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Heads We Win, Tails You Lose Your Retirement: Private Equity, Pension Funds, and the CRE Double Down

There’s blood in the water. Dis­lo­ca­tions pop­ping up across the mar­kets. A mas­sive sup­ply and demand imbal­ance in the cred­it space. With region­al banks poten­tial­ly look­ing at years of trou­ble ahead and inter­est rates well above the his­toric lows that has been the ‘new nor­mal’ since the Great Reces­sion of 2008, fund­ing for real restate projects across the US is very much in ques­tion with the expec­ta­tion of many ‘dis­tressed’ prop­er­ties com­ing on the mar­ket in the lat­ter half of 2023. That’s the recent news in the com­mer­cial real estate (CRE) mar­kets.

And it’s great news. That’s also the news we’re hear­ing about the com­mer­cial real estate mar­kets. Every­thing is look­ing won­der­ful. Or, rather, about to look won­der­ful. After it falls apart. It’s the news for the usu­al sus­pects when things fall apart: Pri­vate Equi­ty, which is pal­pa­bly excit­ed about all the dis­tressed real estate that’s bound to come on the mar­ket now that region­al banks are reel­ing and inter­est rates have caused bor­row­ing costs to spike. All signs are point­ing a whole lot of ‘dis­lo­ca­tion’ in the com­mer­cial real estate cred­it mar­kets. The kind of sup­ply and demand dis­lo­ca­tion that can turn blood in water into a gold laced sil­ver lin­ing for the enti­ties with cash on the side­lines. As we’ve seen, being the ‘cash on the side­lines’ oppor­tunis­ti­cal­ly wait­ing for things to fall apart or blow is a big part of the ‘Heads we win, tails you lose’ pri­vate equi­ty busi­ness mod­el.

Of course, as we’ve also seen, the ‘Heads we win, tails you lose’ busi­ness mod­el of the pri­vate equi­ty indus­try is also root­ed in the fact that the fund man­agers charge high fees whether they’re invest­ments pan out or not. It’s a ‘Heads we win, tails you lose’ client rela­tion­ship. Includ­ing the grow­ing num­ber of pen­sion fund clients lured in with promis­es of dou­ble dig­it yields in a his­tor­i­cal­ly low inter­est envi­ron­ment. Charg­ing giant pub­lic pub­lic pen­sion funds with opaque fees a very big part of today’s pri­vate equi­ty indus­try. And grow­ing.

So it should come as no sur­prise to learn that one of the big invest­ment oppor­tu­ni­ties pri­vate equi­ty has been steer­ing bil­lions of dol­lars of pub­lic pen­sion mon­ey into in recent years is...*drumroll*...commercial real estate! Yes, the same sec­tor that has pri­vate equi­ty lick­ing its chops over dis­tressed debt and deals gone sour is the same sec­tor pri­vate equi­ty has been pour­ing tons of client cash into in recent years. Because of course that’s the case. Heads we win, tails you lose.

So does this mean pen­sion funds are about to take a big bath on their com­mer­cial real estate invest­ments? Prob­a­bly. But don’t wor­ry, their pri­vate equi­ty fund man­agers are going to be paid hand­some­ly either way. And they have a plan to turn this com­mer­cial real estate lemon into lemon­ade and for their pen­sion fund clients: dou­ble down on their com­mer­cial real estate invest­ments.

Now, on the one hand, that could end up be a decent way of recoup­ing the com­mer­cial real estate loss­es pen­sion funds have incurred and will incur as the region­al bank­ing cri­sis con­tin­ues to weigh on com­mer­cial real estate cred­it mar­kets. If they buy the decent com­mer­cial real estate options at a rea­son­able point in this whole ‘mar­ket dis­lo­ca­tion’ event, and not over­pay for the lemons.

But with this cri­sis in the com­mer­cial real estate cred­it mar­kets expect­ed to poten­tial­ly play out for years to come, and some warn­ing it could be worse than the Great Reces­sion of 2008 for office build­ings specif­i­cal­ly thanks to the post-pan­dem­ic shift to remote work, and pen­sion funds already deeply invest­ed in this sec­tor and ready to invest more, we have to ask to what extent we’re going to see the pen­sion fund giants end up get­ting wield­ed as some sort of mar­ket sup­port pool for com­mer­cial real estate sec­tor, and whether or not that’s real­ly going to be in the best inter­ests of those pen­sion­ers. Should we be wor­ried about such a sce­nario? Well, the head of JP Mor­gan’s com­mer­cial real estate divi­sion, Alfred Brooks, pre­dict­ed ear­li­er this month, he did­n’t fore­see the com­plete col­lapse of the com­mer­cial real estate mar­ket hap­pen­ing. Why? Well, he cit­ed the Black­stone Real Estate Part­ners X, recent­ly cre­at­ed fund that raised $30.4 bil­lion to take advan­tage of emerg­ing deals in the com­mer­cial real estate mar­ket. As we’re going to see, that’s fund’s clients con­sist of a bunch of large pub­lic pen­sion funds. The same ones that are already reel­ing from grow­ing CRE loss­es from their pri­vate equi­ty-led CRE invest­ments made over the last few years. So with the head of JP Mor­gan’s com­mer­cial real estate divi­sion point­ing to big pri­vate equi­ty-led pen­sion funds cre­ate a floor for a mar­ket that oth­er­wise looks poised for years of tur­moil, should­n’t we be con­cerned? It did­n’t sound like he was advis­ing his own clients to jump into com­mer­cial real estate. Just that they should­n’t wor­ry about it drop­ping too far thanks to pen­sion funds.

And as we’ll also see, when Alfred Brooks gets into the nit­ty grit­ty, he does admit that, yeah, actu­al­ly a lot of com­mer­cial real estate might end up expe­ri­enc­ing some­thing as bad as 2008 or worse. Just not nec­es­sar­i­ly the best real estate which will pre­sum­ably get bought up by the pen­sion funds and oth­ers look for deals. That was Brook­s’s pre­dic­tion eeri­ly this month on the great CRE blood­bath of 2023: don’t wor­ry, pub­lic pen­sions are here to catch this falling knife. How wor­ried should those pen­sion­ers be? And how about the rest of us? Let’s not for­get that ‘the pub­lic’ is poten­tial­ly on the hook here if the pen­sion funds of pub­lic employ­ees expe­ri­ence some sort of emer­gency and need to be bailed out. Might we be see­ing the set up for a pub­lic bailout of the com­mer­cial real estate sec­tor by tying it the fate of pen­sion funds? These are just some of the dis­turb­ing kind of ques­tions we have to start ask­ing.

Oh, and it turns out pri­vate equi­ty has also been direct­ing bil­lions of pub­lic pen­sion dol­lars into res­i­den­tial rental prop­er­ties, turn­ing pub­lic pen­sions into land­lords. Rather cru­el land­lords in many cas­es as rent-con­trolled prop­er­ties have been bought up and effec­tive­ly cleared of rent-con­trolled ten­ants in one case after anoth­er, all jus­ti­fied, in part, in the premise of earn­ing the high returns pub­lic pen­sion funds need (and please just ignore the high pri­vate equi­ty fees). Kick out grand­ma to save grand­ma’s pen­sion. That’s kind of investor dynam­ic. So while pub­lic pen­sion funds are get­ting ready to get even more deeply inter­twined with the com­mer­cial real estate cri­sis, keep in mind that it’s also get­ting even more deeply inter­twined with the hous­ing afford­abil­i­ty cri­sis in the US too.

Ok, here’s a quick review of the arti­cle excerpts we’re going to cov­er:

* June 1, 2023: How Pri­vate Equi­ty Plans to Cap­i­tal­ize on Com­mer­cial Real Estate Dis­tress

An arti­cle in the Com­mer­cial Observ­er about the ‘blood in water’ already detect­ed in the com­mer­cial real estate mar­ket. “We’re in a mean­ing­ful peri­od of dis­lo­ca­tion,” as the co-chief exec­u­tive offi­cer of Mor­gan Stan­ley Real Estate Invest­ments put it at a recent forum. “We’re see­ing risk and asset val­ues repriced before our eyes, and I think that’s true across the entire investable uni­verse and cer­tain­ly across all of pri­vate real estate, every sec­tor, vir­tu­al­ly every glob­al mar­ket.” But Black­stone Pres­i­dent and COO Jonathan Gray had a far cheerier way of describ­ing the moment: “We think there’s a real oppor­tu­ni­ty to deploy more cap­i­tal,” Gray said. “I think the pri­vate cred­it area is real­ly at a gold­en moment because we do see tight­en­ing out there.” A gold­en moment for pri­vate equi­ty. A gold­en moment cre­at­ed by a region­al bank­ing cri­sis, ris­ing rates, a $1.5 tril­lion in CRE loans com­ing due by the end of 2025, with $500 bil­lion matur­ing in the next 6 months. Is it real­ly a “gold­en moment” like Black­stone’s Gray pre­dicts? The clients who just invest­ed $30.4 bil­lion in Black­stone’s new com­mer­cial real estate fund had bet­ter hope so.

* June 5, 2023: Black­stone will help pre­vent an office mar­ket ‘cat­a­stro­phe’, says JPMor­gan’s com­mer­cial real estate chief

Fol­low­ing up on Black­stone Pres­i­dent Jonathan Gray’s “gold­en oppor­tu­ni­ty” moment about the com­mer­cial real estate sec­tor, JP Mor­gan’s head of com­mer­cial real estate, Alfred Brooks, had some com­men­tary Gray might find reas­sur­ing. Brooks pre­dict­ed that, while the mar­ket dis­tress in the com­mer­cial real estate sec­tor could go on for a while, we prob­a­bly won’t see a huge fall at least for the high­er qual­i­ty prop­er­ties. Why? Brooks cites Black­stone’s new $30.4 com­mer­cial real estate fund as an exam­ple of the mon­ey wait­ing on the side­lines. So the “Class A” prop­er­ties should avoid mass declines. The Class B and Class C, on the oth­er hand, could go “down to the last bot­tom,” in ref­er­ence to 2008. In oth­er words, this is a mar­ket filled with some gems and a lot of tick­ing time bombs so if you’re going to pick through it you bet­ter pick wise­ly.

* April 11, 2023: Black­stone clos­es $30.4 bil­lion oppor­tunis­tic real estate fund

A short report from Pen­sion & Invest­ment not­ing the clos­ing (off to new funds) of the Black­stone Real Estate Part­ners X fund at $30.4 bil­lion, sig­nif­i­cant growth over the $20.5 bil­lion raised in 2019 for the Black­stone Real Estate Part­ners IX fund. Investors in the news fund include the Cal­i­for­nia State Teach­ers’ Retire­ment Sys­tem (Cal­STRS); the State of Wis­con­sin Invest­ment Board; the North Car­oli­na Retire­ment Sys­tems; the Vir­ginia Retire­ment Sys­tem; the Penn­syl­va­nia State Employ­ees’ Retire­ment Sys­tem. This a fund for pub­lic pen­sions.

* Octo­ber 31, 2022: Pen­sion funds scale back on CRE invest­ing

An arti­cle from Hal­loween of 2022 with news that might sound rather spooky to pen­sion­ers today: pen­sion funds were scal­ing back their com­mer­cial real estate invest­ing after record lev­els of invest­ing in the sec­tor in the first half of 2022. In oth­er words, the pub­lic pen­sion funds were mak­ing record invest­ments right before this CRE mar­ket tur­moil. Oops. But the pri­vate equi­ty man­agers get paid either way.

* April 24, 2023: Banks aren’t the only ones that hold risky com­mer­cial-real-estate debt. Pen­sion funds are about to feel the pain, too.

A Busi­ness Insid­er report from a cou­ple of months ago about the loom­ing pain for pen­sion funds in the CRE mar­ket. Pain many pen­sion funds were already feel­ing, with Cal­i­for­nia State Teach­ers Retire­ment Sys­tem (Cal­STRs), one of the investors in the Black­stone Real Estate Part­ners X fund, announc­ing it would be writ­ing down the val­ue of its $52 bil­lion in real estate hold­ings, with a 20% drop in the val­ue of those hold­ings due to the Fed’s inter­est rates moves alone. That’s a 20% drop that pre­sum­ably hit a lot of pen­sion funds’ new­ly acquired CRE hold­ings pur­chased over the last cou­ple of years.

* March 2, 2020: Pen­sion fund mon­ey is get­ting tan­gled in some con­tro­ver­sial hous­ing deals

A look at the oth­er pen­sion fund dive into the real estate space: mul­ti-fam­i­ly rental prop­er­ties. Yes, pen­sion funds have increas­ing­ly become land­lords. Mean stingy land­lords who kick out ten­ants and thwart rent con­trols in the pur­suit of the high yields need­ed to pay for pub­lic pen­sions.

* August 4, 2022: Pri­vate Equi­ty Doesn’t Want You to Read This

A NY Times col­umn by Farhad Man­joo writ­ten in the wake of the pri­vate equi­ty indus­try’s mul­ti­ple vic­to­ries in the big con­gres­sion­al fights over what was going to go into the Democ­rats’ big ‘Infla­tion Reduc­tion Act’ thanks to the hold­ing out by Sen­a­tor Kyrsten Sine­ma act­ing as pri­vate equi­ty’s cham­pi­on. As we saw, those vic­to­ries includ­ed keep­ing the ‘car­ried inter­est loop­hole’ and the pro­vi­sion that allowed the many small­er busi­ness owned by pri­vate equi­ty giants to dodge a new 15 per­cent min­i­mum cor­po­rate tax. As Man­joo reminds us, this is all part of pri­vate equi­ty’s broad­er cap­ture of more and more the of econ­o­my despite the fact that its track record as own­ers and man­agers and been a dis­as­trous lega­cy of bloat­ed dead com­pa­nies, laid off work­ers, and increas­ing­ly kicked-out ten­ants. And, of course, the over­paid fund man­agers who will be paid large fees no mat­ter how their invest­ment deci­sions go. Because it’s not their mon­ey. It’s their clients’ mon­ey. Because the “Head We Win, Tails You Lose” dynam­ic of this indus­try applies to the client rela­tion­ships too.

Blood is in the CRE Waters. Sharks Report Great Times Ahead

Ok, first, years that arti­cle in the Com­mer­cial Observ­er about the ‘blood in water’ already detect­ed in the com­mer­cial real estate mar­ket. “We’re in a mean­ing­ful peri­od of dis­lo­ca­tion,” as the co-chief exec­u­tive offi­cer of Mor­gan Stan­ley Real Estate Invest­ments put it at a recent forum. “We’re see­ing risk and asset val­ues repriced before our eyes, and I think that’s true across the entire investable uni­verse and cer­tain­ly across all of pri­vate real estate, every sec­tor, vir­tu­al­ly every glob­al mar­ket.” But Black­stone Pres­i­dent and COO Jonathan Gray had a far cheerier way of describ­ing the moment: “We think there’s a real oppor­tu­ni­ty to deploy more cap­i­tal,” Gray said. “I think the pri­vate cred­it area is real­ly at a gold­en moment because we do see tight­en­ing out there.”

A gold­en moment for pri­vate equi­ty. A gold­en moment cre­at­ed by a region­al bank­ing cri­sis, ris­ing rates, a $1.5 tril­lion in CRE loans com­ing due by the end of 2025, with $500 bil­lion matur­ing in the next 6 months. Is it real­ly a “gold­en moment” like Black­stone’s Gray pre­dicts? The clients who just invest­ed $30.4 bil­lion in Black­stone’s new com­mer­cial real estate fund had bet­ter hope so. Because these investors are either sharks or chum and only time will tell:

Com­mer­cial Observ­er

How Pri­vate Equi­ty Plans to Cap­i­tal­ize on Com­mer­cial Real Estate Dis­tress

There’s blood in the water, as hun­dreds of bil­lions of prover­bial dry pow­der sits poised to enter the financ­ing mar­ket. Here’s how and where.

By Bri­an Pas­cus June 1, 2023 10:45 am

Dur­ing a May 3 appear­ance on Bloomberg TV, Black­stone (BX) Pres­i­dent and COO Jonathan Gray appeared sun­ny, despite his sur­name, as he tout­ed his pri­vate equi­ty firm’s recent glob­al real estate invest­ment fund, BREP X, which closed a $30.4 bil­lion fundrais­ing round in mid-April.

“We think there’s a real oppor­tu­ni­ty to deploy more cap­i­tal,” Gray said. “I think the pri­vate cred­it area is real­ly at a gold­en moment because we do see tight­en­ing out there.”

For the illiq­uid world of pri­vate cred­it — which pro­vides debt for com­mer­cial real estate projects -– and that of pri­vate equi­ty, the recent upheaval in the U.S. region­al bank­ing sec­tor and issues plagu­ing down­town office space has sparked ques­tions sur­round­ing the type of returns CRE can gen­er­ate for investors.

The pri­ma­ry ques­tion being: Is a gold­en moment pos­si­ble in the dark­est of times?

“We’re in a mean­ing­ful peri­od of dis­lo­ca­tion,” said Lau­ren Hochfelder, co-chief exec­u­tive offi­cer of Mor­gan Stan­ley Real Estate Invest­ments and head of MSREI Amer­i­c­as, dur­ing a Com­mer­cial Observ­er forum in late April. “We’re see­ing risk and asset val­ues repriced before our eyes, and I think that’s true across the entire investable uni­verse and cer­tain­ly across all of pri­vate real estate, every sec­tor, vir­tu­al­ly every glob­al mar­ket.”

The dis­lo­ca­tion across mar­kets and asset class­es has been dri­ven by numer­ous exter­nal fac­tors, includ­ing the sec­u­lar shift in office usage since COVID-19, but the largest rea­son for the dis­tress has been the his­tor­i­cal­ly rapid inter­est rate hikes by the Fed­er­al Reserve. Those have caused asset val­ues to decline as bor­row­ing costs have spiked. The increased lever­age ratios on exist­ing loans have put pres­sure on bor­row­ers, and, in some cir­cum­stances, made it impos­si­ble to keep loans cur­rent or to refi­nance matur­ing loans with­out an infu­sion of equi­ty. More­over, the cost of financ­ing acqui­si­tions or new devel­op­ments has also sky­rock­et­ed, cre­at­ing a pause in equi­ty mar­kets as they assess the frac­tured land­scape.

The shift­ing of the tide and sub­se­quent dis­tress has been plain to see: Brook­field (BN) default­ed on $784 mil­lion in loans tied to two Los Ange­les sky­scrap­ers in Feb­ru­ary; Black­stone sent a $270 mil­lion CMBS loan on a Man­hat­tan mul­ti­fam­i­ly port­fo­lio to spe­cial ser­vic­ing in Feb­ru­ary; GFP Real Estate default­ed on a $130 mil­lion mort­gage-backed secu­ri­ties loan for 515 Madi­son Avenue in Decem­ber; and just last month RXR default­ed on a $260 mil­lion loan on 61 Broad­way.

The back­drop is set­ting up for a like­ly sce­nario where we see more dis­tress than we’ve seen since the Great Reces­sion, and maybe even more dis­tress than in 2008, 2009 and 2010,” said War­ren de Haan, founder and man­ag­ing part­ner at Acore Cap­i­tal, one of the largest lenders in com­mer­cial real estate. “We have a sup­ply and demand imbal­ance between the demand for com­mer­cial real estate debt and the sup­ply of CRE debt.

An esti­mat­ed $1.5 tril­lion in CRE debt comes due by the end of 2025, accord­ing to a report by Mor­gan Stan­ley. This matu­ri­ty wave arrives just as cap­i­tal mar­kets have seen a vast reduc­tion of liq­uid­i­ty dri­ven by a retrench­ment of the U.S. bank­ing sys­tem, which has expe­ri­enced the second‑, third- and fourth-largest com­mer­cial bank fail­ures in Amer­i­can his­to­ry since March and is gear­ing up for poten­tial­ly more in the months ahead.

Giv­en that region­al banks (those with $10 bil­lion to $160 bil­lion in assets) rep­re­sent near­ly 14 per­cent of com­mer­cial real estate lend­ing, the pull­back in debt cap­i­tal from the sys­tem at a time when that mon­ey is need­ed to pay down bil­lions in matu­ri­ties is not exact­ly an appe­tiz­ing mix for either investors or prop­er­ty own­ers.

If all of that plays out togeth­er, you’ll have sig­nif­i­cant­ly low­er liq­uid­i­ty in debt mar­kets, a huge wall of matu­ri­ties com­ing due, a high­er inter­est rate envi­ron­ment, mean­ing val­ues decline, and you have a bank­ing cri­sis at the same time, mean­ing that the amount of dis­tress we expect to see in the sys­tem will be expo­nen­tial­ly high­er than what we’ve seen in the last decade,” de Haan told CO.

“That is the big oppor­tu­ni­ty for the $400 bil­lion of pri­vate equi­ty sit­ting on the side­lines,” he added.

Ah, yes, the $400 bil­lion in pri­vate equi­ty cap­i­tal. It’s com­mer­cial real estate’s caped cru­sad­er; an under­wa­ter sponsor’s prover­bial knight in shin­ing armor; the miss­ing lay­er in an emp­ty cap­i­tal stack’s bil­lion-dol­lar sand­wich.

The num­bers dif­fer rather wide­ly, depend­ing on sources – Ernst & Young counts $1.2 tril­lion in dry pow­der; 1,520 funds raised $727.3 bil­lion in 2022, accord­ing to Pri­vate Equi­ty Inter­na­tion­al; pri­vate equi­ty fundrais­ing exceed­ed $259 bil­lion in the first nine months of 2022, accord­ing to Pitch­book — but there’s no deny­ing that at least hun­dreds of bil­lions of dol­lars is ready and wait­ing to enter cap­i­tal stacks and dis­tressed port­fo­lios across the coun­try from all parts of the pri­vate equi­ty uni­verse.

All told, pri­vate cred­it investors account for 12 per­cent of the $6.3 tril­lion U.S. com­mer­cial cred­it mar­ket, while region­al banks account for 40 per­cent of the total, accord­ing to Reuters.

Aside from Blackstone’s $30.4 bil­lion fundraise in April, oth­er heavy hit­ters have made head­lines in recent months: Brook­field Asset Management’s flag­ship real estate fund, Brook­field Strate­gic Real Estate Part­ners IV, raised $17 bil­lion in late 2022; Invesco Real Estate’s U.S. Fund VI closed above its $1.75 bil­lion hard cap in May; and Nuveen Real Estate’s CASA Part­ners IV fund raised $410 mil­lion in Octo­ber to ren­o­vate and repo­si­tion mul­ti­fam­i­ly units.

The mon­ey appeared because cap­i­tal mar­kets, like nature, abhor a vac­u­um.

“De-lev­er­ing has cre­at­ed oppor­tu­ni­ties, lack of cap­i­tal has cre­at­ed oppor­tu­ni­ties,” said Josh Zegen, founder and man­ag­ing direc­tor of Madi­son Real­ty Cap­i­tal, a pri­vate real estate invest­ment firm with more than $10 bil­lion AUM. As for the bank­ing sec­tor shift, “peo­ple say it’s over. It’s absolute­ly not over. We’re see­ing every oth­er day a deal fall apart because a bank pulled out,” Zegen said.

As banks retreat, pri­vate equi­ty play­ers are prep­ping their well-timed pounce, siz­ing up debt and equi­ty envi­ron­ments equal­ly as mar­ket duress runs for­mer­ly well-cap­i­tal­ized spon­sors to exhaus­tion and even­tu­al sub­mis­sion.

On the cred­it side, Zegen not­ed that there’s less appetite avail­able to re-lever posi­tions through A notes, loan-on-loan financ­ing and cred­it lines, while the debt side is beset by prob­lems asso­ci­at­ed with the high­er cost of cap­i­tal and increas­ing­ly expen­sive short-term debt, float­ing-rate debt, and fixed-rate debt from sin­gle-asset sin­gle-bor­row­er loans and col­lat­er­al­ized loan oblig­a­tions.

“There’s a per­cep­tion that there’s so much liq­uid­i­ty, but I don’t share that opin­ion,” Zegen said. “This is a major oppor­tu­ni­ty for some­one like us right now, par­tic­u­lar­ly in the pri­vate cred­it area. But, real­ly, at the end of the day, there’s a lack of sup­ply of cap­i­tal rel­a­tive to the demand.”

He added that one fun­da­men­tal dif­fer­ence between now and the 2008 Glob­al Finan­cial Cri­sis is that pre­vi­ous down­turns car­ried the per­cep­tion that, so long as investors or spon­sors didn’t lever them­selves too bad­ly, they could hold out and wait for the cycle to invari­ably turn back — but now that offices have entered a struc­tur­al shift in the way peo­ple work and busi­ness­es uti­lize space, all bets are off.

“The prob­lem is in one very impor­tant sec­tor of the five major food groups of com­mer­cial real estate,” Zegen said, refer­ring to office. “And it’s some­thing that oppor­tu­ni­ty funds, debt funds, mort­gage REITs, col­lat­er­al­ized loan oblig­a­tions – just a huge sec­tion of these guys – had a 10 per­cent to 40 per­cent expo­sure to.”

While some spon­sors may recoil at the thought of onboard­ing new invest­ment part­ners who’ll pro­vide either mez­za­nine financ­ing or pre­ferred equi­ty stakes in vul­ner­a­ble cap­i­tal stacks, the prac­tice will be unavoid­able over the next six to 12 months as more loans mature and inter­est rates remain high: Over $500 bil­lion of CRE debt comes due this year alone, accord­ing to the Mort­gage Bankers Asso­ci­a­tion.

“Any­time you see this lev­el in asset val­ue repric­ing and this lev­el of cap­i­tal retreat­ing, both for struc­tur­al rea­sons and, frankly, con­cern around the envi­ron­ment, that cre­ates oppor­tu­ni­ties for those of us who have cap­i­tal and have con­vic­tion of where we want to invest it,” Hochfelder said.

Thus, under the pall of 5 per­cent inter­est rates, sig­nif­i­cant por­tions of that $500 bil­lion debt avalanche will strug­gle to main­tain their covenants, whether that’s debt-ser­vice-cov­er­age ratios or loan-to-val­ue ratios, while even those loans that aren’t matur­ing this year car­ry inter­est rate caps that are set to dou­ble upon expi­ra­tion, poten­tial­ly bal­loon­ing expens­es, accord­ing to David Bit­ner, exec­u­tive man­ag­ing direc­tor of glob­al research at New­mark (NMRK). All this will cre­ate “dis­tress and dis­tress adja­cen­cy” for spon­sors who need to pay down at least a por­tion of their matur­ing loans to main­tain own­er­ship of their prop­er­ties, or gen­er­ate new cap­i­tal alto­geth­er for assets sunk under­wa­ter, he said.

“You’ll have to go through a loan mod­i­fi­ca­tion, even if that is split­ting into an A‑B struc­ture, where there’s still upside for incre­men­tal equi­ty,” Bit­ner explained. “These are all very sen­si­tive nego­ti­a­tions, they’re going to be one by one, and they’re going to cre­ate oppor­tu­ni­ties for oppor­tunis­tic cap­i­tal to come into assets, but you have to have the reck­on­ing first.”

The entrance of pri­vate cap­i­tal into this world of dis­tress is expect­ed to take on two dif­fer­ent guis­es in the months ahead, accord­ing to CEOs and ana­lysts.

One route pri­vate equi­ty can take is buy­ing dis­tressed loans – loans that are in default or fore­clo­sure – at a sig­nif­i­cant dis­count and tak­ing con­trol of a prop­er­ty and rid­ing it out into a high rate of return. Anoth­er route is buy­ing per­form­ing loans from dis­tressed sell­ers, who sell loans backed by per­form­ing com­mer­cial prop­er­ties at a sig­nif­i­cant enough dis­count that pri­vate equi­ty firms step into the posi­tion with the abil­i­ty to gen­er­ate high rates of return, usu­al­ly in the 15 to 20 per­cent range. The first avenue offers the chance to buy debt notes on the cheap and fore­close on the entire cap­i­tal struc­ture once pay­ments are missed. The oth­er allows investors to pur­chase good prop­er­ties from des­per­ate sell­ers will­ing to sell for 80 cents on the dol­lar.

“The ques­tion is: What price or cost of cap­i­tal will peo­ple look for to step into the ful­crum of dis­tress?” said Ronald Dick­er­man, pres­i­dent and founder of Madi­son Inter­na­tion­al Real­ty, a real estate pri­vate equi­ty firm with over $8 bil­lion in cap­i­tal com­mit­ments. “Make no mis­take, the equi­ty investors are lick­ing their wounds from their office expo­sure and, gen­er­al­ly speak­ing, have writ­ten down oth­er parts of their office port­fo­lio. There isn’t as much exu­ber­ance to dive into the mar­ket as quick­ly as one might think and peo­ple are super cau­tious, espe­cial­ly about the office sec­tor.”

To be fair, there’s a less rapa­cious side to pri­vate equi­ty. That’s specif­i­cal­ly found in the pre­ferred equi­ty space, which has seen oppor­tu­ni­ty funds at Cer­berus and Rock­point, among oth­ers, help spon­sors deliv­er loan pay­ments upon matu­ri­ty through recap­i­tal­iza­tions, refi­nanc­ings, or mez­za­nine fund­ing on assets that were ini­tial­ly financed at low­er rates and high­er val­ues.

“A lot of peo­ple have thrown their hands up, they don’t have the mon­ey, and then XYZ fund comes in,” explained Zegen. “There’s a per­cep­tion that that’s more secure than buy­ing a piece of real estate today, that it’s more secure in the cap­i­tal stack, so a lot of pri­vate equi­ty firms are doing that.”

Dick­er­man added that pri­vate equi­ty firms will pick their spots in the cap­i­tal stack at risk-mit­i­gat­ed entry points, avoid­ing deep dis­tress, and focus more on viable paths into reli­able returns, like pro­vid­ing mez­za­nine loans or pre­ferred equi­ty financ­ing to help roll over con­struc­tion loans on attrac­tive projects into per­ma­nent financ­ing.

...

There are sev­er­al avenues for that mon­ey to fol­low. Dif­fer­ent funds cater to dif­fer­ent types of CRE invest­ment lev­els, which vary by asset class, debt fund­ing ratios, and pro­ject­ed rate of return. Open-end­ed fund vehi­cles will grav­i­tate toward core and core-plus invest­ments, while closed-end fund vehi­cles will risk more in the val­ue-add and oppor­tunis­tic spaces.

Core invest­ments pro­vide sta­ble income with lit­tle risk and typ­i­cal­ly achieve low­er annu­al­ized returns — think an apart­ment build­ing in a well-pop­u­lat­ed town. Core-plus invest­ments car­ry oppor­tu­ni­ties for increased returns but only so long as more lever­age is used to enhance prop­er­ty improve­ments, like an occu­pied mul­ti­fam­i­ly build­ing that needs a new com­mon area.

Val­ue-add invest­ments usu­al­ly pro­vide no cash-flow upon invest­ment, but car­ry the oppor­tu­ni­ty for ample returns once debt has been used to “add val­ue” into the prop­er­ty – as seen in many old­er, Class A office prop­er­ties under­go­ing changes. Final­ly, oppor­tunis­tic invest­ments car­ry the most risk, require the most lever­age, and gen­er­ate the great­est rewards – ground-up devel­op­ments, emp­ty build­ings, and land deals fall under this cat­e­go­ry.

“You look at equi­ty funds, oppor­tu­ni­ty funds, core funds, val­ue-add funds, all of that is deal­ing with strug­gles that are defen­sive in nature,” Zegen explained, empha­siz­ing that most funds are cur­rent­ly pay­ing down exist­ing lever­age. “Lots of mon­ey raised is being used from a defen­sive stand­point, and the ques­tion is: How do I get new mon­ey going into 2023 and 2024, and how will that mon­ey be cap­i­tal­ized?”

The direc­tion that mon­ey goes upon cap­i­tal­iza­tion is the next ele­ment of the equa­tion.

With more than $57 bil­lion in glob­al invest­ment cap­i­tal, Mor­gan Stanley’s Hochfelder said that her firm is look­ing to buy “high-qual­i­ty assets at below replace­ment cost” and at sub­stan­tial dis­counts to their prices from the first quar­ter of 2022.

“We’re not chas­ing val­ue traps,” Hochfelder said at the con­fer­ence. “We’re much more focused — rather than try­ing to buy a Down­town L.A. office at X per­cent off peak val­ues, we want to buy the high­est-qual­i­ty assets that we believe have the longest-term demand dri­vers”

To this end, Mor­gan Stan­ley is bull­ish on acquir­ing repriced core indus­tri­al assets and endors­ing its “tremen­dous long-term con­vic­tion” around the mul­ti­fam­i­ly sec­tor, she said.

...

Acore’s de Haan said his focus is on top 25 mar­kets, specif­i­cal­ly cities like Mia­mi where assets can be had at deep dis­counts in an envi­ron­ment poised for future growth.

“I fol­low migra­tion pat­terns, states and cities where we’ve got strong gov­er­nance, busi­ness-friend­ly envi­ron­ments, low­er cost of hous­ing and low­er tax­a­tion,” he said. “Those are migra­tion ponds that I think are deep and broad.”

Avi Fein­berg, a real estate part­ner at Fried Frank in New York, said that many of his pri­vate equi­ty clients are using the dis­tress to invest in alter­na­tive asset class­es: mari­nas, RV parks with ameni­ties, cor­po­rate-brand­ed RV parks, and logis­tics cen­ters.

“Any­time there’s dis­tress, it breathes oppor­tu­ni­ties. Every cloud has a sil­ver lin­ing for some­body,” Fein­berg said. “Some peo­ple are unfor­tu­nate­ly scarred by the down­turn, but there’s oth­ers who will find oppor­tu­ni­ties in that sit­u­a­tion.

“As a gen­er­al mat­ter, there will be oppor­tu­ni­ty in real estate because real estate hasn’t died,” he added. “That’s what we learned from pri­or cycles.”

———–

“How Pri­vate Equi­ty Plans to Cap­i­tal­ize on Com­mer­cial Real Estate Dis­tress” By Bri­an Pas­cus; Com­mer­cial Observ­er; 06/01/2023

““The back­drop is set­ting up for a like­ly sce­nario where we see more dis­tress than we’ve seen since the Great Reces­sion, and maybe even more dis­tress than in 2008, 2009 and 2010,” said War­ren de Haan, founder and man­ag­ing part­ner at Acore Cap­i­tal, one of the largest lenders in com­mer­cial real estate. “We have a sup­ply and demand imbal­ance between the demand for com­mer­cial real estate debt and the sup­ply of CRE debt.””

More dis­tress than we’ve seen since the Great Reces­sion, and maybe even more dis­tress than in 2008, 2009 and 2010. That’s quite a pre­dic­tion from the founder of of the largest lenders in com­mer­cial real estate. But that’s the mes­sage we’re get­ting, from a range a fig­ures across this indus­try. A “sup­ply and demand imbal­ance” of his­toric pro­por­tions is seem­ing­ly just get­ting is under­way with no clear end in sight thanks, in part, to the recent routes in the US’s region­al bank­ing sys­tem. But it’s not just Amer­i­ca’s tee­ter­ing mid-sized banks that are at the source of this unfold­ing mar­ket tur­moil. It’s also the fact that an esti­mat­ed $1.5 tril­lion in com­mer­cial real estate loans set to come due by the end of 2025, with $500 bil­lion com­ing due this year alone. Plus there’s the fact that the one big remain­ing pool of cred­it — the pri­vate equi­ty sec­tor — appears to smell blood in the water and is more than hap­py to allow the tur­moil to ensue as prices and col­lapse and bor­row­ers become des­per­ate. So we have com­mer­cial banks — which com­prise about 40 per­cent of the US com­mer­cial cred­it mar­ket — pulling back dra­mat­i­cal­ly at the same time pri­vate equi­ty and oth­er pri­vate cred­it investors — which only account for around 12 per­cent of that mar­ket — sit­ting on the side­lines wait­ing for this finan­cial time bomb to go off before they swoop in to feed on the ‘dis­tressed’ assets:

...
An esti­mat­ed $1.5 tril­lion in CRE debt comes due by the end of 2025, accord­ing to a report by Mor­gan Stan­ley. This matu­ri­ty wave arrives just as cap­i­tal mar­kets have seen a vast reduc­tion of liq­uid­i­ty dri­ven by a retrench­ment of the U.S. bank­ing sys­tem, which has expe­ri­enced the second‑, third- and fourth-largest com­mer­cial bank fail­ures in Amer­i­can his­to­ry since March and is gear­ing up for poten­tial­ly more in the months ahead.

Giv­en that region­al banks (those with $10 bil­lion to $160 bil­lion in assets) rep­re­sent near­ly 14 per­cent of com­mer­cial real estate lend­ing, the pull­back in debt cap­i­tal from the sys­tem at a time when that mon­ey is need­ed to pay down bil­lions in matu­ri­ties is not exact­ly an appe­tiz­ing mix for either investors or prop­er­ty own­ers.

If all of that plays out togeth­er, you’ll have sig­nif­i­cant­ly low­er liq­uid­i­ty in debt mar­kets, a huge wall of matu­ri­ties com­ing due, a high­er inter­est rate envi­ron­ment, mean­ing val­ues decline, and you have a bank­ing cri­sis at the same time, mean­ing that the amount of dis­tress we expect to see in the sys­tem will be expo­nen­tial­ly high­er than what we’ve seen in the last decade,” de Haan told CO.

“That is the big oppor­tu­ni­ty for the $400 bil­lion of pri­vate equi­ty sit­ting on the side­lines,” he added.

...

All told, pri­vate cred­it investors account for 12 per­cent of the $6.3 tril­lion U.S. com­mer­cial cred­it mar­ket, while region­al banks account for 40 per­cent of the total, accord­ing to Reuters.

Aside from Blackstone’s $30.4 bil­lion fundraise in April, oth­er heavy hit­ters have made head­lines in recent months: Brook­field Asset Management’s flag­ship real estate fund, Brook­field Strate­gic Real Estate Part­ners IV, raised $17 bil­lion in late 2022; Invesco Real Estate’s U.S. Fund VI closed above its $1.75 bil­lion hard cap in May; and Nuveen Real Estate’s CASA Part­ners IV fund raised $410 mil­lion in Octo­ber to ren­o­vate and repo­si­tion mul­ti­fam­i­ly units.

...

“De-lev­er­ing has cre­at­ed oppor­tu­ni­ties, lack of cap­i­tal has cre­at­ed oppor­tu­ni­ties,” said Josh Zegen, founder and man­ag­ing direc­tor of Madi­son Real­ty Cap­i­tal, a pri­vate real estate invest­ment firm with more than $10 bil­lion AUM. As for the bank­ing sec­tor shift, “peo­ple say it’s over. It’s absolute­ly not over. We’re see­ing every oth­er day a deal fall apart because a bank pulled out,” Zegen said.

As banks retreat, pri­vate equi­ty play­ers are prep­ping their well-timed pounce, siz­ing up debt and equi­ty envi­ron­ments equal­ly as mar­ket duress runs for­mer­ly well-cap­i­tal­ized spon­sors to exhaus­tion and even­tu­al sub­mis­sion.

On the cred­it side, Zegen not­ed that there’s less appetite avail­able to re-lever posi­tions through A notes, loan-on-loan financ­ing and cred­it lines, while the debt side is beset by prob­lems asso­ci­at­ed with the high­er cost of cap­i­tal and increas­ing­ly expen­sive short-term debt, float­ing-rate debt, and fixed-rate debt from sin­gle-asset sin­gle-bor­row­er loans and col­lat­er­al­ized loan oblig­a­tions.

“There’s a per­cep­tion that there’s so much liq­uid­i­ty, but I don’t share that opin­ion,” Zegen said. “This is a major oppor­tu­ni­ty for some­one like us right now, par­tic­u­lar­ly in the pri­vate cred­it area. But, real­ly, at the end of the day, there’s a lack of sup­ply of cap­i­tal rel­a­tive to the demand.”

He added that one fun­da­men­tal dif­fer­ence between now and the 2008 Glob­al Finan­cial Cri­sis is that pre­vi­ous down­turns car­ried the per­cep­tion that, so long as investors or spon­sors didn’t lever them­selves too bad­ly, they could hold out and wait for the cycle to invari­ably turn back — but now that offices have entered a struc­tur­al shift in the way peo­ple work and busi­ness­es uti­lize space, all bets are off.

“The prob­lem is in one very impor­tant sec­tor of the five major food groups of com­mer­cial real estate,” Zegen said, refer­ring to office. “And it’s some­thing that oppor­tu­ni­ty funds, debt funds, mort­gage REITs, col­lat­er­al­ized loan oblig­a­tions – just a huge sec­tion of these guys – had a 10 per­cent to 40 per­cent expo­sure to.”

While some spon­sors may recoil at the thought of onboard­ing new invest­ment part­ners who’ll pro­vide either mez­za­nine financ­ing or pre­ferred equi­ty stakes in vul­ner­a­ble cap­i­tal stacks, the prac­tice will be unavoid­able over the next six to 12 months as more loans mature and inter­est rates remain high: Over $500 bil­lion of CRE debt comes due this year alone, accord­ing to the Mort­gage Bankers Asso­ci­a­tion.
...

Adding to the poten­tial dis­tress is the fact that even loans that aren’t com­ing due soon are still poten­tial­ly fac­ing a dou­bling of inter­est rates next year. In oth­er words, the demand for new cap­i­tal in this sec­tor over the next cou­ple of years is prob­a­bly going to be much high­er than the $1.5 tril­lion in expir­ing loans. Ris­ing rates alone on exist­ing loans is going to effec­tive push many bor­row­ers into a cri­sis:

...
“Any­time you see this lev­el in asset val­ue repric­ing and this lev­el of cap­i­tal retreat­ing, both for struc­tur­al rea­sons and, frankly, con­cern around the envi­ron­ment, that cre­ates oppor­tu­ni­ties for those of us who have cap­i­tal and have con­vic­tion of where we want to invest it,” Hochfelder said.

Thus, under the pall of 5 per­cent inter­est rates, sig­nif­i­cant por­tions of that $500 bil­lion debt avalanche will strug­gle to main­tain their covenants, whether that’s debt-ser­vice-cov­er­age ratios or loan-to-val­ue ratios, while even those loans that aren’t matur­ing this year car­ry inter­est rate caps that are set to dou­ble upon expi­ra­tion, poten­tial­ly bal­loon­ing expens­es, accord­ing to David Bit­ner, exec­u­tive man­ag­ing direc­tor of glob­al research at New­mark (NMRK). All this will cre­ate “dis­tress and dis­tress adja­cen­cy” for spon­sors who need to pay down at least a por­tion of their matur­ing loans to main­tain own­er­ship of their prop­er­ties, or gen­er­ate new cap­i­tal alto­geth­er for assets sunk under­wa­ter, he said.

“You’ll have to go through a loan mod­i­fi­ca­tion, even if that is split­ting into an A‑B struc­ture, where there’s still upside for incre­men­tal equi­ty,” Bit­ner explained. “These are all very sen­si­tive nego­ti­a­tions, they’re going to be one by one, and they’re going to cre­ate oppor­tu­ni­ties for oppor­tunis­tic cap­i­tal to come into assets, but you have to have the reck­on­ing first.”
...

Tak­en togeth­er, it’s not hard to see why so many in the pri­vate equi­ty space are view­ing the upcom­ing peri­od as a poten­tial “gold­en moment”. And yet, as we’re also see­ing, many of the play­ers in the pri­vate equi­ty space aren’t exact­ly in a posi­tion to sim­ply wait and exploit the upcom­ing dis­tressed oppor­tu­ni­ties. Instead, they’re oper­at­ing from a defen­sive posi­tion. Because pri­vate equi­ty isn’t a new play­er in this space. So the pri­vate equi­ty sec­tor isn’t just sys­tem­at­i­cal­ly wait­ing on the side­lines for things to get worse and more dis­tressed in this space. It’s already expe­ri­enc­ing that dis­tress, which, in turn, sug­gests we might see a lot more hes­i­tan­cy in the pri­vate equi­ty space to pile onto more com­mer­cial real estate invest­ments. At least until things get a lot worse:

...
For the illiq­uid world of pri­vate cred­it — which pro­vides debt for com­mer­cial real estate projects -– and that of pri­vate equi­ty, the recent upheaval in the U.S. region­al bank­ing sec­tor and issues plagu­ing down­town office space has sparked ques­tions sur­round­ing the type of returns CRE can gen­er­ate for investors.

The pri­ma­ry ques­tion being: Is a gold­en moment pos­si­ble in the dark­est of times?

“We’re in a mean­ing­ful peri­od of dis­lo­ca­tion,” said Lau­ren Hochfelder, co-chief exec­u­tive offi­cer of Mor­gan Stan­ley Real Estate Invest­ments and head of MSREI Amer­i­c­as, dur­ing a Com­mer­cial Observ­er forum in late April. “We’re see­ing risk and asset val­ues repriced before our eyes, and I think that’s true across the entire investable uni­verse and cer­tain­ly across all of pri­vate real estate, every sec­tor, vir­tu­al­ly every glob­al mar­ket.”

The dis­lo­ca­tion across mar­kets and asset class­es has been dri­ven by numer­ous exter­nal fac­tors, includ­ing the sec­u­lar shift in office usage since COVID-19, but the largest rea­son for the dis­tress has been the his­tor­i­cal­ly rapid inter­est rate hikes by the Fed­er­al Reserve. Those have caused asset val­ues to decline as bor­row­ing costs have spiked. The increased lever­age ratios on exist­ing loans have put pres­sure on bor­row­ers, and, in some cir­cum­stances, made it impos­si­ble to keep loans cur­rent or to refi­nance matur­ing loans with­out an infu­sion of equi­ty. More­over, the cost of financ­ing acqui­si­tions or new devel­op­ments has also sky­rock­et­ed, cre­at­ing a pause in equi­ty mar­kets as they assess the frac­tured land­scape.

...

The entrance of pri­vate cap­i­tal into this world of dis­tress is expect­ed to take on two dif­fer­ent guis­es in the months ahead, accord­ing to CEOs and ana­lysts.

One route pri­vate equi­ty can take is buy­ing dis­tressed loans – loans that are in default or fore­clo­sure – at a sig­nif­i­cant dis­count and tak­ing con­trol of a prop­er­ty and rid­ing it out into a high rate of return. Anoth­er route is buy­ing per­form­ing loans from dis­tressed sell­ers, who sell loans backed by per­form­ing com­mer­cial prop­er­ties at a sig­nif­i­cant enough dis­count that pri­vate equi­ty firms step into the posi­tion with the abil­i­ty to gen­er­ate high rates of return, usu­al­ly in the 15 to 20 per­cent range. The first avenue offers the chance to buy debt notes on the cheap and fore­close on the entire cap­i­tal struc­ture once pay­ments are missed. The oth­er allows investors to pur­chase good prop­er­ties from des­per­ate sell­ers will­ing to sell for 80 cents on the dol­lar.

“The ques­tion is: What price or cost of cap­i­tal will peo­ple look for to step into the ful­crum of dis­tress?” said Ronald Dick­er­man, pres­i­dent and founder of Madi­son Inter­na­tion­al Real­ty, a real estate pri­vate equi­ty firm with over $8 bil­lion in cap­i­tal com­mit­ments. “Make no mis­take, the equi­ty investors are lick­ing their wounds from their office expo­sure and, gen­er­al­ly speak­ing, have writ­ten down oth­er parts of their office port­fo­lio. There isn’t as much exu­ber­ance to dive into the mar­ket as quick­ly as one might think and peo­ple are super cau­tious, espe­cial­ly about the office sec­tor.”

...

“You look at equi­ty funds, oppor­tu­ni­ty funds, core funds, val­ue-add funds, all of that is deal­ing with strug­gles that are defen­sive in nature,” Zegen explained, empha­siz­ing that most funds are cur­rent­ly pay­ing down exist­ing lever­age. “Lots of mon­ey raised is being used from a defen­sive stand­point, and the ques­tion is: How do I get new mon­ey going into 2023 and 2024, and how will that mon­ey be cap­i­tal­ized?”

The direc­tion that mon­ey goes upon cap­i­tal­iza­tion is the next ele­ment of the equa­tion.
...

And then there’s the some­what puz­zling cheer­i­ness of Black­stone Pres­i­dent and COO Jonathan Gray, who recent­ly observed that “the pri­vate cred­it area is real­ly at a gold­en moment because we do see tight­en­ing out there.” Now, on the one hand, it’s not hard to under­stand why Gray would be excit­ed on behalf of pri­vate equi­ty play­ers who aren’t yet invest­ed in this space. But on the oth­er hand, what about all of Black­stone’s clients who are already heav­i­ly invest­ed in com­mer­cial real estate? Like the clients who had a $270 mil­lion loan on Man­hat­tan rental prop­er­ties go into “spe­cial ser­vice” in Feb­ru­ary? It’s hard to see how it’s a ‘gold­en moment’ for them. It’s the kind of jux­ta­po­si­tion that serves as a reminder that the inter­ests of the pri­vate equi­ty giants like Black­stone don’t always align with the inter­est of their clients:

...
Dur­ing a May 3 appear­ance on Bloomberg TV, Black­stone (BX) Pres­i­dent and COO Jonathan Gray appeared sun­ny, despite his sur­name, as he tout­ed his pri­vate equi­ty firm’s recent glob­al real estate invest­ment fund, BREP X, which closed a $30.4 bil­lion fundrais­ing round in mid-April.

“We think there’s a real oppor­tu­ni­ty to deploy more cap­i­tal,” Gray said. “I think the pri­vate cred­it area is real­ly at a gold­en moment because we do see tight­en­ing out there.”

...

The shift­ing of the tide and sub­se­quent dis­tress has been plain to see: Brook­field (BN) default­ed on $784 mil­lion in loans tied to two Los Ange­les sky­scrap­ers in Feb­ru­ary; Black­stone sent a $270 mil­lion CMBS loan on a Man­hat­tan mul­ti­fam­i­ly port­fo­lio to spe­cial ser­vic­ing in Feb­ru­ary; GFP Real Estate default­ed on a $130 mil­lion mort­gage-backed secu­ri­ties loan for 515 Madi­son Avenue in Decem­ber; and just last month RXR default­ed on a $260 mil­lion loan on 61 Broad­way.
...

