Evening Reading: Buffett Profits From Bailout

Buffett gets the Goldman treatment: Goldman Sachs has faced much criticism for profiting from taxpayer largesse. Now the spotlight is turning Warren Buffett’s way. Berkshire Hathaway has more than $26 billion invested in eight financial companies that have received bailout money, writes Rolfe Winkler. “The TARP at one point had nearly $100 billion invested in these companies and, according to new data released by Thomson Reuters, FDIC backs more than $130 billion of their debt. To put that in perspective, 75 percent of the debt these companies have issued since late November has come with a federal guarantee. Without FDIC’s debt guarantee program, even impregnable Goldman would have collapsed.”

Another horse in the race: BofA’s merger with Merrill has cost its shareholders billions, brought the firm to its knees, cost Ken Lewis his job as chairman and cast doubt over his job as CEO. Yet one of the oft mentioned problems with ousting Lewis is who will replace him? John Thain seemed like the obvious choice back in September, but we all know what happened there. So who then? The list got a bit of a shake up this week. Sallie Krawcheck’s name was added to the list, while Thomas Montag ’s name was removed. Dealscape runs through the potential contenders.

Why did Pepsi buy its bottlers? Pepsi and Coke spun off their bottlers a decade ago. That allowed the soft drink giants to focus on their core products and brands, while the bottlers did the grunt work. But things have changed. Fewer people are drinking soda these days. By taking back control of its bottlers, Pepsi will have greater power in dealing with stors such as Wal-Mart and can eliminate redundancies in its distribution system, writes the Big Money. But the real question is will Coca-Cola follow suit? Right now, it doesn’t seem likely, writes the Big Money.

Geithner should be angry, but at who? Tim Geithner had had enough last Friday, and unleashed a tongue lashing on the financial regulators standing in the way of Obama administrations efforts to reform the financial regulatory system. Matthew Goldstein over at Reuters says good for him. But before you think Goldstein thinks the regulators had it coming, he doesn’t. Rather Goldstein thinks the anger should have been directed at — surprise, surprise — the bankers. “It’s about time someone in the Obama administration got a little red in the face over the financial crisis. But here’s the thing: the Treasury Secretary’s temper tantrum was misdirected and he ended up taking his anger out on the wrong parties. The people Geithner really needs to be delivering a few choice words to are the nation’s bankers — especially the ones who were bailed out by U.S. taxpayers and now act as if last fall never happened.”

Citi, Andrew Hall and $100 million: Should Hall get his $100 million pay day? Should Citi offload the Phibro unit Hall runs? Felix Salmon weighs in again on the topic. “Citi isn’t and shouldn’t be in the business of running hedge funds, and the great thing about Phibro (compare and contrast Old Lane) is that the bank will have not only made billions of dollars in total profits to date but will also make a large gain on selling the business as well.”

Court Kills Chrysler Conspiracy Theories

Remember the delay that holdout Indiana pension funds caused in Chrysler’s historic bankruptcy case? A federal appeals court ruled against the Hoosier pensioners in early June, and the U.S. Supreme Court declined to hear the case.

But things moved so fast that the 2nd Circuit Court of Appeals had to rule from the bench. Today the 2nd Circuit issued its final written opinion, striking down a series of arguments made by the funds that attempted to block the government-backed Chrysler-Fiat deal. The big takeaways: If you’re a debt holder, you need to offer solutions of your own – otherwise a company can sell its assets free and clear to a white-knight buyer. And if you’re part of a group of secured lenders, the lead agent holds sway on whether to cut deals with whomever it chooses.

For companies who want to use quick bankruptcy asset sales – known as 363 sales for the relevant section of the Bankruptcy Code – to remake themselves, New York is your venue.
“Short of the Supreme Court or Congress changing the status quo, it seems practitioners could feel very comfortable using a 363 sale in New York, because they have a strong precedent here,” said Stephen Lubben, a bankruptcy professor at Seton Hall law school who has testified before lawmakers on the Chrysler and General Motors cases.

Here’s a rundown of the Indiana pension funds’ arguments and how the court knocked them down:

1) Chrysler’s use of a 363 sale to sell its assets to Fiat constituted a “sub rosa” plan that trampled on creditors’ rights.

In bankruptcy, companies typically have to submit reorganization plans subject to creditors’ approval. But the government feared that would take too long, and risk liquidation. So instead, Chrysler used a quick 363 sale to unload its assets to Fiat, the only buyer available.

The pension funds, angry they would receive only 29 cents on the dollar, said that plan violated their rights. They deplored a deal with the government that would give the United Auto Workers union, an unsecured creditor, equity in the new Chrysler owned by Fiat while secured lenders got about $2 billion for their $6.9 billion in debt.

But the court found that legal precedent allows judges to approve these sales if there is a “good business reason” that maximizes the value of eroding assets:

To preserve resources, Chrysler factories had been shuttered, and the business was hemorrhaging cash. According to the bankruptcy court, Chrysler was losing going concern value of nearly $100 million each day … With its revenues sinking, its factories dark, and its massive debts growing, Chrysler fit the paradigm of the melting ice cube. Going concern value was being reduced each passing day that it produced no cars, yet was obliged to pay rents, overhead, and salaries. Consistent with an underlying purpose of the Bankruptcy Code – maximizing the value of the bankrupt estate – it was no abuse of discretion to determine the sale prevented further unnecessary losses.

2) The sale cheats pension funds by releasing their liens against their will.

The court beat back the funds’ arguments that its liens couldn’t be released by other secured lenders, which cleared the way for the sale. In its opinion, the court said the lenders’ lead agent has broad discretion to act on behalf of other debtholders.

The bottom line: agents rule the day. “This is one of the first circuit court opinions to address the structure of senior debt agreements and the control that an agent has in a bankruptcy case,” said Lubben. “The relationship between the agent bank and all the other banks in line is going to be a very important issue in the next 18 months as we work our way through a number of Chapter 11 cases.”

3) The Treasury Department illegally used TARP funds to aid Chrysler, because the auto maker isn’t a “financial institution.”

The court said the pension funds “lack standing” to bring an argument that the Treasury illegally used TARP funds. The funds “raise interesting and unresolved constitutional issues,” the court wrote, but the judges didn’t have jurisdiction to consider it. See Deal Journal’s previous interview with Chrysler’s lawyer, Jones Day partner Corinne Ball.

