The Financial Times recently reported that private equity firm Apollo Management plans to launch its own bank, by using “an obscure provision buried in the US financial regulations.” Or, as the headline writer put it, “Apollo exploits loophole to create new bank.”
Lots of news outlets picked up on the story — including us — because it just sounded so darned significant. But is it actually much ado about very little?
That’s the argument of law firm Wachtell Lipton, according to a July 26 client memo obtained by peHUB. It reads:
Recent media accounts have cited a bank in formation – Aris Bank – as taking advantage of a “loophole” in the Dodd-Frank Act signed into law last week. Contrary to these reports, the transaction is part of a familiar theme in which a private equity firm proposes to make a noncontrolling investment in a bank as part of a capital raise with other passive investors who invest side-by-side. What is new under Dodd-Frank is a modestly enhanced ability of both national and state-chartered banks alike to branch “de novo” into new states notwithstanding state laws to the contrary. Like many other banks, Aris Bank would reportedly take advantage of this enhanced ability to cross state lines via de novo branching.
Over the past year, there have been numerous capital raises, led by one or more noncontrolling investors, by both existing banks and start-up banks – particularly “shelf charter” banks set up to participate in FDIC auctions. The new financial reform legislation does not materially impair or expand the ability of investors to make these types of investments in banks. In fact, as regulatory capital demands increase as a result of Dodd-Frank and existing industry trends, many more are likely to follow.
Under the Dodd-Frank Act, a bank may now establish a branch in a new state to the same extent as banks chartered by that state. Despite the fact that a number of states, such as New York, permitted de novo branching by out-of-state banks prior to the new Act and federal savings banks have long had the ability to branch de novo into all 50 states, for many banks de novo branching has not been a preferred method for entry into new states. These banks have instead preferred to enter new markets via acquisition in order to reach critical mass more quickly.
Banks wishing to expand into new geography in other states will still need to make the fundamental business calculation about whether it is more cost effective to do so by acquisition or de novo branching.
“They don’t need a national bank license to build branches in multiple states,” a private equity executive tells me. “This is no big deal.”
Apollo is raising a blind pool of up to $1 billion to support Aris, with Perella Weinberg is acting as placement agent.
The blind pool has been used by PE investors before. North American Financial Holdings recently agreed to buy a 99% stake in TIB Financial Corp. for $175 million. NAFH also bought a trio of banks earlier this month. NAFH is a blind pool that raised $900 million earlier this year. Investors of NAFH include Crestview Partners and Falfurrias Capital Partners. The Blackstone Group and Sageview Capital are reportedly trying to raise their own blind pools.
“This is the same story that others have done,” the PE source says.
While the blind pool isn’t raising eyebrow, Apollo’s decision to start a new bank- rather buy an existing one – is interesting. There are 700 banks listed on the FDIC’s troubled bank list. But Apollo is choosing to fund a startup. In 2008, when banks starting blowing up, numerous buyout shops planned to start their own banks. Very few have materialized. J.C. Flowers and MatlinPatterson are one of the few that started their own banks using the silo method. The FDIC has since said it won’t allow silo structures anymore.
Forming a new bank comes with obstacles, the buyout exec says. A new bank is expensive, there is little demand for loans, and the bank will likely incur losses for a few years while it builds up, the source says. “When you can get a good quality bank at book value why would you start a new bank?” the person says.
Still, PE deals for banks takes a long time, the source says. Green Bancorp spent a year-and-a-half negotiating with regulators to complete a $100 million investment from three private equity firms.
The FDIC also favors banks themselves, and not PE firms, as the best buyers of banks. “It’s a very difficult, long process,” the exec says. “And the FDIC isn’t really sending deals to PE guys.”
Apollo declined comment. Wachtell Lipton couldn’t be reached for comment.