How to buy a bank: Part 1

Part 1: Leverage

There is an increase in private equity buying banks and other highly regulated businesses such as insurers and payment services providers. Regulatory hurdles which were once feared to be insurmountable are being cleared with ever increasing frequency and confidence. Allfunds, LeasePlan, Rothesay, Nets, Concardis and the recently announced sale of the Luminor banking group evidence the fact that previous concerns about the motives and methods of private equity are easing; and as regulators and financial sponsors get better acquainted a common understanding of each others requirements and limitations is developing.

The first investors in this sector now have the kitemark of having already been approved as fit and proper owners of regulated businesses making regulatory approval of future acquisitions easier. But their efforts in clearing the path benefit others.

Whilst everyone knows it’s now possible, I am repeatedly asked the question – how do we buy a bank? As you can imagine, the answer does not easily fit into a single blog post and I will consider some of the issues in more detail in future posts.

There are many factors to consider including the impact of consolidated regulatory capital requirements and whether your acquisition structure has been set up to accommodate them, what regulatory approvals will be needed and what information will have to be provided, the impact of remuneration rules on management incentives that can be offered and how much leverage will be permitted by the regulators.

The question of permitted leverage is the one I am most commonly asked.

The short answer is that I have seen a range of between about 30-60% leverage being accepted by regulators. But to ask the question, and give meaning to the answer, in isolation is to miss the point.

Given the inherent importance of banks, insurers and payment systems to the real economy, and with the trauma of the last financial crisis still relatively fresh in the memory, regulators are understandably anxious to ensure their banks remain stable, well-capitalised and prudently managed. They will expect a private equity acquirer to demonstrate that its acquisition aligns to those imperatives.

Leverage is therefore only part of a package of measures I would expect to be discussed with the regulators and it is likely that higher levels of leverage will come with greater concessions elsewhere. So before presenting your leverage proposals think about your sensitivities to related issues so that you can present a coherent package that helps the regulators manage their nerves.

What can you offer by way of commitments to deleverage over the term of the debt to demonstrate reduced re-financing risks? Are you prepared to agree to limit dividend payments or link your ability to make such payments to meeting certain deleveraging targets? When presented with a proposal involving high levels of leverage it is not uncommon for the regulators to push harder for a greater amount of common equity tier 1 (CET1) capital to be held than is required under the applicable capital rules. Have you planned your response and have you considered whether it would be beneficial to volunteer something rather than start with a number proposed by the regulators? And how does all this play into your investment thesis, intended hold period, exit route and other deal dynamics such as conditionality or MACs?

Presenting the regulators with a package touching on these topics which accommodates the leverage levels you need can be beneficial in ensuring you don’t have any nasty surprises later in the process. It may also enable you to sharpen your pencil in a competitive sales process. It is therefore important to try to retain your ability to speak to the regulators: attempts by the sellers to limit your contact until the back end of the process should therefore be resisted.

It will also show the regulators that you are serious about your responsibilities as a prospective owner of a regulated entity which can only be helpful when you start the process of seeking regulatory approval for the acquisition. We will come to that in future posts.