Why Is AIG Stock Up 63% Today?

AIG rose 63% today.

No, that isn’t a typo. Shares of American International Group, which is 80% owned by the U.S. government, surged two days before the beleagured insurer is scheduled earning’s release on Friday. It was the biggest gain since. The company is now worth — yes — $3 billion, one seventh of the value of its all-time high.

What’s behind the surge?

1) One likely reason was the financial results of a little-known Philadelphia mortgage insurer called Radian Group. The company blew away analysts profit expectation today and cut its claims payments outlook for the rest of the year. The company says mortgage losses are declining as the housing market recovers. While everyone from home builders to banks have been saying there are signs of a turnaround, Radian has some numbers to prove it. Radian’s loan – loss provisions fell 78% to $132.8 million. While first- and second-lien claims were $167.7 million, far below expectations of about $300 million.

That bodes well for AIG, which holds or insured hundreds of millions of dollars of mortgage-related securities and derivatives. Like Radian, AIG could surprise investors with fewer mortgage losses. It could also see big gains, as it marks to market its mortgage and other assets, amid tighter credit spreads, says S&P analyst Cathy A. Seifer.

2) There’s speculation that the recent hiring of MetLife veteran Robert H. Benmosche as AIG’s new chief might have lifted the stock. But it seems doubtful that investors would put that much faith in the ability of AIG’s fourth CEO in 14 months to resurrect the company. And besides, if that were the case, the stock would have reacted days ago. “I hope for his sake that he’s not the reason,’’ for the stock surge, says Seifer. “Those would be big expectations for one person to meet.”

3) Is AIG about to be sold in its entirety? The company has been trying to selling off its assets piecemeal, from New York office buildings to its insurance operations in Japan, with mixed success. Most recently, private-equity firms are in talks to buy AIG’s aircraft leasing business and there’s a possibility that the U.S. government will increase its $5 billion guarantee of the aircraft leasing debt to attract more investors. But it’s doubtful that AIG would have more success selling its whole shop than it has shopping it pieces. In addition, a sale of the company probably isn’t imminent if AIG just signed a contract, totaling as much as $10 million, to hire Benmosche.

4) A potential debt-for-equity swap? As our friends at Marketbeat point out, there’s also been some chatter about a debt-for-equity swap between AIG and the U.S. government. The swap would reduce the debtload AIG has to pay back to the government. It’s seems one of the most positive reasons for the stock movement, though at the moment it’s unconfirmed.

UPDATE: Deal Journal just spoke to two people, both of them highly knowledgeable about goings on inside AIG. They said that the company has no apparent plans for a debt-to-equity swap, big M&A transaction, or other big shakeup. Most people in the company are focused on the new CEO and Friday’s earnings, they said. If anything is driving the stock runup it is market optimism about those results, they speculated. But like many others, they remained stumped by the big move.

Even Goldman Now Sees a Rosier Third Quarter

Economists at Goldman, Sachs & Co., among the most bearish on the outlook for the U.S. economy, are now joining the ranks of those who see a rosier outlook for the U.S. this year than previously thought. 

The bank now sees the U.S. economy expanding by a 3% annual rate in the third quarter, more than double their previous estimate of 1%. In a research note to clients today, they point to last week’s second-quarter GDP report, which showed so much inventory liquidation that factory output is now likely to expand in the July through September months, providing a lift to overall growth.

The economists also see a bigger assist coming from fiscal stimulus efforts than they had previously thought, coupled with surprising strength in residential investment rates, most notably home sales. 

Their forecast tweak has no meaningful implications for existing views on inflation (it will stay low); or hiring, (Goldman expects unemployment levels will increase); or any changes in Federal Reserve policy. 

Goldman’s adjustment comes amid a key week for the economy that is likely to see further revisions to second-half U.S. growth after the government’s July nonfarm payrolls report arrives on Friday. Already, market participants have seen the Institute for Supply Management’s surveys of the factory and nonmanufacturing sectors. While the latter, which was released Wednesday, was unexpectedly weak, it was the former’s surprising strength that offered the most important clue about what lies ahead.

The ISM’s Anthony Nieves, who directs the nonmanufacturing survey, said Wednesday that, “manufacturing led us into this recession and manufacturing will lead - as it does historically - out.”

Bulk of TALF Eligible Deals Sold Ahead of Loan Deadline

The bulk of the deals that emerged ahead of a loan application deadline for TALF have sold, according to people familiar with the matter.

Issuers including General Electric Co., SLM Corp., Wheels Inc. and First National Bank of Omaha sold newly created bonds backed by loans for education, credit card debt and fleet leases.

The Federal Reserve’s Term Asset-Backed Securities Loan Facility, or TALF, launched in March, offers investors with loans at attractive rates to buy newly created asset-backed securities. Over $8 billion in deals surfaced ahead of the sixth loan deadline on Thursday. Last month, that figure was a little over $12 billion and in June, it was $16.4 billion.

Most of the consumer loan-backed deals sold this year were eligible for TALF, which helped revitalize the securitization market and improved the availability of credit for consumers.

Initially, the program was viewed as being user-unfriendly but the Fed’s cheap loans drew investors who overcame lengthy documentation and other implementation issues to participate. Now, many hope it is extended past its scheduled expiration at the end of this year.

The Fed has recently also begun to offer attractive financing for new and existing commercial mortgage-backed loans in an effort to revive that sector. The next loan application deadline for the commercial-property portion is Aug. 20.

On Wednesday, General Electric sold two deals eligible for TALF financing: a $500 million deal, backed by dealer floorplans and dubbed GE Dealer Floorplan Master Note Trust 2009-1, has a duration of 2.94 years. The single-tranche deal sold at 168 basis points over one-month London Interbank Offered Rate, or Libor.

The other deal, a $1.75 billion credit card loan-backed deal dubbed GEMNT 2009-2, was originally $1.25 billion. The single-tranche deal, with a duration of 2.93 years, sold at 155 basis points over a short-term benchmark. Joint leads on the bond are RBS and Credit Suisse.

SLM Corp., better known as Sallie Mae, sold its $1.68 billion deal Wednesday. The student loan-backed deal sold at 25 basis points over prime rate, a benchmark. The single-tranche deal has a duration of 3.86 years. Joint leads are Barclays, Bank of America and JP Morgan.

