Like a lot of companies, TLCM Holdings LLC in Richardson, Texas, was shopping for a failing bank. Its plan: transform the target's business model to provide a secondary market for bank loans.
But then TLCM found Equity Bank in Dallas and no transformation was necessary.
"We never wanted to compete with a traditional retail banking model," said Aaron Graft, TLCM's chief executive. "What we wanted to do was have an institution that provided liquidity to the market as a whole, looking to acquire quality loans and assets in the secondary market."
Last week TLCM announced it had agreed to acquire Equity's $250 million-asset parent company, EJ Financial Corp. Equity's main line of business is buying loans from other banks in the secondary market.
Graft said TLCM Holdings plans to infuse as much as $50 million in fresh capital into Equity and begin buying loans again. Equity has not been buying in recent months.
"We always thought that this area made sense and were waiting for the market dynamics to make sense to move into the market," Graft said. "We think that time is now. You can buy at a good price, and there is a need for an institution that is providing liquidity."
In mid-2007 — when investors were throwing money at banks — Equity raised $19 million in fresh capital with plans to expand its business, which was focused on commercial real estate loans. Yet a little more than two years later, with a regulatory order pending, Equity's problem loans have ballooned to nearly 10% of its assets.
Industry watchers said healthy companies seeking to purchase community or regional banks lately have preferred acquiring failed banks because they often can pick up deposits and assets at a great price — and sometimes are paid to do so — while sharing credit risk with the Federal Deposit Insurance Corp. Some companies also have been interested in small, healthy banks as an entry point into banking.
Yet in areas of the country where the bank failure rate is expected to remain low, troubled banks that are still operating can be attractive acquisition targets. For example, American Trust and Savings Bank in Whiting, Ind., announced in late December that it had found a buyer for most of its assets and deposits even though it has been operating under a regulatory order. (Horizon Bancorp in Michigan City, Ind., was the buyer.)
Analysts question whether regulators will routinely bless such deals, including Equity's.
"There has to be a compelling reason for bank regulators to approve this," said Anita G. Newcomb, the president and managing director of A.G. Newcomb & Co., a bank consulting firm. "Regulators are being very selective and rightfully so, because they are putting the bank insurance fund at risk."
Indeed, regulatory delays have been blamed for unraveling several bank deals in recent months. Some industry watchers said applications to acquire banks operating under significant regulatory orders must receive approval from Washington, rather than from the regulatory agencies' regional offices.
Equity Bank's management team — led by Bryce Fowler, the president and CEO, who joined about a year ago to turn the bank around — is to remain with the company after the merger. Fowler said he does not expect to face regulatory problems closing the deal with TLCM Holdings this quarter.
"We have had many conversations with them," he said. "We wouldn't be proceeding if we didn't feel like it was a transaction that was good for everybody. We have received encouragement from them to continue on with it. … We haven't completed the process yet, but we will see. So far the indications are that everyone is interested in making this transaction happen."
Other analysts were skeptical about quick regulatory approval. Jerry Swords, the president of Swords Associates Inc., said he would be surprised if regulators approved the deal unless TLCM Holdings agreed to move the nonperforming assets off the company's balance sheet to reduce the risks facing the combined company.
"It would be better to get them into a troubled-asset corporation and work them without having the regulators looking over your shoulder on every step and criticizing everything," Swords said.
Graft said the company has proposed a post-merger structure that would include moving some assets off the balance sheet.
Equity received a regulatory order in November that was made public in late December. The order requires Equity to increase its leverage capital ratio to 11%, Tier 1 risk-based ratio to 12% and its total risk-based ratio to 13%.
At Sept. 30, Equity's leverage ratio was 9.92%, its Tier 1 risk-based ratio was 12.74% and its total risk-based capital ratio was 13.99%. The bank's nonperforming assets and other real estate owned were 9.69% of its assets at the end of September.
The new owners plan to diversify Equity's portfolio — of which 70% was in commercial real estate at the end of September. Also, Graft said spreads on loans have improved; banks are getting paid more for the risk of lending.
"Banks in the business of making loans in the last few years have taken on a lot of risk for not a lot of reward," he said. "The scales tipped back. We can make those loans and get a spread and be compensated for the risk we are taking."
Some industry watchers agreed that this is a good time to implement a business model that acquires loans from banks. That's because many banks are being required to increase capital ratios and are choosing to do so by shrinking their balance sheets.
Regulators are requiring other banks to reduce their exposure in a particular area, such as commercial real estate.
Still, in places like Texas, where TLCM hopes to focus its business, many banks are looking for loans to make — not sell, said Curtis Carpenter, a managing director at Sheshunoff & Co. Investment Banking in Austin.
"Most banks we work with are looking for opportunities to lend, not looking for opportunities to shed loans," Carpenter said. "The biggest opportunity to buy loans is from other banks that are under pressure from regulators to shrink their balance sheet and raise capital. Loans from those banks are often distressed."
Graft agrees that the opportunity to acquire loans and shrink the balance sheet immediately would be one way to go, but that is not his plan and he said he believes the market for loans will loosen further.
"There is some deal flow out there, but by no means has the dam broken," he said.