The Debate Over Private Equity In Banking

By John Carney, DealBreaker.com
August 4, 2008

While the collapse of Bear Stearns and financial industry losses now topping $400 billion, many lawmakers and regulators are calling for increased regulation of the banking industry. But a parallel argument has been pointing in the opposite direction: loosening some regulations to allow private equity firms to invest more in banks.

The losses have forced banks to raise somewhere around $400 billion in new capital (the number changes every couple of days, so we forget exactly how much), much of which is now under water from further losses. With estimates of further losses totaling as high as $1 trillion to $2 trillion, many now wonder where the banking industry will find new capital to replace these holes.

One answer might be the government, although contracting revenues due to a dithering, recessionish economy may limit this option. Others have proposed easing rules that have discouraged private equity firms, which have something like $400 billion of capital on hand, from investing in banks.

Those rules subject investment firms which own more than 25 percent of a bank to the full panoply of banking regulations, basically declaring the owner a bank itself. Holders with between 10 percent and 25 percent are prevented from controlling the banks management.

The practical effect of all this limits outside investment firms to holding less than a 10% stake in a bank if they wish to place a director on a bank's board. Perhaps the greatest barrier to private equity investment, however, isn't these limitations. It's the "source of strength" doctrine, which exposes controlling firms to potentially unlimited liability for bank losses. It's meant to ensure depositors that the owners of the banks holding their deposits stand ready to support the banks with their full faith and credit. But it also helps deter investors, such as private equity firms, from taking large stakes in the firms.

Private-equity firms seem eager to invest in banks, and have been encouraging lawmakers to reform the regulations to make this easier. Proponents of the move, including two managing directors at the Carlyle Group who penned an op-ed in the Wall Street Journal in June, argue that the ideas behind the regulations--the need to prevent conflicts of interest and concentration of economic power--do not apply to private equity firms, who generally would only hold their stakes in banks for limited periods of time.

Opponents of the reforms hardly find this reassuring. Andy Stern, president of the Service Employees International Union, last month wrote that "short-term capital infusions from private-equity funds will only make the banking crisis worse, by encouraging risky behavior and abusive banking practices." Of course, the SEIU has become one of the most prominent opponents of private equity firms in recent years.

The fight between private equity and the unionists played out in an especially messy fashion at Washington Mutual. When the Texas Pacific Group's invested in Washington Mutual, the deal diluted shareholder while delivering $50 million in transaction fees to TPG. A pension fund controlled by the SEIU was one of those shareholders. Washington Mutual is now on almost everyone's list of bank's that might wind up in the hands of the FDIC. Not a week goes by that we don't get asked by a WaMu customer about whether they should withdraw their deposits. (As good citizens we naturally tell them that unless they have over $100,000 in the bank, their deposits aren't in danger.)

Yesterday the New York Times weighed in on the issue, accusing the private equity firms of "exploiting the desperation of banks and regulators." It's not exactly surprising to see the Times taking the union position in this matter but the path they took to reach it is unexpected. After echoing the union argument that private equity firms could do a great deal of damage in the short term, the Times concentrates on the need for greater transparency in the banking industry and the allegedly malignant signaling aspect of the reforms.

"Now, when there is great uncertainty about which institutions are too big or too interconnected to fail, is exactly the wrong time to allow less transparency and less regulation," the Times editorialists write. "And with confidence in the financial system badly shaken, it would be a mistake to signal to global markets and American citizens that the government is willing to put expediency above long-term stability."

The Strategic Secret of Private Equity

By Felix Barber and Michael Goold, Harvard Business School
September 2007

Private equity. The very term continues to evoke admiration, envy, and—in the hearts of many public company CEOs—fear. In recent years, private equity firms have pocketed huge—and controversial—sums, while stalking ever larger acquisition targets. Indeed, the global value of private equity buyouts bigger than $1 billion grew from $28 billion in 2000 to $502 billion in 2006, according to Dealogic, a firm that tracks acquisitions. Despite the private equity environment’s becoming more challenging amid rising interest rates and greater government scrutiny, that figure reached $501 billion in just the first half of 2007.

Private equity firms’ reputation for dramatically increasing the value of their investments has helped fuel this growth. Their ability to achieve high returns is typically attributed to a number of factors: high-powered incentives both for private equity portfolio managers and for the operating managers of businesses in the portfolio; the aggressive use of debt, which provides financing and tax advantages; a determined focus on cash flow and margin improvement; and freedom from restrictive public company regulations.

But the fundamental reason behind private equity’s growth and high rates of return is something that has received little attention, perhaps because it’s so obvious: the firms’ standard practice of buying businesses and then, after steering them through a transition of rapid performance improvement, selling them. That strategy, which embodies a combination of business and investment-portfolio management, is at the core of private equity’s success.

Public companies—which invariably acquire businesses with the intention of holding on to them and integrating them into their operations—can profitably learn or borrow from this buy-to-sell approach. To do so, they first need to understand just how private equity firms employ it so effectively.

Clearly, buying to sell can’t be an all-purpose strategy for public companies to adopt. It doesn’t make sense when an acquired business will benefit from important synergies with the buyer’s existing portfolio of businesses. It certainly isn’t the way for a company to profit from an acquisition whose main appeal is its prospects for long-term organic growth.

However, as private equity firms have shown, the strategy is ideally suited when, in order to realize a onetime, short- to medium-term value-creation opportunity, buyers must take outright ownership and control. Such an opportunity most often arises when a business hasn’t been aggressively managed and so is underperforming. It can also be found with businesses that are undervalued because their potential isn’t readily apparent. In those cases, once the changes necessary to achieve the uplift in value have been made—usually over a period of two to six years—it makes sense for the owner to sell the business and move on to new opportunities.

How Private Equity Works: A Primer

The benefits of buying to sell in such situations are plain—though, again, often overlooked. Consider an acquisition that quickly increases in value—generating an annual investor return of, say, 25% a year for the first three years—but subsequently earns a more modest if still healthy return of, say, 12% a year. A private equity firm that, following a buy-to-sell strategy, sells it after three years will garner a 25% annual return. A diversified public company that achieves identical operational performance with the acquired business—but, as is typical, has bought it as a long-term investment—will earn a return that gets closer to 12% the longer it owns the business. For the public company, holding on to the business once the value-creating changes have been made dilutes the final return.

In the early years of the current buyout boom, private equity firms prospered mainly by acquiring the noncore business units of large public companies. Under their previous owners, those businesses had often suffered from neglect, unsuitable performance targets, or other constraints. Even if well managed, such businesses may have lacked an independent track record because the parent company had integrated their operations with those of other units, making the businesses hard to value. Sales by public companies of unwanted business units were the most important category of large private equity buyouts until 2004, according to Dealogic, and the leading firms’ widely admired history of high investment returns comes largely from acquisitions of this type.

Private Inequity

By Neil Weinberg and Nathan Vardi, Forbes
March 13, 2006

Driven by greed and fearlessness, private equity firms are the new power on Wall Street. Investors beware: A reckoning is nigh.

Hamilton James is raising one of the largest private equity funds the world has ever seen, a $13 billion whopper for Blackstone Group, renowned kingpin of the buyout business. Suddenly this thriving trade is redefining the terms of power, profit and greed on Wall Street. He waxes rhapsodic on the benefits to the economy.

“Good private equity funds improve companies operationally and lower the cost of capital for those that are financed inefficiently,” says James, president of Blackstone and chief of its private equity arm. Known as Tony, he is a Harvard M.B.A. who ran investment banking at Credit Suisse First Boston before joining Blackstone in 2002. As he wraps up fundraising for Blackstone V, investors are well aware of its predecessors’ home runs, with Blackstone IV rising 70% a year.

“If you look at our record, or any good buyout fund’s record, you see consistent outperformance in good times and bad.”

