Buying the Bank

The upper floors of 40 Bank Street in Canary Wharf, where The Situs Companies has an office, usually provide clear views of the cluster of high-rise offices nearby. Morgan Stanley’s European HQ, Citigroup’s monolithic tower and the former Lehman Brothers’ European base are among them.

Yesterday, however, fog shrouded the big neighboring banks.

Ralph Howard, principal and chief executive of Situs – a Houston-based real estate consultant that survived the 1980s advising failed banks taken over by the US government, explained why.

He likened the inability to see the banks to the hazy way in which the market currently perceives banks’ treatment of an estimated €1.2 trillion of outstanding European commercial real estate debt, including €600-700 billion due to mature over the next three years. Yet he predicted some of the fog would lift – as indeed it did later in the breakfast briefing as we swapped notes, sipped coffee and munched on croissants.

Among the many observations made was a prediction of how private equity firms would emulate in Europe what has been happening in the US. Call it ‘buying the bank’, if you will.

Private equity firms are currently circling European banks, some names of which not even the most ardent of real estate observers may have heard. Nevertheless, the likes of Kohlberg Kravis & Roberts, Fortress Investment Group, The Carlyle Group, The Blackstone Group, WL Ross & Co or BlackRock to name a few are looking at recapitalisation of banks in which they take a significant stake or even swallow them whole. These types of firms are hiring advisers to evaluate the underlying collateral.

The rough idea is that as banks ponder the myriad ways of restructuring, including splitting up into good banks and bad banks, therein lies opportunity. A financial investor theoretically could benefit from the upside in the good part of the bank as the general economic climate improves. That bank can start to originate real estate loans again. As for the bad bank, this can be thought of as a good investment for private equity investors that can deliver returns through workouts and restructuring portfolios.

Opportunities will arise in Spain, Italy, Germany and the UK, predicts Howard, although there are a host of regulatory issues, economic uncertainties and tax and deal hurdles to overcome before any deals come to fruition.

On the other side of the Atlantic, deals have already been taking place. BankUnited, for instance, was acquired in May of last year for $900 million by WL Ross, Carlyle, Blackstone and Centerbridge Partners. WL Ross also purchased more than a 68% stake in First Bank & Trust Co., another Florida-based bank with $83 million in assets. Just this August, WL Ross, which is a turnaround-focused private equity firm of US financier Wilbur Ross, also joined an investor group that together injected $100 million into Sun National Bank, the second largest commercial bank in New Jersey.

Also, in April this year Carlyle closed a $1.1 billion bank fund, having made a $550 million investment along with the Canadian Imperial Bank of Commerce and other institutional investors in Bank of NT Butterfield in March.

Helping spur activity, the US Federal Deposit Insurance Corporation this summer established rules calling for an acquired financial institution to be capitalised at a Tier 1 leverage ratio of 10%, lower than the 15% originally proposed. A potential obstacle that private equity owners would be required to serve as a source of strength for the banks they invest in was removed altogether, though the rules still stipulate that private equity firms must hold their bank investments for at least three years.

True, Europe in general is behind the US in dealing with its banking issues. Yet there is no shortage of banks in need of the financial equivalent to an electric shock to reverse a cardiac arrest.
In addition, there are clues that some private equity firms are well advanced with moves into banking. Blackstone, for instance, has applied to the Financial Services Authority for a UK banking license. Apollo apparently is launching a mortgage-related business next week, having won approval from the FSA.

So, while there is much talk about buying loan portfolios, forming joint ventures with banks, providing new mezzanine finance and partnering with property operating companies, don’t discount the possibility in Europe that private equity houses will become banks.