December 4, 2009

Private Equity Firm Closes $1 Billion Green Fund

Reuters
December 3, 2009

Private equity firm Hudson Clean Energy Partners said on Thursday that it has closed its first fund, having raised more than $1 billion to invest primarily in the emerging green technology sector.

The fund's major investors include pension funds, both public and private, and financial institutions, the group told Reuters.

Investment areas that interest Hudson Clean Energy Partners are wind, solar, biomass, energy efficiency and energy storage.

The fund would look at grid-scale energy storage as well as automotive applications, said John Cavalier, managing partner.

The group, which is a late-stage expansion growth capital fund, invests about $50 million to $150 million on average in one transaction. It typically does not invest in early-stage technology.

The fund is looking to invest in about 10 to 12 green companies over the next couple of years.

Founded in 2007, Hudson Clean Energy Partners is led by Cavalier, a former vice chairman of Credit Suisse's investment banking department, and Neil Auerbach, who was previously with Goldman Sachs.

Cavalier said raising the funds was not easy, given the tough economy. "It was very challenging," he said.

Hudson's current portfolio includes Element Power, a global utility-scale wind and solar power generator; Recurrent Energy, a distributed solar power company; CaliSolar Inc, a solar photovoltaic wafer and cell manufacturer; SoloPower Inc, which makes solar photovoltaic thin-film cells, and Wind to Power Systems, a Madrid-based manufacturer of power electronics that enable connection of renewables to the grid.

October 31, 2009

Related's Ross, Partners May Seek $1 Billion for Bank

Bloomberg
October 30, 2009

Related Cos. founder Stephen Ross and partners Jeff Blau and Bruce Beal Jr. are trying to raise about $1 billion for their new bank that may acquire a seized U.S. lender, people familiar with the plan said.

SJB National Bank, owned by the executives, is working with advisers including Deutsche Bank AG to raise capital in a private placement, according to the people, who declined to be identified because the plans are private. SJB won approval to bid on failing institutions from the FDIC, according to an Oct. 26 letter from the regulator obtained by Bloomberg News.

The FDIC had 416 companies on its list of “problem” lenders as of June 30, and 106 U.S. banks have failed so far this year, the most since 1992. The executives at New York-based Related received preliminary approval as individuals to establish SJB earlier this year, according to a notice on the U.S. Office of the Comptroller of the Currency’s Web site. Related, the closely held developer of New York’s Time Warner Center, won’t have any stake.

“That would be a nice war chest for them to have,” said Chip MacDonald, a partner with Jones Day in Atlanta who specializes in deals among lenders. “With the approval from the FDIC they could make some really meaningful acquisitions.”

Representatives of Deutsche Bank, SJB and Related declined to comment.

IndyMac, BankUnited

In March, California-based IndyMac Federal Bank, which failed in July 2008, was sold to investors led by Steven Mnuchin, an ex-Goldman Sachs Group Inc. investment banker, and including buyout firm J.C. Flowers & Co. Florida’s BankUnited Financial Corp. was sold in May to firms including Blackstone Group LP and WL Ross & Co.

Related has more than $15 billion of assets including 11 million square feet of commercial property and 17,500 apartment units, according to its Web site.

Ross, 69, completed a purchase of the Miami Dolphins from Wayne Huizenga in January, paying about $1 billion for the National Football League team, its stadium and other properties. He sold stakes to singers Marc Anthony and Gloria Estefan, and her husband, producer Emilio Estefan. The University of Michigan’s business school was named after Ross, following a gift in 2004.

September 29, 2009

Goldman Sachs, Wilbur Ross Seeking to Buy CIT Assets

Reuters
September 29, 2009

CIT Group Inc is negotiating a new credit facility of up to $10 billion that could help the finance company pay off maturing debt and stave off bankruptcy, people familiar with the situation said.

The details of the facility are still being negotiated, and its size might be substantially smaller than $10 billion, two people familiar with the matter said. The company may forgo the loan altogether if it successfully renegotiates the terms of some of its existing credit lines, the sources said.

The existing credit lines include a $3 billion loan that CIT clinched from bondholders in July and a financing facility from Goldman Sachs.

CIT spokesman Curt Ritter declined to comment.

CIT shares rose 34 cents to $2.01 in afternoon trading, up 20.4 percent to their highest level since July. The company's bonds rallied too.

CIT is struggling to fund itself after losing access to the unsecured corporate bond market. The company has $3 billion of debt maturing in the fourth quarter, according to a quarterly filing in August. About half of that maturing debt is unsecured and must be refinanced or repaid from the company's dwindling cash holdings.

Regulators have put CIT Bank under a cease-and-desist order, preventing the unit from accepting new deposits. That bank was supposed to be a key source of funding for the company in the future.

The bank said in a quarterly filing that it hopes to restructure itself. If it is unsuccessful, it might have to file for bankruptcy, it said.

Analysts said CIT is struggling with real problems that may be difficult to solve even with additional loans in the near term.
"You can buy yourself a year of life, or maybe more, but then where are you? The world might get better and you might be able to borrow again in secured and unsecured bond markets, but there's no guarantee that it's going to play out that way," said Shawn Abboud, executive director of credit sales and trading at APS Financial Corp in Austin. Many of CIT's competitors are banks that have much cheaper funding costs.
SOME BULLISH

But some investors in CIT securities are much more bullish on the company's ability to avoid bankruptcy. One debtholder said the company could reduce its debt by exchanging current notes for new securities.

When it has more equity relative to its debt, regulators may lift the cease-and-desist order on its bank, allowing it to gather more deposits. CIT may also be able to sell assets, such as its railcar leasing business, and rely more on secured financing in the future, the debtholder said.

There may be interest in asset sales. Billionaire investor Wilbur Ross (former executive managing director of Rothschild Inc) told the Reuters Restructuring Summit on Tuesday that he would be interested in buying some CIT businesses. He also said he was interested in expanding his railcar leasing business, a unit that CIT has tried in the past to sell.

CIT shares have rallied in recent weeks, and the cost of protecting its debt against default has dropped, helped by rumors of a new credit. Under the terms of the $3 billion July loan, it must come up with a restructuring plan agreeable to lenders by October 1. That plan will likely include debt exchange offers, the company said in a regulatory filing in August.

Several investors who spoke to Reuters said they expect the company to offer new secured CIT debt to holders of short-dated debt, and to offer equity in the company to holders of longer-term debt. Investors may also get some combination of debt and equity, and perhaps even cash, to encourage them to exchange, debtholders said.

CIT's notes with a 4.25 percent coupon due in February 2010, the fifth most actively traded corporate bond in the U.S. market, rose on Tuesday to 76.5 cents on the dollar, from 74.5 cents on September 25, the last most significant trade, according to MarketAxess. That debt traded at 63.25 cents at the start of the month.

September 25, 2009

Rothschild to Start $711M Private Equity Fund

The Deal
September 3, 2009

One of the most famous names in finance, Rothschild, is planning to raise a $711 million investment fund as it welcomes chairman David de Rothschild’s son to the firm.

Sources tell Bloomberg that the private bank’s investment vehicle will buy minority stakes in closely held companies, valued at €100 million to €500 million ($142 million to $711 million), with fundraising expected to be completed by year’s end. Marc-Olivier Laurent, Emmanuel Roth and Javed Khan, who came over from the Blackstone Group in June, will manage the new fund.

Also coming aboard to help with the fund is Alexandre de Rothschild, David de Rothschild’s son, entering the family business from European leveraged buyout shop Argan Capital.

Rothschild is marketing the new vehicle as fundraising for private equity is once again starting to pick up. Over the past two months, U.S. private equity firms put more than $11 billion under management; while other firms are targeting another $10 billion.

Rothschild Said to Start Fund; Chairman’s Son Joins

Bloomberg
September 2, 2009

Rothschild, the largest family-owned bank, plans to raise a 500 million-euro ($711 million) investment fund as chairman David de Rothschild’s son joins the firm, two people familiar with the plan said.

Alexandre de Rothschild, 29, moved to the family bank from Argan Capital, Bank of America Corp.’s former European private equity division, to work on the project, said the people, who declined to be identified before the fundraising is completed. Rothschild Managing Director Marc-Olivier Laurent, 57, will oversee the fund, the people said.

