Private-equity firms are betting that current industry challenges will create opportunities to buy into struggling banking companies at bargain prices, and at least two have recruited experienced bankers to help.
Gerald R. Francis, who spent two decades fixing up troubled community banks and often selling them for top dollar, this month joined Financial Stocks Inc. of Cincinnati as a managing director in its private-equity group. His job is to identify turnaround opportunities throughout the nation and advise companies in which Financial Stocks invests.
As a "management-friendly" investor, Financial Stocks is anticipating that rising margin and credit pressure will give it more chances to get involved with and help revive what it considers underperforming companies, said Robert J. King Jr., senior managing director at the firm and a former banker himself.
Meanwhile, the private-equity firm established by Microsoft co-founder Paul Allen, Vulcan Capital, is on the prowl for undervalued banks in the Southeast. The Seattle firm has teamed up with a group of longtime bankers from the region in a joint venture that is seeking to buy some banks outright and acquire stakes in others, said David N. Capobianco, Vulcan Capital's managing director.
Though banks' asking prices remain high, Mr. Capobianco said he expects the combination of the flat yield curve, the real estate slowdown, and deteriorating credit quality to lower their values and set up more buying opportunities.
"At times likes this, you get a pendulum effect," he said. "The pendulum will swing the other way and valuations will be too low."
Financial Stocks invests mostly in privately held community banks and thrifts and generally owns stakes of no more than 9.9%. Its five funds have a noncontrolling stake in 30 to 40 financial services companies, with more than $350 million invested. Over the past decade, it has made investments in at least 70 companies.
"We think we're unique because of our approach," Mr. King said. "There's more private-equity interest in the space lately, but most people are interested in doing control deals."
Mr. King said Financial Stocks is active at the banks where it invests. Its executives have board seats at eight banks, and visitation rights allow it to sit in on board meetings at other banks.
Financial Stocks has invested in some underperforming banks over the years. "They're harder to find" but worth the search, Mr. King said. "We think they provide outsize returns."
Now his company is gearing up to find more.
"We certainly don't wish ill for the industry, but we think there are opportunities out there where banks are undervalued or underperforming and need capital to effect their turnaround plan," Mr. King said. "We can not only provide the capital, we can provide the expertise to assist in that turnaround."
Aside from hiring Mr. Francis, Financial Stocks added Kevin R. Reevey, formerly an analyst at Ryan Beck & Co., as a vice president last month and Michael P. McMahon, formerly an analyst at Sandler O'Neill & Partners LP, as a managing director and head of Financial Stocks' San Francisco office in March.
Mr. King, who joined in September, had been the president and chief executive officer of Fifth Third Bancorp's northeastern Ohio unit, before retiring in 2005.
Mr. Francis had been a CEO at several banks.
Most recently he led a turnaround of First National Bank and Trust in Indianapolis, which was sold to Harris Bankcorp for $290 million this year. He was named American Banker's Community Banker of the Year in 2002 for his role in rescuing City Holding Co. in Charleston, W.Va., from the brink of failure.
"When you have the intellectual capital to address a variety of situations in the industry, it better positions you from an investment perspective," Mr. King said. "There are margin pressures on banks, and additionally there may be credit pressures. We think we're well positioned to facilitate banks' turnaround plans, with capital and intellectual horsepower."
Financial Stocks aims to buy stakes in companies at a 20% to 40% discount to where a stock would trade if it were public, thenexit at a premium to where the market would trade, Mr. King said. The exit could be the bank's selling or going public, he said.
The firm looks for a 25% internal rate of return and typically invests in a bank for three to five years, Mr. King said. "We tell people, we're patient capital, not forever capital," he said.
Like Financial Stocks, Vulcan is counting on the expertise of a turnaround specialist to help maximize the eventual profit from the investment.
Vulcan, established in 1986, is a multibillion-dollar fund with investments in dozens of companies in many industries.
In March it announced that it had formed a joint investment venture with Bankers' Capital Group LLC, a bank management group formed by Joe Evans, the former CEO at the $1.8 billion-asset Flag Financial Corp. of Atlanta. Mr. Evans helped revive Flag before selling it to Royal Bank of Canada's RBC Centura Banks Inc. for $456 million in December.
The joint venture, Vulcan Bankers Group LLC, has yet to strike a deal, but Mr. Capobianco said the pipeline is robust and that he expects to complete a deal in the next six to 12 months. "We look at multiple opportunities per week," he said.
Some private-equity firms are passive investors and buy minority stakes in start-ups or established banks that might need a capital infusion. But like Financial Stocks, Vulcan Bankers intends to be an active investor. As Mr. Evans put it, his group wants to buy stakes "big enough that it's worth our while to invest our time as well as our money."
It is scouting primarily in metropolitan areas for banks that are not viewed as top performers.
"It could be a bank that is essentially out of favor because of its line of work," Mr. Evans said. "My sense is that the residential-construction-focused banks in the Southeast are probably going to fall further out of favor, and when a sector goes out of favor, typically it undervalues the good players as well as the poor players."
Analysts had differing opinions on whether there might be a growing opportunity for bargains awaiting private equity firms, especially for those seeking to acquire entire banks.
"I know that there are a lot of people who are speculating" that bank valuations will drop, said Curtis D. Carpenter, a managing director at Sheshunoff & Co. Investment Banking in Austin. "But the fact is that in the first quarter of this year prices actually moved higher."
The median acquisition price for banks in the Southeast rose about 15%, to 2.85 times book value, in the first quarter, from 2.47 a year earlier, according to data provided by Sheshunoff.
Nationwide, the median price rose about 23% over the same period, to 2.7 times book value, from 2.2 times book, Mr. Carpenter said.
"I'm not sure there are undervalued banks in the Southeast or anywhere," he said. "Sellers certainly have not accepted the fact that prices have come down any, and we haven't seen any deals that would indicate that."
Mark Muth, an analyst at First Horizon National Corp.'s FTN Midwest Securities Corp., agreed that banks are not cheap, but he said industry pressures eventually might cause some to sell at a discount. "If asset quality becomes an issue and valuations come in further, there could be a lot of opportunity to go in and find some of these undervalued, or arguably undervalued, franchises that just need time to fix their problems," Mr. Muth said.
That's just what Vulcan Bankers' Mr. Evans envisions.
"I am also of the opinion that we have not seen the bottom of this community banking cycle," Mr. Evans said.
"I'm not predicting that the housing market will have a precipitous fall beyond where it is now, but I don't believe that we are going to see a near-term rebound."
