The private (equity) life of banks

Coller Capital chief executive officer Tim Jones explains the cycles of regulation and finance that could lead to banks re-joining the buy-side of the secondaries market.

Bank spin-outs and restructurings have become part and parcel of the secondaries market toolbox. Could we get to the point where regulatory issues might recede and we could see banks taking up private equity again?

Banks are very cyclical animals and they like private equity. European banks, in particular, are keen on private equity because they are structured more as universal banks. They don’t have the kind of regulatory restrictions that exist in America which have prohibited some of the principal banks from investing in private equity for a long time. As a consequence, lots of banks across Europe, large and small, have dabbled in private equity. They like the additional income it brings in, especially in bull market years.

At this moment in time, the global banking system is still under a lot of stress – both regulatory and capital stress – because of the fallout from the financial crisis. In Europe, the pain is far greater than in the US, because a lot of the restructuring needed in Europe’s banking system has not happened yet, whereas it’s been quite fast and deep in the US and UK. There are still a lot of private equity assets, and private equity-like assets, on bank balance sheets on the Continent, and they’re spread far and wide. There’s still a lot of work to be done there.

In the US, by contrast, things are more concentrated. Banks with private equity have numerous factors to contend with: the Volcker Rule, which very severely limits banks’ exposure to private equity; the international Basel III regulations, which make capital more expensive for assets like private equity; and the leverage ratio rule now being implemented in the US, which says banks can only have so much leverage on the balance sheet as an absolute. You have a whole series of rules going through that are making banks refocus on their core businesses; they are having to make big decisions about what assets they want to carry and where they’re going to earn income. The mantra around the banking system at the moment is ‘Go simple’. And if you do that – if you go back to what a commercial bank once was – you end up with a deeper but narrower institution: a ‘plain vanilla’ client-servicing platform and M&A house, not a prop trading business.

So that makes it difficult for banks and private equity?

Yes, because private equity has nowhere to sit. There’s no rationale for a bank to pursue it as a strategy, given all the negatives I’ve mentioned. So the trend right across the banking system is to exit this thing called private equity – which is what we are seeing now. It’s easy to get fixated on the detail, but it’s really the big picture that counts. With the Volcker Rule, for example, banks are able to get an extension to the exit timetable in certain circumstances – but what Volcker is really saying is: this is an area we don’t think you should be in. And I think that’s the conclusion most bank CEOs and chairmen have reached: they don’t want to be in this particular activity at this particular time. That makes sense when banks’ main priority is to rebuild their core businesses and their balance sheets.

And rebuild trust with the public?

Rebuild trust right across society, yes. That’s a major occupation of bank boards today. And works needs to be done, too, on the confidence of the capital markets. The public markets don’t understand private equity. If investors see volatility around a private equity business, it creates downside not upside in the share price. There’s no share price premium for being in private equity – only downside risk. That’s exactly why Deutsche Bank and JPMorgan were big sellers in 2001 – of probably over $10 billion of assets between them – because there was no fit anymore. Then, during the financial crisis obviously, both of them bought banks and ended up loaded with private equity again. Everything goes in cycles. There will be a point in time when banks say: We need strong revenue streams, and you can’t make that much income out of mortgages, plus lending to SMEs, mid-market corporates and the Ford motor company. At that point they may well end up back in private equity. Someone will write a business plan – the strategy will be different from today’s – but it will get them back into private equity in some form or other – probably via their asset management businesses.

What about regulation?

It’s key, of course. Regulators are clear that banks are a hugely important part of the global economy. They must be safe, and they must take far less risk onto their balance sheets than they have done historically. And because we don’t trust banks wholly to do this, we’re going to enforce it through regulation. In retrospect, it’s interesting to remember the soft touch approach we used to have: British banks would receive ‘guidance’ from the Bank of England. Those days are gone, of course. Guidance has had to become rules because the level of trust in the banking system is low. Regulators want banks to follow a set of rules – and they want them to follow the spirit as well as the letter of the rules. In my view, that essentially means getting back to what a bank basically is.