How To Work Around “Drift” When Investing in Bad Bank Assets

It’s no stretch to say LPs are horrified at the idea of private equity firms investing alongside the U.S. Government in the so-called bad banks, as proposed this week by Treasury Secretary Timothy Geithner.

One LP even emailed peHUB, “I would murder them,” when asked his reaction to such a move.

A bit harsh, perhaps, but it’s true that strategy drift is nails on a chalkboard to an LP’s ears. Investors carefully construct their investment allocations, so they’re none too happy when their GPs switch gears from the strategy they marketed.

That hasn’t deterred the handful of PE pros we spoke to from expressing interest in the assets. Several of them said their firm would consider buying “bad bank” assets, depending on the terms of the government backstop and pricing. They presented a clever way to get around the stipulations in their LP agreement.

The solution? Create a portfolio company to buy and manage the assets. Hire an expert in the field to work them out as the CEO of the company. It doesn’t solve the problem for, say, a microcap energy firm, but that firm has no business investing in these assets anyway. For a firm that includes financial sector investments in its strategy, this is one way to get around LP squabbles over drift. As one GP told me, “If you can say, ‘We have the best person there is in this field, and we will capitalize on that person in the form of a business,’ it makes sense.”

In some (small) ways, it’s the same idea Blackstone had when it backed Bayview Asset Management and the firm’s CEO, David Ertel. In July of last year, Blackstone Group firm took a minority stake the Bayview Financial subsidiary, which is an acquirer of secondary mortgage loans and mortgage-backed securities.

So for firms any interested in government-insured mortgage investments, start headhunting.

Read more:

Live-Blogging Tim Geithner

Private Equity-Backed Bailout?

PE To The Rescue? Geinther’s Plan Could Help Private Equity’s Reputation