So we have fig­ures pre­dict­ing poten­tial­ly more mar­ket dis­tress for com­mer­cial real estate than was expe­ri­ence dur­ing the Great Reces­sion of 2008 at the same time Black­stone’s Jonathan Gray is see­ing a “gold­en moment” for the pri­vate equi­ty sec­tor. It’s that seem­ing­ly con­tra­dic­to­ry mix of omi­nous warn­ings and enthu­si­as­tic antic­i­pa­tion that cap­tures the dynam­ic unfold­ing here: the worse things get for the exist­ing own­ers of com­mer­cial real estate prop­er­ty, the bet­ter it’s even­tu­al­ly going to be for pri­vate equi­ty investors sit­ting on the side-lines.

Blackstone is Coming to the Rescue! But Only for the Best. And Not Just Yet. They Just Have to Wait for Everything to Get Worse, First.

But, again, what about all of Black­stone’s clients who aren’t sim­ply sit­ting on the side­lines but have been invest­ing in this space for years? It does­n’t sound too “gold­en” for them? And that brings us the fol­low­ing June 5 arti­cle, pub­lished two weeks ago and just a few days after the above arti­cle, that has anoth­er notable fig­ure in this space with some opti­mistic pre­dic­tions of his own: Accord­ing to Alfred Brooks, head of JP Mor­gan’s com­mer­cial real estate group, all the pre­dic­tions about a col­lapse of the com­mer­cial real estate sec­tor, and office build­ings in par­tic­u­lar, are just wrong. Why? Well, accord­ing to Brooks, the pri­vate equi­ty space has all sorts of cash sit­ting on the side­lines wait­ing to swoop in and cre­ate a mar­ket floor. Brooks specif­i­cal­ly point­ed to the $30.4 bil­lion Black­stone Real Estate Part­ners X fund, closed to new funds back in April, as evi­dence of this office sav­ing force get­ting under­way.

Of course, the dev­il is in the details on mat­ters like this, as we see with some of the con­di­tions Brooks gives on his opti­mism, like the fact that he’s only pre­dict­ing sun­ny days ahead for the high­est qual­i­ty “Class A” com­mer­cial office prop­er­ties. The Class B and C office prop­er­ties could go “down to the last bot­tom,” accord­ing to Brooks, an appar­ent ref­er­ence to price lev­els not seen since 2008 .

So back in May, we have Jonathan Gray of Black­stone see­ing a “gold­en moment” for pri­vate equi­ty in this sec­tor, less than three months after one of Black­stone’s exist­ing CRE funds sent a $270 mil­lion loan into “spe­cial ser­vices”. And a month lat­er, the head of JP Mor­gan’s com­mer­cial real estate divi­sion is point­ing to Black­stone’s new­ly cre­at­ed CRE fund as evi­dence that pri­vate equi­ty is wait­ing in the wings to save the com­mer­cial office space...or at least the high­est qual­i­ty com­mer­cial office space. The low­er qual­i­ty offices are pret­ty doomed, Brooks admits. Yes, the big play­ers have a plan and they’re excit­ed to talk about: a plan to wait for every­thing to fall apart and scoop up the best deals when it hap­pens. Sure, it will be a cat­a­stro­phe, but not for every­one:

Insid­er

Black­stone will help pre­vent an office mar­ket ‘cat­a­stro­phe’, says JPMor­gan’s com­mer­cial real estate chief

Al Yoon
Jun 5, 2023, 4:00 AM CDT

* Reports on the death of offices are “just wrong,” JPMor­gan’s com­mer­cial real estate chief said.
* Despite rough times today, Black­stone is eye­ing oppor­tu­ni­ties to snap up deals, he said.
* But the mar­ket bot­tom isn’t yet in sight, with delin­quen­cies just start­ing to ramp up.

Office build­ings are los­ing val­ue as more peo­ple opt to work from home and com­pa­nies need less space.

Debt defaults by investors such as Brook­field and Pim­co have sig­naled that even the most promi­nent hold­ers of the prop­er­ties have giv­en up on cer­tain build­ings. Office-build­ing prices fell near­ly 7% in April, year over year, and that drop is accel­er­at­ing, accord­ing to MSCI.

But some investors are prepar­ing to strike as val­u­a­tions drop, accord­ing to Alfred Brooks, who as head of JPMor­gan’s com­mer­cial real estate group over­sees more than $30 bil­lion of annu­al orig­i­na­tions. That’s like­ly to pre­vent prices from tum­bling into the abyss.

No ‘cat­a­stro­phe’ for the office mar­ket

“You get the head­line writ­ten that the office mar­ket is a cat­a­stro­phe,” Brooks said dur­ing a JPMor­gan out­look webi­nar on June 1. “That’s just wrong.”

“If it was so bleak, then why do we have peo­ple like our friends in the pri­vate equi­ty side already” rais­ing mon­ey for the sec­tor, he said, not­ing that real-estate giant Black­stone is rais­ing funds. “So obvi­ous­ly, there’s going to be a bot­tom put under the mar­ket,” Brooks con­tin­ued.

In April, Black­stone announced the final close of its Black­stone Real Estate Part­ners X, the largest real estate fund ever raised, with $30.4 bil­lion in cap­i­tal com­mit­ments. It not­ed that it has shift­ed its port­fo­lio away from stressed sec­tors such as offices, and was favor­ing bet­ter per­form­ing areas like logis­tics, rental hous­ing, hos­pi­tal­i­ty, and data cen­ters.

There are sig­nals that demand could return — at least for the bet­ter build­ings. Accord­ing to JLL, a com­mer­cial-real-estate ser­vices firm, there are “promis­ing signs” from cor­po­rate ten­ants of a grad­ual re-entry to offices, so much that com­pa­nies could even­tu­al­ly find them­selves short of space.

It’s unclear when office prices will bot­tom out

Still, a bot­tom in the office sec­tor isn’t expect­ed any­time soon.

Office delin­quen­cy rates were sup­pressed because ten­ants were locked into long-term leas­es. Now, they’re tick­ing high­er. Last month, a “huge spike” in dis­tressed office debt dragged the delin­quen­cy rate of secu­ri­tized com­mer­cial mort­gages high­er by 0.53 per­cent­age points to 3.62%, for the largest sin­gle-month increase since the COVID-19 pan­dem­ic was emp­ty­ing build­ings in June 2020, accord­ing to Trepp.

The “tip­ping point” that investors were wait­ing for on office debt appears to be here, Manus Clan­cy, a senior man­ag­ing direc­tor at Trepp, wrote in a June 1 post to clients, sug­gest­ing delin­quen­cy data is final­ly begin­ning to reflect the long-pro­ject­ed dis­tress.

For all of his mea­sured com­ments, Brooks’ head was­n’t in the sand. The prices of low­er tier, Class B and C office prop­er­ties could go “down to the last bot­tom,” he not­ed, refer­ring to the 2008 finan­cial cri­sis. As that cri­sis unfold­ed, the delin­quen­cy rate for secu­ri­tized com­mer­cial prop­er­ty loans topped out in 2012 at a record 10.34%, near­ly three times that of today, accord­ing to Trepp.

Brooks con­nect­ed his more bear­ish com­ments to the trou­bled large mar­kets, like Los Ange­les. In addi­tion to some Class A prop­er­ties that are retain­ing ten­ants, there are oth­er areas that are still “okay,” such as the Sun­belt, he said.

...

Buy­ing the office dip

Even if a severe cor­rec­tion does emerge in com­mer­cial real estate, Brooks said there will be “vic­tors,” — includ­ing JPMor­gan — that’ll look to pur­chase in advance of the next upturn, which typ­i­cal­ly lasts 10 to 12 years.

There has­n’t been a true cor­rec­tion in the mar­ket since 2008, he said.

“Frankly, actu­al­ly, Black­stone’s pret­ty smart,” Brooks said. “They’re prob­a­bly going to be able to catch this mar­ket at a nice low point and they’re going to prob­a­bly have some very good deals they’re going to be able to under­write because there isn’t tremen­dous liq­uid­i­ty, par­tic­u­lar­ly for B- and C‑grade office.”

“I don’t see that chang­ing for a few years,” he said.

———-

“Black­stone will help pre­vent an office mar­ket ‘cat­a­stro­phe’, says JPMor­gan’s com­mer­cial real estate chief” by Al Yoon; Insid­er; 06/05/2023

““If it was so bleak, then why do we have peo­ple like our friends in the pri­vate equi­ty side already” rais­ing mon­ey for the sec­tor, he said, not­ing that real-estate giant Black­stone is rais­ing funds. “So obvi­ous­ly, there’s going to be a bot­tom put under the mar­ket,” Brooks con­tin­ued.

If the prospects for the com­mer­cial real estate mar­ket are so awful, why did Black­stone just cre­ate a new fund designed for these kinds of invest­ments? That’s the mes­sage not from Black­stone but instead from Alfred Brooks, the head of JP Mor­gan’s com­mer­cial real estate group. Black­stone is going to cre­ate the ‘bot­tom’ for the com­mer­cial real estate mar­ket, accord­ing to Brooks. There is no cat­a­stro­phe on the hori­zon. If there was, Black­stone would­n’t have cre­at­ed its largest com­mer­cial real estate fund ever back in April, the Black­stone Real Estate Part­ners X. At least that’s the mes­sage JP Mor­gan is putting out to the pub­lic:

...
Debt defaults by investors such as Brook­field and Pim­co have sig­naled that even the most promi­nent hold­ers of the prop­er­ties have giv­en up on cer­tain build­ings. Office-build­ing prices fell near­ly 7% in April, year over year, and that drop is accel­er­at­ing, accord­ing to MSCI.

But some investors are prepar­ing to strike as val­u­a­tions drop, accord­ing to Alfred Brooks, who as head of JPMor­gan’s com­mer­cial real estate group over­sees more than $30 bil­lion of annu­al orig­i­na­tions. That’s like­ly to pre­vent prices from tum­bling into the abyss.

No ‘cat­a­stro­phe’ for the office mar­ket

“You get the head­line writ­ten that the office mar­ket is a cat­a­stro­phe,” Brooks said dur­ing a JPMor­gan out­look webi­nar on June 1. “That’s just wrong.”

...

In April, Black­stone announced the final close of its Black­stone Real Estate Part­ners X, the largest real estate fund ever raised, with $30.4 bil­lion in cap­i­tal com­mit­ments. It not­ed that it has shift­ed its port­fo­lio away from stressed sec­tors such as offices, and was favor­ing bet­ter per­form­ing areas like logis­tics, rental hous­ing, hos­pi­tal­i­ty, and data cen­ters.
...

And then we get to the many clar­i­fi­ca­tions on Brook­s’s opti­mism. Like the fact that no one is expect a bot­tom in the com­mer­cial real estate mar­ket any time soon and a “tip­ping point” appears to have been reached in terms of own­ers being pushed into delin­quen­cy, with the “Class B” and “Class C” low­er qual­i­ty prop­er­ties still poised to go “down to the last bot­tom”, when delin­quen­cy rates were triple where they are today. Despite all the hap­py talk, things are poised to get a lot worse for this mar­ket:

...
There are sig­nals that demand could return — at least for the bet­ter build­ings. Accord­ing to JLL, a com­mer­cial-real-estate ser­vices firm, there are “promis­ing signs” from cor­po­rate ten­ants of a grad­ual re-entry to offices, so much that com­pa­nies could even­tu­al­ly find them­selves short of space.

...

Still, a bot­tom in the office sec­tor isn’t expect­ed any­time soon.

Office delin­quen­cy rates were sup­pressed because ten­ants were locked into long-term leas­es. Now, they’re tick­ing high­er. Last month, a “huge spike” in dis­tressed office debt dragged the delin­quen­cy rate of secu­ri­tized com­mer­cial mort­gages high­er by 0.53 per­cent­age points to 3.62%, for the largest sin­gle-month increase since the COVID-19 pan­dem­ic was emp­ty­ing build­ings in June 2020, accord­ing to Trepp.

The “tip­ping point” that investors were wait­ing for on office debt appears to be here, Manus Clan­cy, a senior man­ag­ing direc­tor at Trepp, wrote in a June 1 post to clients, sug­gest­ing delin­quen­cy data is final­ly begin­ning to reflect the long-pro­ject­ed dis­tress.

For all of his mea­sured com­ments, Brooks’ head was­n’t in the sand. The prices of low­er tier, Class B and C office prop­er­ties could go “down to the last bot­tom,” he not­ed, refer­ring to the 2008 finan­cial cri­sis. As that cri­sis unfold­ed, the delin­quen­cy rate for secu­ri­tized com­mer­cial prop­er­ty loans topped out in 2012 at a record 10.34%, near­ly three times that of today, accord­ing to Trepp.
...

Final­ly, there’s the ‘pot of gold at the end of the bloody rain­bow’ sce­nario await­ing this sec­tor: once the com­mer­cial real estate mar­ket is dis­tressed enough, there’s bound to be great deals. It’s a bright future ahead...at least for those not already heav­i­ly invest­ed in the com­mer­cial real estate mar­ket. That’s the mes­sage from the head of JP Mor­gan’s com­mer­cial real estate invest­ment divi­sion:

...
Even if a severe cor­rec­tion does emerge in com­mer­cial real estate, Brooks said there will be “vic­tors,” — includ­ing JPMor­gan — that’ll look to pur­chase in advance of the next upturn, which typ­i­cal­ly lasts 10 to 12 years.

There has­n’t been a true cor­rec­tion in the mar­ket since 2008, he said.

“Frankly, actu­al­ly, Black­stone’s pret­ty smart,” Brooks said. “They’re prob­a­bly going to be able to catch this mar­ket at a nice low point and they’re going to prob­a­bly have some very good deals they’re going to be able to under­write because there isn’t tremen­dous liq­uid­i­ty, par­tic­u­lar­ly for B- and C‑grade office.

“I don’t see that chang­ing for a few years,” he said.
...

There has­n’t been a true cor­rec­tion in the mar­ket since 2008, accord­ing to Brooks. Yikes. But that also explains the eager antic­i­pa­tion. The cred­i­tors have prop­er­ty own­ers over a bar­rel and they know it.

Blackstone’s Pension Fund Clients are Coming to the Rescue. To Save Themselves

Of course, it’s not Black­stone that’s pur­port­ed­ly estab­lish­ing this mar­ket floor for com­mer­cial real estate prices. It’s the investors pil­ing mon­ey into Black­stone’s funds like the Black­stone Real Estate Part­ners X fund Black­stone ‘closed’ to new fund­ing in April. So who are the investors of that fund who will be help­ing to estab­lish the mar­ket floor as JP Mor­gan eager­ly awaits the arrival of the antic­i­pat­ed mar­ket bot­tom? Exact­ly who we should prob­a­bly expect at this point: Pub­lic pen­sion funds:

Pen­sions & Invest­ments

Black­stone clos­es $30.4 bil­lion oppor­tunis­tic real estate fund

Arleen Jaco­bius
April 11, 2023 03:47 PM

Black­stone on Tues­day announced the close of its largest real estate fund, Black­stone Real Estate Part­ners X, at $30.4 bil­lion, a news release said.

...

Black­stone has been rais­ing the fund since 2021, accord­ing to fil­ings with the SEC.

The lat­est oppor­tunis­tic real estate fund sur­passed its pre­de­ces­sor fund, Black­stone Real Estate Part­ners IX, which closed at $20.5 bil­lion in 2019.

Investors in the news fund include the $306 bil­lion Cal­i­for­nia State Teach­ers’ Retire­ment Sys­tem, West Sacra­men­to; $143.3 bil­lion State of Wis­con­sin Invest­ment Board, Madi­son; $109.3 bil­lion North Car­oli­na Retire­ment Sys­tems, Raleigh; $98.9 bil­lion Vir­ginia Retire­ment Sys­tem, Rich­mond; and $33.7 bil­lion Penn­syl­va­nia State Employ­ees’ Retire­ment Sys­tem, Har­ris­burg.

———-

“Black­stone clos­es $30.4 bil­lion oppor­tunis­tic real estate fund” by Arleen Jaco­bius; Pen­sions & Invest­ments; 04/11/2023

“Investors in the news fund include the $306 bil­lion Cal­i­for­nia State Teach­ers’ Retire­ment Sys­tem, West Sacra­men­to; $143.3 bil­lion State of Wis­con­sin Invest­ment Board, Madi­son; $109.3 bil­lion North Car­oli­na Retire­ment Sys­tems, Raleigh; $98.9 bil­lion Vir­ginia Retire­ment Sys­tem, Rich­mond; and $33.7 bil­lion Penn­syl­va­nia State Employ­ees’ Retire­ment Sys­tem, Har­ris­burg.”

Behold: all of the investors list­ed in record-set­ting Black­stone Real Estate Part­ners X fund are pub­lic pen­sion funds. That’s who is ulti­mate­ly cre­at­ing the floor on com­mer­cial real estate prices. Hope­ful­ly! Because there’s no guar­an­tee the floor is actu­al­ly going to be cre­at­ed. At least not by the same pen­sion funds try­ing to ‘catch this falling knife’ today unless they just keep shov­el­ing mon­ey into com­mer­cial real estate until there’s an even­tu­al turn­around.

And we also have to ask: so if com­mer­cial real estate is such a good invest­ment right now, why aren’t we see­ing a lot more play­ers get­ting into this sec­tor? Sure, pen­sion funds have time hori­zons and risk pro­files that not all investors have but that still does­n’t explain why we aren’t read­ing about wider inter­est in scor­ing a great mar­ket oppor­tu­ni­ty in this sec­tor. Why just pen­sion funds in the news? Are pen­sion funds being set up as some sort of ‘bag hold­er’ in the ensu­ing mar­ket rout?

And that brings us to the fol­low­ing arti­cle from back on Hal­loween of 2022, dis­cussing what was then a chang­ing trend in pen­sion fund invest­ing: pen­sion funds were start­ing to pull back from the record lev­els of invest­ing they had been doing in the com­mer­cial real estate sec­tor in the first half of the year. In oth­er words, pen­sion funds have been enthu­si­as­ti­cal­ly mak­ing them­selves the ‘bag hold­ers’ for com­mer­cial real estate mar­ket in the lead up to the antic­i­pat­ed ‘dis­tressed debt’ fire­sale bonan­za that investors are expect­ing some time lat­er this year:

Con­nect­ed Real Estate Mag­a­zine

Pen­sion funds scale back on CRE invest­ing

By Joe Dyton
Octo­ber 31, 2022

U.S. pub­lic pen­sion funds have start­ed to scale back on their invest­ments into the com­mer­cial real estate indus­try, The Wall Street Jour­nal reports. The rever­sal comes after these funds had invest­ed mon­ey into CRE at a record rate dur­ing the first half of 2022.

The retire­ment funds made $32.6 bil­lion of new finan­cial com­mit­ments to offices, build­ings, ware­hous­es and oth­er CRE prop­er­ties in the first half of this year—an approx­i­mate 40 per­cent increase from the same time frame in 2021, accord­ing to Fer­gu­son Part­ners, a pro­fes­sion­al ser­vices firm that tracks the CRE indus­try.

The high demand for CRE prop­er­ty dur­ing the first half of this year was in part due to investors com­ing back to the mar­ket fol­low­ing the start of the COVID-19 pan­dem­ic, Fer­gu­son direc­tor Scott McIn­tosh told The Wall Street Jour­nal.

“Real estate was gen­er­at­ing strong returns,” McIn­tosh said. “We were see­ing strong rental growth and strong trans­ac­tion vol­ume through 2021 and a lot of that momen­tum flowed into the first half of 2022.”

Unfor­tu­nate­ly, increased bor­row­ing rates are not a good sign for an inter­est-rate sen­si­tive indus­try like CRE. Plus, build­ing own­ers haven’t been in the best posi­tion to raise rents because of increased con­cerns about a reces­sion.

Fer­gu­son Part­ners is still cal­cu­lat­ing poten­tial third-quar­ter pen­sion fund invest­ments, but they are most cer­tain­ly going to drop dur­ing the back half of 2022, accord­ing to McIn­tosh. He point­ed to infla­tion, labor costs and sup­ply-chain dis­rup­tions, which have made build­ing more expen­sive, as rea­sons there could be few­er pen­sion-fund com­mit­ments dur­ing the third quar­ter.

CRE fundrais­ing also on the decline

Pri­vate equi­ty funds and oth­er CRE investors that look to pen­sions when they raise mon­ey for their new funds have also noticed a dif­fer­ence, accord­ing to The Wall Street Jour­nal. Pri­vate equi­ty firm man­aged CRE funds raised $112.8 bil­lion from pen­sion funds and oth­er investors world­wide as of Octo­ber 20. The time last year, almost $160 bil­lion was raised, accord­ing to data firm Pre­qin. Mar­ket experts are pro­ject­ing fourth quar­ter fundrais­ing could fall well below the record $80 bil­lion raised dur­ing the final three months of 2021.

...

CRE sales are also down—the $171.2 bil­lion worth of com­mer­cial prop­er­ty acquired dur­ing the third quar­ter is a 21-per­cent drop off from the same time peri­od in 2021, per MSCI data. Decreased sales have made pen­sion funds and oth­er investors hes­i­tant to put more mon­ey into CRE because it’s uncer­tain if prop­er­ty val­ues will con­tin­ue to fall.

A lot of pen­sions have now scaled back on future CRE invest­ments because of what’s known as the “denom­i­na­tor effect,” The Wall Street Jour­nal reports. They want their prop­er­ty hold­ings to only make up a cer­tain per­cent­age of their entire port­fo­lio.

Mean­while, some pen­sions are focus­ing on poten­tial oppor­tu­ni­ties with trou­bled prop­er­ties dur­ing an eco­nom­ic down­turn. For exam­ple, the Con­necti­cut Retire­ment Plans and Trust Funds is look­ing to “take advan­tage of the lack of cap­i­tal in cer­tain areas” as well as “dis­tress in the mar­ket,” a spokes­woman said.

————–

“Pen­sion funds scale back on CRE invest­ing” By Joe Dyton; Con­nect­ed Real Estate Mag­a­zine; 10/31/10222

“U.S. pub­lic pen­sion funds have start­ed to scale back on their invest­ments into the com­mer­cial real estate indus­try, The Wall Street Jour­nal reports. The rever­sal comes after these funds had invest­ed mon­ey into CRE at a record rate dur­ing the first half of 2022.

Yes, it was back in Octo­ber, just around eight months ago, when we were get­ting reports that pen­sion funds were final­ly pulling back from the record com­mer­cial real estate invest­ments the sec­tor made in the first half of 2022. That’s part of the con­text of the opti­mism we hear from JP Mor­gan about Black­stone’s new com­mer­cial real estate fund being an exam­ple of how the pri­vate equi­ty sec­tor is going to step in and pro­vide the ‘floor’ from the com­mer­cial real estate mar­ket at the same time we’re still hear­ing about how com­mer­cial real estate could fall much fur­ther before tru­ly hit­ting a bot­tom. It’s pen­sion funds that have been ‘catch­ing a falling knife’ in the mar­ket for all along and that has­n’t exact­ly stopped the fall. Sure, even­tu­al­ly there’s going to be a bot­tom, and pen­sion funds will invari­ably be invest­ed in the sec­tor to appre­ci­ate the gains from that point. But with that bot­tom poten­tial­ly years ago in many real estate mar­kets, it’s hard not to see this as a rel­a­tive­ly high risk invest­ment:

...
The retire­ment funds made $32.6 bil­lion of new finan­cial com­mit­ments to offices, build­ings, ware­hous­es and oth­er CRE prop­er­ties in the first half of this year—an approx­i­mate 40 per­cent increase from the same time frame in 2021, accord­ing to Fer­gu­son Part­ners, a pro­fes­sion­al ser­vices firm that tracks the CRE indus­try.

...

Unfor­tu­nate­ly, increased bor­row­ing rates are not a good sign for an inter­est-rate sen­si­tive indus­try like CRE. Plus, build­ing own­ers haven’t been in the best posi­tion to raise rents because of increased con­cerns about a reces­sion.

Fer­gu­son Part­ners is still cal­cu­lat­ing poten­tial third-quar­ter pen­sion fund invest­ments, but they are most cer­tain­ly going to drop dur­ing the back half of 2022, accord­ing to McIn­tosh. He point­ed to infla­tion, labor costs and sup­ply-chain dis­rup­tions, which have made build­ing more expen­sive, as rea­sons there could be few­er pen­sion-fund com­mit­ments dur­ing the third quar­ter.
...

At the same time, we can see how some pen­sion funds were prepar­ing to tak­ing advan­tage of upcom­ing oppor­tu­ni­ties to snag a good deal on the expec­ta­tion of a slew of dis­tressed prop­er­ties that would be com­ing on the mar­kets. That’s good news for pen­sion funds that yet aren’t invest­ed in com­mer­cial real estate. But not so good for the funds already in this sec­tor, which is pre­sum­ably quite a few funds giv­en the lev­el of inter­est pen­sion funds have had in pri­vate-equi­ty-led real estate invest­ments over the last decade:

...
CRE sales are also down—the $171.2 bil­lion worth of com­mer­cial prop­er­ty acquired dur­ing the third quar­ter is a 21-per­cent drop off from the same time peri­od in 2021, per MSCI data. Decreased sales have made pen­sion funds and oth­er investors hes­i­tant to put more mon­ey into CRE because it’s uncer­tain if prop­er­ty val­ues will con­tin­ue to fall.

A lot of pen­sions have now scaled back on future CRE invest­ments because of what’s known as the “denom­i­na­tor effect,” The Wall Street Jour­nal reports. They want their prop­er­ty hold­ings to only make up a cer­tain per­cent­age of their entire port­fo­lio.

Mean­while, some pen­sions are focus­ing on poten­tial oppor­tu­ni­ties with trou­bled prop­er­ties dur­ing an eco­nom­ic down­turn. For exam­ple, the Con­necti­cut Retire­ment Plans and Trust Funds is look­ing to “take advan­tage of the lack of cap­i­tal in cer­tain areas” as well as “dis­tress in the mar­ket,” a spokes­woman said.
...

So as we can see from that Octo­ber 2022 report, pen­sion funds were enter­ing into 2023 with a mix of larg­er expo­sure in this sec­tor but also poten­tial oppor­tu­ni­ty. It’s pre­sum­ably going to be a mix for these long-term investors in the sec­tor. But as the fol­low­ing Busi­ness Insid­er piece from Apil describes, pen­sion funds are indeed expect­ed to ‘take a bath’ on their com­mer­cial real estate invest­ments. Cal­STRS, the Cal­i­for­nia pub­lic pen­sion fund, is described as already cut­ting the val­u­a­tion of its office real estate hold­ings by 20% based on the Fed’s inter­est rate hikes alone. Note that this report was from just two weeks after the above report list­ing the pen­sion fund investors in the Black­stone Real Estate Part­ners X fund. Also note that Cal­STRS is one of those investors:

Insid­er

Banks aren’t the only ones that hold risky com­mer­cial-real-estate debt. Pen­sion funds are about to feel the pain, too.

Al Yoon
Apr 24, 2023, 2:01 PM CDT

* Pen­sion funds, REITs, and insur­ers hold more than $1.2 tril­lion in com­mer­cial-real-estate debt.
* Cal­STRS, a Cal­i­for­nia pen­sion fund, told the FT it will be writ­ing down its real-estate port­fo­lio.
* “This is just the begin­ning” for funds, said Trep­p’s Manus Clan­cy.

Investor angst over risky com­mer­cial real estate has explod­ed in recent weeks with expec­ta­tions that banks that hold bil­lions of dol­lars in the debt are too weak to absorb any loss­es.

But while banks hold about half of all US com­mer­cial-real-estate debt, there are oth­er big hold­ers that are start­ing to feel the pain, espe­cial­ly over hold­ings of office prop­er­ties suf­fer­ing from the rise of remote or hybrid work sched­ules. Among them are the large pen­sion funds, REITs, and insur­ance com­pa­nies, togeth­er account­ing for more than $1.2 tril­lion — or 22% — of the $5.62 tril­lion in total com­mer­cial-real-estate debt out­stand­ing, accord­ing to BofA Glob­al Research.

The hold­ings took on new mean­ing last week after the Cal­i­for­nia State Teach­ers Retire­ment Sys­tem, or Cal­STRs, told the Finan­cial Times it would be writ­ing down the val­ue of its $52 bil­lion in real-estate hold­ings because high­er bor­row­ing costs on the heels of Fed­er­al Reserve inter­est rate hikes have sacked prop­er­ty val­ues. In the office sec­tor alone, val­ues are like­ly down 20% just based on the rate move, Christo­pher Ail­man, Cal­STRS chief invest­ment offi­cer, told the FT.

“This is just an indi­ca­tion of what’s to come,” said Manus Clan­cy, a senior man­ag­ing direc­tor at Trepp, a com­mer­cial-real-estate-data firm, said about the pen­sion woes on the Trep­p­Wire pod­cast last week.

“This is the begin­ning of what will be a lot of this from the funds, from the pri­vate equi­ty guys, from the insur­ance com­pa­nies,” Clan­cy said. “There will be a lot of reduc­tions in equi­ty val­ues over the next cou­ple of years, or soon­er. It will be heav­i­ly tilt­ed toward office.”

As the val­ues drop, the refi­nanc­ing of some $2.5 tril­lion in debt over the next five years will be a tall order for land­lords as they face a tight­en­ing of lend­ing stan­dards on top of the high­er inter­est rates. Already, some big land­lords have cho­sen to default, includ­ing Brook­field on $161 mil­lion in debt tied to office prop­er­ties around Wash­ing­ton, DC, Bloomberg report­ed last week.

...

Some pen­sion funds were already plan­ning to reduce their expo­sures to com­mer­cial real estate even before the recent bank fail­ures mag­ni­fied the risks.

In Sep­tem­ber, fund man­agers at Artemis Real Estate Part­ners and PGIM Real Estate said at a Bis­now con­fer­ence that their investors indi­cat­ed they’d be reduc­ing allo­ca­tions to real estate, just because the assets had been out­per­form­ing oth­ers. Asset allo­ca­tions of their investors were “out of whack,” Cathy Mar­cus, PGIM’s head of US equi­ty, said at the con­fer­ence.

Cal­STRS report­ed dou­ble-dig­it returns over a 10-year peri­od, mak­ing it a top per­form­ing asset class, accord­ing to the FT.

Inter­na­tion­al investors are brac­ing for the worst. Some 39% of the 100 investors from 14 coun­tries sur­veyed for the Q1 2023 Pulse Report by AFIRE — an asso­ci­a­tion for inter­na­tion­al investors focused com­mer­cial prop­er­ty in the US —said they planned to reduce their US hold­ings at least some­what in 2023, com­pared with 27% that intend to increase their posi­tions.

There is mon­ey on the side­lines, how­ev­er. With the avail­abil­i­ty and pric­ing of debt imped­ing deals, 70% of the AFIRE respon­dents said they antic­i­pat­ed “mean­ing­ful dis­tressed acqui­si­tion oppor­tu­ni­ties as soon as the next six months.”

...

———-

“Banks aren’t the only ones that hold risky com­mer­cial-real-estate debt. Pen­sion funds are about to feel the pain, too.” by Al Yoon; Insid­er; 04/24/2023

“But while banks hold about half of all US com­mer­cial-real-estate debt, there are oth­er big hold­ers that are start­ing to feel the pain, espe­cial­ly over hold­ings of office prop­er­ties suf­fer­ing from the rise of remote or hybrid work sched­ules. Among them are the large pen­sion funds, REITs, and insur­ance com­pa­nies, togeth­er account­ing for more than $1.2 tril­lion — or 22% — of the $5.62 tril­lion in total com­mer­cial-real-estate debt out­stand­ing, accord­ing to BofA Glob­al Research.

Get ready for the pain. That was warn­ing mes­sage blar­ing back in April for the big hold­ers in com­mer­cial real estate, with pen­sion funds being amount the biggest of those big hold­ers. Even Cal­i­for­nia State Teach­ers Retire­ment Sys­tem (Cal­STRs), one of the investors in the Black­stone Real Estate Part­ners X fund, announced it would be writ­ing down the val­ue of its $52 bil­lion in real estate hold­ings, with a 20% drop in the val­ue of those hold­ings due to the Fed’s inter­est rates moves alone. How much fur­ther are those hold­ings going to drop before the bot­tom is estab­lished? Time will tell, but note the time frame mar­ket experts are talk­ing about here: years of depre­ci­at­ing val­ues. Not months but years. That’s a great sign for oppor­tunis­tic bot­tom-feed­ers with a lot of cash but not so great for the exist­ing investors. And as experts also warn, a lot of pen­sion funds are already rel­a­tive­ly over­weight­ed in their com­mer­cial real estate hold­ings, which obvi­ous­ly does not bode well for those funds:

...
The hold­ings took on new mean­ing last week after the Cal­i­for­nia State Teach­ers Retire­ment Sys­tem, or Cal­STRs, told the Finan­cial Times it would be writ­ing down the val­ue of its $52 bil­lion in real-estate hold­ings because high­er bor­row­ing costs on the heels of Fed­er­al Reserve inter­est rate hikes have sacked prop­er­ty val­ues. In the office sec­tor alone, val­ues are like­ly down 20% just based on the rate move, Christo­pher Ail­man, Cal­STRS chief invest­ment offi­cer, told the FT.

“This is just an indi­ca­tion of what’s to come,” said Manus Clan­cy, a senior man­ag­ing direc­tor at Trepp, a com­mer­cial-real-estate-data firm, said about the pen­sion woes on the Trep­p­Wire pod­cast last week.

“This is the begin­ning of what will be a lot of this from the funds, from the pri­vate equi­ty guys, from the insur­ance com­pa­nies,” Clan­cy said. “There will be a lot of reduc­tions in equi­ty val­ues over the next cou­ple of years, or soon­er. It will be heav­i­ly tilt­ed toward office.”

...

Some pen­sion funds were already plan­ning to reduce their expo­sures to com­mer­cial real estate even before the recent bank fail­ures mag­ni­fied the risks.

In Sep­tem­ber, fund man­agers at Artemis Real Estate Part­ners and PGIM Real Estate said at a Bis­now con­fer­ence that their investors indi­cat­ed they’d be reduc­ing allo­ca­tions to real estate, just because the assets had been out­per­form­ing oth­ers. Asset allo­ca­tions of their investors were “out of whack,” Cathy Mar­cus, PGIM’s head of US equi­ty, said at the con­fer­ence.
...

So how soon can we expect mar­ket con­di­tions to get bad enough that the project fire sales of dis­tressed com­mer­cial prop­er­ties starts hit­ting the mar­kets? 70% of the 100 investors from 14 coun­tries sur­veyed for the Q1 2023 Pulse Report by AFIRE said they expect­ed “mean­ing­ful dis­tressed acqui­si­tion oppor­tu­ni­ties as soon as the next six months.” Keep in mind what was saw in the first arti­cle from a cou­ple of weeks ago: The “tip­ping point” that investors were wait­ing for had arrived. That tip­ping point being the expi­ra­tion of long-term ten­ant leas­es on a lot of com­mer­cial prop­er­ties that is now push­ing a num­ber of prop­er­ties into delin­quen­cy:

...
There is mon­ey on the side­lines, how­ev­er. With the avail­abil­i­ty and pric­ing of debt imped­ing deals, 70% of the AFIRE respon­dents said they antic­i­pat­ed “mean­ing­ful dis­tressed acqui­si­tion oppor­tu­ni­ties as soon as the next six months.”
...

Exploitable mass dis­tress is just around the cor­ner for com­mer­cial real estate. That’s the pre­dic­tion. And as we’ve seen, it’s a pre­dic­tion that has the pri­vate equi­ty indus­try brim­ming with antic­i­pa­tion. That, despite the fact that pen­sion funds , the largest clients in the pri­vate equi­ty space, have been pil­ing into this same dis­tressed mar­ket in recent years under pri­vate equi­ty’s guid­ance of and will invari­ably be the own­ers of a num­ber of those “mean­ing­ful dis­tressed acqui­si­tion oppor­tu­ni­ties.” It’s the com­bi­na­tion of warn­ings about great pain to come for the pen­sion funds who have already invest­ed in this space cou­pled with kind of enthu­si­asm that we’re see­ing that rais­es the ques­tion: Are we see­ing the set up for a fed­er­al bailout of the com­mer­cial real estate sec­tor? A bail that is spun as a bailout for pen­sion funds? Because that might explain, in part, the enthu­si­asm we’re hear­ing.

The Pre-Pandemic Pension Plan: Give Us All Your Commercial Property. And Rental Properties

But it’s not just the enthu­si­asm on dis­play in the pri­vate equi­ty sec­tor in the face of this exploitable oppor­tu­ni­ty that is so trou­bling in this pic­ture. It’s also the fact that the exploitable cri­sis in com­mer­cial real estate is only one exam­ple of exploita­tion in this sto­ry of the pen­sion fund indus­try’s deep­en­ing love affair with pri­vate-equi­ty real estate over the last decade. As the fol­low­ing The Real Deal arti­cle except describes, the pen­sion fund indus­try has been qui­et­ly get­ting into anoth­er area of real estate and, for­tu­nate­ly for the pen­sion funds, there’s ongo­ing and grow­ing demand for these kinds of prop­er­ties: the mul­ti-fam­i­ly res­i­den­tial rental prop­er­ties. Yes, pen­sion funds are increas­ing­ly the own­ers of apart­ment builds and oth­er res­i­den­tial rental port­fo­lios.

But while res­i­den­tial prop­er­ties for­tu­nate­ly aren’t fac­ing the kind of mar­ket melt­down their com­mer­cial real estate coun­ter­parts are fac­ing, there’s still alle­ga­tion of exploita­tion. Except it was­n’t the pen­sion funds get­ting exploit­ed with dis­tressed prop­er­ties. Instead, it’s the pen­sion funds seem­ing­ly doing the exploit­ing, although it’s tech­ni­cal­ly the pri­vate equi­ty firms man­ag­ing these prop­er­ties on behalf of their pen­sion fund clients doing the exploit­ing. Specif­i­cal­ly, it turns out large invest­ments have been made in rental prop­er­ties in locales with rent-con­trol poli­cies. And while many of these rent con­trolled prop­er­ties have seen new capi­tol invest­ments made by their new own­ers intend­ed to increase the prop­er­ty val­ues and max­i­mize the return on the invest­ment, they’ve also seen large num­ber of evic­tions and in par­tic­u­lar the evic­tion of rent-con­trolled units. The bru­tal man­age­ment prac­tices are, in turn, jus­ti­fied as nec­es­sary in order to return to the pub­lic pen­sions the high yields they need to stay sol­vent in an era of low inter­est rates. Yes, the retire­ments of pub­lic teach­ers, fire­fight­ers, police offi­cers, and oth­er state employ­ees is increas­ing­ly get­ting inter­twined with cru­elest aspects of vul­ture cap­i­tal­ism.

Also note the date of the fol­low­ing arti­cle: March 2, 2020, right before the scope of the COVID19 pan­dem­ic became clear. And weeks before Bill Ack­man made what has been called the most prof­itable trade in his­to­ry as the mar­kets swooned over the ensu­ing glob­al shut­down. Keep that in mind with the fol­low­ing arti­cle: right before every­thing kind of all fell apart, one day before the Fed dropped inter­est rates and two weeks before the Fed’s sec­ond rate cut that took rates to his­toric lows and forced an even greater hunt for yield on the part of investors like pen­sion funds. In oth­er words, this arti­cle was pub­lished right before pen­sion funds got real­ly des­per­ate. Which is omi­nous, because it describes what the pen­sion fund indus­try had already been doing in the pri­vate-equi­ty-led res­i­den­tial real estate space for the last decade out of a des­per­a­tion for high­er yields and it was­n’t good:

The Real Deal

Pen­sion fund mon­ey is get­ting tan­gled in some con­tro­ver­sial hous­ing deals

Fraught pol­i­tics and stricter hous­ing laws are caus­ing new con­cerns

By Geor­gia Krom­rei
Mar 2, 2020, 11:00 AM

Madi­son Real­ty Cap­i­tal, a pri­vate real estate invest­ment firm heav­i­ly backed by pub­lic pen­sion mon­ey, has been stuck with a near­ly half-emp­ty rental port­fo­lio in Manhattan’s East Vil­lage.

When the New York-based firm financed con­tro­ver­sial land­lord Raphael Toledano’s pur­chase of the 16 build­ings in 2015, crit­ics called the deal over­lever­aged. Madi­son lent $124 mil­lion for a port­fo­lio that cost $97 mil­lion.

But the lender had its rea­sons.

The firm, led by Josh Zegen, Bri­an Shatz and Adam Tantl­eff, had just land­ed a $100 mil­lion com­mit­ment from the New York State Teach­ers’ Retire­ment Sys­tem, which man­ages a $122.5 bil­lion pen­sion fund. And the pres­sure was on: If the land­lord failed to ren­o­vate and con­vert a bunch of its 226 rent-sta­bi­lized units to mar­ket-rate, he would be unable to make his loan pay­ments.

Of course, Toledano did fail. Low-rent ten­ants moved out, but ren­o­va­tions went unfin­ished — ren­der­ing many apart­ments unliv­able. Now, the East Vil­lage port­fo­lio is mired in bank­rupt­cy pro­ceed­ings that have dragged on since 2017, impact­ing all par­ties that invest­ed.

“The own­er of the prop­er­ties demol­ished the vacant units a few years ago, and there­fore the vacant units are not hab­it­able at this time,” a spokesper­son for Madi­son told The Real Deal, not­ing that the com­pa­ny still does not own them.

Toledano and his attor­ney declined to com­ment.

More than half a year since New York over­hauled its rent law, mul­ti­fam­i­ly land­lords and their lenders — from fam­i­ly-run firms and local banks to larg­er insti­tu­tion­al play­ers — have been feel­ing the heat. But anoth­er sig­nif­i­cant group of investors is exposed to the new rent regime: pub­lic school teach­ers, fire­fight­ers and oth­er state employ­ees.

Four of the largest pub­lic pen­sion sys­tems in New York and Cal­i­for­nia com­mit­ted more than $30 bil­lion to pri­vate real estate funds held by Brook­field Asset Man­age­ment, Black­stone Group, Apol­lo Glob­al Man­age­ment and the Car­lyle Group, accord­ing to the pen­sion funds’ annu­al finan­cial state­ments.

Near­ly all of those pri­vate equi­ty giants have made big invest­ments in rent-reg­u­lat­ed mul­ti­fam­i­ly prop­er­ties in recent years.

Madi­son, a small­er fish by com­par­i­son, has also tout­ed its appeal to pub­lic pen­sion funds and oth­er insti­tu­tion­al investors with “supe­ri­or risk-adjust­ed returns.”

Such pitch­es are often made by place­ment agents who try to per­suade pen­sion funds to invest bil­lions of dol­lars in real estate and oth­er assets, accord­ing to sev­er­al insid­ers. And while the funds almost nev­er over­see the man­age­ment of prop­er­ties, in many cas­es, the returns they are seek­ing can dri­ve spec­u­la­tive bets.

The top pri­or­i­ty for pub­lic pen­sion funds, of course, is to deliv­er the best returns to those who put their future retire­ment sav­ings on the line. But since elect­ed offi­cials often use them to advance social caus­es, such as pover­ty reduc­tion and afford­able hous­ing, being asso­ci­at­ed with dri­ving out rent-reg­u­lat­ed ten­ants can cre­ate more than a few pub­lic-image con­cerns.

Tom Hes­ter, a man­ag­ing direc­tor on the real estate team at advi­so­ry firm Step­Stone — which has received $200 mil­lion in com­mit­ments from the New York State teach­ers’ fund and con­sults on the retire­ment system’s invest­ments — said the stakes are high for pen­sion funds that pour mon­ey into rent-sta­bi­lized hous­ing in today’s polit­i­cal envi­ron­ment.

Many are becom­ing all the more cau­tious when invest­ing in cities like New York and San Fran­cis­co to avoid get­ting tan­gled up in “the busi­ness of hav­ing to evict some­one,” Hes­ter said.

Fund fren­zy

Over­all, pen­sion funds are invest­ing more aggres­sive­ly in real estate as they look fur­ther beyond the stock mar­ket and fixed-income invest­ments.

“Real estate still pro­vides an out­size return over oth­er asset class­es,” said Jef­frey Scott, who runs the com­mer­cial bro­ker­age East­dil Secured’s New York City office.

In 2019, pub­lic pen­sion funds in the “bil­lion dol­lar club” — a list of 412 of the world’s largest investors tracked by pri­vate equi­ty research firm Pre­qin — were the largest sin­gle source of fund­ing for pri­vate equi­ty firms.

Pub­lic pen­sion funds pro­vid­ed a total of $704 bil­lion to pri­vate equi­ty, accord­ing to Pre­qin. The next largest source of cap­i­tal, sov­er­eign wealth funds, pro­vid­ed $272 bil­lion.

“Pen­sions are what real­ly dri­ve the mar­ket at the end of the day. Their appetite or lack there­of deter­mines a lot of trans­ac­tions,” Scott not­ed.

And with inter­est rates close to rock bot­tom, pen­sion funds are keep­ing their return expec­ta­tions high, said Sav­ills’ chief econ­o­mist Hei­di Learn­er, who added that many are tar­get­ing returns of 7 per­cent or high­er. As a result, she not­ed, some are going to have to up their bets on real estate and oth­er alter­na­tive invest­ments to meet those goals.

The Cal­i­for­nia State Teach­ers’ Retire­ment Sys­tem (Cal­STRS) has shown a par­tic­u­lar­ly strong inter­est in real estate and now has near­ly $35 bil­lion invest­ed in prop­er­ty around the coun­try. After years of exceed­ing its real estate tar­get allo­ca­tion of 13 per­cent, in its Jan­u­ary board meet­ing, the state pen­sion fund solid­i­fied a plan to increase that fig­ure to 15 per­cent, from which it expects a 6.3 per­cent return.

LCOR, a New York-based devel­op­ment firm con­trolled by the Cal­i­for­nia teach­ers’ pen­sion since 2012, backed a deal in Jan­u­ary to build a large apart­ment build­ing on Coney Island from the ground up. The com­pa­ny signed a 99-year ground lease to take over a near­ly full-block park­ing lot on Surf Avenue that allows for about 325,000 build­able square feet.

“We are cur­rent­ly in the ini­tial plan­ning stages and antic­i­pate a mixed-income res­i­den­tial devel­op­ment with up to 30 per­cent of the apart­ments des­ig­nat­ed as afford­able,” LCOR’s senior vice pres­i­dent, Antho­ny Tor­to­ra, told TRD at the time.

While pen­sion mon­ey has been present in New York City real estate for years — espe­cial­ly large office tow­ers, rental build­ings and oth­er cash-flow­ing assets — it’s less com­mon in ground-up devel­op­ment, which car­ries its own risks.

Unusu­al in this case is Cal­STRS’ role as a part­ner in the devel­op­ment ven­ture rather than pro­vid­ing cap­i­tal to an out­side advis­er like Mor­gan Stan­ley to invest the cap­i­tal, said Jef­frey Julien, a man­ag­ing direc­tor in JLL’s New York office.

“Pen­sion funds are look­ing to devel­op­ment, tak­ing on the risk and hav­ing a high­er yield on invest­ment,” said Julien, who was part of the bro­ker­age team that arranged the financ­ing for the Coney Island ground lease deal.

He added that pen­sion funds and oth­er insti­tu­tion­al investors, wary of the reg­u­la­to­ry changes tak­ing place in New York, have become more inter­est­ed in fund­ing ground-up devel­op­ments cov­ered by the state’s tax incen­tive pro­gram dubbed Afford­able New York.

But Eric Anton, a vet­er­an invest­ment sales bro­ker who leads Mar­cus & Millichap’s cap­i­tal mar­kets group in New York, under­scored the pref­er­ence among many pen­sion funds to keep a low pro­file. While funds are upping their invest­ments in real estate, they’re also keen­ly aware of their fidu­cia­ry respon­si­bil­i­ty and man­date for social respon­si­bil­i­ty, he not­ed.

“The pen­sions are extreme­ly impor­tant, but it’s qui­et,” Anton said. “These are the kind of peo­ple who pay pub­li­cists to stay out of the news­pa­per.”

A deal undone

In less than two years, Toledano’s East Vil­lage deal went bad and Madi­son moved to fore­close on the landlord’s firm Brookhill Prop­er­ties.

But the 2017 bank­rupt­cy pro­ceed­ing came amid accu­sa­tions that the lender had demand­ed returns that were impos­si­ble to deliv­er with­out aggres­sive man­age­ment tac­tics — a move that car­ried both finan­cial and rep­u­ta­tion­al con­se­quences.

Then-Attor­ney Gen­er­al Eric Schnei­der­man lam­bast­ed Madison’s strat­e­gy, point­ing to an investor memo that stat­ed Toledano planned to vacate, ren­o­vate and dereg­u­late near­ly half of the 279 units in the port­fo­lio with­in the first two years. In some of the build­ings, the required turnover rate was as high as 80 to 100 per­cent.

“Ten­ant advo­cates argue that land­lords dis­place ten­ants,” one mul­ti­fam­i­ly own­er said on the con­di­tion of anonymi­ty, “when their investors are the ones telling them to clear peo­ple out and raise the rents.”

A 2015 investor pitch to the Pub­lic Employ­ees Retire­ment Asso­ci­a­tion of New Mex­i­co, obtained through a Free­dom of Infor­ma­tion Act request, shows Madi­son pro­mot­ed returns of more than 9 per­cent over the bench­mark S&P U.S. Lever­aged Loan Index.

Madi­son did not com­ment on its pen­sion fund hold­ings or the promis­es it made to its investors.

Aggres­sive invest­ment strate­gies can some­times lead to the black­list­ing of some invest­ment firms, accord­ing to Doug Weill, founder and co-man­ag­ing part­ner at the real estate advi­so­ry firm Hodes Weill.

“There are numer­ous exam­ples of pen­sion mon­ey man­agers that had spec­tac­u­lar falls from grace,” he said. “They just kind of with­ered away as their clients aban­doned them on future fund rais­es.”

One of the most notable “falls from grace,” he not­ed, was Broad­way Part­ners, which made a series of high-pro­file acqui­si­tions ahead of the finan­cial cri­sis, flush with mon­ey from insti­tu­tion­al investors that includ­ed pen­sions. After the cri­sis, the com­pa­ny default­ed on sev­er­al prop­er­ties and was forced to sell off the major­i­ty of its port­fo­lio.

But that has yet to hap­pen in Madison’s case.

The New York State teach­ers still have a stake in the firm’s debt deals, accord­ing to the pen­sion fund’s most recent annu­al report (but that doesn’t show how that invest­ment is per­form­ing).

The deci­sion to invest with Madi­son nev­er came up for a vote in the organization’s head­quar­ters on the out­skirts of Albany, where its board meets four times each year in a cham­ber behind tint­ed glass.