CNH Capital America LLC sold a dealer floorplan-backed deal on Wednesday, according to a person familiar with the matter.

The $583.25 million deal sold at 170 basis points over one-month Libor. The bond, led by RBS and Banc of America Securities, is eligible for funding under the Federal Reserve’s Term Asset-Backed Securities Loan Facility, or TALF.

World Financial Network sold three deals on Wednesday. The first, a $500 million deal of which the top-rated tranche is worth $395 million, sold at 165 basis points over a short-term benchmark. This portion is eligible for TALF loans.

The second is a $310 million deal in which the top-rated portion is worth $245 million. It sold at 205 basis points over the same benchmark.

The third, a $139 million deal, had the $110 million portion eligible for TALF. It sold at 160 basis points over a short-term futures benchmark.

Wheels Inc. sold a $703.3 million fleet lease-backed deal. The triple-A-rated portion of $673.9 million sold at 155 basis points over one-month Libor.

First National Bank of Omaha’s $500 million credit card loan-backed deal sold at 135 basis points over one-month Libor.

Year-to-date issuance of deals eligible for TALF funds stands at over $60 billion.

Goldman Sachs’s Barry Bonds Complex

Goldman Sachs Group has been raising eyebrows for both its record trading profits and the risk it took on to earn that money.

barrybonds_CV_20090805105914.jpgBloomberg News
Barry Bonds hits his record-breaking 756th home run in August 2007.

But a look at Goldman’s daily trading record for the months of April, May and June, show that the Wall Street bank may not have been acting very risky at all. Not when Goldman was able to hit a home run nearly three out of every four days that it traded.

Bloomberg is reporting that Goldman recorded at least $100 million in trading revenue on 46 separate trading days in the second quarter, or 71% of the time. That is a record for Goldman, up from a previous high of 34 days in the first quarter.

With that kind of track record, Goldman would have been crazy not to swing for the fences. It also helps to explain why the firm was willing to trade with a record amount of its capital at risk. Goldman’s so-called value-at-risk, an estimate of how much it could lose in any given day, rose to an average of $245 million in the second quarter from $184 million a year earlier.

Consider that Barry Bonds, the home run king of the San Francisco Giants, was hitting homers 16% of his times at bat, or a homer every six at bats, during his best year in 2001. In his career, Bonds averaged a homer roughly every 12 at bats.

Goldman also was able to rap out the doubles. The company earned at least $50 million a day 89% of the time in the second quarter, according to the Bloomberg report, which was based on Goldman’s recent Securities & Exchange Commission filing.

But like Bonds, who was accused of using illegal steroids to juice his hitting, does Goldman’s second-quarter trading profit also need an asterisk next to them in the record books?

Goldman has become a big player in the controversial world of high-frequency trading, in which computers use complex formulas to conduct rapid-fire trades in markets around the world. Certain types of this lightening quick trading is drawing criticism for giving firms unfair advantage by allow them sneak peaks at market activity.

But in a letter sent to clients this week, Goldman said it doesn’t use such “flash” trading, which allows for the sneak peaks. The SEC is considering banning flash trades. Goldman added that high-frequency trading accounted for less than 1% of its total revenue in the first half of the year.

Still, just as steroid suspicions continue to dog many of baseball’s biggest hitters, Goldman probably will have to keep fielding questions about how it could pull off record profits amid a financial crisis and deep recession. That is the price you pay when you are the only team hitting, while the rest of the league is still in a slump.

Live Blog: American Capital 2Q Call

American Capital Ltd. last night reported a big second quarter loss and said it remains in default on some $2.3 billion of debt. It also said it’s cut some 44% of its work force since March 31, 2008.

The business development company didn’t provide too many details on talks with its lenders in its statement. We’re live blogging the conference call, which starts at 11 a.m., to see what else we can learn.

11:03 a.m.: We are still waiting for things to get under way, and in the meantime are finding the saxophone-heavy hold music oddly peaceful.

11:04 a.m.: Here we go with the disclaimers.

11:06: Malon Wilkus is going through the slide show that accompanies the conference call. So far it is a repeat of information available in the press release that we’ve linked to above. You can view the slide show here.

11:10: “I can assure you that we are focused on resolving the defaults with each of our unsecured creditor groups,” Wilkus says.

11:11: The company has 7.2% non-accruing loans at fair value.

11:12: Wilkus is going through realizations in the second quarter, of which it had $125 million. Of that, $52 million came from the sale of portfolio company equity investments. It had $308 million in realized losses, of which $196 million came from the sale of Consolidated Bedding.

11:15: Wilkus says spreads in the middle market are still widening, in contrast to most other markets.

11:16: On the topic of the forthcoming dividend, it will increase total shares outstanding by about 30%.

11:18: The firm’s European Capital affiliate has $700 million net asset value, but is currently assigned a fair value of $97 million.

11:19: We expect economic growth to start happening in the second half, but we do believe that growth will be slow. American Capital remains focused on resolving its credit defaults, providing support to its portfolio companies, and improving its operating efficiencies.

11:20: The Q&A is starting. Can you share details on a resolution to the covenant breaches? Wilkus says, “We’re unsecured on all our credit facilities that we’re in default of. We really are not able to provide any more color…I can tell you that we are working hard on our effort to resolve our credit defaults.” This is less forthcoming than he was in the first quarter conference call, for sure.

11:24: Does it feel like Ebitda has bottomed? “We do feel the economy is improving, but we aren’t going to forecast whether or not our middle-market portfolio of companies are going to be improving or not with respect to their Ebitda in the next quarter or the quarter after. We are going to be particularly cautious about trying to make any forecast.” Without a doubt there was a decline in the middle-market in the second quarter in the middle market and in American Capital’s portfolio. However, if the economy is indeed improving it will flow to the middle market.

11:27: Wilkus has received a broad-ranging question about life, the universe and everything. Even though the firm has exceeded a 1-to-1 debt to equity ratio that limits it from making new investments, it is still able to make some new investments, Wilkus says. The firm is investing in its portfolio and believes it has enough liquidity to meet the needs of its portfolio, both in difficult situations and to grow. Once it resolves the credit default situation, it believes it will be in a position to raise new capital and start deploying it.

