November 26, 2008
Although I never thought I would say so, it would be preferable for us to nationalise our banking system than to allow a private equity consortium to own and control our major banks.
Private equity firms are probably the worst possible owners of a strategic asset like the banking system. If Mr Lenihan sanctions, at these distressed prices, a takeover of the Irish banking system by a private equity consortium, he will have used the guarantee of the Irish taxpayer to subsidise the profits of a tiny few speculators for two years.
Before he announced the guarantee he could have argued that the ownership of the banks has nothing to do with the State because they are private firms.
However, by using the sovereign name to prop up the system, he has changed the game completely. This is also acknowledged in the legislation because the minister now has a veto over who will ultimately buy the Irish banks.
He will also signal chaos in the banking system because the strategy of a private equity fund is to sell. The minute these lads buy an asset the first and only thing on their minds is how to get out of this asset, making the most money by selling to the highest bidder.
What is a private equity fund? A private equity fund is a highly leveraged takeover machine.
For the sake of simplicity, let’s say the investors put in $1bn. The private equity fund then borrows 10 times that so the fund with equity of $1bn now has $11bn to play with.
Crucially, private equity funds have a 10-year lifespan. The manager promises the investor at least 20pc back on his money, which becomes feasible when you see that the initial $1bn investment grows to $11bn with borrowing.
The fund manager spends the first four or five years raising money and buying assets and the next five or six years selling the investment. The manager takes a 1pc fee for managing the money but his real prize comes from the profits he makes when he sells everything and closes the fund after 10 years. He can’t take an extra penny out of the fund until everything is closed, the fund’s assets are re-sold and the profits are divvied up among the original investors and the fund manager after the banks are paid back their borrowings.
Therefore, it is clear that these private equity players are only in the game for the short-term and while they control the asset, they squeeze every last drop out of it in cost savings and the selling of what are called “non-crucial” assets. So, when it comes to selling the bank, the private equity fund ensures that at that particular time, the bank will be at its most profitable, irrespective of how many jobs are lost or how many branches are closed in the process.
The private equity manager doesn’t care who buys the asset, so once a private equity firm or consortium gets the controlling stake, the future of the Irish banking system is anyone’s guess.
Although this seems like a great business to be in, things have not being going well for our private equity friends of late. Many investors have been trying to get out of private equity funds in the past year because they realise that when prices are falling, the private equity managers are just as fallible as the rest of us.
Many of these “masters of the universe” have lost fortunes this year and the problem with private equity funds is you can’t take your cash out until the end of the 10- or 12-year cycle.
As a result, investors who want to get out of private equity funds are selling their stakes at 50pc discounts simply to get hold of some cash. Eighteen months ago, when the markets were soaring this would have been unheard of. Yet the Financial Times reports many such funds are in serious trouble.
If you think about it, it is not surprising that an investment vehicle designed for a bull market when credit was ubiquitous might have problems in a bear market undergoing the most violent credit contraction in history.
The fragile state of the private equity industry and the jumpy nature of previously secure investors, is another reason that Mr Lenihan shouldn’t touch these lads with a barge pole. In these conditions, a private equity owner of the Irish banks will make the debacle of Eircom seem like a honeymoon.
Most crucially, the private equity option doesn’t solve Mr Lenihan’s problem, which is the bad debts of the Irish banks stemming from property.
What happens to the private equity investment if they get their sums wrong today and run out of money to cover the debts of the banking system? They will simply walk away, leaving us with no banking reform and a bigger problem when the rest of the world is coming out of recession in a few years’ time.
Make no mistake about it: they will promise you the sun, moon and stars to get the assets cheaply, but once trouble begins they will not come to your aid and the Government will be back to square one.
Unless Mr Lenihan can quickly find proper strategic investors to take over our financial institutions, such as a large European financial player who knows how to run the business, he’d be better off waiting.
If he feels he can’t wait and private equity is his only option, we’d be better off if he nationalised the banks by taking a significant minority share using a preference share, which should generate a minimum 10pc to the State per annum.
He can also write himself an option to take more of the banks’ equity — on behalf of the taxpayer, exercisable in five years’ time — at a deep discount to today’s share price. You can use private equity money if you need a make weight, but don’t give them control. And of course, open up the recapitalisation to the Irish taxpayer as direct investors. The State can then sell its stake in a few years so the profit accrues to us the Irish people, not a bunch of private equity traders, masquerading as national saviours.
In this way we can stabilise our own ship, and solve our own mess in an orderly fashion. This was what the guarantee was about in the first place.
Private equity fund managers are not investors; they are leveraged traders. They think with a trader’s mind that tells them that as soon as they have bought, they need to arrange how to sell. Even if they wanted to invest for the medium term, the private equity time horizon is legally bound to sell during the timeframe of the fund, normally 10 years, or less.
Ireland’s degenerate bankers do not deserve to be saved.
However, we the Irish people, whose deposits, mortgages and business keep the banks open, deserve more than to be pimped out to the least suitable bidder in this, our weakest moment.