PE-Backed Bank Deals Require Lots of Patience

Just what does it take to get a PE-backed bank deal to the finish line? Think more than a year’s worth of meetings with regulators.

“It’s been a long time coming,” says Manny Mehos, chairman of Houston-based Green Bank, which recently sold around a 74% ownership stake to three private equity firms for $100 million. Mehos estimates the he spent 15 months on the deal, and spoke to roughly 40 buyout shops, as well as some hedge funds and other institutional investors.

The ultimate investors were Friedman Fleischer & Lowe, Harvest Partners and Pine Brook Road Partners.

With the funds, Green Bancorp expects to buy other banks, mainly small ones, via structured deals or FDIC-assisted acquisitions. It also may target branches or loan portfolios. With more than 700 on the FDIC’s troubled bank list, Mehos think there are lots of opportunities. “During distressed times, where the banking industry is downsizing, there are optimum ways to take advantage of opportunities,” he says.

Still, with so many banks in need of help, private equity has been largely out of the picture. There were just a handful of PE-backed bank deals in second quarter, according to data from Thomson Reuters.

Regulatory restrictions on PE investments have largely contributed to the lack of bank deals, Mehos says. In fact, it was regulatory issues that prolonged the Green Bank deal. Mehos met Harvest Partners and Pine Brook in March 2009 and decided on Friedman a month later. “If we had not been in a regulatory environment, [the deal] would’ve happened a lot faster,” Mehos says. “The regulatory uncertainty caused it to be delayed for so long.”

None of the buyout shops that invested in Green Bancorp can own more than 24.9% or they would be deemed a holding company by the Federal Reserve. The firms also are restricted to just one board seat each. “There are several regulatory structures that make it difficult for PE to invest in [FDIC] assisted deals,” he says. “But it’s happening.”

Mehos met with each PE firm separately and claims the firms didn’t know of each other’s interest before the deal. They also invested separately. Such conditions were required to satisfy the Federal Reserve, Mehos says. The firms are also known to the Federal Reserve which had to approve each PE shop as an investor in Green Bancorp. “It’s very important to the Federal Reserve that the investment firms not control the bank or they will be regulated themselves as a bank holding company,” he says.

The lack of management control is another issue that reduces the PE-friendliness of bank investing. Management of Green Bancorp and Greenbank are running the day-to-day operations and Mehos himself is heading up the firm’s investment strategy. In general, buyout execs prefer to have lots of control of the businesses they invest in. But with banking this isn’t allowed.

Despite the constraints, Mehos targeted buyout shops because they are longer-term investors than traditional institutional money. Deals with institutions often contains clauses that provide for a near term liquidity event for them. Mehos also wanted to have as few partners as possible and have investors that were familiar with the complexity of investing in banks, he says.

“We prefer the PE market,” Mehos explains. “We feel like there is more patience there.”