11:30: How about current headcount? “We’ve both reduced the organization almost in half and also cut compensation for the remaining employees substantially,” Wilkus says. They’ve eliminated origination capability. What remains is the ability to manage existing portfolio companies. “If we got back into a mode of reinvesting we certainly could do a modest amount of additional investing,” Wilkus says.

11:35: There is talk about securitizations; it doesn’t seem to have much impact on the firm’s bottom line.

11:38: Wilkus is getting pushed on the difference between his comments on debt now and in the past. He says again, “We feel like we are unable to comment on our negotiations.” In fact, American Capital seems to have developed a general aversion to giving forecasts…

11:41: Somebody reading this blog post has just left a very good question in the comments: could the lenders liquidate the firm?

11:43: Forgive us. They’re discussing excise taxes. Our eyes have glazed over.

11:45 There’s some discussion of how long the firm will be able to pay its dividend in 90% stock. American Capital says it wouldn’t be surprised if that gets extended into next year.

11:47: Part of the challenge of moving quickly to resolve its loan defaults is the number of lenders involved - some 100, if I heard that right…

11:50: There is a question on what happens if the company falls below one times Ebitda to interest expense. Does it breach additional loan covenants? “There isn’t some kind of piling on that occurs if you break other covenants,” Wilkus says.

11:53: Someone asks about the mix of senior debt, sub debt, et. You can find that here.

11:56: “We’ve had $1 billion of liquidity in the last 12 months,” Wilkus says. “Those are large numbers relative to our interest payments. They’re even large numbers relative to the amount of principal we have due this year. He thinks the creditors appreciate the high degree of liquidity from the portfolio and the quality of the portfolio. The firm could get more liquidity if it wanted to take discounts to fair value, but it doesn’t want to do that, and it doesn’t think its creditors want it to do that either.

11:58: As an example of not selling at bad prices, the firm points to People Media. This company was up for sale in the 4Q of last year, but got a bad offer thanks to the environment, which American Capital declined. It reengaged the next quarter and “exited with a very fine outcome.” Here’s our story on that sale.

12:05: We’re in hour two here…on the topic of a possible reverse stock split, “That’s not something we ever want to do. We just want to have the capability of doing it if it becomes appropriate. That mostly would be driven by our stock price and the rules with respect to Nasdaq.” This seems an appropriate point to give a stock price update: looks like it’s trading at right around $3, down around 17%.

12:08: An analyst says he doesn’t understand why the market is pricing the stock at $3, given that the liquidation value as of June 30 should be at around $10. It comes down to the debt default, Wilkus says. That gives the creditors certain rights. “This is not entirely in our control. It’s in part in the hands of our creditors, because they could exercise their rights if they chose to do so. We feel that we’re working in a co-operative manner with our creditors.” So, the analyst says, once you come out of default, what is my risk? Wilkus points to a number of other companies similar to American Capital that are also trading below their net asset values. He says that’s the world we’re living in at the moment.

The Morning Leverage: Recovery Has Yet To Reach American Capital

morningleverage_E_20090803175649.jpgMike Lucas for Dow Jones

In this morning’s media roundup:

News: American Capital’s second quarter returns were a harsh reminder that, amidst signs of recovery, some firms are still having problems. The business development company remains in default on $2.3 billion unsecured debt and reported a loss of $547 million for the second quarter, much wider than its $70 million loss a year ago. Read the LBO Wire story here, and tune in at 11 a.m. ET when we will be live blogging the firm’s conference call.

Italy’s luxury market is becoming a tougher and tougher sell, not just to cash-strapped consumers, but to investors as well. Eyeware maker Safilo is still looking for a partner after Bain Capital and PAI Partners walked out on talks for a 30% stake, and Dow Jones Newswires reported this morning that Clessidra has pulled out of a deal with Roberto Cavalli over the company’s valuation. It can be assumed that both companies are hoping to avoid the fate of their Parisian neighbor/haute couture legend Christian Lacroix.

With their deal for AIG’s aircraft leasing business still in the air, Onex Corp. and Greenbriar Equity are looking to some sovereign wealth funds to provide additional financing for the deal, according to the New York Post. PE firm/sovereign wealth fund tag-teams have long been rumored to be desired; we shall see if they can actually pull this one off.

Paul Capital is bulking up its staff, though mum’s the word on its newest fund, which was slated to begin fundraising this year. The firm picked up nine to its secondaries team, in anticipation of a slew of secondary transactions. Read on in this morning’s LBO Wire.

Analysis: The New York Times takes a look at who is trying to get money from the carcass of Lehman Brothers. One hefty collector looking to jump the line? The city of New York, which claims Lehman owes $627 million in corporate and other taxes dating back to 1996.

Just for fun: With a name like “Platinum Equity,” one would expect that only the finest address would be acceptable on the firm’s letterhead. But Crain’s New York reports Platinum Equity is trading in its Park Avenue address (and Park Avenue price) for swanky digs (with roofdeck) on Vanderbilt Ave., at about a $30 per square foot discount. Not too shabby. For more details, click here.

Deals of the Day: NYC Tries to Jump Ahead in the Lehman Creditor Line

Deals of the Day gathers all the biggest news of the morning related to mergers and acquisitions, bankruptcies, financing and private equity. Deal Journal’s homepage is http://blogs.wsj.com/deals. You can see real-time updates of our posts and our favorite deal-related articles on other Web sites through our Twitter feed at http://twitter.com/wsjdealjournal.

Mergers & Acquisitions

Google: The Web search giant will issue $106.5 million in stock to acquire On2 Technologies as the Internet-search giant looks to buttress its video operations. [WSJ]

American International Group: Private-equity firms that are in talks to buy AIG’s massive aircraft leasing business are trying to raise money from sovereign wealth funds to help keep the government-funded deal on track. [NY Post]

Dow Chemical: The firm raised $2.75 billion through the public sale of debt securities, bringing in enough capital to pay off before the end of the year the $9.2 billion it borrowed to finance its Rohm & Haas acquisition. [MarketWatch]

Opel: GM and Magna have narrowed their differences in talks over the Canadian supplier’s bid for Opel. [Reuters]

Bankruptcy & Restructuring

Hey, No Cuts, Mr. Bloomberg: New York City has accused Lehman of shortchanging the city of $627 million in corporate and other taxes, beginning in 1996. Now it’s trying to convince federal bankruptcy court to let it jump closer to the front of Lehman’s long line of creditors. [NY Times]

