Private Equity to Gain from New Glass-Steagall?

Submittted by Leo Kolivakis, publisher of Pension Pulse.

President Barack Obama's State of the Union address Wednesday is unlikely to translate into dramatic congressional action anytime soon, but it was a phenomenal speech.

The focus was clearly on jobs, which remains the most pressing concern as over 7 million US citizens lost their jobs during this recession. However, President Obama also made it clear that health care reform will remain among his top priority and he urged Congress to finish the job.

One interesting swipe came when President Obama took issue with a recent Supreme Court decision to allow for unlimited campaign donations by corporations (read about the pros & cons of this decision here). The president's comments drew an irate response from Justice Samuel Alito who was obviously one of the judges who voted for this stupid decision.

This brings me to my latest topic, private equity. The Lords of finance were out again, talking up private equity. Jennifer Rossa of the WSJ reports, Apollo's Leon Black Staunchly Defends Buyout Industry:

Leon Black, president and chief executive of Apollo Management, defended Wednesday the private-equity model and the deals done by big buyout shops during the boom years.

"I think it's a pretty good model for an asset class," Black said in a keynote address at the Private Equity Analyst Outlook conference. "I believe in it. I put my own money in it."

Discussing deals done at the top of the boom, he questioned whether Apollo and other firms like it were wrong to pay as much as they did for companies. They were willing to pay more then because the companies for sale were better and because the financing was "incredibly attractive," he said.

"Now you can say these guys overpaid," Black said. "When you look at things at the nadir of the cycle, you're right."

Black agreed that Apollo has made its fair share of mistakes but said that overall he believes the good outweighs the bad by far.

"Apollo has done bad deals in its history," Black said. "Linens N Things was a terrible deal. Having said that, if you look at [the fund that did the deal], we made 21 investments. That portfolio was the best portfolio in our history." He said that fund, Apollo Investment Fund VI LP, has generated a 64% internal rate of return.

Results like this make it easier to have tough conversations with limited partners, Black said. California Public Employees' Retirement System late last year pushed Apollo for more favorable terms, including a lower management fee.

Black didn't directly address the Calpers discussions but said he believes the firm's management fee is already quite low.

"I think we've had a 20-year relationship with our LPs," Black said. "They have every right to complain ... but I do think they believe this is still a very good asset class if you're with a top-quartile performer."

Black also said he believes the opportunity to invest in distressed commercial real estate will be huge and that Apollo will be a player in this area. And he seemed sanguine about the possibility that carried interest taxes may be raised, telling the audience that a higher tax "wouldn't be the worst thing in the world."

Reuters was more specific on where Black sees opportunities in real estate and commodities:

Private equity firm Apollo Management founder Leon Black said on Wednesday he sees investment opportunities in commercial real estate, commodities, metals, energy and agriculture.

He expects to do more distressed investments on a select basis, and sees opportunity for investing in finance-related assets. Black was speaking at a private equity conference in New York sponsored by Dow Jones.

Apollo, which has investments in firms including gaming company Harrah's Entertainment and real estate broker Realogy, has been an active investor in credit and distressed assets.

It said in November it had $13.4 billion of uncalled capital commitments -- or "dry powder" to spend.

Its latest fund, the $14.7 billion Fund VII, started investing in January 2008 in the midst of the economic downturn.

Black conceded that Apollo has done some bad deals, citing Linens 'n Things, a retail investment that filed for bankruptcy protection as sales slumped.

"Linens was a terrible deal but if you look at Fund V, which Linens was in, it was the best (overall) portfolio in our history, and Linens was a wipeout."

Apollo has also been moving closer to following rivals onto the New York Stock Exchange, and in November it updated a regulatory filing regarding its plan. Rival Blackstone Group listed in 2007 and Kohlberg Kravis Roberts & Co, which is listed on Euronext, is expected to move to the NYSE.

Apollo originally filed with the U.S. Securities and Exchange Commission in April 2008 -- before the market slid -- to register securities already traded on a private exchange and said it planned to list them on the NYSE.

Black said on the sidelines of the New York conference that he hopes the shares will be listed by the end of the first quarter, but said the timing was up to the SEC.