A spokesper­son for NYSTRS said its $100 mil­lion com­mit­ment to Madison’s fund “did not require addi­tion­al or sec­ondary approval at a board meet­ing” because it did not exceed the pen­sion fund’s lim­it on sin­gle invest­ments — so it was rub­ber-stamped with­out a vote.

Last Novem­ber, the Texas Munic­i­pal Retire­ment Sys­tem made its own $100 mil­lion com­mit­ment to one of Madison’s four debt funds, which have raised more than $2.8 bil­lion to date. Nick O’Keefe, lead invest­ment attor­ney at the statewide retire­ment sys­tem, said a Texas statute that exempts pri­vate equi­ty invest­ments from the Free­dom of Infor­ma­tion law makes the state more attrac­tive to firms like Madi­son.

“They say, ‘It’s more appeal­ing for us, because you’ll pro­tect our infor­ma­tion,’” O’Keefe, told TRD. “There’s a cer­tain amount of truth to it.”

But that can cause even big­ger headaches when the infor­ma­tion sur­faces. Apart from the neg­a­tive head­lines, pub­lic pen­sion funds are wary of being per­ceived as “tak­ing fidu­cia­ry risks with oth­er people’s mon­ey,” StepStone’s Hes­ter not­ed.

“You don’t want a sit­u­a­tion where you’re seen as gam­bling when the rea­son you exist is to put bread and milk on the table of pen­sion­ers,” he said.

The big pitch

When Blackstone’s Stephen Schwarz­man opened his firm’s third quar­ter earn­ings call, he had a clear mes­sage for investors: The pri­vate equi­ty giant’s hold­ings — includ­ing more than $320 bil­lion in real estate — pro­vide returns to pub­lic pen­sion funds that are unat­tain­able in fixed-income invest­ments.

“The very strong returns we gen­er­ate, par­tic­u­lar­ly in the cur­rent low-inter­est rate envi­ron­ment, enable teach­ers, police offi­cers, fire­men and oth­er pub­lic and cor­po­rate sec­tor employ­ees to retire with suf­fi­cient sav­ings and secure pen­sions,” Schwarz­man said.

Among pub­lic pen­sion-backed pri­vate equi­ty firms, Black­stone leads the pack with more than $9.7 bil­lion in com­mit­ments, invest­ments and assets under man­age­ment from sev­en lead­ing pub­lic pen­sion funds in New York and Cal­i­for­nia, accord­ing to the funds’ annu­al finan­cial reports.

That includes the New York State Com­mon Retire­ment Fund, which has $207.4 bil­lion in assets under man­age­ment, includ­ing $3.6 bil­lion invest­ed with Black­stone, records show, and the Cal­i­for­nia Pub­lic Employ­ees’ Retire­ment Sys­tem (CalPERS), which man­ages $396.9 bil­lion and has $2.7 bil­lion invest­ed with Black­stone.

Those invest­ments have helped to fuel some of the world’s largest com­mer­cial real estate plays, includ­ing Blackstone’s $18.7 bil­lion pur­chase of GLP’s indus­tri­al ware­house port­fo­lio last year and the firm’s $5.3 bil­lion pur­chase, with Ivan­hoé Cam­bridge, of Stuyvesant Town-Peter Coop­er Vil­lage in 2015. Ivan­hoé Cam­bridge is a sub­sidiary of Canada’s sec­ond-biggest pen­sion fund.

...

In New York, Cal­i­for­nia and oth­er states, pub­lic pen­sions are man­dat­ed to pay work­ers’ retire­ments based on an equa­tion that was set when they were first hired — putting pres­sure on the funds to make lucra­tive invest­ments.

The mes­sage wasn’t lost on Tom Ban­non, who over­sees the Cal­i­for­nia Apart­ment Asso­ci­a­tion, the state’s most influ­en­tial real estate trade asso­ci­a­tion.

Ban­non told TRD in Octo­ber that the calls for rent con­trol in Cal­i­for­nia may have been tem­pered by the state’s pub­lic pen­sion mon­ey invest­ed in pri­vate equi­ty firms who gen­er­ate returns for their gov­ern­ment investors through real estate ven­tures.

State politi­cians were aware that a stricter form of rent con­trol would “lit­er­al­ly shut down the Cal­i­for­nia eco­nom­ic machine,” said Ban­non, who also not­ed that “Black­stone is where CalPERS and Cal­STRS invest their mon­ey.”

Pen­sive plays

Dur­ing a CalPERS’ invest­ment com­mit­tee meet­ing last year, Ben Meng, the agency’s chief invest­ment offi­cer, out­lined a plan to meet the fund’s oblig­a­tions to pen­sion­ers.

“We need pri­vate equi­ty, we need more of it, and we need it now,” Meng said.

At the same time, pri­vate equi­ty firms often hire place­ment agents and oth­er advis­ers who pro­mote real estate assets to pen­sion funds as a safe bet.

While place­ment agents have been banned in some states with­in the past decade, they still play a big role in pen­sion invest­ment strate­gies as a whole. In 2010 — after a series of pay-to-play scan­dals involv­ing elect­ed offi­cials steer­ing pub­lic pen­sion fund invest­ments to firms — New York, Illi­nois and New Mex­i­co out­lawed the use of such inter­me­di­aries.

The U.S. Secu­ri­ties and Exchange Com­mis­sion then imple­ment­ed new rules to cur­tail the influ­ence of pay-to-play prac­tices by invest­ment advis­ers.

But Cal­i­for­nia has no such bans. Instead, place­ment agents are required to reg­is­ter as lob­by­ists with the state.

In oth­er states, like New York, com­mer­cial real estate bro­kers and oth­er invest­ment advis­ers are still fair game as long as they don’t make or bun­dle cam­paign con­tri­bu­tions to politi­cians who could influ­ence the selec­tion of the advis­er.

And since most pub­lic pen­sion funds don’t have in-house real estate teams to guide their invest­ing, that task is still large­ly out­sourced to firms with the exper­tise to hunt down deals.

“It’s the advis­er guid­ing the pen­sion fund, whether they have full dis­cre­tion or not,” said Adam Stein­berg, a prin­ci­pal at Ack­man-Ziff Real Estate Group who co-heads the brokerage’s equi­ty busi­ness. “If the rec­om­mend­ed invest­ments go well, they should main­tain their cur­rent role and could even get a greater allo­ca­tion [to advise on] — so the stakes are high.”

But Eileen Appel­baum, an econ­o­mist and author who research­es pri­vate equi­ty, said the deals nego­ti­at­ed between advis­ers and pen­sion fund man­agers have become an even big­ger cause for con­cern in recent years.

“There is a con­flict,” she said, “because at some point in the not too dis­tant past, we allowed pen­sion funds to make risky invest­ments as long as the risk is bal­anced in the over­all port­fo­lio.”

That risk-reward trade­off is becom­ing increas­ing­ly vis­i­ble to ten­ants, sources say.

Jim Markowich, who lived in one of Toledano’s East Vil­lage rentals, argued that the poten­tial returns for pen­sion fund investors like the New York State teach­ers do not out­weigh the poten­tial harms to those who are evict­ed from their apart­ments.

“The goal is to make dou­ble dig­it returns for investors,” Markowich said. “It all makes sense except it does it at the expense of peo­ple try­ing to live in their own homes, which is real­ly hard to jus­ti­fy.”

———-

“Pen­sion fund mon­ey is get­ting tan­gled in some con­tro­ver­sial hous­ing deals” By Geor­gia Krom­rei; The Real Deal; 03/02/2020

“More than half a year since New York over­hauled its rent law, mul­ti­fam­i­ly land­lords and their lenders — from fam­i­ly-run firms and local banks to larg­er insti­tu­tion­al play­ers — have been feel­ing the heat. But anoth­er sig­nif­i­cant group of investors is exposed to the new rent regime: pub­lic school teach­ers, fire­fight­ers and oth­er state employ­ees.

It was the sto­ry of pri­vate equi­ty’s ongo­ing for­ay into the real estate right as the COVID19 pan­dem­ic was about to ensue: pub­lic pen­sion funds were already major play­ers in the res­i­den­tial rental mar­kets. In par­tic­u­lar, the rent-reg­u­lat­ed mar­kets of New York and Cal­i­for­nia. Iron­i­cal­ly, these invest­ments in rent-reg­u­lat­ed mar­kets were done as part of the pen­sion funds’ dri­ve to earn high­er returns. Iron­i­cal­ly, or cyn­i­cal­ly. As we should have expect­ed, the pur­suit of those high returns came with a cost. A cost that was most­ly paid by the ten­ants in these prop­er­ties who found them­selves evict­ed as the new pri­vate-equi­ty-man­aged own­er­ship sought to max­i­mize those returns by min­i­miz­ing the num­ber of rent-con­trolled units. That’s the dynam­ic behind the now per­verse sit­u­a­tion where pub­lic pen­sions have tak­en on the role of the cru­el miser­ly land­lord to pay for the retire­ments of pub­lic school teach­ers, fire­fight­ers and oth­er state employ­ees:

...
Four of the largest pub­lic pen­sion sys­tems in New York and Cal­i­for­nia com­mit­ted more than $30 bil­lion to pri­vate real estate funds held by Brook­field Asset Man­age­ment, Black­stone Group, Apol­lo Glob­al Man­age­ment and the Car­lyle Group, accord­ing to the pen­sion funds’ annu­al finan­cial state­ments.

Near­ly all of those pri­vate equi­ty giants have made big invest­ments in rent-reg­u­lat­ed mul­ti­fam­i­ly prop­er­ties in recent years.

Madi­son, a small­er fish by com­par­i­son, has also tout­ed its appeal to pub­lic pen­sion funds and oth­er insti­tu­tion­al investors with “supe­ri­or risk-adjust­ed returns.”

Such pitch­es are often made by place­ment agents who try to per­suade pen­sion funds to invest bil­lions of dol­lars in real estate and oth­er assets, accord­ing to sev­er­al insid­ers. And while the funds almost nev­er over­see the man­age­ment of prop­er­ties, in many cas­es, the returns they are seek­ing can dri­ve spec­u­la­tive bets.

...

In less than two years, Toledano’s East Vil­lage deal went bad and Madi­son moved to fore­close on the landlord’s firm Brookhill Prop­er­ties.

But the 2017 bank­rupt­cy pro­ceed­ing came amid accu­sa­tions that the lender had demand­ed returns that were impos­si­ble to deliv­er with­out aggres­sive man­age­ment tac­tics — a move that car­ried both finan­cial and rep­u­ta­tion­al con­se­quences.

Then-Attor­ney Gen­er­al Eric Schnei­der­man lam­bast­ed Madison’s strat­e­gy, point­ing to an investor memo that stat­ed Toledano planned to vacate, ren­o­vate and dereg­u­late near­ly half of the 279 units in the port­fo­lio with­in the first two years. In some of the build­ings, the required turnover rate was as high as 80 to 100 per­cent.

“Ten­ant advo­cates argue that land­lords dis­place ten­ants,” one mul­ti­fam­i­ly own­er said on the con­di­tion of anonymi­ty, “when their investors are the ones telling them to clear peo­ple out and raise the rents.”

A 2015 investor pitch to the Pub­lic Employ­ees Retire­ment Asso­ci­a­tion of New Mex­i­co, obtained through a Free­dom of Infor­ma­tion Act request, shows Madi­son pro­mot­ed returns of more than 9 per­cent over the bench­mark S&P U.S. Lever­aged Loan Index.

...

When Blackstone’s Stephen Schwarz­man opened his firm’s third quar­ter earn­ings call, he had a clear mes­sage for investors: The pri­vate equi­ty giant’s hold­ings — includ­ing more than $320 bil­lion in real estate — pro­vide returns to pub­lic pen­sion funds that are unat­tain­able in fixed-income invest­ments.

“The very strong returns we gen­er­ate, par­tic­u­lar­ly in the cur­rent low-inter­est rate envi­ron­ment, enable teach­ers, police offi­cers, fire­men and oth­er pub­lic and cor­po­rate sec­tor employ­ees to retire with suf­fi­cient sav­ings and secure pen­sions,” Schwarz­man said.

Among pub­lic pen­sion-backed pri­vate equi­ty firms, Black­stone leads the pack with more than $9.7 bil­lion in com­mit­ments, invest­ments and assets under man­age­ment from sev­en lead­ing pub­lic pen­sion funds in New York and Cal­i­for­nia, accord­ing to the funds’ annu­al finan­cial reports.

That includes the New York State Com­mon Retire­ment Fund, which has $207.4 bil­lion in assets under man­age­ment, includ­ing $3.6 bil­lion invest­ed with Black­stone, records show, and the Cal­i­for­nia Pub­lic Employ­ees’ Retire­ment Sys­tem (CalPERS), which man­ages $396.9 bil­lion and has $2.7 bil­lion invest­ed with Black­stone.

...

That risk-reward trade­off is becom­ing increas­ing­ly vis­i­ble to ten­ants, sources say.

Jim Markowich, who lived in one of Toledano’s East Vil­lage rentals, argued that the poten­tial returns for pen­sion fund investors like the New York State teach­ers do not out­weigh the poten­tial harms to those who are evict­ed from their apart­ments.

“The goal is to make dou­ble dig­it returns for investors,” Markowich said. “It all makes sense except it does it at the expense of peo­ple try­ing to live in their own homes, which is real­ly hard to jus­ti­fy.”
...

Beyond the push to elim­i­nate exist­ing rent-con­trolled units, we also find that push­es to cre­ate new rent-con­trolled units are fur­ther restrained by the real­i­ty that the fate of state pen­sions now increas­ing­ly rides on rental prop­er­ty returns. That’s on top of the ‘pay-to-play’ dynam­ics — legal or not — pre­sum­ably sway­ing pub­lic offi­cials:

...
In New York, Cal­i­for­nia and oth­er states, pub­lic pen­sions are man­dat­ed to pay work­ers’ retire­ments based on an equa­tion that was set when they were first hired — putting pres­sure on the funds to make lucra­tive invest­ments.

The mes­sage wasn’t lost on Tom Ban­non, who over­sees the Cal­i­for­nia Apart­ment Asso­ci­a­tion, the state’s most influ­en­tial real estate trade asso­ci­a­tion.

Ban­non told TRD in Octo­ber that the calls for rent con­trol in Cal­i­for­nia may have been tem­pered by the state’s pub­lic pen­sion mon­ey invest­ed in pri­vate equi­ty firms who gen­er­ate returns for their gov­ern­ment investors through real estate ven­tures.

State politi­cians were aware that a stricter form of rent con­trol would “lit­er­al­ly shut down the Cal­i­for­nia eco­nom­ic machine,” said Ban­non, who also not­ed that “Black­stone is where CalPERS and Cal­STRS invest their mon­ey.”

Pen­sive plays

Dur­ing a CalPERS’ invest­ment com­mit­tee meet­ing last year, Ben Meng, the agency’s chief invest­ment offi­cer, out­lined a plan to meet the fund’s oblig­a­tions to pen­sion­ers.

“We need pri­vate equi­ty, we need more of it, and we need it now,” Meng said.

At the same time, pri­vate equi­ty firms often hire place­ment agents and oth­er advis­ers who pro­mote real estate assets to pen­sion funds as a safe bet.

While place­ment agents have been banned in some states with­in the past decade, they still play a big role in pen­sion invest­ment strate­gies as a whole. In 2010 — after a series of pay-to-play scan­dals involv­ing elect­ed offi­cials steer­ing pub­lic pen­sion fund invest­ments to firms — New York, Illi­nois and New Mex­i­co out­lawed the use of such inter­me­di­aries.
...

And as experts were pre­dict­ing at the time in March of 2020, when rates were still near his­toric lows, pen­sion funds are only going to have to deep­en their dives into real estate and oth­er alter­na­tive invest­ments as long as rates remained low. Keep in mind that the Fed only start­ed hik­ing rates from their his­toric lows in March of 2022. That’s all part of the con­text of the dive into com­mer­cial real estate in recent years: A lot of the com­mer­cial real estate pur­chas­es hap­pened at a time when pen­sion funds were on an even greater quest for yield:

...
Over­all, pen­sion funds are invest­ing more aggres­sive­ly in real estate as they look fur­ther beyond the stock mar­ket and fixed-income invest­ments.

“Real estate still pro­vides an out­size return over oth­er asset class­es,” said Jef­frey Scott, who runs the com­mer­cial bro­ker­age East­dil Secured’s New York City office.

In 2019, pub­lic pen­sion funds in the “bil­lion dol­lar club” — a list of 412 of the world’s largest investors tracked by pri­vate equi­ty research firm Pre­qin — were the largest sin­gle source of fund­ing for pri­vate equi­ty firms.

Pub­lic pen­sion funds pro­vid­ed a total of $704 bil­lion to pri­vate equi­ty, accord­ing to Pre­qin. The next largest source of cap­i­tal, sov­er­eign wealth funds, pro­vid­ed $272 bil­lion.

“Pen­sions are what real­ly dri­ve the mar­ket at the end of the day. Their appetite or lack there­of deter­mines a lot of trans­ac­tions,” Scott not­ed.

And with inter­est rates close to rock bot­tom, pen­sion funds are keep­ing their return expec­ta­tions high, said Sav­ills’ chief econ­o­mist Hei­di Learn­er, who added that many are tar­get­ing returns of 7 per­cent or high­er. As a result, she not­ed, some are going to have to up their bets on real estate and oth­er alter­na­tive invest­ments to meet those goals.

The Cal­i­for­nia State Teach­ers’ Retire­ment Sys­tem (Cal­STRS) has shown a par­tic­u­lar­ly strong inter­est in real estate and now has near­ly $35 bil­lion invest­ed in prop­er­ty around the coun­try. After years of exceed­ing its real estate tar­get allo­ca­tion of 13 per­cent, in its Jan­u­ary board meet­ing, the state pen­sion fund solid­i­fied a plan to increase that fig­ure to 15 per­cent, from which it expects a 6.3 per­cent return.
...

Yes indeed, Cal­STRS has shown a par­tic­u­lar­ly strong inter­est in real estate, as evi­denced by its Black­stone Real Estate Part­ners X fund invest­ment. And all Cal­STRS’s pri­or com­mer­cial real estate invest­ments made over the past three years that are now at risk of implod­ing.

And more gen­er­al­ly, it’s clear at this point that the pan­dem­ic and result­ing rate cuts effec­tive­ly ampli­fied the stam­pede into pri­vate equi­ty, and in turn into real estate, as the hunt for yield only got stronger. But, impor­tant­ly, it’s also rather clear that this all be dri­ven, in part, but a rel­a­tive lack of alter­na­tives. There sim­ply aren’t a lot of oth­er invest­ment options that both promise high yields and scale to the size of the pen­sion fund indus­try’s demands. Keep in mind that the flood of pen­sion fund mon­ey into pri­vate equi­ty isn’t new. Alter­na­tive invest­ment indus­tries have had years to make their pitch. But we keep hear­ing about a greater and greater share of pen­sion fund mon­ey flood­ing into pri­vate equi­ty hands, which, again, is part of the com­mer­cial real estate sto­ry too.

Pre-Pandemic/Post-Pandemic, it’s the Same Businss Model: Heads I Win, Tails You Lose

But as is also clear from the avail­able data is that we’re still very much look­ing at the same “Head We Win, Tails You Lose” busi­ness mod­el that under­pins the entire pri­vate equi­ty indus­try. As we’ve seen, it’s “Head We Win, Tails You Lose” in how pri­vate equi­ty sys­tem­at­i­cal­ly ben­e­fits from eco­nom­ic tur­moil and things like mass lay­offs and dis­lo­ca­tion. But as Farhad Man­joo remind­ed us in the fol­low­ing New York Times opin­ion piece back in August, pri­vate equi­ty firms have a “Head We Win, Tails You Lose” rela­tions with their clients too. Because it does­n’t real­ly mat­ter if the invest­ments sour, the pri­vate equi­ty part­ners are still going to be paid hand­some­ly. It’s some­thing to keep when it comes to the things like mass evic­tions by pri­vate equi­ty man­age­ment in the name of its pen­sion fund clients. That hand­some “Head We Win, Tails You Lose” pay has to come from some­where:

The New York Times

Pri­vate Equi­ty Doesn’t Want You to Read This

By Farhad Man­joo
Aug. 4, 2022

Opin­ion Colum­nist

This col­umn has been updat­ed.

This col­umn is about the excess­es of the pri­vate equi­ty invest­ment indus­try. It delves into the minu­ti­ae of the tax code, cor­po­rate struc­ture and cer­tain abstruse prac­tices of finan­cial engi­neer­ing. There will be jar­gon: car­ried inter­est, lever­aged buy­out, joint lia­bil­i­ty. I am aware that none of this is anyone’s favorite thing to be dis­cussing on a summer’s day.

But pri­vate equi­ty is count­ing on your lack of inter­est; the seem­ing impen­e­tra­bil­i­ty of its prac­tices has been called one of its “super­pow­ers,” among the rea­sons the tril­lion-dol­lar indus­try keeps get­ting away with it.

With what? An accel­er­at­ing, behind-the-scenes des­ic­ca­tion of the Amer­i­can econ­o­my. Democ­rats in the Sen­ate were poised to pass a rule that might slight­ly clip the industry’s wings — a change to the tax code that would force part­ners in pri­vate equi­ty firms, hedge fund man­agers and ven­ture cap­i­tal­ists to pay a fair­er share of tax­es on the mon­ey they make.

But pri­vate equi­ty has wan­gled out of pro­posed reg­u­la­tion before, and it’s done so again. Sen­ate Democ­rats have agreed to drop the mea­sure from their cli­mate leg­is­la­tion to win the sup­port of Sen­a­tor Kyrsten Sine­ma, the Ari­zona Demo­c­rat who has often frus­trat­ed her party’s agen­da and has expressed oppo­si­tion to rais­ing tax­es on the wealthy.

I can’t fath­om what her reluc­tance might be. One of pri­vate equity’s main plays is the lever­aged buy­out, which involves bor­row­ing huge sums of mon­ey to gob­ble up com­pa­nies in the hopes of restruc­tur­ing them and one day sell­ing them for a gain.

But the acquired com­pa­nies — which range across just about every eco­nom­ic sec­tor, from retail­ing to food to health care and hous­ing — are often over­loaded with debt to the point of unsus­tain­abil­i­ty. They fre­quent­ly slash jobs and ben­e­fits for employ­ees, cut ser­vices and hike prices for con­sumers, and some­times even endan­ger lives and under­mine the social fab­ric.

It is a dis­mal record: Pri­vate equi­ty firms presided over many of the largest retail­er bank­rupt­cies in the last decade — among them Toys “R” Us, Sears, RadioShack and Pay­less Shoe­Source — result­ing in near­ly 600,000 lost jobs, accord­ing to a 2019 study by sev­er­al left-lean­ing eco­nom­ic pol­i­cy advo­cates.

Oth­er inves­ti­ga­tions have shown that when pri­vate equi­ty firms buy hous­es and apart­ments, rents and evic­tions soar. When they buy hos­pi­tals and doc­tors’ prac­tices, the cost of care shoots up. When they buy nurs­ing homes, patient mor­tal­i­ty ris­es. When they buy news­pa­pers, report­ing on local gov­ern­ments dries up and par­tic­i­pa­tion in local elec­tions declines.

It is unclear even if pri­vate equi­ty pays off for the investors — like uni­ver­si­ty endow­ments, pub­lic pen­sion funds and wealthy indi­vid­u­als — who put mon­ey into the indus­try in the hopes of out­size returns. Since at least 2006, accord­ing to a study by the econ­o­mist Ludovic Phalip­pou, the per­for­mance of the largest pri­vate equi­ty funds has essen­tial­ly matched returns of com­pa­ra­ble pub­licly trad­ed com­pa­nies.

...

With the help of lax reg­u­la­tion and inde­fen­si­ble tax loop­holes, pri­vate equity’s appar­ent destruc­tive­ness can be enor­mous­ly prof­itable for its part­ners. Pri­vate equi­ty firms make mon­ey by extract­ing hefty fees from their investors and from the com­pa­nies they pur­chase, mean­ing they can suc­ceed even if their invest­ments go kaput. Phalip­pou found that between 2005 and 2020, the indus­try pro­duced 19 multi­bil­lion­aires.

“It’s a heads-I-win, tails-you-lose mod­el,” said Jim Bak­er, the exec­u­tive direc­tor of a watch­dog group called the Pri­vate Equi­ty Stake­hold­er Project.

But it gets worse: Not only do pri­vate equi­ty part­ners make mon­ey even if their com­pa­nies blow up; they also get a pret­ty good deal from the gov­ern­ment on what they earn. Pri­vate equi­ty funds gen­er­al­ly charge their investors two dif­fer­ent fees: a man­age­ment fee of 2 per­cent of invest­ed assets per year (funds are held for an aver­age of about six years), and a “car­ried inter­est” fee that is 20 per­cent of any invest­ment gains real­ized in the fund.

In most oth­er indus­tries, the Inter­nal Rev­enue Ser­vice would cat­e­go­rize a fee like car­ried inter­est as ordi­nary income (like how your salary is taxed) rather than a cap­i­tal gain (like how your stock mar­ket win­nings are taxed). After all, the part­ners are receiv­ing the fee as com­pen­sa­tion for per­form­ing a ser­vice (man­ag­ing investors’ mon­ey), not col­lect­ing a gain on their own invest­ed cap­i­tal (because it’s the investors’ mon­ey, not theirs).

But that’s not how it works for part­ner­ships like pri­vate equi­ty, hedge funds and ven­ture cap­i­tal firms. Under I.R.S. guide­lines, car­ried inter­est is taxed as a cap­i­tal gain, which has a top rate of 20 per­cent, rather than as income, which has a top rate of near­ly 40 per­cent. The upshot: Mil­lion­aire and bil­lion­aire part­ners in pri­vate equi­ty firms pay a far low­er tax rate on much of their income than many of the rest of us.

The pri­vate equi­ty indus­try defends its pref­er­en­tial rate by cit­ing “sweat equi­ty” — even if part­ners don’t put much of their own cap­i­tal at stake, they are being reward­ed for invest­ing their “ideas and ener­gy,” as Steve Klin­sky, a for­mer chair of the Amer­i­can Invest­ment Coun­cil, put it in a recent arti­cle. But it’s dif­fi­cult to find many beyond the indus­try who will defend car­ried interest’s low tax­a­tion.

...

Despite wide­spread oppo­si­tion, though, the tax break has some­how endured — as Tim Mur­phy wrote recent­ly in Moth­er Jones, it has been “the most unkil­l­able bad idea in a town with no short­age of them, a tes­ta­ment to the unstop­pable com­bi­na­tion of mon­ey and iner­tia.” (Murphy’s piece was part of an excel­lent, mul­ti­part inves­ti­ga­tion of the pri­vate equi­ty indus­try pub­lished by the mag­a­zine.)

The Democ­rats’ pro­pos­al would have mere­ly nar­rowed — but would not have elim­i­nat­ed — the car­ried inter­est loop­hole. Pass­ing it would have been a good start toward reform­ing the pri­vate equi­ty indus­try.

Even if it passed, though, much more would need to be done. Eileen Appel­baum, an expert on the pri­vate equi­ty indus­try who is a co-direc­tor of the Cen­ter for Eco­nom­ic and Pol­i­cy Research, a lib­er­al think tank, told me she favored many of the ideas in the Stop Wall Street Loot­ing Act, a bill intro­duced last year by Sen­a­tor Eliz­a­beth War­ren and sev­er­al oth­er lib­er­al Democ­rats. The act would impose lots of new rules on the indus­try, includ­ing lim­it­ing tax deduc­tions on exces­sive debt and adding work­er pro­tec­tions for when debt binges lead to bank­rupt­cy.

One of the most impor­tant ideas, Appel­baum said, is known as joint lia­bil­i­ty, which would hold pri­vate equi­ty firms respon­si­ble for the debt incurred by port­fo­lio com­pa­nies if the com­pa­nies go bel­ly up.

“It doesn’t tell you how much debt you can put on it,” Appel­baum said. “It just says, ‘what­ev­er debt you put on it, you’re going to be joint­ly respon­si­ble.’”

That struck me as an ele­gant and sen­si­ble idea. If pri­vate equi­ty firms claim they should get cred­it for their “sweat equi­ty,” why shouldn’t they be held respon­si­ble when the sweat turns to tears?

———-

“Pri­vate Equi­ty Doesn’t Want You to Read This” by Farhad Man­joo; The New York Times; 08/04/2022

It is unclear even if pri­vate equi­ty pays off for the investors — like uni­ver­si­ty endow­ments, pub­lic pen­sion funds and wealthy indi­vid­u­als — who put mon­ey into the indus­try in the hopes of out­size returns. Since at least 2006, accord­ing to a study by the econ­o­mist Ludovic Phalip­pou, the per­for­mance of the largest pri­vate equi­ty funds has essen­tial­ly matched returns of com­pa­ra­ble pub­licly trad­ed com­pa­nies.”

And that’s the fun­da­men­tal issue at hand. Or at least one of them: for all the hype about how pen­sion funds are get­ting a great deal, that’s unclear from the data. What is clear from the data is the pri­vate equi­ty’s track record is dis­mal for the debt-laden com­pa­nies bought in these lever­aged buy outs or the ten­ants liv­ing in the homes and apart­ments that have come under pri­vate equi­ty’s man­age­ment. Oh, and it’s also very clear from the data that pri­vate equi­ty pays very well for the part­ners of the pri­vate equi­ty firms. Whether the clients do well or not. Because there is no joint lia­bil­i­ty in these deals. It’s a “It’s a heads-I-win, tails-you-lose mod­el”:

...
It is a dis­mal record: Pri­vate equi­ty firms presided over many of the largest retail­er bank­rupt­cies in the last decade — among them Toys “R” Us, Sears, RadioShack and Pay­less Shoe­Source — result­ing in near­ly 600,000 lost jobs, accord­ing to a 2019 study by sev­er­al left-lean­ing eco­nom­ic pol­i­cy advo­cates.

Oth­er inves­ti­ga­tions have shown that when pri­vate equi­ty firms buy hous­es and apart­ments, rents and evic­tions soar. When they buy hos­pi­tals and doc­tors’ prac­tices, the cost of care shoots up. When they buy nurs­ing homes, patient mor­tal­i­ty ris­es. When they buy news­pa­pers, report­ing on local gov­ern­ments dries up and par­tic­i­pa­tion in local elec­tions declines.

...

With the help of lax reg­u­la­tion and inde­fen­si­ble tax loop­holes, pri­vate equity’s appar­ent destruc­tive­ness can be enor­mous­ly prof­itable for its part­ners. Pri­vate equi­ty firms make mon­ey by extract­ing hefty fees from their investors and from the com­pa­nies they pur­chase, mean­ing they can suc­ceed even if their invest­ments go kaput. Phalip­pou found that between 2005 and 2020, the indus­try pro­duced 19 multi­bil­lion­aires.

“It’s a heads-I-win, tails-you-lose mod­el,” said Jim Bak­er, the exec­u­tive direc­tor of a watch­dog group called the Pri­vate Equi­ty Stake­hold­er Project.
...

A ‘dis­mal-for-thee-rich-for-we’ kind of busi­ness mod­el. At least for the work­ers and ten­ants whose work­places and homes have come under pri­vate equi­ty con­trol. Ever more so as pri­vate equi­ty takes con­trol of more and more sec­tors of the econ­o­my con­tin­ue to expand. In an expan­sion iron­i­cal­ly tur­bo-charged by pub­lic pen­sions with a seem­ing­ly end­less appetite to take on the kinds of high earn­ing projects pri­vate equi­ty assures them will keep these pen­sion funds afloat. Maybe they’ll be wise fund advis­ers who nav­i­gate these pub­lic pen­sion funds through the chop­py invest­ing waters ahead. Maybe not and pen­sions will drown beneath wave after waver of mis­takes. Either way, the pri­vate equi­ty fund part­ners are going to make A LOT of mon­ey in the process.

And that ‘Heads we win, tails you lose’ busi­ness mod­el is real­ly the big warn­ing loom­ing over this entire sto­ry. It would be one thing if pri­vate equi­ty firms actu­al­ly had a mean­ing­ful stake in the out­come of this grand ‘knife catch­ing’ CRE invest­ment strat­e­gy. But that’s not how it is. At worse, these firms will lose some pen­sion fund clients should these invest­ments go sour and that’s about it. And either way, it’s going to be the cut-throat ‘prof­its über alles’ pri­vate equi­ty busi­ness phi­los­o­phy that is ulti­mate­ly man­ag­ing all of these prop­er­ties. On top of all the oth­er busi­ness and enter­pris­es that have fall­en into pri­vate equi­ty’s grip.

Even worse, it’s unclear where else pen­sions are even going to go in the pur­suit of high­er yields should their pri­vate equi­ty-led CRE invest­ments end going “down to the last bot­tom.” Sure, ris­ing inter­est rates do low­er the appeal of alter­na­tive high­er risk invest­ments like real estate. Infla­tion, on the oth­er hand, does quite the oppo­site. We should­n’t expect ris­ing inter­est rates to some­how pro­vide pen­sion funds a real estate escape plan.

Final­ly, just to main­tain some per­spec­tive here on a sto­ry that is pri­mar­i­ly about the fate of pub­lic pen­sions in the US, it’s worth keep­ing in mind that the vast major­i­ty of US work­ers aren’t pub­lic employ­ees and only rough­ly 4% of employ­ees in pri­vate sec­tor even have defined ben­e­fit pen­sions any­more, down from 60% in in ear­ly 1980s. And with 58% of US work­ers cit­ing out­liv­ing their assets as their great­est retire­ment fear in a recent sur­vey, it’s pret­ty obvi­ous that the US is fac­ing a much larg­er retire­ment cri­sis than sim­ply keep­ing pub­lic pen­sions ade­quate­ly financed. This is all part of some­thing much larg­er and more dire.

That’s part of the grim con­text of this pen­sion cri­sis: it’s just a drop in a buck­et com­pared to the upcom­ing long-fore­seen mass retire­ment cri­sis this is creep­ing clos­er and clos­er with each pass­ing years. And while major col­lec­tive chal­lenges should be and oppor­tu­ni­ty for a com­ing togeth­er with major col­lec­tive solu­tions, that’s clear­ly not how the US oper­ates. At least not any­more. Major crises are indeed a major oppor­tu­ni­ty in mod­ern Amer­i­can. But only for those with large pools of cash on the side­lines wait­ing to swoop in after every­thing has fall­en apart. Which obvi­ous­ly isn’t the best sys­tem to be retir­ing into. Unless you hap­pen to be a fund man­ag­er and don’t actu­al­ly care whether or not your fel­low cit­i­zens can retire too. In that case every­thing is going great and only get­ting bet­ter.

Discussion

14 comments for “Heads We Win, Tails You Lose Your Retirement: Private Equity, Pension Funds, and the CRE Double Down”

  1. Turn­ing lemons into lemon­ade is kind of the theme of the ongo­ing pen­sion fund push into the pri­vate equi­ty space now that so many of the com­mer­cial real estate (CRE) invest­ments of 2022 have start­ed to sour. That’s the whole ratio­nale behind Black­stone’s Real Estate Part­ners IX fund, where pen­sion funds are hop­ing to recoup their CRE loss­es by scoop­ing prop­er­ties as prices col­lapse. But what if the loss­es pen­sion funds are fac­ing in their pri­vate equi­ty invest­ments are actu­al­ly much larg­er than pre­vi­ous­ly dis­closed? How might that affect this ‘mak­ing lemon­ade’ strat­e­gy? Would it cause pen­sion funds to pull back on this dou­ble-down? Or dou­ble-down hard­er? That’s the omi­nous ques­tion raised by the fol­low­ing pair of arti­cles describ­ing a dynam­ic that hints at poten­tial­ly much larg­er loss­es from the pen­sion fund indus­try’s pri­vate equi­ty binge than has been yet dis­closed. A dynam­ic that per­verse­ly incen­tivizes even more pen­sion fund invest­ments in the pri­vate equi­ty space the worse their under­ly­ing fis­cal sit­u­a­tion gets.

    So what is this per­verse dynam­ic? Well, as pro­gres­sive colum­nist David Siro­ta warned back in Feb­ru­ary, it’s not just the promis­es of high returns that has caused US pen­sion funds have fall in love with pri­vate equi­ty in recent decades. There’s also the account­ing gim­mick that syn­er­gizes with those promis­es of high returns and allows pen­sions to effec­tive­ly make up their own returns and make their finances appear stronger than they actu­al­ly are. That account­ing gim­mick is root­ed in the fact that it is both extreme dif­fi­cul­ty to a val­ue on a lot of pri­vate equi­ty invest­ments but also required by law. As a result, pri­vate equi­ty firms are allowed to sim­ply make up the alleged mar­ket val­ues for the invest­ments they are hold­ing on behalf of their pen­sion fund clients.

    And as stud­ies have shown, those made up val­ues tend to be inflat­ed val­ues that fraud­u­lent­ly puff up the bal­ance sheets of pen­sion funds and at least tem­porar­i­ly make every­thing seem bet­ter than they actu­al­ly are. It’s a con­ve­nient fic­tion for both parties...until the bill comes due. Because at some point these invest­ments have to be sold and real­i­ty inter­venes. That’s the basis for David Siro­ta’s warn­ings that, as bad as things were look­ing for the pri­vate equi­ty-led pen­sion fund invest­ments as CRE write-downs pick up the pace, it’s prob­a­bly actu­al­ly worse.

    Inter­est­ing­ly, as we’re going to see in a Bloomberg opin­ion piece from last month by Alli­son Schrager of con­ser­v­a­tive Man­hat­tan Insti­tute, this issue of fraud­u­lent pri­vate equi­ty book­keep­ing just might be one of those issues that can res­onate across the ide­o­log­i­cal spec­trum. Because not only does Schrager acknowl­edge the real abus­es inflict­ed by pri­vate equi­ty man­age­ment on work­ers and com­mu­ni­ties, but she has a solu­tion: giv­en that pen­sion funds now account for rough­ly two-thirds of the capi­tol under pri­vate equi­ty con­trol, one way of reduc­ing the amount of pri­vate equi­ty-induced social harms is to sim­ply starve pri­vate equi­ty of the bil­lions of dol­lars its using to inflict these harms by fix­ing these account­ing loop­holes that make pri­vate equi­ty such an entic­ing tem­porar­i­ly solu­tion to pen­sion funds look­ing to chase high­er returns.

    Will such a fix ever actu­al­ly get imple­ment­ed? It’s hard to see that hap­pen­ing in the US, but it’s worth keep­ing in mind that the longer it takes to fix these account­ing gim­micks, the more painful it’s even­tu­al­ly going to be to fix:

    The Guardian

    US pen­sion funds are on the brink of implo­sion – and Wall Street is ignor­ing it

    Pri­vate equi­ty firms man­ag­ing mil­lions of Amer­i­cans’ retire­ment sav­ings may be inflat­ing their invest­ments

    David Siro­ta
    Thu 2 Feb 2023 06.15 EST

    As pub­lic offi­cials across Amer­i­ca pre­pare to fun­nel even more of gov­ern­ment work­ers’ sav­ings to pri­vate equi­ty moguls, an alarm just sound­ed for any­one both­er­ing to lis­ten. It is a warn­ing that Wall Street exec­u­tives, busy skim­ming fees off retire­ment nest eggs, want you to ignore. The longer the warn­ing goes unheed­ed, how­ev­er, the big­ger the finan­cial time bomb may be for work­ers, retirees and the gov­ern­ments that pay them.

    Ear­li­er this month, Pitch­Book – the go-to news out­let of the pri­vate equi­ty indus­try – declared that “pri­vate equi­ty returns are a major threat to pen­sion plans’ abil­i­ty to pay retirees in 2023”.

    With more than one in 10 pub­lic pen­sion dol­lars invest­ed in pri­vate equi­ty assets – and with states con­tin­u­ing to keep their pri­vate equi­ty con­tracts secret – Pitch­Book cit­ed a new study find­ing that loss­es from the invest­ments may be on the hori­zon for retire­ment sys­tems that sup­port mil­lions of teach­ers, fire­fight­ers, first respon­ders and oth­er gov­ern­ment employ­ees.

    “Pri­vate equi­ty returns get report­ed on a lag of up to six months, and with each update in 2022 val­ues were com­ing down – which means 2022 num­bers were includ­ing over­stat­ed pri­vate equi­ty asset val­u­a­tions and 2023 num­bers are going to incor­po­rate those loss­es,” not­ed the study from the Equable Insti­tute.

    To com­pre­hend this time­bomb, you have to under­stand pri­vate equity’s busi­ness mod­el.

    In gen­er­al, pri­vate equi­ty firms use pen­sion mon­ey to buy up and restruc­ture com­pa­nies to then sell them at a high­er price than they were pur­chased. In between buy­ing and sell­ing, there are no trans­par­ent met­rics for valu­ing the pur­chased asset – pri­vate equi­ty firms can man­u­fac­ture an alleged val­ue to tell pen­sion investors (and there’s evi­dence they inflate val­u­a­tions when seek­ing new invest­ments).

    In a sto­ry about an investor receiv­ing two dif­fer­ent val­u­a­tions for the same com­pa­ny, Insti­tu­tion­al Investor under­scored the absur­di­ty: “Every­one Wants to Know What Pri­vate Assets Are Real­ly Worth. The Truth: It’s Com­pli­cat­ed.”

    Mean­while, val­u­a­tion and fee terms in con­tracts between pri­vate equi­ty firms and pub­lic pen­sions are kept secret, exempt from open records laws.

    With that in mind, the new warn­ings are sim­ple: pri­vate equi­ty firms may have told their pen­sion offi­cials that their assets were worth much more than they actu­al­ly are, all while the firms were skim­ming bil­lions of dol­lars of fees off retirees’ mon­ey.

    If write-downs now hap­pen, it could mean that when it’s time to sell the assets to pay promised retiree ben­e­fits, pen­sion funds would have far less mon­ey avail­able than pri­vate equi­ty firms led them to believe. At that point, there are three painful choic­es: cut retire­ment ben­e­fits, slash social pro­grams to fund the ben­e­fits, or raise tax­es to recoup the loss­es.

    Signs of a dooms­day sce­nario are already evi­dent: some of the world’s largest pri­vate equi­ty firms have been report­ing big declines in earn­ings, and fed­er­al reg­u­la­tors are report­ed­ly inten­si­fy­ing their scruti­ny of the industry’s write-downs of asset val­u­a­tions. Mean­while, one invest­ment bank report­ed that in its 2021 trans­ac­tions, pri­vate equi­ty assets sold for just 86% of their stat­ed val­ue last year.

    But while pen­sion­ers may be imper­iled, Wall Street exec­u­tives are pro­tect­ed thanks to their heads-we-win-tails-you-lose busi­ness mod­el. While report­ing asset loss­es for investors, some of the firms man­ag­ing pen­sion­ers’ mon­ey are rak­ing in even more fees from investors and con­tin­u­ing to raise exec­u­tives’ pay.

    Mean­while, even as some sophis­ti­cat­ed pri­vate investors rush to get out of pri­vate equi­ty, the world’s largest pri­vate equi­ty firm, Black­stone, recent­ly reas­sured Wall Street ana­lysts that state pen­sion offi­cials will con­tin­ue using retirees’ sav­ings to boost rev­enues for pri­vate equi­ty firms, hedge funds, real estate funds and oth­er so-called “alter­na­tive invest­ments”.

    “The desire for alter­na­tives remains very strong,” the pres­i­dent of Black­stone, Jon Gray, said in an investor call last week. “New York’s state leg­is­la­ture actu­al­ly increased the allo­ca­tion for the big three pen­sion funds here by rough­ly a third.”

    Gray was refer­ring to New York Demo­c­ra­t­ic law­mak­ers pass­ing leg­is­la­tion sig­nif­i­cant­ly increas­ing the amount of retiree mon­ey that pen­sion offi­cials can deliv­er to Wall Street. The bill was cham­pi­oned by the New York City comp­trol­ler, Brad Lan­der, just weeks after the Demo­c­rat won office promis­ing he would be “review­ing the funds’ posi­tions with risky and spec­u­la­tive assets includ­ing hedge funds, pri­vate equi­ty, and pri­vate real estate funds”.

    The New York gov­er­nor, Kathy Hochul, qui­et­ly signed the leg­is­la­tion on the Sat­ur­day before Christ­mas, just weeks after the Wall Street Jour­nal report­ed that ana­lysts have start­ed warn­ing pen­sion funds of loom­ing pri­vate equi­ty loss­es. New York law­mak­ers simul­ta­ne­ous­ly reject­ed sep­a­rate leg­is­la­tion that would have allowed work­ers and retirees to see the con­tracts signed between state pen­sion offi­cials and Wall Street firms man­ag­ing their mon­ey.

    The Empire State is hard­ly alone in con­tin­u­ing to use retirees’ mon­ey to enrich the planet’s wealth­i­est finan­cial spec­u­la­tors – from Cal­i­for­nia to Texas to Iowa, pen­sion funds con­trol­ling hun­dreds of bil­lions of dol­lars of work­ers’ retire­ment sav­ings are plan­ning to dump more mon­ey into pri­vate equi­ty, while keep­ing the terms of the invest­ments secret.

    While glo­be­trot­ting to elite con­fer­ences in exot­ic locales, pen­sion offi­cials have defend­ed the high-fee invest­ments by par­rot­ing Wall Street exec­u­tives’ claim that pri­vate equi­ty reli­ably out­per­forms low-fee stock index funds. At the same time, those offi­cials con­tin­ue to con­ceal the terms of the invest­ments, rais­ing the ques­tion: if the invest­ments are so great, why are the details being hid­den?

    Per­haps because the invest­ments aren’t as won­der­ful as adver­tised. In a land­mark study enti­tled An Incon­ve­nient Fact: Pri­vate Equi­ty Returns & the Bil­lion­aire Fac­to­ry, Oxford University’s Ludovic Phalip­pou doc­u­ment­ed that pri­vate equi­ty funds “have returned about the same as pub­lic equi­ty indices since at least 2006”, while extract­ing near­ly a quar­ter-tril­lion dol­lars in fees from pub­lic pen­sion sys­tems.

    A 2018 Yahoo News analy­sis found that US pen­sion sys­tems had paid more than $600bn in fees for hedge fund, pri­vate equi­ty, real estate and oth­er alter­na­tive invest­ments over a decade.

    “The big pic­ture is that they’re get­ting a lot of mon­ey for what they’re doing, and they’re not deliv­er­ing what they have promised or what they pre­tend they’re deliv­er­ing,” Phalip­pou told the New York Times in 2021.

    Even some on Wall Street admit the truth: a JP Mor­gan study in 2021 found that pri­vate equi­ty has bare­ly out­per­formed the stock mar­ket, but it remains unclear whether that “very thin” out­per­for­mance is worth the risk of opaque and illiq­uid invest­ments whose actu­al val­ue is often impos­si­ble to deter­mine – invest­ments that could crater when the mon­ey is most need­ed.

    While the warn­ings have not halt­ed the flood of pen­sion cash to pri­vate equi­ty, they have bro­ken through in at least some cor­ners of Amer­i­can pol­i­tics.

    The Secu­ri­ties and Exchange Com­mis­sion is con­sid­er­ing new rules to require pri­vate equi­ty firms to bet­ter dis­close the fees they charge.

    Sim­i­lar­ly, Ohio’s state audi­tor, Kei­th Faber, just issued a report sound­ing an alarm about state pen­sion offi­cials keep­ing pri­vate equi­ty con­tracts secret – a prac­tice repli­cat­ed in states across the coun­try.

    And fol­low­ing a pen­sion cor­rup­tion scan­dal in Penn­syl­va­nia – whose state gov­ern­ment over­sees near­ly $100bn in pen­sion mon­ey – there’s a poten­tial finan­cial earth­quake: dur­ing his first week in office, Gov­er­nor Josh Shapiro promised to shift pen­sion­ers’ mon­ey out of the hands of Wall Street firms.

    “We need to get rid of these risky invest­ments,” Shapiro told his state’s largest news­pa­per. “We need to move away from rely­ing on Wall Street mon­ey man­agers.”

    ...

    Bet­ter late than nev­er – though the lat­er it gets, the big­ger the risk for mil­lions of work­ers and retirees.

    ———–

    “US pen­sion funds are on the brink of implo­sion – and Wall Street is ignor­ing it” by David Siro­ta; The Guardian; 02/02/2023

    But while pen­sion­ers may be imper­iled, Wall Street exec­u­tives are pro­tect­ed thanks to their heads-we-win-tails-you-lose busi­ness mod­el. While report­ing asset loss­es for investors, some of the firms man­ag­ing pen­sion­ers’ mon­ey are rak­ing in even more fees from investors and con­tin­u­ing to raise exec­u­tives’ pay.”

    It’s a cri­sis for pen­sion funds. A cri­sis of under­per­form­ing pri­vate equi­ty invest­ments that sim­ply aren’t liv­ing up to Wall Street’s promis­es. But it’s a cri­sis for the under­per­form­ing fund man­agers. It’s the heads-we-win-tails-you-lose busi­ness mod­el in action. The kind of busi­ness mod­el that rais­es the basic ques­tion of why pen­sion funds agree to these terms in the first place. And that brings us to the brew­ing scan­dal in this sec­tor. The kind of scan­dal that’s only going to grow as pen­sion funds pour more and more mon­ey into pri­vate equi­ty fol­low­ing promis­es of high returns. Because as a grow­ing num­ber of voic­es are point­ing out, these promised returns aren’t meet­ing the hype. Quite the oppo­site, the 2022 returns were actu­al­ly get­ting writ­ten down, with more asset reval­u­a­tions on the way. And that brings us to the dis­turb­ing under­ly­ing fac­tor incen­tiviz­ing the sys­tem­at­ic infla­tion of pen­sion fund’s pri­vate equi­ty returns: pri­vate equi­ty invest­ments are dif­fi­cult to price, with returns often not being real­ized for years. And yet they must be priced for basic account­ing needs. Exist­ing rules han­dle that account­ing para­dox by effec­tive­ly allow­ing pri­vate equi­ty firms to just make up an assumed val­u­a­tion. And the high­er that assumed val­u­a­tion, the less under­fund­ed pen­sion funds will appear. It’s a recipe for cre­at­ing fis­cal time bombs in the bal­ance sheets of pen­sion funds:

    ...
    Ear­li­er this month, Pitch­Book – the go-to news out­let of the pri­vate equi­ty indus­try – declared that “pri­vate equi­ty returns are a major threat to pen­sion plans’ abil­i­ty to pay retirees in 2023”.