Investors poured $106 billion into leveraged buyout funds last year, double the total of 2004, says Private Equity Analyst. Weary of the wobbly stock market and alarmed by the real estate run-up, they were lured by eye-popping returns of 50% a year (or better) at a few elite funds. Globally, 2,700 funds are raising half a trillion dollars in cash to invest; this will bankroll them for $2.5 trillion in deals, given their penchant for putting $4 (or more) of debt leverage atop every dollar they put up.

Just half a dozen giant firms control half of all private-equity assets. Three titans--Blackstone, Carlyle Group and Texas Pacific Group--lord over companies with 700,000 employees and $122 billion in sales. Buyout shops own such iconic brands as Hertz, Burger King, Metro-Goldwyn-Mayer, amc Entertainment, Linens ’N Things and more. Adept at reaping riches whether their investors win or lose, ten buyout chiefs grace the Forbes 400 list of wealthiest Americans. Among them is the billionaire cofounder of Blackstone: Stephen Schwarzman.

Egging on the buyout boys: all of Wall Street, which collects marvelous fees from all the buying and selling. While it was making its own executives quite comfortable, Blackstone rewarded investment banks with $358 million in fee revenue last year. Investment banks get fees for brokering or advising on tender offers; get fees for underwriting bonds or arranging the bank debt to pay most of the acquisition costs; get more fees for selling off some of the assets to pay back the debt; and get still more fees for taking target firms public all over again.

Last year saw $35 billion of public equity money raised globally as bought-out firms went public again. Underwriting fees on those stock sales, plus all of the other fees generated by the private equity business, added up to an $11.8 billion payday for investment banks in 2005, according to Dealogic. jpmorgan Chase collected $933 million of this loot; Goldman Sachs scooped up $870 million.

There would be no reason to begrudge the financiers their take if they were building enterprises and creating jobs. But they do not make their fortunes by discovering new drugs, writing software or creating retail chains. They are making all this money by trading existing assets.

Some buyout firms dabble in deeds that got Wall Street and Big Business in trouble in the post-Enron era--conflicts of interest, inadequate disclosure, questionable accounting, influence-peddling and more. Increasingly the big guys jump into bed with each other. Last year buyout firms sold more than $100 billion in assets back and forth to one another, 28% of all buyout fund deals are up fourfold in two years, says Dealogic.

Moreover, some buyout shops ply rape-and-pillage tactics at their new properties. They exact multimillion-dollar fees advising businesses they just bought. They burden a target company with years of new debt, raised solely to pay out instant cash to the buyout partners. It is akin to letting the Sopranos come in and gut your business to cover your gambling debts.

More politely known as a dividend recapitalization, this quick-buck ploy, entirely legal, paid out $18 billion in instant gratification to new owners last year, Standard & Poor’s says. Now and again corporate carnage follows, as thousands of employees lose their jobs, long-term prospects are diminished and the business files for bankruptcy, stranding minority investors and debtholders.

Buyout funds defend brutal tactics by citing their results: They claim to beat the overall market by five percentage points. But in fact they trailed the rise in the S&P 500 from 1980 to 2001, say professors Steven Kaplan of the University of Chicago and Antoinette Schoar of the Massachusetts Institute of Technology.

Worse, their results could be headed for a slump as a huge influx of new money and bidders inflates the prices of properties at a time when interest rates could rise and increase the cost of new debt. Buyout firms are bidding “extraordinary” prices at frenzied corporate auctions, says Michael Gibbons of Brown Gibbons Lang & Co., a Cleveland investment bank doing 25 such deals.

“They’re going to have to assume very substantial growth rates to justify it.”

“There’s a group of new private equity guys chasing deals for the sake of putting money to work,” says Darrell Butler of Billow Butler & Co., an investment bank in Chicago. “They’re affectionately known as ‘dumb money.’ They’re going to have a hard time when the economy turns, profits go south and covenants get blown and banks come calling. And it will happen.”

Millions of low-rollers--employees and taxpayers--could feel the impact. Pension plans provide 40% of the roughly $600 billion now committed to buyout funds. Many pension plans, both corporate and governmental, are so underfunded they look to private equity to help them close the gap, or at least to tell their actuaries that they can close the gap. The stock market has gone nowhere for the past six years. How does a pension sponsor justify the assumed 8% or 9% annual return on its fund? By putting a fairly large chunk of that fund in “alternative” investments. It is taken as axiomatic that exotic investments will yield higher profits than plain old stocks and bonds.

Public and private pension funds overall have less than 4% of assets in private equity. But in a cruel coincidence, underfunded pension plans and companies in bad shape rely more heavily on buyout funds than healthy firms do; the sick ones need to jack up pension plans hurt by their own faltering finances.

“Not only is the relationship significant, it’s perverse,” says Stephen Nesbitt, chief executive of Cliffwater llc, a pension consulting firm. “Some companies don’t want to take a hit to earnings or increase pension contributions,” so they load up on buyout funds.

Philadelphia’s city employee pension board, at only 59% of the funding it needs, aims to double its bet on private equity to 11.2% of assets in four years. Eastman Kodak’s pension fund has 20% of assets in private equity; Delta has 13%; ailing automaker General Motors is at 10%.

But if Darrell Butler is right--if too much dumb money is getting in at the top--the insiders who run funds will still thrive. Private-equity funds typically take a 2% cut of assets annually plus a 20% chunk of everyone else’s profits. If Blackstone is doing this--and it won’t say--it’s getting $260 million a year up front, on its new fund and one-fifth of any upside. Warburg Pincus, Goldman Sachs Capital Partners and Carlyle rounded up $8 billion to $10 billion each last year, ensuring hundreds of millions in fees even if they never produce a nickel of profit for anyone else.

This vigorish, common when a $1 billion fund was the norm, hasn’t come down even as buyout funds have grown ten times as large.

“It’s like Moses brought down a third tablet from the Mount--and it said ‘2 and 20,’” says Christopher Ailman, chief investment officer of the California State Teachers’ Retirement System, the nation’s third-largest pension fund. “We’ve been trying to get the fees lower, but it’s tough.”

lbo funds popped up in the 1980s, feeding on the junk-bond takeover craze. Blackstone was formed in 1985 when Peter G. Peterson, a former Lehman Brothers chairman who had served as President Nixon’s secretary of commerce, teamed with Lehman alum Schwarzman. They put up $400,000 and raised $810 million for Blackstone I two years later.

The 1980s buyout binge peaked at 365 deals worth $99 billion in 1988. The era was immortalized in Barbarians at the Gate: The Fall of RJR Nabisco, which profiled Kohlberg Kravis Roberts’ contentious takeover of rjr. At $31 billion in 1989 ($49 billion in today’s dollars), it remains the largest buyout on record. Six of the next largest deals occurred only in the past year: Hertz ($15 billion, led by Clayton, Dubilier & Rice); Danish telco tdc ($12 billion, Apax Partners); and SunGard Data Systems ($11.4 billion, Silver Lake Partners).

This time the boom is fueled by the pop of a market bubble. More companies are going private, frustrated by the antifraud Sarbanes-Oxley Act. Thomson Financial counts 32 firms with a combined market value of $54 billion that went private in 2005, up tenfold in three years. Banks, meanwhile, have loosened up lending to extend five times as much senior debt as the equity put up by buyout funds.

Thus buoyed, buyout titans have done well grabbing underpriced, down-but-not-out businesses and whipping them into shape: Texas Pacific with memc Electronic Materials; Silver Lake Partners with Seagate Technology; Blackstone with trw Automotive. Their success has stoked ever more investor demand--never mind that buyout-fund returns go down as money inflows go up.

“People think of private equity as Barbarians at the Gate, but we’re investors with tool boxes that can help companies change capital structures and management strategies,” says James Coulter, a founding partner of Texas Pacific.

Investors with toolboxes? Germany’s Social Democrats described the Blackstone bankers who bought chemical maker Celanese off the Frankfurt stock exchange in 2004 as “locusts.” The hedge fund Paulson & Co. claimed Blackstone’s $650 million price was a lowball bid made possible only by a “fairness opinion” from its pals at Goldman Sachs, which collected $21 million in fees from Blackstone last year.

