Fund Goes Down Blind Alley

The Wall Street Journal

Developer Set Up Vehicle to Invest in Banks but Couldn't 'Make the Numbers Work'

Real-estate developer Stephen Ross and his partners spent more than a year digging into U.S. banks, including more than 100 with loans to local bakeries, gas stations and amusement parks. They hoped to spend about $1.1 billion buying or investing in lenders.

But the deeper they went, the worse things looked. As a result, Related Cos., the New York firm in which Mr. Ross is chief executive, gave back the money it raised from roughly 150 investors, including hedge-fund manager David Einhorn. The firm did find several investments it was interested in but was outbid.

Just 18 months ago, Mr. Ross thought the U.S. banking industry was a lucrative investment opportunity that could yield big profits as the economy recovered. At the time, private-equity firms, hedge funds and other investors were pouring capital into banks.

Since then, signs of economic improvement have faded, leaving many of the nation's 7,500 banks and savings institutions besieged with troubled assets, weak loan demand, rising regulatory costs and few growth prospects.

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"We're disappointed to see the opportunity evaporate," said Mr. Ross, whose company developed the Time Warner Center in Manhattan's Columbus Circle. He also is the majority owner of the Miami Dolphins football team.

Mr. Ross now believes it could take the U.S. banking industry another three years to get back on its feet. The weak economy put the brakes on an uptick in loan demand, creating more competition among banks for credit-worthy borrowers. Low interest rates are eating into the bread-and-butter business of making money on the difference between what banks pay for deposits and what they charge for loans.

"If you look at the environment today, I feel even more comfortable that we made the right decision," Mr. Ross said, referring to volatility in global markets tied to worries about European debt and the U.S. economy.

The fund, called SJB Escrow Corp., was set up amid a brief flurry of so-called blind pools aimed at banks. Blind pools raise money to invest in a stated objective. Since 2009, investors have ponied up billions of dollars for the pools. Most of the investment funds are led by former bank executives who intended to buy a string of small financial institutions, recapitalize them and combine them into a larger bank that goes public at a profit for investors.

Most of the pools are required to invest a big chunk of the money within two years or return it to investors.

The performance of the blind pools is difficult to gauge because the banks they own often aren't publicly traded. Still, many of the stakes are likely underwater, given the persistent decline in bank stocks. The KBW Regional Bank Index is down more than 20% this year.

Other blind pools still are pouring money into sick banks.

"I'm not suggesting to anyone it will be a walk in the park, but I'm a believer long term that we can create value for shareholders in this market by operating a commercial bank very well," said Paul Murphy, chief executive of Community Bancorp. The Houston bank-holding company is backed by a blind pool and has bought two banks this year.

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In addition to the $1 billion that Related raised from investors, Mr. Ross and partners Jeff Blau and Bruce Beal sank $100 million of their own money into SJB, named after the first letter in their names. Terms of the pool required SJB to invest the money within 18 months. SJB got a bank charter from regulators, hired an industry veteran as its chief executive and assembled a board of directors.

In a prospectus, SJB told potential investors: "We believe the environment presents a significant opportunity for SJB to consummate an attractive acquisition of one or more institutions, whereas the current weakness in the banking sector and a potential long duration of any recovery create a favorable long-term environment to build a successful commercial bank."

Mr. Blau, Related's president, led the effort to find potential investments for the fund. In many cases, Mr. Blau didn't like what he saw, including loans that were secured by portable toilets and bowling balls.

"It was a lot of work, and it was hard to make the numbers work," he said.

SJB initially was attracted to banks with lots of real-estate exposure. One example: condominium lender Corus Bank, a unit of Corus Bankshares Inc. that failed in 2009. SJB bid on Corus's real-estate development loans that were being auctioned off by the Federal Deposit Insurance Corp., but was outbid by a group of investors led by Barry Sternlicht's Starwood Capital Group.

The blind pool made four other unsuccessful bids, including one for failed Cleveland thrift AmTrust Bank, part of AmTrust Financial Corp. More recently, SJB made an offer to acquire the U.S. online-banking business of ING Groep NV, but lost out to Capital One Financial Corp. The $9 billion deal was announced in June.

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With the clock ticking on its 18-month deadline, Messrs. Ross, Blau and Beal sent a letter to investors Aug. 18 informing them that the fund would be liquidated. Investors received roughly 97 cents on the dollar after expenses. Mr. Einhorn, one of the investors, declined to comment through a spokesman.

"While we are disappointed that we were not able to acquire a banking franchise and execute the SJB business plan, we refused to compromise on transactions that did not offer both an appropriate margin of safety and attractive returns," the letter said.

Mr. Ross said there is "a lot of money to be made in the future of banks," especially in online banking. "We want to be back in it. The question is when."

Write to Robin Sidel at robin.sidel@wsj.com

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