in overhead annually by combining the banks. There was even the possibility of making a profit after just one year. Fleet and KKR agreed to bid $600 million in cash and stock.
At first, Fleet-KKR's bid seemed weak. "We had gotten vibes that we weren't doing so well," recalls Sarles. Bank lobbyists say that early in the process, it appeared that the FDIC was favoring BofA because of its size and the cash-laden bid it had apparently put on the table. Bank of Boston, which had lagged behind the pack with commitments for only $500 million, lined up $1 billion.
Then, on Apr. 3, BofA seems to have made a gaffe. Sources say that in a letter to the FDIC, BofA tried to discredit its rivals. A transparent reference to Bank of Boston and KKR questioned the wisdom of selecting "a marginally capitalized" bank or investors who would be beyond regulatory control. BofA and the FDIC won't comment, but those familiar with the bidding say the tactic rubbed regulators the wrong way.
Although the FDIC revealed nothing about the bids, Murray and KKR raised the cash component of their bid to $462 million from $300 million early on after seeing BofA's letter. Then, on the last day, they threw in an extra $25 million in cash, says Murray. That may have tipped the balance. Beyond saying that the Fleet-KKR offer was the least costly for the bank insurance fund, Chairman L. William Seidman has declined to explain the FDIC's reasoning. Bank of Boston and BofA also declined to comment on their bids.
The debate over the bidding isn't over. Although the Federal Reserve approved the deal, critics worry that it circumvents the Bank Holding Company Act limiting ownership of a bank by nonbank institutions to 25%. Representative John D. Dingell (D-Mich.), of the House Energy & Commerce Committee, is looking at the provision: "Is KKR's participation truly passive, or will it have sufficient control to raise questions about the separation of banking and commerce?"
The deal is surely complex. KKR and its 75 investors will purchase $283 million of so-called dual-convertible preferred stock in Fleet. The group also will get warrants to buy 6.5 million shares of Fleet. The stock, convertible after three years into Fleet common at $17.65 a share, has no voting rights.
KKR's investors could end up with 16.5% of Fleet, though KKR won't be entitled to a seat on the board. Another option: KKR's investors could, after four years, convert their preferred stock into 50% of Newco, a company that will control much of BNE's former franchise. KKR then would leave the investment, says Fleet. "In a disaster scenario, Newco is still a clean bank," says one investment banker. Barring that, Fleet, once a regional also-ran, would be more than just New England's biggest bank. It could be the most profitable, too.