Financial Institutions

Goldman Sachs Group: The banks earned more than $100 million in trading revenue on a record 46 separate days in the second quarter, breaking the previous high of 34 set in the prior three months. [Bloomberg]

UBS: A cleaner balance sheet and a modest profit will count for little if UBS can’t stop hemorrhaging employees. [WSJ]

How Healthy Are the Banks Really? A controversial change in accounting rules earlier this year has allowed banks to claim billions of dollars in additional earnings simply by tweaking their bookkeeping, greatly enhancing the appearance that the industry is returning to health. [Washington Post]

Standard Chartered: Banks have raised plenty of capital over the last couple of years, but most of it has been used to fill black holes or satisfy regulators. So Standard Chartered’s equity placing comes as a surprise. [WSJ]

Lloyds Steadies the Ship: If a rising tide lifts all boats, then even a badly holed tanker like Lloyds Banking Group, carelessly steered onto the rocks by its skipper, stands a chance. [WSJ]


Kohlberg Kravis Roberts: The private-equity firm inched another step closer to merging with its Euronext-listed fund after the fund received enough support from its unitholders for the deal. [Reuters]

What Spooks Wall Street These Days? The traction some private-equity firms appear to be “backward integrating” into investment banking by building up their businesses that compete with Wall Street in the lucrative underwriting of debt and equity securities, William Cohan writes. [FT.com]

Fortress Investment Group: The firm second-quarter loss narrowed despite declines in assets under management and fees as revenue beat analysts’ views. [WSJ]

See, Somebody Likes You, Private Equity: Shanghai authorities are working to make it easier for foreign private-equity firms to establish themselves in the city by urging an adjustment in foreign-exchange rules. [WSJ]

People & Players

Daniel Sontag: The head of the Merrill Lynch brokerage force and a 31-year veteran of the Wall Street firm is retiring. [WSJ]

A Higher Calling: The Church of England has appointed Tom Joy, the chief investment office at RMB Asset Management, as fund manager for its $7.5 billion investment portfolio. [WSJ]

Trumping Bondholders? Donald Trump may have set a deal to retake control of his eponymous Atlantic City casino company but skeptics said it mightn’t happen. [WSJ]

Secondary Sources: Recovery?, Stimulus, Setser Signs Off

A roundup of economic news from around the Web.

  • Economic Conditions: James Hamilton of Econbrowser looks at the latest economic data, and isn’t convinced of a turnaround. “I wish we had something else besides the auto numbers that would indicate that things have started to get better rather than simply reassuring us that things are getting worse more slowly than they used to be. I’ll be watching Thursday’s unemployment claims and Friday’s employment report with unusual interest this week. But Phil Rothman, like other forecasters, is predicting we lost another 350,000 jobs in July, or two to three times the number we’d need to add each month just to keep the unemployment rate from rising.”
  • China vs. U.S. Stimulus: The Economist’s Democracy in America blog looks at the differences between U.S. and Chinese stimulus. “America’s federal stimulus package serves partly to counteract massive cuts by state governments, many of which are required to run balanced budgets. That’s a problem China doesn’t need to cope with… It’s certainly true that China’s ability to get infrastructure spending into the pipeline rapidly has made its stimulus package more effective. Equally important is the Chinese ability to get commercial banks to lend more money and stimulate credit growth essentially through party officials jawboning bankers — something that works much better in a communist system than in a laissez-faire capitalist one, as Timothy Geithner has repeatedly discovered. Some may now yearn for America to emulate one or even both of these Chinese traits. But it should be recognized that one major reason China’s stimulus package has been more effective than America’s is that relative to the size of the economy, it’s much, much bigger.”
  • Setser Moves to NEC: Brad Setser, one of the Journal’s picks among top economics bloggers, is leaving his excellent blog to work for Larry Summers at the National Economic Council. “I always intended to write extensively about the world’s emerging markets. I never anticipated that I would end up writing most frequently about an emerging economy that I hardly knew when I first started writing this blog: China. Back in 2004, I was an expert on sovereign debt, not sovereign wealth. But some stories seize you. And China’s rise as a global creditor was just that story. I never thought China’s government would ever add close to $800 billion to its foreign assets over four quarters — accumulate close to $2,500 billion in foreign assets. China has stretched all definitions of the possible. There is — understandably — an enormous amount of interest in the consequences of a world where China is the world’s key creditor country; that, more than anything, seemed to drive this blog’s traffic.” Good luck to Brad. His contributions to the blogophere will be sorely missed.

Compiled by Phil Izzo

Summer Reading, Treasury Style

Some people like to read mindless fiction during their summer vacations, but in case lawmakers were looking for something a little more wonky, the Treasury Department sent a 19-page briefing packet to Capitol Hill in the last few days talking up the Obama administration’s efforts to address the ongoing financial market turmoil.

“The Department of the Treasury has initiated a number of programs as part of the Administration’s plan to revitalize the economy,” reads the briefing packet, signed by Treasury assistant secretary Kim N. Wallace. “While there are signs that the economy is improving, there is still work that must be done in order to build the foundation for long-term economic stability. We must act now to restore confidence in the integrity of our financial system. Secretary Timothy Geithner believes it is imperative that we build a new foundation for financial regulation and supervision that is simpler and more effectively enforced, that protects consumers and investors, that rewards innovation and is able to adapt and evolve with changes in the financial market.”

The briefing packet has three main sections.

1) The Consumer Financial Protection Agency Vs. the Status Quo

a. The “status quo” section says “banks can switch charters to pick their own primary federal supervisors based on who will be the most permissive.”
b. It also says “community banks will benefit from the Consumer Financial Protection Agency” and tries to dispel “six myths” about the agency.

2) Talking Points on American Recovery and Reinvestment Act

a. “The Recovery Act is helping to stabilize the economy and setting the stage for a return to positive growth in the second half of 2009, with solid growth in 2010. Private analysts believe that the Recovery Act is adding about 3 percentage points to annualized real GDP growth.”

3) Department of Treasury Overview of Recent Activity

a. This is essentially an assortment of different press releases and fact sheets Treasury has put out in the last several months.

Geithner Becomes Easy Target for Senate Banking Members

Treasury Secretary Timothy Geithner’s expletive-laced chat with banking regulators on Friday doesn’t seem to have won him too many new friends on Capitol Hill. At today’s Senate Banking Committee hearing featuring many of those same regulators, some lawmakers simply couldn’t resist a few digs.