Blackstone, unrepentant, took Celanese public on the New York Stock Exchange nine months after acquiring it, netting one of its funds a $3 billion profit (and that doesn’t include shares it held on to).

Far less attention is focused on the flops and buyout funds’ sometimes central role in same, albeit subsequent lawsuits have begun to surface. In one get-rich-quick scheme, a dividend recap let Bain Capital turn an $18 million stake in faltering kb Toys into $85 million in cash--but left kb itself in much weaker shape.

Bain put up $18 million and took on $237 million in debt to buy the company in December 2000. In April 2002 kb raised $66 million more in bank debt and used cash on hand to pay out $121 million in special dividends--$85 million for Bain and $36 million for senior executives who signed off on the recap. But kb went on to lose $109 million in less than two years, creditors say, filing for Chapter 11 protection in January 2004.

Since then it has shut half of its 1,200 stores and laid off more than half of its 16,000 employees. Big Lots, the discount retailer that had sold kb Toys to Bain, was owed $45 million but lost most of it in the bankruptcy filing. It has sued Bain for fraud in Delaware state court. Bain, anticipating further opposition from creditors, preemptively sued Big Lots to get a Delaware state court to explicitly endorse the recap; that case is pending. kb Toys was bought out of bankruptcy for $20 million by another buyout firm, Prentice Capital. Unsecured creditors, who were owed $218 million, got only 8 cents on the dollar. In January they also sued Bain, in state court in Massachusetts, charging it ginned up bogus fairness opinions in imposing the recap. Bain blames kb Toys’ troubles on competition from Wal-Mart.

The Equal artificial sweetener business has been through similarly sour times.

Billionaire Michael Dell’s msd Capital and Pegasus Capital bought Monsanto’s Equal business, Merisant Worldwide, for $600 million in 2000 by putting up $160 million in cash and borrowing the rest on Merisant’s assets. Three years later the new owners had Merisant borrow $206 million in new debt and pay the proceeds to themselves; months later they did it again, this time for $75 million. The two moves gave them a 76% profit on their initial investment, while letting them continue to hold 100% ownership.

Merisant, with a negative net worth of $130 million and having spent $44 million on interest in nine months, was forced to shelve an initial public offering last year. Its Equal line is losing ground to Johnson & Johnson’s Splenda, which now has over half the market. Merisant is expected to post a loss for 2005, its third consecutive year in the red. In February Moody’s cut its credit rating to Caa3, its third-lowest ranking. Pegasus and msd won’t comment.

These days nearly half the big buyout funds take their 20% slice from the dividend recaps before their investors break even, says Karl Hartmann, chief operating officer of Franklin Park, which advises institutional investors. Previously the funds waited until outside investors (the limited partners) were in the black before collecting their own cut.

Private-equity fund managers further cash in by charging their own portfolio firms for everything from negotiating loans to helping run the business.

Heartland Industrial Partners, cofounded by David Stockman, President Reagan’s budget director, bought control of auto parts maker Collins & Aikman in 2001 for $260 million. Then it charged C&A $45 million for services and gave a cut to its limited partners; often buyout firms pocket half the take rather than only 20% of realized profits.

That may be all the partners ever get. Last spring C&A said it had violated accounting rules in booking sales, filing for Chapter 11 soon after. It is shutting five U.S. plants and firing 975 people.

In other instances, buyout shops goose returns with “secondary deals”--selling their holdings to one another.

Simmons Co., a bedmaker, is the industry’s fruitcake, changing hands five time in 20 years. Now owned by Thomas H. Lee Partners, it was forced to pull a public offering in 2004, yet the buyout firm gets a 1% cut of Simmons’ operating earnings each year. For helping Simmons issue $200 million in new debt, the firm charged Simmons $20 million plus expenses. Simmons received no cash from the offering; it all went to refinance old debt.

In another secondary deal, abry Partners last August paid $500 million to Providence Equity Partners to acquire F&W Publications, a book and magazine publisher that Providence had taken private for $130 million in 2002. In November 2005 abry filed a lawsuit in Delaware state court claiming Providence had “engaged in various fraudulent practices such as channel stuffing and other schemes to overstate (F&W’s) revenue.” Providence denies wrongdoing.

In another recent case, employees of Canadian Imperial Bank of Commerce accuse the bank of using a buyout fund to rip them off. Former brokers James Forsythe and Alan Tesche say they and 490 colleagues invested $561 million, half of it borrowed, in a cibc fund in 2000. Since then it is down a shocking $420 million. In a lawsuit filed in Delaware, they allege the bank used the fund as a “dumping ground” to pawn off “worthless investments” and suck out $35 million in fees. Its holdings include Spectrasite, which went Chapter 11, and CityNet, a telecom on which the fund took a 50% writeoff. cibc says the lawsuit is baseless.

When things go bad, limited partners can look to a specialty firm that will buy out what’s left of their stakes--but even in this game fraud can happen.

“We’ve seen general partners convert funds to their own accounts, use them for personal reasons, and overdraw management fees,” says Frank Morgan, who runs the U.S. arm of London-based Coller Capital, which has $2.6 billion in assets and runs the world’s largest fund for buying out limited partners of other funds. He says such disputes happen more often than they should and usually are handled quietly.

But Coller itself went to court. Coller sued private equity firm Houston Partners in 2003 after becoming its top investor. Coller sued the firm in state court in Texas, claiming Houston managing partner Harvard Hill Jr. had made unauthorized distributions and loans to himself and his son and had set up secret fee arrangements with related parties. The two sides reached an undisclosed settlement in August. Hill denies wrongdoing.

Other buyout firms come under fire for shrewd (or illegal) fundraising tactics.

In Illinois a scandal erupted over allegations private equity firms paid hundreds of thousands of dollars in bribes to coax investments out of officials of the state’s teachers pension fund. A HealthPoint director recently pleaded guilty to federal charges of attempted extortion in the scheme; a pension plan lawyer also pleaded guilty, and a board member, Stuart Levine, has pled not guilty and awaits trial, charged with soliciting bribes.

Levine also plays a role in a second controversy, this one involving Carlyle, the Washington-based buyout behemoth with $35 billion in assets. U.S. Attorney Patrick Fitzgerald in Chicago has issued a subpoena to the teachers’ fund in the matter. After being spurned by the pension plan, Carlyle hired a local pol, Robert Kjellander; he lobbied Levine on the pension board, and Carlyle landed $500 million from the pension plan.

Only later did pension officials learn that Kjellander had approached Levine and that Carlyle Group had agreed to pay Kjellander a $4.5 million finder’s fee, says the pension plan’s executive director, Jon Bauman. The board now bars such finder’s fees. Kjellander and officials at Carlyle insist they acted properly.

More such conflict-of-interest cases could arise as buyout funds harvest more retirement dollars from strapped pension plans. Corporate retirement funds collectively face a $450 billion pension funding shortfall and are throwing Hail Mary passes to private equity funds to close the chasm; likewise for public pension plans.

“I can’t think of an industry structure that’s more screwed up,” says one manager of a midsize buyout firm.

“The biggest suppliers of capital”--the pension funds--“are the most thinly staffed and underpaid,” he says. State plans with a few employees oversee billion-dollar investments and report to “political entities--their boards--relying on consultants whose business is mostly about marketing and politics,” he says.

They aren’t any match for the buyout guys--who already are anticipating a coming correction and are preparing to profit from it. Some of the biggest names in buyouts--Blackstone, Carlyle, Apollo Advisors--now are raising “distressed investment funds” (read: vulture funds). Feeding on big discounts, they will buy the equity and debt of companies their brethren helped get into trouble.

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Fed Loosens Reins on Private Funds Buying Into Banks

Rob Quinn, Wall Street Journal
September 23, 2008

The Fed has loosened the rules that curtailed private investments in banks, the Wall Street Journal reports. The move may inject more cash into the financial system—if private equity chooses to invest—but will raise fears of profit-hungry investors snapping up stakes in banks to make quick cash with risky loans.

