CIBC recently considerably reduced its remaining exposure to U.S. residential mortgages through a fund arranged by Cerberus Capital Management. Cerberus agreed to invest $1.05 billion in cash in CIBC's U.S. residential real estate portfolio.
This move by CIBC is an example of a growing trend of financial institutions combining asset disposition through risk transfer and capital-raising.
"This is one of several different ways institutions like CIBC shed risk and obtain financing," said Paul Jorissen, a partner at Mayer Brown. Jorissen explained that through the credit-linked note, limited recourse financing - which combines the elements of structured finance and traditional private equity investment - the deal became beneficial for both CIBC and Cerberus. "Through this deal, it effectively shifts the risk of further write-downs to the investor, which is able to shoulder that this risk."
Similar deals are that of Lone Star Funds buying bad loans from Merrill Lynch. This transaction included the sale of $30.6 billion of repackaged CDOs to Lone Star for just $6.7 billion, or about 22 cents on the dollar.
"We're seeing interest in these types of transactions that combine asset disposition, risk transfer and capital-raising," Jorissen said. "Every client has their own goal, some are trying to reduce risk-weighted capital or raise new capital, so the structure of each transaction would differ from each other and hit upon the motivation of the client."
Opportunities for Private Equity
In this "time of enormous stress," there are two things happening, according to Oliver Ireland, a partner at Morrison & Foerster: Private equity investors that are interested in return see that bank stocks are undervalued and, because of this, there are buy opportunities. At the same time, these banks are trying to raise capital.
However, there are constraints on investors purchasing equity in these banks. Specifically, Ireland said that voting equity interest in banks could result in the investor having control of the bank, without having the power to run it. "Basically you are trying to make sure no single investor in aggregate would own more than 10% of the voting equity preferred stocks," Ireland said. "There are ways you could structure investments to provide more equity to the bank without it becoming a bank holding company."
In this regard, the Federal Reserve in late September eased bank ownership thresholds. The new thresholds allow private equity firms to buy larger-sized stakes in banking companies along with board representation. The new Fed guidelines enable a private equity investor to acquire 33% of a bank's stock, including 15% of its voting shares and secure board representation.
Additionally, the new minority-stake investments that are made by private equity firms would not result in added regulatory oversight, as these would have done previously under the Bank Holding Company Act.
"The regulatory issues aside, you have a possibility here of a win-win situation for both sides, private equity looking for good investments can look into banks that are historically good buys," Ireland said. Because of the current market, "there are transactions, both happening or which are in the exploration stage, on a fairly wide range. To what extent is hard to tell because these deals don't result in bank holding companies."
Ireland said that these types of investment are different from what the Troubled Assets Relief Program (TARP), which is part of the Economic Stabilization Act of 2008, is trying to accomplish. "TARP is focused on restarting the market and taking certain assets off balance sheet as oppose to direct equity contributions to the bank." He added that this would be most effective if, through this program, the government buys the assets at a higher price than what banks would carry them for on their balance sheet.
Jorissen said that with the Economic Stabilization Act, there's a very real likelihood that many financial institutions will look to the Treasury for alternative risk measures and to valuate those alternatives.
"However, the Treasury's solutions may be too restrictive for some institutions. For some institutions, the bespoke solutions offered by private equity and other investors might continue to be attractive alternatives to TARP." He added that the TARP is not necessarily designed to increase a bank's capital position.
The market has yet to learn "the meat on the bone" in terms of the TARP. "Under TARP, institutions might have to issue equity and there might be questions about executive compensation. These limitations aren't part a private equity arrangement," Jorissen said.
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