The Strange Allure of Florida Banks

You would think a semiobscure failed Florida thrift, hobbled by $10 billion or so of bad assets, wouldn't draw an A-list of potential acquirers. In the case of BankUnited Financial of Coral Gables, however, you would be wrong.

The company was seized last week by its regulators, who then immediately turned around and sold it to a group of Wall Street big shots including W.L. Ross, Carlyle Group, and Blackstone Group . To win the deal, the Ross group had to top competing bids from the likes of Goldman Sachs . J.C. Flowers was said to be sniffing around, as well. This was a private-equity version of a buying frenzy.

It's an example of the almost mystical hold the Florida banking market can have on investors. BankUnited may be insolvent, but it still has one distinction that sets it apart from the rest of

the walking-dead banks in the Sunshine State: It's the largest locally based FDIC-insured depositary institution. Which is to say, BankUnited is the closest thing there is to a platform an investor might use to create a Florida banking empire. As you'll see in a minute, that's the kind of thing that can set certain hearts racing. The private-equity powerhouse that bought BankUnited could very well transform the banking business in Florida and seems intent on trying. It might end up transforming the entire banking industry as well.

Let's start at the beginning. Florida has a special spot in bank investors' hearts for one simple reason. It is a burgeoning source of what bankers prize most: low-cost, stable deposits. In banking, loans may get the headlines (especially when, like now, they're going sour), but it's those federally insured deposits that are the secret sauce that can make the business so boring and reliably profitable when run properly. The basic proposition, of course, couldn't be simpler: Take in deposits that cost next to nothing, lend them prudently at a reasonable interest rate, and pocket the spread. With one-year CDs yielding less than 1 percent in Florida lately, and savings accounts even less than that, it's not hard to make the numbers work. Banks can extract additional revenues from their depositors in the form of fees, mainly bounced-check charges.

So deposits are it. And for banks seeking steady deposit growth, Florida is the closest thing there is to Shangri-La. To begin with, it's already a huge market. Florida has $368 billion in bank deposits, the fourth-highest of any state, according to the FDIC. Plus, it's still growing fast. Statewide population grew by 14 percent annually, on average, from 2000 through 2007—twice the national rate. Those newcomers have to put their money somewhere. Sure enough, over the past five years, deposits at Florida-based banks have grown by more than 20 percent annually, on average. For perspective, deposit growth industrywide averaged just below 9 percent per year over the same period.

It all adds up to a fire hose spewing semifree money. No wonder, then, that before the banking industry imploded last year, non-Florida banks were beating down the door to enter the market. The numbers some buyers were willing to pay were, in retrospect, wondrous. One illustrative transaction happened in 2004, when Cincinnati's Fifth Third Bancorp acquired Naples-based First National Bankshares of Florida, then the state's largest locally based institution, for $1.6 billion. That price works out to (and this is not a typo) 42 times earnings, 2.6 times book value, and nearly six times tangible book value. For reference, the typical non-Florida bank buyout this decade occurred at around 2.2 times tangible book. Typical bank-stock price-earnings ratios, meanwhile, tend to range between 12 and 14.

The Fifth Third-Bankshares of Florida deal was hardly a one-off, though. In July 2006, National City Corp. of Cleveland acquired Fort Pierce-based Harbor Florida Bancshares for $1.1 billion, or 3.2 times book value and 22 times earnings. Then, later that same month, it bought Fidelity Bankshares of West Palm Beach for 3.7 times book and 30 times earnings.

Florida-bank buyouts have consistently occurred at a premium compared with buyouts of banks in other states. From 2002 through 2007, deals nationwide were priced at 2.2 times book value, on average. The typical acquisition of a Florida-based bank, by contrast, was at 2.8 times book.

But the collapse of the housing market brought it all to an end. Florida banks might be bodacious gatherers of deposits. On the lending side, though, they have the disadvantage recently of being located in, well, Florida. As the housing market there collapsed beginning in 2007, so did the credit quality of the loans local banks wrote to finance it. In 2008, fully 60 percent of Florida banks lost money, the FDIC reports. As a group, Florida banks earned negative 1 percent on their assets last year. (That's no mean feat when the government subsidizes your funding.) In specific markets where the housing crackup has been most severe, the numbers are even uglier. Of the 20 banks headquartered in Sarasota, Manatee, and Charlotte counties in southwestern Florida, for instance, 17 lost money.

Result: All of a sudden non-Florida banks (many of which have their own credit problems, remember) aren't so eager to buy their way into the market anymore.

Which gets us back to BankUnited. As noted, the company is the largest Florida-based FDIC-insured depository institution, with $15 billion in assets and $7.2 billion in deposits. That's not saying as much as you might think, by the way. The Florida market is dominated by huge out-of-staters such as Bank of America and Wachovia (lately acquired by Wells Fargo). BankUnited comes in at just eighth as measured by deposit market share, with 2 percent of the market.

Still, the proto-empire-builder has to start somewhere. The winning bidder for the company is a consortium of private-equity investors headed by W.L. Ross, the distressed-asset investor, that includes Carlyle Group, Blackstone, and Centerbridge Partners. They're injecting $900 million in fresh capital into the bank and have installed John Kanas, the former CEO of North Fork Bancorp in New York, to run the place. The government will also take most of the losses on a pool of $10.7 billion of iffy assets.

The Ross group plans to use BankUnited as a vehicle to acquire additional banks and thrifts (and their deposits), both in and out of Florida, at what will presumably be a fraction of the prices acquirers were paying just a few years ago. Given the stressed nature of the Florida banking industry, in particular, the group can potentially put a lot of money to work in a short period of time.

The entry of big-time private-equity players, meanwhile, may be something of a watershed for the banking industry. Federal regulators have historically been reluctant to let nonbank investors invest in the banking system. But with the system (in places like Florida, in particular) in need of serious injections of new capital to help shore up failing institutions, regulators have adopted a new approach. That could turn out to have huge implications for the banking industry. Something like $450 billion of private-equity money is lately sitting on the sidelines. If the Ross group's planned rollup of Florida banks turns out to be lucrative, a lot of that money will find its way into the banking business, as well. Before long, these new private-equity-controlled entities could likely become very big players. (How well freewheeling private-equity investors will take to being regulated by the feds is an open question. For that matter, how comfortable they'll be competing against the same institutions they rely on for funding their other deals is also an open question.) In any event, the private-equity industry is apt to create some major institutions out of the banking husk the housing implosion has created.

-- Matt Stichnoth is a managing director at Second Curve Capital, a New York hedge fund.

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