Under the new rules, an investor can take a stake of up to 33% in a bank without being deemed a controlling investor—a designation that would open up the investor to direct scrutiny from the Fed. Some experts say the relaxed rules don't mark a complete turnaround for the Fed, but may encourage investors to help shore up a banking industry that hasn't had any big injections of investor cash since April.

Fed Loosens Rules for Control of Bank Holding Companies

DealBook
September 22, 2008

The Federal Reserve late Monday revised some of its rules governing bank holding companies, loosening some ownership restrictions as Goldman Sachs and Morgan Stanley seek to shed their status as “investment banks.”

Among the biggest changes by the Fed, as outlined in a policy statement on its Web site, is permission for private equity firms to take one seat on boards of bank holding companies in which they have an investment, and in some cases two. Private equity firms can also expand their voting interest to 15 percent from 9.99 percent and hold a total of 33 percent economic interest in the bank holding company, up from 25 percent.

The changes come amid a big shakeup in the banking industry. Several banks have already collapsed this year, and Washington Mutual, the nation’s largest thrift, is seeking to sell itself before it may be thrust into receivership. WaMu has already received a $7 billion investment from a consortium led by TPG.

And late Sunday night, the Fed allowed Goldman and Morgan to become bank holding companies, abandoning their statuses as investment banks to become direct competitors to JPMorgan Chase, Citigroup, Bank of America and the like.

The Fed’s primary goal has been to limit the control that a private investment firm could exercise over a bank holding company, an issue that has gained prominence because of WaMu’s troubles and the changeover of Morgan, which already sold a 9.9 percent stake in itself to the China Investment Corporation.

Go to Federal Reserve Statement »

§ 225.144 Policy statement on equity investments in banks and bank holding companies
(a) Introduction and guiding principles. For many years, bank holding
companies, nonbank financial companies, private equity funds, and other firms
have made minority equity investments in banks and bank holding companies.
These investments often raise a common set of questions about the extent to which
the investment would cause the investor to become subject to supervision,
regulation, and the other requirements applicable to bank holding companies under
the Bank Holding Company Act (“BHC Act” or the “Act”) and the Board’s
Regulation Y. In general, the BHC Act applies to any company that controls a
bank or bank holding company (“banking organization”). The BHC Act provides
that a company has control over a banking organization if (i) the company directly
or indirectly or acting through one or more other persons owns, controls, or has
power to vote 25 percent or more of any class of voting securities of the banking
organization; (ii) the company controls in any manner the election of a majority of
the directors or trustees of the banking organization; or (iii) the Board determines,
after notice and opportunity for hearing, that the company directly or indirectly
exercises a controlling influence over the management or policies of the banking
organization. Minority equity investments in banking organizations are designed not to trigger either of the first two prongs of the definition of control. These investments often raise questions, however, regarding whether the investor will be able to exercise a controlling influence over the management or policies of a banking organization.

The Fed Wants More Private Equity Investments

By Tom Taulli, RSS feed
September 23, 2008

While the government plans to write some big checks to stabilize the financial system, it's probably not enough. There are various sources of capital that can help out, such as private equity.

But there has been a big stumbling block: regulation. That is, if a private equity operator takes a 10% equity stake in a bank, the firm may be considered "controlling," which would trigger some onerous compliance requirements and may mean becoming a bank holding company.

Well, according to the Wall Street Journal [a paid publication], the Federal Reserve is now going to loosen things up. The trigger point is now a 33% equity stake (up to 15% can be voting stock). Something else: a private equity firm can even have as many as two board seats.

No doubt, this is a big deal for private equity firms. And it's a nice option for ailing banks.

According to Bloomberg, private equity firms raised $324.4 billion in the first half of this year, and as should be no surprise, the hot area is distressed investing. In other words, the private equity folks have something to be happy about.

Fed Eases Private-Equity Rule

American Banker
September 23, 2008

In what is emerging as a multipronged effort to reinvigorate the financial sector, the Federal Reserve Board said Monday that it would loosen rules that limit private-equity investments in banking companies.

The 15-page policy statement could ease struggling financial institutions' access to new sources of capital.

Reversing previous policies, the Fed said a private-equity investor could hold a single seat on a bank's board without wielding too much control over the institution.

"Although having a representative on the board of the banking organization enhances the influence of a minority investor, the Board's experience has shown that, in the absence of other indicia of control, it would be difficult for a minority investor with a single board seat to have a controlling influence over the management or policies of the banking organization," the Fed said in its policy statement.

While maintaining its interpretation of the Bank Holding Company Act as barring an investor from holding more than 25% of voting stock without registering as a bank holding company, the Fed said the law "does not impose an express limit" on the ownership of nonvoting shares.

Now, the Fed will allow private equity investors to hold up to a third of a bank's total shares. But in an effort to minimize the holding's influence, the Fed said private equity investors could not hold more than 15% of voting shares. The remaining 18% must be nonvoting.

"In particular, the Board would not expect that a minority investor would have a controlling influence over a banking organization if the investor owns a combination of voting shares and nonvoting shares that, when aggregated, represents less than one-third of the total equity of the organization (and less than one-third of any class of voting securities, assuming conversion of all convertible nonvoting shares held by the investor) and does not allow the investor to own, hold, or vote 15% or more of any class of voting securities of the organization," according to the policy statement. "In these situations, the limitation on voting rights reduces the potential that the investor may exercise influence that is controlling."

Finally, the Fed clarified the type of communications a private-equity firm with a minority stake in a bank could have with the institution's management.

"The board believes that a noncontrolling minority investor, like any other shareholder, generally may communicate with banking organization management about, and advocate with banking organization management for changes in, any of the banking organization's policies and operations," according to the policy statement.

"For example, an investor may, directly or through a representative on a banking organization's board of directors, advocate for changes in the banking organization's dividend policy; discuss strategies for raising additional debt or equity financing; argue that the banking organization should enter into or avoid a new business line or divest a material subsidiary; or attempt to convince banking organization management to merge the banking organization with another firm or sell the banking organization to a potential acquirer."

At issue is the Bank Holding Company Act, which requires any investor with a stake in a bank larger than 24.9% to register as a bank holding company and submit to regulation and examination by the Fed.

In an effort to limit control over banks, the Fed also steps up supervision of investors when their stake in a bank exceeds 9.9% by, for instance, limiting their voting rights and the number of seats they hold on bank boards of directors.

Though it would take an act of Congress to raise the standard for bank holding company registration beyond 24.9%, the Fed's move serves to provide more flexibility for investors with holdings higher than 9.9%.

Private Equity Firms Eye Banks as Fed Considers Rules

By Jeannine Aversa, AP Economics Writer
June 27, 2008

The Federal Reserve is looking into making it easier for private equity firms to invest in banks. The move could usher new capital infusions to cash-hungry banks to cope with credit problems.

Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson have been encouraging banks to raise more money to rebuild balance sheets that have been hit by billions of dollars in losses from bad investments in mortgage-backed securities.

A global credit crisis and financial turmoil have made it increasingly difficult for banks, Wall Street firms and other financial institutions to line up capital.

The Fed is considering steps that would help give private equity firms a better understanding of what they can and cannot do as they weigh making an investment in a bank.

"We are looking at ways we can make those things more workable and gain from the experience we've had over the past few years," said Scott Alvarez, the Fed's general counsel.

Private equity firms, which put together massive pools of money to invest, can take stakes in banks now. However, the Fed has gotten a lot more questions from private equity firms and others recently about how large a stake they can take without being subject to regulatory supervision.

Under federal law, an investment of 25% or more in a bank would trigger Fed regulations. In reviewing individual cases, the Fed has generally found that investments of less than 10% don't constitute a "controlling interest" in the bank and thus don't trigger regulatory oversight.

That's left a gray area — the treatment of potential bank investments of more than 10% and less than 25%.

For several years, the Fed's legal staff has been looking into this matter. No decision is imminent, but some clarity could come later this year. It's not known how this might happen, through guidance from the Fed, changes in rules or some other method.