Asked whether he expected tax on carried interest to rise -- a controversial debate for private equity -- he said that "when you're dealing with the world of politics nothing is inevitable."

The U.S. House of Representatives has several times voted to increase taxes on carried interest -- compensation earned by hedge fund and private equity fund managers for money management.

These individuals now pay a capital gains tax of 15 percent. The proposal would treat such compensation as income and therefore be taxed at 35 percent.

U.S. President Barack Obama included the proposal in his 2010 budget, though the idea has failed to gain momentum in the U.S. Senate.

"The government is, as it should be, looking for every revenue source," said Black. "It wouldn't be the worst thing in the world for some adjustment," he added.

Others are also selectively betting on commercial real estate. Lavonne Kuykendall reports in the WSJ that Weak Commercial Real Estate Market Hides Deals:

Bonds aren't getting a lot of love lately, as high-profile investors such as Warren Buffett say they favor equities right now.

Bill Bemis, portfolio manager for Aviva Investors, a unit of Aviva USA Corp., manages the group's securitized asset portfolio. He believes there are some great bond deals to be had, particularly in securities backed by commercial mortgages--even as expectations for a downturn in that market grow.

Aviva Investors is a global asset manager whose customers are primarily institutional investors. The group had $362 billion in assets under management at June 30, 2009.

Aviva Investors' fixed income capabilities can be summarized by comparing the net performance of their Core Aggregate portfolio to the Barclays U.S. Aggregate. In the fourth quarter of 2009, Aviva Investors rose 0.77%, compared with the benchmark's 0.2% rise. Over three years, Aviva Investors rose 7.33%, compared to 6.04% for the benchmark.

The minimum investment required for the Core Aggregate portfolio is $25 million. "We expect higher delinquencies, falling property values and lower rents, and commercial mortgage property values will decline in 2010 as well," Bemis said. Market fear over the performance of commercial mortgage bonds is still high, he said, but "that doesn't necessarily mean there is no value in [commercial mortgage-backed securities]."

Even though he said he expects to see the commercial real estate market continue to deteriorate for at least the next year, Bemis said his group is adding exposure to commercial mortgage-backed securities, but only at the highest credit enhancement level, which typically means the triple-A or most protected of the securities.

Bemis buys securities backed by "seasoned" 2005 and earlier mortgages. After that, underwriting on the loans began to deteriorate, he said, just as it did in the residential market, though not to the same degree.

"Our view is that currently you are getting more than compensated for the risks which lie ahead in the commercial real estate market," Bemis said.

Bemis is more bearish on mortgage-backed securities packaged by Fannie Mae (FNM) and Freddie Mac (FRE), the government sponsored enterprises that ran into trouble as the residential mortgage market imploded over the past two years. Bemis expects those securities to underperform in 2010, as the Federal Reserve pulls back on purchasing.

"That is a general theme for 2010," Bemis said. "What happens as the government starts to pull back on some of the stimulus they have put out there?"

For his part, Carlyle Group co-founder David Rubenstein said the private equity industry is still weighing its response to proposals from President Barack Obama’s administration related to limiting banks’ risky bets:

“The private equity industry is not certain what position to take because if we come out in favor, it may not pass, so I’m not sure we should say anything,” said Rubenstein. “I suspect something along those lines will get done in a transition in three to five years so no dramatic affect right away.”

Obama made a proposal this month to limit the size of banks and prohibit them from investing in hedge funds and private equity funds as a way to reduce risk-taking and prevent a repeat of the financial crisis. The plan would also bar banks from running proprietary trading operations solely for their own profit.

Congress may pass some regulatory reforms because of public pressure, though the final outcome remains unclear, Rubenstein said. It is too early to know whether new regulation will be “good or bad” for private equity firms, he said.

Getting national regulatory solutions is “difficult enough,” so getting multilateral solutions are “almost impossible,” he said.

Some think the new reforms will benefit the private equity industry. Jim Kim of Fierce Finance asks, Private equity to gain from new Glass-Steagall?:

Wall Street collectively shuddered at the thought of a new Glass-Steagall. But not all sectors of Wall Street will be affected in the same way. The private equity industry--firms that are not owned by banks anyway--may even gain.