The two-century-old firm, which is run by 66-year-old David de Rothschild, plans to buy minority stakes in closely held companies after the pace of global mergers and acquisitions dropped 46 percent in the past year. The fund’s backers include Rothschild partners and clients. It will target companies valued at 100 million euros to 500 million euros, the people said.
“It’s normal for them to bring in family members to ensure succession,” said Anis Bouayad, founder of Paris-based advisory firm AB Conseils. “The bank has always found a way to promote its own, while also bringing outside talent to the top jobs.”
Javed Khan, who joined Rothschild from New York-based private equity firm Blackstone Group LP in June, and Emmanuel Roth, a former executive at investment firm Paris-Orleans, will also manage the fund, the people said. Rothschild plans to complete the fundraising before the end of the year, they said.

‘Family is Fine’

“In a business, the key is to have the best people,” David de Rothschild said in a 2005 interview, addressing the subject of succession. “The family is fine as long as they do a good job. If they don’t, it has to be someone else.”

David de Rothschild took managerial control of the U.K. side of the bank after his cousin Evelyn retired in 2004, cementing control of both the Paris and London businesses by a French Rothschild, a first for the family firm.

David’s younger brother, Edouard, stepped down in 2004 after helping to expand the French bank. Today, he oversees France Galop, the country’s horse-racing association. David’s cousin, Eric, is chairman of Rothschild’s asset-management and private-banking units and also runs the family’s Chateau Lafite vineyard.

Mayer Amschel, founder of the Rothschild banking dynasty, started out buying and selling old coins in a Frankfurt Jewish ghetto in the late 1700s and built an embryonic banking business by extending credit to clients. In the early 1800s, he sent his five sons to establish bases in London, Paris, Naples and Vienna, in addition to Frankfurt.

His great-great-grandson, Guy de Rothschild, rebuilt the French business in the 1950s and 1960s after reclaiming the bank, which had been seized by the pro-Nazi Vichy regime. In 1981, the French bank was nationalized by Socialist President Francois Mitterrand. Two years later, David persuaded the French government to grant the Rothschilds a new banking license.

Ex-Leaders of Countrywide Profit from Bad Loans

By J. Emilio Flores, The New York Times
March 3, 2009

Fairly or not, Countrywide Financial and its top executives would be on most lists of those who share blame for the nation’s economic crisis. After all, the banking behemoth made risky loans to tens of thousands of Americans, helping set off a chain of events that has the economy staggering.

So it may come as a surprise that a dozen former top Countrywide executives now stand to make millions from the home mortgage mess.

Stanford L. Kurland, Countrywide’s former president, and his team have been buying up delinquent home mortgages that the government took over from other failed banks, sometimes for pennies on the dollar. They get a piece of what they can collect.
“It has been very successful — very strong,” John Lawrence, the company’s head of loan servicing, told Mr. Kurland one recent morning in a glass-walled boardroom here at PennyMac’s spacious headquarters, opened last year in the same Los Angeles suburb where Countrywide once flourished.

“In fact, it’s off-the-charts good,” he told Mr. Kurland, who was leaning back comfortably in his leather boardroom chair, even as the financial markets in New York were plunging.
As hundreds of billions of dollars flow from Washington to jump-start the nation’s staggering banks, automakers and other industries, a new economy is emerging of businesses that hope to make money from the various government programs that make up the largest economic rescue in history.

They include big investors who are buying up failed banks taken over by the federal government and lobbyists. And there is PennyMac, led by Mr. Kurland, 56, once the soft-spoken No. 2 to Angelo R. Mozilo, the perpetually tanned former chief executive of Countrywide and its public face.

Mr. Kurland has raised hundreds of millions of dollars from big players like BlackRock, the investment manager, to finance his start-up. Having sold off close to $200 million in stock before leaving Countrywide, he has also put up some of his own cash.

While some critics are distressed that Mr. Kurland and his team are back in business, the executives say that PennyMac’s operations serve as a model for how the government, working with banks, can help stabilize the housing market and lead the nation out of the recession.
“It is very important to the entire team here to be part of a solution,” Mr. Kurland said, standing in his office, which has views of the Santa Monica Mountains.
It is quite evident that their efforts are, in fact, helping many distressed homeowners.
“Literally, their assistance saved my family’s home,” said Robert Robinson, of Felton, Pa., whose interest rate was cut by more than half, making his mortgage affordable again.
But to some, it is disturbing to see former Countrywide executives in the industry again.
“It is sort of like the arsonist who sets fire to the house and then buys up the charred remains and resells it,” said Margot Saunders, a lawyer with the National Consumer Law Center, which for years has sought to place limits on what it calls abusive lending practices by Countrywide and other companies.
More than any other major lending institution, Countrywide has become synonymous with the excesses that led to the housing bubble. The firm’s reputation has been so tarnished that Bank of America, which bought it last year at a bargain price, announced that the name and logo of Countrywide, once the biggest mortgage lender in the nation, would soon disappear.

Mr. Kurland acknowledges pushing Countrywide into the type of higher-risk loans that have since, in large numbers, gone into default. But he said that he always insisted that the loans go only to borrowers who could afford to repay them. He also said that Countrywide’s riskiest lending took place after he left the company, in late 2006, after what he said was an internal conflict with Mr. Mozilo and other executives, whom he blames for loosening loan standards.

In retrospect, Mr. Kurland said, he regrets what happened at Countrywide and in the mortgage industry nationwide, but does not believe he deserves blame.
“It is horrible what transpired in the industry,” said Mr. Kurland, who has never been subject to any regulatory actions.
But lawsuits against Countrywide raise questions about Mr. Kurland’s portrayal of his role. They accuse him of being at the center of a culture shift at Countrywide that started in 2003, as the company popularized a type of loan that often came with low “teaser” interest rates and that, for some, became unaffordable when the low rate expired...

PennyMac, whose full legal name is the Private National Mortgage Acceptance Company, also received backing from BlackRock and Highfields Capital, a hedge fund based in Boston. It makes its money by buying loans from struggling or failed financial institutions at such a huge discount that it stands to profit enormously even if it offers to slash interest rates or make other loan modifications to entice borrowers into resuming payments.

Its biggest deal has been with the Federal Deposit Insurance Corporation, which it paid $43.2 million for $560 million worth of mostly delinquent residential loans left over after the failure last year of the First National Bank of Nevada. Many of these loans resemble the kind that Countrywide once offered, with interest rates that can suddenly balloon. PennyMac’s payment was the equivalent of 38 cents on the dollar, according to the full terms of the agreement.

Under the initial terms of the F.D.I.C. deal, PennyMac is entitled to keep 20 cents on every dollar it can collect, with the government receiving the rest. Eventually that will rise to 40 cents.

Phone operators for PennyMac — working in shifts — spend 15 hours a day trying to reach borrowers whose loans the company now controls. In dozens of cases, after it has control of loans, it moves to initiate foreclosure proceedings, or to urge the owners to sell the house if they do not respond to calls, are not willing to start paying, or cannot afford the house. In many other cases, operators offer drastic cuts in the interest rate or other deals, which PennyMac can afford, given that it paid so little for the loans.

PennyMac hopes to achieve a profit of at least 20 percent annually, and it is actively courting other investors to build its portfolio, which now consists of $800 million in loans, to as much as $15 billion in the next 18 months, executives said. For the borrowers whose loans have ended up with PennyMac, it can translate into an extraordinary deal.

The Laverdes, of Porter Ranch, Calif., had fallen three months behind on their mortgage after sales at a furniture store owned by the family dipped in the economic crisis. Margarita Laverde and her husband were fearful that they might need to move their four children, three dogs and giant saltwater aquarium into a cramped apartment, leaving behind their dream home — a five-bedroom ranch on a suburban street overlooking the San Fernando Valley.

But a PennyMac representative instead offered to cut the interest rate on their $590,000 loan to 3 percent, from 7.25 percent, cutting their monthly payments nearly in half, Ms. Laverde said.
“I kept on asking, ‘Are you sure this is correct? Are you sure?’ ” Ms. Laverde said. Even with this reduction, PennyMac stands to make a profit of at least 50 percent, a company official said.
Ms. Laverde could not care less that executives at PennyMac used to work at Countrywide.
“What matters,” she said, “is that we know our house is secure and our credit is safe.”

Nasdaq Gives High Rollers a Market Free of Regulation

By David Cho, Washington Post
Originally Published on August 14, 2007

Nasdaq is set to launch tomorrow what its executives are calling one of the most significant developments on Wall Street in decades -- a private stock market for super-wealthy investors.