The committee’s top Republican, Sen. Richard Shelby of Alabama, opened with a few questions for each of the banking regulators. Then he had this to throw in: “Today’s Wall Street Journal had a tough article dealing with Secretary Geithner when he met with a bunch of you, where he told the financial regulators that they should stop. Can you imagine the gall here of the secretary, that they should stop criticizing the Obama administration regulatory reform plan? My gosh. I hope you won’t quit. I think your honesty and your candor here is very important. And we recognize the role of the Treasury to set some policy for financial regulation, but ultimately, it’s going to be the Congress up here. This committee, both sides of the aisle and the House, that’s going to set the tone and create the laws. And I appreciate you bringing this independent perspective with all kind of pressure placed on you.”

As if that weren’t enough, Shelby asked each of the regulators (from the Federal Reserve, FDIC, Office of Thrift Supervision and Office of the Comptroller of the Currency) to affirm that their testimony was not influenced by Mr. Geithner’s little sit-down over at Treasury.  “Serious question,” Shelby said.  Most of them had already raised their objections to parts of the Treasury’s regulatory-overhaul plan.  “I don’t think anybody thinks we’re not independent,” FDIC Chairman Sheila Bair said, drawing laughter. “It was absolutely our testimony.”

Sen. Bob Corker (R., Tenn.) actually asked the regulators of today’s article, “generally speaking, did it capture the essence of the attitude in the meetings?”  Comptroller of the Currency John Dugan drew the short straw to answer. “Senator, it was a candid conversation about institutions — I mean, our agencies’ different views on the different subjects,” he responded.   Asked Corker: “So it was a generally fair article?”  Said Dugan: “A lot of it was true.”

It’s not a Senate Banking Committee hearing without Sen. Jim Bunning (R., Ky.), who we expect will have some fun on the way out.  “I’m very happy to see all of you here today,” he said. “After you’ve kissed the ring of the secretary of Treasury, you finally got out of the room and you’re here in person to testify — independently. It’s really nice to see that.”

A couple of Democrats fought back a tiny bit for the administration, though most steered clear. Sen. Sherrod Brown (D., Ohio) brought up the regulatory failures of recent years and regulator shopping by Wall Street firms, suggesting “there may be some turf issues” in the dispute between the Obama administration and regulators. “That may be a cynical way to look at it, and I apologize if that’s the way you take it. But I hear that — I see the president’s plan, the president’s proposed bank supervision framework. I hear each of you disputing major parts of it.”

Sen. Charles Schumer (D., N.Y.) also pointed out the obvious about turf protection among some regulators.  “If I were sitting where you were with hard-working men and women working for you, I’d say keep my agency, keep all the powers, don’t do any consolidation. I think we in the committee have to see the testimony as coming from at least partially that perspective.”

Read the regulators’ full testimony here.

What’s Happened to Wall Street’s Senior Women?

Sallie Krawcheck has found work. But what about the rest of the hot-shot women on Wall Street?

Deal Journal checked up on where other prominent women on Wall Street have landed amid the turmoil.

For starters, we reviewed the WSJ’s 50 Women to Watch lists from the boom times of 2006 and 2007 and charted where the top women bankers ended up.

Not every female deal maker has been as lucky as Krawschek in finding a second act. Three out of the five female bankers on the 2007 list at bulge bracket firms have lost their jobs or their positions are in flux.

erincallan0804_D_20090804173325.jpgBloomberg News/Landov

Erin Callan

Zoe Cruz: The former Morgan Stanley co-president was ousted after huge mortgage related losses hit the bank in 2007. She continues to look for a job in investment management.

Erin Callan: After she was demoted as Lehman’s chief financial officer in 2008, Callan headed Credit Suisse’s investment bank’s global hedge-fund business. Callan has been on a leave of absence from Credit Suisse since February. A Credit Suisse spokeswoman said it is unclear when she would return. The spokeswoman declined to comment on the reasons for Callan’s leave. Callan has declined numerous WSJ requests for comment.

Amy Woods Brinkley: Once mentioned as a possible successor to Bank of America Chief Executive Kenneth Lewis, Brinkley stepped down as the bank’s chief risk officer in June amid pressure on the bank to shore up its governance. She is staying on at the bank through the end of the summer and will serve on BofA’s charitable board, a bank spokeswoman said.

Two other top women bankers on the WSJ’s 2006 and 2007 ranking have kept their jobs: Wei Son Christianson remains Morgan Stanley’s China chief executive, while Manishra Griortra still heads UBS’ investment banking operation in India.

zoecruz0803_CV_20090804173633.jpgBloomberg News/Landov

Zoe Cruz

Other high-profile survivors (so far) include:

Heidi Miller, continues to head J.P. Morgan Chase’s Treasury & Securities Services unit, one of the bank’s six business units and a big revenue generator. She is a close lieutenant of CEO James Dimon

Barbara Desoer, president of Bank of America Home Mortgage, who was given the thankless task of overseeing the integration of BofA and Countrywide Financial, the troubled mortgage lender that BofA acquired amid the housing slump. Desoer is considered among the top three candidates to succeed Lewis.

Terri Dial was tapped to head Citigroup’s retail banking unit in March 2008. Since then, those operations haven’t rejuvenated as some Citigroup executives had hoped.

Barbara Byrne kept her role as Vice Chairman in Investment Banking when Barclays Capital took over those operations from Lehman Brothers, where Byrne was a 28-year veteran banker.
Ros Stephenson also kept her job as Co-Head of Corporate Finance in Barclay’s investment banking division, a post she previously held at Lehman.

PE Industry To SEC: ‘Please Stop All This Nonsense’


That was fast.

In the day since the Securities and Exchange Commission published proposed rules on pay-to-play, four comment letters have already been posted to the agency’s Web site. Three of them deal with the provision in the rules that would ban the use of placement agents by investment firms seeking capital from public pension funds. This is the part of the proposed rules that has generated the most objections from the investment community.

The most recent letter to be posted is short and sweet, getting straight to the point. From Ted Carroll, a partner at small buyout firm Noson Lawen, here it is in its entirety:

“Please stop all this nonsense. Placement agents provide a valuable service to small and midsized investment firms and 99.99% are honest diligent people. Its offensive to see the many large political donors involved in the recent pay to play schemes get to pay fines and adopt hollow policies to avoid real prosecution. Catch and punish the guilty, leave the innocent alone.”