The Financial Times notes data from consulting firm Prequin that shows banks provide only 9 percent of all private equity investments. So the top banks in this arena, mainly Goldman Sachs (GS) and JPMorgan (JPM), do not stand to be affected in the main.

The wider industry may also welcome the changes. If a bank ends its private equity investment business, "it will no longer get first look at deals the investment bank is working on. Smaller fund managers will welcome the level playing field."

At the same time, if a target goes bankrupt, will the bank be able to assume ownership? It's unclear. If a bank will not be able to hold principal investments, that line of assumed protection goes away. Costs may rise, but that may not be the case. There may be a fine distinction.

Let me end by stating that my favorite part of President Obama's speech was how he ended by talking about the growing cynicism gripping Americans. He made reference to the "resilience" and "values" that helped shape America. He also noted, in the past, politicians didn't sign bills for the next election, but for the next generation. Let's hope this wasn't empty rhetoric and that both he and Congress will pass meaningful reforms.

Comments

[mtguy]

I didn't vote for McCain either, but I don't think he is the perpetual liar that MR. O is. And no, the President isn't supposed to berate the Supreme Court, even if he disagrees. BTW, it wasn't a dumb decision on their part unless they cut out all contributions or severely limit contr's to political campaigns. Why should corp. America go around with their hands tied behind their backs while the Unions can rape their employees for as much money as they want to generate political contr. dollars. At least this levels the playing field a bit.

Personally I'm for term limits and severe limits to political campaigns. It's just a form of bribery, which, last time I looked was illegal in this country, I don't know about your country, Canada.

[mtguy]

Leo, Leo, Leo

I used to have some respect for your opinion, but this might be the last time I ever read one of your comments. Obama and his cohorts are lying, cheating thugs who cannot be trusted, period. I've learned in this very long year he has been in office that when he says something, it means the polar opposite. If he says look left, you better be watching your right side. He believes in "the big lie" (alinsky).

As for him denegrating a Supreme Court decision, well that is just wrong! Separation of the judicial branch is absolutely necessary for our country to function. To blur those lines is to create a mockery of our system. We might as well be a dictatorship.

Pension liabilities, yes a huge problem. But we've got so many I stopped counting.

One last point, I am so tired of hearing how intelligent he is. Don't we all know people who are 'book smart' but can barely turn on a light bulb? Intelligence to me means that you add value to society, you don't see how many times you can get away with scamming it. If he was so fucking smart, how come he can't get his beloved health care through when he had a majority in the house & senate? How come he couldn't fool the people of this country for even one year to get his socialist policies in place? He's an f ing Chicago thug.

For the record, I was no Bush fan either. Our gov't is out of control and has been for many years. At least there are more than a handful of us realizing it now, after one year with this phony bastard. If he's done anything good, that is it.

[Leo Kolivakis]

The Supreme Court decision was just plain stupid. Obama expressed this potlitely last night and he's entitled to his opinion. He knows he has no say over how these judges vote (except for those he appoints). As far as Obama being a "phony", I think we put too much weight on what a President can or can't do. Honestly, would it have been that much more different if McCain was elected? Think about that.

[exportbank]

A great orator isn't necessarily a great policy maker nor leader. I admit I was swayed by the words of CHANGE in the campaign and got warm and fuzzy when he was elected but I doubt it would be any different if McCain had won.
We have debt and deception problems at every turn in the economy - but the government knows, that by propping up the market, all appears well to the American Idol watching public.
Leo, like all of us "has his book" but he often brings pension issues of importance to ZH and I think pensions and health care is what will truly sink all of us because they are harder to kick down the road. I think there isn't a pension plan in North America with assets(marked to market) at even 50% of what they show. Private Equity is great because the first money out is the money the PE guy put in - the others end up holding the bag -- it's a win-win.

[Leo Kolivakis]

Listen up folks,

I am Canadian and having listened to eight years of "W", I am glad you elected an intelligent president in office. Having said this, I am the first to admit that President Obama has the potential to be far more dangerous than "W" because of his intelligence, popularity and his ability to bullshit people. Thus far, his administration is just an extension of the previous one, basically pandering to the financial oligarchs. But he may want to leave his mark by actually taking bold steps on financial and health care reform (after all, he's a narcissist like Clinton and "W"). Talk is cheap, and I agree with you, actions speak louder than words. Enough with rhetoric and let's see some real action. As I stated in my blog, Obama and his economic advisors better pay close attention to the pension crisis. If they ignore it, they are toast. And that is a prediction I stand by.