Minimum requirement for traders: $100 million in assets.

Any private firm can list on Nasdaq's new platform, which is called the Portal Market, and raise money by selling stock to an elite group of shareholders. These companies would remain private and not have to make public their financial statements or submit to federal regulation, such as the Sarbanes-Oxley corporate accountability law.

Once a tiny influence on the markets, private money has gained unprecedented power on Wall Street. This year, the biggest deals have been swung not by public companies, but by private-equity firms that are spending hundreds of billions of dollars to buy household names, such as Hilton Hotels, Sallie Mae and Chrysler, and turn them into private companies.

For the first time last year, corporate America raised more money -- $162 billion -- from private investors than from initial public offerings, which raised $154 billion from the three major U.S. stock markets -- Nasdaq, the New York Stock Exchange and the American Stock Exchange.

The boom in private money has become so important to the financial system that major investment banks, including Goldman Sachs, Merrill Lynch, Lehman Brothers and Citigroup are setting up rival private stock markets of their own. But none will be as large as Portal, which will list the shares of about 500 firms on its first day of trading.

Ordinary investors can only participate indirectly if their mutual fund creates an account to trade on the private markets.

These markets are creating an alternative and exclusive investment world buffeted from the turmoil that has roiled the major stock indicators in recent weeks. In the public markets, investors dumped stock during a credit crisis caused by the deteriorating mortgage industry. Private-market traders generally are sophisticated financial groups that take a long-term view of their investments.
"One of the problems that business faces in America today is what I would call 'short-termism,' " said Howard S. Marks, chairman of Oaktree Capital, an investment firm that was the first to list on the private market developed by Goldman Sachs called GSTrUE. "There's a lot of expense and complication associated with being a public company today. . . . Now it is possible to gain most of the advantages of being public while sidestepping the disadvantages."
The private market, Marks said, shields companies from regulation and from wild swings in their share prices that are caused by a temporary drop in earnings or a bad rumor.

In just a few years, Nasdaq officials predict, stock offerings on private markets will far exceed IPOs on public exchanges.
"It's a transformational development in the capital markets," John Jacobs, executive vice president of Nasdaq, said of Portal's arrival.
The rise of private money has created a new class of powerbrokers on Wall Street who have enriched themselves even as they have provided billions of investment dollars to companies in all kinds of industries. But the trend is causing a backlash among working-class Americans who generally are shut out from investing directly in those circles, said Colin Blaydon, director of the Center for Private Equity and Entrepreneurship.
"While there has been great value creation in the American economy, it has not gone to the large bulk of American citizens," Blaydon said. "It has gone to the very top slice -- and I mean the very top slice -- with no increase of real incomes of American workers, including the middle-class management class. And that is something that people sense in their guts. They know they are not better off, and yet there are a handful of people who are extraordinarily better off."
Portal is the first centralized private stock market for an elite class of investors called Qualified Institutional Buyers, or "QIBs," that was created in 1990 by securities rule 144A. This law defined QIBs as investing institutions with at least $100 million in assets. It also allowed private companies to raise money by selling shares only to QIBs and remain exempt from regulatory scrutiny. These firms, however, disclose their financial statements to their investors.

Since they began, QIBs have only been able to trade in the old-fashioned way: calling each other over the phone and negotiating a price. They had no way to trade shares on an exchange. No electronic system existed that could give them instant updates on the price of a firm's stock or the number of shares traded each day.

Now, with Portal and other private markets, these investors can log onto a secure Web site and get a wealth of data on a company's stock. They can trade shares by clicking a few buttons. Stock prices are updated automatically.

Analysts say the new ease-of-use is another incentive for super-wealthy investing groups to shun the public markets and focus on making money in the private sphere.

Going private is also becoming increasingly attractive to public companies that must spend large sums to comply with complex accounting regulations that are part of Sarbanes-Oxley.
"There's definitely a growing desire to get away from the public markets," Blaydon said.

Carlyle Group's Plan to Takeover the Banking Industry

Economic Policy Journal
Originally Published on June 28, 2008

Watching The Power Elite As They Grab Some Power and Money

Earlier this year, April 6, 2008, to be exact, I attended a luncheon meeting of the Washington D.C. National Economists Club. The guest speaker was Randal Quarels.

Quarles was former Under Secretary of the Treasury who led the Treasury Department’s effort in the coordination of the President’s Working Group on Financial Markets (aka, The Plunge Protection Team), and he is currently a Managing Director at Carlyle Group.

Plunge Protection Team coordinator? Managing Director at Carlyle Group? Folks, this is what is known as a major league insider.

At the time, I posted on the luncheon meeting and wrote in part:
In his talk, Quarles said that estimates go into the hundreds of billions in terms of capital that will be required by the financial industry because of losses sustained as a result of the current crisis. He said there will be more financial institutions that will go under in coming months.

He said that public markets will not supply the necessary funds because they don’t have the capabilities to study in detail the risks and potential rewards of the complex financials of financial institutions. He said private equity firms have the capabilities to do so and to supply the necessary funds. (N.B. Carlyle Group is a private equity firm).

Quarles stated that some changes in the structure of regulations that Paulson proposed were necessary but would take time to develop. He specifically stated that one regulation that needed to be changed is the limitation on the size of positions that non-banks can take in banks. (Note: Limitations in the size of non-banks positions in banks now limits Carlyle Group from taking large positions in banks).
It sounded to me like a power grab was being set up, and I titled my post: Carlyle Group's Plan to Takeover the Banking Industry

Lo and behold, three months later Bloomberg is reporting that the Carlyle Group, and other private equity firms, have been meeting with the Federal Reserve to discuss removing limitations on the size of positions equity funds can take in banks.

Writes Craig Torres at Bloomberg:
Federal Reserve officials are reviewing regulations that limit investment firms' stakes in banks in an effort to channel more capital into the U.S. banking system... Fed officials have met with the Washington-based buyout fund Carlyle Group, spokeswoman Ellen Gonda confirmed. "There is an ongoing dialogue,'' she said. "It's not unusual for regulators to seek private sector input on policy.''
There's a few lessons to be learned here about how the power elite operate.

First, they always take advantage of crisis to make a grab. Notice how Quarles in his talk at the luncheon mentions Treasury Secretary Paulson's call for reform in financial regulation and structures.

Of course, Paulson made his comments about financial reform under the guise of changing things because of the current mortgage crisis. Nowhere did Paulson specifically state: "As part of this reform we are going to allow private equity funds, such as Carlyle Group, to buy bigger stakes in banks."

Quarles at the luncheon also mentioned that he picked the topic of financial reform way back in January. So we now have something of a timeline. Quarles had financial reform on his mind in January. Thus, one can assume, with a large degree of confidence, that the plotting was certainly going on at Carlyle back then. Paulson doesn't come out with a speech about the need for financial reform until late March. And, viola, here we are in late June and meetings between the Fed and the Carlyle Group are leaked to the press.

Which brings us to point two of how the elite operate: they always make things complicated. Just what exactly are the Fed and Carlyle Group meeting about? It's "an ongoing dialogue," says the Carlyle Group.

If the Fed simply wanted to increase the amount of capital that banks could take from any one investor or investor group, the problem is fairly simple and could be solved with a Fed statement as follows: restrictions are hereby removed that prevent investors from increasing their stake in a financial institution above a specified level: restrictions on what individual investors or investor groups can invest in a financial institution have been increased.

Anytime a regulation is more than one sentence long, special interests are carving up little slivers for themselves and putting up barriers to entry that make it difficult or impossible for others to play the game.

The barriers to entry come in the form of complex regulations that require teams of lawyers to understand. Unless, of course, you are "in dialogue" with the regulators and help design the regulations so you know where the loopholes are, and in fact probably suggested some of them.

Taking advantage of crisis and making things complex is how the elite play.

The current crisis is the mortgage crisis. They are taking advantage of the crisis to sweep up and buy into banks on the cheap, and they are sitting in a conference room with the Fed to create regulations so onerous that only the elite will be able to play.

When do you as an individual investor come in? Three to five years down the road when the banks stocks are prettied up and sold to the public at a price somewhere between 5 to 20 times what the elite paid for them.