    With more than one in 10 pub­lic pen­sion dol­lars invest­ed in pri­vate equi­ty assets – and with states con­tin­u­ing to keep their pri­vate equi­ty con­tracts secret – Pitch­Book cit­ed a new study find­ing that loss­es from the invest­ments may be on the hori­zon for retire­ment sys­tems that sup­port mil­lions of teach­ers, fire­fight­ers, first respon­ders and oth­er gov­ern­ment employ­ees.

    “Pri­vate equi­ty returns get report­ed on a lag of up to six months, and with each update in 2022 val­ues were com­ing down – which means 2022 num­bers were includ­ing over­stat­ed pri­vate equi­ty asset val­u­a­tions and 2023 num­bers are going to incor­po­rate those loss­es,” not­ed the study from the Equable Insti­tute.

    To com­pre­hend this time­bomb, you have to under­stand pri­vate equity’s busi­ness mod­el.

    In gen­er­al, pri­vate equi­ty firms use pen­sion mon­ey to buy up and restruc­ture com­pa­nies to then sell them at a high­er price than they were pur­chased. In between buy­ing and sell­ing, there are no trans­par­ent met­rics for valu­ing the pur­chased asset – pri­vate equi­ty firms can man­u­fac­ture an alleged val­ue to tell pen­sion investors (and there’s evi­dence they inflate val­u­a­tions when seek­ing new invest­ments).

    ...

    Mean­while, val­u­a­tion and fee terms in con­tracts between pri­vate equi­ty firms and pub­lic pen­sions are kept secret, exempt from open records laws.

    With that in mind, the new warn­ings are sim­ple: pri­vate equi­ty firms may have told their pen­sion offi­cials that their assets were worth much more than they actu­al­ly are, all while the firms were skim­ming bil­lions of dol­lars of fees off retirees’ mon­ey.

    If write-downs now hap­pen, it could mean that when it’s time to sell the assets to pay promised retiree ben­e­fits, pen­sion funds would have far less mon­ey avail­able than pri­vate equi­ty firms led them to believe. At that point, there are three painful choic­es: cut retire­ment ben­e­fits, slash social pro­grams to fund the ben­e­fits, or raise tax­es to recoup the loss­es.
    ...

    But it’s not just account­ing trick­ery at work here. There’s also the fact that the terms of these con­tracts between pen­sion funds and pri­vate-equi­ty firms are typ­i­cal­ly hid­den. And as stud­ies have found, a rather grim con­clu­sion is reached when you fac­tor all those hid­den fees: pri­vate equi­ty returns have been more or less in line with pub­lic equi­ty returns:

    ...
    While glo­be­trot­ting to elite con­fer­ences in exot­ic locales, pen­sion offi­cials have defend­ed the high-fee invest­ments by par­rot­ing Wall Street exec­u­tives’ claim that pri­vate equi­ty reli­ably out­per­forms low-fee stock index funds. At the same time, those offi­cials con­tin­ue to con­ceal the terms of the invest­ments, rais­ing the ques­tion: if the invest­ments are so great, why are the details being hid­den?

    Per­haps because the invest­ments aren’t as won­der­ful as adver­tised. In a land­mark study enti­tled An Incon­ve­nient Fact: Pri­vate Equi­ty Returns & the Bil­lion­aire Fac­to­ry, Oxford University’s Ludovic Phalip­pou doc­u­ment­ed that pri­vate equi­ty funds “have returned about the same as pub­lic equi­ty indices since at least 2006”, while extract­ing near­ly a quar­ter-tril­lion dol­lars in fees from pub­lic pen­sion sys­tems.

    ...

    Even some on Wall Street admit the truth: a JP Mor­gan study in 2021 found that pri­vate equi­ty has bare­ly out­per­formed the stock mar­ket, but it remains unclear whether that “very thin” out­per­for­mance is worth the risk of opaque and illiq­uid invest­ments whose actu­al val­ue is often impos­si­ble to deter­mine – invest­ments that could crater when the mon­ey is most need­ed.
    ...

    And despite all of these warn­ing signs, all indi­ca­tions are that the flood of pen­sion fund mon­ey into the pri­vate-equi­ty space is only going to grow, with New York law­mak­ers recent­ly rais­ing the cap on the amounts of pen­sion fund mon­ey that can flow into pri­vate-equi­ty invest­ments:

    ...
    Mean­while, even as some sophis­ti­cat­ed pri­vate investors rush to get out of pri­vate equi­ty, the world’s largest pri­vate equi­ty firm, Black­stone, recent­ly reas­sured Wall Street ana­lysts that state pen­sion offi­cials will con­tin­ue using retirees’ sav­ings to boost rev­enues for pri­vate equi­ty firms, hedge funds, real estate funds and oth­er so-called “alter­na­tive invest­ments”.

    “The desire for alter­na­tives remains very strong,” the pres­i­dent of Black­stone, Jon Gray, said in an investor call last week. “New York’s state leg­is­la­ture actu­al­ly increased the allo­ca­tion for the big three pen­sion funds here by rough­ly a third.”

    Gray was refer­ring to New York Demo­c­ra­t­ic law­mak­ers pass­ing leg­is­la­tion sig­nif­i­cant­ly increas­ing the amount of retiree mon­ey that pen­sion offi­cials can deliv­er to Wall Street. The bill was cham­pi­oned by the New York City comp­trol­ler, Brad Lan­der, just weeks after the Demo­c­rat won office promis­ing he would be “review­ing the funds’ posi­tions with risky and spec­u­la­tive assets includ­ing hedge funds, pri­vate equi­ty, and pri­vate real estate funds”.

    The New York gov­er­nor, Kathy Hochul, qui­et­ly signed the leg­is­la­tion on the Sat­ur­day before Christ­mas, just weeks after the Wall Street Jour­nal report­ed that ana­lysts have start­ed warn­ing pen­sion funds of loom­ing pri­vate equi­ty loss­es. New York law­mak­ers simul­ta­ne­ous­ly reject­ed sep­a­rate leg­is­la­tion that would have allowed work­ers and retirees to see the con­tracts signed between state pen­sion offi­cials and Wall Street firms man­ag­ing their mon­ey.

    The Empire State is hard­ly alone in con­tin­u­ing to use retirees’ mon­ey to enrich the planet’s wealth­i­est finan­cial spec­u­la­tors – from Cal­i­for­nia to Texas to Iowa, pen­sion funds con­trol­ling hun­dreds of bil­lions of dol­lars of work­ers’ retire­ment sav­ings are plan­ning to dump more mon­ey into pri­vate equi­ty, while keep­ing the terms of the invest­ments secret.
    ...

    That was the assess­ment from pro­gres­sive David Siro­ta from ear­li­er this year. An assess­ment that are part­ly echoed last month in the fol­low­ing Bloomberg piece by Alli­son Schrager of the con­ser­v­a­tive Man­hat­tan Insti­tute. As Schrager acknowl­edges, pri­vate equi­ty earned its ruth­less rep­u­ta­tion for a rea­son. It’s been gen­uine­ly ruth­less in the pur­suit of prof­its and it’s not hard to see why the pub­lic would want that ruth­less­ness reigned in. But Schrager argues against cre­at­ing new rules that would direct­ly restrain pri­vate equi­ty from engag­ing in these kinds of ruth­less man­age­ment tac­tics and instead pro­pos­es an indi­rect approach: fix the account­ing rule chi­canery that has made pri­vate equi­ty such an appe­tiz­ing invest­ment to pen­sion funds. That’s it. Fix that, and there’s going to be A LOT less pen­sion fund mon­ey flow­ing into the pri­vate equi­ty space. Less pri­vate equi­ty mon­ey = less pri­vate equi­ty-caused social dam­age.

    That’s the fix Schrager is propos­ing. And while it remains very unclear if any such fix is polit­i­cal­ly fea­si­ble giv­en the immense lob­by­ing pow­er of this indus­try, it’s pret­ty notable that reign­ing in the abus­es of pri­vate equi­ty is a poten­tial point of agree­ment between peo­ple as ide­o­log­i­cal­ly diverse as David Siro­ta and Alli­son Schrager:

    Bloomberg
    Opin­ion

    Pen­sion Funds Share Blame for Pri­vate Equity’s Hor­ror Sto­ries

    The promise of high returns — whether true or not — has encour­aged retire­ment funds to pour mon­ey into PE invest­ments, with ter­ri­ble results.

    by Alli­son Schrager
    May 8, 2023 at 5:00 AM CDT

    Pri­vate equi­ty is the lat­est eco­nom­ic boogey­man. And there are good rea­sons for that.

    Assets in the pri­vate mar­ket have grown expo­nen­tial­ly in the last 20 years, espe­cial­ly in North Amer­i­ca, and now amount to near­ly $12 tril­lion. The num­ber of com­pa­nies backed by pri­vate equi­ty more than dou­bled between 2006 and 2020, while the num­ber of pub­lic com­pa­nies shrank. Pri­vate equi­ty firms are buy­ing up com­pa­nies that pro­vide ser­vices we use and depend on: hos­pi­tals, nurs­ing homes, real estate, chain restau­rants and even pris­ons.

    That’s caused alarm because pri­vate equi­ty firms have a rep­u­ta­tion for focus­ing ruth­less­ly on the bot­tom line to the detri­ment of those depend­ing on the company’s ser­vices. One study even found pri­vate equi­ty con­trol can kill you. Two new books argue the pri­vate equi­ty indus­try is not only killing you, it’s ruin­ing your local busi­ness­es by laden­ing them with debt, har­vest­ing their assets and push­ing them to bank­rupt­cy.

    There are some ter­ri­ble abus­es that pri­vate equi­ty firms should be held account­able for, and the mar­ket does need to change. But mit­i­gat­ing the dam­age doesn’t require a bunch of new rules on pri­vate equi­ty itself. A bet­ter and less obvi­ous solu­tion would be fix­ing a dis­tor­tion in the mar­ket that’s pro­vid­ed pri­vate equi­ty funds with so much mon­ey in the first place. It starts with look­ing at the investors in these funds, and in par­tic­u­lar pub­lic sec­tor pen­sions that have pro­vid­ed some of the bags of cash that have empow­ered the reck­less behav­ior.

    Some of the crit­i­cisms of pri­vate equi­ty are unfair. There’s noth­ing wrong with run­ning a com­pa­ny for prof­it. Pri­vate equi­ty can serve an impor­tant func­tion in the econ­o­my by mak­ing unpro­duc­tive com­pa­nies bet­ter. When it comes to mak­ing com­pa­nies more prof­itable and pro­duc­tive, pri­vate equi­ty firms have had a fair­ly suc­cess­ful track record. And while pri­vate equi­ty takeovers tend to lead to job cuts in the short term, over the long run more jobs are cre­at­ed.

    Not all com­pa­nies are a good fit for pri­vate equi­ty, though, and in the last decade PE buy­outs have become asso­ci­at­ed with more job loss­es and less pro­duc­tiv­i­ty.

    The change began when pri­vate equi­ty funds start­ed get­ting more mon­ey from pub­lic pen­sion funds, argued Colum­bia Busi­ness School Ph.D. can­di­date Vrin­da Mit­tal in a recent paper. Pub­lic pen­sions make up 31.3% of all investors to pri­vate equi­ty funds and con­tribute 67% of their cap­i­tal. Many of these pen­sions don’t have enough assets to pay out all their promised ben­e­fits. Mit­tal esti­mates that between 2006 and 2018, the cap­i­tal invest­ed in PE funds from the most under­fund­ed pub­lic pen­sions tripled to 15.6% of all com­mit­ted cap­i­tal.

    These under­fund­ed pen­sions had a good rea­son to invest in pri­vate equi­ty. Ultra-low inter­est rates in the past 15 years added urgency to pen­sions’ need to boost returns. Pub­lic pen­sion account­ing stan­dards sug­gest the pen­sion funds mea­sure their lia­bil­i­ties based on the expect­ed rate of return on their invest­ments. The way it works is that pen­sion funds project future ben­e­fits and dis­count them to today’s dol­lars using this return esti­mate. The high­er the return, the low­er their lia­bil­i­ties appear. It’s an account­ing con­ven­tion that, to put it mild­ly, enrages finan­cial econ­o­mists because it doesn’t account for how risky the pension’s invest­ments are. Pub­lic pen­sion funds should account for risk because their ben­e­fits must be paid no mat­ter what hap­pens to finan­cial mar­kets. If the pen­sion can’t pay ben­e­fits, tax­pay­ers are on the hook.

    The cur­rent account­ing stan­dards not only ignore risk, they cre­ate an incen­tive to invest in riski­er assets that claim high­er returns with lit­tle trans­paren­cy. Pri­vate equi­ty is per­fect for this because it locks up pen­sion fund mon­ey for years. In the mean­time, they can claim a high and sta­ble return because the pri­vate equi­ty invest­ments don’t have an objec­tive mar­ket val­ue. If you are an under­fund­ed pub­lic pen­sion, it’s the ide­al solu­tion because the high­er (on paper, at least) pri­vate equi­ty return will increase your over­all expect­ed return and, like mag­ic, your pen­sion looks much bet­ter fund­ed.

    This is a prob­lem not only because the pen­sion fund will even­tu­al­ly real­ize its loss­es and may run out of mon­ey. It also cre­at­ed a big mar­ket dis­tor­tion that result­ed in a lot of mon­ey flood­ing into sub­par pri­vate equi­ty funds. Mittal’s argu­ment seems right to me: Flush with what he calls “des­per­ate cap­i­tal,” these pri­vate equi­ty funds made many poor invest­ments that result­ed in worse out­comes for the com­pa­nies they tar­get­ed.

    ...

    The good news is that there’s a sim­ple solu­tion: revise the pub­lic pen­sion account­ing stan­dards. Pri­vate-sec­tor pen­sion plans must deter­mine their lia­bil­i­ties using the inter­est rates of bonds trad­ed in the mar­ket. Pub­lic-sec­tor pen­sions should do the same. Ide­al­ly the bonds used to mea­sure lia­bil­i­ties should have the same default risk as the pen­sion ben­e­fits. Since pub­lic pen­sions can’t default on their ben­e­fits (it is writ­ten into their state con­sti­tu­tions) the appro­pri­ate rate should be Trea­suries, or maybe munic­i­pal bonds. This would have been a heavy lift a few years ago because if you dis­count­ed future ben­e­fits with near zero inter­est rates, the under-fund­ed plans’ sit­u­a­tion would look dire. Today, the boost from high­er rates offers an oppor­tu­ni­ty to switch to a bet­ter stan­dard.

    ...

    ———–

    “Pen­sion Funds Share Blame for Pri­vate Equity’s Hor­ror Sto­ries” by Alli­son Schrager; Bloomberg; 05/08/2023

    “There are some ter­ri­ble abus­es that pri­vate equi­ty firms should be held account­able for, and the mar­ket does need to change. But mit­i­gat­ing the dam­age doesn’t require a bunch of new rules on pri­vate equi­ty itself. A bet­ter and less obvi­ous solu­tion would be fix­ing a dis­tor­tion in the mar­ket that’s pro­vid­ed pri­vate equi­ty funds with so much mon­ey in the first place. It starts with look­ing at the investors in these funds, and in par­tic­u­lar pub­lic sec­tor pen­sions that have pro­vid­ed some of the bags of cash that have empow­ered the reck­less behav­ior.

    If you are wor­ried about pri­vate equi­ty’s bru­tal track record of abus­es, there’s a pret­ty pow­er­ful rem­e­dy just sit­ting right there wait­ing to be used: end the per­verse account­ing incen­tives that have encour­age pen­sion funds to flood the pri­vate-equi­ty indus­try with bil­lions of dol­lars based on a lie. The kind of lie of fake high returns that have enticed so many pen­sion funds to engage in a kind of mutu­al­ly con­ve­nient fic­tion with pri­vate equi­ty firms that will keep all par­ties sat­is­fied until the music stops. A fic­tion so con­ve­nient that pen­sion fund mon­ey now accounts for rough­ly two-thirds of the cap­i­tal under pri­vate-equi­ty man­age­ment. In oth­er words, this con­ve­nient account­ing fic­tion has dou­bled as a ampli­fi­er for dam­age inflict­ed upon soci­ety at large by pri­vate-equi­ty’s heads-we-win-tails-you-lose busi­ness mod­el:

    ...
    Some of the crit­i­cisms of pri­vate equi­ty are unfair. There’s noth­ing wrong with run­ning a com­pa­ny for prof­it. Pri­vate equi­ty can serve an impor­tant func­tion in the econ­o­my by mak­ing unpro­duc­tive com­pa­nies bet­ter. When it comes to mak­ing com­pa­nies more prof­itable and pro­duc­tive, pri­vate equi­ty firms have had a fair­ly suc­cess­ful track record. And while pri­vate equi­ty takeovers tend to lead to job cuts in the short term, over the long run more jobs are cre­at­ed.

    Not all com­pa­nies are a good fit for pri­vate equi­ty, though, and in the last decade PE buy­outs have become asso­ci­at­ed with more job loss­es and less pro­duc­tiv­i­ty.

    The change began when pri­vate equi­ty funds start­ed get­ting more mon­ey from pub­lic pen­sion funds, argued Colum­bia Busi­ness School Ph.D. can­di­date Vrin­da Mit­tal in a recent paper. Pub­lic pen­sions make up 31.3% of all investors to pri­vate equi­ty funds and con­tribute 67% of their cap­i­tal. Many of these pen­sions don’t have enough assets to pay out all their promised ben­e­fits. Mit­tal esti­mates that between 2006 and 2018, the cap­i­tal invest­ed in PE funds from the most under­fund­ed pub­lic pen­sions tripled to 15.6% of all com­mit­ted cap­i­tal.

    These under­fund­ed pen­sions had a good rea­son to invest in pri­vate equi­ty. Ultra-low inter­est rates in the past 15 years added urgency to pen­sions’ need to boost returns. Pub­lic pen­sion account­ing stan­dards sug­gest the pen­sion funds mea­sure their lia­bil­i­ties based on the expect­ed rate of return on their invest­ments. The way it works is that pen­sion funds project future ben­e­fits and dis­count them to today’s dol­lars using this return esti­mate. The high­er the return, the low­er their lia­bil­i­ties appear. It’s an account­ing con­ven­tion that, to put it mild­ly, enrages finan­cial econ­o­mists because it doesn’t account for how risky the pension’s invest­ments are. Pub­lic pen­sion funds should account for risk because their ben­e­fits must be paid no mat­ter what hap­pens to finan­cial mar­kets. If the pen­sion can’t pay ben­e­fits, tax­pay­ers are on the hook.
    ...

    And then Schrager points to anoth­er fact that is only going to grow as more and more pen­sion fund mon­ey flows into pri­vate equi­ty’s hands: not all pri­vate equi­ty firms are of the same cal­iber and with pen­sion funds now func­tion­ing and pri­vate-equi­ty’s the pri­ma­ry cus­tomer it’s inevitable that at least some of those bil­lions of dol­lars are being thrown at sub­par pri­vate-equi­ty funds. It’s not just invest­ment oppor­tu­ni­ties get­ting sys­tem­at­i­cal­ly crowd­ed out. It’s invest­ment tal­ent too:

    ...
    The cur­rent account­ing stan­dards not only ignore risk, they cre­ate an incen­tive to invest in riski­er assets that claim high­er returns with lit­tle trans­paren­cy. Pri­vate equi­ty is per­fect for this because it locks up pen­sion fund mon­ey for years. In the mean­time, they can claim a high and sta­ble return because the pri­vate equi­ty invest­ments don’t have an objec­tive mar­ket val­ue. If you are an under­fund­ed pub­lic pen­sion, it’s the ide­al solu­tion because the high­er (on paper, at least) pri­vate equi­ty return will increase your over­all expect­ed return and, like mag­ic, your pen­sion looks much bet­ter fund­ed.

    This is a prob­lem not only because the pen­sion fund will even­tu­al­ly real­ize its loss­es and may run out of mon­ey. It also cre­at­ed a big mar­ket dis­tor­tion that result­ed in a lot of mon­ey flood­ing into sub­par pri­vate equi­ty funds. Mittal’s argu­ment seems right to me: Flush with what he calls “des­per­ate cap­i­tal,” these pri­vate equi­ty funds made many poor invest­ments that result­ed in worse out­comes for the com­pa­nies they tar­get­ed.

    ...

    The good news is that there’s a sim­ple solu­tion: revise the pub­lic pen­sion account­ing stan­dards. Pri­vate-sec­tor pen­sion plans must deter­mine their lia­bil­i­ties using the inter­est rates of bonds trad­ed in the mar­ket. Pub­lic-sec­tor pen­sions should do the same. Ide­al­ly the bonds used to mea­sure lia­bil­i­ties should have the same default risk as the pen­sion ben­e­fits. Since pub­lic pen­sions can’t default on their ben­e­fits (it is writ­ten into their state con­sti­tu­tions) the appro­pri­ate rate should be Trea­suries, or maybe munic­i­pal bonds. This would have been a heavy lift a few years ago because if you dis­count­ed future ben­e­fits with near zero inter­est rates, the under-fund­ed plans’ sit­u­a­tion would look dire. Today, the boost from high­er rates offers an oppor­tu­ni­ty to switch to a bet­ter stan­dard.
    ...

    Do the sub­par pri­vate equi­ty fund man­agers charge sub­par fees too? It’s a nice thought but it’s hard to imag­ine that’s actu­al­ly the case for this heads-we-win-tails-you-lose indus­try. Instead, we can expect more of the same, but pre­sum­ably worse. Espe­cial­ly should a wave of pre­vi­ous­ly undis­closed loss­es belat­ed­ly get revealed as David Siro­ta warned. Don’t for­get the under­ly­ing log­ic of the CRE dou­ble down: good deals have to be snagged in order to make up for all the loss­es pil­ing up from last year’s CRE binge. So the worse the sur­prise write­downs get, the more com­pelling the log­ic to dou­ble down even more. Yes, the worse it turns out all these pri­vate equi­ty invest­ments ulti­mate­ly turn out to be, the more pen­sions funds are going to be com­pelled to dive into pri­vate equi­ty because they don’t have no where else to go. Pri­vate equi­ty has become the pen­sion fund indus­try’s last resort, for good or ill. That’s the dement­ed death spi­ral dynam­ic at work here. Well, a death spi­ral at least for the pen­sion­ers’ retire­ments. The fund man­agers of course be get­ting paid either way.

    Posted by Pterrafractyl | June 26, 2023, 8:50 pm
  2. The best invest­ments are often the ones made when every­one is look­ing else­where. When the mar­ket zigs, the best investors zag. Of course, invest­ing in some­thing that almost every­one else is try­ing to get out of is all so a great way to lose your shirt. So what kind of invest­ment did the Uni­ver­si­ty of Cal­i­for­ni­a’s pen­sion fund make ear­li­er this year with its $4.5 bil­lion invest­ment in one of Black­stone’s real estate invest­ment trusts (REITs)? It’s a ques­tion that isn’t just poten­tial­ly weigh­ing on the minds of UC pen­sion­ers. It’s also a ques­tion for a grow­ing num­ber of renters. Espe­cial­ly stu­dent renters. Yes, this large invest­ment was made just months after this same REIT pur­chased 69 per­cent of Amer­i­can Cam­pus Com­mu­ni­ties (ACC), the US’s largest stu­dent hous­ing com­pa­ny, in a $12.8 bil­lion deal in August of 2022. Stu­dent rents from the nation’s largest stu­dent hous­ing com­pa­ny are now help­ing to pay the pen­sion of the largest pub­lic col­lege sys­tem. With Black­stone rak­ing in the hefty pri­vate equi­ty fees the whole time. Was this a good invest­ment?

    But there’s anoth­er wrin­kle to this invest­ing deci­sion: that $4.5 bil­lion invest­ment did­n’t hap­pen at time when oth­er investors were scram­bling to cap­i­tal­ize on the avail­able REIT oppor­tu­ni­ties. It hap­pened as the oth­er investors in that same Black­stone REIT were mak­ing redemp­tion requests. So many redemp­tion requests that Black­stone was block­ing them. And it’s not like those redemp­tion requests end­ed after this $4.5 bil­lion UC infu­sion. In fact, In March, the Black­stone REIT received $4.5 bil­lion in redemp­tion requests, while only ful­fill­ing $666 mil­lion of those requests. Does that sound like a sound pri­vate equi­ty fund­ing to be dump­ing bil­lions of dol­lars into? Is the UC pen­sion sys­tem’s Black­stone REIT play ‘crazy like a fox’? Or just crazy?:

    Jacobin

    The Uni­ver­si­ty of Cal­i­for­nia Is Bail­ing Out Pri­vate Equi­ty Giant Black­stone

    By Matthew Cun­ning­ham-Cook
    04.24.2023

    Amid a hous­ing cri­sis that is leav­ing thou­sands of its stu­dents and employ­ees home­less, the Uni­ver­si­ty of Cal­i­for­nia is bail­ing out pri­vate equi­ty behe­moth Black­stone, siphon­ing bil­lions of dol­lars to pri­va­tized stu­dent hous­ing and cor­po­rate land­lords.

    As the world’s largest pri­vate equi­ty firm faces poten­tial loss­es from a cloudy real estate mar­ket, its exec­u­tives blocked jit­tery investors from with­draw­ing their mon­ey from one of its real estate funds, while insist­ing that rent increas­es and evic­tions will bol­ster returns.

    Now, the Black­stone Group’s real estate invest­ment trust has received a multi­bil­lion-dol­lar bailout from a source whose employ­ees and stu­dents are already suf­fer­ing through the hous­ing cri­sis: California’s pub­lic uni­ver­si­ty sys­tem.

    Just months after Blackstone’s real estate invest­ment trust pur­chased America’s largest own­er of pri­vate stu­dent hous­ing, the same trust received a $4.5 bil­lion infu­sion from the Uni­ver­si­ty of California’s Board of Regents, two of whom have close ties to the com­pa­ny. The invest­ment rewards the finan­cial firm only a few years after the com­pa­ny and its exec­u­tives spent $5.6 mil­lion to kill Cal­i­for­nia bal­lot ini­tia­tives that would have expand­ed rent con­trol in the state.

    Black­stone, a firm that’s val­ued at $111 bil­lion and man­ages $991 bil­lion in assets, also faces broad­er head­winds in its real estate sec­tor. The prof­its that the firm dis­trib­utes to share­hold­ers plunged 36 per­cent last year, dri­ven by real estate loss­es.

    Effec­tive­ly, Uni­ver­si­ty of Cal­i­for­nia (UC) is fun­nel­ing cash into pri­va­tized stu­dent hous­ing and cor­po­rate land­lords — dou­bling down on a con­tro­ver­sial invest­ment strat­e­gy that comes with a mas­sive lay­er of fees and Wall Street prof­its — instead of doing its part to address a grow­ing hous­ing cri­sis, one that affects its stu­dents and employ­ees.

    In 2021, 5 per­cent of UC stu­dents, or more than four­teen thou­sand, expe­ri­enced home­less­ness, while the university’s unions report that many of their most­ly blue-col­lar mem­bers sim­ply can­not make ends meet due to California’s spi­ral­ing cost of rental hous­ing.

    The lat­est episode revolves around the Black­stone Real Estate Income Trust, or BREIT. In August 2022, BREIT pur­chased 69 per­cent of Amer­i­can Cam­pus Com­mu­ni­ties (ACC), the country’s largest stu­dent hous­ing com­pa­ny, in a $12.8 bil­lion deal. ACC’s busi­ness mod­el is built around rent rev­enues; in Jan­u­ary 2022 the company’s CEO boast­ed that it was “expe­ri­enc­ing the most sub­stan­tial fun­da­men­tal tail­winds we’ve seen in many years” thanks in part to soar­ing rents.

    ACC has apart­ments at the Uni­ver­si­ty of Cal­i­for­nia, Berke­ley, and the Uni­ver­si­ty of Cal­i­for­nia, Irvine.

    Five months after this acqui­si­tion, the UC Regents pumped $4.5 bil­lion into BREIT. Around the same time, Black­stone spent more than $150,000 in the final quar­ter of 2022 on lob­by­ing UC for more invest­ment dol­lars, dou­bling the amount it spent the pre­vi­ous quar­ter.

    In Decem­ber, Nadeem Meghji, Blackstone’s head of real estate for the Amer­i­c­as, told CNBC that UC’s unprece­dent­ed bailout of BREIT “changed the nar­ra­tive” around the fund.

    That same month, Black­stone began block­ing redemp­tions to investors, after it received an influx of redemp­tion requests. But that didn’t stop Black­stone from dis­trib­ut­ing to itself more than $200 mil­lion in man­age­ment fees in the fourth quar­ter of 2022, a Lever review of Secu­ri­ties and Exchange Com­mis­sion (SEC) fil­ings show. Between man­age­ment and per­for­mance fees, Black­stone extract­ed more than $1.5 bil­lion in fees from the $50 bil­lion fund in 2022.

    Black­stone CEO Stephen Schwarz­man earned $1.3 bil­lion in 2022 and has a net worth of $30.7 bil­lion, accord­ing to Bloomberg, and he is a major donor to Repub­li­can can­di­dates.

    Now, in a near­ly unprece­dent­ed coor­di­nat­ed inter­ven­tion, the university’s labor unions — rep­re­sent­ing 110,000 work­ers — have called on UC to divest itself not just from the university’s hold­ings in the Black­stone real estate fund, but all of the university’s $6.5 bil­lion invest­ed in Black­stone hold­ings.

    “Essen­tial­ly UC is invest­ing in a cor­po­ra­tion that fur­ther dri­ves UC’s own work­ers’ hous­ing inse­cu­ri­ty,” said Kathryn Lybarg­er, the Pres­i­dent of Amer­i­can Fed­er­a­tion of State, Coun­ty & Munic­i­pal Employ­ees (AFSCME) Local 3299, which rep­re­sents blue-col­lar and health care work­ers at the Uni­ver­si­ty of Cal­i­for­nia. “The bot­tom line is that people’s hous­ing should not be a basis for mak­ing a prof­it, espe­cial­ly when it’s a pub­lic insti­tu­tion like UC. We’re demand­ing they divest and it’s on the scale of divest­ing from South Africa in the ’80s. We’re talk­ing about hous­ing as a human right, not as an invest­ing oppor­tu­ni­ty.”

    Blackstone’s Hous­ing Play

    Real estate invest­ment trusts are pools of investor-backed cash that pur­chase real estate. While pen­sion funds rou­tine­ly invest in both real estate invest­ment trusts (REITs) and pri­vate equi­ty real estate, it is extreme­ly uncom­mon to have a pen­sion effec­tive­ly do a bailout of a fund fac­ing mas­sive redemp­tion requests.

    Blackstone’s BREIT dif­fers sub­stan­tial­ly from the $1.3 tril­lion REIT mar­ket. Near­ly all REITs are pub­licly trad­ed, which means that investors can cash out their mon­ey at will. This is not the case with BREIT, which allows Black­stone to sus­pend redemp­tions.

    In response to ques­tions from the Lever, Black­stone spokesman Jef­frey Kauth not­ed in an email that “BREIT is not a mutu­al fund and has nev­er gat­ed. It is a semi-liq­uid prod­uct and is work­ing exact­ly as planned.” “Gat­ing” refers to a prac­tice by hedge funds and pri­vate equi­ty where redemp­tions are entire­ly blocked, as opposed to just par­tial­ly blocked, like with BREIT.

    Black­stone is the largest pri­vate land­lord in the coun­try, own­ing three hun­dred thou­sand units across the Unit­ed States. In Cal­i­for­nia alone, Black­stone and its affil­i­ates, includ­ing BREIT, own at least nine thou­sand hous­ing units, includ­ing con­cen­tra­tions in San Diego, Los Ange­les, Sacra­men­to, and the Bay Area, accord­ing to research done by the Pri­vate Equi­ty Stake­hold­er Project.

    Those units tend to be locat­ed in low­er-income cen­sus tracts, where on aver­age res­i­dents make rough­ly 25 per­cent less than the state’s medi­an house­hold income. Over the past few years, BREIT has also made a play into mobile home parks, acquir­ing near­ly six thou­sand units in the San Diego area, where Black­stone has been rou­tine­ly jack­ing up list­ed rents by 40 per­cent or more.

    Esca­lat­ing hous­ing costs are inte­gral to Blackstone’s busi­ness strat­e­gy. “Our major con­cern with Black­stone is that this is a com­pa­ny whose mod­el for mak­ing mon­ey for investors is to buy up rental prop­er­ties and raise the rent,” said Lybarg­er at AFSCME.

    Black­stone spent more than $5.6 mil­lion oppos­ing a 2018 bal­lot ini­tia­tive that would have allowed Cal­i­for­nia cities to imple­ment new rent con­trol mea­sures.

    In 2019, the UN accused Black­stone of “wreak­ing hav­oc” on the hous­ing mar­ket by its aggres­sive pur­suit of evic­tions and high­er rents. Some ten­ants have suc­cess­ful­ly fought back as it seeks to expand its pres­ence in the hous­ing mar­ket, how­ev­er. In Jan­u­ary, ten­ants at the Stuy­Town com­plex in New York City suc­cess­ful­ly fought an effort to raise rents, and in San Diego, Black­stone ten­ants have formed a union.

    “We believe we have the most favor­able res­i­dent poli­cies among any large land­lord in the US, includ­ing not mak­ing a sin­gle non­pay­ment evic­tion for over two years dur­ing COVID,” not­ed Kauth in his email.“We oper­ate in accor­dance with California’s rent sta­bi­liza­tion laws and are invest­ing $100 mil­lion to make these com­mu­ni­ties bet­ter places to live.”

    But some BREIT ten­ants say that if any­thing, the trust’s mas­sive for­ay into hous­ing has been any­thing but ben­e­fi­cial.

    One ten­ant, Michael McBride, says that since BREIT pur­chased his apart­ment com­plex in Chu­la Vista out­side of San Diego a cou­ple of years ago, basic main­te­nance has fall­en by the way­side. It took “at least” a month for BREIT to fix the heat in his apart­ment after he had com­plained about it in win­ter.

    ...

    BREIT’s approach has late­ly faced tur­bu­lence. Because the fund is sub­stan­tial­ly indebt­ed — it car­ries $90 bil­lion in debt on $140 bil­lion in total assets — even small down­turns like the recent eco­nom­ic decline put the fund in jeop­ardy, since both gains and loss­es are mag­ni­fied because of high lever­age.

    What’s more, BREIT has a small but sig­nif­i­cant por­tion of its hold­ings in the office and retail sec­tor, which have been bat­tered in the post-pan­dem­ic econ­o­my. Ear­li­er this month, BREIT sold two office tow­ers in Orange Coun­ty, Cal­i­for­nia, for 36 per­cent less than it paid for them nine years ago.

    ...

    Such upheaval has led many BREIT investors to get cold feet. In March, BREIT received $4.5 bil­lion in redemp­tion requests, but only ful­filled $666 mil­lion of them.

    But now, UC has come to the res­cue. In Jan­u­ary, the uni­ver­si­ty announced it was invest­ing $4.5 bil­lion in the strug­gling fund — which in effect allows it to start refund­ing oth­er investors’ mon­ey.

    “I Have to Make Some Cap­i­tal­is­tic Deci­sions”

    UC’s pen­sion sys­tem is fair­ly unique in that work­ers have no pow­er over how invest­ment deci­sions are made. All deci­sions are made by the regents, which are appoint­ed by the Cal­i­for­nia gov­er­nor for twelve-year terms.

    One of the main deci­sion-mak­ers behind the plan to pump bil­lions of UC dol­lars into Black­stone was Richard Sher­man, chair of the UC Invest­ment Com­mit­tee, who has strong con­nec­tions to the invest­ment firm. On Jan­u­ary 3, Sher­man announced in a Black­stone press release, “This type of large, oppor­tunis­tic invest­ment effec­tive­ly lever­ages the UC’s more than $150 bil­lion port­fo­lio to ben­e­fit the 600,000 stu­dents, fac­ul­ty, staff, and pen­sion­ers from our 10 cam­pus­es and six aca­d­e­m­ic health cen­ters.”

    Sher­man, who heads up music mogul David Geffen’s invest­ment office, col­lab­o­rat­ed with Black­stone on the 2012 buy­out of music pub­lish­er EMI. What’s more, the late Black­stone cofounder Pete Peter­son pur­chased his New York pent­house from Gef­fen in 2007.

    An addi­tion­al mem­ber of the eleven-per­son Invest­ment Com­mit­tee, Mark Robin­son, also has ties to Black­stone. Robin­son is a part­ner at invest­ment bank­ing firm Cen­ter­view Part­ners, which advised Black­stone on a $2.2 bil­lion acqui­si­tion in 2021.

    On behalf of the regents, the invest­ment was launched by Jagdeep Singh Bach­her, UC’s chief invest­ment offi­cer — who has been accused of mak­ing invest­ments in response to pres­sure from indi­vid­ual regents with con­flicts of inter­est in the past. In 2018, he invest­ed an unprece­dent­ed $240 mil­lion into a fund meant for high-net-worth indi­vid­u­als head­ed by the for­mer chair of the Regents’ Invest­ment Com­mit­tee, Paul Wachter.

    Accord­ing to Kauth, the Black­stone spokesper­son, “The UC Invest­ments team saw [Black­stone pres­i­dent] Jon Gray speak­ing on CNBC in Decem­ber and reached out to Black­stone to see if they could be help­ful by deploy­ing cap­i­tal in a way that would cre­ate a win-win. Fol­low­ing the ini­tial call, UC Invest­ments did exten­sive dili­gence on the port­fo­lio and as a result of that process, decid­ed to invest $4 bil­lion in the fund. To sug­gest that the invest­ment was the result of any­thing oth­er than robust dili­gence is a com­plete mis­char­ac­ter­i­za­tion.”

    Kauth added, “Black­stone has nev­er had a cor­po­rate PAC or made cor­po­rate dona­tions to polit­i­cal can­di­dates. The firm has always been bipar­ti­san, and all of our exec­u­tives’ polit­i­cal dona­tions are strict­ly per­son­al.” Schwarz­man pumped $20 mil­lion into the Super­PACs of con­gres­sion­al Repub­li­cans in the 2022 elec­tion and was a major advis­er to Don­ald Trump.

    In response to uproar over UC’s invest­ment in Black­stone, Bach­her played it off as a zero-sum game of cap­i­tal­ism.

    “The job of this team day in and day out is to pick assets that are going to be accre­tive to future gen­er­a­tions and future retirees,” Bach­her said at a regents meet­ing in March. “And to do that… I have to make some cap­i­tal­is­tic deci­sions. And that deci­sion around Black­stone… was pure­ly an invest­ment deci­sion for the ben­e­fit of the UC… and to help the needs of our pen­sion­ers and our endow­ment.”

    But a Lever review of UC’s per­for­mance under Bachher’s lead­er­ship shows that his “cap­i­tal­is­tic“ invest­ment deci­sions have result­ed in the university’s pen­sion and endow­ment funds mas­sive­ly trail­ing a plain vanil­la index fund of stocks and bonds.

    Had the pen­sion fund pur­sued a low­er-risk index fund strat­e­gy for the last decade — the kind advo­cat­ed by War­ren Buf­fett — it would now boast $32 bil­lion more in its cof­fers or 40 per­cent more than its cur­rent val­ue. Like­wise, the university’s endow­ment fund would have an addi­tion­al $6.4 bil­lion in its cof­fers or 36 per­cent increase of its cur­rent val­ue.

    In response to a request for com­ment from the Lever, the uni­ver­si­ty spokesper­son stat­ed that a sub­stan­tial por­tion of the UC’s invest­ment approach was in index funds. They did not answer ques­tions about poor fund per­for­mance under Bachher’s lead­er­ship, and Bach­her declined an inter­view with the Lever.

    ...

    “A Mean­ing­ful Increase in Eco­nom­ic Occu­pan­cy”

    While Black­stone likes to empha­size that it halt­ed all non­pay­ment evic­tions dur­ing the height of the pan­dem­ic, that pol­i­cy is no longer in place. UC’s bailout came just as Black­stone began ramp­ing up evic­tions.

    The Finan­cial Times report­ed at the end of Jan­u­ary that Blackstone’s glob­al real estate head had said that the firm was “see­ing a mean­ing­ful increase in eco­nom­ic occu­pan­cy as we move past what were vol­un­tary evic­tion restric­tions that had been in place for the last cou­ple of years,” acknowl­edg­ing that the removal of evic­tion restric­tions has allowed Black­stone to improve its cash flow.

    The arti­cle also stat­ed that con­sul­tants work­ing with Black­stone had reached out to local elect­ed offi­cials in Cal­i­for­nia to say that Black­stone planned on restart­ing evic­tion pro­ceed­ings that had been dor­mant dur­ing the COVID-19 pan­dem­ic.

    Research from the Pri­vate Equi­ty Stake­hold­er Project in March found that Black­stone launched evic­tion pro­ceed­ings against a ten­ant in Orange Coun­ty, Flori­da, for being one month late on rent.

    Addi­tion­al­ly, Black­stone declared in Decem­ber report­ing from Seek­ing Alpha that what they were charg­ing for rents could go 20 per­cent high­er in the mul­ti­fam­i­ly and indus­tri­al sec­tors if they charged what they con­sid­ered to be “mar­ket rates.”

    An esti­mat­ed 2.5 mil­lion Cal­i­for­ni­ans are cost bur­dened in pay­ing their rent, mean­ing that they spend more than 30 per­cent of their income on hous­ing, accord­ing to a report pro­duced at the end of Feb­ru­ary by the Cal­i­for­nia Leg­isla­tive Analyst’s Office.

    ———-

    “The Uni­ver­si­ty of Cal­i­for­nia Is Bail­ing Out Pri­vate Equi­ty Giant Black­stone” vy Matthew Cun­ning­ham-Cook; Jacobin; 04/24/2023

    “Just months after Blackstone’s real estate invest­ment trust pur­chased America’s largest own­er of pri­vate stu­dent hous­ing, the same trust received a $4.5 bil­lion infu­sion from the Uni­ver­si­ty of California’s Board of Regents, two of whom have close ties to the com­pa­ny. The invest­ment rewards the finan­cial firm only a few years after the com­pa­ny and its exec­u­tives spent $5.6 mil­lion to kill Cal­i­for­nia bal­lot ini­tia­tives that would have expand­ed rent con­trol in the state.”

    The Uni­ver­si­ty of Cal­i­for­nia just pumped $4.5 bil­lion into a Black­stone’s REITs that pur­chased 69 per­cent of Amer­i­can Cam­pus Com­mu­ni­ties (ACC), the largest stu­dent hous­ing com­pa­ny in the US, in August of 2022. Now, if the ACC was ded­i­cat­ed to pro­vid­ing stu­dents with afford­able hous­ing, that might be seen as a some­what noble area of invest­ment for the UC pen­sion plan. But this isn’t that kind of an invest­ment. It’s a prof­it-max­i­miz­ing invest­ment. Which means it’s a stu­dent-hous­ing-min­i­miz­ing invest­ment too. Hence the four­teen thou­sands home­less UC stu­dents:

    ...
    Effec­tive­ly, Uni­ver­si­ty of Cal­i­for­nia (UC) is fun­nel­ing cash into pri­va­tized stu­dent hous­ing and cor­po­rate land­lords — dou­bling down on a con­tro­ver­sial invest­ment strat­e­gy that comes with a mas­sive lay­er of fees and Wall Street prof­its — instead of doing its part to address a grow­ing hous­ing cri­sis, one that affects its stu­dents and employ­ees.

    In 2021, 5 per­cent of UC stu­dents, or more than four­teen thou­sand, expe­ri­enced home­less­ness, while the university’s unions report that many of their most­ly blue-col­lar mem­bers sim­ply can­not make ends meet due to California’s spi­ral­ing cost of rental hous­ing.

    The lat­est episode revolves around the Black­stone Real Estate Income Trust, or BREIT. In August 2022, BREIT pur­chased 69 per­cent of Amer­i­can Cam­pus Com­mu­ni­ties (ACC), the country’s largest stu­dent hous­ing com­pa­ny, in a $12.8 bil­lion deal. ACC’s busi­ness mod­el is built around rent rev­enues; in Jan­u­ary 2022 the company’s CEO boast­ed that it was “expe­ri­enc­ing the most sub­stan­tial fun­da­men­tal tail­winds we’ve seen in many years” thanks in part to soar­ing rents.

    ACC has apart­ments at the Uni­ver­si­ty of Cal­i­for­nia, Berke­ley, and the Uni­ver­si­ty of Cal­i­for­nia, Irvine.

    ...

    Now, in a near­ly unprece­dent­ed coor­di­nat­ed inter­ven­tion, the university’s labor unions — rep­re­sent­ing 110,000 work­ers — have called on UC to divest itself not just from the university’s hold­ings in the Black­stone real estate fund, but all of the university’s $6.5 bil­lion invest­ed in Black­stone hold­ings.

    “Essen­tial­ly UC is invest­ing in a cor­po­ra­tion that fur­ther dri­ves UC’s own work­ers’ hous­ing inse­cu­ri­ty,” said Kathryn Lybarg­er, the Pres­i­dent of Amer­i­can Fed­er­a­tion of State, Coun­ty & Munic­i­pal Employ­ees (AFSCME) Local 3299, which rep­re­sents blue-col­lar and health care work­ers at the Uni­ver­si­ty of Cal­i­for­nia. “The bot­tom line is that people’s hous­ing should not be a basis for mak­ing a prof­it, espe­cial­ly when it’s a pub­lic insti­tu­tion like UC. We’re demand­ing they divest and it’s on the scale of divest­ing from South Africa in the ’80s. We’re talk­ing about hous­ing as a human right, not as an invest­ing oppor­tu­ni­ty.”
    ...

    But the con­tro­ver­sy over this invest­ment isn’t sim­ply the cap­i­tal­ist moral­i­ty of pay­ing for pen­sion by pau­per­ing stu­dents. It’s the fact that this $4.5 bil­lion invest­ment hap­pened at the same time Black­stone was fac­ing mas­sive redemp­tion requests from the oth­er investors in the fund. So many redemp­tion requests that Black­stone began block­ing redemp­tion requests in Decem­ber, the same month Nadeem Meghji, Blackstone’s head of real estate for the Amer­i­c­as, announced on CNBC that the $4.5 bil­lion UC invest­ment “changed the nar­ra­tive”. And through­out this all, Black­stone dis­trib­uted $200 mil­lion to itself in man­age­ment fees. You almost could­n’t come up with a bet­ter exam­ple of the ‘heads we win, tails you lose’ pri­vate equi­ty busi­ness mod­el:

    ...
    Five months after this acqui­si­tion, the UC Regents pumped $4.5 bil­lion into BREIT. Around the same time, Black­stone spent more than $150,000 in the final quar­ter of 2022 on lob­by­ing UC for more invest­ment dol­lars, dou­bling the amount it spent the pre­vi­ous quar­ter.

    In Decem­ber, Nadeem Meghji, Blackstone’s head of real estate for the Amer­i­c­as, told CNBC that UC’s unprece­dent­ed bailout of BREIT “changed the nar­ra­tive” around the fund.

    That same month, Black­stone began block­ing redemp­tions to investors, after it received an influx of redemp­tion requests. But that didn’t stop Black­stone from dis­trib­ut­ing to itself more than $200 mil­lion in man­age­ment fees in the fourth quar­ter of 2022, a Lever review of Secu­ri­ties and Exchange Com­mis­sion (SEC) fil­ings show. Between man­age­ment and per­for­mance fees, Black­stone extract­ed more than $1.5 bil­lion in fees from the $50 bil­lion fund in 2022.

    ...

    Real estate invest­ment trusts are pools of investor-backed cash that pur­chase real estate. While pen­sion funds rou­tine­ly invest in both real estate invest­ment trusts (REITs) and pri­vate equi­ty real estate, it is extreme­ly uncom­mon to have a pen­sion effec­tive­ly do a bailout of a fund fac­ing mas­sive redemp­tion requests.

    Blackstone’s BREIT dif­fers sub­stan­tial­ly from the $1.3 tril­lion REIT mar­ket. Near­ly all REITs are pub­licly trad­ed, which means that investors can cash out their mon­ey at will. This is not the case with BREIT, which allows Black­stone to sus­pend redemp­tions.

    In response to ques­tions from the Lever, Black­stone spokesman Jef­frey Kauth not­ed in an email that “BREIT is not a mutu­al fund and has nev­er gat­ed. It is a semi-liq­uid prod­uct and is work­ing exact­ly as planned.” “Gat­ing” refers to a prac­tice by hedge funds and pri­vate equi­ty where redemp­tions are entire­ly blocked, as opposed to just par­tial­ly blocked, like with BREIT.

    ...

    Such upheaval has led many BREIT investors to get cold feet. In March, BREIT received $4.5 bil­lion in redemp­tion requests, but only ful­filled $666 mil­lion of them.

    But now, UC has come to the res­cue. In Jan­u­ary, the uni­ver­si­ty announced it was invest­ing $4.5 bil­lion in the strug­gling fund — which in effect allows it to start refund­ing oth­er investors’ mon­ey.

    ...

    So why did the UC board of Regents decide to make a $4.5 bil­lion invest­ment in a fund that was sus­pend­ing redemp­tions at the time? Well, per­haps the inces­tu­ous rela­tion­ship between Black­stone and the UC Invest­ment Com­mit­tee has some­thing to do with it:

    ...
    UC’s pen­sion sys­tem is fair­ly unique in that work­ers have no pow­er over how invest­ment deci­sions are made. All deci­sions are made by the regents, which are appoint­ed by the Cal­i­for­nia gov­er­nor for twelve-year terms.

    One of the main deci­sion-mak­ers behind the plan to pump bil­lions of UC dol­lars into Black­stone was Richard Sher­man, chair of the UC Invest­ment Com­mit­tee, who has strong con­nec­tions to the invest­ment firm. On Jan­u­ary 3, Sher­man announced in a Black­stone press release, “This type of large, oppor­tunis­tic invest­ment effec­tive­ly lever­ages the UC’s more than $150 bil­lion port­fo­lio to ben­e­fit the 600,000 stu­dents, fac­ul­ty, staff, and pen­sion­ers from our 10 cam­pus­es and six aca­d­e­m­ic health cen­ters.”

    Sher­man, who heads up music mogul David Geffen’s invest­ment office, col­lab­o­rat­ed with Black­stone on the 2012 buy­out of music pub­lish­er EMI. What’s more, the late Black­stone cofounder Pete Peter­son pur­chased his New York pent­house from Gef­fen in 2007.

