Assembling the Iron Triangle

Getting through regulatory hurdles is a tough slog for many private-equity firms that want to buy banks or start them up, but some have found that having former bank regulators by their side help make a deal work.

Some of these ex-regulators are high-profile professionals like former Federal Housing Finance Agency director and chairman James Lockhart, who signed on in August with WL Ross, Wilbur Ross' private-equity firm. Some are professionals who have worked at the Federal Reserve for several decades. This may be a new twist to what is already a routine on Wall Street, where brokerages have lured specialists from the Securities and Exchange Commission for advice on legal issues or to serve on boards.

Just recently, a private-equity investor group composed of Parthenon Capital Partners, Lovell Minnick Partners and Continental Investors used the counsel of former regulators to acquire a controlling interest in Orlando-based Seaside National Bank & Trust. Ex-Philadelphia Fed bank examiner Paul Pilecki, now a partner at Winston & Strawn LLP, was one counselor who worked on the task.

Parthenon and Lovell Minnick led the investment in the nationally chartered commercial bank, which has $830 million worth of assets and 13 offices. The two each acquired roughly 23% stakes on the eve of Thanksgiving, investing $40 million in the bank, with Continental taking a 9.9% stake.

"The fact that some of the attorneys were ex-regulators made a tremendous difference," says Brian Golson, a managing partner of Parthenon Capital Partners.

As Golson sees it, the former regulators were able to parse through concerns expressed by their counterparts at the Fed, the primary overseer of the Seaside deal. The task might sound simple enough, but regulators drew up a list of 29 different points to discuss with the investors, according to Golson.

"The level of knowledge they had about our transaction was immense. The regulators worked very constructively with us to make sure we were doing things by the book," he says.

The consortium hashed out the concerns over two-and-a-half months, and ultimately invested in the bank through its holding company Three Shores Bancorporation.

"Bringing a regulator in creates confidence in respect to the team's integrity — you bring some level of regulatory sensitivity and knowledge to the table and that makes you a better buyer," says Edwin del Hierro, a partner at Kirkland & Ellis who led the legal advisory assignment for the Seaside investor group.

Robert Fiallo, the ex-chief executive of Washington's Fidelity & Trust Bank, and other dealmakers believe that former regulators standing by your side is a key ingredient in the deal-approval recipe. Now that he's completed the sale of Fidelity & Trust to Eagle Bancorp, Fiallo is ready for his next transaction and he plans on hiring an ex-regulator.

"The idea is to bring a former senior regulator on as our chief risk officer and a well-seasoned senior bank CEO that has successfully run a model predicated on quality acquisitions," Fiallo says.

Fiallo is in talks with a number of different bank-holding companies with assets ranging from $300 million to $1 billion. Ideally, these would serve as a springboard for acquisitions of other banks, particularly troubled ones.

"There are firms out there that have brought on former bank regulators as part of their bank acquisition strategy. Getting a workable private-equity proposal through a regulatory review process can be a daunting task, and having people who have worked on this process from the other side can be very helpful," says Charles Horn, a partner at Mayer Brown LLP.

Nick Kirk, a co-founder of the Hickory Group, a New York investment banking boutique, is helping Fiallo round up private-equity capital for the bank play.

"The template which has been successful for private equity is partnering with a management team that possesses both regulatory and operating experience. Without these two pieces, groups will be missing valuable process insight," Kirk says.

Meanwhile, there are aspects to operating in the bank industry that may come as a surprise to some private-equity executives. Take, for example, the case of New York's Herald National Bank, which is partly owned by a private-equity group.

When executives at Herald National were waiting to get regulatory clearance to open last year, a half dozen Federal Deposit Insurance Corp. officials showed up at the bank's Fifth Avenue headquarters last fall like a regulatory version of a SWAT team. The group swarmed the private-equity backed bank's offices, putting its business operations and computer systems through a battery of field tests — time-tested procedures that bank examiners have long carried out.

Herald raised $62 million from an investor group that included Palladium Equity Partners, FrontPoint Partners and Carpenter & Co. last year. Its efforts at managing the regulatory aspects of the process were enhanced by the presence of its chief credit officer, Joseph Harpster, the former head credit officer at HSBC Bank USA. Harpster joined Herald last year after two decades at Republic National Bank.

He also worked for six years as a bank examiner in the Fed's New York branch, working with small to large banks.

"It's always helpful when you have someone on the team that's a former bank examiner; the regulators like that. It helped us when we went out to raise capital," says David Bagatelle, president and CEO of Herald National, a middle-market commercial bank.

Bagatelle and Harpster helped get the Office of the Comptroller of the Currency and the FDIC comfortable that Herald had all its ducks in a row — namely that its safety, soundness and operating procedures were in order. The bank secured conditional approval from the OCC in June, followed by conditional approval from the FDIC in July. It went through the aforementioned field test and subsequently opened three branches.

"They're basically assessing the quality of the bank by looking at the quality of its assets, capital adequacy, earnings ability, liquidity and management [team]," says Harpster.

Herald, which has put out $300 million in commercial loans this year, isn't done with the capital-raising process, either.

Meanwhile, as is often the case in finance, no new tactic is truly original. Consider the case of Deerfield, Ill.'s CenTrust Bank, which raised more than $20 million worth of private capital to launch its business in February 2006. Its staff included Carl Vander Wilt, a 33-year senior veteran of the Chicago Fed who led up CenTrust's formation as its CEO.