The Carlyle Group & The Carlyle Group Bailout, March 2008
How the Bush Administration Stopped the States from Stepping In to Stop Predatory Lenders
Bush Administration Rejected Tougher Mortgage Rules in 2005
AIG, Blackstone, and Kissinger Associates Joint Venture in Private Equity Funds
Max Keiser: Goldman Sachs Gang Are 'Scum' Who Have Co-Opted the U.S. Government

Private Cash Fuels Boom in Takeovers

By Tom Petruno, Los Angeles Times
Originally Published on November 21, 2006

Elite private investors are buying up major companies at a record pace in a wave of deals that is raining riches on Wall Street, but also may be raising the risk of a financial bust.

Investors led by Blackstone Group announced late Sunday the biggest takeover ever by a so-called private equity fund, a $36-billion deal to buy Equity Office Properties Trust, the largest U.S. owner of office buildings.

The proposed purchase follows announcements in recent months of buyouts that would put firms including radio giant Clear Channel Communications Inc., casino titan Harrah's Entertainment Inc., and food-service company Aramark Corp. in private hands, taking their shares off the stock market.

Takeovers are nothing new in American business, but historically the largest deals have involved companies whose shares are publicly traded buying other companies.

This year, the buyers behind the biggest deals are private equity funds -- run by generally secretive investment firms that raise money from pension funds, wealthy individuals, and other investors who are hungry for double-digit returns on their capital.
"It's obviously a boom," said C. Kevin Landry, a managing director at TA Associates, a Boston-based private equity firm. "You can raise as much money as you want" to do deals.
A private equity fund typically buys a company using mostly borrowed money, then seeks to improve the firm's bottom line through measures that may include refocusing the business or forcing cost cuts. The goal is to eventually sell the firm to another company, or take it public again, at a fat profit.

The buyout wave is enriching company shareholders because private equity investors usually pay more than a stock's current price to clinch a deal. That is helping to drive share prices higher overall, analysts say; the Dow Jones industrial average has been hitting record highs.

Yet the surge in buyouts this year is making some on Wall Street wonder whether they're witnessing a replay of other episodes when too many investors threw too much money in the same direction -- the dot-com boom of the late 1990s, for example, or a late-1980s company buyout wave led by corporate raiders. Both of those booms gave way to painful busts.
"It's sort of feeding on itself now," said Edward Yardeni, investment strategist at money management firm Oak Associates in Akron, Ohio. "You could make a pretty good case that a bubble is building in private equity, and that it will burst."
Private equity buyers have announced about 1,000 U.S. takeovers this year worth a record $356 billion, according to data tracker Thomson Financial. That dwarfs the $138 billion in such deals announced last year.

Private-fund deals still account for a minority of U.S. takeover activity. In all, the value of announced corporate takeovers this year exceeds $1.2 trillion; most of those are company-to-company deals. But the rising clout of private equity buyers shows in the sizes of the deals they're behind, experts say.

Five of the six top deals this year are private equity. That's never happened before," said Richard Peterson, an analyst at Thomson Financial in New York.

Most private equity firms aren't household names, but more may be on their way to that status as their corporate assets balloon. Big players include Blackstone, Bain Capital, Carlyle Group, Silver Lake Partners and Texas Pacific Group. One -- Kohlberg Kravis Roberts & Co. -- became famous for its massive deals in the 1980s.

More than any other factor, the ascendance of private equity buyers over the last few years reflects the willingness of well-heeled investors to pony up mountains of cash in search of better returns than they can earn in stocks or bonds.
"There is tremendous liquidity in the market," said Brad Freeman, a 23-year buyout fund veteran whose Los Angeles-based firm, Freeman Spogli & Co., has a $1-billion private equity fund it's putting to work. "Deals are being done because they can be."
Private equity firms have raised an unprecedented $178 billion in new capital from investors this year, about 10 times what they raised in 1995, according to data firm Dealogic. The cash comes from investors such as the California Public Employees' Retirement System, or CalPERS, the nation's largest public pension fund.

CalPERS has about $6.3 billion invested in buyout funds, said Joncarlo Mark, a senior portfolio manager. The pension plan expects to earn an annual percentage return in the upper teens on that money, he said. By contrast, U.S. blue-chip stocks have generated a return of 11.4% a year over the last three years.
"There are a lot of investors out there looking for yield," said Josh Lerner, a finance professor at Harvard University.
But the success of buyout deals depends in large part on the purchased companies' ability to handle the debt loads they take on with their new owners.

With many private equity funds wielding huge war chests, competition to acquire companies has become fierce, said Stephen Presser, a partner at private equity firm Monomoy Capital Partners in New York.
"At the moment, private equity firms are paying almost historically high prices for businesses, and are depending on those businesses to continue to grow in order to pay down their debt," Presser said. "If the economy softens -- and someday it will -- those companies are going to have a tough time" managing their debt loads.
Some analysts also question whether companies that are targets of private equity buyers today can be substantially improved by their new owners.
"Companies already are under so much pressure to be lean and mean," Yardeni said. "It's not clear what they're [private equity owners] going to bring to the table to make these companies more profitable."
Still, corporate managers often are happy to attract private equity buyers. One reason is that top managers often participate as investors in buyouts, with the potential to reap hefty financial rewards if the company is eventually sold at a profit.

The costs and regulatory hassles of being a public company also are spurring corporate boards down the go-private road, said Scott Honour, a managing director at Gores Group, a private equity firm in Los Angeles.
"Companies are bogged down by Sarbanes-Oxley requirements," he said, referring to the law Congress passed in 2002 tightening regulation of public companies after the financial scandals at Enron Corp. and other firms.

"Boards are saying, 'Geez, we're better off being private,' " Honour said.
That worries the Bush administration. In a speech Monday, Treasury Secretary Henry M. Paulson Jr. questioned whether the going-private trend might signal that U.S. regulation of shareholder-owned companies had become too severe, and was driving them out of the public market.

The deal wave also has attracted the attention of another branch of the government: The Justice Department reportedly is looking into the power wielded by private equity funds and whether the biggest players may be illegally colluding to increase their clout.

Elite Private Investors Are Buying Up Major Companies at a Record Pace

By Tom Petruno, Los Angeles Times
Originally Published on November 21, 2006

Elite private investors are buying up major companies at a record pace in a wave of deals that is raining riches on Wall Street, but also may be raising the risk of a financial bust.

Investors led by Blackstone Group announced late Sunday the biggest takeover ever by a so-called private equity fund, a $36-billion deal to buy Equity Office Properties Trust, the largest U.S. owner of office buildings.

The proposed purchase follows announcements in recent months of buyouts that would put firms including radio giant Clear Channel Communications Inc., casino titan Harrah's Entertainment Inc., and food-service company Aramark Corp. in private hands, taking their shares off the stock market.

Takeovers are nothing new in American business, but historically the largest deals have involved companies whose shares are publicly traded buying other companies.

This year, the buyers behind the biggest deals are private equity funds -- run by generally secretive investment firms that raise money from pension funds, wealthy individuals, and other investors who are hungry for double-digit returns on their capital.
"It's obviously a boom," said C. Kevin Landry, a managing director at TA Associates, a Boston-based private equity firm. "You can raise as much money as you want" to do deals.
A private equity fund typically buys a company using mostly borrowed money, then seeks to improve the firm's bottom line through measures that may include refocusing the business or forcing cost cuts. The goal is to eventually sell the firm to another company, or take it public again, at a fat profit.

The buyout wave is enriching company shareholders because private equity investors usually pay more than a stock's current price to clinch a deal. That is helping to drive share prices higher overall, analysts say; the Dow Jones industrial average has been hitting record highs.

Yet the surge in buyouts this year is making some on Wall Street wonder whether they're witnessing a replay of other episodes when too many investors threw too much money in the same direction -- the dot-com boom of the late 1990s, for example, or a late-1980s company buyout wave led by corporate raiders. Both of those booms gave way to painful busts.
"It's sort of feeding on itself now," said Edward Yardeni, investment strategist at money management firm Oak Associates in Akron, Ohio. "You could make a pretty good case that a bubble is building in private equity, and that it will burst."
Private equity buyers have announced about 1,000 U.S. takeovers this year worth a record $356 billion, according to data tracker Thomson Financial. That dwarfs the $138 billion in such deals announced last year.

Private-fund deals still account for a minority of U.S. takeover activity. In all, the value of announced corporate takeovers this year exceeds $1.2 trillion; most of those are company-to-company deals. But the rising clout of private equity buyers shows in the sizes of the deals they're behind, experts say.

