Commentaries

from Rolfe Winkler:

Lunchtime Links 2-1

President's budget (gpoaccess.gov)

Barney Frank: The poor should rent, not own (Indiviglio, Atlantic)

Citigroup said to plan sale of private equity unit (Keoun/Keehner, Bloomberg) Citi cites raising cash to pay down debt as the reason to sell this unit. Of course this would also get Pandit some brownie points with Paul Volcker, who wants commercial banks out of private equity, hedge funds and proprietary trading...

HCA owners get $1.75 billion payout (Lattam, WSJ) Speaking of private equity...a nice payout for investors in one of the biggest LBOs in history.

All those little Stuy towns (Morgenson, NYT) Bullying as a business model...

Goldman Sachs and the $100 million question (Times UK) This is a thinly sourced article that claims Lloyd Blankfein will get a blowout $100m bonus for 2009. If true, talk about giving the finger to, well, pretty much everyone.

Five myths about America's credit card debt (Manning, WaPo)

True confessions

Journalists are suckers for a confessional story.

There’s belief among journalists that confessional stories carry more resonance with readers because they often are narrative tales about insiders fessing-up to the truth.

And so today we have Andrew Ross Sorkin in The New York Times telling us the great confession of British private equity chieftain Guy Hands. What’s Hands’s great admission? That private equity firms charge excessive fees to investors and that highly-leveraged takeover artists aren’t always the great managers they purport to be.

Shocking, right? Critics of private equity have been saying those same things for years.

So why does it matter that Hands wants to spill his guts to Sorkin over tea at the Jumeriah Essex House, a fancy hotel overlooking New York’s Central Park? To be blunt, it doesn’t.

This true confession might seem a bit more sincere if Hands also announced he was rebating to investors some of the management fees his firm had collected over the years. Or, better yet, he helped find work for some of the people who lost jobs at the now debt-laden companies his firm has acquired.

Oh, and one more thing Hands: what about moving out of the island of Guernsey so you can start paying your fair share of taxes to the British government.

Tax high earners (but not me) says Ronald Cohen

Ronald Cohen, friend of Gordon and multi-millionaire founder of Apax Partners, would like to put something back into society. More accurately, he’d like those who are trying to replicate his own career to put something back into society, in the form of higher taxes.

Plugging his latest private equity venture, which promises to look at social as well as financial returns, in the Sunday Telegraph, he is quoted as urging “higher levels of taxation for very high levels of remuneration.”

Curiously, he doesn’t seem to be advocating a tax on the wealth (his own is reported to be over 200 million pounds) which he accumulated in a period of low taxation on income, coupled with a grotesquely inappropriate tax break on the sort of deals that Apax did.

There may be a case for punitive taxes on seven or eight figure bonuses (although clever people like him would quickly find ways round them) but it ill behoves Cohen to suggest cutting off lower rungs on the ladder he has so successfully climbed.

Moulton’s parting shot at Alchemy

It is full of wonderful nuggets about the private equity boutique he set up in 1997 and gives insight into a wider malaise in financial services.  Moulton is not saying if the letter — which is addressed to investors — is authentic.

The letter’s parting words capture the tone: “I would do it again – but better“.

(Photo: Reuters file photo)

Take the L out of LBO

In a perfect world, we would simply ban leveraged buyouts. The vast majority of these debt-laden corporate takeovers are no less predatory and value-destroying to a company than a loan shark who charges usurious rates of interest.

Realistically, a prohibition on private equity deals will never happen, given the big dollars involved in these transactions and the sizeable campaign contributions that private equity chieftains shower on politicians from both parties.

So here’s another way to prevent private equity firms from again saddling their corporate prey with too much debt: Prohibit banks from committing financing to any LBO where the private equity buyers are not willing to pony up at least 50 percent of the purchase price.

A 50 percent equity threshold would stop banks from giving in to their worst impulses, which are to do whatever they can to win favor with the private equity firms, in the hopes of rich fees and the promise of lucrative stock and bond underwriting deals down the road.

And it will force banks going forward to make more loans to companies looking to expand their operations and create jobs — not destroy jobs, as is often the end result of an LBO.

Requiring a private equity firm to put up a dollar for every dollar in a financing that a deal needs to get done is not as extreme as it may sound.