[caconhma]

I like to summarize Obama and his administration by the two excellent comments above:
1. "Last night's speech finally made me truly realize that BHO is a pathological lier. So it is not his ears, it is his complete lack of integrity."
Well, what else one can expect from a rotten Chicago gutter.

2. "BO taking a swipe at the SCOTUS for its decision to uphold free speech is absurd when he destroyed campaign finance by forgoing public financing with his $750 million dollar warchest from the very same people he's bailed out the first year of his presidency."
Well, what else one can expect from a hypocrite and a fraud.

Great leaders challenge their people with their vision and great ideas. Unfortunately, our politicians are intellectually bankrupt. The only thing our leaders can do is to lie to and bribe voters with money they have stolen from them.
This economic/political model is utterly unsustainable leading to major "structural" society changes.

[wang]

Dear Leo:

I know that it is common for economic bloggers to wear their politics on their sleeve (or under their sleeve) e.g. Mark Thoma, James Kwak, Simon Johnson, Paul Krugman etc., so you are in the company of Nobel Laureates and Harvard professors. The concern I have when reading those blogs is that their partisan bias seems to color  their perspectives. Over time I find myself visiting their sites less and less, much like I avoid HuffPo as a news site.  Krugman is a smart guy but his economic prescriptions have more to do with promoting a political agenda and quite frankly it is too much effort to try and filter out the partisan crap in the hope of finding an economic nugget.  Bloggers like Johnson and Kwak  or Thoma are even more frustrating than Krugman as their politics are more subtle, yet every bit as biased as Krugman's. At the end of the day when I sense that a blogger is covertly / overtly injecting partisan politics into their opinion I tend to discount what they are saying and eventually stop reading them all together. 

You are a smart guy with some great insights but to be honest I can't stomach the politics.

Best Regards,

Wang

[Noah Vail]

Our government can be likened to two crime families that try to avoid destroying each other by sharing power in the same city. They end up destroying the city instead. There is no out for the inhabitants because the mobsters are in contol of every facet. Get used to it; we lost our nation by default as we accepted their bribes and failed to resist their extorions.

[Anonymous]

"There is a difference between Republicans and Democrats. One has no heart and the other has no has no spine. But they both work for the same crime syndicate."
Joe Bagaent - Author, Deer Hunting With Jesus

[Anonymous]

"but it was a phenomenal speech".

You are crazy Leo

[Anonymous]

"but it was a phenomenal speech".

You are crazy Leo

[Anonymous]

More financial reform written by Goldman Sachs lobbyists!! That is what happens when script reading actors, get elected, instead of leaders. So far the only thing Obama has run is his mouth.

[Anonymous]

Earth to Leo:

Any time Obama speaks it's *empty rhetoric*. This is pay to play, the Chicago way, Leo. Meaningful reforms? Get out.

[Anonymous]

Compared to FDR Obama is a glittering jewel of colossal ignorance and stupidity! That speech is further proof he's not listening.

[MarketTruth]

Last night's speech finally made me truly realize that BHO is a pathological lier. So it is not his ears, it is his complete lack of integrity.

[Anonymous]

Awe c'mon, you thought he wasn't the third Bush term?

You're the idiot.

A play right out of the Bush playbook. .

Obama speech = epic failure.

Now, back to lying cheating and stealing from the middle class to give to the rich and poor alike.

[Anonymous]

One interesting swipe came when President Obama took issue with a recent Supreme Court decision to allow for unlimited campaign donations by corporations (read about the pros & cons of this decision here). The president's comments drew a irate response from Justice Samuel Alito who was obviously one of the judges who voted for this stupid decision.
~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~
What's wrong the trial lawyers and unions having a little competition. And what do you have against free speech?

[earnyermoney]

BO taking a swipe at the SCOTUS for its decision to uphold free speech is absurd when he detstroyed campaign finance by forgoing public financing with his $750 million dollar warchest from the very same people he's bailed out the first year of his presidency. I'd say his contributors are getting and will continue to get a nice ROI.