    An addi­tion­al mem­ber of the eleven-per­son Invest­ment Com­mit­tee, Mark Robin­son, also has ties to Black­stone. Robin­son is a part­ner at invest­ment bank­ing firm Cen­ter­view Part­ners, which advised Black­stone on a $2.2 bil­lion acqui­si­tion in 2021.

    On behalf of the regents, the invest­ment was launched by Jagdeep Singh Bach­her, UC’s chief invest­ment offi­cer — who has been accused of mak­ing invest­ments in response to pres­sure from indi­vid­ual regents with con­flicts of inter­est in the past. In 2018, he invest­ed an unprece­dent­ed $240 mil­lion into a fund meant for high-net-worth indi­vid­u­als head­ed by the for­mer chair of the Regents’ Invest­ment Com­mit­tee, Paul Wachter.
    ...

    And then there’s the fact that Black­stone did­n’t just spend $5.6 mil­lion oppos­ing a Cal­i­for­nia rent con­trol bal­lot ini­tia­tive. Its man­age­ment prac­tices as land­lord have been so harm­ful towards renters that the UN accused it of “wreak­ing hav­oc” on hous­ing mar­ket. It’s so bad the UN felt the need to make a state­ment:

    ...
    Black­stone is the largest pri­vate land­lord in the coun­try, own­ing three hun­dred thou­sand units across the Unit­ed States. In Cal­i­for­nia alone, Black­stone and its affil­i­ates, includ­ing BREIT, own at least nine thou­sand hous­ing units, includ­ing con­cen­tra­tions in San Diego, Los Ange­les, Sacra­men­to, and the Bay Area, accord­ing to research done by the Pri­vate Equi­ty Stake­hold­er Project.

    Those units tend to be locat­ed in low­er-income cen­sus tracts, where on aver­age res­i­dents make rough­ly 25 per­cent less than the state’s medi­an house­hold income. Over the past few years, BREIT has also made a play into mobile home parks, acquir­ing near­ly six thou­sand units in the San Diego area, where Black­stone has been rou­tine­ly jack­ing up list­ed rents by 40 per­cent or more.

    Esca­lat­ing hous­ing costs are inte­gral to Blackstone’s busi­ness strat­e­gy. “Our major con­cern with Black­stone is that this is a com­pa­ny whose mod­el for mak­ing mon­ey for investors is to buy up rental prop­er­ties and raise the rent,” said Lybarg­er at AFSCME.

    Black­stone spent more than $5.6 mil­lion oppos­ing a 2018 bal­lot ini­tia­tive that would have allowed Cal­i­for­nia cities to imple­ment new rent con­trol mea­sures.

    In 2019, the UN accused Black­stone of “wreak­ing hav­oc” on the hous­ing mar­ket by its aggres­sive pur­suit of evic­tions and high­er rents. Some ten­ants have suc­cess­ful­ly fought back as it seeks to expand its pres­ence in the hous­ing mar­ket, how­ev­er. In Jan­u­ary, ten­ants at the Stuy­Town com­plex in New York City suc­cess­ful­ly fought an effort to raise rents, and in San Diego, Black­stone ten­ants have formed a union.
    ...

    So is Black­stone at least mak­ing the out­sized mar­ket-beat­ing returns that the­o­ret­i­cal­ly jus­ti­fy squeez­ing renters to pay pen­sion­ers? Does this bru­tal ‘zero-sum game of cap­i­tal­ism’ at least help pay for grand­ma’s retire­ment? Nope. Low risk index funds would have per­formed bet­ter over the last decade:

    ...
    In response to uproar over UC’s invest­ment in Black­stone, Bach­her played it off as a zero-sum game of cap­i­tal­ism.

    “The job of this team day in and day out is to pick assets that are going to be accre­tive to future gen­er­a­tions and future retirees,” Bach­her said at a regents meet­ing in March. “And to do that… I have to make some cap­i­tal­is­tic deci­sions. And that deci­sion around Black­stone… was pure­ly an invest­ment deci­sion for the ben­e­fit of the UC… and to help the needs of our pen­sion­ers and our endow­ment.”

    But a Lever review of UC’s per­for­mance under Bachher’s lead­er­ship shows that his “cap­i­tal­is­tic“ invest­ment deci­sions have result­ed in the university’s pen­sion and endow­ment funds mas­sive­ly trail­ing a plain vanil­la index fund of stocks and bonds.

    Had the pen­sion fund pur­sued a low­er-risk index fund strat­e­gy for the last decade — the kind advo­cat­ed by War­ren Buf­fett — it would now boast $32 bil­lion more in its cof­fers or 40 per­cent more than its cur­rent val­ue. Like­wise, the university’s endow­ment fund would have an addi­tion­al $6.4 bil­lion in its cof­fers or 36 per­cent increase of its cur­rent val­ue.

    In response to a request for com­ment from the Lever, the uni­ver­si­ty spokesper­son stat­ed that a sub­stan­tial por­tion of the UC’s invest­ment approach was in index funds. They did not answer ques­tions about poor fund per­for­mance under Bachher’s lead­er­ship, and Bach­her declined an inter­view with the Lever.
    ...

    The renters got squeezed for noth­ing. Well, not noth­ing. Black­stone got a big pay­day. Behold the glo­ries of cap­i­tal­ism!

    But who knows. Maybe this real­ly will end up being a great invest­ment for the UC pen­sion sys­tem in the long run. Time will tell. Time and the abil­i­ty of Black­stone to ‘squeeze blood from a stone’ in extract­ing every last pen­ny it can from all those renters. Includ­ing all those UC stu­dent renters. Every last pen­ny is going to be need­ed to pay those hefty pri­vate equi­ty fees. Fees that will be paid whether or not the UC pen­sion sys­tem is crazy like a fox or just crazy. Which makes this a reminder that there’s no con­flict between ‘zero-sum cap­i­tal­ism’ and ‘head we win, tails you lose’ busi­ness mod­els. Quite the oppo­site.

    Posted by Pterrafractyl | July 5, 2023, 1:10 am
  3. Finan­cial mar­kets are no stranger to diverg­ing opin­ions. But they aren’t exact­ly ‘diver­gent opinion’-friendly either. Espe­cial­ly when actu­al­ly buy­ing and sell­ing and hap­pen­ing in the midst of those diver­gent opin­ions. Some­one is get­ting a deal and some­one else is end­ing up with the short end of the stick.

    So when we see the fol­low­ing sto­ry about pub­lic and pri­vate real estate funds arriv­ing at sharply diver­gent com­mer­cial real estate (CRE) val­u­a­tions, we have to ask: who is get­ting the short end of the CRE stick? Are the pub­licly trad­ed Real Estate Invest­ment Trusts (REITs) over­ly bear­ish in their CRE val­u­a­tions? Or are the pri­vate real estate funds — the same pri­vate-equi­ty-man­aged funds pub­lic pen­sions have been dou­bling down on — over­ly opti­mistic? That’s one of the big ques­tions raised by a report issued a cou­ple of weeks ago that com­pared the implied “cap rates” between pub­licly trad­ed REITs and their pri­vate real estate fund coun­ter­parts and found sig­nif­i­cant dif­fer­ences in how these dif­fer­ent mar­ket play­ers are esti­mat­ing the future val­ues of var­i­ous CRE invest­ments. Specif­i­cal­ly, it turns out pub­lic REITs are con­sis­tent­ly issu­ing high­er cap rate esti­mates than their pri­vate-equi­ty counter-parts, includ­ing 27 per­cent high­er cap rates for office build­ings.

    What are the impli­ca­tions of a pub­lic-pri­vate cap-rate gap? Well, since high­er cap rates are asso­ci­at­ed with high­er-risk (and low­er val­ued) CRE projects, this report is indi­cat­ing that pub­lic REITs are sys­tem­at­i­cal­ly using low­er val­u­a­tion esti­mates for CRE projects than their pri­vate-equi­ty counter-parts. So pri­vate-equi­ty is oper­at­ing off of high­er over­all CRE val­ue esti­mates, and this pub­lic-pri­vate val­u­a­tion gab is hap­pen­ing at the same time pub­lic pen­sion-funds are allow­ing pri­vate equi­ty funds to lead them on a grand CRE dou­ble-down gam­ble. Is this a red flag? Because that seems like maybe it’s a red flag:

    Com­mer­cial Observ­er

    Report: Pri­vate Mar­ket Lags Pub­lic REITs in CRE Cap Rate Met­rics
    Cen­ter­Square Invest­ment Man­age­ment found val­u­a­tion gaps between both mar­kets

    By Bri­an Pas­cus
    June 27, 2023 12:34 pm

    In office real estate — as in life sup­port­ing the New York Mets — real­i­ty often dif­fers from per­cep­tion.

    A new report from a real estate-focused invest­ment firm found sharp diver­gences between real estate invest­ment trust (REIT) implied cap rate met­rics and pri­vate mar­ket for­ward-out­look cap rates, under­scor­ing the dis­con­nect between pri­vate mar­ket and pub­lic assump­tions around com­mer­cial real estate val­ues.

    The report also showed sig­nif­i­cant val­u­a­tion gaps in how the pub­lic and pri­vate mar­kets view the office, hotel and life sci­ences sec­tors.

    Cen­ter­Square Invest­ment Man­age­ment, a Philadel­phia-based real estate invest­ment firm, exam­ined implied cap rate met­rics for rough­ly 200 pub­licly list­ed U.S. REIT com­pa­nies. The firm then used pri­vate real estate data from the NFI-ODCE — an index of the largest pri­vate real estate funds — and esti­mates from ana­lysts and bro­kers. Both data sets use sec­ond-quar­ter 2023 met­rics.

    Cen­ter­Square esti­mat­ed that the val­u­a­tion gap between all pub­lic REITs and pri­vate mar­ket val­ues rose from 28 basis points to 50 basis points between the first quar­ter of 2023 and the sec­ond quar­ter, with the pub­lic REITs cap rate ris­ing to 5.96 per­cent and the for­ward-marked pri­vate mar­kets cap rate hit­ting 5.46 per­cent in the sec­ond quar­ter — a val­u­a­tion gap of 8.3 per­cent.

    “In the ide­al world, where mar­kets are com­plete­ly ratio­nal, the pub­lic mar­ket val­u­a­tions would reflect what we are see­ing in that for­ward-marked pri­vate mar­ket cap rate,” Uma Mori­ar­i­ty, senior invest­ment strate­gist at Cen­ter­Square, told Com­mer­cial Observ­er. But there’s a real­ly mean­ing­ful dis­con­nect between where trans­ac­tions are hap­pen­ing and where val­u­a­tions are hap­pen­ing in the pri­vate mar­ket … com­pared to where we think pri­vate mar­ket val­u­a­tions should be.”

    Cap rates are among the most crit­i­cal met­rics for mea­sur­ing com­mer­cial real estate. They can gen­er­al­ly be defined as the yields on real estate invest­ments and are found by divid­ing net oper­at­ing income by asset val­ue. Cap rates typ­i­cal­ly rise and fall in con­cert with inter­est rates; low­er cap rates sug­gest low­er inter­est rates, cheap­er lever­age, high­er prices for prop­er­ty and thus greater val­ues, while high­er cap rates sug­gest the inverse: high risk, low prices and low val­ues on those assets.

    For most CRE under­writ­ing to make sense, a building’s cap rate should be high­er than the annu­al debt cost, oth­er­wise cash flow will move toward pay­ing off the debt rather than pro­vid­ing the spon­sor with an annu­al prof­it. The rise in inter­est rates over the past 15 months has pro­duced cap rate expan­sion, Mori­ar­i­ty said.

    CenterSquare’s research report found that pub­lic REITs cap rates for offices — the industry’s most dis­tressed sec­tor — have reached 8.75 per­cent, com­pared to a for­ward-marked pri­vate mar­kets cap rate of 6.39 per­cent, reflect­ing a pub­lic-pri­vate val­u­a­tion gap of 27 per­cent.

    Mori­ar­i­ty said that pub­lic mar­ket sen­ti­ment toward office is “over­ly bear­ish.” Mean­while, pri­vate mar­ket val­u­a­tions have lagged behind where they should be because pri­vate firms are using “trail­ing num­bers” from pri­vate apprais­ers who haven’t account­ed for updat­ed bal­ance sheets.

    “The gap between where apprais­ers are mark­ing pri­vate mar­ket val­u­a­tions, there’s an even big­ger gap because those [assets] have not been appro­pri­ate­ly marked to mar­ket for today’s debt costs and don’t reflect the impli­ca­tions of an eco­nom­ic slow­down from a growth per­spec­tive,” she said. “There’s such a big dis­con­nect between where we think real­i­ty should sit ver­sus where the pri­vate mar­ket actu­al­ly is sit­ting, and the REIT mar­kets have sig­nif­i­cant­ly over­cor­rect­ed on the oth­er side.”

    Oth­er asset class­es that are show­ing sim­i­lar­ly large pub­lic-pri­vate val­u­a­tion gaps in cap rates are hotels (18.2 per­cent) and life sci­ences (27 per­cent), accord­ing to Cen­ter­Square data.

    Cap rates on hotels have like­ly expand­ed due to the asset class’ unique cash-flow mod­el, which relies on leas­es that are more or less dai­ly agree­ments between man­age­ment and con­sumers, many of whom are impact­ed by wider macro­eco­nom­ic pat­terns like pull­backs in con­sumer spend­ing and fluc­tu­at­ing unem­ploy­ment lev­els.

    ...

    Life sci­ences cap rates have like­ly expand­ed due to the over­build­ing, mut­ed leas­ing demand and the asset class being lumped into the office sec­tor, which has expe­ri­enced sim­i­lar head­winds. Some investors have erro­neous­ly equat­ed low cell­phone usage at life sci­ences cen­ters to low office uti­liza­tion num­bers, accord­ing to Mori­ar­i­ty.

    ...

    On the flip side, the sin­gle-fam­i­ly rental and data cen­ter sec­tors saw cap rate com­pres­sion in the last quar­ter (a basis point decrease of 29 and 10 basis points, respec­tive­ly, over three months), accord­ing to Cen­ter Square.

    ...

    ———–

    “Report: Pri­vate Mar­ket Lags Pub­lic REITs in CRE Cap Rate Met­rics” By Bri­an Pas­cus; Com­mer­cial Observ­er; 06/27/2023

    ““In the ide­al world, where mar­kets are com­plete­ly ratio­nal, the pub­lic mar­ket val­u­a­tions would reflect what we are see­ing in that for­ward-marked pri­vate mar­ket cap rate,” Uma Mori­ar­i­ty, senior invest­ment strate­gist at Cen­ter­Square, told Com­mer­cial Observ­er. “But there’s a real­ly mean­ing­ful dis­con­nect between where trans­ac­tions are hap­pen­ing and where val­u­a­tions are hap­pen­ing in the pri­vate mar­ket … com­pared to where we think pri­vate mar­ket val­u­a­tions should be.” ”

    A mean­ing­ful dis­con­nect between pub­lic and pri­vate mar­ket CRE val­u­a­tions. How mean­ing­ful? Well, for office build­ings, pub­lic REITS have aver­age cap rates of 8.75 per­cent com­pared to the 6.39 per­cent aver­age cap rate they found pri­vate REITS were esti­mat­ing, a pub­lic-pri­vate val­u­a­tion gap of 27 per­cent. That’s a pret­ty mean­ing­ful dis­con­nect con­sid­er­ing that these same pub­lic and pri­vate enti­ties are make deals in the same space. Pre­sum­ably mak­ing deals with each oth­er:

    ...
    The report also showed sig­nif­i­cant val­u­a­tion gaps in how the pub­lic and pri­vate mar­kets view the office, hotel and life sci­ences sec­tors.

    Cen­ter­Square Invest­ment Man­age­ment, a Philadel­phia-based real estate invest­ment firm, exam­ined implied cap rate met­rics for rough­ly 200 pub­licly list­ed U.S. REIT com­pa­nies. The firm then used pri­vate real estate data from the NFI-ODCE — an index of the largest pri­vate real estate funds — and esti­mates from ana­lysts and bro­kers. Both data sets use sec­ond-quar­ter 2023 met­rics.

    Cen­ter­Square esti­mat­ed that the val­u­a­tion gap between all pub­lic REITs and pri­vate mar­ket val­ues rose from 28 basis points to 50 basis points between the first quar­ter of 2023 and the sec­ond quar­ter, with the pub­lic REITs cap rate ris­ing to 5.96 per­cent and the for­ward-marked pri­vate mar­kets cap rate hit­ting 5.46 per­cent in the sec­ond quar­ter — a val­u­a­tion gap of 8.3 per­cent.

    ...

    CenterSquare’s research report found that pub­lic REITs cap rates for offices — the industry’s most dis­tressed sec­tor — have reached 8.75 per­cent, com­pared to a for­ward-marked pri­vate mar­kets cap rate of 6.39 per­cent, reflect­ing a pub­lic-pri­vate val­u­a­tion gap of 27 per­cent.

    ...

    Oth­er asset class­es that are show­ing sim­i­lar­ly large pub­lic-pri­vate val­u­a­tion gaps in cap rates are hotels (18.2 per­cent) and life sci­ences (27 per­cent), accord­ing to Cen­ter­Square data.
    ...

    And as the arti­cle describes, that high­er cap rate for pub­lic REITs trans­lates to low­er val­u­a­tions. In oth­er words, pri­vate real estate funds are sys­tem­at­i­cal­ly putting high­er assumed val­u­a­tions on CRE invest­ments than their pub­lic REIT coun­ter­parts. And as we’ve seen, it’s the pri­vate real estate fund that so many pub­lic pen­sions are increas­ing­ly invest­ed in. That’s why we have to ask: are the pub­lic REITs over­ly bear­ish or are the pri­vate equi­ty funds not bear­ish enough? That’s the big ques­tion posed by this pub­lic-pri­vate val­u­a­tion gap that is as high as 27 per­cent for office build­ings:

    ...
    Cap rates are among the most crit­i­cal met­rics for mea­sur­ing com­mer­cial real estate. They can gen­er­al­ly be defined as the yields on real estate invest­ments and are found by divid­ing net oper­at­ing income by asset val­ue. Cap rates typ­i­cal­ly rise and fall in con­cert with inter­est rates; low­er cap rates sug­gest low­er inter­est rates, cheap­er lever­age, high­er prices for prop­er­ty and thus greater val­ues, while high­er cap rates sug­gest the inverse: high risk, low prices and low val­ues on those assets.

    ...

    Mori­ar­i­ty said that pub­lic mar­ket sen­ti­ment toward office is “over­ly bear­ish.” Mean­while, pri­vate mar­ket val­u­a­tions have lagged behind where they should be because pri­vate firms are using “trail­ing num­bers” from pri­vate apprais­ers who haven’t account­ed for updat­ed bal­ance sheets.

    “The gap between where apprais­ers are mark­ing pri­vate mar­ket val­u­a­tions, there’s an even big­ger gap because those [assets] have not been appro­pri­ate­ly marked to mar­ket for today’s debt costs and don’t reflect the impli­ca­tions of an eco­nom­ic slow­down from a growth per­spec­tive,” she said. “There’s such a big dis­con­nect between where we think real­i­ty should sit ver­sus where the pri­vate mar­ket actu­al­ly is sit­ting, and the REIT mar­kets have sig­nif­i­cant­ly over­cor­rect­ed on the oth­er side.”
    ...

    Keep in mind that one effect of over­ly-opti­mistic pri­vate val­u­a­tions is the over­ly opti­mistic val­u­a­tion of the many CRE invest­ments already held by by these pri­vate equi­ty funds. Which, in turn, means the many pen­sion funds invest­ed in these pri­vate equi­ty real estate funds are also going to be sys­tem­at­i­cal­ly over-esti­mat­ing the val­ue of their pri­vate equi­ty invest­ments. So when we see signs of over­ly inflat­ed CRE val­u­a­tions by pri­vate equi­ty funds, it’s worth keep­ing in mind that fix­ing those over­ly inflat­ed esti­mates will simul­ta­ne­ous­ly make their clients finan­cial posi­tions that much worse. And that much more des­per­ate. Per­haps des­per­ate enough for a CRE triple down, which can no doubt be arranged if need­ed.

    Posted by Pterrafractyl | July 9, 2023, 8:47 pm
  4. The US econ­o­my is no stranger to moral injury. One could argue that moral injury is one of the core fuels dri­ving the econ­o­my. And while the US health­care sec­tor is very obvi­ous­ly no stranger to moral injury, it’s worth not­ing the grow­ing pan­dem­ic of moral injury that was high­light­ed in a New York Times Mag­a­zine piece last month about the moral injury increas­ing­ly felt by US doc­tors. Job dis­sat­is­fac­tion is for doc­tors and oth­er med­ical pro­fes­sion­als appar­ent­ly at such lev­els that, as of March of last year, 1 in 5 health care work­ers had quit their job and anoth­er 31 per­cent were con­sid­er­ing it.

    And while the stress­es of the COVID are clear­ly a big part of this job dis­sat­is­fac­tion cri­sis across the health care sec­tor, the moral injury we’re talk­ing about did­n’t start with COVID and isn’t abat­ing. On the con­trary, it’s only grow­ing as the pri­vate equi­ty busi­ness mod­el takes over more and more of the health care sec­tor. A prof­its-over-peo­ple busi­ness mod­el that has result­ed in med­ical pro­fes­sion­als increas­ing­ly feel­ing like they expe­ri­enced a moral injury in car­ry­ing out their jobs.

    Specif­i­cal­ly, the kind of moral injury anal­o­gous to what mil­i­tary psy­chi­a­trists describe as an emo­tion­al wound sus­tained when, in the course of ful­fill­ing their duties, sol­diers wit­nessed or com­mit­ted acts — raid­ing a home, killing a non­com­bat­ant — that trans­gressed their core val­ues. Doc­tors are increas­ing­ly feel­ing like they are forced to trans­gress their core val­ues. And increas­ing­ly for the prof­its of their employ­ers. In par­tic­u­lar their pri­vate-equi­ty hos­pi­tal own­ing employ­ers. That’s the rel­a­tive­ly new form of moral injury increas­ing­ly being report­ed by work­ers in the US health care sec­tor. And increas­ing­ly report­ed anony­mous­ly as more and more doc­tors are fired for speak­ing out about sub-stan­dard prac­tices man­dates by their prof­it-hun­gry employ­ers.

    And, sur­prise, it turns out pri­vate equi­ty firms backed by US pub­lic pen­sion funds are the major play­ers in this space. Black­stone, which pur­chased $6.1 bil­lion TeamHealth in 2016, and KKR, which acquired Envi­sion Health­care for $9.9 bil­lion in 2018, are now two of the biggest play­ers in the US health care space. And there­fore two of the biggest boss­es, deter­min­ing doc­tors’ patient vs prof­its pri­or­i­ties. Moral­ly inju­ri­ous patient vs prof­its pri­or­i­ties that health care work­ers have to work under or get fired. Moral injury done in the name of not just prof­its but the prof­its need­ed to fund the pen­sion fund investors behind those Black­stone and KKR acqui­si­tions. And prof­its need­ed pay for the fund man­agers, of course.

    So to get an idea of pri­vate-equi­ty approach to run­ning hos­pi­tals, here’s an arti­cle from Novem­ber of 2019, right before the COVID pan­dem­ic broke out, describ­ing how US pen­sion plans were dodg­ing ques­tions over the grow­ing con­gres­sion­al ire raised by a pan­dem­ic of sur­prise med­ical bills fac­ing patients. Sur­prise med­ical bills that pri­vate-equi­ty-owned hos­pi­tals in par­tic­u­lar were noto­ri­ous for issu­ing, with Envi­sion and TeamHealth lead­ing the way in sur­prise med­ical bills and the focus of the con­gres­sion­al inves­ti­ga­tion:

    Finan­cial Times
    FTfm

    US pen­sion plans dodge queries on health­care hold­ings

    Schemes from Cal­i­for­nia to Ore­gon invest in Black­stone and KKR deals that are being probed by US Con­gress

    Chris Flood
    Novem­ber 2 2019

    US pub­lic pen­sion plans have refused to answer ques­tions about their invest­ments in pri­vate equi­ty funds that are under inves­ti­ga­tion by the US Con­gress for their role in dri­ving up health­care costs.

    FTfm asked pen­sion plans in Cal­i­for­nia, Ida­ho, Michi­gan, New Jer­sey and Ore­gon if they had con­cerns about dam­age to their rep­u­ta­tion as social­ly respon­si­ble investors from their links to Black­stone and KKR, two of the pri­vate equi­ty man­agers under inves­ti­ga­tion.

    These US pen­sions plans, along with Cana­da Pen­sion Plan Invest­ment Board, one of the world’s largest retire­ment funds, declined to answer or failed to respond to ques­tions about their invest­ments in the US health­care indus­try made via funds run by Black­stone and KKR.

    Mil­lions of Amer­i­cans with med­ical insur­ance poli­cies have been hit with “sur­prise” bills for thou­sands of dol­lars after receiv­ing hos­pi­tal treat­ment from a health­care com­pa­ny owned by a pri­vate equi­ty man­ag­er.

    Mount­ing pub­lic anger prompt­ed US law­mak­ers to launch a bipar­ti­san inves­ti­ga­tion in Sep­tem­ber. The probe is focused on Black­stone and KKR as the respec­tive own­ers of TeamHealth and Envi­sion, two of the largest providers of med­ical ser­vices to hos­pi­tals and oth­er health­care providers.

    The Con­gres­sion­al inves­ti­ga­tion is led by Greg Walden from Ore­gon and Frank Pal­lone from New Jer­sey, even though they rep­re­sent two of the states where pub­lic pen­sion plans have invest­ed in health­care via Black­stone and KKR.

    Welsh, Car­son, Ander­son & Stowe, a New York-based pri­vate equi­ty man­ag­er that has invest­ed in 85 health­care com­pa­nies over its 40-year his­to­ry, is also under inves­ti­ga­tion by the US Con­gress.

    Ludovic Phalip­pou, pro­fes­sor of finance at Oxford Saïd Busi­ness School, said savers were told that retire­ment funds must move into more aggres­sive invest­ment vehi­cles because future returns on pub­licly trad­ed stocks and bonds would be too low to deliv­er on pen­sion promis­es.

    “These vehi­cles do every­thing pos­si­ble to gen­er­ate cash, squeez­ing everyone’s pock­ets includ­ing pen­sion­ers. The final nail in the cof­fin is that most of this extra cash cap­tured goes into the hands of the rich­est 1 per cent of the pop­u­la­tion in the form of fees. It is unclear whether pen­sion­ers will get even a crumb,” said Mr Phalip­pou.

    Thir­teen US states includ­ing Cal­i­for­nia, New Jer­sey, New York, Ore­gon and Wash­ing­ton have passed bills pro­vid­ing con­sumers with com­pre­hen­sive pro­tec­tion against sur­prise med­ical bills. A fur­ther 15 states offer par­tial pro­tec­tions, accord­ing to the Com­mon­wealth Fund, a New York-based health­care think-tank.

    This rais­es the ques­tion of whether the invest­ments by pub­lic pen­sion plans are con­sis­tent with the laws passed in their home states.

    ...

    ———-

    “US pen­sion plans dodge queries on health­care hold­ings” by Chris Flood; Finan­cial Times; 11/02/2019

    “Mil­lions of Amer­i­cans with med­ical insur­ance poli­cies have been hit with “sur­prise” bills for thou­sands of dol­lars after receiv­ing hos­pi­tal treat­ment from a health­care com­pa­ny owned by a pri­vate equi­ty man­ag­er.”

    The sur­prise med­ical bill pan­dem­ic of of 2019 was a prod­uct of pri­vate equi­ty-owned hos­pi­tals. In par­tic­u­lar, two of the largest health care providers in the US, TeamHealth and Envi­sion, which hap­pen to be owned by pri­vate equi­ty giants Black­stone and KKR. Sur­prise:

    ...
    Mount­ing pub­lic anger prompt­ed US law­mak­ers to launch a bipar­ti­san inves­ti­ga­tion in Sep­tem­ber. The probe is focused on Black­stone and KKR as the respec­tive own­ers of TeamHealth and Envi­sion, two of the largest providers of med­ical ser­vices to hos­pi­tals and oth­er health­care providers.

    ...

    Welsh, Car­son, Ander­son & Stowe, a New York-based pri­vate equi­ty man­ag­er that has invest­ed in 85 health­care com­pa­nies over its 40-year his­to­ry, is also under inves­ti­ga­tion by the US Con­gress.
    ...

    And as Oxford finance pro­fes­sor Ludovic Phalip­pou grim­ly points out, while pri­vate-equi­ty firms may insist that the cut-throat tac­tics are need­ed to earn the high returns retirees need to fund their pen­sions, it’s not like the prof­it gen­er­at­ed by these sur­prise fees are nec­es­sar­i­ly going to pri­vate equi­ty investors. But we can be very con­fi­dent the pri­vate equi­ty fund man­agers are get­ting a cut. It’s how the ‘heads we win, tails you lose your retire­ment’ busi­ness mod­el oper­ates. Opaque­ly:

    ...
    Ludovic Phalip­pou, pro­fes­sor of finance at Oxford Saïd Busi­ness School, said savers were told that retire­ment funds must move into more aggres­sive invest­ment vehi­cles because future returns on pub­licly trad­ed stocks and bonds would be too low to deliv­er on pen­sion promis­es.

    “These vehi­cles do every­thing pos­si­ble to gen­er­ate cash, squeez­ing everyone’s pock­ets includ­ing pen­sion­ers. The final nail in the cof­fin is that most of this extra cash cap­tured goes into the hands of the rich­est 1 per cent of the pop­u­la­tion in the form of fees. It is unclear whether pen­sion­ers will get even a crumb,” said Mr Phalip­pou.
    ...

    And in case it’s not clear that sur­prise med­ical billing is very much part of the pri­vate-equi­ty pre­ferred health care busi­ness mod­el, here’s an arti­cle from Sep­tem­ber of 2019 about the dis­cov­ery of the iden­ti­ties of the enti­ties behind a mas­sive ad cam­paign oppos­ing any gov­ern­ment action to address the sur­prise billing pan­dem­ic. A dark mon­ey cam­paign that had, at that point, anony­mous­ly spent $28 mil­lion on the “Doc­tor Patient Uni­ty” dark mon­ey group: TeamHealth and Envi­sion were behind the ad spend­ing binge ded­i­cat­ed to pro­tect­ing the abil­i­ty to sur­prise bill. In oth­er words, pri­vate-equi­ty was behind the ad cam­paign ded­i­cat­ed to pro­tect­ing the abil­i­ty to sur­prise bill patients. Sur­prise:

    The New York Times

    Mys­tery Solved: Pri­vate-Equi­ty-Backed Firms Are Behind Ad Blitz on ‘Sur­prise Billing’

    Two doc­tor-staffing com­pa­nies are push­ing back against leg­is­la­tion that could hit their bot­tom lines.

    By Mar­got Sanger-Katz, Julie Creswell and Reed Abel­son
    Pub­lished Sept. 13, 2019
    Updat­ed Sept. 30, 2021

    Ear­ly this sum­mer, Con­gress appeared on its way to erad­i­cat­ing the large med­ical bills that have shocked many patients after emer­gency care. The leg­is­la­tion to end out-of-net­work charges was pop­u­lar and had sup­port from both sides of the aisle. Pres­i­dent Trump promised his sup­port.

    Then, in late July, a mys­te­ri­ous group called Doc­tor Patient Uni­ty showed up. It poured vast sums of mon­ey — now more than $28 mil­lion — into ads oppos­ing the leg­is­la­tion, with­out dis­clos­ing its staff or its fun­ders.

    Try­ing to guess who was behind the ads became some­thing of a par­lor game in some Belt­way cir­cles.

    Now, the mys­tery is solved. The two largest finan­cial back­ers of Doc­tor Patient Uni­ty are TeamHealth and Envi­sion Health­care, pri­vate-equi­ty-backed com­pa­nies that own physi­cian prac­tices and staff emer­gency rooms around the coun­try, accord­ing to Greg Blair, a spokesman for the group.

    “Doc­tor Patient Uni­ty rep­re­sents tens of thou­sands of doc­tors across the coun­try who under­stand the impor­tance of pre­serv­ing access to life­sav­ing med­ical care and sup­port a solu­tion to sur­prise med­ical billing that pro­tects patients,” said Mr. Blair, who issued the state­ment weeks after the group was first con­tact­ed about the cam­paign. “We oppose insur­ance-indus­try-backed pro­pos­als for gov­ern­ment rate set­ting that will lead to doc­tor short­ages, hos­pi­tal clo­sures and loss of access to med­ical care, par­tic­u­lar­ly in rur­al and under­served com­mu­ni­ties.”

    TeamHealth was acquired in 2016 by the pri­vate-equi­ty firm Black­stone Group in a deal val­ued at $6.1 bil­lion. And last fall, in one of the largest takeovers of the year, the pri­vate-equi­ty giant KKR spent $9.9 bil­lion to acquire Envi­sion Health­care.

    The ads gen­er­al­ly omit ref­er­ences to sur­prise bills. Instead, they warn of “gov­ern­ment rate set­ting” that could harm patient care. In one ad, an ambu­lance crew arrives with a patient, only to find the hos­pi­tal dark and emp­ty.

    The pro­posed leg­is­la­tion, which may advance to floor votes this year, is poten­tial­ly bad for busi­ness for TeamHealth and Envi­sion. The two groups have waged many bat­tles against insur­ers over what they see as low physi­cian pay­ments for emer­gency room vis­its. When there is no agree­ment with an insur­er, the physi­cians work “out of net­work,” and bill patients for the amount that insur­ance does not pay.

    A recent aca­d­e­m­ic analy­sis of fil­ings from a large com­mer­cial insur­ance com­pa­ny found that the firms, though Envi­sion more than TeamHealth, have rou­tine­ly oper­at­ed out­side the insur­ance net­works of hos­pi­tals where their doc­tors prac­tice. This often leads to sur­prise bills for patients.

    Like all so-called dark mon­ey polit­i­cal action groups, Doc­tor Patient Uni­ty is not legal­ly required to reveal the names of its sup­port­ers and, in fact, appears to have worked hard to obscure its iden­ti­ty.

    The bread crumbs were scant. Fil­ings by the group to the Fed­er­al Com­mu­ni­ca­tions Com­mis­sion for pur­pos­es of adver­tis­ing list­ed the name of a trea­sur­er who works for a firm that often fills such roles for Repub­li­can polit­i­cal groups. The group’scor­po­rate fil­ing in Vir­ginia lists an agent who is com­mon to more than 150 oth­er polit­i­cal action groups. Nei­ther the trea­sur­er, the named part­ners in her firm, the adver­tis­ing firm or the lawyer asso­ci­at­ed with the cor­po­rate enti­ty respond­ed to calls or emails. An email to the address on the group’s bare-bones web­site went unan­swered for weeks until the group’s state­ment on Fri­day.

    Rep­re­sen­ta­tives of both com­pa­nies con­firmed Fri­day that they had fund­ed the group, offer­ing writ­ten state­ments sim­i­lar to the one from Mr. Blair. Nei­ther company’s com­ments explained why they pur­sued a dark-mon­ey advo­ca­cy strat­e­gy.

    Sev­er­al Wash­ing­ton news out­lets had looked into the ori­gin of the ads, as had some local reporters in sev­er­al states where the ads have run, includ­ing Col­orado, Texas, Alaba­ma and Min­neso­ta

    The $28 mil­lion that Doc­tor Patient Uni­ty has spent on tele­vi­sion and radio adver­tis­ing out­strips the amount spent on adver­tis­ing around Jus­tice Brett Kavanaugh’s Supreme Court con­fir­ma­tion vote, accord­ing to an analy­sis of fil­ings with the F.C.C. by Adver­tis­ing Ana­lyt­ics.

    Doc­tor Patient Uni­ty has also spent hun­dreds of thou­sands of dol­lars on Face­book and Google adver­tis­ing, and has been send­ing direct mail to vot­ers in dozens of con­gres­sion­al dis­tricts. In some cas­es, the group describes the leg­is­la­tion as the “first step toward social­ists’ Medicare-for-all dream.”

    The group has focused its broad­cast ads in areas where sen­a­tors, most­ly Repub­li­can, are run­ning for re-elec­tion next year. In North Car­oli­na, Doc­tor Patient Uni­ty has spent more than $4 mil­lion on ads to influ­ence Sen­a­tor Thom Tillis’s vote on the bill. Anoth­er tar­get of the ads is Mitch McConnell, the Sen­ate major­i­ty leader, who has expressed sup­port for leg­is­la­tion end­ing sur­prise billing.

    One ad, in heavy rota­tion in ear­ly August, fea­tured a woman stand­ing in front of a blank back­ground urg­ing vot­ers to call their sen­a­tors to stop a prac­tice she calls “gov­ern­ment rate set­ting.” She warned the pol­i­cy could affect patients’ access to doc­tors in an emer­gency.

    Sen­a­tor Tina Smith, a Demo­c­rat from Min­neso­ta, said she found the ads con­fus­ing and frus­trat­ing. She is a co-spon­sor of a bill that would resolve sur­prise bills using arbi­tra­tion, the stat­ed pref­er­ence of the group. But she was still the tar­get of more than $2 mil­lion in ads. She said she had heard from con­stituents at the Min­neso­ta State Fair dur­ing the August recess, many ask­ing what the ads were about.

    “If they were gen­uine­ly inter­est­ed in engag­ing in the polit­i­cal process, they at least would have called me,” she said. “I think the ads are designed to intim­i­date us into back­ing down about doing some­thing about sur­prise med­ical bills, and I refuse to be intim­i­dat­ed.”

    The adver­tise­ments are not all neg­a­tive: The group ran one thank­ing Sen­a­tor David Per­due, a Repub­li­can from Geor­gia, and Mag­gie Has­san, a Demo­c­rat from New Hamp­shire. Ms. Has­san, who is the co-spon­sor (with Ms. Smith) of a more doc­tor-friend­ly sur­prise billing approach, was not pleased by the endorse­ment. Aaron Jacobs, her com­mu­ni­ca­tions direc­tor, described the ads as “deeply harm­ful to our efforts to pass bipar­ti­san leg­is­la­tion to end the out­ra­geous prac­tice of sur­prise med­ical billing,” and said the group was act­ing in “bad faith.”

    Leg­is­la­tion that has passed out of the Sen­ate Com­mit­tee on Health, Edu­ca­tion, Labor and Pen­sions and a sim­i­lar bill that has passed in the House Ener­gy and Com­merce Com­mit­tee would ban the prac­tice of send­ing bills to patients when they vis­it a hos­pi­tal cov­ered by their insur­ance. In sit­u­a­tions where the doc­tors fail to nego­ti­ate a price with the patient’s insur­er, the bills before Con­gress would mean that the doc­tors would be paid the medi­an price that oth­er such doc­tors in the area get.

    Most doc­tor and hos­pi­tal groups would rather have both sides present their pre­ferred price to an inde­pen­dent arbi­tra­tor. Experts say the cur­rent leg­is­la­tion would prob­a­bly low­er the pay for doc­tors in the rel­e­vant med­ical spe­cial­ties, even those who do not engage in sur­prise billing.

    ...

    Togeth­er, Envi­sion and TeamHealth employ tens of thou­sands of physi­cians, most in the kinds of hos­pi­tal-based spe­cial­ties — like emer­gency med­i­cine, radi­ol­o­gy and anes­the­si­ol­o­gy — that can gen­er­ate large sur­prise bills.

    After researchers in 2017 point­ed to its high share of out-of-net­work doc­tors, Envi­sion, then a pub­lic com­pa­ny, vowed it would have more of its doc­tors accept insur­ance. A spokes­woman said 90 per­cent of its care is now in-net­work. Dan Col­lard, an exec­u­tive vice pres­i­dent at TeamHealth, said around 85 per­cent of its care is deliv­ered in-net­work.

    This sum­mer, Fitch Rat­ings put the debt of both com­pa­nies at the top of its list of “loans of con­cern,” not­ing that the com­pa­nies have been “pres­sured by uncer­tain­ty over the out­come of polit­i­cal efforts to cut med­ical bills.”

    “Pri­vate equi­ty com­pa­nies have the most to lose from pro­hibit­ing sur­prise billing, so it’s no sur­prise that they’d be fight­ing the hard­est to blow up the process,” Loren Adler, an asso­ciate direc­tor of the U.S.C.-Brookings Scha­ef­fer Ini­tia­tive for Health Pol­i­cy, said in an email. Mr. Adler, who has stud­ied the issue, endors­es the approach Con­gress is con­sid­er­ing.

    Doc­tor Patient Uni­ty is not the only physi­cian group try­ing to influ­ence the sur­prise billing leg­is­la­tion in Con­gress. Physi­cians for Fair Cov­er­age has also begun a dig­i­tal ad cam­paign and has spent an esti­mat­ed $240,000 on con­ven­tion­al lob­by­ing this year, accord­ing to the Cen­ter for Respon­sive Pol­i­tics. That physi­cians group lists its mem­bers on its web­site, and its staff speaks with jour­nal­ists about the group’s per­spec­tive. (Some of its mem­bers also have pri­vate equi­ty ties.)

    The Amer­i­can Col­lege of Emer­gency Physi­cians and the Amer­i­can Soci­ety of Anes­the­si­ol­o­gists have also sought changes to the sur­prise billing leg­is­la­tion, but their mes­sage is milder than the TV ads, and they say they want the prob­lem resolved.

    Lead­ers in each of those groups denied know­ing who fund­ed Doc­tor Patient Uni­ty or com­mu­ni­cat­ing with the group direct­ly.

    “I have no idea who they are — I actu­al­ly tried Google, and when you look at their web­site, there’s noth­ing,” said Michele Kim­ball, the pres­i­dent of Physi­cians for Fair Cov­er­age.

    Lau­ra Woost­er, a spokes­woman for the Amer­i­can Col­lege of Emer­gency Physi­cians, said she found the group’s first ad con­fus­ing. After learn­ing about the group’s fun­ders, Ms. Woost­er dis­tin­guished the dark mon­ey group’s strat­e­gy from that of the col­lege.

    “ACEP does not want our proac­tive efforts over the past two years to help pro­tect patients from sur­prise bills to be con­flat­ed with more neg­a­tive mes­sages that are per­ceived as obstruc­tion­ist,” she said. The organization’s cur­rent pres­i­dent works for TeamHealth; its pres­i­dent elect works for Envi­sion.

    Insur­ance com­pa­nies, which strong­ly favor the pre­vail­ing leg­isla­tive approach, are also heav­i­ly invest­ed in efforts to influ­ence the sur­prise billing leg­is­la­tion, although they have been more trans­par­ent about their involve­ment. An indus­try group, the Coali­tion Against Sur­prise Med­ical Billing, has run dig­i­tal and tele­vi­sion ads worth sev­er­al mil­lion dol­lars. Its lat­est, which ran in Wash­ing­ton dur­ing the Demo­c­ra­t­ic pres­i­den­tial debate on Thurs­day, shows men and one woman nego­ti­at­ing in a dark room as a voice-over describes sur­prise billing as a “pri­vate equi­ty busi­ness mod­el.”

    “Can we get a lit­tle pri­va­cy in here?” one per­son asks the cam­era.

    The Doc­tor Patient Uni­ty cam­paign is sim­i­lar to oth­er dark-mon­ey efforts in which groups try to influ­ence pub­lic pol­i­cy with­out dis­clos­ing donors. Anna Mas­soglia, a researcher at the Cen­ter for Respon­sive Pol­i­tics, which tracks such cam­paigns, said many of the tac­tics used by Doc­tor Patient Uni­ty were famil­iar. “You do see the same groups and the same oper­a­tives pop­ping up time and time again as these new issues emerge,” she said.

    ...

    ———-

    “Mys­tery Solved: Pri­vate-Equi­ty-Backed Firms Are Behind Ad Blitz on ‘Sur­prise Billing’” By Mar­got Sanger-Katz, Julie Creswell and Reed Abel­son; The New York Times; 09/13/2023

    Now, the mys­tery is solved. The two largest finan­cial back­ers of Doc­tor Patient Uni­ty are TeamHealth and Envi­sion Health­care, pri­vate-equi­ty-backed com­pa­nies that own physi­cian prac­tices and staff emer­gency rooms around the coun­try, accord­ing to Greg Blair, a spokesman for the group.”

    What a shock­ing rev­e­la­tion: the two largest pri­vate equi­ty-owned health care providers that hap­pen to be noto­ri­ous for sur­prise billing are behind dark mon­ey ad cam­paign opposed to end­ing the prac­tice.

    And while the iden­ti­ty of the groups behind Doc­tor Patient Uni­ty was tech­ni­cal­ly anony­mous for months after the dark mon­ey group sud­den­ly popped out of nowhere in July of 2019, note how FEC fil­ings indi­cate that the group trea­sur­er worked for a firm that often played sim­i­lar rolls for Repub­li­can affil­i­at­ed groups. Which makes it rather like­ly that the secret iden­ti­ties of the groups behind Doc­tor Patient Uni­ty was real­ly more of a DC open secret:

    ...
    Then, in late July, a mys­te­ri­ous group called Doc­tor Patient Uni­ty showed up. It poured vast sums of mon­ey — now more than $28 mil­lion — into ads oppos­ing the leg­is­la­tion, with­out dis­clos­ing its staff or its fun­ders.

    Try­ing to guess who was behind the ads became some­thing of a par­lor game in some Belt­way cir­cles.

    ...

    Like all so-called dark mon­ey polit­i­cal action groups, Doc­tor Patient Uni­ty is not legal­ly required to reveal the names of its sup­port­ers and, in fact, appears to have worked hard to obscure its iden­ti­ty.

    The bread crumbs were scant. Fil­ings by the group to the Fed­er­al Com­mu­ni­ca­tions Com­mis­sion for pur­pos­es of adver­tis­ing list­ed the name of a trea­sur­er who works for a firm that often fills such roles for Repub­li­can polit­i­cal groups. The group’scor­po­rate fil­ing in Vir­ginia lists an agent who is com­mon to more than 150 oth­er polit­i­cal action groups. Nei­ther the trea­sur­er, the named part­ners in her firm, the adver­tis­ing firm or the lawyer asso­ci­at­ed with the cor­po­rate enti­ty respond­ed to calls or emails. An email to the address on the group’s bare-bones web­site went unan­swered for weeks until the group’s state­ment on Fri­day.
    ...

    Also note how both TeamHealth and Envi­sion Health­care were tak­en over recent­ly, with Black­stone acquir­ing TeamHealth for $6.1 bil­lion in 2016 and KKR pay­ing $9.9 bil­lion for Envi­sion Health­care in 2018. As such, we also should­n’t be sur­prised to learn that Fitch Rat­ings had the debt loads of both com­pa­nies at the top of its list of “loans of con­cern”. Yes, the talk of the pro­posed anti-sur­prise billing gov­ern­ment action had to be a fact in Fitch’s loan con­cerns, but also keep in mind the under­ly­ing pri­vate-equi­ty busi­ness mod­el: buy a com­pa­ny and load it up with debt to pay out to investors and fund man­agers. It’s a reminder that when pri­vate-equi­ty-own firms engage in sur­prise billing in the pur­suit of prof­it max­i­miza­tion, that extra pro­ceeds aren’t going direct­ly to pay investors and fund man­agers. The extra pro­ceeds are used to pay off the debt that was already issued to pay off the investors and fund man­agers. In keep with the ‘heads we win, tails you lose’ busi­ness mod­el:

    ...
    TeamHealth was acquired in 2016 by the pri­vate-equi­ty firm Black­stone Group in a deal val­ued at $6.1 bil­lion. And last fall, in one of the largest takeovers of the year, the pri­vate-equi­ty giant KKR spent $9.9 bil­lion to acquire Envi­sion Health­care.

    ...

    Togeth­er, Envi­sion and TeamHealth employ tens of thou­sands of physi­cians, most in the kinds of hos­pi­tal-based spe­cial­ties — like emer­gency med­i­cine, radi­ol­o­gy and anes­the­si­ol­o­gy — that can gen­er­ate large sur­prise bills.

    ...

    This sum­mer, Fitch Rat­ings put the debt of both com­pa­nies at the top of its list of “loans of con­cern,” not­ing that the com­pa­nies have been “pres­sured by uncer­tain­ty over the out­come of polit­i­cal efforts to cut med­ical bills.”

    “Pri­vate equi­ty com­pa­nies have the most to lose from pro­hibit­ing sur­prise billing, so it’s no sur­prise that they’d be fight­ing the hard­est to blow up the process,” Loren Adler, an asso­ciate direc­tor of the U.S.C.-Brookings Scha­ef­fer Ini­tia­tive for Health Pol­i­cy, said in an email. Mr. Adler, who has stud­ied the issue, endors­es the approach Con­gress is con­sid­er­ing.
    ...

    And in case it’s unclear just how depen­dent the pri­vate-equi­ty-owned firms are on sur­prise billing, not the then-recent study that found that TeamHealth and Envi­sion both rou­tine­ly oper­at­ed “out of net­work”, which more or less guar­an­tees that patients will often face a sur­prise bill:

    ...
    The pro­posed leg­is­la­tion, which may advance to floor votes this year, is poten­tial­ly bad for busi­ness for TeamHealth and Envi­sion. The two groups have waged many bat­tles against insur­ers over what they see as low physi­cian pay­ments for emer­gency room vis­its. When there is no agree­ment with an insur­er, the physi­cians work “out of net­work,” and bill patients for the amount that insur­ance does not pay.

    A recent aca­d­e­m­ic analy­sis of fil­ings from a large com­mer­cial insur­ance com­pa­ny found that the firms, though Envi­sion more than TeamHealth, have rou­tine­ly oper­at­ed out­side the insur­ance net­works of hos­pi­tals where their doc­tors prac­tice. This often leads to sur­prise bills for patients.
    ...

    And when we see how most doc­tor and hos­pi­tal groups would rather have both sides (insur­ers and providers) present their pre­ferred price to an inde­pen­dent arbi­tra­tor, it’s impor­tant to keep in mind that these ‘doc­tor and hos­pi­tal groups’ are also going to be heav­i­ly influ­enced by the pri­vate-equi­ty indus­try. So when we see the Amer­i­can Col­lege of Emer­gency Physi­cians (ACEP) dis­tin­guish its own oppo­si­tion to the pro­posed leg­is­la­tion to end sur­prise billing from the dark mon­ey cam­paign of TeamHealth and Envi­sion, and then see that the group’s cur­rent pres­i­dent worked for TeamHealth and its then-pres­i­dent elect worked for Envi­sion, it’s a reminder that pri­vate-equi­ty’s views on these mat­ters are increas­ing­ly going to be the indus­try’s views as pri­vate-equi­ty’s stake in the sec­tor grows:

    ...
    Most doc­tor and hos­pi­tal groups would rather have both sides present their pre­ferred price to an inde­pen­dent arbi­tra­tor. Experts say the cur­rent leg­is­la­tion would prob­a­bly low­er the pay for doc­tors in the rel­e­vant med­ical spe­cial­ties, even those who do not engage in sur­prise billing.

