Most private-equity firms that bum-rushed the banking industry in 2009 failed to get past a regulatory bulwark designed to repel buy-and-flip investors.

Warburg Pincus LLC was among the few that got in. It has arguably had the best track record in the space of any of its peers: The U.S. banks it has invested in — Webster Financial Corp., Sterling Financial Corp. and National Penn Bancshares — are doing well, along with the underlying value of the investments.

"We're up considerably on all three of our U.S. banks," says Daniel Zilberman, a managing director in Warburg's financial services group in New York. "I think the thesis is playing out."

That thesis is different from the tack employed with mixed results by firms such as MatlinPatterson Global Advisors and WL Ross & Co. Those investors took over failed or deeply troubled banks with an objective of taking them on acquisition sprees.

Warburg bought into promising franchises at a discount: Webster needed some capital stability, Sterling had some bad loans to write off and National Penn needed to retire its bailout debt. All could be buyers when consolidation picks up, Zilberman says.

So could Warburg, which in the 1960s helped invent the whole concept of private equity, which is basically a form of investment banking, and rebuilt Mellon Bank in the 1980s. The key difference is that the bankers in private equity put deals together for companies they own afterward with money invested by pension funds and insurance companies.

Warburg expects its next round of bank investments to involve giving cash to would-be buyers on the eve of their deals.

"It's sort of a win-win. We get to invest in an accretive merger that we think makes sense. They get just-in-time capital, which they only need if the deal happens," Zilberman says. Following is an edited transcript of a recent interview he did with American Banker.

We've seen some private-equity-backed banks sell or attempt selling recently. Is this a trend?
DANIEL ZILBERMAN: Perhaps. Because private-equity guys are in fact fiduciaries, they're looking to make a return and they're going to sell. But I also think you have to look very closely at how long have they been in the investment, and what kind of investment do they have.

Some guys who invested in lower-quality banks with government assistance made some money that way. Well great. It's been a good investment. You made your money. But if you're not invested in a great bank, what are you going to do then? Which is why — I suppose and I have no information — why some of these guys are thinking of selling. If you're still invested in a high-quality bank that you think has opportunity to grow — will you sell if somebody gives you a really great price? Sure, perhaps. I mean, you're supposed to do that. But I'm not sure you should be inclined to say, "Oh, gosh, I need to figure out a way to sell ASAP" if you have a high-quality bank with upside.

The beauty of buying something really inexpensive is you can sort of make a gain just on bringing it up to normalized value. But then if what you have is not a high-quality franchise — what are you going to do with it? We think we have high-quality franchises. So we think there is plenty of runway.

Warburg sees a chance to invest in more banks when M&A picks up. Do you think we'll see another wave of private-equity firms try and do the same?
If you asked me five years ago how many folks we were really competing with, I would have said four or five. If you asked me two years ago how many folks we compete with, I would have said 100. If you asked me today how many folks we compete with, it's probably six or seven.

The reason I give you that anecdote is investing in banks and investing in financial services generally for private equity is very different, it is very tough. The reason that we've been fortunate, is Warburg has done it for a long time. The firm has comfort in financial services. That's all I do. I live and breathe financial services.

My colleague David Coulter ran Bank of America [Corp.] and was the No. 2 guy at JPMorgan [Chase], and my colleague Michael Martin was a former vice chairman of UBS Investment Bank. We happen to have folks who really get the sector. So there is institutional comfort in investing in the sector.

The reason I said two years ago I saw a hundred is because every private-equity fund said, "Oh I've got to go do a bank deal." And the vast majority got in and said, "Holy cow, this is really different. What, do you mean I can't control a bank? You mean I can't lever it like an LBO?" It's just a very different sector. So most private-equity guys came and went.

Now you're back to the usual suspects again. I think the opportunity was really great two years ago. Most of them didn't get anything done just because it was too hard and they didn't get the sector. I think they've realized that they kind of wasted their time, and they could either invest a whole lot of time and a whole lot of money and really become experts in the sector or just stop playing. It seems to me that most have stopped playing.

Warburg Pincus has a lot of money invested in the financial sector. What's your outlook on your holdings in the U.S. and the sector in general?
We're long on the U.S. financial services sector. Long-term we feel very good. We're up considerably on all three of our U.S. banks. I think the thesis is playing out. Every day that we're not selling our stocks means we're investing in our stocks. We can sell the stock any day, but we're going to hold it. Which means we like our teams; we like the stories; we like the prospects.

Certainly the environment right now is challenging, right? It's tough to grow loans. Margins are soft. That said: Look, bank valuations are still at historic lows. We think we're invested in three high-quality franchises that have real value because they're strong franchises in important markets. All three have opportunity for better valuations because of margin expansion. Multiples will ultimately come back toward normal levels. We think that the M&A wave is only going to help our banks. Hopefully our banks will be aggressive consolidators.

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