In Search of the Perfect Investment

I put money into the Park Avenue Bank. A few months later the president was arrested for fraud and the FDIC closed the bank. By pure chance I’d taken my money out. I’ve never had money in a failed bank but lots of people have had. I’m sure it’s not not pleasant.

Yesterday I wrote about my love for the deal which BankDirect was offering on money deposited with it — namely American Airline miles. If you added in the value of the miles to the interest you were getting it looked like a return of 8% a year. Totally phenomenal. Especially when every other bank or money market fund is paying no more then sixty  basis points (typically fifty basis points) for on-demand money. Perhaps too good to be true?

My motto is CHECK. CHECK. CHECK. We’re in a post-Madoff world. You don’t trust nobody.

You can’t check everything, of course. I had no way of checking if  the Park Avenue Bank’s president was a crook. I had no way of knowing that the Park Avenue Bank would fail. But I could check into the fundamental question of FDIC insurance. After all, that’s the key to not losing your principal. (Warren Buffett’s first principle of investing.)

Is the money I propose giving to BankDirect FDIC-insured, or not? Not a very difficult question you’d figure. Many of my readers emailed me yesterday with quotes from BankDirect’s web site saying it was FDIC-insured. Others sent me material  telling me that BankDirect was part of Texas Capital Bancshares Inc. and one of its companies — Texas Capital Bank, National Association (FDIC Cert: 34383) is FDIC Insured, according to the FDIC’s website. Fine.

But what about BankDirect? What relationship does BankDirect  have to Texas Capital Bank?

I called BankDirect’s banking reps and asked my relationship question. One told me BankDirect was a “subsidiary” of Texas Capital Bank and another said it was a “division.” What the heck? They can’t even get their story straight. This is banking. Serious business. Even technology companies do a better job with the “facts.” In my career I’ve seen companies walk from the liabilities of their subsidiaries.

I then figured I’d call a senior executive of Texas Capital Bancshares. Calling corporate executives out of the blue is not an easy (or quick) task. I started with the CFO, Peter Bartholow. His  secretary, an uncooperative woman called Candace, actually hung up on me.  He wasn’t “available” — which is  a really dumb thing to tell a financial reporter, i.e. me.

I called most of the executives listed on the Wall Street Journal’s listing of executives.   Finally I actually fluked a live person — Joseph M. Grant, 71 or 72,  chairman emeritus and senior executive advisor. Mr. Grant knew exactly what I wanted — written proof that BankDirect (which he apparently helped form) was FDIC-insured. He promised it quickly. He took my email address, promised to read my column and promised to get back to me with my proof by 8:00 AM this morning eastern time — my deadline.

He never got back to me.

This doesn’t mean BankDirect is or isn’t FDIC-insured. But it does raise a pretty serious red flag.

If you’re a director of a public company by now you’ve figured out the power of Google. When some potential BankDirect depositor starts his checking into BankDirect, Google is going to find my columns. And it’s going to look very bad for BankDirect and Texas Capital Bancshares. Hence, the fact that Grant and his people never got back to me is a very, very serious red flag.

I wanted to give them real money ($500,000), and use the airline miles. Drat.

Wall Street takes care of Wall Street. But not necessarily its clients. I have money in private equity funds run by prestigious large Wall Street firms. I know two things: First, all my monies are way under water.  Second, all my monies have generated huge fees for the Wall Street firms that sold me the investments. Of course, you could argue I was stupid. You’d be right. But there was a time when private equity investments actually made money for their investors, like me. What happened? Things changed.

Not all private equity stories are as egregious as the following ones. This  is from last Sunday’s New York Times. Read it and puke.

Private Equity’s Trojan Horse of Debt
By GRETCHEN MORGENSON
WHENEVER savvy private equity firms sell debt in the companies they own, buyer beware.

That’s the lesson — learned the hard way — for bondholders in Wind Hellas, a Greek mobile phone operator whose parent company defaulted on some of its debt payments last November.

A once-healthy company that is Greece’s third-largest mobile phone operator, Wind Hellas was taken over in a 2005 buyout by two global private equity giants: Apax Partners out of London and the Texas Pacific Group, led by David Bonderman. The two firms larded Wind Hellas with debt before selling it off just two years after they bought it.

Wind Hellas filed for the British equivalent of bankruptcy protection last fall, and now some investors are trying to figure how such a promising enterprise went aground. Apax and T.P.G. officials declined to comment for this column.

But Bertrand des Pallières, the chief executive of SPQR Capital, a London investment firm, was one of the larger bondholders in Wind Hellas. He says the decision by Apax and T.P.G. to heap debt onto the company while simultaneously extracting so much cash from it ultimately contributed mightily to its woes.

“The private equity industry always pitches how constructive it is as an investor force to create jobs and growth,” says Mr. des Pallières. “But there are private equity funds that get rich by breaking companies and making others poor — whether they are creditors, states or employees.”

When the deal to buy Wind Hellas — then known as TIM Hellas — was struck in 2005, the buyers gave it a nifty code name: “Project Troy.” Apax and T.P.G. paid 1.1 billion euros for 81 percent of the company; later that year, they paid 264 million euros more for the rest.

At the time of the buyout, TIM Hellas was a young company with a history of operating growth, regulatory filings show. From 1999 to 2004, the year before the buyout, cash flow at TIM Hellas grew almost 17 percent, annualized. It generated cumulative earnings of 283 million euros for the years 2001 through 2004, and by the time of the deal was serving 2.3 million customers.