Five of the six top deals this year are private equity. That's never happened before," said Richard Peterson, an analyst at Thomson Financial in New York.

Most private equity firms aren't household names, but more may be on their way to that status as their corporate assets balloon. Big players include Blackstone, Bain Capital, Carlyle Group, Silver Lake Partners and Texas Pacific Group. One -- Kohlberg Kravis Roberts & Co. -- became famous for its massive deals in the 1980s.

More than any other factor, the ascendance of private equity buyers over the last few years reflects the willingness of well-heeled investors to pony up mountains of cash in search of better returns than they can earn in stocks or bonds.
"There is tremendous liquidity in the market," said Brad Freeman, a 23-year buyout fund veteran whose Los Angeles-based firm, Freeman Spogli & Co., has a $1-billion private equity fund it's putting to work. "Deals are being done because they can be."
Private equity firms have raised an unprecedented $178 billion in new capital from investors this year, about 10 times what they raised in 1995, according to data firm Dealogic. The cash comes from investors such as the California Public Employees' Retirement System, or CalPERS, the nation's largest public pension fund.

CalPERS has about $6.3 billion invested in buyout funds, said Joncarlo Mark, a senior portfolio manager. The pension plan expects to earn an annual percentage return in the upper teens on that money, he said. By contrast, U.S. blue-chip stocks have generated a return of 11.4% a year over the last three years.
"There are a lot of investors out there looking for yield," said Josh Lerner, a finance professor at Harvard University.
But the success of buyout deals depends in large part on the purchased companies' ability to handle the debt loads they take on with their new owners.

With many private equity funds wielding huge war chests, competition to acquire companies has become fierce, said Stephen Presser, a partner at private equity firm Monomoy Capital Partners in New York.
"At the moment, private equity firms are paying almost historically high prices for businesses, and are depending on those businesses to continue to grow in order to pay down their debt," Presser said. "If the economy softens -- and someday it will -- those companies are going to have a tough time" managing their debt loads.
Some analysts also question whether companies that are targets of private equity buyers today can be substantially improved by their new owners.
"Companies already are under so much pressure to be lean and mean," Yardeni said. "It's not clear what they're [private equity owners] going to bring to the table to make these companies more profitable."
Still, corporate managers often are happy to attract private equity buyers. One reason is that top managers often participate as investors in buyouts, with the potential to reap hefty financial rewards if the company is eventually sold at a profit.

The costs and regulatory hassles of being a public company also are spurring corporate boards down the go-private road, said Scott Honour, a managing director at Gores Group, a private equity firm in Los Angeles.
"Companies are bogged down by Sarbanes-Oxley requirements," he said, referring to the law Congress passed in 2002 tightening regulation of public companies after the financial scandals at Enron Corp. and other firms.

"Boards are saying, 'Geez, we're better off being private,' " Honour said.
That worries the Bush administration. In a speech Monday, Treasury Secretary Henry M. Paulson Jr. questioned whether the going-private trend might signal that U.S. regulation of shareholder-owned companies had become too severe, and was driving them out of the public market.

The deal wave also has attracted the attention of another branch of the government: The Justice Department reportedly is looking into the power wielded by private equity funds and whether the biggest players may be illegally colluding to increase their clout.

The Dangers of Private Equity Funds

With little government oversight, they control a sizable chunk of U.S. companies -- and their workers.

By Kelly Candaele, The Los Angeles Times
Originally Published on August 12, 2007

Most Americans -- unless they read the daily financial press -- are probably not fully aware of the influence that private equity funds now have on business in the United States and on the economy as a whole. But perhaps it's time to start paying attention.

With half a trillion dollars in capital, these lightly regulated firms are transforming the lives of millions of people in the United States. The 20 top private equity firms control companies with more than 4 million employees.

The largest of them -- Carlyle Group, Kohlberg Kravis Roberts & Co., Blackstone Group, Bain Capital, Cerberus Capital Management -- are not exactly household names, yet they have purchased some of the most widely recognized companies in the country.

Carlyle Group, for instance, has purchased Del Monte Foods and Loews Cineplex Entertainment. And last week, Cerberus obtained the majority interest in Chrysler Group by purchasing that division from DaimlerChrysler. Blackstone now owns Houghton Mifflin Co., one of the premier educational publishing companies, and HCA, the nation's largest hospital chain, was purchased last year by Bain Capital and Kohlberg Kravis Roberts.

FOR THE RECORD:
Private equity: An article in the Aug. 12 Opinion section on private equity funds buying U.S. companies stated that the Carlyle Group owns Del Monte Foods Co. It does not own the company.
In recent months, the outside world has begun, slowly, to take notice. The Economist magazine, for instance, ran a cover story three weeks ago on "The Trouble With Private Equity." The 1.8 million-member Service Employees International Union issued a stinging report about the effect of private equity firms on workers and called for broad regulatory reform. And now, leading Democratic congressional leaders are pushing legislation that would increase taxes on the mega-millions that private equity fund managers receive as compensation.

The way these companies work is that they create enormous private equity funds, often made up of investments from pension funds, insurance companies and endowments. The funds then invest in private companies -- either ones that are not traded on public stock exchanges or ones that are publicly traded but are then taken private.

The primary goal is to make profits that beat what investors can get in the publicly traded stock market. Through various mechanisms -- including management restructuring, selling unprofitable divisions and personnel cuts -- companies are "retooled" and "turned around," and then often brought back into the public stock markets or sold to another firm. If all goes well, the fund mangers make enormous profits and fees, investors are rewarded with high returns and the new company operates more efficiently and productively. If job losses occur or company pension obligations are jettisoned along the way, then that is the price we must pay -- according to this philosophy -- to sustain a dynamic market economy.

So what's the problem? For the fund managers there is no problem. Stephen Schwarzman, co-founder of Blackstone Group, has a net worth close to $10 billion. He celebrated his now famous 60th birthday with a $3-million bash and hired rocker Rod Stewart to perform. Blackstone collected $850 million in management fees in 2006, a sum similar to other large private equity firms.

Free-market defenders argue that the fees collected by these fund managers are well worth it. Private equity funds discipline the market, they say, by finding undervalued companies that are transformed into job and wealth creating entities. Capital is thereby deployed more effectively, companies become more efficient and productive, and investors are rewarded for their risk.

But the labor movement and other analysts paint a darker, less beneficent picture. They point out that private equity funds have little oversight from regulators and virtually no input from the workers who are employed by the companies they purchase. While takeover firms argue that their machinations create more jobs in the long term, unions say that the types of jobs created are not always as well paid or do not always offer full-time employment. For instance, after a consortium of private equity firms bought rental car firm Hertz Global Holdings Inc. from Ford Motor Co., the new owners took out loans to give themselves a special dividend payment. After Hertz was taken public again, the company announced a "restructuring" that would eliminate 2,000 of the company's 31,500 workers.

Moreover, because high amounts of debt are used in buyout strategies, there is a fear that as debt financing becomes more risky -- as it has in recent weeks -- the financial stability of the overall economy will be undermined. If the goal is to strip and flip a company in the shortest time -- not unlike what has happened in the housing market -- the long-term planning, investment and stewardship of businesses will disappear. While fund managers pocket the profits, workers and communities suffer the consequences of these highly leveraged transactions.

Some analysts see private equity mania as reflective of a deeper problem with the evolution of contemporary American capitalism. Robin Blackburn, a journalist and historian, argues in his book "Age Shock: How Finance Is Failing Us," that modern corporations are seen by the new financiers less as producers of products than as bundles of assets and liabilities that can be manipulated and shaped by ever more complex techniques of financial engineering -- such as risk arbitrage, lease-backs, derivatives and hedging techniques.

Private equity funds have been a boon to institutional investors like pension funds, which these days control a large percentage of the country's investment capital. At the Los Angeles City Employees' Retirement System, of which I am one of seven trustees, we have generated significant returns through private equity investing. Our $750-million private equity portfolio (out of an $11-billion total portfolio) has had a three-year investment return of 24%. That is good for our retirees, good for the city and good for taxpayers. A well-run pension fund will make it less likely that taxpayers will have to bail out unfunded pension liabilities.

