The Wall Street Journal’s Deal Journal tells us that former Comptroller of the Currency and later Bankers Trust Vice Chairman Eugene Ludwig is forming a (target size) $1 billion private equity fund to acquire banks.
Now the bit the WSJ doesn’t seem to know is that Ludwig has been looking to form a fund in the $500 to $1 billion range since he left BT to establish Promontory Financial Group, a firm that does bank-related consulting, in 2001. I happen to have hired Gene as my attorney in the late 1980s when I had a senior banking industry job and Gene was a partner at DC law firm Covington & Burling. Although it isn’t listed on his site, he has done some roll-ups (as I recall in trust banking), which may have taken place via another entity.
If anyone could make a banking private equity fund work, it’s Gene, by having a simply enormous Rolodex and good commercial instincts. But banking isn’t an obvious area for a private equity fund. Aside from a regulatory regime that makes doing a deal more costly and time consuming, one is also faced by competition from “strategic,” meaning not always economically rational competitors. And the fragmentation of the industry means there are a lot of them.
In addition, the basic thesis, that the industry is well suited for consolidation, doesn’t hold. As we have mentioned before, the industry exhibits a slightly increasing cost curve, which means bigger banks are less cost efficient than smaller ones. Specialized, pure play financial player of various sorts likely would show scale economies, but diversified banks don’t. Any economies they achieve by cost cutting post acquisition could have been realized independent of the deal.
So with all due respect to Gene, if his fund gets funded now, it’s another sign of too much liquidity and desperation for return. Like the Blackstone IPO, it’s another indicator that the end of this cycle is nigh.
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Supreme Court justices test arguments by querying the extremes. In an era of seemingly unlimited liquidity and deficit finance at what Steven Ratner terms “rates and terms that make no sense to the lender”, most of the S&P500, and probably much of the Russell3000 could theoretically have their balance sheets forcibly blitzkrieged by P/E Gestapo.
My extreme question to private equity folk – and intended for the writers of this Blog as thoughtful consultants – is: Why in this leveraged purgatory of modernity do we need “equity” at all? The P/E boys (and they are ALL boys if you notice) seem to have no difficulty returning enterprises, stripped of cash, marketable securities, saleable assets, excess pension reserves, replaced with optimistic return forecasts, even capital equipment whose sales been replaced with smoke-and-mirror loing-term leases, and employees, now engaged sans filial obligations as consultants, all which sum to reasonably large negative equity when the dust has settled upon the balance sheet re-orientation.
So why, do we need equity at all? If “they” can do it, why shouldn’t every management team do it? And if every management team does it, would this exacerbate the savings glut? Is there a fallacy of composition here? Where would interest rates go? What ever happen to princpal-agent conflicts, i.e. GP management supporting the bid as current CEO and future CEO of the newly private company?
In short, is PE seen as good and deterministic business, or simply an evil opportunitstic end-run so long as debt is cheap, and one can get away with it for lack of any other constituent othern than shareholders?? For IF its not “good” then policymakers need examine the externalities that result from ecomnomic policy and an international monetary system that permits unlimited liquiidty growth, mis-priced, and apparently without consequence.
Market top? Maybe. But I think it is an indication that something of a far larger magnitude is broken with our economic and political sysem.