Flowers sees Shinsei-style deals across US

JC Flowers is targeting troubled financial institutions in line to receive US government assistance, hoping to repeat the dynamics of the private equity firm’s recent co-investment in IndyMac, the bankrupt California mortgage lender.

The strategy was detailed by firm founder J. Christopher Flowers last Friday at the Columbia Business School Private Equity & Venture Capital Conference in New York.

In a rare public appearance, Flowers, delivering the afternoon keynote speech, described the approach as utilising a “risk-sharing agreement with the [US] government where they are sharing in the downside”.

JC Flowers has already completed one such deal – the recent $13.9 billion sale of IndyMac to a Flowers-led consortium that includes Stone Point Capital, MSD Capital and Dune Capital, as well as hedge fund managers George Soros and John Paulson. The bank was purchased from the government-chartered Federal Deposit Insurance Corporation (FDIC), which had taken over operations of the bank. Under terms of the deal, the reorganised bank will absorb the first 20 percent of losses and the FDIC will assume the rest.

The IndyMac deal is similar in structure to the takeover of Long Term Credit Bank of Japan, which Flowers and Tim Collins’ Ripplewood Holdings acquired in 2000 for $1.2 billion and renamed Shinsei. Key to the Shinsei acquisition was a guarantee from the Japanese government’s Deposit Insurance Corporation that it would buy back any bank loan that lost 20 percent or more of its value. Shinsei ultimately shifted some $10 billion in bad debt to the government under this put agreement.

The bank was taken public in 2004, producing a windfall for its owners.

In his comments, Flowers described conditions in the US market conducive to more Shinsei-style deals, including a general absence of competitors. “There's a dearth of other buyers,” he said.

Banks that go bankrupt “tend not to be very good banks”, requiring buyers to install quality new management teams, as was the case with IndyMac, Flowers said.

Federal rules prevent private firms investing in banks from acquiring more than a 25 percent stake without being a bank holding company, regulations that Flowers said might well evolve under the newly elected US president.

“My guess is that by the end of this administration, we and other firms will be permitted to own significant stakes in banks,” Flowers said.

Flowers also discussed the financial meltdown that occurred in September and revealed that he considered investing in AIG and Lehman. He declined to invest in Lehman once the US government made it clear it would not assist in rescuing the bank in any way.

“We all knew that Lehman was going bankrupt,” Flowers said. “I knew it. I didn't really foresee what a gargantuan colossal mess that it was going to trigger. The Lehman bankruptcy put us in a whole new era.”

He noted that he consulted with Bank of America on its acquisition of Merrill Lynch.

The US will be the first country to come out of the ongoing recession because of more aggressive government action and because of its “flexible and dynamic economy”, Flowers predicted.

JC Flowers has reportedly raised $2.5 billion for its third private equity fund, having raised $7 billion for Fund II early last year. It is unclear how much further capital the new fund will draw.

According to an article in the February issue of sister magazine Private Equity International, at least 10 limited partners in JC Flowers’ beleaguered second fund are seeking liquidity through the secondaries market, clouding prospects for a Fund III of similar magnitude.

Meanwhile, the German government has reportedly called Flowers “uncooperative” over a potential rescue plan for the embattled commercial real estate lender, Hypo Real Estate. The firm has been reluctant for Berlin to take a 75 percent stake of Hypo in a bid to inject capital and liquidity into the struggling bank, according to the Financial Times.