In fact, at the end of the two most recent LBO booms, it was not uncommon for the small number of deals that did get consummated to involve equity commitments in excess of 40 percent, according to data compiled by Standard & Poor’s Leveraged Commentary & Data.

The FDIC plays hide the ball too

The Federal Reserve is fighting hard to keep details about the $2 trillion in emergency loans it has made during the financial crisis from seeing the light of day. And now it seems the Federal Deposit Insurance Corp. also has started playing the game of keeping secrets from the public.

The American Banker earlier this week reported that the FDIC is holding back on disclosing information about failed bids for troubled banks the government agency has taken over. The industry newspaper reports the FDIC is delaying the processing of Freedom of Information Act requests seeking such information, while the agency reviews its disclosure policy.

The FDIC announcement is disturbing because it comes at a time that the FDIC has been forced to close banks at a brisk clip and just put in place a plan for allowing private equity firms to bid on bank assets. (Full disclosure: my wife used to be an editor for the American Banker).

The FDIC’s position on releasing information about failed bids is not as sweeping as the Fed’s opposition to a Bloomberg News lawsuit seeking access to information about the $2 trillion in emergency loans. But as The Audit, a Columbia Journalism Review blog, point outs, the FDIC’s stance is another move towards “creeping government secrecy.”

Of all the financial regulators, I’ve been the most supportive of FDIC Chair Sheila Bair. I’ve praised her for not being afraid to take positions that offend the nation’s bankers. But on this issue of disclosure, Bair is doing a disservice not only to her reputation, but the public’s right to know.

from Rolfe Winkler:

FDIC lowers capital rule, but there’s a twist

FDIC concluded its quarterly board meeting earlier this afternoon and the big news is it approved lower capital requirements for private equity shops looking to buy failed banks.*

But the weaker requirements come with a silver lining.

The previous proposal was that banks in the hands of private equity would have to maintain Tier 1 capital of 15%, triple the standard of 5% that is currently considered "well-capitalized."  [Your humble columnist thinks that threshold is way too low, but that's another discussion].

Under the rule that was adopted, such banks will have to maintain a 10% capital ratio, but the definition of capital isn't Tier 1, it's Tier 1 common equity.

Tier 1 common equity is close to tangible common equity, which is a stronger measure of capital than simple Tier 1.

Why does this matter? As I wrote about in my column updating Q2 leverage stats, it's not just the size of the capital cushion that matters. It's also the quality of that cushion. (If this post seems a little wonky, I recommend going back to that column.)

Common equity is the best cushion of all because it sits in the first loss position. Preferred equity -- which is included when calculating Tier 1 but excluded when calculating Tier 1 common -- failed totally last year. Banks had issued a bunch in late '07 and early '08 in order to boost Tier 1, but because common was nearly overwhelmed with losses, investors higher up the capital structure panicked.

from Neil Unmack:

Bond investors won’t bail out private equity

Private equity and European high-yield bond investors have an awkward relationship. Investors recoiled from the market after telecom companies went bust in the dot-com crash. Issuance picked up during the recent credit boom, but PE firms raised most of their funding through private bank loans, many of which were repackaged into collateralised loan obligations (CLOs).

Now that banks won't lend and the CLO machine is broken, financial sponsors need to find a way of refinancing the hundreds of billions of euros of loans that will come due over the next five years (S&P estimates over 500 by the end of 2015).

Just in the nick of time, investor interest in European high-yield bonds seems to be reviving. Investors are increasing their allocation to the sector, enticed by juicy returns as the market rallied after the credit market collapse last year. So far this year, high-yield issuers have managed to raise over eight billion euros, and bankers are hoping that companies who haven't issued before will be able to come to market soon.

The great hope for PE firms is that this resurgence will allow them to refinance maturing debt, probably by issuing senior-ranking high-yield bonds to refinance a portion of senior bank debt, and extending the rest. Certainly, the high-yield market will help, but PE firms and banks hoping to pass the buck by dumping overleveraged companies on the bond markets will have a hard time.

First, they will have to compete for a share of investors' money with companies that are already well known: existing issuers and the growing number of fallen angels -- companies that have slid below the investment grade band.