    ...

    The Amer­i­can Col­lege of Emer­gency Physi­cians and the Amer­i­can Soci­ety of Anes­the­si­ol­o­gists have also sought changes to the sur­prise billing leg­is­la­tion, but their mes­sage is milder than the TV ads, and they say they want the prob­lem resolved.

    Lead­ers in each of those groups denied know­ing who fund­ed Doc­tor Patient Uni­ty or com­mu­ni­cat­ing with the group direct­ly.

    “I have no idea who they are — I actu­al­ly tried Google, and when you look at their web­site, there’s noth­ing,” said Michele Kim­ball, the pres­i­dent of Physi­cians for Fair Cov­er­age.

    Lau­ra Woost­er, a spokes­woman for the Amer­i­can Col­lege of Emer­gency Physi­cians, said she found the group’s first ad con­fus­ing. After learn­ing about the group’s fun­ders, Ms. Woost­er dis­tin­guished the dark mon­ey group’s strat­e­gy from that of the col­lege.

    “ACEP does not want our proac­tive efforts over the past two years to help pro­tect patients from sur­prise bills to be con­flat­ed with more neg­a­tive mes­sages that are per­ceived as obstruc­tion­ist,” she said. The organization’s cur­rent pres­i­dent works for TeamHealth; its pres­i­dent elect works for Envi­sion.
    ...

    And that role pri­vate-equi­ty is increas­ing­ly play­ing in speak­ing for doc­tors and oth­er peo­ple work­ing in the health care sec­tor brings us to the fol­low­ing NY Times report from last month about anoth­er form of injury being inflict­ed upon this sec­tor in the pur­suit of prof­its. The moral injury a grow­ing num­ber of health care pro­fes­sion­als are expres­sion as they are deal­ing with new hos­pi­tal own­ers who are increas­ing­ly ask­ing them to pri­or­i­tize prof­its over patient health. With pri­vate-equi­ty hos­pi­tal own­ers being the pri­ma­ry per­pe­tra­tors of this moral injury. It’s anoth­er sur­prise:

    The New York Times

    The Moral Cri­sis of America’s Doc­tors

    The cor­po­ra­ti­za­tion of health care has changed the prac­tice of med­i­cine, caus­ing many physi­cians to feel alien­at­ed from their work.

    By Eyal Press
    Pub­lished June 15, 2023
    Updat­ed June 16, 2023

    Some years ago, a psy­chi­a­trist named Wendy Dean read an arti­cle about a physi­cian who died by sui­cide. Such deaths were dis­tress­ing­ly com­mon, she dis­cov­ered. The sui­cide rate among doc­tors appeared to be even high­er than the rate among active mil­i­tary mem­bers, a notion that star­tled Dean, who was then work­ing as an admin­is­tra­tor at a U.S. Army med­ical research cen­ter in Mary­land. Dean start­ed ask­ing the physi­cians she knew how they felt about their jobs, and many of them con­fid­ed that they were strug­gling. Some com­plained that they didn’t have enough time to talk to their patients because they were too busy fill­ing out elec­tron­ic med­ical records. Oth­ers bemoaned hav­ing to fight with insur­ers about whether a per­son with a seri­ous ill­ness would be preap­proved for med­ica­tion. The doc­tors Dean sur­veyed were deeply com­mit­ted to the med­ical pro­fes­sion. But many of them were frus­trat­ed and unhap­py, she sensed, not because they were burned out from work­ing too hard but because the health care sys­tem made it so dif­fi­cult to care for their patients.

    In July 2018, Dean pub­lished an essay with Simon G. Tal­bot, a plas­tic and recon­struc­tive sur­geon, that argued that many physi­cians were suf­fer­ing from a con­di­tion known as moral injury. Mil­i­tary psy­chi­a­trists use the term to describe an emo­tion­al wound sus­tained when, in the course of ful­fill­ing their duties, sol­diers wit­nessed or com­mit­ted acts — raid­ing a home, killing a non­com­bat­ant — that trans­gressed their core val­ues. Doc­tors on the front lines of America’s prof­it-dri­ven health care sys­tem were also sus­cep­ti­ble to such wounds, Dean and Tal­bot sub­mit­ted, as the demands of admin­is­tra­tors, hos­pi­tal exec­u­tives and insur­ers forced them to stray from the eth­i­cal prin­ci­ples that were sup­posed to gov­ern their pro­fes­sion. The pull of these forces left many doc­tors anguished and dis­traught, caught between the Hip­po­crat­ic oath and “the real­i­ties of mak­ing a prof­it from peo­ple at their sick­est and most vul­ner­a­ble.”

    The arti­cle was pub­lished on Stat, a med­ical-news web­site with a mod­est read­er­ship. To Dean’s sur­prise, it quick­ly went viral. Doc­tors and nurs­es start­ed reach­ing out to Dean to tell her how much the arti­cle spoke to them. “It went every­where,” Dean told me when I vis­it­ed her last March in Carlisle, Pa., where she now lives. By the time we met, the dis­tress among med­ical pro­fes­sion­als had reached alarm­ing lev­els: One sur­vey found that near­ly one in five health care work­ers had quit their job since the start of the pan­dem­ic and that an addi­tion­al 31 per­cent had con­sid­ered leav­ing. Pro­fes­sion­al orga­ni­za­tions like Nation­al Nurs­es Unit­ed, the largest group of reg­is­tered nurs­es in the coun­try, had begun refer­ring to “moral injury” and “moral dis­tress” in pam­phlets and news releas­es. Mona Masood, a psy­chi­a­trist who estab­lished a sup­port line for doc­tors short­ly after the pan­dem­ic began, recalls being struck by how clin­i­cians react­ed when she men­tioned the term. “I remem­ber all these physi­cians were like, Wow, that is what I was look­ing for,” she says. “This is it.”

    Dean’s essay caught my eye, too, because I spent much of the pre­vi­ous few years report­ing on moral injury, inter­view­ing work­ers in menial occu­pa­tions whose jobs were eth­i­cal­ly com­pro­mis­ing. I spoke to prison guards who patrolled the wards of vio­lent pen­i­ten­tiaries, undoc­u­ment­ed immi­grants who toiled on the “kill floors” of indus­tri­al slaugh­ter­hous­es and roustabouts who worked on off­shore rigs in the fos­sil-fuel indus­try. Many of these work­ers were hes­i­tant to talk or be iden­ti­fied, know­ing how eas­i­ly they could be replaced by some­one else. Com­pared with them, physi­cians were priv­i­leged, earn­ing six-fig­ure salaries and doing pres­ti­gious jobs that spared them from the drudgery endured by so many oth­er mem­bers of the labor force, includ­ing nurs­es and cus­to­di­al work­ers in the health care indus­try. But in recent years, despite the esteem asso­ci­at­ed with their pro­fes­sion, many physi­cians have found them­selves sub­ject­ed to prac­tices more com­mon­ly asso­ci­at­ed with man­u­al labor­ers in auto plants and Ama­zon ware­hous­es, like hav­ing their pro­duc­tiv­i­ty tracked on an hourly basis and being pres­sured by man­age­ment to work faster.

    Because doc­tors are high­ly skilled pro­fes­sion­als who are not so easy to replace, I assumed that they would not be as reluc­tant to dis­cuss the dis­tress­ing con­di­tions at their jobs as the low-wage work­ers I’d inter­viewed. But the physi­cians I con­tact­ed were afraid to talk open­ly. “I have since recon­sid­ered this and do not feel this is some­thing I can do right now,” one doc­tor wrote to me. Anoth­er texted, “Will need to be anon.” Some sources I tried to reach had signed nondis­clo­sure agree­ments that pro­hib­it­ed them from speak­ing to the media with­out per­mis­sion. Oth­ers wor­ried they could be dis­ci­plined or fired if they angered their employ­ers, a con­cern that seems par­tic­u­lar­ly well found­ed in the grow­ing swath of the health care sys­tem that has been tak­en over by pri­vate-equi­ty firms. In March 2020, an emer­gency-room doc­tor named Ming Lin was removed from the rota­tion at his hos­pi­tal after air­ing con­cerns about its Covid-19 safe­ty pro­to­cols. Lin worked at St. Joseph Med­ical Cen­ter, in Belling­ham, Wash. — but his actu­al employ­er was TeamHealth, a com­pa­ny owned by the Black­stone Group.

    E.R. doc­tors have found them­selves at the fore­front of these trends as more and more hos­pi­tals have out­sourced the staffing in emer­gency depart­ments in order to cut costs. A 2013 study by Robert McNa­ma­ra, the chair­man of the emer­gency-med­i­cine depart­ment at Tem­ple Uni­ver­si­ty in Philadel­phia, found that 62 per­cent of emer­gency physi­cians in the Unit­ed States could be fired with­out due process. Near­ly 20 per­cent of the 389 E.R. doc­tors sur­veyed said they had been threat­ened for rais­ing qual­i­ty-of-care con­cerns, and pres­sured to make deci­sions based on finan­cial con­sid­er­a­tions that could be detri­men­tal to the peo­ple in their care, like being pushed to dis­charge Medicare and Med­ic­aid patients or being encour­aged to order more test­ing than nec­es­sary. In anoth­er study, more than 70 per­cent of emer­gency physi­cians agreed that the cor­po­ra­ti­za­tion of their field has had a neg­a­tive or strong­ly neg­a­tive impact on the qual­i­ty of care and on their own job sat­is­fac­tion.

    There are, of course, plen­ty of doc­tors who like what they do and feel no need to speak out. Clin­i­cians in high-pay­ing spe­cial­ties like ortho­pe­dics and plas­tic surgery “are doing just fine, thank you,” one physi­cian I know joked. But more and more doc­tors are com­ing to believe that the pan­dem­ic mere­ly wors­ened the strain on a health care sys­tem that was already fail­ing because it pri­or­i­tizes prof­its over patient care. They are notic­ing how the empha­sis on the bot­tom line rou­tine­ly puts them in moral binds, and young doc­tors in par­tic­u­lar are con­tem­plat­ing how to resist. Some are mulling whether the sac­ri­fices — and com­pro­mis­es — are even worth it. “I think a lot of doc­tors are feel­ing like some­thing is trou­bling them, some­thing deep in their core that they com­mit­ted them­selves to,” Dean says. She notes that the term moral injury was orig­i­nal­ly coined by the psy­chi­a­trist Jonathan Shay to describe the wound that forms when a person’s sense of what is right is betrayed by lead­ers in high-stakes sit­u­a­tions. “Not only are clin­i­cians feel­ing betrayed by their lead­er­ship,” she says, “but when they allow these bar­ri­ers to get in the way, they are part of the betray­al. They’re the instru­ments of betray­al.”

    Not long ago, I spoke to an emer­gency physi­cian, whom I’ll call A., about her expe­ri­ence. (She did not want her name used, explain­ing that she knew sev­er­al doc­tors who had been fired for voic­ing con­cerns about unsat­is­fac­to­ry work­ing con­di­tions or patient-safe­ty issues.) A soft-spo­ken woman with a gen­tle man­ner, A. referred to the emer­gency room as a “sacred space,” a place she loved work­ing because of the pro­found impact she could have on patients’ lives, even those who weren’t going to pull through. Dur­ing her train­ing, a patient with a ter­mi­nal con­di­tion somber­ly informed her that his daugh­ter couldn’t make it to the hos­pi­tal to be with him in his final hours. A. promised the patient that he wouldn’t die alone and then held his hand until he passed away. Inter­ac­tions like that one would not be pos­si­ble today, she told me, because of the new empha­sis on speed, effi­cien­cy and rel­a­tive val­ue units (R.V.U.), a met­ric used to mea­sure physi­cian reim­burse­ment that some feel rewards doc­tors for doing tests and pro­ce­dures and dis­cour­ages them from spend­ing too much time on less remu­ner­a­tive func­tions, like lis­ten­ing and talk­ing to patients. “It’s all about R.V.U.s and going faster,” she said of the ethos that per­me­at­ed the prac­tice where she’d been work­ing. “Your door-to-doc­tor time, your room-to-doc­tor time, your time from ini­tial eval­u­a­tion to dis­charge.”

    Appeas­ing her peers and supe­ri­ors with­out breach­ing her val­ues became increas­ing­ly dif­fi­cult for A. On one occa­sion, a frail, elder­ly woman came into the E.R. because she was unable to walk on her own. A nurse case man­ag­er deter­mined that the woman should be dis­charged because she didn’t have a spe­cif­ic diag­no­sis to explain her con­di­tion and Medicare wouldn’t cov­er her stay, even though she lived alone and couldn’t get out of a chair to eat or go to the bath­room. A. cried with the woman and tried to com­fort her. Then she plead­ed with the hos­pi­tal­ist on duty to admit her. A.’s appeal was suc­cess­ful, but after­ward, she won­dered, What are we being asked to do? When we spoke, A. had tak­en a leave from work and was unsure if she would ever go back, because of how deplet­ed she felt. “It’s all about the almighty dol­lar and all about pro­duc­tiv­i­ty,” she said, “which is obvi­ous­ly not why most of us sign up to do the job.”

    That’s not always clear to patients, many of whom nat­u­ral­ly assume that their doc­tors are the ones who decide how much time to spend with them and what to charge them for care. “Doc­tors are increas­ing­ly the scape­goats of sys­temic prob­lems with­in the health care sys­tem,” Masood says, “because the patient is not see­ing the insur­ance com­pa­ny that denied them the pro­ce­dure, they’re not see­ing the elec­tron­ic med­ical records that are tak­ing up all of our time. They’re just see­ing the doc­tor who can only spend 10 min­utes with them in the room, or the doc­tor who says, ‘I can’t get you this med­ica­tion, because it costs $500 a month.’ And what ends up hap­pen­ing is we inter­nal­ize that feel­ing.”

    I spoke to a rheuma­tol­o­gist named Diana Gir­ni­ta, who found this cycle deeply dis­tress­ing. Orig­i­nal­ly from Roma­nia, Gir­ni­ta came to the Unit­ed States to do a post­doc at Har­vard and was daz­zled by the qual­i­ty of the train­ing she received. Then she began prac­tic­ing and hear­ing patients com­plain about the exor­bi­tant bills they were sent for rou­tine labs and med­ica­tions. One patient came to her in tears after being billed $7,000 for an IV infu­sion, for which the patient held her respon­si­ble. “They have to blame some­one, and we are the inter­face of the sys­tem,” she said. “They think we are the greedy ones.” Fed up, Gir­ni­ta even­tu­al­ly left the prac­tice.

    Some doc­tors acknowl­edged that the pres­sures of the sys­tem had occa­sion­al­ly led them to betray the oaths they took to their patients. Among the physi­cians I spoke to about this, a 45-year-old crit­i­cal-care spe­cial­ist named Kei­th Corl stood out. Raised in a work­ing-class town in upstate New York, Corl was an ide­al­ist who quit a lucra­tive job in finance in his ear­ly 20s because he want­ed to do some­thing that would ben­e­fit peo­ple. Dur­ing med­ical school, he felt inspired watch­ing doc­tors in the E.R. and I.C.U. stretch them­selves to the break­ing point to treat who­ev­er hap­pened to pass through the doors on a giv­en night. “I want to do that,” he decid­ed instant­ly. And he did, spend­ing near­ly two decades work­ing long shifts as an emer­gency physi­cian in an array of hos­pi­tals, in cities from Prov­i­dence to Las Vegas to Sacra­men­to, where he now lives. Like many E.R. physi­cians, Corl viewed his job as a call­ing. But over time, his ide­al­ism gave way to dis­il­lu­sion­ment, as he strug­gled to pro­vide patients with the type of care he’d been trained to deliv­er. “Every day, you deal with some­body who couldn’t get some test or some treat­ment they need­ed because they didn’t have insur­ance,” he said. “Every day, you’re remind­ed how sav­age the sys­tem is.”

    Corl was par­tic­u­lar­ly haunt­ed by some­thing that hap­pened in his late 30s, when he was work­ing in the emer­gency room of a hos­pi­tal in Paw­tuck­et, R.I. It was a frigid win­ter night, so cold you could see your breath. The hos­pi­tal was busy. When Corl arrived for his shift, all of the facility’s E.R. beds were filled. Corl was espe­cial­ly con­cerned about an elder­ly woman with pneu­mo­nia who he feared might be slip­ping into sep­sis, an extreme, poten­tial­ly fatal immune response to infec­tion. As Corl was mon­i­tor­ing her, a call came in from an ambu­lance, inform­ing the E.R. staff that anoth­er patient would soon be arriv­ing, a woman with severe men­tal health prob­lems. The patient was famil­iar to Corl — she was a fre­quent pres­ence in the emer­gency room. He knew that she had bipo­lar dis­or­der. He also knew that she could be a hand­ful. On a pre­vi­ous vis­it to the hos­pi­tal, she detached the bed rails on her stretch­er and fell to the floor, injur­ing a nurse.

    In a hos­pi­tal that was ade­quate­ly staffed, man­ag­ing such a sit­u­a­tion while keep­ing tabs on all the oth­er patients might not have been a prob­lem. But Corl was the sole doc­tor in the emer­gency room that night; he under­stood this to be in part a result of cost-cut­ting mea­sures (the hos­pi­tal has since closed). After the ambu­lance arrived, he and a nurse began talk­ing with the incom­ing patient to gauge whether she was sui­ci­dal. They deter­mined she was not. But she was com­bat­ive, argu­ing with the nurse in an increas­ing­ly aggres­sive tone. As the argu­ment grew more heat­ed, Corl began to fear that if he and the nurse focused too much of their atten­tion on her, oth­er patients would suf­fer need­less­ly and that the woman at risk of sep­tic shock might die.

    Corl decid­ed he could not let that hap­pen. Exchang­ing glances, he and the nurse unplugged the patient from the mon­i­tor, wheeled her stretch­er down the hall, and pushed it out of the hos­pi­tal. The blast of cold air when the door swung open caused Corl to shud­der. A nurse called the police to come pick the patient up. (It turned out that she had an out­stand­ing war­rant and was arrest­ed.) Lat­er, after he returned to the E.R., Corl could not stop think­ing about what he’d done, imag­in­ing how the med­ical-school ver­sion of him­self would have judged his con­duct. “He would have been hor­ri­fied.”

    Con­cerns about the cor­po­rate takeover of America’s med­ical sys­tem are hard­ly new. More than half a cen­tu­ry ago, the writ­ers Bar­bara and John Ehren­re­ich assailed the pow­er of phar­ma­ceu­ti­cal com­pa­nies and oth­er large cor­po­ra­tions in what they termed the “med­ical-indus­tri­al com­plex,” which, as the phrase sug­gests, was any­thing but a char­i­ta­ble enter­prise. In the decades that fol­lowed, the offi­cial bod­ies of the med­ical pro­fes­sion seemed untrou­bled by this. To the con­trary, the Amer­i­can Med­ical Asso­ci­a­tion con­sis­tent­ly opposed efforts to broad­en access to health care after World War II, under­tak­ing aggres­sive lob­by­ing cam­paigns against pro­pos­als for a sin­gle-pay­er pub­lic sys­tem, which it saw as a threat to physi­cians’ auton­o­my.

    But as the soci­ol­o­gist Paul Starr not­ed in “The Social Trans­for­ma­tion of Amer­i­can Med­i­cine,” physi­cians earned the public’s trust and derived much of their author­i­ty because they were per­ceived to be “above the mar­ket and pure com­mer­cial­ism.” And in fields like emer­gency med­i­cine, an ethos of ser­vice and self-sac­ri­fice pre­vailed. At aca­d­e­m­ic train­ing pro­grams, Robert McNa­ma­ra told me, stu­dents were taught that the needs of patients should always come first, and that doc­tors should nev­er allow finan­cial inter­ests to inter­fere with how they did their jobs. Many of these pro­grams were based in inner-city hos­pi­tals whose emer­gency rooms were often filled with indi­gent patients. Car­ing for peo­ple regard­less of their finan­cial means was both a legal oblig­a­tion — cod­i­fied in the Emer­gency Med­ical Treat­ment and Labor Act, a fed­er­al law passed in 1986 — and, in pro­grams like the one McNa­ma­ra ran at Tem­ple, a point of pride. But he acknowl­edged that over time, these val­ues increas­ing­ly clashed with the real­i­ty that res­i­dents encoun­tered once they entered the work force. “We’re train­ing peo­ple to put the patient first,” he says, “and they’re run­ning into a buzz saw.”

    Through­out the med­ical sys­tem, the insis­tence on rev­enue and prof­its has accel­er­at­ed. This can be seen in the shut­ter­ing of pedi­atric units at many hos­pi­tals and region­al med­ical cen­ters, in part because treat­ing chil­dren is less lucra­tive than treat­ing adults, who order more elec­tive surg­eries and are less like­ly to be on Med­ic­aid. It can be seen in emer­gency rooms that were under­staffed because of bud­getary con­straints long before the pan­dem­ic began. And it can be seen in the push by multi­bil­lion-dol­lar com­pa­nies like CVS and Wal­mart to buy or invest in pri­ma­ry-care prac­tices, a rapid­ly con­sol­i­dat­ing field attrac­tive to investors because many of the patients who seek such care are enrolled in the Medicare Advan­tage pro­gram, which pays out $400 bil­lion to insur­ers annu­al­ly. Over the past decade, mean­while, pri­vate-equi­ty invest­ment in the health care indus­try has surged, a wave of acqui­si­tions that has swept up physi­cian prac­tices, hos­pi­tals, out­pa­tient clin­ics, home health agen­cies. McNa­ma­ra esti­mates that the staffing in 30 per­cent of all emer­gency rooms is now over­seen by pri­vate-equi­ty-owned firms. Once in charge, these com­pa­nies “start squeez­ing the doc­tors to see more patients per hour, cut­ting staff,” he says.

    As the focus on rev­enue and the adop­tion of busi­ness met­rics has grown more per­va­sive, young peo­ple embark­ing on careers in med­i­cine are begin­ning to won­der if they are the ben­e­fi­cia­ries of cap­i­tal­ism or just anoth­er exploit­ed class. In 2021, the aver­age med­ical stu­dent grad­u­at­ed with more than $200,000 in debt. In the past, one priv­i­lege con­ferred on physi­cians who made these sac­ri­fices was the free­dom to con­trol their work­ing con­di­tions in inde­pen­dent prac­tices. But today, 70 per­cent of doc­tors work as salaried employ­ees of large hos­pi­tal sys­tems or cor­po­rate enti­ties, tak­ing orders from admin­is­tra­tors and exec­u­tives who do not always share their val­ues or pri­or­i­ties.

    Philip Sossen­heimer, a 30-year-old med­ical res­i­dent at Stan­ford, told me that these changes had begun to pre­cip­i­tate a shift in self-per­cep­tion among doc­tors. In the past, physi­cians “didn’t real­ly see them­selves as labor­ers,” he notes. “They viewed them­selves as busi­ness own­ers or sci­en­tists, as a class above work­ing peo­ple.” Sossen­heimer feels that it is dif­fer­ent for his gen­er­a­tion, because younger doc­tors real­ize that they will have far less con­trol over their work­ing con­di­tions than their elders did — that the pres­tige of their pro­fes­sion won’t spare them from the degra­da­tion expe­ri­enced by work­ers in oth­er sec­tors of the econ­o­my. “For our gen­er­a­tion, mil­len­ni­als and below, our feel­ing is that there is a big pow­er imbal­ance between employ­ers and work­ers,” he says.

    Last May, the med­ical res­i­dents at Stan­ford vot­ed to form a union by a tal­ly of 835 to 214, a cam­paign Sossen­heimer enthu­si­as­ti­cal­ly sup­port­ed. “We’ve seen a boom in union­iza­tion in many oth­er indus­tries,” he told me, “and we real­ize it can lev­el the pow­er dynam­ics, not just for oth­er work­ers but with­in med­i­cine.” One thing that drove this home to him was see­ing the nurs­es at Stan­ford, who belong to a union, go on strike to advo­cate for safer staffing and bet­ter work­ing con­di­tions. Their out­spo­ken­ness stood in strik­ing con­trast to the silence of res­i­dents, who risked being sin­gled out and dis­ci­plined if they dared to say any­thing that might attract the notice of the admin­is­tra­tion or their supe­ri­ors. “That’s a big rea­son that union­iza­tion is so impor­tant,” he says.

    The Stan­ford exam­ple has inspired med­ical res­i­dents else­where. Not long ago, I spoke with a group of res­i­dents in New York City who were think­ing about union­iz­ing, on the con­di­tion that I not dis­close their iden­ti­ties or insti­tu­tion­al affil­i­a­tions. Although the med­ical pro­fes­sion has been slow to diver­si­fy, the res­i­dents came from strik­ing­ly var­ied back­grounds. Few grew up in wealthy fam­i­lies, judg­ing by the num­ber of hands that went up when I asked if they’d tak­en on debt to fin­ish med­ical school. “Any­one here not take on debt?” said a woman sit­ting on the car­pet in the liv­ing room where we gath­ered, prompt­ing sev­er­al peo­ple to laugh.

    Hav­ing a union, one res­i­dent explained, would enable the group to demand bet­ter work­ing con­di­tions with­out hav­ing to wor­ry about get­ting in trou­ble with their supe­ri­ors or los­ing fel­low­ship oppor­tu­ni­ties. They would be able to advo­cate for patients rather than apol­o­giz­ing to them for prac­tices they con­sid­ered shame­ful, anoth­er added. When I asked what they meant by shame­ful, I learned that a num­ber of the res­i­dents had trained at a hos­pi­tal that served an extreme­ly poor com­mu­ni­ty with a lim­it­ed num­ber of I.C.U. beds — beds that dur­ing the pan­dem­ic were some­times giv­en to wealthy “V.I.P.” patients from oth­er states while sick­er patients from the sur­round­ing neigh­bor­hood lan­guished on the gen­er­al floor.

    Form­ing unions is just one way that patient advo­cates are find­ing to push back against such inequities. Crit­ics of pri­vate equity’s grow­ing role in the health care sys­tem are also close­ly watch­ing a Cal­i­for­nia law­suit that could have a major impact. In Decem­ber 2021, the Amer­i­can Acad­e­my of Emer­gency Med­i­cine Physi­cian Group (A.A.E.M.P.G.), part of an asso­ci­a­tion of doc­tors, res­i­dents and med­ical stu­dents, filed a law­suit accus­ing Envi­sion Health­care, a pri­vate-equi­ty-backed provider, of vio­lat­ing a Cal­i­for­nia statute that pro­hibits non­med­ical cor­po­ra­tions from con­trol­ling the deliv­ery of health ser­vices. Pri­vate-equi­ty firms often cir­cum­vent these restric­tions by trans­fer­ring own­er­ship, on paper, to doc­tors, even as the com­pa­nies retain con­trol over every­thing, includ­ing the terms of the physi­cians’ employ­ment and the rates that patients are charged for care, accord­ing to the law­suit. A.A.E.M.P.G.’s aim in bring­ing the suit is not to pun­ish one com­pa­ny but rather to pro­hib­it such arrange­ments alto­geth­er. “We’re not ask­ing them to pay mon­ey, and we will not accept being paid to drop the case,” David Mill­stein, a lawyer for the A.A.E.M.P.G. has said of the suit. “We are sim­ply ask­ing the court to ban this prac­tice mod­el.” In May 2022, a judge reject­ed Envision’s motion to dis­miss the case, rais­ing hopes that such a ban may take effect.

    ...

    ———–

    “The Moral Cri­sis of America’s Doc­tors” By Eyal Press; The New York Times; 06/15/2023

    Because doc­tors are high­ly skilled pro­fes­sion­als who are not so easy to replace, I assumed that they would not be as reluc­tant to dis­cuss the dis­tress­ing con­di­tions at their jobs as the low-wage work­ers I’d inter­viewed. But the physi­cians I con­tact­ed were afraid to talk open­ly. “I have since recon­sid­ered this and do not feel this is some­thing I can do right now,” one doc­tor wrote to me. Anoth­er texted, “Will need to be anon.” Some sources I tried to reach had signed nondis­clo­sure agree­ments that pro­hib­it­ed them from speak­ing to the media with­out per­mis­sion. Oth­ers wor­ried they could be dis­ci­plined or fired if they angered their employ­ers, a con­cern that seems par­tic­u­lar­ly well found­ed in the grow­ing swath of the health care sys­tem that has been tak­en over by pri­vate-equi­ty firms. In March 2020, an emer­gency-room doc­tor named Ming Lin was removed from the rota­tion at his hos­pi­tal after air­ing con­cerns about its Covid-19 safe­ty pro­to­cols. Lin worked at St. Joseph Med­ical Cen­ter, in Belling­ham, Wash. — but his actu­al employ­er was TeamHealth, a com­pa­ny owned by the Black­stone Group.”

    It’s a pret­ty damn­ing state­ment on the pow­er rela­tion­ship between the ‘investor class’ in the US and every­one else: even doc­tors are so pow­er­less in mod­ern Amer­i­ca that they have suc­cess­ful­ly been ter­ri­fied into silence under the threat of get­ting fired. Silence over sys­temic patient abus­es all done in the name of ‘pro­duc­tiv­i­ty’ and high­er investor returns. And it’s the doc­tors work­ing under pri­vate-equi­ty firm — which over­see the staffing in rough­ly 30 per­cent of Emer­gency Rooms already — who are the most ter­ri­fied to share their sense of moral injury with the rest of soci­ety. It’s hard to come up with a more apt metaophor for pri­vate equi­ty’s cap­ture of Amer­i­can soci­ety than this tru­ly sick state of affairs:

    ...
    E.R. doc­tors have found them­selves at the fore­front of these trends as more and more hos­pi­tals have out­sourced the staffing in emer­gency depart­ments in order to cut costs. A 2013 study by Robert McNa­ma­ra, the chair­man of the emer­gency-med­i­cine depart­ment at Tem­ple Uni­ver­si­ty in Philadel­phia, found that 62 per­cent of emer­gency physi­cians in the Unit­ed States could be fired with­out due process. Near­ly 20 per­cent of the 389 E.R. doc­tors sur­veyed said they had been threat­ened for rais­ing qual­i­ty-of-care con­cerns, and pres­sured to make deci­sions based on finan­cial con­sid­er­a­tions that could be detri­men­tal to the peo­ple in their care, like being pushed to dis­charge Medicare and Med­ic­aid patients or being encour­aged to order more test­ing than nec­es­sary. In anoth­er study, more than 70 per­cent of emer­gency physi­cians agreed that the cor­po­ra­ti­za­tion of their field has had a neg­a­tive or strong­ly neg­a­tive impact on the qual­i­ty of care and on their own job sat­is­fac­tion.

    There are, of course, plen­ty of doc­tors who like what they do and feel no need to speak out. Clin­i­cians in high-pay­ing spe­cial­ties like ortho­pe­dics and plas­tic surgery “are doing just fine, thank you,” one physi­cian I know joked. But more and more doc­tors are com­ing to believe that the pan­dem­ic mere­ly wors­ened the strain on a health care sys­tem that was already fail­ing because it pri­or­i­tizes prof­its over patient care. They are notic­ing how the empha­sis on the bot­tom line rou­tine­ly puts them in moral binds, and young doc­tors in par­tic­u­lar are con­tem­plat­ing how to resist. Some are mulling whether the sac­ri­fices — and com­pro­mis­es — are even worth it. “I think a lot of doc­tors are feel­ing like some­thing is trou­bling them, some­thing deep in their core that they com­mit­ted them­selves to,” Dean says. She notes that the term moral injury was orig­i­nal­ly coined by the psy­chi­a­trist Jonathan Shay to describe the wound that forms when a person’s sense of what is right is betrayed by lead­ers in high-stakes sit­u­a­tions. “Not only are clin­i­cians feel­ing betrayed by their lead­er­ship,” she says, “but when they allow these bar­ri­ers to get in the way, they are part of the betray­al. They’re the instru­ments of betray­al.”

    Not long ago, I spoke to an emer­gency physi­cian, whom I’ll call A., about her expe­ri­ence. (She did not want her name used, explain­ing that she knew sev­er­al doc­tors who had been fired for voic­ing con­cerns about unsat­is­fac­to­ry work­ing con­di­tions or patient-safe­ty issues.) A soft-spo­ken woman with a gen­tle man­ner, A. referred to the emer­gency room as a “sacred space,” a place she loved work­ing because of the pro­found impact she could have on patients’ lives, even those who weren’t going to pull through. Dur­ing her train­ing, a patient with a ter­mi­nal con­di­tion somber­ly informed her that his daugh­ter couldn’t make it to the hos­pi­tal to be with him in his final hours. A. promised the patient that he wouldn’t die alone and then held his hand until he passed away. Inter­ac­tions like that one would not be pos­si­ble today, she told me, because of the new empha­sis on speed, effi­cien­cy and rel­a­tive val­ue units (R.V.U.), a met­ric used to mea­sure physi­cian reim­burse­ment that some feel rewards doc­tors for doing tests and pro­ce­dures and dis­cour­ages them from spend­ing too much time on less remu­ner­a­tive func­tions, like lis­ten­ing and talk­ing to patients. “It’s all about R.V.U.s and going faster,” she said of the ethos that per­me­at­ed the prac­tice where she’d been work­ing. “Your door-to-doc­tor time, your room-to-doc­tor time, your time from ini­tial eval­u­a­tion to dis­charge.”

    ...

    Con­cerns about the cor­po­rate takeover of America’s med­ical sys­tem are hard­ly new. More than half a cen­tu­ry ago, the writ­ers Bar­bara and John Ehren­re­ich assailed the pow­er of phar­ma­ceu­ti­cal com­pa­nies and oth­er large cor­po­ra­tions in what they termed the “med­ical-indus­tri­al com­plex,” which, as the phrase sug­gests, was any­thing but a char­i­ta­ble enter­prise. In the decades that fol­lowed, the offi­cial bod­ies of the med­ical pro­fes­sion seemed untrou­bled by this. To the con­trary, the Amer­i­can Med­ical Asso­ci­a­tion con­sis­tent­ly opposed efforts to broad­en access to health care after World War II, under­tak­ing aggres­sive lob­by­ing cam­paigns against pro­pos­als for a sin­gle-pay­er pub­lic sys­tem, which it saw as a threat to physi­cians’ auton­o­my.

    But as the soci­ol­o­gist Paul Starr not­ed in “The Social Trans­for­ma­tion of Amer­i­can Med­i­cine,” physi­cians earned the public’s trust and derived much of their author­i­ty because they were per­ceived to be “above the mar­ket and pure com­mer­cial­ism.” And in fields like emer­gency med­i­cine, an ethos of ser­vice and self-sac­ri­fice pre­vailed. At aca­d­e­m­ic train­ing pro­grams, Robert McNa­ma­ra told me, stu­dents were taught that the needs of patients should always come first, and that doc­tors should nev­er allow finan­cial inter­ests to inter­fere with how they did their jobs. Many of these pro­grams were based in inner-city hos­pi­tals whose emer­gency rooms were often filled with indi­gent patients. Car­ing for peo­ple regard­less of their finan­cial means was both a legal oblig­a­tion — cod­i­fied in the Emer­gency Med­ical Treat­ment and Labor Act, a fed­er­al law passed in 1986 — and, in pro­grams like the one McNa­ma­ra ran at Tem­ple, a point of pride. But he acknowl­edged that over time, these val­ues increas­ing­ly clashed with the real­i­ty that res­i­dents encoun­tered once they entered the work force. “We’re train­ing peo­ple to put the patient first,” he says, “and they’re run­ning into a buzz saw.”

    Through­out the med­ical sys­tem, the insis­tence on rev­enue and prof­its has accel­er­at­ed. This can be seen in the shut­ter­ing of pedi­atric units at many hos­pi­tals and region­al med­ical cen­ters, in part because treat­ing chil­dren is less lucra­tive than treat­ing adults, who order more elec­tive surg­eries and are less like­ly to be on Med­ic­aid. It can be seen in emer­gency rooms that were under­staffed because of bud­getary con­straints long before the pan­dem­ic began. And it can be seen in the push by multi­bil­lion-dol­lar com­pa­nies like CVS and Wal­mart to buy or invest in pri­ma­ry-care prac­tices, a rapid­ly con­sol­i­dat­ing field attrac­tive to investors because many of the patients who seek such care are enrolled in the Medicare Advan­tage pro­gram, which pays out $400 bil­lion to insur­ers annu­al­ly. Over the past decade, mean­while, pri­vate-equi­ty invest­ment in the health care indus­try has surged, a wave of acqui­si­tions that has swept up physi­cian prac­tices, hos­pi­tals, out­pa­tient clin­ics, home health agen­cies. McNa­ma­ra esti­mates that the staffing in 30 per­cent of all emer­gency rooms is now over­seen by pri­vate-equi­ty-owned firms. Once in charge, these com­pa­nies “start squeez­ing the doc­tors to see more patients per hour, cut­ting staff,” he says.

    As the focus on rev­enue and the adop­tion of busi­ness met­rics has grown more per­va­sive, young peo­ple embark­ing on careers in med­i­cine are begin­ning to won­der if they are the ben­e­fi­cia­ries of cap­i­tal­ism or just anoth­er exploit­ed class. In 2021, the aver­age med­ical stu­dent grad­u­at­ed with more than $200,000 in debt. In the past, one priv­i­lege con­ferred on physi­cians who made these sac­ri­fices was the free­dom to con­trol their work­ing con­di­tions in inde­pen­dent prac­tices. But today, 70 per­cent of doc­tors work as salaried employ­ees of large hos­pi­tal sys­tems or cor­po­rate enti­ties, tak­ing orders from admin­is­tra­tors and exec­u­tives who do not always share their val­ues or pri­or­i­ties.
    ...

    What does the future hold for this field? Well, less trained doc­tors, if the stun­ning lev­els of per­son­al dis­tress reflect­ed in the sur­vey results of med­ical pro­fes­sion­als are any indi­ca­tion of what to expect: one recent sur­vey found that 1 in 5 health care work­ers had already quit their job since the start of the pan­dem­ic, with anoth­er 31 per­cent con­sid­er­ing that option. So a major­i­ty of med­ical pro­fes­sion­als have either quit or are con­sid­er­ing quit­ting in just the last few years. And while the unique stress­es of the pan­dem­ic obvi­ous­ly played a role in those sur­vey results, the ‘moral injury’ report­ed by these pro­fes­sion­als was­n’t cre­at­ed by the pan­dem­ic. It was cre­at­ed by the stress­es of pro­vid­ed care to peo­ple while adher­ing to the prof­it-max­i­miz­ing man­dates of their employ­ers. The pan­dem­ic has reced­ed. Pri­vate equi­ty’s ruth­less­ness in the pur­suit of those prof­its will nev­er end:

    ...
    In July 2018, Dean pub­lished an essay with Simon G. Tal­bot, a plas­tic and recon­struc­tive sur­geon, that argued that many physi­cians were suf­fer­ing from a con­di­tion known as moral injury. Mil­i­tary psy­chi­a­trists use the term to describe an emo­tion­al wound sus­tained when, in the course of ful­fill­ing their duties, sol­diers wit­nessed or com­mit­ted acts — raid­ing a home, killing a non­com­bat­ant — that trans­gressed their core val­ues. Doc­tors on the front lines of America’s prof­it-dri­ven health care sys­tem were also sus­cep­ti­ble to such wounds, Dean and Tal­bot sub­mit­ted, as the demands of admin­is­tra­tors, hos­pi­tal exec­u­tives and insur­ers forced them to stray from the eth­i­cal prin­ci­ples that were sup­posed to gov­ern their pro­fes­sion. The pull of these forces left many doc­tors anguished and dis­traught, caught between the Hip­po­crat­ic oath and “the real­i­ties of mak­ing a prof­it from peo­ple at their sick­est and most vul­ner­a­ble.”

    The arti­cle was pub­lished on Stat, a med­ical-news web­site with a mod­est read­er­ship. To Dean’s sur­prise, it quick­ly went viral. Doc­tors and nurs­es start­ed reach­ing out to Dean to tell her how much the arti­cle spoke to them. “It went every­where,” Dean told me when I vis­it­ed her last March in Carlisle, Pa., where she now lives. By the time we met, the dis­tress among med­ical pro­fes­sion­als had reached alarm­ing lev­els: One sur­vey found that near­ly one in five health care work­ers had quit their job since the start of the pan­dem­ic and that an addi­tion­al 31 per­cent had con­sid­ered leav­ing. Pro­fes­sion­al orga­ni­za­tions like Nation­al Nurs­es Unit­ed, the largest group of reg­is­tered nurs­es in the coun­try, had begun refer­ring to “moral injury” and “moral dis­tress” in pam­phlets and news releas­es. Mona Masood, a psy­chi­a­trist who estab­lished a sup­port line for doc­tors short­ly after the pan­dem­ic began, recalls being struck by how clin­i­cians react­ed when she men­tioned the term. “I remem­ber all these physi­cians were like, Wow, that is what I was look­ing for,” she says. “This is it.”

    Dean’s essay caught my eye, too, because I spent much of the pre­vi­ous few years report­ing on moral injury, inter­view­ing work­ers in menial occu­pa­tions whose jobs were eth­i­cal­ly com­pro­mis­ing. I spoke to prison guards who patrolled the wards of vio­lent pen­i­ten­tiaries, undoc­u­ment­ed immi­grants who toiled on the “kill floors” of indus­tri­al slaugh­ter­hous­es and roustabouts who worked on off­shore rigs in the fos­sil-fuel indus­try. Many of these work­ers were hes­i­tant to talk or be iden­ti­fied, know­ing how eas­i­ly they could be replaced by some­one else. Com­pared with them, physi­cians were priv­i­leged, earn­ing six-fig­ure salaries and doing pres­ti­gious jobs that spared them from the drudgery endured by so many oth­er mem­bers of the labor force, includ­ing nurs­es and cus­to­di­al work­ers in the health care indus­try. But in recent years, despite the esteem asso­ci­at­ed with their pro­fes­sion, many physi­cians have found them­selves sub­ject­ed to prac­tices more com­mon­ly asso­ci­at­ed with man­u­al labor­ers in auto plants and Ama­zon ware­hous­es, like hav­ing their pro­duc­tiv­i­ty tracked on an hourly basis and being pres­sured by man­age­ment to work faster.
    ...

    So are there any viable cures avail­able for the grow­ing num­bers of doc­tors who feel like they are vio­lat­ing their own con­sciences in the pur­suit of investor prof­its? Well, there are solu­tions. Unfor­tu­nate­ly, they’re the kinds of solu­tions that are increas­ing­ly unthink­able for the cap­tured Amer­i­can econ­o­my: union­iza­tion. This is a good time to recall how threat­en­ing employ­ees if they vote to union­ize remains ram­pant among large US employ­ers:

    ...
    Philip Sossen­heimer, a 30-year-old med­ical res­i­dent at Stan­ford, told me that these changes had begun to pre­cip­i­tate a shift in self-per­cep­tion among doc­tors. In the past, physi­cians “didn’t real­ly see them­selves as labor­ers,” he notes. “They viewed them­selves as busi­ness own­ers or sci­en­tists, as a class above work­ing peo­ple.” Sossen­heimer feels that it is dif­fer­ent for his gen­er­a­tion, because younger doc­tors real­ize that they will have far less con­trol over their work­ing con­di­tions than their elders did — that the pres­tige of their pro­fes­sion won’t spare them from the degra­da­tion expe­ri­enced by work­ers in oth­er sec­tors of the econ­o­my. “For our gen­er­a­tion, mil­len­ni­als and below, our feel­ing is that there is a big pow­er imbal­ance between employ­ers and work­ers,” he says.

    Last May, the med­ical res­i­dents at Stan­ford vot­ed to form a union by a tal­ly of 835 to 214, a cam­paign Sossen­heimer enthu­si­as­ti­cal­ly sup­port­ed. “We’ve seen a boom in union­iza­tion in many oth­er indus­tries,” he told me, “and we real­ize it can lev­el the pow­er dynam­ics, not just for oth­er work­ers but with­in med­i­cine.” One thing that drove this home to him was see­ing the nurs­es at Stan­ford, who belong to a union, go on strike to advo­cate for safer staffing and bet­ter work­ing con­di­tions. Their out­spo­ken­ness stood in strik­ing con­trast to the silence of res­i­dents, who risked being sin­gled out and dis­ci­plined if they dared to say any­thing that might attract the notice of the admin­is­tra­tion or their supe­ri­ors. “That’s a big rea­son that union­iza­tion is so impor­tant,” he says.

    The Stan­ford exam­ple has inspired med­ical res­i­dents else­where. Not long ago, I spoke with a group of res­i­dents in New York City who were think­ing about union­iz­ing, on the con­di­tion that I not dis­close their iden­ti­ties or insti­tu­tion­al affil­i­a­tions. Although the med­ical pro­fes­sion has been slow to diver­si­fy, the res­i­dents came from strik­ing­ly var­ied back­grounds. Few grew up in wealthy fam­i­lies, judg­ing by the num­ber of hands that went up when I asked if they’d tak­en on debt to fin­ish med­ical school. “Any­one here not take on debt?” said a woman sit­ting on the car­pet in the liv­ing room where we gath­ered, prompt­ing sev­er­al peo­ple to laugh.

    Hav­ing a union, one res­i­dent explained, would enable the group to demand bet­ter work­ing con­di­tions with­out hav­ing to wor­ry about get­ting in trou­ble with their supe­ri­ors or los­ing fel­low­ship oppor­tu­ni­ties. They would be able to advo­cate for patients rather than apol­o­giz­ing to them for prac­tices they con­sid­ered shame­ful, anoth­er added. When I asked what they meant by shame­ful, I learned that a num­ber of the res­i­dents had trained at a hos­pi­tal that served an extreme­ly poor com­mu­ni­ty with a lim­it­ed num­ber of I.C.U. beds — beds that dur­ing the pan­dem­ic were some­times giv­en to wealthy “V.I.P.” patients from oth­er states while sick­er patients from the sur­round­ing neigh­bor­hood lan­guished on the gen­er­al floor.
    ...

    Final­ly, we get to this inter­est­ing legal approach to weak­en­ing pri­vate equi­ty’s grow­ing grip on med­i­cine in the US: state laws that pro­hibits non­med­ical cor­po­ra­tions from con­trol­ling the deliv­ery of health ser­vices. Cal­i­for­nia has such a law. And as we can see, it’s a law the pri­vate equi­ty indus­try has already wormed its way around. But that does­n’t mean the law can’t be changed and fixed. And then actu­al­ly enforced. Legal­ly reign­ing in these kinds of busi­ness mod­els real­ly is an option, even if it does­n’t feel like one in a soci­ety cap­tured by spe­cial inter­ests. But it is an option:

    ...
    Form­ing unions is just one way that patient advo­cates are find­ing to push back against such inequities. Crit­ics of pri­vate equity’s grow­ing role in the health care sys­tem are also close­ly watch­ing a Cal­i­for­nia law­suit that could have a major impact. In Decem­ber 2021, the Amer­i­can Acad­e­my of Emer­gency Med­i­cine Physi­cian Group (A.A.E.M.P.G.), part of an asso­ci­a­tion of doc­tors, res­i­dents and med­ical stu­dents, filed a law­suit accus­ing Envi­sion Health­care, a pri­vate-equi­ty-backed provider, of vio­lat­ing a Cal­i­for­nia statute that pro­hibits non­med­ical cor­po­ra­tions from con­trol­ling the deliv­ery of health ser­vices. Pri­vate-equi­ty firms often cir­cum­vent these restric­tions by trans­fer­ring own­er­ship, on paper, to doc­tors, even as the com­pa­nies retain con­trol over every­thing, includ­ing the terms of the physi­cians’ employ­ment and the rates that patients are charged for care, accord­ing to the law­suit. A.A.E.M.P.G.’s aim in bring­ing the suit is not to pun­ish one com­pa­ny but rather to pro­hib­it such arrange­ments alto­geth­er. “We’re not ask­ing them to pay mon­ey, and we will not accept being paid to drop the case,” David Mill­stein, a lawyer for the A.A.E.M.P.G. has said of the suit. “We are sim­ply ask­ing the court to ban this prac­tice mod­el.” In May 2022, a judge reject­ed Envision’s motion to dis­miss the case, rais­ing hopes that such a ban may take effect.
    ...

    Can the pri­vate-equi­ty indus­try actu­al­ly get reigned in? Well, in Decem­ber of 2020 Con­gress did pass the “No Sur­pris­es Act” that was signed into law and has been in force in Jan­u­ary of 2022, remov­ing patients from pay­ment dis­putes between hos­pi­tals and insur­ance com­pa­nies. Yes, to some extent, the pri­vate-equi­ty indus­try real­ly has been reigned in on this par­tic­u­lar front.

    Of course, pri­vate-equi­ty will still be allowed to own a seem­ing­ly ever-grow­ing stake in the health care sec­tor and inflict gen­er­al moral injury on its staff. And as the Biden admin­is­tra­tion’s recent updates to the No Sur­pris­es Act imple­men­ta­tion — updates designed to thwart var­i­ous cheats and workarounds the indus­try has already come up with to get around the new reg­u­la­tions — we can’t real­ly expect the sur­prise billing to tru­ly end. Nor can we expect the dark mon­ey lob­by­ing cam­paigns to end. Or the grow­ing num­bers of doc­tors quit­ting or think­ing of quit­ting. We can’t real­ly real­is­ti­cal­ly that to end. But at least the pri­vate-equi­ty indus­try’s sur­prise billing spree has sort of put of hold for now. Seem­ing­ly to the detri­ment of the pen­sion­ers indi­rect­ly rely­ing on those sur­prise bills to pay for their retire­ments. Yes, Amer­i­ca’s bro­ken retire­ment sys­tem and bro­ken health sys­tem are increas­ing­ly the same bro­ken sys­tem. Owned and oper­at­ed by pri­vate-equi­ty, for whom the sys­tem is very much not bro­ken and work­ing just fine.

    Posted by Pterrafractyl | July 16, 2023, 11:09 pm
  5. Is anoth­er Fed rate hike on the way? Or might we be look­ing at the begin­ning of the end of the cur­rent cycle? We’ll pre­sum­ably have bet­ter answers to those ques­tions fol­low­ing this week’s sched­uled Fed­er­al Reserve meet­ing, when the Fed is expect­ed to hike rates once again, but pos­si­ble for the last time for a while.