The Fed's possible action was first reported by The Wall Street Journal.

The newspaper said J.C. Flowers, Carlyle Group, Kohlberg Kravis Roberts and Warburg Pincus were among those meeting with Fed officials on the matter.

In an opinion piece Thursday in The Wall Street Journal, Randal Quarles and Olivier Sarkozy, managing directors at the Carlyle Group, made the case for leeway.

"Private equity is ready and willing to step forward in large amounts — restoring lending capacity, encouraging efficiency and protecting the taxpayer," they wrote. "The Federal Reserve and other banking regulators can help remove obstacles to this important pool of capital."

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Blackstone Sees Pain Ahead for Regional Banks

Reuters
August 7, 2008

Private equity firm Blackstone Group (BX.N: Quote, Profile, Research) said on Wednesday the weak economy and high consumer debt levels may hurt regional banks, which may lack sufficient reserves to withstand potential losses.

"There's a lot more pain to be taken in financial institutions, particularly the regional banks," Blackstone President and Chief Operating Officer Tony James said on a conference call.

The comments were made during a conference call after Blackstone posted better-than-expected second-quarter results despite the weak market for leveraged buyouts.

James said regional banks may lack enough reserves to absorb losses or customer defaults on subprime auto loans, construction loans, home equity loans and credit cards.

The regional banks may have difficulty raising extra funding given the tight credit markets, and may lack the brand name or size to lure help from international funds, James said.

Sovereign wealth funds, based mainly in Asia and the Middle East, have provided funding to larger financial institutions such as Citigroup Inc (C.N: Quote, Profile, Research) and Morgan Stanley (MS.N: Quote, Profile, Research).

Regulators are looking at easing rules to help private equity firms take stakes in U.S. banks. That might only offer a short-term benefit, however, since private equity firms typically invest for five years or less.

Private equity firms like Carlyle Group [CYL.UL] are pushing regulators to loosen the rules, but the U.S. Federal Reserve has not made any final decision.

Last month, Goldman Sachs analysts said U.S. banks may need to raise $65 billion of additional capital to cope with mounting losses from a global credit crisis that may not peak until 2009. That would be on top of the estimated $120 billion already raised by U.S. banks, Goldman said.

The KBW RegionalBank Index is down almost 15 percent this year, while the Standard & Poor's Financials Index has dropped almost 24 percent.

Several financial companies, such as Merrill Lynch & Co MER.N, have already taken write-downs of more than $400 billion due to their exposure to mortgages and complex debt.

Blackstone, Meet Blackstone

Could the private equity firm buy itself out?

By Daniel Gross
July 23, 2007

The next target of a private equity firm takeover should be a private equity firm: the Blackstone Group.

LaRouch Press Release

Executive Intelligence Review, EIRNS
June 26, 2008

Soros, Carlyle Group Say Locusts Will Take Over; LaRouche Says `This is Fascism'

With the banks bankrupt, and the investment banks collapsing, George Soros says not to worry — the private equity funds will save us all. In a joint interview in the British Prospect Magazine with his British brothers Martin Wolf (Financial Times), Anatole Kaletsky (London Times), and John Gieve (Deputy Governor of the Bank of England), Soros said the financial sector is "overblown," and that it should shrink. Who will benefit? "If we do pass through this without a hitch," said the blood sucker, "you will find that the private equity funds wil replace the investment banks as the dominant force in the economy, because they are the ones who are now buying the assets."

LaRouche immediately identified this as pure fascism, exactly of the sort being demanded by Michael Bloomberg and the Rockefeller Foundation.

The drive was backed up by another of the leading Private Equity funds, the Carlyle Group. Today's Wall Street Journal runs an op-ed by two of Carlyle's managing directors, Olivier Sarkozy (Nicolas Sarkozy's half-brother) and Randal Quarles, a former Bush Treasury official. It is modestly titled: "Private Equity Can Save the Banks." Noting that the financial services industry has so far taken about $350 billion in losses, they add:

"This is only the beginning," saying losses will go to $1 trillion (one wag in Leesburg noted that the oligarchs are now getting to within a few orders of magnitude of the true figure).

But, the Carlyle boys argue, the Private Equity firms have "demonstrated the ability to shoulder risk and improve efficiency and profitability," so: do away with the "needless regulations, restrictions and disincentives" against the unregulated hedge funds and private equity funds; i.e., usher in Mussolini fascism.

Hearing on Medicare Payment Advisory Commission's Annual March Report

U.S. House of Representatives, Committee on Ways and Means, Subcommittee on Health
November 15, 2007

The Subcommittee met, pursuant to notice, at 10:13 a.m., in room 1100, Longworth House Office Building, Hon. Fortney Pete Stark (Chairman of the Subcommittee) presiding.

[The advisory announcing the hearing follows:]

Mr. STARK. With an apology to my colleagues and our guests for the late start, I would like to begin our hearing on the issue of nursing home quality. Thank you for joining us in the first of a series of hearings on nursing home quality issues. It has been 20 years since the passage of the Nursing Home Reform Act, and I guess over a decade since we have held any hearings on nursing home issues on the Committee on Ways and Means. Despite improvements in areas of quality, there is still much to be done. I think our return to this issue is long overdue.

I don't want to prejudge any segment of the industry or anyone in the industry, but I am concerned about a trend that is underway. In recent years, several nursing home chains have changed their corporate structure in ways that may obfuscate the real ownership and management of the individual facilities. I will talk more just for a second at the conclusion of my remarks about that by itself. It seems that--I will talk more about that in a minute.

Without this transparency and accountability, it is hard to hold chains accountable for the quality of care of an individual unit. I worry that this move to more large private equity firm ownership will exacerbate that trend. It has been suggested that there is a negative effect on quality that may result from these corporate structures. I was alarmed to read The New York Times article earlier this year that suggested the decline in quality among private equity owned nursing homes. I guess in a nutshell, they are suggesting that the private equity firms spin off the real estate to leverage the value of the real estate to pay for the acquisition, and in so doing either increase the interest payments needed by the individual units to support the increased mortgages or increase, if they spin it off into a REIT, for instance, they increase the rent to the individual units to sustain their purchase obligations.

I have no quarrel with that if it doesn't result in their reducing the funds they spend for the needed facilities and needed employment to maintain quality of care. I don't intend to question what they do as a business practice. But I do worry that the end result could create an incentive to cut costs, as we like to say. The only costs that I know that they can cut are either in nursing care or food or tender loving care. I don't know how you legislate tender loving care. This industry operates largely on the government's dime. Sixty percent of the spending on nursing homes annually comes from the government, and the remainder is out-of-pocket or from private insurance. At any time nearly 80 percent of the residents in nursing homes are supported by public funds.

The same nursing home industry is enjoying very healthy Medicare--and I have to underline Medicare because there is a distinct difference here between Medicare and Medicaid throughout the industry. But with margins of nearly 13 percent at the last reportable period, and we hear indirectly they are close to that even in the most recent figures that are available, the for-profit nursing homes are doing even better, with Medicare margins north of 15 percent. For those of you who follow the hospital margins, we are used to dealing with acute care hospitals in the neighborhood of somewhere between zero and far out would be five percent margins. The industry is publicly supported, and therefore must be held accountable to the public for the care it provides. The nursing home chains should be striving to improve care and not cut corners to increase profits at the expense of the seniors and people with disabilities. I plan to continue looking into the issue of nursing home quality and accountability. We have already received some policy recommendations from a coalition of consumer groups. I would like to review those.

I would like to enter into the record a letter from the National Consumer Voice for Quality Long-Term Care, a letter addressed to Mr. CAMP. and myself. Without objection I would make that part of today's record.

