What makes a good FIG investment in PE?

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Hi all,

Interviewing in a couple weeks for a Financial Services specific MM PE shop but not sure how to think about investments in this space from a PE perspective.

What makes a good LBO target in Financial Services (banks, insurance companies, investment managers, etc.)? And what are things to look for in financial statements? Would appreciate any and all help, thanks!

Comments (16)

 
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  • Associate 2 in HF - Other
Jun 4, 2020 - 1:15am

stick to the easy fake fig stuff. insurance brokers (acrisure, Alliant, HUB, AssuredPartners) and payments companies (First Data, Evo, Elavon) make the easiest LBO candidates within FIG. nobody tryna LBO a bank or insurance company out here. private equity activity in the real bank and insurance space is much more complex like with what Apollo is doing with Athene and what everyone is trying to copy. it's not simple LBO stuff

 
Jun 5, 2020 - 4:30pm

The FIG sector is mostly services to FIGs rather than the FIGs themselves. I would describe payments as more fintech than traditional FIG (although many payments companies don't do very tech-y things, they certainly trade at tech multiples..) Having said that, there are some common attractive characteristics I've seen:
* Sources of recurring and reoccuring revenue: AUM-based fee models have been attractive e.g. Mercer Advisors (Genstar, Oak Hill), Wealth Enhancement Group (Lightyear) have built recurring revenue businesses on AUM roll-ups. AUM-based models come with the downside of often being correlated with the public markets. Brokerage businesses benefit from years of trailing revenue from products sold e.g. Hub (H&F, Altas), Alliant (Stone Point).
* Unique challenger business models: many smaller leaner PE-owned FIG businesses challenge larger, slower and complacent players (Schwabs and big banks of the world) and / or carve out a niche for themselves. e.g. Kestra (Warburg, Stone Point) is a challenger to the LPLs and Commonwealths of the world. Many will have a tech-enabled model to challenge labor-intensive old-school services e.g. SourceNet (Vista).
* Complex regulatory and fiduciary landscape - many FIG firms are heavily regulated. Firms such as Stone Point pride themselves in understanding the regulatory landscape and finding firms that can stay ahead of regulation and have strong back-ends to deal with regulatory burdens (compliance policies, depts, technology).
* Commission and incentive structures - many of these FIG firms share their economics with the other parts of the financial ecosystem. Strong, under-the-radar (making money but not being controversial / not getting a lot of attention) unit economics are very attractive. Wealth managers pay commissions to advisors (commission structures are very important and will drive part of the business valuation), vehicle insurance product distributors will share fees with the auto dealer (Protect My Car, Crestview) etc.
* Under-served populations: some PE firms will venture into (questionable imo) specialty lending businesses for underserved populations such as litigation finance, subprime credit, small business factoring/invoice financing.

Having said that, once in a while, you WILL find investors in banks and insurance companies ("balance sheet" rather than "P&L/EBITDA" businesses). I do not understand these too well and suspect they are minority equity stakes e.g. Stone Point - OneWest Bank.

Best segmentation of the industry and companies to explore are likely on Stone Point's website:
https://www.stonepoint.com/companies/

 
Jun 5, 2020 - 9:33pm

The key in FIG is to understand that the entire ecosystem stems from balance sheet intensive models (banks, insurance carriers, etc.). PE opportunities in the sector are generally platforms that help these businesses acquire customers (eg brokers/RIAs), underwrite customers (regtech, analytics), or service customers (BPOs, TPAs). Capital flows very quickly to attractive risk-adjusted returns, so balance sheet opportunities in lending or insurance are incredibly rare since attractive ROAs are rarely sustainable unless you are taking some other risk (regulatory, servicing, etc).

 
Jun 7, 2020 - 1:37pm

Stone Point is the single largest FIG-only PE shop and certainly a top dog.

But plenty of the large funds play in the space frequently: Blackstone (Refinitiv, Promontory), Apollo, Carlyle. Almost every large fund has done something in insurance brokerage, it seems.

Fintech is the usual names: Vista, Thoma, SL, Francisco but also Bain Cap, Advent, H&F, WP, Permira, KKR etc. (lots of payments plays)

Some MM FIG-exclusive names: Aquiline, Flexpoint Ford, Lovell Minick, Lightyear, Corsair, FTV.

 
Jul 29, 2020 - 6:57pm

You can't own more than 24.99% of a bank without having to register as a bank holding company and becoming a regulated entity, so a PE investment in a bank would need to be minority--could be a partnership with another bank that owns the majority or you could put together a consortium of sponsors who each own less than 24.99% of the bank

I can only speak for specialty lending and not insurance, but an attractive acquisition of a non-bank lender might look like the following
-Lender serving a market that's relatively nichey or underserved by banks or where the lender has some advantage over banks (i.e., small business loans, loans to undocumented immigrants with no or limited credit history, near or subprime installment loans)
-Very strong Unlevered risk-adj. return and unit economics - With a much higher cost of capital than a bank, the unlevered ROA needs to be pretty high for the margins to still make sense for a non-bank lender
- strong marketing/customer acquisition advantage/origination engine. Lenders make money as a % of the loans they make. All else equal, in order to grow earnings, you need to grow the book.
-proprietary technology or some other advantage/differentiator
-asset class that from a regulatory perspective would be permissible inside of a bank. Given the cost of capital and capital structure advantages that banks have, any business that is (1) of a scale where a bank would care about it and that (2) is an asset class that banks are permitted to own, all else equal, would be more profitable if owned by a bank. That being said, after a sponsor buys a small niche lender, the goal is often to scale it and then exit to a bank. A recent example is Regions buying Ascentium from Warburg

The other play in PE for the big sponsors that run multiple strategies like Apollo, Blackstone, KKR, Ares, Carlye, etc.) is for the sponsor to acquire a specialty lender then throw the loans into a credit fund it also manages. Depending on the firm and deal, this type of transaction could either be done at the fund or GP level. Also depending on the firm, this might be handled by the FIG PE team or by a corporate strategy/internal M&A team and be treated more like a corporate acquisition

 
Jul 30, 2020 - 10:02am

While I agree that there are limits to leverage because of regulations, most banks are more levered than that (lower equity/assets)

2 random examples: JP Morgan has TCE/TA of ~6% and Capital One has TCE/TA of ~9% as of Q2 2020. A mature non-bank lender that is properly capitalized is probably going to be less levered than a bank--probably in the high teens - high 20s range.

 
Jul 31, 2020 - 12:53am

I think that might be a little overstated. Usually non-bank lenders have facilities secured by the loans they are making (think 80%-90%+ advance rates depending on the product) which isn't really the same as corporate leverage. So while the BS may look like it has an enormous amount of leverage a good chunk of it is likely non-recourse to the company.

 
Jul 31, 2020 - 6:00am

Not sure I follow - the leverage ratios you're referring to don't apply in a depository context in the same way. The primary item on the liability side of a balance sheet for a bank is deposits, which in the most technical sense is still 'debt', but .50% interest expense on perpetual funding is very different from traditional corporate debt. Banks are levered, but they aren't paying huge debt service on top of the interest expense on deposits.

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