But beyond investment return, we also have to be cognizant of how our investment strategies help shape the economy. Political and labor leaders are calling for further regulation of private equity investing with an emphasis on worker and community involvement in the opaque decision-making that now rests in the hands of a financial elite. While some argue that privately owned firms should be free from government intrusion, the sheer size and broad social effect of these deals distinguishes them from the mom-and-pop hardware store down the street.

Perhaps it is time for increased oversight to tame these new economic behemoths. It is never a good idea to simply leave capitalism to the capitalists.

Pension funds can help by looking for smart, socially responsible ways to invest. At our pension fund, we have made investments in "worker-friendly" private equity funds that look for companies that can be supported and strengthened. One of these funds -- the Yucaipa American Alliance Fund -- is run by Los Angeles billionaire Ronald Burkle. Of the 10 companies in his portfolio, eight have a unionized workforce. The fund has posted superior returns while avoiding the slash-and-burn strategy of other less socially responsible investors. Front-line workers often see what management overlooks, so Burkle engages unions as partners and strategic allies rather than as adversaries.

If we have to make a decision between two investments with the same risk-and-return profile, it makes economic and social sense to choose the fund manager that will manage our capital in a responsible way.

Trustees of pension funds and foundations are not stock pickers, but we are stewards of a larger investment community -- a community that private equity funds have dramatically affected. It is part of our fiduciary responsibility to follow that money to the end of the trail.

Kelly Candaele is a trustee of the Los Angeles City Employees' Retirement System.

U.S. Insurer of Pensions Sees Flood of Red Ink

New York Times
May 20, 2009

The deficit at the federal agency that guarantees pensions for 44 million Americans tripled in the last six months to a record high, reaching $33.5 billion, largely as a result of surging bankruptcies among companies whose pensions it expects it will soon need to take over.

The agency, the Pension Benefit Guaranty Corporation, faced a shortfall of just $11 billion as of October. The combined effect of lower interest rates, losses on its investment portfolio and rising numbers of companies filing for bankruptcy produced the jump in its projected deficit, officials said Wednesday.

Because the agency has $56 billion in assets — most of which is invested in Treasury bonds — it is not facing any prospect of default in the short term, officials said.
“The P.B.G.C. has sufficient funds to meet its benefit obligations for many years because benefits are paid monthly over the lifetimes of beneficiaries, not as lump sums,” the agency’s acting director, Vince Snowbarger, testified Wednesday at a Senate hearing. “Nevertheless, over the long term, the deficit must be addressed.”
The financial troubles are just a small part of the challenges facing the pension agency, which was created by Congress in 1974 and today is responsible for pension programs covering 1.3 million people. It pays about 640,000 people actual benefits worth about $4.3 billion a year.

The P.B.G.C.’s former director, Charles E. F. Millard, was subpoenaed to testify at the hearing Wednesday. But he cited his constitutional right to avoid self-incrimination and declined to answer any questions.

Mr. Millard, who resigned in January, has been accused by the agency’s inspector general of having inappropriate contact with companies including BlackRock, JPMorgan Chase and Goldman Sachs, all of which competed for and won contracts to help manage $2.5 billion of the agency’s funds. Those contracts will now most likely be canceled.

Employers nationwide with so-called defined-benefit, or traditional, pension plans pay fees to the P.B.G.C. in return for a promise that it will take over their pension plan if a company fails.

On Tuesday, for example, the agency announced that it had assumed the pension plan once run by the Lenox Group, a bankrupt maker of tableware, giftware and collectibles based in Eden Prairie, Minn. Assuming control of pensions for this company’s 4,300 workers will cost the agency an estimated $128 million — the difference between what Lenox had in its pension fund and what the total estimated obligations are.

In the last six months, 93 companies whose pension plans are covered by the agency have filed for bankruptcy, including Chrysler, whose failure alone could cost the agency $2 billion. A bankruptcy by General Motors would make the situation worse. G.M. had 670,000 workers as of late last year in its pension system, whose collapse would cost the agency an estimated $6 billion.

Options to close the $33.5 billion deficit include a federal bailout by taxpayers, a change in insurance premiums it charges employers, or increasing its investment returns.

Last year, the agency’s board voted to allow it to shift its investment strategy to put more money into stocks, private equity and real estate, in an effort to reduce the deficit. If that shift had taken place, the losses would most likely have been larger. But only a relatively small amount of the funds have already been shifted to stocks, so the losses on the investment portfolio were responsible for just $3 billion of the jump in the deficit in the last six months.

Senator Herb Kohl, Democrat of Wisconsin and chairman of the Senate Special Committee on Aging, which held the hearing Wednesday, blamed poor supervision by the agency’s board and management, at least in part, for the troubles, adding that he intended to introduce legislation that would expand the board and require it to meet at least four times a year. The board has not met in person since February 2008.
“The role of P.B.G.C. is too crucial to allow its governance to slip through the cracks,” Mr. Kohl said.

How Firms Wooed a U.S. Agency With Billions to Invest

New York Times
July 28, 2009

As a New York money manager and investment banker at four Wall Street firms, Charles E. F. Millard never reached superstar status. But he was treated like one when he arrived in Washington in May 2007, to run the Pension Benefit Guaranty Corporation, the federal agency that oversees $50 billion in retirement funds.

BlackRock, one of the world’s largest money-management firms, assigned a high school classmate of Mr. Millard’s to stay in close contact with him, and it made sure to place him next to its legendary founder, Laurence D. Fink, at a charity dinner at Chelsea Piers. A top executive at Goldman Sachs frequently called and sent e-mail messages, inviting Mr. Millard out to the Mandarin Oriental and the Ritz-Carlton in Washington, even helping him hunt for his next Wall Street job.

Both firms were hoping to win contracts to manage a chunk of that $50 billion. The extensive wooing paid off when a selection committee of three, including Mr. Millard, picked BlackRock and Goldman from among 16 bidders to manage nearly $1.6 billion and to advise the agency, which Mr. Millard ran until January.

But on July 20, the agency permanently revoked the contracts with BlackRock, Goldman and JPMorgan Chase, the third winner, nullifying the process. The decision was based on questions surrounding Mr. Millard’s actions during the formal bidding process. His actions have also drawn the scrutiny of Congressional investigators and the agency’s inspector general.

An examination of thousands of pages of e-mail messages and other internal documents obtained by The New York Times shows the other side of the story: the two firms aggressively courted Mr. Millard, so extensively that they may have compromised federal contracting rules or at least violated the spirit of the law, contracting experts said. The records also illustrate the clash between Washington’s by-the-letter rules on contracting and the culture of Wall Street, where deals are often struck over expensive meals.
“Both sides should have known better,” said Steven L. Schooner, co-director of the Government Procurement Law Program at the George Washington University, who reviewed some of the material for The Times. “What happened here is wrong, stupid and probably illegal.”
BlackRock and Goldman, as well as Mr. Millard, all said that nothing improper happened either before the formal competition for the contract started last July, or while the competition, which concluded in October, was under way.
“Among the reasons that Mr. Millard was selected to head the P.B.G.C. is his understanding of the industry, his extensive background and the quality of his professional relationships,” said Stanley M. Brand, a lawyer for Mr. Millard. “He correctly separated his personal relationships from his official actions.”
A review of the documents shows that the third winner, JPMorgan Chase, had contacts with Mr. Millard before and during the competition, but did not display the same intensity as the other two.

Goldman and BlackRock saw Mr. Millard’s selection as a major business opportunity, the records show.
“This is a very big fish on the line,” one BlackRock executive wrote to another, discussing the government official.
Mr. Millard had at least seven meetings with Goldman executives in the year before the bidding started, and 163 phone contacts, the documents show. BlackRock had less frequent contact — 39 phone calls in that 12-month period. But one BlackRock executive told another that Mr. Millard had assured him in April, four months before the bidding, that he wanted to hire the company to help manage some of the money, company documents show.
“It sounds like we may have a tiger by the tail here,” one BlackRock executive wrote in an e-mail message.
The agency takes over pension programs when private companies go bankrupt. For years there was talk it might have to be bailed out by the government, and Mr. Millard, like many others, saw shifting from low-yield conservative investments like Treasury bonds to those with higher risks and higher potential returns as a way to solve the problem.

Before coming to Washington Mr. Millard had been a money manager for Prudential Securities and Lehman Brothers, a senior economic development official in New York City while Rudolph W. Giuliani was mayor, a member of the New York City Council and a Republican nominee for Congress.