Behind the Buyouts: Inside the World of Private Equity

How Carlyle Hurts Public Services by Avoiding Taxes

The Carlyle Group was literally born out of profits made from tax loopholes. In 1987, David Rubenstein and three partners saw an opportunity to profit off the financial troubles and bankruptcies of Native Alaskan Corporations.i Taking advantage of new tax laws that allowed struggling Native Corporations to sell their (tax deductible) debt to other parties, who could then write off the debt on their own corporate taxes, the partners did an estimated $1 billion worth of deals, and their share--approximately $10 million--allowed them to set up the Carlyle Group.

Carlyle continues to benefit from favorable tax rules. Rubenstein himself pays only the 15% capital gains tax rate on his take of buyout profits rather than the 35% income tax that regular wage earners in his tax bracket are required to pay.iii The IRS is investigating whether private equity firms may also be using offshore corporate structures, cross-border loans and improper accounting methods to shield earnings and assets from the taxman. Carlyle and other firms have paid dearly to protect their tax break--both through big lobbying bills and big political contributions--arguing alternately that it is "equitable" and that it is justified simply because it's long been on the books.

But the carried interest debate is just the tip of the private-equity-tax-avoidance iceberg; by loading up the companies it buys with high levels of debt, Carlyle -- like every other private equity firm -- benefits from big tax deductions. Already, corporate taxes account for only 7% of the country's tax revenues, and this practice has the potential to drive big business' share even lower.

How does this play out in practice? Consider the proposed Carlyle buyout of Manor Care nursing homes. Because the buyout includes $4.6 billion in new debt, under Carlyle ownership Manor Care will be required to pay little or no corporate taxes. This practice of avoiding corporate taxes is especially troubling in the case of Manor Care because, like most nursing home companies, the company receives two-thirds of its revenue from federal and state taxpayer-funded payments, including Medicare and Medicaid.

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Goldman Sachs & Morgan Stanley, Banks Yet Still Not Banks

24/7 Wall St.
May 26, 2009

Goldman Sachs Group Inc. (NYSE: GS) and Morgan Stanley (NYSE: MS) have so far not lived up to the notion of being “bank holding companies.” These companies have not just been poor acquirers of banks, because for all practical purposes they have been no acquirers of banks. The companies made the jump from investment banking and brokerage firms to “bank holding companies” last year, perhaps not by choice but by necessity. The problem is that Goldman Sachs and Morgan Stanley are still acting like brokerage firm and investment banking firms rather than as banks.

Where was the last banking branch you saw with the Goldman Sachs or Morgan Stanley name on the front door that looked like a bank with people in line, safety deposit boxes, tellers, and such? You haven’t. The switch to a “bank holding company” was one of several moves in the forced and needed de-leveraging of Wall Street during the financial meltdown. It also allowed for a more easy funding of TARP monies on the government’s behalf when it came to baling out the banks and bailing out Wall Street without the appearance of Uncle Sam turning on a printing press down in lower Manhattan.

So far we have seen Morgan Stanley do a deal with Citigroup, Inc. (NYSE: C) for the brokerage operations in what started as a venture that most believe will be a smaller Citi and a larger Morgan Stanley in the brokerage world. But that is not exactly a move into real banking.

The New York Post reported over the long weekend that Goldman Sachs came up short in its bid with Toronto-Dominion Bank (NYSE: TD) for the assets of failed BankUnited (NASDAQ: BKUNA) in Florida. It also noted that Goldman Sachs came up short in its IndyMac bid. The New York Post noted that the BankUnited bid was short of the Wilbur Ross and Carlyle private equity bid.

What seems obvious is that if Goldman Sachs and Morgan Stanley really want to go buy up a physical presence banking operation, then these buys will only be on the cheap. Neither firm seems interested in getting into an expensive bank with multiple and endless problems. It seems as though buying banks out of FDIC receivership is not working out for these investment banking behemoths, but as things continue to stabilize and as things keep getting “less-bad” in the financial markets it seems logical that buying failed institutions will only get more expensive. As time goes on, the price of poker goes up.

At what point will the FDIC, the Treasury, the SEC, and others ask these “bank holding companies” where their banks are that they can inspect? For now those regulators may just have to monitor what goes on at these firms’ trading desk operations.

WSJ.com Forums :: View topic - Public Companies Going Private -- Good ...
... many publicly traded companies are falling into the arms of private-equity firms? ... purchase the ownership of an enterprise from what is perceived to be ...
Wall Street's tax problem - Mar. 4, 2009
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Private equity, baby boomers soon will be driving business sales ...
Record amounts of money flowing in from private equity firms -- entities that ... It's no secret that private equity deals are making well-heeled investors ...
The impact of private equity on gcc family businesses...
GCC focused analysis on PE and how it relates to traditional familiy owned conglomerates
Private equity chiefs face crackdown on exploiting tax break Mail Online
Gordon Brown today promised to crack down on private equity firms from abusing Britain's generous tax regime. He promised he would 'deal with the issue' whereby some ...
Too Much: A Commentary on Excess and Inequality
Private equity companies, by contrast, can keep that information secret, so long ... A "full evaluation" of the impact of private equity firms on our contemporary ...
naked capitalism: Fed Considering Relaxing Rules on Private Equity ...
... relaxing rules on bank ownership so as to facilitate private equity investment. ... the dirty little secret of the success of some of these firms has little to do ...
The Decision to Go Public: Evidence from Mandatory SEC Filings of ...
sample of private firms has inside ownership that exceeds 50 ... Many of the firms taken over in mergers had private equity investors: 23 of the 37 mergers ...
Unable To Find Buyers, WaMu (WM) Turns To Private Equity
Among the private-equity firms that are considering a possible transaction are ... partly because federal rules limit ownership of banks and thrifts by nonbank ...
Growing the 'Private' Club - WSJ.com
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Spurred by Manor Care deal, union targets private equity
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FDIC may ease private equity buys of failed banks
... light of concerns over private equity firms' ability to apply adequate capital ... That ownership period could be substantially reduced in the final ...
China or India: Which Is the Better Long-term Investment for Private Equity Firms?
The prospects for investment are strong in both China and India, according to Wharton faculty
and industry experts. But the debate over which country is the better venue for investing is
less important than knowing how the strengths and weaknesses of each nation would impact a
specific investment.
Bad News Is Good News: Distressed for Control Investing
2005 was a record year for distressed for control transactions, and Wharton faculty and private
equity experts say “a growing wave” of bankruptcies is on the horizon, leading to what one fund
co-founder calls “an extraordinary market” for distressed for control investors.
Wharton Private Equity Review
Advisory Board
Karl Beinkampen (WG’94), Executive Director, Morgan Stanley Alternative Investment Partners
Andrew Heyer (WG’79), Managing Partner, Trimaran Capital
Praveen Jeyarajah (WG’95), Managing Director, The Carlyle Group
Michael Kopelman (WG’05), Vice President, Edison Venture
Esther Lee, Vice President, Apax Partners
Andrew Metrick, Associate Professor of Finance, The Wharton School
Dean Miller (WG’99), Partner, PA Early Stage
Vinay Nair, Assistant Professor of Finance, The Wharton School
Stephen Sammut (WG’84), Senior Fellow and Lecturer, The Wharton School
Weijian Shan, Managing Partner, Newbridge Capital

For One Billion You Get...

By Duncan Cameron
July 5, 2007

U.S. hedge fund and private equity managers have been taking their income as capital gains, and paying tax at a 15 per cent rate instead of the normal income tax rate of 35 per cent. The Democratic Congress has taken up the issue. Why should the $1-billion-a-year earner pay a smaller percentage of tax than a regular worker?

Private Equity Firms

Wikipedia

According to an updated 2009 ranking created by industry magazine Private Equity International (published by PEI Media called the PEI 300), the largest private equity firm in the world today is TPG, based on the amount of private equity direct-investment capital raised over a five-year window. As ranked by the PEI 300, the 10 largest private equity firms in the world are:

TPG
Goldman Sachs Principal Investment Area
The Carlyle Group
Kohlberg Kravis Roberts
Apollo Global Management
Bain Capital
CVC Capital Partners
The Blackstone Group
Warburg Pincus
Apax Partners

Additionally, Preqin (formerly known as Private Equity Intelligence), an independent data provider, ranks the 25 largest private equity investment managers. Among the larger firms in that ranking were AlpInvest Partners, AXA Private Equity, AIG Investments, Goldman Sachs Private Equity Group and Pantheon Ventures.