Then there is a letter from David Pohndorf, managing director at placement agent Source Capital Group Inc. His comments make explicitly clear that he believes the problem of pay-to-play generally originates at the pension funds, not at the investment firms or at the placement agents they use.

“The SEC proposal punishes those placement agents who provide a meaningful service to the private equity fund community while doing nothing to preclude wrongdoing by state and municipal pension fund personnel who continue to work with questionable registered and non-registered persons attempting to win investment commitments on behalf of private equity fund clients,” Pohndorf writes.

But we are most intrigued by the first letter to be posted to the site. It went up sometime yesterday, not too long after the rules themselves were published, and was posted by Christian Broadbent, the counsel to SEC Commissioner Elisse Walter. It says, tersely, that “Christian Broadbent of Commissioner Walter’s office spoke by telephone with Mary Whalen of Credit Suisse (head of Credit Suisse’s public policy Americas) regarding the above-referenced proposal.”

Credit Suisse has a very active placement arm. We would have liked to be a fly on the wall for that conversation.

You can view all the comment letters on the SEC’s proposal here.

SEC’s Pay-To-Play Rules Would Hit Large Firms’ Bottom Lines Too

The impact of the Securities and Exchange Commission’s proposed pay-to-play rules on smaller private equity firms has been much discussed. But according to the SEC, the new rules will also have a not entirely insignificant impact on large firms.

Firms would bear a variety of new costs associated with the rules, primarily because they would now be required to monitor political contributions by their associates. There will also be initial costs associated with the set-up of such systems. Larger firms will obviously have higher costs - 81 times as much, the SEC estimates - since they have more employees to monitor.

According to the SEC, annual compliance costs will be about $209,250 for larger firms (more than 15 associates), $104,625 for medium-sized ones (five to 15) and $2,580 for smaller shops (fewer than five). The initial compliance cost will be about $52,313 for larger firms, $26,156 for medium firms and $2,064 for smaller firms. The SEC also expects some advisers will spend money on outside legal services in drafting policies and procedures.

These figures might even be too conservative; in similar cost estimates made in 1999, the SEC gave figures that some say were too low. The SEC notes that it has “significantly increased” its cost estimates since then.

“The entire discussion of cost at this point will be very speculative,” said Robert Kelner, partner at Covington & Burling LLP. “Most of the time regulators get it wrong when they try to estimate ahead of time what the cost of a new regulatory regime will be.” There are soft costs involved too, which can be difficult to quantify, he said.

Kelner added that some smaller firms that don’t have the infrastructure in place to comply with the new rules might simply ban political activity by their personnel as a cost-saving measure. However, such a measure would raise some First Amendment concerns, he noted.

Video: More on Geithner’s Expletive-Laced Tongue-Lashing of Regulators

The proposed revamp of the financial regulatory system is one of President Barack Obama’s top domestic priorities.

But since it was unveiled in June, the plan has run into problems. It has been criticized by the financial-services industry and financial regulators alike. Some have questioned the wisdom of giving the Federal Reserve more power to oversee the financial system. And that criticism, in particular seems to be resonating with Congress.

So what is a Treasury Secretary to do? The WSJ reported today that Tim Geithner told the regulators Friday that “enough is enough,” and that they had been given a chance to air their concerns, but that it was time to stop. And he wasn’t always as polite as perhaps he might have been in delivering the message. Below the WSJ’s Deborah Solomon discusses what went on at the meeting.

Deal Profile: Pepsi Reaches Deal for Two Largest Bottlers

PepsiCo finally sweetened its bid and secured deals to acquire its two largest bottlers for a total of $7.8 billion in a push to revive its North American beverage business.

PepsiCo, based in Purchase, N.Y., raised its offer to $36.50 for each share of Pepsi Bottling Group Inc. it doesn’t already own, well above its April bid of $29.50 a share. It raised its offer for PepsiAmericas Inc. to $28.50 a share from $23.27 a share. Both offers are in cash and stock.

Below is is Dealogic’s profile of Pepsi’s deal to acquire Pepsi Bottling Group.


Below is is Dealogic’s profile of Pepsi’s deal to acquire PepsiAmericas.


Inside the Pepsi-Pepsi Bottling Deal

Forget the bankers. Forget the lawyers. The spreadsheets. And the fancy boardrooms.

Real deals are struck between people, not institutions.

Such was the case last Friday, when PepsiCo CEO Indra Nooyi invited Pepsi Bottling Group director Ira Hall to her home, according to a person familiar with the matter. The two companies had spent three months sniping at one another in public over the price PepsiCo would pay for its affiliate. PepsiCo had filed a lawsuit. Pepsi Bottling went on a very public roadshow to fight for a higher price.

But it was in that one-on-one session where Nooyi and Hall would negotiate the final deal price: $36.50 per share, half in cash and half in stock.

How did the two get to that price? Was it via books full of financial analysis, synergy calculations, and comparable transactions?

Those things surely had their place. But in the end, “I think they just split it down the middle,” this person said.

The two sides had largely avoided each other since Pepsi first made its offer in April. Negotiations only began in earnest over July 15 and 16, at PepsiCo’s airplane hangar at the Westchester, N.Y. airport, this person added.

In April, PepsiCo first offered $29.50 for Pepsi Bottling. By the unspoken rules of dealmaking, an unsolicited offer never is the best one. PBG’s shareholders and board directors responded in kind, signaling they wouldn’t take less than $40 per share.

There the two sides sat, until the meeting in the airplane hangar. PepsiCo first indicated it would pay $34.50, then $35.50 per share. PBG softened its stance, and said it had to be over $37 per share, this person said. But the two couldn’t reach a final price and walked away without a deal.

The final deal came together at Ms. Nooyi’s home, at $36.50, for a total of about $7.9 billion.

What about all those bankers and lawyers? Can deals really get done without them in the room? “That’s what happened and should happen,” this person quipped.

Economists React: Consumers Still ‘Missing Link’ in Recovery

Economists and others weigh in on the drop in June personal income and the rise in consumer spending.