Then there is a more basic problem in that many PE deals simply have too much debt. At the moment, bond investors will buy BB-rated companies, and flirt with single-Bs, such as Virgin Media <VMED.O>, if they know the name well. But compared to these companies, the most recent batch of large PE deals such as EMI, which is tipped for a bond refinancing, doesn't look very appealing.

Many LBO companies are terribly overleveraged after sponsors piled on debt to pay themselves a hefty dividend or as a result of secondary and tertiary buyouts, where PE firms sold companies to each other in a debt-fuelled game of musical chairs. The business plans drawn up at the time envisaged the companies reducing debt over the short term, but in many cases that hasn't happened.

The right route for National Express

    It’s hard to get too excited about bus and coach travel. So why is there so much interest in taking over British bus and rail group National Express?     Buses, including ferrying kids to school, and coaches are relatively recession proof. National Express ran into trouble by running more than a billion pounds in debt by expanding too far in the U.S. and Spain. It also over-bid for a British rail franchise, the east coast main line, and ended up such big losses that it was forced to surrender it.     The business faces a potential liquidity crunch. It must repay a 540 million euro loan maturing in September 2010, which is daunting given its market capitalisation is only 515 million pounds. Moreover its two other rail franchises are under threat if the government tries to exercise a “cross-default” clause because of the east coast surrender.     These mistakes cost its chief executive, Richard Bowker, his job. They now threaten its independence, with opportunistic bidders — including its largest shareholder, a private equity firm and its biggest competitors Stagecoach, FirstGroup and Go-Ahead — all sniffing around.     The latest bidder to declare an interest, Spain’s Cosmen family, which already holds some 18.5 percent of National Express, has even teamed up with a private equity bidder, CVC, in order to offer cash. The Cosmens know the value of the Spanish business. After all, they sold Alsa to National Express in 2005.     There is more than an air of vultures descending. After all, broker UBS puts a sum-of-the-parts enterprise value of almost 1.6 billion pounds on National Express, while Cazenove reckons it is worth 1.8 billion to 2 billion pounds. Strip out the debt and the equity is worth 530 to 909 million pounds, with a per share value of 350 to 530 pence.     That’s above the current price of 344 pence. It also puts into perspective a putative offer price of 400 pence, which is the level at which the National Express board is reported to be willing to start talking.     Fear of being lowballed may explain why shareholders are talking about stumping up for a rights issue of as much as 350 million pounds ($586 million) rather than cashing out.     This would eliminate the liquidity crunch risk and buy National Express some time, while the company appoints a new chief executive. It would eliminate the need for a fire sale.     Whether investors are serious about shutting bidders out and letting National Express trade on to recovery remains to be seen. It could of course just be a negotiating tactic to squeeze out a higher price.     It will be intriguing to see how the Spanish, or indeed any of the other bidders, react.

CIT doomed by PE

The most compelling argument for saving CIT Group from collapse is the impact it would have on small- and mid-sized business that depend on the New York-based lender for financing. But it’s increasingly looking like that argument is more hype than anything else.

First of all, CIT pretty much hasn’t been doing any new lending for the past six months, when its financial troubles really began to mount. Most of the lines of credit the firm has out to hundreds of thousands of small companies were arranged long before the collapse of Lehman Brothers.

Second, and maybe the best reason for letting CIT fail, is that a good number of CIT’s financing deals are with companies owned and operated by private equity firms. Our sister publication PEHub reports that in recent years, CIT has moved aggressively to provide financing to mid-sized companies that were taken over in leveraged buyouts. PEHUB has found at least 36 PE-owned companies that CIT is the primary lender to.

For instance, CIT has provided the bulk of the financing to Texas-based chain CiCi’s Pizza, acquired by Canadian private equity firm Onex in 2007. CIT’s financing has been provided the fuel for the chain’s rapid expansion.

Sure, the PE-owned companies are small- and mid-sized businesses. But this isn’t mom and pop we’re talking about here.

And CIT hasn’t just been a lender to PE-owned companies, it’s also arranged deals through its investment banking arm.

The case for saving CIT becomes a lot less compelling when you realize that an indirect beneficiary of keeping the lender afloat will be the strip-and-flip crowd. The idea of bailing out CIT to save the investment returns of PE funds isn’t too compelling. In fact, it would make for bad public policy.