For private-equity investors who bought shares in struggling banking companies this year, the goal was clear: Secure a stake in solid, though temporarily troubled, operation whose shares were available at bargain prices.
As the market has lurched from one piece of bad news to the next, initial investments by these funds have fallen sharply, and this week TPG Inc., which sunk $7 billion into Washington Mutual Inc. in April, said it was willing to forgo the so-called reprice clause, which would have paid the Fort Worth company additional compensation if Wamu raised more capital or pursued a deal. The Seattle thrift company is reportedly in negotiations to sell itself.
Private equity bankers are concerned that such provisions may become obsolete, making investments in financial companies less attractive. Concerns that regulators may be getting more involved with such transactions only raises their concerns.
"If no one can negotiate this provision, it will impact the attractiveness of an investment," said John A. Kanas, the former chief executive of North Fork Bancorp, who now oversees financial investments at WL Ross & Co. "There is also an understanding that regulators have a lot to say in this industry. It is all part of the process of learning, and it creates a 'buyer beware' situation."
A source closed to the TPG decision said Thursday that the Office of Thrift Supervision was not involved. Some market participants have speculated that the Federal Reserve Board may have influenced Corsair Capital LLC's June amendment of a similar clause in its April investment in National City Corp., which capped what Corsair could recoup from the Cleveland company if it raised more capital. The participants note that the Fed allowed Nat City to treat the investor group's infusion as Tier 1 capital.
Spokesmen for Corsair and Nat City would not discuss the amendment. Sources familiar with the matter said the clause was amended to give Nat City more flexibility in its capital position while providing some protection for Corsair's investment. A call to Wamu was not returned. Representatives for the OTS, the Fed, and the Office of the Comptroller of the Currency, which also regulates Nat City, would not discuss the matter.
Whatever the reason, some investors say killing these clauses might not be welcome for banks that still need capital.
Vernon Hill 2nd, the former CEO of Commerce Bancorp Inc. in Cherry Hill, N.J., and now the chairman of Hill-Townsend Capital LLC, oversaw a $10.8 million investment in Republic First Bancorp Inc. in Philadelphia in May. He said that without a backstop provision, "you simply don't know if you're going to get watered down three months from now."
A private-equity banker, who asked not to be named, said eliminating reset options and similar clauses could make it more costly for financial companies to raise capital.
"I think if you have to give up some protections, you're just going to drive a harder bargain on the front end," the banker said. "At the end of the day, it's a pricing decision."
Mr. Hill said: "The industry needs more capital and those who have it are in a stronger position and can dictate the terms."
Christopher Marshall, the former chief financial officer for Fifth Third Bancorp, said he is less concerned about any effort to eliminate the clauses than he is about "how do you invest and know that you have the right amount of control," referring to the current regulatory caps on private-equity investments in the banking sector.
Private-equity agreements, he said, still have 9.9% regulatory caps on investment and passivity clauses that bar "undue influence."
However, in a worsening environment for the banking industry, regulators are reportedly in discussions with private equity firms about relaxing several investment obstacles to encourage more investment, including upping the 24.9% firms can invest in banking holding company, and the 9.9% direct investment cap.
Mr. Marshall and others said that private equity firms are rethinking the structure of their investments, possibly by making more investments in bank holding companies that in turn can invest more in banks and thrifts. There is also the possibility of more individual investment similar to Mr. Hill's infusion at Republic, though he said that can get expensive if private investors try to place funds with larger companies.
However, as banks stocks continue to be battered by skittish investors, TPG's investment has tanked. On Thursday, it was worth roughly a third of the value that existed when the firm paid $2 billion in April. Wamu's shares rose nearly 49% Thursday on talk of a possible sale. For Corsair, the value of its investment has fallen more than 12%. The source close to the TPG-Wamu situation said Thursday that the investor group's decision was made with the understanding that Wamu faced serious challenges without having the flexibility to pursue other options. Their agreement would have required Wamu to compensate the investor group for any dilution suffered if Wamu had raised more than $500 million in capital.
Walter G. Moeling 4th, a lawyer at Powell Goldstein LLP in Atlanta, said that private-equity investors still see financials as " horrendously" undervalued. "The question is whether they are willing to take the castor oil of bank regulation."