  • Personal income fell in June by 1.3%, in line with our expectation. The swing over the last two months reflected one-off payments associated with the fiscal stimulus package. These payments sharply boosted the May figure and were substantially smaller in June, resulting in a significant drag on the headline result (specifically, eligible individuals receiving social security, supplemental security income, and railroad retirement benefits each received $250 in May, which boosted current transfers by $157.6 billion in that period, while one-time payments of $250 billion to eligible individuals receiving veterans benefits boosted transfer receipts in June by just $5.6 billion). Excluding those payments, personal income was essentially flat in May and down by 0.1% in June. –Michelle Girard, RBS
  • The wallets are still being held quite tightly. Consumer spending rose in June but when you adjust for price changes, it was actually down slightly. Part of the problem may have been the Cash for Clunkers program. Durable spending was off and it was likely that some of the demand for vehicles held in abeyance until the program took effect. We are likely to see a large increase in July and August, especially if the additional $2 billion passes. Households have also been quite conservative in the purchases of services. Right now, if it isn’t necessary, they don’t seem to be buying it. –Naroff Economic Advisors
  • Consumer spending rose 0.4% in nominal dollars in June (the biggest increase since February), but that’s not good news since all of the extra spending was eaten up by inflation. Higher gasoline prices drove the consumption price index up 0.5% and meant that spending fell 0.1% in real terms. The June decline takes real spending to its lowest level yet in this cycle, down 1.8% from a year earlier… When given sufficient incentive (as in cash-for-clunkers) consumers will spend. But reduced wealth, high debt, tight credit, and a weakening labor market are all weighing on consumers. Consumers remain a missing link in hopes for strong recovery. –Nigel Gault, IHS Global Insight
  • Real personal spending bounced early in the year as falling prices lifted purchasing power; however real spending has been flat or falling since February. The cash for clunkers program lifted vehicle sales 16.5% in July and should lead to a real gain. –Julia Coronado, BNP Paribas
  • No green shoots at all in these data; no surprise given the leverage overhang and the fall in incomes. The absence of stimulus effects accounts for most of the swing in incomes between May and June, but wages and salaries are less volatile than headline income and they are dropping steadily every month, -0.4% in June. The saving rate has not yet peaked, despite the June dip. Third quarter spending will rise due to cash-for-clunkers, but fourth quarter down again? –Ian Shepherdson, High Frequency Economics
  • Though we still have limited data for the quarter, factoring in the comprehensive revisions and what we know about car sales in July (and taking into account that it seems likely that ‘cash for clunkers’ will boost vehicle sales in August also), we could see real PCE rise in the neighborhood of 4% in the third quarter. –RDQ Economics
  • We simply do not expect the type of forceful rebound in consumer spending that would be a necessary ingredient in the robust, “V-shaped” recovery that many analysts are calling for. Whether by their choice – motivated by heavy debt loads and the loss of significant amounts of net worth over recent quarters – or by the choice of lenders less willing to extend credit, households are likely to maintain a higher savings rate than has been seen over the past decade. –Richard F. Moody, Forward Capital
  • Today’s data does not particularly change the view in any way, especially given the fact that much of this information has been digested by the market due to the fact that Friday’s GDP report captured much of this data. We know that consumers continue to be backed into a corner, and despite the reduction in the personal savings rate, we continue to believe that going forward consumers are likely to have more propensity to save than to spend. As we suspected, the magnitude of the advance seen in May has dissipated largely because of lower amount of government transfers (by way of stimulus dollars and jobless benefits). –Ian Pollick, TD Securities

Compiled by Phil Izzo

BofA’s SEC Fine: Lewis’s Pain, John Thain’s Gain

Ken Lewis’s week may be off to a bad start, but John Thain must be feeling pretty good right now.

thainlewis_D_20090804112556.jpgBloomberg News
John Thain, then chief executive of Merrill Lynch, listens as Kenneth Lewis, chief executive of Bank of America, speaks at the September news conference at which they announced their $50 billion deal.

On Monday, the Securities & Exchange Commission fined Lewis’s Bank of America for failing to tell shareholders that it agreed to allow Merrill Lynch to bay big bonuses to its executives ahead of this year’s $50 billion takeover.

The SEC allegations contradict CEO Lewis’s prior statements that he was distanced from the decision making about Merrill bonuses. And they bolster the claims of Thain, the former Merrill chief executive, that BofA was, in fact, intimately involved in determining Merrill bonuses.

Thain was on a plane when the SEC settlement broke on Monday afternoon. Of course, Thain still has much to answer for, like how he could have approved paying nearly $3.6 billion in bonuses for 2008, when the securities firm was posting an annual loss of $28 billion. But it still must have been a sweet homecoming for the once-disgraced Wall Street banker.

A person close to the matter sent Deal Journal a Jan. 25 email from the former Merrill chief to Merrill’s top brass, helping drive home the point.

From: “Thain, John \(Chairman and CEO\)”
Date: Sun, 25 Jan 2009 22:56:11 -0500


To my Merrill Lynch colleagues

It has been an honor to lead this company over the last very difficult year. The decisions that I made were always with the best interests of our shareholders and employees above all. I believe that the decision to sell to Bank of America was the right one for our company and our clients. While the execution has been difficult, I still believe in the strategic rationale of the transaction and I wish you all the best for the future of the combined companies.

I want to address several topics that have been inaccurately reported in the press. The first issue is our year end bonus payments. Our 2008 discretionary bonus pool was 41% lower than 2007. The size of the pool, its composition (cash and stock mix), and the timing of the payments for both the cash and stock were all determined together with Bank of America [emphasis added] and approved by our Management Development and Compensation Committee and our Board. The total bonus pool was also substantially less than the amount allowed under our merger agreement.

The second topic is the losses in the fourth quarter, which were very large and unfortunate. However, they were incurred almost entirely on legacy positions and were due to market movements. We were completely transparent with Bank of America. They learned about these losses when we did. The acting CFO of my businesses was Bank of America’s former Chief Accounting Officer. They had daily access to our p&l, our positions and our marks. Our year end balance sheet target (which we more than met) was given to us by Bank of America’s CFO.

The final topic is the expenses related to my office. The $1.2 million reported in the press was for the renovation of my office, two conference rooms and a reception area. The expenses were incurred over a year ago in a very different environment. Nonetheless, they were a mistake in the light of the world we live in today. I will therefore reimburse the company for all of the costs incurred.

I thank all of you for your hard work and your support over the past year. I wish you all success in the future.