Not many US private equity firms invest in banks, and for good reason: until September 2008, in order to own more than 24.9 percent of a US bank, a firm had become a bank holding company, after which it would be treated as a fully regulated bank. If a firm owned between 10 percent and 25 percent of a bank, it could not control the bank’s management. To have a director on a bank’s board, a firm’s ownership stake had to be less than 10 percent.
Private equity firms like their privacy, and they also like to control what they invest in, so it’s not surprising that few have made bank investing their specialty. But of the handful of firms that have, Belvedere Capital was one of the first. Back in 1994 the California- based firm worked with the San Francisco Federal Reserve, as well as then-Fed chairman Alan Greenspan’s general counsel, to consider allowing private equity firms to become bank holding companies.
It was something that hadn’t been done before, so the concept needed to be explored. Belvedere did eventually get approval, and shortly after received a bit of good fortune when the California
Public Employees’ Retirement System agreed to become lead investor in its first fund.
GTE, Cargill, Bell Atlantic, Verizon, Allstate and Old Republic followed suit, with Belvedere able to close that fund on $160 million. Between 1997 and 2004, Fund I bought five community banks in Southern California and three banks around Sacramento – largely underperformers – and aggregated them into a single holding company: Placer Sierra Bancshares. The holding company was acquired by Wells Fargo in 2007 for $645 million.
Belvedere has now almost fully invested its $160 million secondfund, and will soon begin to think about going back out to market for a third. Certainly these days there is ample deal flow in the firm’s chosen sector. And given the formidable barriers to entry for other private equity firms, the competition will be limited.
Life as a BHC
The process of becoming a bank holding company was “long and laborious”, says chairman and cofounder Richard Decker. Belvedere first had to be vetted and reviewed by the Federal Reserve, the Federal Deposit Insurance Corporation and the other principal bank regulators. The founders had to submit to background checks and evaluation of their experience and abilities, which typically takes between two and four months. For Belvedere this wasn't a problem, as its senior members had all been chairmen, presidents, CEOs or board members of banks. But the process of filling out papers, presenting to regulators, and working through the checks and balances of the system was still time consuming, and the legal costs were substantial.
Even after the initial transition, a bank holding company must submit to extensive monitoring and oversight. Belvedere and its portfolio banks are now subject to the oversight of the Federal Reserve, the FDIC, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the California Department of Financial Institutions, to name a few. The Federal Reserve comes in once a year to inspect the firm, and it's not a quick check either but a thorough examination, Decker says.
“The regulators come into our offices every year and review not only our banks, but everything else,” he says. “The reviews are exhaustive. The regulators are good to work with and they know their stuff, but they're very thorough, very detailed, and drill down to detailed information. They come in for two to three weeks with a whole team of examiners.”
Belvedere's books must also be freely accessible to regulators, and every quarter Belvedere's portfolio banks must file a call report, which is a quarterly report on each bank's balance sheet and income statement.
“It's probably one of the reasons why there are only three to five bank holding company private equity firms in America,” Decker says. “A lot of people don't like the oversight, they don't like the transparency, and they don't like the Federal Reserve or the regulators in their offices that often.”
In addition, Belvedere's portfolio banks are subject to Tier 1 and Tier 2 capital ratio requirements, and leverage ratio requirements. Belvedere must also serve as a source of strength for its portfolio companies, which means that if one of its banks needs a capital infusion, Belvedere must either provide the capital itself or find a third party to provide the capital.
Another unique aspect of investing in banks is that board members can be hit with civil penalties for failing in their fiduciary duty. So when you sit on a bank board, your whole net worth is potentially at risk.
Finally, bank holding companies are prohibited from investing in non-financial companies. This prohibition is a serious drawback for firms who want to pursue a diversified investment strategy, and has largely kept most private equity firms from making the change.
Belvedere has to employ specialised personnel to handle the regulatory burdens of being a bank holding company. The firm has a vice president of LP relations and regulatory affairs who is responsible for all communications with each of the regulatory bodies overseeing its operations. Along with the chief administrative officer, they file reports, give the regulators updates and make sure the regulators are comfortable with what Belvedere and its banks are doing.
“We have a dedicated staff that interfaces with the regulators on a daily basis. In essence, we consider the regulators our partners, so we have to be proactive; we want to overcommunicate with them and we want to anticipate what they think to make sure that we have the answers,” Decker says.
The firm also retains multiple law firms to help it navigate the complexities of being a bank holding company, as well as specialised CPA firms that are used to dealing with regulators and familiar with bank accounting.
With such high barriers to entry, it's no wonder that Belvedere finds itself standing on a thinly populated playing field. The Federal Reserve recently relaxed its rules to allow non-bank holding company investors to own as much as 15 percent of a bank's voting shares and 33 percent of a bank's total equity and to appoint a director to the board without raising a control issue. They can also appoint two directors to the board as long as (i) its board representation is proportionate to its total equity interest and doesn't exceed 25 percent of the voting members of the board and (ii) another, larger shareholder is a bank holding company that controls the bank. Still, the market has yet to see a flood of investment into the banking sector.
Partly this is because the few high-profile deals where private equity has taken a stake in a bank – namely TPG's $7 billion investment in Washington Mutual and Corsair Capital's $7 billion investment in National City – haven't exactly been stunning successes. Partly this is because 33 percent control isn't enough for most private equity firms, and partly this is because there is so much uncertainty over the value of bank assets right now, Decker says.
“There are a number of firms who won't play in this space without some form of credit guarantees from the government, because people don't really know until we find the bottom of this market how deep the black hole of bad loans is is in a particular bank,” he says. “So if you're on the investment committee and you're getting ready to buy, you think you're going to have to put $100 million in, and 15 months later you've got to put in another $50 million, what does that do to your projections and pro formas and modeling and IRRs and multiples? Until you start seeing open bank assistance, I think private equity money may not be as active. Although they're talking the talk, they may not be as active as the government would like.”
All of these deterrents leave Belvedere with its pick of the lot. Its deal flow is strong: after 15 years of relationship-building, the firm now sees deals from not just investment bankers, but attorneys, CPAs, and even regulators.
“There are not too many spaces or sectors or silos in America that are incredibly opportunistic now to buy, and financial services/ banking is certainly one of them,” Decker says. “When we visit with prospective investors, we find that they like distressed and banking. So we're in a very good space.”