The company had little debt — 166 million euros — before the buyout and boasted shareholder’s equity of almost 500 million euros. Then Apax and T.P.G. came calling.

Major banks, including JPMorgan Chase, Deutsche Bank, Lehman Brothers and Merrill Lynch, financed Project Troy. Apax and T.P.G. put approximately 450 million euros into TIM Hellas as equity, but this money was returned to the firms less than a year later after the phone company issued a round of debt.

The private equity firms also received consulting fees worth 2 million euros per year, company filings show. In addition, Apax and T.P.G. received 15 million euros for “business advisory services rendered in connection with debt placement and preparation of business and strategic plans,” according to the company’s 2005 annual report.

Under its private equity owners, TIM Hellas took on debt immediately. By the end of 2005, the company was carrying 1.26 billion euros in long-term debt, almost eight times the level a year earlier. Then came the bond offering of 500 million euros in April 2006 that let Apax and T.P.G. get their money out of the company. After that deal, Standard & Poor’s cut the company’s debt rating to B, citing “the significant increase in leverage and material weakening of free cash flow.”

Still another trip to the debt markets for TIM Hellas occurred in December 2006, when it raised roughly 1.4 billion euros. By the end of that year, the company’s debt load had grown to over 3 billion euros, 20 times the level of two years earlier, before the buyout.

At the same time, the company’s financial performance was declining. Net income at the company rose from 35.9 million euros in 2001 to almost 80 million in 2004 but shifted to losses in 2005. From 2004 to 2008, the company showed losses totaling 155 million euros.

Perhaps the most interesting part of this tale involves a transaction that occurred around the time of the December 2006 debt offering. In that deal, 974 million euros — out of the 1.4 billion euros raised in the offering — went from the company to Apax and T.P.G. The prospectus for that transaction described the 974 million euro payout as a repayment of “deeply subordinated shareholder loans.”

But at the time of the offering there weren’t any such “shareholder loans” listed on the company’s balance sheet. In other words, the company was paying back Apax and T.P.G. for loans that were listed as equity rather than as debts at TIM Hellas.

ADDING to the mystery, the repayment was made using a peculiar transaction involving the redemption of “convertible preferred equity certificates” that TIM Hellas had issued. These exotic securities can be accounted for as debt or equity, an option that allows companies that issue them to choose whichever category gives them the most tax advantages in a given country. TIM Hellas classified the certificates as equity.

TIM Hellas had issued such certificates when it was bought out in 2005, and as of April 2006, each certificate carried a value of 1 euro, according to the company’s filings. The company’s 33.8 million certificates outstanding as of September 2006, therefore, had a value of 33.8 million euros.

Company filings from September 2006 seemed to assure potential bondholders that TIM Hellas could redeem these certificates at prices greater than par value or market value only when “the company does not have any other debt liability to pay or to provide for with priority” to the certificates.

On Dec. 21, 2006, however, the certificates were redeemed to pay back those mysterious “shareholder loans.” And they were redeemed for 35.6 euros each, which generated the 974 million euros used to pay Apax and T.P.G.

Just 10 days later, as 2006 was drawing to a close, the value of the equity certificates fell back to 1 euro each, according to company filings.

Why did the certificates suddenly spike in value? Neither Apax nor T.P.G. would say. But their lofty price, according to the debt prospectus accompanying the transaction, was determined by a friendly crowd: the directors of one of TIM Hellas’s own subsidiaries.

These board members weren’t identified, but at the time the board of TIM Hellas itself was very clubby. It consisted of 10 people; six were employees of Apax and T.P.G., and two were company insiders. The other two directors were independent.

In February 2007, less than two months after Apax and T.P.G. snared the windfall from their certificate payout, the firms sold TIM Hellas for 3.4 billion euros in equity and debt.

Last fall, the parent company for the mobile phone operator now known as Wind Hellas defaulted on some of its debts, an unhappy situation that has left Mr. des Pallières, the investor, shaking his head.

“Private equity and banking can be very constructive functions of the economy, but they will destroy this industry if the leading players do not regulate themselves,” he says.

It’s yet another tale for our times.

Still Not Convinced Job Growth Is Coming? These words and the chart is from Clusterstock. This is powerful, optimistic stuff.

This relationship makes complete sense yet is frequently forgotten — There has been a simple long-term correlation between U.S. power production and job growth, going back decades, as shown below.

U.S. power production fell with the recent economic downturn, most likely because there was less economic activity (plus some belt tightening when it came to energy usage).

Yet now it is rebounding. Which unless this relationship has suddenly changed, means that new jobs are highly likely to be created in the coming quarters.

The chart below is also interesting as a validation of the U.S. recovery because, right now, many who doubt the validity of Chinese government statistics look to Chinese power usage numbers as a tangible check on the economic growth that the government claims.

Well the same works for the U.S. It has passed the ‘China’ test.

The Big Spenders in the Big City.  Son Michael and fiancé Anne (future daughter-in-law) are spending the weekend in “The Big City” — Seattle. They got a free train ride from Portland, Oregon on Michael’s frequent Amtrak miles. They  found a $70 a night luxury hotel in downtown Seattle on a classy website. Son Michael gives cheapness a whole new meaning.

They’re visiting the Alexander Calder exhibit at the Seattle Art Museum.