    And while many fac­tors — in par­tic­u­lar ris­ing wages — play a role in the Fed’s rate hike deci­sion-mak­ing, you have to won­der how big a fac­tor the fol­low­ing pri­vate-equi­ty finan­cial time-bomb is in the Fed’s deci­sion-mak­ing process. Because as the fol­low­ing arti­cles describe, the pri­vate-equi­ty indus­try’s rate-sen­si­tiv­i­ty goes well beyond just the impact ris­ing rates have on the sec­tor’s bloat­ed com­mer­cial real estate (CRE) hold­ings.

    For exam­ple, there’s all the cor­po­rate debt that’s become increas­ing­ly pop­u­lar with pri­vate-equi­ty investors in recent year. Cor­po­rate debt that obvi­ous­ly has­n’t per­formed well in response to all the rate hikes.

    But then there’s the rate-sen­si­tiv­i­ty asso­ci­at­ed with the pri­vate-equi­ty assets that have been fuel­ing the cor­po­rate bond buy­ing binge: insur­ance com­pa­ny asset pools. Yes, insur­ance com­pa­nies are one of the oth­er sec­tors pri­vate-equi­ty has been increas­ing­ly invest­ing in over the last decade. Why insur­ance com­pa­nies? Well, thanks to reg­u­la­tions, they tend to have large pools of assets that well exceed their long-term lia­bil­i­ties. Assets that can be tak­en and invest­ed by a pri­vate-equi­ty par­ent com­pa­ny. Insur­ance com­pa­nies also have a lot of ‘float’, which is the mon­ey com­ing into the firm before it has to lat­er be paid out. Gam­bling with the ‘float’ is the appar­ent­ly one of the new hot things in pri­vate-equi­ty.

    And here’s where it gets extra dement­ed. There’s one par­tic­u­lar type of insur­ance prod­uct pri­vate-equi­ty firms are espe­cial­ly inter­est­ed in: Annu­ities, which are effec­tive­ly like per­son­al pen­sion insur­ance prod­ucts. It turns out annu­ities have a fea­ture that pri­vate equi­ty finds par­tic­u­lar­ly attrac­tive in the form of ‘sur­ren­der charges’, which impose a poten­tial­ly stiff fee for the ear­ly with­draw­al of funds. So what we are ulti­mate­ly see­ing is pri­vate-equi­ty firms using pen­sion fund mon­ey to pur­chase insur­ance com­pa­nies so they can gam­ble with the assets back­ing the annu­ity poli­cies. And the gam­ble of choice has been cor­po­rate bonds, a par­tic­u­lar­ly dis­tressed asset class in a ris­ing rate envi­ron­ment. It’s not great.

    Ok, first, here’s an Insti­tu­tion­al Investor arti­cle from Feb­ru­ary 2022 describ­ing pri­vate-equi­ty’s big dive into insur­ance. A big dive that comes with enor­mous oppor­tu­ni­ties. In par­tic­u­lar, a big oppor­tu­ni­ty to take those giant insur­ance asset pools and invest them in high­er-risk/high­er-yield­ing oppor­tu­ni­ties. But also risks. Like the obvi­ous risk that the under­ly­ing assets placed in high­er-risk invest­ments will be mis­man­aged and lose mon­ey:

    Insti­tu­tion­al Investor

    Pri­vate Equi­ty Is Tak­ing a Long, Hard Look at Insur­ance. So Far, It Likes What It Sees.

    Life and annu­ity com­pa­nies are now pro­vid­ing pri­vate equi­ty firms with “a once-in-a-gen­er­a­tion oppor­tu­ni­ty,” accord­ing to McK­in­sey.

    Han­nah Zhang
    Feb­ru­ary 2, 2022

    Pri­vate equi­ty and oth­er alter­na­tives firms have long sali­vat­ed over insur­ance com­pa­ny assets as a source of per­ma­nent cap­i­tal. Now that trend has been kicked into high gear.

    Just look at deal mak­ing. In Decem­ber, Allianz Life entered a rein­sur­ance agree­ment with Sixth Street’s port­fo­lio com­pa­ny Tal­cott and part­ner Res­o­lu­tion Life. Late last month, Sixth Street announced a $25 bil­lion rein­sur­ance trans­ac­tion between an affil­i­ate of Tal­cott Res­o­lu­tion and Prin­ci­pal Finan­cial Group. Ear­li­er in 2021, pri­vate equi­ty giants like Black­stone, KKR, and Apol­lo all announced merg­ers or acqui­si­tion plans to fur­ther build up their insur­ance port­fo­lios. In total, pri­vate investors in the U.S. acquired or rein­sured more than $200 bil­lion in 2021, accord­ing to a McK­in­sey report.

    “Assum­ing the pend­ing deals close suc­cess­ful­ly, pri­vate investors will own 12 per­cent of the life and annu­ity assets in the U.S., total­ing $620 bil­lion, and rep­re­sent more than a third of U.S. net writ­ten pre­mi­ums of indexed annu­ities,” the report said.

    Accord­ing to McK­in­sey, one major fac­tor that has attract­ed pri­vate equi­ty firms to the insur­ance space is the spread between the cost of lia­bil­i­ties and the poten­tial invest­ment returns. Insur­ance com­pa­nies are “well stocked with assets,” which usu­al­ly exceed the future pay­outs by a large amount. Until the com­pa­nies approve insur­ance claims, they need to find return-gen­er­at­ing invest­ment vehi­cles in which to park the assets, and that falls into pri­vate equity’s area of exper­tise. Of course, insur­ance firms are high­ly reg­u­lat­ed and only a small por­tion of these firms’ assets, which back poli­cies, can be moved into high­er risk invest­ments.

    The report not­ed that there are three advan­tages to PE firms con­trol­ling life and annu­ity firms through equi­ty invest­ments. First, asset man­agers can gen­er­ate inter­nal rates of return as high as 10 to 14 per­cent by rotat­ing through dif­fer­ent asset class­es. Insur­ers are thus exposed to assets with high­er risks, such as asset-backed secu­ri­ties, and high­er poten­tial returns. Sec­ond, insur­ance invest­ments are a nat­ur­al way for GPs to expand their foot­print in cred­it invest­ments, which “is a strate­gic growth area for many firms at a time when PE mar­kets are becom­ing more com­pet­i­tive.” Last­ly, the mas­sive insur­ance mar­ket could help PE firms scale up quick­ly, accord­ing to the report.

    ...

    The report also list­ed three main chal­lenges for PE firms that are look­ing to expand their foot­print in insur­ance. The first one is illiq­uid­i­ty and cred­it risk. “Rotat­ing the port­fo­lio into high­er-risk cred­it assets has advan­tages, but [it] also cre­ates risk that is impor­tant to man­age, par­tic­u­lar­ly as the port­fo­lio has typ­i­cal­ly been invest­ed in more liq­uid, sta­ble assets,” the report said. The sec­ond is that life insur­ance is a high­ly reg­u­lat­ed indus­try, and PE firms need to find their own meth­ods of engag­ing with state insur­ance com­mis­sions.

    ———

    “/private Equi­ty Is Tak­ing a Long, Hard Look at Insur­ance. So Far, It Likes What It Sees.” by Han­nah Zhang; Insti­tu­tion­al Investor; 02/02/2022

    “Accord­ing to McK­in­sey, one major fac­tor that has attract­ed pri­vate equi­ty firms to the insur­ance space is the spread between the cost of lia­bil­i­ties and the poten­tial invest­ment returns. Insur­ance com­pa­nies are “well stocked with assets,” which usu­al­ly exceed the future pay­outs by a large amount. Until the com­pa­nies approve insur­ance claims, they need to find return-gen­er­at­ing invest­ment vehi­cles in which to park the assets, and that falls into pri­vate equity’s area of exper­tise. Of course, insur­ance firms are high­ly reg­u­lat­ed and only a small por­tion of these firms’ assets, which back poli­cies, can be moved into high­er risk invest­ments.”

    Yes, there was one major fac­tor dri­ving the recent pri­vate equi­ty insur­ance com­pa­ny binge: insur­ance com­pa­nies tend to have far more assets on hand than their future lia­bil­i­ties, as required by reg­u­la­tions. Assets that’s that need to be invest­ed in the mean time. It’s those giant pools of reg­u­lat­ed assets fuel­ing pri­vate equi­ty’s grow­ing insur­ance appetite.

    Of course, giant pools of assets don’t gen­er­ate out­sized returns with­out tak­ing on addi­tion­al risks. And that’s why the push towards pri­vate equi­ty-owned insur­ance com­pa­nies should real­ly be seen as an ele­va­tion in the over­all risk of the insur­ance indus­try. That’s how pri­vate-equi­ty oper­ates, after all.

    But the arti­cle also hints at anoth­er risk: many of the insur­ance indus­try’s reg­u­la­tions hap­pen at the state lev­el. As such, it’s state reg­u­la­tors that pri­vate-equi­ty firms nav­i­gat­ing the insur­ance indus­try’s reg­u­la­tions have to work with. In oth­er words, every state rep­re­sents oppor­tu­ni­ties to find an extreme­ly com­pli­ant reg­u­la­tor:

    ...
    The report not­ed that there are three advan­tages to PE firms con­trol­ling life and annu­ity firms through equi­ty invest­ments. First, asset man­agers can gen­er­ate inter­nal rates of return as high as 10 to 14 per­cent by rotat­ing through dif­fer­ent asset class­es. Insur­ers are thus exposed to assets with high­er risks, such as asset-backed secu­ri­ties, and high­er poten­tial returns. Sec­ond, insur­ance invest­ments are a nat­ur­al way for GPs to expand their foot­print in cred­it invest­ments, which “is a strate­gic growth area for many firms at a time when PE mar­kets are becom­ing more com­pet­i­tive.” Last­ly, the mas­sive insur­ance mar­ket could help PE firms scale up quick­ly, accord­ing to the report.

    ...

    The report also list­ed three main chal­lenges for PE firms that are look­ing to expand their foot­print in insur­ance. The first one is illiq­uid­i­ty and cred­it risk. “Rotat­ing the port­fo­lio into high­er-risk cred­it assets has advan­tages, but [it] also cre­ates risk that is impor­tant to man­age, par­tic­u­lar­ly as the port­fo­lio has typ­i­cal­ly been invest­ed in more liq­uid, sta­ble assets,” the report said. The sec­ond is that life insur­ance is a high­ly reg­u­lat­ed indus­try, and PE firms need to find their own meth­ods of engag­ing with state insur­ance com­mis­sions.
    ...

    That was the sit­u­a­tion in Feb­ru­ary 2022. Flash for­ward a year and we find the fol­low­ing Amer­i­can Prospect piece by David Dayen describ­ing how the pen­sion fund clients ulti­mate­ly financ­ing these pri­vate-equi­ty insur­ance acqui­si­tions aren’t the only retire­ment funds put at risk by this strat­e­gy. Pri­vate equi­ty has a par­tic­u­lar appetite for insur­ance com­pa­nies that issue large vol­umes of annu­ities. The kinds of annu­ities that oper­ate as per­son­al retire­ment sup­ple­ments.

    Why annu­ities? Well, the funds put into annu­ities have a num­ber of obsta­cles to the ear­ly with­draw­al of funds, mak­ing the pools of annu­ity pre­mi­ums par­tic­u­lar­ly use­ful in cre­at­ing what is known as ‘float’, or rev­enue streams com­ing into insur­ers before it goes out to pay claims and ben­e­fits. But while large pools of ‘float­ing’ cash rep­re­sent an obvi­ous­ly use­ful source for gen­er­at­ing income, that’s not nec­es­sar­i­ly risk free income. There’s no guar­an­tee the ‘float­ed’ funds aren’t going to be lost. Loss­es that could ulti­mate­ly trans­late to retirees not receiv­ing their promised annu­ity pay­ments. Annu­ities aren’t pro­tect­ed against an insur­ance com­pa­ny’s default, after all. And as the arti­cle also notes, while the insur­ance indus­try is indeed reg­u­lat­ed at the state lev­el, the track record for state reg­u­la­tors over the last decade has been rather under­whelm­ing. Which is why we prob­a­bly should­n’t assume reg­u­la­tors will pre­vent the next melt­down:

    Prospect

    Pri­vate Equity’s Newest Play

    Insur­ance com­pa­nies are the lat­est morsel for these finan­cial preda­tors to devour.

    by David Dayen
    Feb­ru­ary 7, 2023

    Black­stone is the world’s largest pri­vate equi­ty firm.

    To some observers, the flip side of the Fed­er­al Reserve’s inter­est rate hikes, and their poten­tial­ly dam­ag­ing impact on labor mar­kets, is that the end of cheap cred­it is pun­ish­ing some of the most preda­to­ry mon­ey­mak­ing schemes in the econ­o­my. Obvi­ous­ly sketchy enter­pris­es in the form of cryp­to com­pa­nies or SPACs have fal­tered or out­right col­lapsed. Even the alleged­ly more rep­utable cor­ners of the mar­ket (at least to men in suits) also appear to be strug­gling.

    At the head of that is the pri­vate equi­ty indus­try. As David Siro­ta report­ed last week, returns for pri­vate equi­ty firms aver­aged around ‑6.1 per­cent in the 2022 fis­cal year, with “dra­mat­ic” declines expect­ed to be report­ed in 2023. An advis­er to pub­lic employ­ee retire­ment sys­tems recent­ly sent out a warn­ing that these loss­es could impact pen­sion fund­ing sta­tus, or the amount of mon­ey on hand avail­able to pay promised retiree ben­e­fits.

    On top of over­promis­ing returns, some PE funds have got­ten tied up in the prop­er­ty mar­ket, where droves of investors are scram­bling to escape. Black­stone, the world’s largest PE firm, whose Real Estate Invest­ment Trust (BREIT) lim­it­ed with­drawals in Decem­ber, saw with­draw­al requests jump to $5 bil­lion in a sec­ond fund in Jan­u­ary. Hilar­i­ous­ly, Black­stone pres­i­dent Jonathan Gray told the Finan­cial Times that “the tone of the con­ver­sa­tions … is much improved,” which I guess means that investors are say­ing “please” when they ask for all their mon­ey back right now. Black­stone has increased its ten­ant evic­tions in a scram­ble to raise cash.

    Between the less favor­able invest­ing envi­ron­ment and reg­u­la­to­ry pres­sure from the likes of the Secu­ri­ties and Exchange Com­mis­sion, investors may final­ly rec­og­nize that pri­vate equi­ty returns—which were nev­er all that good even dur­ing the bull market—could be a mon­ey pit today. Some nation­al lead­ers, like Penn­syl­va­nia Gov. Josh Shapiro, have dared to say out loud the unmen­tion­able: that pub­lic pen­sion funds should get out of the pri­vate equi­ty busi­ness, and stop sup­ply­ing work­er funds to an indus­try that relent­less­ly harms work­ers. As I wrote last sum­mer, weak­en­ing the pri­vate equi­ty mon­ey stream is the key to get­ting these enti­ties’ bad prac­tices out of the econ­o­my.

    The prob­lem is that PE always man­ages to find a new vic­tim. Even as it reports loss­es to pen­sion funds and oth­er investors, man­agers are feel­ing lit­tle pain thanks to astro­nom­i­cal fees. And anoth­er juicy meal for the indus­try has recent­ly emerged: insur­ance com­pa­nies.

    For the past decade, pri­vate equi­ty firms have either bought out or forged part­ner­ships with the insur­ance indus­try, which always has a mas­sive amount of assets avail­able for invest­ment. This is known as the “float,” rep­re­sent­ing the rev­enue com­ing into insur­ers before it goes out to pay claims and ben­e­fits. This does not just rep­re­sent home and auto insur­ance pre­mi­ums. There’s retire­ment mon­ey in there in the form of life insur­ance plans and annu­ities, the often high-cost plans that give seniors a ded­i­cat­ed fund­ing stream in their lat­er years.

    Float is what built War­ren Buffett’s empire, and PE sees a way to adapt this mod­el for a new age of finance. In oth­er words, pri­vate equi­ty is insu­lat­ed from the loss of cheap mon­ey by lit­er­al­ly buy­ing mon­ey out. But hand­ing the insur­ance float pile over to pri­vate equi­ty puts more work­ers at risk of not see­ing the ben­e­fits they were promised.

    “It’s about hav­ing a steady flow of invest­ment funds with­out hav­ing to recruit,” said Eileen Appel­baum, co-direc­tor of the Cen­ter for Eco­nom­ic and Pol­i­cy Research. “It’s also about increas­ing assets under man­age­ment so big boys look even big­ger. And it’s about lack of reg­u­la­tion or over­sight.”

    That last part is key: While the SEC and oth­er fed­er­al finan­cial reg­u­la­tors can mon­i­tor pieces of the pri­vate equi­ty mar­ket, insur­ance is typ­i­cal­ly reg­u­lat­ed at the state lev­el. And though the pri­vate equi­ty move to insur­ance began over a decade ago, state insur­ance com­mis­sion­ers appear to have done lit­tle to mit­i­gate the risks.

    Accord­ing to the Nation­al Asso­ci­a­tion of Insur­ance Com­mis­sion­ers, at the end of 2021 (the last year stud­ied) pri­vate equi­ty out­right owned insur­ers with total cash and invest­ed assets of $472 bil­lion. This was actu­al­ly a lit­tle down from 2020, but a 37 per­cent increase over 2019. This is only about 6 per­cent of the insur­ance industry’s mon­u­men­tal $8 tril­lion in avail­able cash and assets, so there’s lots more room to run.

    The mod­el for pur­chas­ing insur­ers and gain­ing the abil­i­ty to man­age their invest­ments was pio­neered by Apol­lo, which cre­at­ed Athene, an annu­ity com­pa­ny, in 2012. The Wall Street Jour­nal notes that half of the $523 bil­lion that Apol­lo has under man­age­ment comes from Athene.

    Some PE firms have fol­lowed that path by buy­ing into annu­ity or life insur­ance com­pa­nies. But Black­stone, Car­lyle, and oth­ers have more recent­ly made deals to man­age insur­ance com­pa­ny assets. Oth­ers pro­vide rein­sur­ance (the insur­ance that insur­ance com­pa­nies buy for them­selves) and invest the pre­mi­ums from that. They are also sell­ing pri­vate-debt instru­ments to insur­ers that promise greater returns than gov­ern­ment bonds. This is just an exten­sion of the acqui­si­tions pri­vate equi­ty always makes, except their goal is real­ly to get their hands on more mon­ey so they can buy more firms.

    Appel­baum has pro­posed three key guardrails for pri­vate equi­ty annu­ity and insur­ance invest­ments: a cap on man­age­ment fees for mon­ey that comes from retire­ment sav­ings vehi­cles, an increase in reserve require­ments to absorb poten­tial loss­es from riski­er invest­ments, and a ban on firms “self-deal­ing” by invest­ing insur­ance assets in their own funds. That last one seems to be the entire ratio­nale for this maneu­ver. “They’re claim­ing they want to only move 5 to 10 per­cent of assets into risky things,” Appel­baum told me last year. “That’s a lot of mon­ey. And if they have a fund that’s fail­ing, they can give [the mon­ey] to their own fund.”

    But the Nation­al Asso­ci­a­tion of Insur­ance Com­mis­sion­ers, which would be a first line of defense from this trend, blew off an ini­tial inquiry about it from Sen­ate Bank­ing Com­mit­tee chair Sen. Sher­rod Brown (D‑OH), who asked about the impact of pri­vate equi­ty on insur­ance. The NAIC response boiled down to assur­ing Brown that there was noth­ing to wor­ry about, and that PE firms were “in it for the long term.” Appel­baum said that there has been no move­ment on reg­u­la­tion since then.

    Insur­ance com­mis­sion­ers are either elect­ed or select­ed by state gov­er­nors, and have a vary­ing ide­o­log­i­cal com­mit­ment to strong reg­u­la­tion, along with lit­tle expe­ri­ence deal­ing with pri­vate equi­ty. An indus­try that thrives on reg­u­la­to­ry cap­ture like­ly faces lit­tle threat from this cohort.

    ...

    Unfor­tu­nate­ly, this gives pri­vate equi­ty anoth­er steady stream of cash to plow into buy­ing cloth­ing stores or ski resorts or tod­dler gyms or what­ev­er else they want. The idea of a “reck­on­ing” for pri­vate equi­ty is seduc­tive but wrong. Changes in the inter­est rate envi­ron­ment may take some of their cheap mon­ey away. But there’s always some­one else will­ing to step up and pro­vide those dol­lars. As a wise man once said, there’s one born every minute.

    ———–

    “Pri­vate Equity’s Newest Play” by David Dayen; Prospect; 02/07/2023

    “The prob­lem is that PE always man­ages to find a new vic­tim. Even as it reports loss­es to pen­sion funds and oth­er investors, man­agers are feel­ing lit­tle pain thanks to astro­nom­i­cal fees. And anoth­er juicy meal for the indus­try has recent­ly emerged: insur­ance com­pa­nies.

    As David Dayen warned just five months ago, pri­vate-equi­ty has been on an insur­ance binge of late, and the con­se­quences of putting those mas­sive insur­ance reserves under pri­vate equi­ty man­age­ment are still unfold­ing. Down­stream con­se­quences like the even­tu­al fall­out from all of the gam­bling done using the insur­ance ‘float’. In par­tic­u­lar, the ‘float’ com­ing in from annu­ity poli­cies, which are them­selves basi­cal­ly per­son­al pen­sion insur­ance prod­ucts. So pri­vate-equi­ty is pur­chas­ing insur­ance com­pa­nies and tak­ing the ‘float­ed’ mon­ey allo­cat­ed for annu­ities to make big bets and earn the high returns their most­ly-pen­sion fund clients desire. Yes, pen­sion funds are being financed by mak­ing bets with annu­ity mon­ey. Sure, all that ‘float­ed’ mon­ey will have to be paid out to the insur­ance clients some­day. But not today. And if the mon­ey isn’t actu­al­ly there when its even­tu­al­ly need­ed, it’s the annu­ity hold­ers and pen­sion­ers who will feel the pain. The pri­vate equi­ty fund man­agers will be just fine:

    ...
    For the past decade, pri­vate equi­ty firms have either bought out or forged part­ner­ships with the insur­ance indus­try, which always has a mas­sive amount of assets avail­able for invest­ment. This is known as the “float,” rep­re­sent­ing the rev­enue com­ing into insur­ers before it goes out to pay claims and ben­e­fits. This does not just rep­re­sent home and auto insur­ance pre­mi­ums. There’s retire­ment mon­ey in there in the form of life insur­ance plans and annu­ities, the often high-cost plans that give seniors a ded­i­cat­ed fund­ing stream in their lat­er years.

    Float is what built War­ren Buffett’s empire, and PE sees a way to adapt this mod­el for a new age of finance. In oth­er words, pri­vate equi­ty is insu­lat­ed from the loss of cheap mon­ey by lit­er­al­ly buy­ing mon­ey out. But hand­ing the insur­ance float pile over to pri­vate equi­ty puts more work­ers at risk of not see­ing the ben­e­fits they were promised.

    “It’s about hav­ing a steady flow of invest­ment funds with­out hav­ing to recruit,” said Eileen Appel­baum, co-direc­tor of the Cen­ter for Eco­nom­ic and Pol­i­cy Research. “It’s also about increas­ing assets under man­age­ment so big boys look even big­ger. And it’s about lack of reg­u­la­tion or over­sight.”

    That last part is key: While the SEC and oth­er fed­er­al finan­cial reg­u­la­tors can mon­i­tor pieces of the pri­vate equi­ty mar­ket, insur­ance is typ­i­cal­ly reg­u­lat­ed at the state lev­el. And though the pri­vate equi­ty move to insur­ance began over a decade ago, state insur­ance com­mis­sion­ers appear to have done lit­tle to mit­i­gate the risks.

    ...

    Appel­baum has pro­posed three key guardrails for pri­vate equi­ty annu­ity and insur­ance invest­ments: a cap on man­age­ment fees for mon­ey that comes from retire­ment sav­ings vehi­cles, an increase in reserve require­ments to absorb poten­tial loss­es from riski­er invest­ments, and a ban on firms “self-deal­ing” by invest­ing insur­ance assets in their own funds. That last one seems to be the entire ratio­nale for this maneu­ver. “They’re claim­ing they want to only move 5 to 10 per­cent of assets into risky things,” Appel­baum told me last year. “That’s a lot of mon­ey. And if they have a fund that’s fail­ing, they can give [the mon­ey] to their own fund.”

    But the Nation­al Asso­ci­a­tion of Insur­ance Com­mis­sion­ers, which would be a first line of defense from this trend, blew off an ini­tial inquiry about it from Sen­ate Bank­ing Com­mit­tee chair Sen. Sher­rod Brown (D‑OH), who asked about the impact of pri­vate equi­ty on insur­ance. The NAIC response boiled down to assur­ing Brown that there was noth­ing to wor­ry about, and that PE firms were “in it for the long term.” Appel­baum said that there has been no move­ment on reg­u­la­tion since then.
    ...

    And note the com­pa­ny that appears to have pio­neered the approach of using the large vol­umes of ‘float­ed’ annu­ity pre­mi­ums to earn high­er returns: Apol­lo, which cre­at­ed Athene in 2012 to focus on annu­ities. Annu­ities that now account for half of Apol­lo’s total assets under man­age­ment:

    ...
    Accord­ing to the Nation­al Asso­ci­a­tion of Insur­ance Com­mis­sion­ers, at the end of 2021 (the last year stud­ied) pri­vate equi­ty out­right owned insur­ers with total cash and invest­ed assets of $472 bil­lion. This was actu­al­ly a lit­tle down from 2020, but a 37 per­cent increase over 2019. This is only about 6 per­cent of the insur­ance industry’s mon­u­men­tal $8 tril­lion in avail­able cash and assets, so there’s lots more room to run.

    The mod­el for pur­chas­ing insur­ers and gain­ing the abil­i­ty to man­age their invest­ments was pio­neered by Apol­lo, which cre­at­ed Athene, an annu­ity com­pa­ny, in 2012. The Wall Street Jour­nal notes that half of the $523 bil­lion that Apol­lo has under man­age­ment comes from Athene.
    ...

    So if pri­vate-equi­ty’s new mod­el is to buy insur­ance com­pa­nies to con­trol those giant pools of as sets, what kinds of invest­ments are pri­vate-equi­ty firms mak­ing with all that mon­ey? Well, as the fol­low­ing Finan­cial Times arti­cle from last month describes, the pri­vate-equi­ty indus­try has found a new ‘tar­get’ for its large pools of cash to invest in: cor­po­rate debt.

    Keep in mind that, the insur­ance indus­try in gen­er­al has been on a cor­po­rate debt binge over the past decade, so it’s prob­a­bly not entire­ly a coin­ci­dence that the pri­vate-equi­ty cor­po­rate debt spree fol­lowed its insur­ance indus­try spree. And the fact that Apol­lo in par­tic­u­lar is seen as lead­ing the way in this trend only under­scores that it’s like­ly Athene annu­ity pre­mi­ums ulti­mate­ly financ­ing a lot of those debt pur­chas­es.

    But as the fol­low­ing arti­cle also describes, it’s not as sim­ple as just buy­ing more cor­po­rate debt. Pri­vate-equi­ty is increas­ing­ly using ‘finan­cial wiz­ard­ly’ to issue that debt in a man­ner that par­tial­ly obscures the debt from cor­po­rate bal­ance sheets. Tech­niques like trans­fer­ring a man­u­fac­tur­ing facil­i­ty or real estate port­fo­lio into a sub­sidiary or “spe­cial pur­pose vehi­cle” and then bor­row­ing against that, allow­ing the par­ent com­pa­ny to avoid report­ing that debt on its bal­ance sheet.

    Don’t for­get the caveat we got in the above piece: self-deal­ing is an inher­ent dan­ger when we’re talk­ing about pri­vate-equi­ty. Self-deal­ing like using pri­vate-equi­ty funds to pur­chase the debt of oth­er com­pa­nies owned by the same fund. And here we are find­ing that pri­vate-equi­ty is increas­ing­ly involved in set­ting ‘spe­cial pur­pose vehi­cles’ that can obscure cor­po­rate debt lev­els. It’s not hard to see how this ends poor­ly:

    The Finan­cial Times

    Pri­vate cred­it finds its next big tar­get: invest­ment-grade debt

    Blue-chip com­pa­nies bypass banks and bond mar­kets to bor­row from indus­try with $1.4tn war chest

    Eric Platt in New York
    June 26 2023

    Alter­na­tive asset man­agers such as Apol­lo, KKR and Black­stone are increas­ing­ly financ­ing blue-chip com­pa­nies, as busi­ness­es look for new sources of cap­i­tal to help coun­ter­act the effects of high­er inter­est rates and a slow­ing econ­o­my.

    The deals — includ­ing two announced this month with AT&T and Pay­Pal — under­score the grow­ing reach of the pri­vate cred­it indus­try as it helps com­pa­nies bypass tra­di­tion­al banks and bond mar­kets to raise mon­ey.

    Pri­vate cred­it has boomed in the decade since the glob­al finan­cial cri­sis into a sec­tor with $1.4tn in assets. Loans from pri­vate cred­it typ­i­cal­ly went to com­pa­nies that were small­er or riski­er.

    Now, alter­na­tive asset man­ag­er lenders are tar­get­ing larg­er, more sta­ble com­pa­nies. “Pri­vate cred­it is going invest­ment grade,” said Akhil Bansal, head of cred­it strate­gic solu­tions at Car­lyle, the pri­vate equi­ty group.

    Exec­u­tives said the shift was a nat­ur­al out­growth of pri­vate credit’s fundrais­ing spree, giv­ing man­agers cash to lend. As well, most major pri­vate equi­ty groups have bought or invest­ed in an insur­ance com­pa­ny in the past five years, draw­ing in hun­dreds of bil­lions of pre­mi­ums to invest.

    Super­charg­ing the push has been Apol­lo, whose insur­er Athene has amassed near­ly $260bn in cap­i­tal — rough­ly half of Apollo’s assets.

    “We made a bet on pri­vate invest­ment grade,” Marc Rowan, Apollo’s chief exec­u­tive, told a con­fer­ence this month. “We are also a ben­e­fi­cia­ry of this de-bank­ing of the world because the assets that we need . . . were the kinds of things that used to go on to the bal­ance sheets of banks, invest­ment-grade pri­vate cred­it.”

    Apol­lo is not alone. KKR in 2021 bought a major­i­ty stake in insur­er Glob­al Atlantic, adding $90bn to the group’s assets at the time. Car­lyle pur­chased just under a fifth of rein­sur­er For­ti­tude Re from AIG in 2018 before strik­ing a new deal last year that reduced its stake but boost­ed Carlyle’s assets by about $50bn. Black­stone, mean­while, invests on behalf of insur­ers such as Core­bridge through its insur­ance solu­tions divi­sion.

    The insur­ance units are required by state reg­u­la­tors to invest the vast major­i­ty of their hold­ings in invest­ment-grade rat­ed debt, to safe­guard pol­i­cy­hold­ers.

    But unlike tra­di­tion­al insur­ers, alter­na­tive invest­ment man­agers have been more com­fort­able using finan­cial wiz­ardry to design pri­vate trans­ac­tions that can pro­vide a few extra per­cent­age points of return com­pared with tra­di­tion­al invest­ment-grade cor­po­rate bonds, which yield about 5.5 per cent.

    That can prove attrac­tive to com­pa­nies need­ing to raise cash with­out tap­ping the invest­ment-grade bond mar­ket, par­tic­u­lar­ly when issu­ing more debt at the cor­po­rate lev­el would influ­ence a business’s cred­it rat­ing.

    The deals have tak­en sev­er­al dif­fer­ent forms, but often a com­pa­ny will move some assets — per­haps a man­u­fac­tur­ing facil­i­ty or real estate port­fo­lio — to a sub­sidiary or new spe­cial pur­pose vehi­cle. Then com­pa­nies raise pre­ferred equi­ty or debt against the unit, which brings in cash the par­ent can use to run its day-to-day busi­ness.

    Rat­ing agen­cies typ­i­cal­ly treat pre­ferred stock deals more favourably than run-of-the-mill loans. And often, because the equi­ty is raised in a spe­cial pur­pose vehi­cle, the par­ent com­pa­ny does not have to report it on its bal­ance sheet.

    Apol­lo bought $2bn of AT&T pre­ferred stock in a deal that allowed the wire­less car­ri­er to par­tial­ly repay some of its out­stand­ing pre­ferred equi­ty. That fol­lowed a $1bn invest­ment in Ger­man real estate group Vonovia in a sim­i­lar struc­ture.

    ...

    Oth­er deals, such as KKR’s agree­ment last week to pur­chase up to €40bn of con­sumer loans orig­i­nat­ed by Pay­Pal, have more close­ly resem­bled tra­di­tion­al asset-backed secu­ri­ties. In those trans­ac­tions, a pool of assets — such as mort­gages, cred­it card receiv­ables or auto loans — are pack­aged togeth­er, with the inter­est pay­ments fund­ing new slices of debt that are sold on to investors.

    The use of insur­ance cap­i­tal and pri­vate cred­it is just the lat­est exam­ple of blue-chip com­pa­nies pair­ing up with alter­na­tive asset man­agers.

    Intel last year struck a $30bn deal with Brook­field and its infra­struc­ture funds, with the asset man­ag­er invest­ing $15bn in a new chip foundry.

    Intel, like most com­pa­nies enter­ing into these agree­ments, did not say how much it would pay Brook­field for the invest­ment. How­ev­er, its chief finan­cial offi­cer David Zin­sner told ana­lysts last year that Brook­field would receive part of the cash flows the plant gen­er­ates once it is oper­a­tional, giv­ing the invest­ment firm a return some­where between 4.4 per cent and 8.5 per cent.

    ...

    ———-

    “Pri­vate cred­it finds its next big tar­get: invest­ment-grade debt” ny Eric Platt; The Finan­cial Times; 06/26/2023

    “Exec­u­tives said the shift was a nat­ur­al out­growth of pri­vate credit’s fundrais­ing spree, giv­ing man­agers cash to lend. As well, most major pri­vate equi­ty groups have bought or invest­ed in an insur­ance com­pa­ny in the past five years, draw­ing in hun­dreds of bil­lions of pre­mi­ums to invest.

    A giant pool of insur­ance com­pa­ny assets. That’s appar­ent­ly what’s fuel­ing the cur­rent pri­vate-equi­ty binge on cor­po­rate debt. It start­ed with a binge on insur­ance com­pa­nies over the past decade, leav­ing pri­vate equi­ty firms with large pools of assets avail­able for invest­ment. And in the case of Apol­lo, rough­ly half its assets under man­age­ment are thanks to a sin­gle insur­er, Athene:

    ...
    Super­charg­ing the push has been Apol­lo, whose insur­er Athene has amassed near­ly $260bn in cap­i­tal — rough­ly half of Apollo’s assets.

    “We made a bet on pri­vate invest­ment grade,” Marc Rowan, Apollo’s chief exec­u­tive, told a con­fer­ence this month. “We are also a ben­e­fi­cia­ry of this de-bank­ing of the world because the assets that we need . . . were the kinds of things that used to go on to the bal­ance sheets of banks, invest­ment-grade pri­vate cred­it.”

    Apol­lo is not alone. KKR in 2021 bought a major­i­ty stake in insur­er Glob­al Atlantic, adding $90bn to the group’s assets at the time. Car­lyle pur­chased just under a fifth of rein­sur­er For­ti­tude Re from AIG in 2018 before strik­ing a new deal last year that reduced its stake but boost­ed Carlyle’s assets by about $50bn. Black­stone, mean­while, invests on behalf of insur­ers such as Core­bridge through its insur­ance solu­tions divi­sion.
    ...

    But unlike tra­di­tion­al insur­ance com­pa­nies, pri­vate equi­ty-owned insur­ance com­pa­nies don’t face the same kinds of reg­u­la­tions that require they invest their hold­ings in rel­a­tive­ly safe invest­ments. This allows the pri­vate equi­ty firms to engage in ‘finan­cial wiz­ardry’ poten­tial­ly involv­ing the cre­ation of “spe­cial pur­pose vehi­cles” that have the ben­e­fit of hid­ing the new­ly issued cor­po­rate debt. So it sounds like we have pri­vate equi­ty firms buy­ing up insur­ance com­pa­nies and then using those mas­sive new asset war chests to make the kinds of risky invest­ments the insur­ance com­pa­nies them­selves would­n’t be legal­ly allowed to engage in. Risky invest­ments that, in turn, allow com­pa­nies to obscure their debt loads. What could pos­si­bly go wrong?

    ...
    Pri­vate cred­it has boomed in the decade since the glob­al finan­cial cri­sis into a sec­tor with $1.4tn in assets. Loans from pri­vate cred­it typ­i­cal­ly went to com­pa­nies that were small­er or riski­er.

    Now, alter­na­tive asset man­ag­er lenders are tar­get­ing larg­er, more sta­ble com­pa­nies. “Pri­vate cred­it is going invest­ment grade,” said Akhil Bansal, head of cred­it strate­gic solu­tions at Car­lyle, the pri­vate equi­ty group.

    ...

    The insur­ance units are required by state reg­u­la­tors to invest the vast major­i­ty of their hold­ings in invest­ment-grade rat­ed debt, to safe­guard pol­i­cy­hold­ers.

    But unlike tra­di­tion­al insur­ers, alter­na­tive invest­ment man­agers have been more com­fort­able using finan­cial wiz­ardry to design pri­vate trans­ac­tions that can pro­vide a few extra per­cent­age points of return com­pared with tra­di­tion­al invest­ment-grade cor­po­rate bonds, which yield about 5.5 per cent.

    That can prove attrac­tive to com­pa­nies need­ing to raise cash with­out tap­ping the invest­ment-grade bond mar­ket, par­tic­u­lar­ly when issu­ing more debt at the cor­po­rate lev­el would influ­ence a business’s cred­it rat­ing.

    The deals have tak­en sev­er­al dif­fer­ent forms, but often a com­pa­ny will move some assets — per­haps a man­u­fac­tur­ing facil­i­ty or real estate port­fo­lio — to a sub­sidiary or new spe­cial pur­pose vehi­cle. Then com­pa­nies raise pre­ferred equi­ty or debt against the unit, which brings in cash the par­ent can use to run its day-to-day busi­ness.

    Rat­ing agen­cies typ­i­cal­ly treat pre­ferred stock deals more favourably than run-of-the-mill loans. And often, because the equi­ty is raised in a spe­cial pur­pose vehi­cle, the par­ent com­pa­ny does not have to report it on its bal­ance sheet.
    ...

    And if this already does­n’t sound like a dicey enough sit­u­a­tion, deals resem­bling tra­di­tion­al asset-backed secu­ri­ties are also increas­ing­ly pop­u­lar in the pri­vate equi­ty space. This is a good time to recall how the sys­tem­at­ic mis­pric­ing of mort­gage-backed secu­ri­ties played a key role in the lead up to the 2008 finan­cial cri­sis. Let’s hope the pri­vate equi­ty indus­try is doing a bet­ter job this time around!

    ...
    Oth­er deals, such as KKR’s agree­ment last week to pur­chase up to €40bn of con­sumer loans orig­i­nat­ed by Pay­Pal, have more close­ly resem­bled tra­di­tion­al asset-backed secu­ri­ties. In those trans­ac­tions, a pool of assets — such as mort­gages, cred­it card receiv­ables or auto loans — are pack­aged togeth­er, with the inter­est pay­ments fund­ing new slices of debt that are sold on to investors.
    ...

    Will pri­vate-equi­ty’s big insur­ance play pan out for all of its pen­sion fund clients? Time will tell. And as the fol­low­ing Reuters piece from the end of March, this insur­ance-fueled invest­ment strat­e­gy has a rather large poten­tial vul­ner­a­bil­i­ty: ris­ing inter­est rates. Yes, ris­ing rates pose an acute threat to this annu­ity-cen­tric insur­ance-fueled phase of pri­vate-equi­ty expan­sion. A threat in the form of annu­ity hold­ers ask­ing for an ear­ly with­draw­al as high­er rates cre­ate more and more temp­ing alter­na­tive oppor­tu­ni­ties. Hence, Apol­lo hav­ing to assure the mar­kets that it was­n’t going to face its own ver­sion of a ‘bank run’ due on Athene’s large annu­ity hold­ings. As Apol­lo point­ed out, the bulk of its annu­ities have ‘sur­ren­der charges’ that impose a fine for ear­ly with­drawals. It’s a finan­cial “fortress” as the com­pa­ny put it. But as the arti­cle also notes, that only cov­ers 82% of Apol­lo’s annu­ity hold­ings, mean­ing 18%, or $33 bil­lion, in annu­ities are indeed eli­gi­ble for an ear­ly with­draw­al. Apol­lo’s fortress has a pret­ty wide open back door.

    Apol­lo also tout­ed its then-$73 bil­lion in avail­able liq­uid­i­ty (as of March 10) includ­ing $56.9 bil­lion in invest­ment-grade cor­po­rate bonds. Also keep in mind that bond port­fo­lio pre­sum­ably dropped in val­ue with each Fed rate hike since then. It’s all a reminder that the pri­vate-equi­ty indus­try’s strat­e­gy in recent years of of plow­ing annu­ity pre­mi­ums into cor­po­rate bond pur­chas­es could be par­tic­u­lar­ly vul­ner­a­ble to a ris­ing rate envi­ron­ment:

    Reuters

    Focus: Apol­lo assures investors deposit flight won’t spill over to Athene

    By Chibuike Oguh
    March 30, 2023 5:33 AM CDT
    Updat­ed

    March 30 (Reuters) — Apol­lo Glob­al Man­age­ment Inc (APO.N) has been telling investors and ana­lysts in the last few days that its rein­sur­ance busi­ness Athene does not face the risk of a run on its annu­ities akin to how deposits fled some U.S. region­al banks.

    Apol­lo shares have lost 15% of their val­ue since the bank­ing cri­sis start­ed on March 8, a greater drop than expe­ri­enced by major peers Black­stone Inc (BX.N), KKR & Co Inc (KKR.N) and Car­lyle Group Inc (CG.O).

    In a quar­ter­ly update to share­hold­ers pub­lished on March 13, Apol­lo out­lined how Athene’s fund­ing mod­el is dif­fer­ent than a bank’s. Most of the annu­ities that Athene pro­vides can­not be sur­ren­dered by their hold­ers, it said, and Apol­lo called its bal­ance sheet a “fortress” that can with­stand with­drawals from those who have the right to pull their mon­ey.

    Annu­ities are finan­cial prod­ucts pur­chased for a lump sum or through install­ments in exchange for a fixed stream of pay­ments over time.

    They are typ­i­cal­ly offered by insur­ance firms. Apol­lo, one of the world’s biggest pri­vate equi­ty firms, helped launch Athene in 2009 and has used the cap­i­tal raised from the annu­ities offered to earn lucra­tive fees and grow its assets beyond its tra­di­tion­al funds.

    ...

    “Now that we are see­ing runs on select U.S. region­al banks, we’re also start­ing to see some investors voice those same con­cerns about insur­ance firms. What’s going on in region­al banks is like a wake­up call,” said BMO Cap­i­tal Mar­kets ana­lyst Rufus Hone. Fol­low­ing a meet­ing with Apol­lo exec­u­tives, Hone wrote in a note last week that he does not antic­i­pate a spike in with­drawals from Athene’s annu­ity hold­ers and that Athene’s fund­ing base was sta­ble.

    An Apol­lo spokesper­son said Athene had ample cash and liq­uid­i­ty and that its issuance of new annu­ity poli­cies “mean­ing­ful­ly” exceed­ed the poli­cies that matured and oth­er with­drawals.

    Apol­lo said in its March 13 pre­sen­ta­tion to investors that it had seen inflows of $8.8 bil­lion to Athene from the start of the year to March 10. Out­flows have been con­sis­tent with the quar­ter­ly aver­age of around $5 bil­lion, a per­son famil­iar with the mat­ter said.

    Athene’s esti­mat­ed lia­bil­i­ties stood at $184 bil­lion as of March 10. About 82% of those annu­ities are not at risk of with­draw­al by clients, either because their terms make them non-sur­rend­able or finan­cial­ly oner­ous to sur­ren­der, or because the hold­ers are insur­ance firms rather than indi­vid­u­als, accord­ing to the Apol­lo pre­sen­ta­tion.

    But annu­ities worth about $33 bil­lion, equiv­a­lent to 18% of Athene’s lia­bil­i­ties, are not pro­tect­ed by sur­ren­der charges, mak­ing them eas­i­er to be with­drawn by hold­ers. Ques­tions from investors and ana­lysts to Apol­lo have focused on this sub­set of annu­ity poli­cies that have a poten­tial­ly high­er flight risk.

    STICKY ASSETS

    Apol­lo in the pre­sen­ta­tion gave sev­er­al rea­sons why annu­ity hold­ers are less like­ly to with­draw their mon­ey than bank account hold­ers, includ­ing that annu­ities are long-term invest­ment prod­ucts that are typ­i­cal­ly used for retire­ment and offer high­er returns than tra­di­tion­al bank prod­ucts.

    Apol­lo also said it had $73 bil­lion in avail­able liq­uid­i­ty as of March 10 to meet any poten­tial spikes in demand for annu­ity with­drawals, includ­ing a $56.9 bil­lion fixed-income port­fo­lio com­prised most­ly of pub­licly trad­ed invest­ment-grade cor­po­rate bonds.

    Apol­lo would like­ly have to real­ize loss­es if it sold some of that port­fo­lio giv­en that the rise in inter­est rates in the last few months has led to a gen­er­al drop in the val­ue of bonds, said Argus Research ana­lyst Stephen Big­gar.

    Oth­er insur­ers that are major providers of annu­ities, includ­ing Amer­i­can Equi­ty Invest­ment Life Hold­ing Co (AEL.N), have also seen a drop in their mar­ket cap­i­tal­iza­tion in the wake of the bank­ing cri­sis.

    Wells Far­go ana­lyst Fin­ian O’Shea said he did not believe Athene’s busi­ness was cur­rent­ly at risk because with­drawals from annu­ities remained lim­it­ed. But he said the fall­out from the Fed­er­al Reserve’s push to raise inter­est rates as well as the recent col­lapse of some U.S. region­al banks prompt­ed some Apol­lo investors to raise con­cerns about Athene’s bal­ance sheet.

    “It’s not a right-now thing. Peo­ple are think­ing about it for more down the road — if inter­est rates keep going up that Athene’s sur­ren­der lev­els on annu­ities could go up,” O’Shea said.

    ———

    “Focus: Apol­lo assures investors deposit flight won’t spill over to Athene” By Chibuike Oguh; Reuters; 03/30/2023

    “Now that we are see­ing runs on select U.S. region­al banks, we’re also start­ing to see some investors voice those same con­cerns about insur­ance firms. What’s going on in region­al banks is like a wake­up call,” said BMO Cap­i­tal Mar­kets ana­lyst Rufus Hone. Fol­low­ing a meet­ing with Apol­lo exec­u­tives, Hone wrote in a note last week that he does not antic­i­pate a spike in with­drawals from Athene’s annu­ity hold­ers and that Athene’s fund­ing base was sta­ble.”

    So with banks start­ing to teeter, what’s the sta­tus of all those annu­ity invest­ments? That was one of the big ques­tions fac­ing Apol­lo back in March as the region­al bank run was play­ing out.

    But Apol­lo had an answer ready: Don’t wor­ry about us! Our annu­ities are fine because of all the sur­ren­der charges that penal­ize annu­ity hold­ers for ear­ly with­drawals! That was the mes­sage to the mar­kets Apol­lo had to issue back in March as the bank run was play­ing out. A mes­sage of assur­ance: there sim­ply could­n’t be a ‘run on annu­ities’ the same way there was a run on the banks. Except, of course, it’s not that sim­ple. Yes, sur­ren­der charges do impose an obsta­cle to annu­ity with­drawals, but not a com­plete obsta­cle. If inter­est rates rise enough, it’s going to be worth pay­ing those sur­ren­der charge fees and with­draw­ing any­way:

    ...
    Oth­er insur­ers that are major providers of annu­ities, includ­ing Amer­i­can Equi­ty Invest­ment Life Hold­ing Co (AEL.N), have also seen a drop in their mar­ket cap­i­tal­iza­tion in the wake of the bank­ing cri­sis.

    Wells Far­go ana­lyst Fin­ian O’Shea said he did not believe Athene’s busi­ness was cur­rent­ly at risk because with­drawals from annu­ities remained lim­it­ed. But he said the fall­out from the Fed­er­al Reserve’s push to raise inter­est rates as well as the recent col­lapse of some U.S. region­al banks prompt­ed some Apol­lo investors to raise con­cerns about Athene’s bal­ance sheet.

    “It’s not a right-now thing. Peo­ple are think­ing about it for more down the road — if inter­est rates keep going up that Athene’s sur­ren­der lev­els on annu­ities could go up,” O’Shea said.
    ...

    And then there’s the fact that 18% of Athene’s annu­ity lia­bil­i­ties don’t have sur­ren­der charges. Yes, it turns out the whole ‘no prob­lem, we have sur­ren­der charges to save us from ear­ly with­drawals’ nar­ra­tive ignores about $33 bil­lion in lia­bil­i­ties:

    ...
    In a quar­ter­ly update to share­hold­ers pub­lished on March 13, Apol­lo out­lined how Athene’s fund­ing mod­el is dif­fer­ent than a bank’s. Most of the annu­ities that Athene pro­vides can­not be sur­ren­dered by their hold­ers, it said, and Apol­lo called its bal­ance sheet a “fortress” that can with­stand with­drawals from those who have the right to pull their mon­ey.

    Annu­ities are finan­cial prod­ucts pur­chased for a lump sum or through install­ments in exchange for a fixed stream of pay­ments over time.

    They are typ­i­cal­ly offered by insur­ance firms. Apol­lo, one of the world’s biggest pri­vate equi­ty firms, helped launch Athene in 2009 and has used the cap­i­tal raised from the annu­ities offered to earn lucra­tive fees and grow its assets beyond its tra­di­tion­al funds.

    ...

    An Apol­lo spokesper­son said Athene had ample cash and liq­uid­i­ty and that its issuance of new annu­ity poli­cies “mean­ing­ful­ly” exceed­ed the poli­cies that matured and oth­er with­drawals.

    ...

    But annu­ities worth about $33 bil­lion, equiv­a­lent to 18% of Athene’s lia­bil­i­ties, are not pro­tect­ed by sur­ren­der charges, mak­ing them eas­i­er to be with­drawn by hold­ers. Ques­tions from investors and ana­lysts to Apol­lo have focused on this sub­set of annu­ity poli­cies that have a poten­tial­ly high­er flight risk.
    ...

