Banking crisis/private equity: bargain prices create huge opportunities

The US regional banking crisis started with private equity. Could it similarly end with the so-called masters of the universe?

Silicon Valley Bank had tried to sell stock to raise capital in conjunction with an equity raise from the firm General Atlantic. The announcement spooked the stock market and depositors and the deal never happened. Since then, US regulators have seized SVB along with Signature Bank and First Republic Bank and sold them off cheaply.

Other small regional lenders including PacWest Bancorp have too been trounced this week on worries about their durability. But their troubles might be less about deposit flight. On Thursday, PacWest said its deposit base had stabilised in recent weeks and that its insured deposit proportion had jumped to 75 per cent. Like First Republic, however, PacWest’s profitability has diminished as it had to rely on expensive funding sources.

One option for a private equity buyer would be to create a so-called private-investment-in-public-equity or PIPE. This equity vehicle provides liquidity as well as loss absorption capital to soak up elevated interest costs. Later, the bank could adjust its assets — loans and securities — to take advantage of higher interest rates.

A bolder gambit would be for a private equity firm simply to acquire a bank and take it private. Such a deal may crystallise accounting losses and would require a substantial contribution of equity. Yet these besieged banks may offer once-in-a-lifetime bargain prices with huge return potential, if owners can weather the storm.

Shares in the acquirers of SVB and Signature Bank surged after those fire sale deals. PacWest two months ago had a market capitalisation of $3bn. That has collapsed to about $400mn. Bank profitability can snap back quickly too as their balance sheets are levered 10:1.

Some of the biggest private equity firms made their names investing in distressed financial institutions, particularly after the 1980s savings and loan meltdown and later the global financial crisis.

It is no lay-up. Private equity firms now would have both regulatory challenges and political opposition. But they also bring hundreds of billions of dollars in capital, plus operating expertise. It is surprising that financial investors have not become deeply involved in bank rescues. Perhaps there are too many from which to choose, but the potential is there.