Thursday, May 13, 2010

Deal for toxic assets may serve as model

Friday, April 30, 2010

Atlanta Business Chronicle - by J. Scott Trubey Staff Writer


An assets and equity deal set to close April 30 for Georgia’s third-largest bank could prove to be a model path to health for larger struggling community lenders across the nation, industry leaders say.

Private equity firms are said to be approaching other Georgia lenders, betting a similar transaction to take toxic assets off a bank’s books in exchange for an equity stake could prove to be lucrative for investors and a shot in the arm for ailing banks in need of medicine.

Blairsville-based United Community Banks Inc. announced April 1 it had struck a deal with a New York-based private equity firm that would acquire $100 million in nonperforming assets in exchange for a piece of the bank.

Essentially a play on the “bad bank” model from the Savings & Loan Crisis, Fletcher International Ltd. will acquire $100 million in United’s most illiquid assets — ones the bank couldn’t have shed from its books without essentially giving it away and burning enormous capital — and in exchange the private equity group receives warrants for equity in the company.

“I’m surprised it’s taken this long to make a deal like this happen,” said Bobby Schwartz, banking attorney with Smith Gambrell & RussellLLP. “It works very well, especially with assets that are so illiquid and such a long-term hold. If a bank can get it off its books for something and the bank can have an interest in the project, it can be long-term solution.”

Such a transaction won’t work for all banks. Investors want scale, a stock that is publicly traded at volume and a franchise free from the most onerous regulatory restrictions. They also want a bank with a plan to go on offense.

United certainly appears to be readying itself.

Bank President and CEO Jimmy Tallent told analysts April 22, “one of our key goals is to participate in the failed bank activity that will most likely occur in [2010] and [2011]. This removal of [nonperforming assets] gets us closer to that goal.”

By taking the dead weight of soured loans off the North Georgia lender’s balance sheet, Fletcher is banking on United’s return to fighting shape, the market for the assets rebounding and its stock price taking off.

Indeed, the market has responded favorably. United (Nasdaq: UCBI) shares traded at $5.54 April 28, up 25 percent since March 31.

The complex transaction covers nonperforming commercial and residential mortgages and foreclosed property – mostly partially built houses and raw lots — in the North Georgia Mountains, the western Carolinas and along the Georgia coast.

The deal will essentially take illiquid assets off the balance sheet and free up capital industry watchers expected the banking company to burn by backstopping its losses.

Instead of capital lost in fire sales, United Community gets that capital back, while also structuring the deal to be accretive to capital over time through a stock investment by its new private equity partner.

As a result, United could go from limping through the crisis to potentially being a consolidator of failed institutions.

As part of the deal, Fletcher entered into a securities purchase agreement for rights to acquire $65 million in convertible preferred stock, and will acquire warrants to purchase up to an additional $65 million in common stock. It will also put $10 million in deposits into the bank in exchange for financing.

United posted a $36 million loss in the first quarter, with a slowing pace of nonperforming loans.

It lost $238 million in 2009, as the bank’s portfolio of residential construction loans in the North Georgia Mountains, suburban Atlanta, Western Carolinas and the Georgia coast were battered by the fallout of the housing market and recession.

The deal appears to signal a growing willingness on the part of bank regulators to allow private equity to play a part in bringing the banking sector back to health. Thus far in the cycle, private equity has been limited — players would argue extremely limited — to backing management teams in the acquisition of failed institutions.

Two groups in Georgia, State Bank and Trust Co. and Community & Southern Bank, have made multiple failed bank buys and other groups are said to be scouring prospects in the Peach State.

The Federal Deposit Insurance Corp. has been generally wary of private equity investment in banks. The groups typically have higher hurdles to clear because of the perception of the industry that it’s only around for a quick buck.

Adam Greene, investment banker and principal with BenAlon Capital LLC in New York, said his firm is “quite enthused that the United deal got done.”

BenAlon has approached about 10 Georgia lenders about a similar partnership.

“You will see more of them,” Greene said.

Banks face four primary challenges: capital adequacy, classified asset concentrations, recurring earnings and liquidity.

“This structure responds to all four challenges,” said Brian Olasov, a managing director at McKenna Long & Aldridge LLP. “This particular structure, this is very patient money. These are long-dated warrants.”

The capital needs to be around for length of the workout of the assets, Olasov said.

“Many of these markets are gong to be multi-year workouts,” he said.

Greene said he expects some markets won’t turn around for three to five years.

BenAlon is “asset agnostic,” meaning it is less concerned about the type of soured asset it would hold. What it is most concerned with is finding a partner with a solid franchise and management and getting back to performing profitability.

Holding toxic loans requires reserving capital, which then doesn’t enter the marketplace, curtailing growth.

“It’s key for the U.S. economy to clean the banking industry,” said Asher Fogel, BenAlon’s managing partner.

“We have a phenomena here — the zombie banks,” Fogel said. “[So far] any [investment] activity is at the top end of the market, not the middle end. But that’s where we need to see the activity.”


Reach Trubey at strubey@bizjournals.com