Advantages and Disadvantages of Private Equity by sui38131

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									                                                                        Strategic Paths For
                                                                             Non-Bank,
                                                                         Non-Traditional &
                                                                            Private Equity
                                                                           Investments In
                                                                        Financial Institutions




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FinPro views the process of evaluating what form an investment in a financial
institution should take as a ‘Decision Tree’ analysis that begins with an
evaluation of your current status and future goal(s). FinPro can provide
guidance on one or simultaneous paths . . .




       Start Point                                                             End Point
                                                                             Successful
                                                                        Investment / Position
        Today                           Process                             in Financial
                                                                             Institution




           • The speed and intensity of the banking crisis has left many nonbank
           organizations/entities without a clear indication of the process for entry into
           the industry. The regulatory agencies are responding “as it happens”.
           • FinPro is currently working with multiple non-bank organizations and non-
           traditional investors towards successful positioning in the industry.

                                                                                                1
FinPro’s Decision Process for Non-Bank, Non-Traditional, & Private Equity
Investors For Investment In Financial Institutions . . .




               Investment
               Objectives                      Paths For Entry

              Control Needs       Factors        De Novo
                                    For           Minority       Transaction
Investor     Funding Needs
                                   Entry        Investment        Execution
               Geographic         Decision
                                                Acquisition
              Consideration
                 Charter
                Selection



                                                                               2
Table of Contents . . .

   Chartering/Regulatory Authority        4
   Paths For Entry                        9
   Factors For Regulatory Approvability   15
   Timeline and Process                   17
   Advantages & Disadvantages             19




                                               3
Chartering/Regulatory Authority




                                  4
There are two regulated financial institution structures. One is a freestanding
bank or thrift. The second is a bank holding company with a bank/thrift under
the holding company. The choice of structure will determine the regulatory
oversight . . .


      Regulator                                      Structure 1                                      Structure 2
                                                      Freestanding                            Bank Holding Co. with Bank
                                                      Bank or Thrift                             of Thrift Subsidiary



                                    No Bank Holding Company                                Bank Holding Company
                                            Not subject to regulator at this level.        Subject to Regulation by Federal Reserve




               or                                Bank or Thrift                                    Bank or Thrift
                                                    All institutions are subject to oversight by the FDIC. Banks and thrifts pay
       State Charter                             premiums into the FDIC Reserve Fund based on their domestic deposit portfolio.



Institutions may be regulated by either a
federal agency (OTS or OCC) or state
agency. The future of the OTS is
uncertain as Obama’s proposal calls for
the OTS to merge with the OCC.
                                                                                                                                   5
Charter - Whichever of the four paths is chosen, the regulatory oversight and
charter selection is a key issue. As illustrated below, there are differences
between the federal and state charters . . .


  One regulator with a holding company       More Board Experience Required


  Interstate branching         Avoiding QTL test              Local regulator

                                                 Lower fee structure
          Federal Preemption




                Federal Charters                           State Charters
                                                                                6
Charter - The selection of the preferred type of charter also must deal with the
issue of becoming or acquiring a Bank Holding Company. A BHC means
oversight from an additional regulator, the Federal Reserve . . .

   Conditions where an organization would NOT be subject to the Bank Holding
   Company Act:
    − If a de novo bank, the proposed Bank does not need to apply for BHC status
        (may apply at a later date if desired)
    − Investor is an individual (recent example: Christopher Flowers acquisition of First
        National Bank of Cainesville)
    − Equity investment is below 9.9% of outstanding voting shares.
    − Equity investment is between 10% and 24.9% of total equity whereas the
        investment is structured in a way that would constitute a non-controlling stake.
   The transactions involving multiple investors have been structured as holding
   companies where each investor is an equity holder in the holding company.
   To structure a deal with multiple investor groups the following tactics can be
   utilized to avoid BHC status:
    − Disaggregation among equity holders
    − Executing passivity agreements
    − Utilizing capital instruments with convertibility or non-voting procedures
    − Nominating voting trustees



                                                                                        7
Charter - Bank Holding Company Status . . .

  Advantages
   − Corporate structure that makes offering non-bank products and services easier
   − Expanded ability to raise capital
        − Can borrow at the holding company level and downstream to the bank as
          capital
        − Can issue trust preferred stock
   − Ability to issue stock with the legal authority to repurchase
   − Riskier subsidiaries can be kept separate of the bank as independent
     subsidiaries
  Disadvantages
   − Additional regulation from the Federal Reserve
   − Expenses from taking on extra administration
   − If you choose anything but the OTS, approval is required from an additional
     regulator
   − Bank holding companies may also face taxes separate from those the bank is
     subject to
   − Regulation W (23 A and B) issues regarding transactions with affiliates


                                                                                     8
Paths For Entry




                  9
There are 4 main paths for entry which a non-bank financial firm or investor can
take with the objective of acquiring or making a strategic investment in a
financial institution . . .