J.P. Morgan Chase & Co.'s PE arm, One Capital Partners

Private equity firms... the increasing involvement of private financing in public company ownership.

Regulating Private Equity
Financial Institutions Consulting: Consider Private Equity

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Ross, Expecting More Defaults, Gets $685 Million from Goldman Sachs

Bloomberg
Originally Published on November 9, 2006

Billionaire investor Wilbur Ross obtained $685 million from a partnership formed by Goldman Sachs Group Inc. to help him fund larger buyouts of bankrupt companies as the U.S. economy weakens.

The arrangement with Goldman Sachs WLR Opportunities Fund LP is a first for the former turnaround specialist at Rothschild Inc. The Goldman fund mainly will invest alongside Ross rather than put its money in buyout funds run by New York-based WL Ross & Co. LLC, the 68-year-old financier said in an interview.

Ross anticipates better opportunities for so-called distressed investing next year as slower economic growth throttles companies loaded down with debt. The investor, who rolled up five bankrupt steel companies and sold the group to Mittal Steel Co. for $4.5 billion last year, said he's bulking up his war chest as leveraged buyouts swell in size.

"It's inevitable that we will see higher default rates than where we are today," Ross said. "We are trying to get ourselves organized to deal with that opportunity."

Goldman spokeswoman Andrea Raphael said the fund "provides a unique investment opportunity for our clients." WLR Opportunities reported it was raising money from Goldman clients in private-placement notices filed with the U.S. Securities and Exchange Commission on Oct. 25. Raphael declined to comment on whether New York-based Goldman put its own money in the fund.

In addition to steelmakers, Ross's buyout funds have purchased textile, coal and car-parts companies. The next wave of defaults will be in "a whole range of industries," said Ross, who sold his firm to U.K. mutual-fund company Amvescap Plc last month.

More Optimistic

He's more optimistic than other distressed investors. A glut of capital has driven up prices for risky companies, cutting returns. Cheaper borrowing costs have propped up companies that otherwise might have failed.

The result has been a dearth of troubled companies in which to invest as junk-bond defaults worldwide fell to a record 0.89 percent in September, according to Standard & Poor's. The 24- year average is 4.61 percent.

Some distressed investors have been predicting for several years that economic shocks would drive up default rates among highly leveraged companies, only to be proven wrong time after time.

"Higher interest rates haven't done it, higher oil prices haven't done it and, so far, a cooling of the housing market hasn't done it," said David Pauker, a managing director at Goldin Associates LLC and the chief restructuring officer for the failed futures broker Refco Inc. "About nine months ago, I decided I was going to stop predicting" when default rates would return to historic levels.

The U.S. economy grew at a 1.6 percent annual rate in the third quarter, the slowest pace in more than three years. Homebuilding slumped the most in 15 years, and energy prices are near all-time highs.

Club Deals

Ross said the Goldman fund is "a new product for us" to keep pace with so-called club deals by private-equity firms that band together to take on bigger targets. A group including Bain Capital LLC and Kohlberg Kravis Roberts & Co. agreed to pay $33 billion for hospital operator HCA Inc. in July.

The Goldman partnership will supplement Ross's two main sources of capital: the $1.15 billion raised through the WLR Recovery Fund III LP in June 2005 and fund clients who also make direct investments in his buyouts. Ross said the Goldman fund will co-invest 85 percent of its assets in his buyouts, with the rest devoted to a fourth recovery fund slated to open next year.

By forming a partnership, Goldman avoids paying management fees on Ross's funds and maintains control over the assets it acquires, Pauker said. Ross benefits because he can pursue larger buyouts without betting the entire WLR Recovery fund on one or two companies, increasing returns and diversifying risk.

"Goldman has been a longtime investor with us," Ross said. "They put together this special fund, which will only come into our very large transactions when there is room."

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Wilbur Ross Seeks Justice and Deals

By Luisa Beltran, CBS.MarketWatch.com
Originally Published on June 24, 2003

For Wilbur Ross, who has been called the king of bankruptcy, the steel industry is an example of all that ails the U.S. economy.

Battered by falling prices and competition from overseas, the once-dominant U.S. industry has shed thousands of jobs, and more than 35 steel companies have filed for bankruptcy protection since 1997. But for Ross, one of Wall Street's top experts in reviving businesses, the dismal situation has created opportunity.

Since April 2002, Ross has acquired the assets of three steel companies - Bethlehem Steel Corp. , LTV Steel and Acme Steel - and has combined them into his International Steel Group. With the $1 billion purchase of Bethlehem last month, he has created one of the largest steel producers in North America, and hopes to use his "workout" expertise to revive what everyone else on Wall Street had written off.

"We are the eraser on Wall Street's pencil," said Ross, who is chairman of International Steel, or ISG. "There are always things going bankrupt."

Ross, who spent 26 years as executive managing director of Rothschild Inc., doesn't mind being nicknamed the "man of steel" or the "king of bankruptcy."

Just don't call him an asset stripper. He doesn't plan to sell, at least not just yet.

"We don't buy things to shut them down and liquidate," Ross said in an interview with CBS.MarketWatch.com. "We buy things to turn them around."

The Hunt

At 65, with decades of Wall Street work under his belt, Ross knows how to find a deal. Every morning at 8 a.m., he and his team of 20 workout professionals, sort through a shopping list of 50 to 75 companies that could collapse over the next year.

His methodology is simple: look for industries that are undergoing a radical change, like telecommunications, steel and health care.

"What we have learned over the years is that companies don't go bankrupt in an isolated mode," Ross said. "Generally, it's an industry wave."

Ross has wielded the knife at his U.S. steel companies, chopping employment by nearly 40 percent to less than 11,000 employees at the combined LTV-Acme-Bethlehem companies.

"Without Wilbur, basically these (remaining) jobs would've been lost," said attorney Lewis Kruger, of law firm Stroock & Stroock & Lavan, who worked with Ross on the LTV deal. "[He] made a great effort to understand the unions, the employees, their needs."

Internationally, Ross also sees opportunity. In May, his investment firm W.L. Ross & Co., announced plans to lead a $300 million buy, along with Goldman Sachs, of Kia Steel Co. of South Korea, which is also in bankruptcy.

But Ross appears to be hitting a stumbling block in South Korea. The Korean government is requiring the Ross-Goldman consortium to put up a deposit before bargaining is to begin. The consortium has also asked for a tax ruling that would allow them to acquire Kia. The Ross-Goldman group has not agreed to put up a deposit and talks with the Korean government have stopped. It is unclear whether they will start up again, a spokeswoman said Tuesday.

In the U.S., Ross maintains that his steel employees are amongst the best paid. He has implemented two bonus reward systems, with the average worker capable of receiving five weeks of extra pay due to productivity gains.

"The steel workers realize that the only good job is with a healthy company, rather than having a glamorous contract with a guy that went bust," Ross said.

Dave McCall, a district director for the United Steel Workers of America, agreed that the ISG employees are well compensated.

"They are also some of the most productive and most talented," he said. "But all those things were put in by virtue of the collective bargaining agreement."

McCall, who was chairman of the ISG negotiating committee, called Ross a "tough and reasonable businessman" who has a great concern for workers.

"He also has a concern for a return on investment," said McCall, who worked for 20 years as a "mill wright" (mill mechanical repairman) for Bethlehem Steel.

However, McCall disputed claims that no one else would have bought Bethlehem or LTV or Acme if Ross had not appeared.

"He was the first one who came in and purchased them, but I don't know if those jobs would've been lost," he said.

But Ross predicts demand will eventually catch up to supply.

He currently controls 360 Networks, Group Telecom and Dynegy Global Communications and has a stake in Level 3 Communications.