Within weeks of his arrival at the agency, he told Goldman Sachs about his plans to shake up the agency’s portfolio.
“I just became head of the pension benefit guaranty corp in dc appointed by pres bush,” he wrote in a June 2007 e-mail message to John S. Weinberg, a vice chairman and a member of the family that has helped run Goldman since the 1930s. Mr. Millard told Mr. Weinberg, a longtime acquaintance, that he wanted to revamp the agency’s investment strategy.

“Is there a team at Goldman that does this and that would be interested in pursuing this business?”

“Yes, absolutely!” Mr. Weinberg wrote back.
Almost immediately, Goldman started to work informally for Mr. Millard by providing one of its top pension analysts at no charge to prepare at least six reports over the coming year, based on internal agency data, detailing possible investment strategies.

Goldman also coached Mr. Millard as he sought to sway skeptics in the Bush administration...

Implications for Private Equity Funds with Portfolio Company Pension Liability

By Jeffrey London, International Law Office
August 19, 2009

In September 2007 the Appeals Board of the Pension Benefit Guaranty Corporation (PBGC) held a private equity fund liable for the pension underfunding of one of the fund's bankrupt portfolio companies. Given the potentially severe economic implications of the decision for private equity funds, funds must remain focused on this issue and follow ongoing developments in this area.

Background

Under the Employee Retirement Income Security Act of 1974, when a pension plan sponsor terminates a plan, members of the sponsor's controlled group are jointly and severally liable for the corresponding unfunded liabilities, even though the members may have had no relationship to the pension plan. Entities are part of the same controlled group if they are (i) engaged in a 'trade or business', and (ii) under 'common control'.

In general, a parent-subsidiary group is under common control where the parent owns at least 80% of the stock of the subsidiary, based on either voting power or value, or, in the case of a partnership, at least 80% of the capital or profits interest. Accordingly, if a private equity fund engages in trade or business and owns at least an 80% interest in a portfolio company, it may be liable for certain pension and benefit liabilities of the portfolio company.

The controlled group liabilities would generally not extend further up the ownership chain to the fund's partners, unless any partner acquired an 80% or greater capital or profits interest in the fund. However, under general partnership law, the general partner of the fund would be responsible for any liabilities incurred by the fund, including the pension liabilities described herein.

Until the PBGC's decision, many practitioners had taken the position that private equity funds were not trades or businesses and, therefore, were shielded from the pension liabilities of their portfolio companies. However, the decision revealed that the PBGC disagrees.

Decision

The private equity fund involved in the decision was a Delaware limited partnership. The fund owned a 96% interest in a Delaware corporation which had sponsored a pension plan that was terminated when the corporation filed for bankruptcy.

The PBGC asserted that the fund, as a member of the corporation's controlled group, was liable for the corporation's unfunded pension liabilities of over $3 million arising from the plan's termination.

The fund disputed any liability, arguing that it could not be in the corporation's controlled group because the fund was not engaged in a trade or business. The fund argued that it was merely a "passive investment vehicle that has no employees, no involvement in the day-to-day operations of its investments and no income other than passive investment income".

The PBGC rejected the fund's argument and held the fund liable for its portfolio company's termination liability. The PBGC distinguished its decision from cases where individuals with passive investment activities were found not to have been conducting a trade or business. It explained that the fund, unlike the taxpayers in those cases, was actively involved in its investments, as evidenced by the general partners' investment and management services and compensation for such services. The fund was formed as a business entity "to select, acquire, dispose of, and manage investments... through its agent", unlike individual taxpayers, who invest their own money for their own gain.

Implications

Aside from the obvious effect that private equity funds (and members of their controlled group) may be liable for the pension plan termination liability of their portfolio companies, the decision has implications for numerous other situations in which liability can be imposed on funds.

If the PBGC's interpretation of engaging in 'trade or business' is followed by arbitrators or courts, a private equity fund that owns 80% of its portfolio company may be liable for the withdrawal liability incurred by a portfolio company when it withdraws from a multi-employer pension plan. In addition, portfolio companies may be barred from terminating underfunded pension plans unless all members of the controlled group are in bankruptcy or liquidation. Further, for failing to meet minimum funding standards the fund may be liable for:
  • certain payments under the Consolidated Budget Reconciliation Act of 1985;
  • PBGC premiums; and
  • excise taxes.
Credit agreements may also be affected by the decision. Credit agreements often contain clauses that prohibit the underfunding of any pension plans in the debtor's controlled group, as well as requiring certain financial covenants to be maintained. An underfunded pension plan sponsored by a portfolio company could cause a different portfolio company owned by the fund, or the fund itself, to violation of its covenants under ERISA or financial covenants.

Since the issuance of the PBGC decision, interested parties have awaited further interpretative guidance, but to date there has been no guidance from the federal courts on whether they will apply the PBGC's position. However, because the structure of the fund in the PBGC decision was similar to that of many private equity funds, it is reasonable to expect that in future the PBGC will pursue other funds. Given the potentially large liabilities, prudent private equity funds should use careful planning before acquiring portfolio companies and when determining the ownership levels of such companies.

Recommendations

One way to avoid the issue, or to minimize its impact, is to perform thorough due diligence on target companies and their ERISA-controlled groups. Due diligence should enable private equity funds to determine whether a target's pension plan is underfunded and potential multi-employer pension plan withdrawal liability exists. If so, the private equity fund may consider reflecting these potential liabilities in the purchase price. Due diligence should also be used to determine whether the target is a member of a controlled group with plan sponsors whose plans are or may become underfunded. The due diligence should be continued after the deal closes because plan underfunding fluctuates according to changes in, among other things, the equity markets, the debt markets and the plan sponsor's workforce.

Another possible way to avoid liability is to structure the acquisition such that even if the private equity fund is engaged in a trade or business, the fund is not under common control with the target. This can be achieved in several ways. For example, the fund may keep its ownership level, by vote and value, to less than the 80% threshold. Alternatively, the private equity firm might split the interest in the target among two or more of its funds, if possible, or employ an alternative investment vehicle, either of which can dilute the fund's interest in the target to under 80%. Even in the event of such a bifurcation, there remains a risk that the PBGC could posit that the investment is, in effect, maintained by a single entity, in which case the PBGC decision could be applied.

Since this area of law continues to evolve, funds should remain updated on developments, both administrative and judicial. While these potential control group liabilities have been largely ignored in the past, the risk of having liabilities assessed against a fund or among portfolio companies has substantially increased based upon the PBGC's position and the current lack of judicial authority to the contrary.

For further information on this topic please contact Jeffrey London at Kaye Scholer LLP by telephone (+1 312 583 2300), fax (+1 312 583 2360) or email (jlondon@kayescholer.com).

FDIC to Soften Stance, Luring Private Capital

Reuters
August 27, 2009

U.S. regulators are likely to back down from the tough stance they took a month ago on rules for auctions of troubled banks, which could clear the way for more private equity bidders to come back into the game.

The Federal Deposit Insurance Corp (FDIC), voting on final guidelines on Wednesday, is still likely to make it hard for private investors to buy failed banks, but is seen rolling back some of the most controversial measures following vociferous complaints from the industry.

Regulators are trying to reach a middle ground with the private equity industry because it represents a crucial source of capital as the United States tries to resuscitate its struggling banking industry.
"The potential pool, from us and other private equity firms, could be a hundred billion dollars -- its a huge amount of money that's at stake," billionaire investor Wilbur Ross told Reuters. He estimates that up to 500 banks could fail between now and the end of 2010.
The biggest complaint from the industry has been that the proposed rules called for a Tier 1 leverage ratio -- the ratio of a bank's capital to its assets -- of 15 percent for three years, above 5 percent required of well-capitalized banks.

The FDIC may roll that back to 10 percent, two sources familiar with the process said. One of the sources said there were some questions about whether the level would be a fixed number or a range of perhaps 8 percent to 10 percent.

The sources declined to be identified because the rules are not public.

Some experts argue that even at 10 percent it will be more expensive for private equity to buy a failed bank than for a strategic bidder, such as a well-capitalized large bank.
"I don't think an imposition of 10 percent will keep people like us from bidding," BankUnited Chief Executive John Kanas told Reuters. "But having a higher level of capital like that would be reflected in our bid."
Kanas led a consortium that included private equity giants Blackstone Group, Carlyle Group and Ross to take over failed Florida lender BankUnited earlier this year. Kanas did not expect the FDIC to want to change the terms of the BankUnited deal in light of the new guidelines, but hold them to the new standard in the future.