                                                  Each point of entry will have multiple
                                  1               smaller paths. Furthermore, current
                                                  regulatory decisions are being made on
                              De Novo             a case-by-case basis.


                                  2
                               Minority                           3
 Paths For Entry
                             Investment
                                                   Application Concurrent
                                                   w/ Majority Investment
                             Acquisition                          4
                                                   Application Concurrent
                                                   w/ Minority Investment


                                                                                           10
Paths for entry . . .

                                         • De novo formation is the
                                         creation of an entirely new bank
                                         or thrift.
                                         • Equity is raised through a PPM
                                         (private placement
                        1. De Novo       memorandum) or Public Offering.
                           Application          - Another common capital
                                                structure is the utilization of
                                                LLC capital. The LLC is
 Paths For Entry                                formed during the
                                                organizing and application
                                                process.

                                         • Minority investment into an
                                         existing financial institution.
                                         • No change of control triggered.
                        2. Minority      • Typically, the maximum interest
                           Investment    must be less than 9.9% of voting
                                         shares or up to 24.9% of total
                                         shares under certain conditions.


                                                                              11
Paths for entry (continued) . . .

                                                                            This path is utilized when
                                                                            the non-bank entity may
                                            Non-bank entity has a           want a control position
                                                majority position           (Typically 25-100% equity
                                                                            ownership).



   Points of Entry            Acquisition
                                                                            This path is typically utilized
                                                                            by a non-bank entity that is
                                                                            looking to be part of a
                                            Non-bank entity has a           consortium that acquires
                                                minority position           control of a bank/thrift or
                                                                            BHC, but the non-bank
                                                                            entity does not want to
The regulatory approval process will be different in both types of
                                                                            directly be considered a
transactions. In some instances the investor(s) has adopted a dual          BHC (i.e. PE firms in the
approach of filing a de novo application and a change in control            IndyMac transaction).
application. The reason for following two paths is to be flexible, nimble
and ready to pounce on opportunity when it becomes available.

                                                                                                              12
Shown below is the possible deal structure for acquisition by non-bank entities
seeking majority position . . .


                         Sample Majority Deal Structure
                                                                                        The non-
                                                                                      bank entity is
                                    Acquisition                                         subject to
                                                                                         Federal
                                                                                      Reserve BHC
                               4. Non-bank entity has a                                regulations
                                     majority position



                                      60% Equity          3 Other PE firms totaling
                                        Interest            40% Equity Interest



                                          Bank Holding Co.
                                              BHC owns 100% of
                                              Community Bank

                                          Community Bank

                                                                                                       13
Shown below is the possible deal structure for acquisition by non-bank entities
seeking minority position . . .


       The non-
                         Sample Minority Deal Structure
    bank entity is
    NOT subject                     Acquisition
      to Federal
    Reserve BHC
     regulations
                               3. Non-bank entity has a
                                     minority position



                                      9.9% Equity         4 Other PE firms totaling
                                        Interest            90.1% Equity Interest



                                           Bank Holding Co.
                                               BHC owns 100% of
                                               Community Bank

                                           Community Bank

                                                                                      14
Factors For Regulatory Approvability




                                       15
There are some major factors for regulatory approvability no matter which path
is chosen . . .

   Management Team
    − Does the proposed management team have the expertise and experience in banking?
    − Do the prospective management have past circumstances (financial or legal) that would
       adversely affect their approvability?
   Investor (Individual or Team)
    − Does the investor(s) have affiliated transactions that would adversely affect their
       approvability?
    − Does the investor group have control issues in other financial institutions or across other
       industries?
   Loan to One Borrower Limitations
    − Is the nonbank entity using the position in the bank or thrift to secure financing? If so, how
       much?
   Monoline lending
    − What type of lending/services would be offered by the nonbank entity after the investment
       in the bank or thrift?
   Wholesale Funding
    − How will the bank or thrift fund itself?
    − Will controversial volatile funding sources, such as brokered deposits, be utilized?