Last week, Ross announced his fourth telecom transaction. 360 Networks, which is backed by W.L. Ross, is buying the private line and dedicated Internet business of Touch America Holdings for $28 million. Butte, Mont.-based Touch America filed for Chapter 11 bankruptcy protection on June 19.

"This gives us tier two cities, not the big cities like Chicago or Detroit," Ross said.

Like dot.coms, telecom companies suffered from unrealistic expectations coupled with inexperienced entrepreneurs at the helm during the bubble years. ..

Searching for Justice

But the normally mild-mannered Ross, clad in a typical gray pinstriped suit with blue tie, became angry when talks turned to international trade. In his mid-town Manhattan office, he pushed papers filled with charts and data around on a dark mahogany table showing how steel prices have fallen in the past decade.

"The real reason we are having a recession is that we are importing more than we are exporting," he said, the frustration sounding through his voice.

The one-time writing major from Yale read off the data. After rebounding to more than $360 a ton last year for hot-rolled band steel, prices fell back to nearly $260 in May 2003. He pointed to the 154,000 steel workers that have lost their jobs, fallout from the 39 U.S. steel companies that have filed for bankruptcy in the past six years.

The trade deficit, he said, totals $500 billion a year, representing a 5 percent drag on the economy. Another 2.4 million jobs in manufacturing have been lost since 1998 mostly because of imports, he said.

"Everyone in the world talks about free trade but the problem is that we are the only ones who practice it," Ross fumed. "And everyone else is taking advantage."

Last year, President Bush imposed a controversial steel tariff that is aimed at protecting the U.S. steel industry from a surge of foreign imports. The tariff includes a 5 percent price increase for carbon flat rolled products, the largest category of steel imports.

In March, the World Trade Organization ruled that the tariffs violate international trade. The International Trade Commission, a quasi-judicial agency that enforces trade laws, will submit a report on the tariff's effects to Bush by Sept. 20.

Ross called on the government to change how the WTO makes decisions, where the U.S. has failed to protect itself from illegal imports.

"Our country must take a tougher stand about enforcing the rules," he said. "I am not talking protectionism. Just the existing rules and making people live by them."

The tariffs, he said, are trying to compensate for the many countries that are dumping steel into the U.S. market. With a glut of steel worldwide, many smaller countries are pushing their cheaper steel into the U.S. market.

"American steel companies can compete against foreign ones if it's fair and if it's not government subsidized," he said...

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Wilbur Ross: Watch the Chrysler Deal

CNNMoney.com
Originally Published on July 24, 2007

Private equity firms have become the titans of Wall Street but the industry that built its reputation on nimble deal making is being put to the test.

Financing for deals has become tougher as worries ripple through the credit markets, and investor enthusiasm for at least one newly public buyout firm, Blackstone, appears to be on the wane.

Buyout veteran Wilbur Ross is keeping his eye on the Chrysler deal.

For the latest view on the market, CNNMoney.com spoke with Wilbur Ross, the turnaround expert who most recently has been placing bets on the auto parts business.

In a phone interview, the buyout veteran discussed the new routes private equity is taking to raise capital as well as why he's closely watching the buyout of Chrysler by Cerberus Capital Management.

CNNMoney.com: We're seeing more firms like Apollo and OakTree Capital choosing to list their shares on a new private exchange run by Goldman. What's behind the rise in private markets?

Private vs. public markets

Ross: I think it's a relatively new innovation that Goldman Sachs came up with. It's a kind of marketplace for sophisticated investors and it seems to be attracting some attention.

Q: Why are private equity firms finding such listings attractive compared to public listings?

A: Well they're doing both - Blackstone had a public listing. But public offerings take longer and require much more involvement. There's a bit more disclosure. There are a variety of reasons. Private equity in general tries to explore all avenues for capital raising and this is simply another iteration of that.

Q: If you had not joined up with Invesco last year, would such a private share placement have been attractive to you? (Ross sold his company to British investment firm Amvescap, now known as Invesco, last year for $375 million.)

A: Well that's a hypothetical so it's really hard to answer that. I think you'll see more [private share placements] and not just for private equity funds. This trading platform that Goldman has established is not only available to private equity firms but could potentially be [attractive to] other kinds of businesses.

Q: Do you think exchanges like the new Goldman one will pose a serious threat to traditional exchanges?

A: It's inherently limited. [Private markets] aren't as liquid as the regular exchanges and are confined to large-scale institutional investors as opposed to accommodating smaller public investors, so it's a very different kind of market.

Q: What's your view on conditions in the buyout market? Are credit concerns a big problem?

A: In the last week or so there's been market indigestion over a couple of deals, most notably the Chrysler financing. As I understand it most people feel it was a bit of spillover from concerns about the subprime mortgage market. The real question is how widespread will the contagion become, how long will it last? We're in the early days of it now and clearly it has been taking a toll on other kinds of leveraged financing.

Q: How do you think uncertainty in the debt markets will affect some of the big deals?

A: The test cases are the ones that are in process, like the Chrysler deal. When we see the eventual outcome of that, it will be a very good indicator.

Q: What is the deal landscape like right now?

A: The market seems to be at an all-time high. Deals on the one hand are more expensive, but on the other hand more things tend to be on sale when prices are high. We're in a high-price environment but with an extraordinarily large amount of volume. Those are the main characteristics of the market right now.

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Private Equity Giant Going Public

The Green Sheet
August 11, 2008

Kohlberg Kravis Roberts & Co. LP, one of the world's largest alternative asset managers, and KKR Private Equity Investors LP (KPE), an equity trust limited partnership that invests its assets in private equity and investment opportunities identified by KKR, signed an agreement in which KKR will acquire all assets and assumption of liabilities of KPE.

In conjunction with this transaction, KKR will become publicly listed on the New York Stock Exchange under the symbol KKR. Industry sources indicate the initial public offering (IPO) could generate between $12 billion and $15 billion.

Under the agreement, KPE investors will turn over their KPE assets to KKR in exchange for equity interests in KKR; KPE will be delisted from the Euronext Amsterdam stock exchange. This move comes less than a year after KKR made some of the largest acquisitions in the company's 32-year history, including a $29 billion deal for First Data Corp. and a $45 billion merger agreement and privatization of Dallas-based TXU Corp., in the summer of 2007.

As of Sept. 30, 2007, KKR's equity investments were valued at over $86 billion. KKR has 46 companies in its portfolio in which it invested over $39 billion.

Executives exempt from profit

When the merger is completed, current KPE investors will own 21 percent of the equity in the newly combined business. The remaining 79 percent will be retained by KKR executives. Additionally, none of KKR's existing owners will be allowed to sell shares of KKR or otherwise receive any net proceeds or cash in connection with the IPO for six to eight years.

In a released statement, Henry R. Kravis, co-founder of KKR, said, "This transaction offers substantial benefits for KPE unitholders, and it builds KKR for the long-term.

"Going forward, KPE unitholders will benefit by being owners in a diversified asset management business that generates regular distribution of cash earnings.

"For KKR, this transaction provides us with additional capital for our business.

"Moving forward with a public listing will allow KKR to do what we do best - grow companies around the world and produce solid returns for our investors from a larger platform and a deeper capital base."

Partnership promotes liquidity

When asked how he thought its portfolio of companies would benefit by KKR's IPO, George R. Roberts, KKR's other co-founder, added, "Through our listing on the New York Stock Exchange, KPE holders will have access to a broader investor base in a significantly more liquid market ... and unitholders will benefit from a far more diverse income stream than they do today."

KPE was created in May 2006 to enable certain public market investors, including financial institutions and qualified individuals, to participate in certain KKR investments.

The independent directors of KPE said this transaction "will create a partnership with a more diverse asset base in terms of strategies, geographies and companies ... and facilitate the purchase and sale of stock in a more liquid market."

KKR expects to complete the transaction during the fourth quarter 2008.

Until then, KPE shares will continue to trade on Euronext. KKR said this transaction will have no effect on KKR's strategy or operations, or on how the firm works with its portfolio companies.