The FDIC, led by Chairman Sheila Bair, regulates more than 8,000 banks and insures their deposits. It has said it needs to issue tough guidelines to ensure that private equity groups are interested in nursing ailing banks back to health.
"The only way that private equity gets any bank ... is by bidding more than the commercial banks would bid," said Ross. "There's really no need to have draconian rules when the process already calls for competitive bids."
RULES ROLLBACK

Another guideline causing concern among the private equity industry says investors would be expected to serve as a "source of strength" for the bank they buy, which could put them on the hook for more capital if the institution struggles.

However, the FDIC may make it such that the holding company can raise capital, so that it doesn't necessarily have to come from the investors themselves, the first source said.

A cross-guaranty proposal -- meaning if a company owns more than one bank the FDIC can use the assets of the healthier bank to cut losses from the one that's faltered -- could also be modified, both sources said.

A guideline, which calls for a minimum holding period of three years for the investments, is less likely to change, both sources said.
FDIC spokesman Andrew Gray said, "We have taken the feedback of all stakeholders into account as we have worked to craft a final rule."
HEAVIER BURDEN

Despite a marked pull-back from the FDIC's initial proposals, the new rules will impose a heavier burden on private equity investors. But they may still find they can achieve high enough returns to make investments in U.S. banks worthwhile.

Indeed, the threat of tough rules did not stop private equity investors from bidding on FDIC-run auctions.

An auction for the assets of failed Texas lender Guaranty Financial Group this month drew a bid from at least one private equity consortium, which included Blackstone, Carlyle and TPG. A U.S. unit of Spain's BBVA won the auction.

The FDIC is correct in toeing a hard line, said John Chrin, a former JPMorgan Chase & Co investment banker who is now executive-in-residence at Lehigh University's College of Business and Economics.
"They (FDIC) staked out a position that was probably overly conservative to start. The PE firms wanted to be where the industry is," said Chrin, referring to the lower capital requirements for well capitalized banks. "And you wind up settling in between."

U.S. Gets Tough on Funds Trying to Buy Failed Banks

By Edmund L. Andrews, The New York Times
July 2, 2009

Federal bank regulators toughened policies on Thursday that have allowed private equity firms to buy up failing banks, saying they were worried if such investors would have enough capital and the willingness to run the banks in a “prudent manner.”

The surprisingly tough rules came as a blow to high-rolling private equity firms, which control vast amounts of capital and have been pushing for greater ability to buy up failed banks at bargain prices from the government.

The Federal Deposit Insurance Corporation adopted tentative rules that would require banks owned by private equity firms to have three times as much capital as ordinary banks.

Private equity firms also would not be able to sell their stakes for three years. Firms would also have to make commitments about providing subsequent financing if the banks need it, and they would have to disclose much more than many do right now about their own ownership structures.

The F.D.I.C. has seized 45 banks and thrift institutions so far this year and 70 in the last year, more than in any year since the Great Depression. The wave of bank failures is seen as far from over.

The F.D.I.C., which insures customer deposits, is responsible for seizing insolvent banks and usually tries to find new buyers for them in order to minimize the potential losses to taxpayers.

But officials said they had numerous concerns about whether private equity firms would provide additional capital if a bank’s problems deepened. They also expressed discomfort with the sometimes opaque ownership structures that some investment firms have been proposing.
“Obviously, we want to maximize investor interest in failed bank resolutions,” said Sheila C. Bair, the chairwoman of the F.D.I.C. However, she said, she did not want to see the same institutions fall into a failed state again.

Ms. Bair said she was also concerned that the ownership proposed by some private investment firms was murky. “We have seen bids where it has been difficult to determine actual ownership. We have seen bidders who have wanted permission to immediately flip ownership interests.”
In the rules outlined on Thursday, private equity firms that own more than one bank would have to provide “cross-guarantees,” under which they would use capital from a healthier bank to shore up a weaker one. The investment firms would also have to accept limits on their ability to extend credit to other affiliates, and they would have to make sure that their banks remain well capitalized.

Industry executives said the new rules would be unworkable and prevent their putting new money into deals that might alleviate the banking crisis. But they held out hope that the F.D.I.C. would relax its requirements after it received public comment on its proposals.
“We believe that the F.D.I.C.’s proposed guidance would deter future private investments in banks that need fresh capital,” said the Private Equity Council, a trade association for firms like the Carlyle Group, J. C. Flowers and Stone Castle Partners, all of which have been actively seeking to acquire banks.
The new guidelines will go into effect immediately, but the F.D.I.C. asked for comment on its requirements and said it would consider changes based on the reaction it received.
“I remain open-minded on many aspects of this proposal,” Ms. Bair said.

Wall Street's Tax Problem

Taxing "carried interest" as ordinary income could mean a smaller payday for private equity firms and hedge funds. Critics warn of unintended consequences.

By David Ellis, CNNMoney
March 4, 2009

Hoping to help plug the gaping hole in the nation's deficit, the Obama administration is looking for a little help from an unlikely source: the financial services industry.

One key item embedded within the White House's 142-page proposed budget is a tax increase on what is known in the private equity and hedge fund industries as "carried interest." This refers to the portion of their fund's profits that some managers receive as compensation.

For decades, managers paid the capital gains tax rate of just 15% on carried interest. When it was first designed, the thinking was that the lower tax rate would encourage long-term investments and ultimately fuel economic growth.

The proposed change, however, would tax this compensation as ordinary income, bringing the rate up to 35% or more.

The proposal, which would not go into effect until 2011, is expected to generate over $2.7 billion in tax revenue during its first year, and a combined $14.7 billion through fiscal year 2014, according to White House estimates.

Such changes, which have been debated amongst members of Congress in recent years, would represent a major setback for a many investment-related industries, including private equity firms and venture capitalists.

In better economic times, when those industries were thriving, carried interest typically represented the largest chunk of a fund manager's compensation. And being taxed at a lower rate only made their payday that much sweeter.

One study published by a Congressional committee in 2008 estimated that the tax-favored treatment of carried interest would save private equity and hedge fund managers $31 billion over the next 10 years.

With that in mind, some critics have argued that the way these types of partnerships are currently taxed amounts to nothing more than a subsidy from fellow taxpayers.

In addition, the lower tax rate may have encouraged many of these fund managers to take bigger risks in search of higher returns when credit was cheap.
"This is something, in a small way, that probably contributed a little bit to the bubble," said Joseph Bankman, a professor of law and business at Stanford University.
Unintended consequences

Industry groups, however, have been quick to point out that making changes to the way carried interest is currently taxed is fraught with potentially disastrous consequences.

Among those is the potential for a "brain drain" within the industry, the notion that the best and brightest would no longer be interested in working for these types of funds if they didn't have the promise of large financial incentives.

Other groups, such as the National Venture Capital Association, have argued that raising the tax would also discourage long-term, high-risk investments and potentially stifle U.S. economic growth.

It is also worth noting that many large institutional investors, such as university endowments and pension funds, have benefited from impressive hedge fund and private equity returns over the years.

Mark Luscombe, federal tax analyst at CCH, Inc., added that any changes could also raise questions about tax fairness.

Many oil and gas companies, as well as biotech firms for example, are typically structured as partnerships and have their carried interest taxed at the capital gains rate as well.

It is still not clear if the White House is seeking to change the tax rate on carried interest for all partnerships or not, but there are signs that a change may be focused only on investment-related industries.
"How do you rationalize that?" said Luscombe.
Chances of success?

Those claims aside, the carried interest proposal seems likely to make its way into the final budget since it appears to have the support of the White House and many members of the Democratically-controlled Congress as well.

At the same time, private equity shops and hedge funds will likely find little sympathy among the American public after taxpayers pumped billions of dollars into ailing banks and Wall Street firms.

Nevertheless, industry groups have been lobbying lawmakers in the hopes of preventing any changes to how carried interest is taxed. And large investment firms have had a lot of success beating back the threat of regulatory reform in recent years.

Hedge funds, for example, thwarted an attempt by the Securities and Exchange Commission in 2006 that would have required them to register as investment advisers.
"You never know," said Stanford's Bankman. "On the other hand, people are a little upset with the titans of industry these days."

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