                                                                                                   16
Timeline & Process




                     17
Estimated timeline and process for the 4 paths . . .
                                    4 Paths For Entry Into the Bank/Thrift Industry
      De Novo Formation            Minority Investment                             Acquisition
                                                                Minority Investment          Majority Investment
           Timetable                Timetable                                           Timetable
  ● 12+ months depending on ● Immediate                        ● Varied depending upon target. Timetable could be
  the geographic region                                        shortened if investor has the application and capital raising
                                                               process organized and moving expeditiously

        Cost of Process                Cost of Process                              Cost of Process
  ● Potential to be costly due to ● Low Cost                   ● Varied depending on number of applications filed and
  length.                                                      amount of due diligence on prospective deals.

    Major Regulatory Issues      Major Regulatory Issues                       Major Regulatory Issues
  ● Viability of management    ● Level of investor influence   ● Bank Holding Company classification
  team

       Factors Inhibiting             Factors Inhibiting
                                                                             Factors Inhibiting Completion
          Completion                      Completion
  ● Approvability of application ● Lack of confidence in the ● Ability to raise capital and complete application process
  Raising the capital            company’s future prospects ● Negotiations over possible loss sharing arrangements and
                                 due to less control          transaction structure
                                 ● Investors want more say in
                                 the Board room


                                                                                                                               18
Advantages & Disadvantages




                             19
Path For Entry – De novo . . .

   Advantages
    − Allows for a clean balance sheet on Day 1
    − High level of capital on Day 1
    − Excitement of a new brand
   Disadvantages
    − More overall regulatory oversight
       − Must maintain higher capital ratios in years 1-3 when compared to an
          existing bank
    − Higher noninterest expenses due to organizational costs
    − Not established in the marketplace
    − Fewer de novo charters being granted than in past years, especially in
      certain market areas
    − No immediate synergies with existing nonbank business
    − Constraints of following the business plan for the first 3 years


                                                                            20
Path For Entry – Minority Investment . . .

   Advantages
    − Investor may not be subject to Bank Holding Company Act
         − May need to file a rebuttal for presumption of control
    − Flexibility for investor to participate in multiple deals/transactions
    − Clear regulatory path and guidelines
    − Ability to complete transaction/investment quickly
    − If the investor is a non-bank financial institution, may get better access to
      financing
    − Potential cost savings and/or revenue enhancement due to synergies and
      complementary business combinations
    − More liquidity in equity position
   Disadvantages
    − May not be able to be involved or weigh in on strategic planning decisions
    − May not be able to alter management team
    − If investor is nonbank financial institution, loan to one borrower limit is still in
      effect

                                                                                             21
Path For Entry – Application + Acquisition (with nonbank entity assuming a
majority position) . . .

  Advantages
   − De novo application or shelf charter will allow the organizing entity to
     quickly take advantage of opportunities as they arise
   − Ability to change management and the Board of Directors
   − Possible loss sharing arrangement with regulatory bodies
   − Potential cost savings and/or revenue enhancement due to synergies
     and complementary business combinations
  Disadvantages
   − Possible existing asset and credit quality issues
   − Investor will probably be subject to Bank Holding Company Act
   − Inability to do multiple deals outside of the regulated bank and thrift
     industry (assuming a ‘silo’ deal structure is not allowed)
   − Attractive acquisition targets may be limited (i.e. regulators may only
     allow group transactions, such as the BankUnited deal, for institutions
     where failure poses a systemic risk)
                                                                                22
Path For Entry – Application + Acquisition (with nonbank entity assuming a
minority investment) . . .

  Advantages
   − De novo application or shelf charter will allow the organizing entity to
     quickly take advantage of opportunities as they arise
   − Investor is not directly subject to the Bank Holding Company Act
   − Ability for investor to participate in multiple deals/transactions
   − Possible loss sharing arrangement with regulatory bodies
   − Depending on the size of minority investment, investor may have Board
     representation and decision making capabilities
  Disadvantages
   − Possible existing asset and credit quality issues
   − Attractive acquisition targets may be limited
   − Process can be costly if it drags on too long
   − Murky and difficult regulatory process

                                                                                23
At the end of the day, value creation should be the goal of each investor. The
current environment is ripe for creative and opportunistic acquisitions with
potential for high return . . .

 FinPro’s 7 Ways For Banks to Build Value                FinPro’s Strategic Paths For
                                                       Investments In Financial Institutions



                                                          Investment
                                                          Objectives                Paths For Entry

                                                        Control Needs    Factors     De Novo
                                                                           For        Minority        Transaction
                                            Investor    Funding Needs
                                                                          Entry     Investment         Execution
                                                          Geographic     Decision
                                                                                    Acquisition
                                                         Consideration
                                                            Charter
                                                           Selection




                                  Accretive, Value
                                 Building Transaction

                                                                                                              24

								
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