PRIVATE EQUITY BUYING BANKS IS NOT A GOOD MIX / THE FINANCIAL TIMES EDITORIAL

Private equity buying banks is not a good mix

The financial crisis taught that spiralling leverage can be dangerous


Blackstone has paidt €1bn for a 60% stake in Luminor


One deal does not necessarily signal a trend. But it is to be hoped that Blackstone’s €1bn purchase last week of a 60 per cent stake in Luminor, a Baltic lender — one of the largest private equity banking deals of the past decade — does not mark the start of a series of such acquisitions.

In itself, the deal looks straightforward. If approved by regulators, it will offer Sweden’s Nordea and Norway’s DNB, Luminor’s owners, a convenient way to reduce exposure to a market they no longer view as a priority. Blackstone sees a chance to boost Luminor’s return on equity, which lags behind some other Nordic banks, and says the Baltics are a high-growth market.

That makes this deal different from the rescues over the past two years of Germany’s HSH Nordbank by US private equity groups led by Cerberus and JC Flowers, and of Portugal’s Novo Banco by Lone Star of the US — or from JC Flowers’ stake in the UK’s Kent Reliance building society in 2010. Those deals either saved ailing institutions or met regulators’ demands to find new owners for parts of restructured banks.

While specialist investors may offer the only viable option in exceptional cases, any tendency in which banking becomes a normal destination of private equity funds seems ill-advised. Indeed, widespread mixing of private equity with banking could be a recipe for disaster.

Both sectors are highly leveraged. Boosting one with the other would be toxic. If the financial crisis taught us anything, it is that spiralling levels of leverage are not a good idea. A decade since the crisis erupted, the continuing weakness of parts of Europe’s banking sector makes prudence even more well-advised. High volumes of non-performing loans continue to afflict several banking markets; economic growth remains subdued.

Private equity, meanwhile, is looking like a bubble waiting to burst. Deal valuations are at record highs, surpassing pre-crisis levels. Globally, about half of private equity deals last year were priced at over 11 times the target company’s earnings before interest, taxes, depreciation and amortisation, according to Bain & Company. In the UK, that multiple spiked to an astonishing 26 times ebitda in Jacobs Holding’s acquisition of Cognita, a private schools group, earlier this month.

High deal valuations are being accompanied by growing levels of leverage, too. Between January and August this year, debt to ebitda ratios on European deals averaged 5.59 times, according to S&P Global Market Intelligence. This hovers worryingly close to the pre-crisis peak of 6.12. The European Central Bank’s advice to the institutions it oversees is for their own leveraged transactions to keep under a ratio of 6 times. It appears that many private equity deals would not pass that test.

With unprecedented levels of capital at their disposal, private equity funds might not care. Over the past five years, private equity houses have raised a total of $3tn. They are still sitting on some $1.7tn of unallocated capital. New sectors, such as banking, might catch their attention. A few successful deals, beyond one-off rescues, might lead other funds to follow suit.

Banking should not become just another investment sector for private equity houses. Problems could quickly escalate and move from the latter to the former, potentially leading to systemic failures. The consequences could be dangerous. Blackstone’s acquisition may well turn out a success for all parties involved. But it is not one that other PE counterparts should be rushing to copy. Banking regulators should keep a close eye on such deals.