Private Equity Moves In on Banks

Many U.S. banks need cash. Private equity players are eager to give it to them. Will such deals save banks or set the stage for trouble later?

In recent weeks big buyout firms have been scooping up banks—and more likely will follow. A team of investors, including Carlyle Group and Lightyear Capital, is close to making a deal for Silverton Bank, a failed $4.1 billion institution in Georgia. In a different deal, Lightyear and two other firms will invest $450 million in First Southern Bancorp.

The new deals are changing the face of bank ownership. For decades only bank holding companies—highly regulated entities devoted exclusively to banking—could own banks. Now regulators are letting private equity firms, which invest in all kinds of companies, control banks. The worry: Private equity will pillage the banks' resources to fund their other operations or investments. "We think that this is the worst idea," says John Adler, a director at Service Employees International Union, which invests in private equity funds.

Following the wave of bank failures in the Great Depression, regulators decided that bank ownership should be limited to bank holding companies. Why? Back then several banks failed when owners diverted resources to prop up other holdings like retailers and manufacturers. With 305 banks on the verge of collapse today, regulators have begun to relax the rules. Now the Federal Reserve will let a single private equity firm own as much as 33% of a bank. Firms can team up to buy an entire bank.

But different regulators are applying different standards. In January the U.S. Office of Thrift Supervision gave one firm, New York's Matlin Patterson, the green light to purchase Flagstar Bancorp in Michigan. Some lawmakers aren't happy. Last month, Senator Jack Reed (D-R.I.) sent a letter to top regulators calling the Flagstar purchase a case of investors "shopping around a potentially risky activity until they can find a regulator who will allow it." Matlin Patterson declined to comment.

Critics fear private equity firms—which collectively own hundreds of companies—will succumb to the same temptation as bank owners in the '30s. "If I've got a bank, and I have a business that's going down, where do you think the bank funding is going?" says Rochdale Securities bank analyst Dick Bove.

If private equity stumbles, taxpayers could end up footing the bill. When Carlyle, Blackstone Group, WL Ross, and investor John Kanas made a deal to buy Florida's BankUnited Financial for $900 million, for example, the FDIC agreed to eat the bulk of losses on the bank's $10 billion loan portfolio. Carlyle Managing Director Randal Quarles says critics' fears are misplaced, in part because under the terms of the deal, BankUnited's owners won't make any transactions between the bank and their other holdings.

In the end, regulators don't have a choice. They don't have the funds to bail out every troubled bank, and few investors have the financial muscle of private equity firms. Says Hal S. Scott, a Harvard University finance law professor: Banks "need capital, and private equity has capital."

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