Private equity: Distressed funds are Europe’s new shareholder of last resort

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By:
Dominic O’Neill
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Private equity funds specializing in distressed debt will strike a hard bargain before acquiring and recapitalizing troubled banks, but European state-aid rules make the alternative even less appealing.


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Private-equity buy-outs are not the ideal solution to capital shortages at European banks. But needs must. These deals are on the up, made possible by the grudging acquiescence of the European Central Bank and the appetite of a handful of US distressed-debt investors, principally Apollo, Cerberus and Lone Star. 

They are no longer restricted to minor lenders. 

The pending central bank sale of Portugal’s Novo Banco could see Lone Star take a majority stake in a systemically important bank in a medium-sized European economy. In Germany, Apollo is rumoured to be a bidder for Kiel-based HSH Nordbank, an institution with €84 billion of assets. 

Aside from the banks’ desperation for capital, this is a European trend partly because of European Union restrictions on public recapitalizations. HSH Nordbank, Novo Banco and Italian lenders Banca Popolare di Vicenza and Veneto Banca must all find private capital to avoid being wound down under the ECB’s bank resolution framework – and they all are possible private-equity targets. 

The other fundamental driver is the lack of other private-sector options. In Portugal, for example, Angolan and Chinese alternatives to US funds are less palatable to the ECB, despite being more flexible on price and costs.

Other lenders, if they were well-run, would be ideal. Banks have the benefit of an IT system, synergies and lower funding costs, so could offer better terms. Yet many of the target banks’ troubles are too big for privately owned domestic peers to handle. Banks across the border have their own problems and worry about managing the neighbouring nation’s banking idiosyncrasies. This is in contrast to the US, where the Tarp asset-purchase programme propped up the bigger lenders, and regional bank consolidation more easily filled smaller banks’ capital gaps. 

Incidental

In Europe, banks are sometimes so troubled that their deposit base and performing book is almost incidental to the bad debt. The PE funds say they are interested, nevertheless, because they are better than others at valuing and managing non-performing loans and because it is a chance to make money in the longer term from a franchise that is fundamentally worth more than they will pay. “The end game is to have a healthy and profitable bank that’s ready to be listed,” says one insider. 

However, their capital could be tied up for years. Cerberus has turned Bawag PSK, Austria’s fourth-biggest bank, into the country’s most-profitable and best-capitalized lender; it has even paid some dividends, but has not reached an IPO, 10 years after the takeover. Lone Star is still trying to list IKB, the German mid-cap financier it bought in 2008. 

The funds are seeking returns on purchases of controlling stakes in these banks of around 25%, compared with between 15% and 20% in an acquisition of a non-performing loan portfolio, although they expect to take as long as eight years to realize the gains from a bank takeover, compared with as little as three years in an NPL purchase, according to another fund staffer. This will clearly have an impact on their management of the banks and the prices they are prepared to pay. 

Politicians are naturally suspicious. Banks’ propensity to lend has an impact on jobs across the economy, and technology is culling lower-skilled jobs in the banks, which are big employers themselves. Banks in this regard can be akin to the company in a company town, but the town is a nation, or a region, like Veneto in northeast Italy, or Schleswig-Holstein in northern Germany. When a whole country is at stake, as in Portugal, the political push-back will be that much greater. (Apollo’s 2015 purchase of Nova KBM, Slovenia’s third-largest bank, is another example.)

Wary

Regulators, too, are understandably wary of asset strippers seeking to make a quick buck at the cost of financial stability. As a result, leaving aside the greater difficulty of leveraging a bank buy-out, private-equity buyers of these troubled banks face minimum ownership periods as long as five years and similarly lengthy restrictions on dividends. Regulators must approve the composition of the board, as well as their business plans. 

One benefit in a country like Portugal could be that the bank might manage its legacy assets more actively under Lone Star, and its acquisition could give a much-needed catalyst to the local non-performing-loan and real estate markets. But these funds are not going to agree to recapitalize these banks without all the support they can get from the banks and their cash-strapped governments, no matter the spirit of Europe’s state-aid rules. 

In Novo Banco’s case, the fund is initially putting in €750 million with another €250 million to follow within three years, and the country’s state-owned, bank-financed resolution fund is retaining a 25% stake. 

According to the Portuguese central bank, the resolution fund will bolster Novo Banco’s capital after the acquisition, if sales from a non-core asset portfolio disappoint. Similar schemes have been deployed since the crisis in Ireland and Spain, such as Sabadell’s 2011 acquisition of Banco CAM. The consensus in the local financial industry is that the contents of Novo Banco’s portfolio is such that the use of this additional resolution-fund capital is not a possibility, it is a certainty.