    Final­ly, note the type of assets Apol­lo was tout­ing as part of its assur­ances that it has enough assets on hand to weath­er any upcom­ing storms: $56.9 bil­lion in cor­po­rate bonds. It’s a finan­cial war chest for sure. A war chest that shrinks with each rate hike:

    ...
    Apol­lo in the pre­sen­ta­tion gave sev­er­al rea­sons why annu­ity hold­ers are less like­ly to with­draw their mon­ey than bank account hold­ers, includ­ing that annu­ities are long-term invest­ment prod­ucts that are typ­i­cal­ly used for retire­ment and offer high­er returns than tra­di­tion­al bank prod­ucts.

    Apol­lo also said it had $73 bil­lion in avail­able liq­uid­i­ty as of March 10 to meet any poten­tial spikes in demand for annu­ity with­drawals, includ­ing a $56.9 bil­lion fixed-income port­fo­lio com­prised most­ly of pub­licly trad­ed invest­ment-grade cor­po­rate bonds.

    Apol­lo would like­ly have to real­ize loss­es if it sold some of that port­fo­lio giv­en that the rise in inter­est rates in the last few months has led to a gen­er­al drop in the val­ue of bonds, said Argus Research ana­lyst Stephen Big­gar.
    ...

    Of course, rates and fall and this ever-grow­ing bond port­fo­lio could end up being a great invest­ment. Again, time will tell. But it’s hard to avoid notic­ing how a lot of the under­ly­ing moti­va­tion for these invest­ment strate­gies seem to have less to do with the under­ly­ing qual­i­ty of the invest­ments and more to do with the fact that these pri­vate-equi­ty firms have more and more mon­ey under man­age­ment with few­er and few­er remain­ing invest­ment oppor­tu­ni­ties to work with. More and more mon­ey under man­age­ment thanks to the insa­tiable appetite of pen­sion funds that, them­selves, hav­ing been plow­ing more and more mon­ey into pri­vate-equi­ty for the same lack of alter­na­tives.

    We’ll see if this ulti­mate­ly blows up. But it’s also worth keep­ing in mind that when you have a sit­u­a­tion where pri­vate-equi­ty firms can self-deal — like you sing the assets of insur­ance com­pa­nies they own to pur­chase the cor­po­rate debt from oth­er com­pa­nies in their own port­fo­lios that might be run­ning into dif­fi­cul­ties — and obscure, for a time, the real finan­cial sta­tus of that port­fo­lio of com­pa­nies, it might take a while for things to all apart. But when it does, let’s just say Amer­i­ca’s grow­ing retire­ment cri­sis might final­ly be too big to real­is­ti­cal­ly ignore. Not that we won’t still find an unre­al­is­tic way to ignore it.

    Posted by Pterrafractyl | July 24, 2023, 11:17 pm
  6. Up we go. Ever high­er. They did it. The Fed pulled the trig­ger and raised inter­est rates to the high­est lev­el in 22 years on Thurs­day and hint­ed at more rate hikes to come lat­er this year.

    On one lev­el, it points to a robust econ­o­my seem­ing­ly intent on a ‘soft land­ing’ in the face of his­toric rate hikes. But as we’re going to see in the fol­low­ing pair of arti­cles, the high­er these rates go the more we’re see­ing busi­ness­es forced scram­ble to adjust to a cred­it mar­ket envi­ron­ment that also has­n’t been seen in years. A cred­it mar­ket envi­ron­ment that is par­tic­u­lar­ly poor­ly suit­ed for the pri­vate equi­ty mod­el of lever­aged buy­outs in antic­i­pa­tion of an IPO.

    And that brings us to a new trend in pri­vate-equi­ty invest­ing. Two trends, in fact: first, pri­vate-equi­ty firms are increas­ing­ly pur­chas­ing the debt issued by their own ‘port­fo­lio com­pa­nies’ (i.e. the com­pa­nies held by a pri­vate-equi­ty fir­m’s invest­ment port­fo­lio man­aged on behalf of its clients). Sec­ond, it turns out that pri­vate-equi­ty firms are increas­ing­ly sell­ing shares of com­pa­nies in their port­fo­lios despite mar­ket con­di­tions being dis­tinct­ly unap­pe­tiz­ing for such sales. Oh, and it also turns out that the investors on the oth­er side of these share sales are the port­fo­lio com­pa­nies them­selves buy­ing back their own shares. So we have pri­vate-equi­ty firms pur­chas­ing the debt of their own com­pa­nies at the same time they are sell­ing shares in their com­pa­nies back to the com­pa­nies them­selves. Is this a prob­lem? Because that seems like a poten­tial prob­lem.

    Now, we should prob­a­bly had some addi­tion­al details. For starters, the reports on the new trend in pri­vate-equi­ty buy­ing the debt of their own com­pa­nies came back in April, right in the mid­dle of the region­al bank­ing cri­sis. A cri­sis that cre­at­ed some rather appe­tiz­ing oppor­tu­ni­ties for investors with cash to spend as banks scram­bling for cap­i­tal were will­ing to sell off their cor­po­rate bond hold­ings at fire sale prices. In that sense, the sto­ry was an exam­ple of the enor­mous eco­nom­ic advan­tage pri­vate-equi­ty for oppor­tunis­tic mar­ket plays like tak­ing advan­tage of crises that have oth­er mar­ket play­ers scram­bling for the exits.

    But as with all of these sto­ries, there’s anoth­er side to the sto­ry. Like the fact that banks were will­ing to sell those bonds at reduced prices in part because of the expec­ta­tion of fur­ther Fed rate hikes to come. Rate hikes that threat­en to depress the prof­its, and there­fore the share prices, of the same com­pa­nies held in these port­fo­lios. Which, of course, is direct­ly relat­ed to the sec­ond trend, which Bloomberg report­ed on ear­li­er this month, about the grow­ing vol­ume of “fol­low-on share sales” (share sales by insid­ers fol­low­ing an IPO) that are also increas­ing­ly be sold back to the port­fo­lio com­pa­nies them­selves. Share sales tak­ing place in a notably week mar­ket envi­ron­ment that has extend­ed the 12–18 month peri­od tra­di­tion­al­ly need­ed to com­plete all the fol­low-on share sales into a much longer time­frame. And as the report notes, part of the motive for these ques­tion­able share sales is the fact that ris­ing inter­est rates are not only putting a crimp on cor­po­rate prof­its but also poten­tial­ly mak­ing the upcom­ing refi­nanc­ing of cor­po­rate debt all the more expen­sive. In oth­er words, the shares are being rushed to mar­ket over fears of an even worse mar­ket to come. And that’s all why we have to ask: it’s this a loom­ing pri­vate-equi­ty prob­lem of self-deal­ing, con­flicts of inter­est, and ‘kick­ing the can down the road’ strate­gies? Or pri­vate-equi­ty earn­ing its out­sized ser­vice fees by being extra savvy? As always, time will tell.

    Ok, first, here’s that Bloomberg arti­cle from back in April, right in the mid­dle of the region­al bank­ing cri­sis, describ­ing pri­vate-equi­ty’s big play: buy­ing port­fo­lio com­pa­ny debt. And as the arti­cle notes, while there were indeed bar­gains to be had, it was still a gam­ble. The kind of gam­ble that may not pan out well should inter­est rates keep ris­ing:

    Bloomberg

    Pri­vate Equity’s Lat­est Mon­ey-Mak­ing Trade: Buy­ing Its Own Debt

    * Advent, CD&R, Elliott boost bets in port­fo­lio com­pa­nies
    * Banks offer­ing steep dis­counts to shed debt stuck on books

    By Claire Ruckin, and Paula Selig­son
    April 12, 2023 at 6:00 AM EDT
    Updat­ed on April 12, 2023 at 11:33 AM EDT

    Some of the world’s top pri­vate equi­ty firms are scoop­ing up the debt of their own port­fo­lio com­pa­nies from banks at steep dis­counts as they seek juicy returns amid a lull in deal mak­ing.

    Advent Inter­na­tion­al Corp. recent­ly bought a por­tion of a loan that helped fund its buy­out of a Roy­al DSM unit, while Clay­ton Dubili­er & Rice has pur­chased debt sup­port­ing at least two of its deals over the past year. Just last week Elliott Invest­ment Man­age­ment snapped up a $550 mil­lion chunk of bonds back­ing its acqui­si­tion of Cit­rix Sys­tems Inc. at 79 cents on the dol­lar, fol­low­ing a sim­i­lar move in Sep­tem­ber.

    The trades come as banks have stepped up efforts to offload bil­lions of dol­lars of debt stuck on their bal­ance sheets — the prod­uct of a sharp repric­ing of risk assets last year that upend­ed under­writ­ing pledges. With Wall Street will­ing to real­ize sig­nif­i­cant loss­es in some cas­es to shed the risk, buy­out firms com­ing off the weak­est quar­ter for M&A since 2020 are find­ing the often dou­ble-dig­it yields on debt of com­pa­nies they’re already well acquaint­ed with too good to pass up.

    “A lot of these pri­vate equi­ty firms are smart buy­ers of debt when the time is right,” said Steven Messi­na, head of the bank­ing group at Skad­den, Arps, Slate, Meagher & Flom LLP in its New York office. “Right now, we’re in a sit­u­a­tion where pri­vate equi­ty firms gen­er­al­ly are flush with cash and have the abil­i­ty to take advan­tage of sit­u­a­tions where the debt is trad­ing at a dis­count.”

    When firms buy the debt at the spon­sor lev­el, it’s gen­er­al­ly held as an invest­ment. This allows them to prof­it from the inter­est pay­ments, as well as any poten­tial refi­nanc­ing, sale of the com­pa­ny or ini­tial pub­lic offer­ing, where­in the debt gets repaid at around par. Some­times it’s bought via an invest­ment firm’s cred­it arm, which are often man­aged sep­a­rate­ly from the pri­vate equi­ty unit.

    Alter­na­tive­ly, the debt can be pur­chased by the port­fo­lio com­pa­ny itself, in which case it’s usu­al­ly can­celed, cut­ting future inter­est costs while reduc­ing lever­age.

    Either way, the wager is far from a sure thing. The Fed­er­al Reserve con­tin­ues to raise inter­est rates to tame run­away infla­tion, while a poten­tial reces­sion in the com­ing months could weigh on cor­po­rate earn­ings, dent­ing already depressed prices for risky debt.

    “Pri­vate equi­ty is expand­ing into oth­er venues and look­ing at dif­fer­ent ways to carve up the car­cass,” said John McClain, port­fo­lio man­ag­er at Brandy­wine Glob­al Invest­ment Man­age­ment. “There’s a con­cen­tra­tion of sin­gle-name risk.”

    ‘Pos­i­tive Sig­nal’

    Still, the appeal is plain to see.

    Elliott last week bought $550 mil­lion of sec­ond-lien bonds that are part of a $15 bil­lion debt pack­age banks under­wrote to finance its buy­out of Cit­rix with Vista Equi­ty Part­ners. The bonds have a 9% coupon and were sold at a price of 79 cents, bring­ing the all-in yield to rough­ly 14%.

    The firm made a sim­i­lar trade last year, buy­ing about $1 bil­lion of Citrix’s first-lien junk bonds from banks at around 83.6 cents on the dol­lar.

    Vista’s cred­it arm also bought a $200 mil­lion slice of the sec­ond-lien bonds, Bloomberg report­ed. A rep­re­sen­ta­tive for the firm declined to com­ment.

    “Buy­ing the debt of a port­fo­lio com­pa­ny at a dis­count is an inter­est­ing way of poten­tial­ly cre­at­ing more equi­ty val­ue at a cheap­er lev­el,” said Brad Rogoff, head of fixed-income research at Bar­clays Plc. “If you liked it at one price, you prob­a­bly like it more at a cheap­er price.”

    There are often also oth­er incen­tives for pur­chas­ing port­fo­lio com­pa­ny debt, accord­ing to CreditSights’s glob­al head of strat­e­gy Win­nie Cis­ar.

    Pri­vate equi­ty firms may val­ue the stronger nego­ti­at­ing posi­tion being a cred­i­tor affords should the com­pa­ny need to amend or extend its debt, espe­cial­ly if the eco­nom­ic out­look wors­ens, she said. Buy­ing their port­fo­lio com­pa­ny debt also sends a strong mes­sage to exist­ing and poten­tial lenders that the spon­sor has con­vic­tion in the invest­ment.

    “That’s a very pos­i­tive sig­nal to oth­er investors,” said Cis­ar. “That lends some reas­sur­ance.”

    For some firms, part of the ratio­nal is undoubt­ed­ly about main­tain­ing strong rela­tion­ships with Wall Street lever­aged finance desks, indus­try insid­ers say.

    CD&R bought a $475 mil­lion slice of debt back­ing its pur­chase of a major­i­ty stake in Rop­er Tech­nolo­gies Inc.’s indus­tri­al oper­a­tions busi­ness in Novem­ber, reliev­ing some of the bur­den on its bank lenders. The sec­ond-lien loan was offered at around 90 cents, accord­ing to peo­ple famil­iar with the mat­ter who asked not to be iden­ti­fied dis­cussing a pri­vate trans­ac­tion.

    It also bought rough­ly $464 mil­lion of risky pay­ment-in-kind notes back­ing its acqui­si­tion of Cor­ner­stone Build­ing Brands Inc. at a dis­count of about 60 cents mid-last year, the peo­ple said.

    Buy­ing junior debt of port­fo­lio com­pa­nies can also make it eas­i­er for under­writ­ers to place senior debt down the road.

    More Bar­gains

    In Europe, Advent Inter­na­tion­al recent­ly pur­chased the equiv­a­lent of €450 mil­lion of debt back­ing its buy­out of Roy­al DSM’s engi­neer­ing mate­ri­als busi­ness, which lenders under­wrote a year ago. Banks sold the remain­der of debt at a dis­count­ed price of 90 cents just before it was con­sid­ered hung, and Advent was like­ly able to secure slight­ly bet­ter terms as an ear­ly anchor order, mar­ket watch­ers say.

    Going for­ward, there are like­ly to be few­er oppor­tu­ni­ties to scoop up port­fo­lio com­pa­ny debt at dis­count­ed prices as banks con­tin­ue to chip away at the pile of hung debt on their bal­ance sheet, accord­ing to Barclays’s Rogoff. Oth­ers say a steady stream of new deals pric­ing with attrac­tive dis­counts will con­tin­ue to lure buy­out firms.

    Pri­vate equi­ty could also increas­ing­ly turn to the sec­ondary mar­ket in search of bar­gains, espe­cial­ly if high-yield bond and lever­aged loan prices remain depressed, Rogoff added.

    Some firms are already doing just that. KKR & Co.-owned Upfield bought its own Pol­ish zlo­ty and ster­ling debt worth about €250 mil­lion in recent months, accord­ing to a per­son famil­iar with the mat­ter, can­cel­ing the debt and reduc­ing its inter­est bur­den.

    ...

    “There will con­tin­ue to be sec­ondary-mar­ket oppor­tu­ni­ties that com­pa­nies can take advan­tage of,” CreditSights’s Cis­ar said.

    ———–

    “Pri­vate Equity’s Lat­est Mon­ey-Mak­ing Trade: Buy­ing Its Own Debt” By Claire Ruckin, and Paula Selig­son; Bloomberg; 04/12/2023

    The trades come as banks have stepped up efforts to offload bil­lions of dol­lars of debt stuck on their bal­ance sheets — the prod­uct of a sharp repric­ing of risk assets last year that upend­ed under­writ­ing pledges. With Wall Street will­ing to real­ize sig­nif­i­cant loss­es in some cas­es to shed the risk, buy­out firms com­ing off the weak­est quar­ter for M&A since 2020 are find­ing the often dou­ble-dig­it yields on debt of com­pa­nies they’re already well acquaint­ed with too good to pass up.”

    It was a pri­vate-equi­ty bond buy­ing bonan­za back in April, thanks in large part to bank­ing cri­sis that left region­al banks scram­bling for cash and will­ing to take a loss. In that sense, step­ping in to buy those cheap bonds might be a shrewd busi­ness deci­sion. The bank­ing cri­sis cre­at­ed a fire sale too good to pass up.

    And yet, as the arti­cle notes, it’s impor­tant to keep in mind that the same fac­tor that trig­gered the bank­ing cri­sis — rapid­ly ris­ing inter­est rates — is the same fac­tor that was depress­ing those bond prices and cre­at­ing the oppor­tu­ni­ty too good to pass up. And as we were just remind­ed of on Wednes­day’s Fed rate hike, there was nev­er a guar­an­tee rates would­n’t keep ris­ing and keep depress­ing those bond prices:

    ...
    “A lot of these pri­vate equi­ty firms are smart buy­ers of debt when the time is right,” said Steven Messi­na, head of the bank­ing group at Skad­den, Arps, Slate, Meagher & Flom LLP in its New York office. “Right now, we’re in a sit­u­a­tion where pri­vate equi­ty firms gen­er­al­ly are flush with cash and have the abil­i­ty to take advan­tage of sit­u­a­tions where the debt is trad­ing at a dis­count.”

    When firms buy the debt at the spon­sor lev­el, it’s gen­er­al­ly held as an invest­ment. This allows them to prof­it from the inter­est pay­ments, as well as any poten­tial refi­nanc­ing, sale of the com­pa­ny or ini­tial pub­lic offer­ing, where­in the debt gets repaid at around par. Some­times it’s bought via an invest­ment firm’s cred­it arm, which are often man­aged sep­a­rate­ly from the pri­vate equi­ty unit.

    Alter­na­tive­ly, the debt can be pur­chased by the port­fo­lio com­pa­ny itself, in which case it’s usu­al­ly can­celed, cut­ting future inter­est costs while reduc­ing lever­age.

    Either way, the wager is far from a sure thing. The Fed­er­al Reserve con­tin­ues to raise inter­est rates to tame run­away infla­tion, while a poten­tial reces­sion in the com­ing months could weigh on cor­po­rate earn­ings, dent­ing already depressed prices for risky debt.
    ...

    Also note how pur­chas­ing port­fo­lio com­pa­ny debt — the debt of com­pa­nies held in a pri­vate-equi­ty fir­m’s port­fo­lio — can be spun as a sign a strength and con­fi­dence in the com­pa­ny. And while that could indeed be the moti­va­tion, there’s obvi­ous­ly a range of oth­er motives when we’re talk­ing about com­pa­nies that are intend­ed to be sold off for a big prof­it some­day, espe­cial­ly if we’re in an envi­ron­ment where there sim­ply aren’t a lot pri­vate­ly-held com­pa­nies going to mar­ket of late. In oth­er words, are pri­vate-equi­ty firms pur­chas­ing their own port­fo­lio debt because they have a lot of con­fi­dence in those com­pa­nies? Or because they don’t have a lot of oth­er invest­ment options and want to low­er debt loads to sell those com­pa­nies as soon as they can?

    ...
    There are often also oth­er incen­tives for pur­chas­ing port­fo­lio com­pa­ny debt, accord­ing to CreditSights’s glob­al head of strat­e­gy Win­nie Cis­ar.

    Pri­vate equi­ty firms may val­ue the stronger nego­ti­at­ing posi­tion being a cred­i­tor affords should the com­pa­ny need to amend or extend its debt, espe­cial­ly if the eco­nom­ic out­look wors­ens, she said. Buy­ing their port­fo­lio com­pa­ny debt also sends a strong mes­sage to exist­ing and poten­tial lenders that the spon­sor has con­vic­tion in the invest­ment.

    “That’s a very pos­i­tive sig­nal to oth­er investors,” said Cis­ar. “That lends some reas­sur­ance.”
    ...

    That was the news back in April, as the bank­ing cri­sis that prompt­ed that bond sale was still shak­ing out. Jump to ear­li­er this month, and we find a very inter­est­ing new trend in self-deal­ing: pri­vate-equi­ty firms are increas­ing­ly engaged in “fol­low-on share sales” (share sales by insid­ers fol­low­ing an IPO), despite the unfa­vor­able mar­ket con­di­tions. And guess who is increas­ing­ly buy­ing those shares: the port­fo­lio com­pa­nies them­selves.

    What’s dri­ving this trend? Well, it sounds like the IPO mar­ket in gen­er­al has been awful, with the nor­mal 12 to 18 month expect­ed time­frame for a com­pa­ny ful­ly unload­ing its shares after an IPO dis­rupt­ed and tak­ing longer. As a result, pri­vate-equi­ty firms have yet to real­ize and lock in the gains much of the for their clients. Large­ly pen­sion fund clients that are increas­ing­ly over­ex­posed to pri­vate-equi­ty and eager to see results.

    But there’s anoth­er omi­nous rea­son for the rushed sales that only grew more omi­nous fol­low­ing the lat­est rate hike: ris­ing inter­est rates are depress­ing the prof­its of these port­fo­lio com­pa­nies. In oth­er words, they don’t expect these shares to actu­al­ly do well going for­ward. Bet­ter to sell them now.

    So we have pri­vate-equi­ty rush­ing the remain­ing shares in port­fo­lio com­pa­nies into a lousy mar­ket in a race against high­er inter­est rates and, in turn, increas­ing­ly sell­ing them back to the port­fo­lio com­pa­nies them­selves. Is this a pen­ny-wise but pound-fool­ish invest­ment strat­e­gy? Or some­thing savvi­er? *fin­gers crossed*:

    Bloomberg

    Pri­vate Equi­ty Firms Are Forc­ing Stock Sales Into Frag­ile Mar­ket

    Funds need to show investors prof­its regard­less of con­di­tions
    Pres­sure due to slug­gish fundrais­ing, high­er oper­at­ing costs

    By Amy Or
    July 10, 2023 at 10:07 AM EDT

    With pres­sure mount­ing on pri­vate equi­ty funds to show prof­its, many are push­ing through share sales of the com­pa­nies they own even as mar­ket con­di­tions remain far from opti­mal.

    PE-backed com­pa­nies rep­re­sent­ed 17% of the fol­low-on share sales in the sec­ond quar­ter, up from only 6% a year ear­li­er, accord­ing to data provider Dealog­ic. There were 27 deals worth $5.3 bil­lion last quar­ter, up from eight deals total­ing $1.2 bil­lion in the year-ear­li­er peri­od.

    “Funds need to recy­cle cap­i­tal,” to show they can make prof­its and attract new invest­ments, said Daniel Klaus­ner, head of equi­ty cap­i­tal mar­kets advi­so­ry at Houli­han Lokey. “They have been hav­ing a chal­leng­ing time fundrais­ing, as we are no longer in a zero-inter­est rate envi­ron­ment.”

    While fol­low-up share sales have picked up, they are prob­a­bly not going at the pace pri­vate equi­ty funds need to show mean­ing­ful gains to investors. It used to take 12 to 18 months for a fund to ful­ly unload its shares in a com­pa­ny after going pub­lic. But high volatil­i­ty vir­tu­al­ly shut down the IPO mar­ket for much of the past 18 months and dis­rupt­ed the rhythm of fol­low-ons.

    ...

    With a lack of real­ized gains on their invest­ments as proof of their capa­bil­i­ties, PE firms have a tough time con­vinc­ing insti­tu­tion­al investors like pen­sion funds and endow­ments to fork over fresh cap­i­tal for their lat­est funds. That’s exac­er­bat­ed by the fact that insti­tu­tion­al investors have an over­ex­po­sure to pri­vate equi­ty after last years’ infla­tion-fueled mar­ket swoon.

    Mar­gin Headaches

    The delay in pub­lic mar­ket exits and the result­ing longer hold peri­ods cre­ate anoth­er headache: The prof­it mar­gins of many of the com­pa­nies they own are being squeezed by high­er inter­est rates.

    “We’re in a high­er rate envi­ron­ment and some of these pri­vate com­pa­nies are lev­ered five and six times,” said UBS AG’s Brad Miller, head of US equi­ty cap­i­tal mar­kets syn­di­cate. “If that debt matu­ri­ty comes due, com­pa­nies would have to refi­nance at 200, 300 basis points high­er than where the his­tor­i­cal debt was, which is going to have an impact on your net income.”

    As a result, PE firms are get­ting cre­ative. For exam­ple, when Clay­ton Dubili­er & Rice win­nowed its posi­tion in Agilon Health Inc. in May, the PE firm agreed not to sell its remain­ing 24.7% stake for 900 days so it didn’t inun­date the mar­ket with stock and depress prices. The wait for fol­low-ons is typ­i­cal­ly 30-to-60 days.

    Pri­vate equi­ty funds also are increas­ing­ly sell­ing their stock back to the com­pa­nies them­selves, said Eric Juer­gens, a part­ner at Debevoise & Plimp­ton.

    “It allows the com­pa­ny to get a big chunk of shares back, and allows the PE spon­sor to sell shares with­out sell­ing into the mar­ket,” Juer­gens said.

    Look­ing ahead, there’s still a lot of pent-up demand for pri­vate equi­ty funds to sell down their hold­ings. Near­ly 200 pri­vate equi­ty-backed com­pa­nies list­ed in the US in 2021, and 51 more fol­lowed suit last year, Pre­qin said. Almost all of them will be prime can­di­dates for fol­low-on deals.

    ———-

    “Pri­vate Equi­ty Firms Are Forc­ing Stock Sales Into Frag­ile Mar­ket” By Amy Or; Bloomberg; 07/10/2023

    With a lack of real­ized gains on their invest­ments as proof of their capa­bil­i­ties, PE firms have a tough time con­vinc­ing insti­tu­tion­al investors like pen­sion funds and endow­ments to fork over fresh cap­i­tal for their lat­est funds. That’s exac­er­bat­ed by the fact that insti­tu­tion­al investors have an over­ex­po­sure to pri­vate equi­ty after last years’ infla­tion-fueled mar­ket swoon.

    Yikes. It appears that pri­vate-equi­ty firms are feel­ing pres­sured to bring shares to mar­ket under very non-ide­al mar­ket con­di­tions. What are the sources of these pres­sures? Well, a lack of real­ized gains for their clients — which are large­ly pen­sion funds at this point — is iron­i­cal­ly one of the pri­ma­ry rea­son these shares are being sold as pre­sum­ably sub-opti­mal prices. But there’s also the fact that pen­sion funds are sim­ply over-exposed to pri­vate equi­ty at this point mak­ing them all the more sen­si­tive to a lack of real­ized results:

    ...
    While fol­low-up share sales have picked up, they are prob­a­bly not going at the pace pri­vate equi­ty funds need to show mean­ing­ful gains to investors. It used to take 12 to 18 months for a fund to ful­ly unload its shares in a com­pa­ny after going pub­lic. But high volatil­i­ty vir­tu­al­ly shut down the IPO mar­ket for much of the past 18 months and dis­rupt­ed the rhythm of fol­low-ons.
    ...

    But then we get to the real­ly scary poten­tial sce­nario down the road pen­sion funds who are ulti­mate­ly depen­dent on the sale of these shares to see the nec­es­sary yield on their invest­ments: with inter­est rates poised to go high­er, the future sale of the remain­ing shares might have to take place in a high­er inter­est rate envi­ron­ment that has not just erod­ed the prof­its of these port­fo­lio com­pa­nies but made their debt-ser­vice more expen­sive. And because these are pri­vate-equi­ty-owned com­pa­nies, they are loaded with debt. So this is like a ‘hot pota­to’ kind of sce­nario: they need to sell those shares before ris­ing inter­est rates tank their val­ue. Fear of what’s to come is part of what’s behind this rush to mar­ket:

    ...
    The delay in pub­lic mar­ket exits and the result­ing longer hold peri­ods cre­ate anoth­er headache: The prof­it mar­gins of many of the com­pa­nies they own are being squeezed by high­er inter­est rates.

    “We’re in a high­er rate envi­ron­ment and some of these pri­vate com­pa­nies are lev­ered five and six times,” said UBS AG’s Brad Miller, head of US equi­ty cap­i­tal mar­kets syn­di­cate. “If that debt matu­ri­ty comes due, com­pa­nies would have to refi­nance at 200, 300 basis points high­er than where the his­tor­i­cal debt was, which is going to have an impact on your net income.”

    As a result, PE firms are get­ting cre­ative. For exam­ple, when Clay­ton Dubili­er & Rice win­nowed its posi­tion in Agilon Health Inc. in May, the PE firm agreed not to sell its remain­ing 24.7% stake for 900 days so it didn’t inun­date the mar­ket with stock and depress prices. The wait for fol­low-ons is typ­i­cal­ly 30-to-60 days.
    ...

    Notably, it’s the port­fo­lio com­pa­nies them­selves who are pur­chas­ing a grow­ing num­ber of these new­ly shares. And while such moves have the ben­e­fit of allow­ing the com­pa­nies to retire those shares, the shares aren’t free. Are the com­pa­nies pay­ing the low­est price they can get away with when repur­chas­ing these shares or are they padding the port­fo­lio’s imme­di­ate returns by pay­ing an inflat­ed price? We don’t know, but con­flicts of inter­est abound:

    ...
    Pri­vate equi­ty funds also are increas­ing­ly sell­ing their stock back to the com­pa­nies them­selves, said Eric Juer­gens, a part­ner at Debevoise & Plimp­ton.

    “It allows the com­pa­ny to get a big chunk of shares back, and allows the PE spon­sor to sell shares with­out sell­ing into the mar­ket,” Juer­gens said.
    ...

    And with the pri­vate-equi­ty firms pur­chas­ing the bonds of their own port­fo­lio com­pa­nies, we have to ask the ques­tion: so is it the port­fo­lio com­pa­nies that had their debt pur­chased and can­celed back in April who are now pur­chas­ing these new shares? And are they issu­ing new debt to pur­chase these shares? If so, who is ulti­mate­ly pur­chas­ing that debt? The pri­vate-equi­ty firms ben­e­fit­ing from those share pur­chas­es, per­haps? Again, time will tell.

    But let’s not for­get that the com­ple­tion of the fol­low-on share sales might allow pri­vate-equi­ty firms to exit their expo­sure to the com­pa­nies in their port­fo­lios, damn the down­stream con­se­quences. But the peo­ple work­ing for those com­pa­nies are pre­sum­ably going to care about those down­stream con­se­quences. And we’re talk­ing about the pri­vate-equi­ty indus­try here, an indus­try noto­ri­ous for lard­ing up the com­pa­nies they buy with debt and then screw­ing over the employ­ees and strip­ping the assets. So when we read about port­fo­lio com­pa­nies buy­ing the fol­low-on shares them­selves, we should prob­a­bly be ask­ing whether or not we’re look­ing at anoth­er round of that same pat­tern. Those shares aren’t free and aren’t nec­es­sar­i­ly being pur­chased at the best price.

    And while some sort of upcom­ing pri­vate-equi­ty self-deal­ing dis­as­ter sounds pos­si­ble should inter­est rates just keep tick­ing high­er and high­er, let’s not for­get the down­sides to this pan­ning out and actu­al­ly being a great invest­ment strat­e­gy. Sure, it would be great for the pri­vate-equi­ty fund man­agers and their pen­sion fund clients if all of these trends ends up being savvy moves. But when the biggest play­ers sit­ting on large piles of cash are able to cap­i­tal­ize on finan­cial crises through self-deal­ing in their large port­fo­lios of com­pa­nies, what kind of sys­temic risks does this pose to the broad­er econ­o­my? Don’t for­get that one of the clas­sic crit­i­cisms of the rise of pri­vate-equi­ty indus­try has been how it oper­ates with an unfair mar­ket advan­tage that oth­er play­ers lack, mean­ing a lot of that savvi­ness is real­ly just exploit­ing those unfair advan­tages. Advan­tages that, again, are per­verse­ly ampli­fied with large­ly pen­sion fund mon­ey these days. Pen­sion­ers increas­ing­ly rely on a busi­ness mod­el that dam­ages soci­ety and prob­a­bly should­n’t exist.

    And that’s all why we already kind of know how this ‘Heads we win, tails you lose your pen­sion fund, and soci­ety is dam­aged either way’ gam­ble is going to pan out. The details have yet to be worked out, but it’s sure to work out great for a few insid­ers, espe­cial­ly the fund man­agers, and not to great for pret­ty much every­one else, espe­cial­ly pen­sion­ers and the employ­ees of these com­pa­nies. Which is sort of the meta-busi­ness mod­el for the world in 2023, and anoth­er rea­son the pri­vate-equi­ty busi­ness mod­el, and many, many oth­er busi­ness mod­els, prob­a­bly should­n’t exist.

    Posted by Pterrafractyl | July 28, 2023, 10:29 pm
  7. Pen­sion funds increas­ing­ly invest­ing in the annu­ity indus­try is one of those fea­tures of the US’s retire­ment indus­try that should raise all sorts of ques­tions about what the future holds for Amer­i­ca’s grow­ing retire­ment cri­sis. Lim­it­ing annu­ity pay­outs to retirees to help pay pen­sion plans is a rather ques­tion­able busi­ness mod­el, after all.

    But how about pen­sion fund invest­ments in oth­er areas of insur­ance? Like auto insur­ance? What kinds of busi­ness mod­el conun­drums can we expect from these types of invest­ments? Well, we got a hint of those conun­drums thanks to a recent $90 mil­lion set­tle­ment arrived at in a law­suit that pit­ted the investors of All­state auto insur­ance indus­try against All­state’s exec­u­tives. Investors who were large­ly pen­sion funds and annu­ity funds who faced a sud­den 10% drop in the val­ue of their invest­ments back in 2015 after All­state’s exec­u­tives decid­ed to update investors on the rea­sons for the then-38% drop in quar­ter­ly prof­its.

    It was­n’t the weath­er, as the exec­u­tives had pre­vi­ous­ly sug­gest­ed. No, it turns out that the pre­cip­i­tous decline in quar­ter­ly prof­its was due to a loos­en­ing of under­writ­ing stan­dards the com­pa­ny engaged in start­ing in 2013, the year Geico over­took All­state in the auto insur­ance mar­ket. Loos­ened under­writ­ing stan­dards that, for a peri­od of time, did indeed increase All­state’s cus­tomer base. But by the last quar­ter of 2014, that busi­ness strat­e­gy came with a pre­dictable cost in the form of high­er pay­outs. It was that loos­en­ing of stan­dards, and the ini­tial­ly decep­tion about the impact of those loos­ened stan­dards, that formed the basis for the now-suc­cess­ful law­suit.

    And while it’s not clear that the pen­sion fund invest­ments in All­state were done through a pri­vate-equi­ty fund — All­state accepts a range of insti­tu­tion­al investors includ­ing pen­sion funds and hedge funds — this remains a sto­ry with poten­tial­ly sig­nif­i­cant future impli­ca­tions for the pen­sion fund indus­try’s ongo­ing and deep­en­ing love affair with pri­vate-equi­ty. Because it’s hard not to notice the par­al­lels between the short-term enrich­ment strat­e­gy pur­sued by the All­state exec­u­tives and the over­all pri­vate-equi­ty ‘heads we win, tails you lose’ busi­ness mod­el.

    And that brings us to one of the very inter­est­ing details of this law­suit: when it was first file in 2017, the pen­sion fund plain­tiffs were seek­ing to have at least part of the set­tle­ment paid via dis­gorge­ments from the top exec­u­tives’ salaries from 2014 and 2015. Which makes sense if you think about the fact that many of these plain­tiff were pos­si­ble still All­state investors. Hav­ing the com­pa­ny itself pay a fine over the malfea­sance of top exec­u­tives out to share­hold­ers might direct­ly com­pen­sate the share­hold­ers, but poten­tial­ly also impact the exist­ing share prices, a prob­lem that pre­sum­ably would­n’t come if the fine is paid via the dis­gorge­ments from the top exec­u­tives past salaries.

    Sad­ly, it does­n’t appear that such dis­gorge­ments were part of the ulti­mate $90 mil­lion set­tle­ment. At least the report­ing does­n’t men­tion it. But still, it’s nice to see pen­sion funds at least pur­su­ing the option. You nev­er know when dis­gorge­ments might come in handy for deal­ing with the pen­sion funds’ part­ners in this ‘heads we win, tails you lose your retire­ment’ indus­try.

    Ok, first, here’s a report on the $90 mil­lion set­tle­ment. A set­tle­ment pur­sued by two class­es of investor: pen­sion funds and annu­ity funds:

    Reuters

    All­state to pay $90 mln in share­hold­er set­tle­ment

    By Jonathan Stem­pel
    August 16, 2023 2:56 PM CDT
    Updat­ed

    Aug 16 (Reuters) — All­state (ALL.N) agreed to pay $90 mil­lion to set­tle a class action law­suit by share­hold­ers who accused the insur­er of defraud­ing them by con­ceal­ing that it low­ered under­writ­ing stan­dards to boost growth.

    A pre­lim­i­nary set­tle­ment was filed on Mon­day in fed­er­al court in Chica­go, and requires a judge’s approval.

    The law­suit came after All­state on Aug. 3, 2015, report­ed unex­pect­ed­ly high claims pay­outs from auto acci­dents, caus­ing a larg­er-than-expect­ed 38% decline in quar­ter­ly oper­at­ing prof­it.

    All­state’s share price fell 10.1% the next day, wip­ing out $2.8 bil­lion of mar­ket val­ue.

    Share­hold­ers said All­state had false­ly assured ear­li­er in the year that claims had been increas­ing because of fac­tors beyond its con­trol, such as the econ­o­my and weath­er.

    They said the stock fell after it became clear that loos­ened under­writ­ing stan­dards were the cause.

    The North­brook, Illi­nois-based insur­er denied wrong­do­ing, but set­tled to avoid the bur­den, cost and uncer­tain­ty of lit­i­ga­tion, accord­ing to the set­tle­ment.

    ...

    The law­suit is led by pen­sion and annu­ity funds asso­ci­at­ed with the Car­pen­ter Funds of Oak­land, Cal­i­for­nia.

    Their law firms plan to seek up to $22.5 mil­lion from the set­tle­ment for legal fees and up to $4.6 mil­lion for expens­es.

    Share­hold­ers may recov­er an aver­age 46 cents per share if a judge approves the fee and expense request.

    The case is In re All­state Corp Secu­ri­ties Lit­i­ga­tion, U.S. Dis­trict Court, North­ern Dis­trict of Illi­nois, No. 16–10510.

    ———–

    “All­state to pay $90 mln in share­hold­er set­tle­ment” By Jonathan Stem­pel; Reuters; 08/16/2023

    “The law­suit came after All­state on Aug. 3, 2015, report­ed unex­pect­ed­ly high claims pay­outs from auto acci­dents, caus­ing a larg­er-than-expect­ed 38% decline in quar­ter­ly oper­at­ing prof­it.”

    All­state’s pen­sion fund and annu­ity fund investors did­n’t like being lied to by the exec­u­tives. Espe­cial­ly when the exec­u­tives were lying about the cause of the 38% drop in quar­ter­ly oper­at­ing prof­its. Hence the set­tle­ment. $90 mil­lion paid out to the share­hold­ers at that time who actu­al­ly took a hit from the 10% drop in All­state’s stock fol­low­ing the belat­ed mea cul­pa be All­state’s top exec­u­tives that, yes, it was a loos­en­ing of the under­writ­ing stan­dards two years ear­li­er that was the cause. Not the weath­er as pre­vi­ous­ly claimed

    Again, keep in mind the grow­ing trend of pen­sion funds invest­ing in annu­ity com­pa­nies via pri­vate-equi­ty. So when we see both pen­sion fund and annu­ity funds suing over this, don’t for­get that the pen­sion funds may be behind those annu­ity fund too:

    ...
    All­state’s share price fell 10.1% the next day, wip­ing out $2.8 bil­lion of mar­ket val­ue.

    Share­hold­ers said All­state had false­ly assured ear­li­er in the year that claims had been increas­ing because of fac­tors beyond its con­trol, such as the econ­o­my and weath­er.

    They said the stock fell after it became clear that loos­ened under­writ­ing stan­dards were the cause.

    ...

    The law­suit is led by pen­sion and annu­ity funds asso­ci­at­ed with the Car­pen­ter Funds of Oak­land, Cal­i­for­nia.
    ...

    So giv­en that the law­suit suc­ceed­ed in arriv­ing at a set­tle­ment, it’s worth not­ing what the plain­tiffs orig­i­nal­ly asked for when the suit was filed back in 2017: a dis­gorge­ment of the top exec­u­tives’ salaries from 2014–2015, on top of dam­ages. And while it does­n’t appear that such dis­gorge­ments were part of the set­tle­ment, it’s a rather remark­able request from screwed over investors. Espe­cial­ly should such insur­ance-relat­ed law­suits end up hit­ting the pri­vate-equi­ty indus­try. An indus­try with a ‘heads we win, tails you lose’ busi­ness mod­el where the pri­vate-equi­ty fund man­agers make a for­tune regard­less of how the invest­ments per­form. That’s part of the sig­nif­i­cance of this law­suit: It was almost tai­lor-mode for address­ing the inher­ent gross injus­tices with the indus­try’s ‘heads we win, tails you lose’ busi­ness mod­el:

    Cour­t­house News Ser­vice

    All­state Share­hold­ers Sue Over Under­writ­ing Changes

    All­state relaxed under­writ­ing stan­dards in 2013 to boost auto insur­ance sales but did not tell investors about the change – caus­ing shares to fall more than 10 per­cent when the truth came out, a deriv­a­tive law­suit filed Thurs­day claims.

    Lor­raine Bai­ley / August 3, 2017

    CHICAGO (CN) – All­state relaxed under­writ­ing stan­dards in 2013 to boost auto insur­ance sales but did not tell investors about the change – caus­ing shares to fall more than 10 per­cent when the truth came out, a deriv­a­tive law­suit filed Thurs­day claims.

    Share­hold­ers, led by Don­na Biefeldt, sued Allstate’s CEO Thomas J. Wil­son, CFO Steven E. Shed­bik and mem­bers of the insurer’s board of direc­tors in Cook Coun­ty Court.

    In 2013, Geico passed All­state to become the sec­ond largest auto insur­er in the Unit­ed States after State Farm.

    In response, the share­hold­ers say All­state man­age­ment decid­ed to aggres­sive­ly chase growth in auto insur­ance sales, which account for 90 per­cent of its busi­ness.

    “The eas­i­est way to achieve this growth was for All­state to increase renewals and new poli­cies by loos­en­ing under­writ­ing stan­dards. Low­er­ing under­writ­ing stan­dards comes with risks, how­ev­er. In par­tic­u­lar, low­er­ing under­writ­ing stan­dards can increase PIF [poli­cies in force] but it can also increase the fre­quen­cy and cost of claims,” the com­plaint says.

    Unsur­pris­ing­ly, relax­ing under­writ­ing stan­dards improved Allstate’s sales. But by the fourth quar­ter of 2014, All­state expe­ri­enced a cor­re­spond­ing increase in claims, cut­ting direct­ly into the company’s prof­its.

    Its exec­u­tives blamed the prob­lem on exter­nal fac­tors, accord­ing to the com­plaint, with­out acknowl­edg­ing the change in under­writ­ing prac­tices.

    When All­state final­ly told investors in August 2015 that the new poli­cies were the cause of declin­ing prof­its for the past few quar­ters, Allstate’s share price fell more than 10 per­cent – from $69.38 per share to $62.34 per share.

    ...

    Share­hold­ers seek dis­gorge­ment of top exec­u­tives’ salaries for 2014 and 2015, plus dam­ages for breach of fidu­cia­ry duty and unjust enrich­ment. The com­plaint also demands share­hold­ers be allowed to vote on pro­pos­als to strength­en con­trols over finan­cial report­ing and to strength­en the board’s over­sight of under­writ­ing stan­dards.

    They are rep­re­sent­ed by Charles F. Mor­ris­sey with Mor­ris­sey & Don­ahue in Chica­go, and Bri­an J. Rob­bins with Rob­bins Arroyo in San Diego.

    All­state did not imme­di­ate­ly respond to a request for com­ment.

    ———-

    “All­state Share­hold­ers Sue Over Under­writ­ing Changes” by Lor­raine Bai­ley; Cour­t­house News Ser­vice; 08/03/2017

    Share­hold­ers seek dis­gorge­ment of top exec­u­tives’ salaries for 2014 and 2015, plus dam­ages for breach of fidu­cia­ry duty and unjust enrich­ment. The com­plaint also demands share­hold­ers be allowed to vote on pro­pos­als to strength­en con­trols over finan­cial report­ing and to strength­en the board’s over­sight of under­writ­ing stan­dards.”

    It sure would have been nice to see some top exec­u­tives have their past salaries dis­gorged. If only as a tiny first step in the right direc­tion. That did­n’t hap­pen, but it was nice to see some investors actu­al­ly call­ing for those kinds of solu­tions.

    And note how, for a while, the strat­e­gy of loos­en­ing those under­writ­ing stan­dards did indeed improve All­state’s sales. It’s a reminder of why this strat­e­gy was so tempt­ing: it was guar­an­teed to get results in the short-term. It obvi­ous­ly came with the implic­it gam­ble that those poli­cies were going to have to be paid out one day, but it worked for a while:

    ...
    Unsur­pris­ing­ly, relax­ing under­writ­ing stan­dards improved Allstate’s sales. But by the fourth quar­ter of 2014, All­state expe­ri­enced a cor­re­spond­ing increase in claims, cut­ting direct­ly into the company’s prof­its.

    Its exec­u­tives blamed the prob­lem on exter­nal fac­tors, accord­ing to the com­plaint, with­out acknowl­edg­ing the change in under­writ­ing prac­tices.

    When All­state final­ly told investors in August 2015 that the new poli­cies were the cause of declin­ing prof­its for the past few quar­ters, Allstate’s share price fell more than 10 per­cent – from $69.38 per share to $62.34 per share.
    ...

    Also note part of the motive behind the loos­en­ing under­writ­ing stan­dards: All­state was los­ing mar­ket share in 2013. Loos­en­ing under­writ­ing stan­dards was a clear way of revers­ing that trend. It came at a price. But, again, it’s not like the loos­en­ing of the under­writ­ing stan­dards did­n’t accom­plish the desired results in the short-run:

    ...
    In 2013, Geico passed All­state to become the sec­ond largest auto insur­er in the Unit­ed States after State Farm.

    In response, the share­hold­ers say All­state man­age­ment decid­ed to aggres­sive­ly chase growth in auto insur­ance sales, which account for 90 per­cent of its busi­ness.

    “The eas­i­est way to achieve this growth was for All­state to increase renewals and new poli­cies by loos­en­ing under­writ­ing stan­dards. Low­er­ing under­writ­ing stan­dards comes with risks, how­ev­er. In par­tic­u­lar, low­er­ing under­writ­ing stan­dards can increase PIF [poli­cies in force] but it can also increase the fre­quen­cy and cost of claims,” the com­plaint says.
    ...

    Also keep in mind that what we are see­ing play out in this auto insur­ance sec­tor will poten­tial­ly apply to all sort of areas of insur­ance. Health insur­ance, home insur­ance, life insur­ance. All of these sec­tors could ‘ben­e­fit’ in the short-run from loos­en­ing of under­writ­ing stan­dards. That’s, again, why the dis­gorge­ment law­suit strat­e­gy to end up being much more pop­u­lar in future years.

    Also keep in mind that, with cli­mate change wors­en­ing, it’s entire­ly pos­si­ble that ‘the weath­er’ real­ly will be the cul­prit. In oth­er words, for weath­er-vul­ner­a­ble forms of insur­ance like home and auto insur­ance, a refusal to tight­en under­writ­ing stan­dards could effec­tive­ly oper­at­ing as a ‘loos­en­ing’ over time. The insur­ance indus­try, like the pen­sion indus­try, is based on a mak­ing sane long-term bets. Which is also a reminder that the whole econ­o­my-wide par­a­digm of pay­ing top exec­u­tives gobs of mon­ey to ensure short-term share price appre­ci­a­tion isn’t actu­al­ly com­pat­i­ble with pen­sions. Or insur­ance. Or a viable future. The kind of future we won’t be able to dis­gorge our way out of.

    Posted by Pterrafractyl | August 31, 2023, 10:29 pm
  8. How dan­ger­ous would an AI-dri­ven pri­vate equi­ty firm be to the world? It’s one of those fun thoughts that’s no longer idle spec­u­la­tion. At least it won’t be some­day. It’s real­ly just a mat­ter of time before the CEOs of large invest­ment firms — some of the most expen­sive employ­ees on the plan­et — get replaced by AIs, so we might as well start think­ing about the poten­tial con­se­quences. And per­haps a good way to ask that ques­tion is to try and answer a close­ly relat­ed ques­tion: how much more, or less, dan­ger­ous would an AI pri­vate equi­ty CEO be to human­i­ty than, for exam­ple, Tim Gurn­er, the lat­est financier to ‘say the qui­et part out loud’ before quick­ly apol­o­giz­ing? Those would be the com­ments, now heard loud­ly around the world, that Gurn­er — founder of the Gurn­er Group real estate devel­op­ment firm — made at a recent Aus­tralian Finan­cial Review pan­el. Com­ments that decried how uppi­ty employ­ees were get­ting with respect to employ­ers, with all sorts of employ­ees get­ting the notion that their employ­ers are actu­al­ly for­tu­nate to have some­one capa­ble of pro­vid­ing their labor and con­tri­bu­tions. Gurn­er went on to cheer the pol­i­cy cur­rent­ly being pur­sued by cen­tral banks — notably the Fed — of rais­ing inter­est rates for the expressed pur­pose of rais­ing unem­ploy­ment and tamp­ing down wage gain demands. Gurn­er pines for “pain in the econ­o­my”, in par­tic­u­lar a rise in unem­ploy­ment by 50%, so peo­ple would relearn that they work for their employ­ers who aren’t actu­al­ly for­tu­nate to get their labor. Yep, he said that. In pub­lic.

    And then, pre­dictably, Gurn­er apol­o­gized a few days lat­er and retract­ed the insen­si­tive com­ments. Pre­sum­ably after all his pri­vate-equi­ty friends called him up and hound­ed him out for say­ing the qui­et part out loud. The ultra-rich aren’t sup­posed to pub­licly share their con­tempt for the rab­ble. It’s not just class­less. It’s like an invi­ta­tion for a class war. Or rather, an invi­ta­tion for the rab­ble to rec­og­nize that the major rea­son aver­age peo­ple have been strug­gling so much in recent decades is pre­cise­ly because the ultra-rich have been qui­et­ly wag­ing a class war the whole time. Wag­ing and win­ning that class war, one tax cut, dereg­u­la­tion, and gut­ted social pro­gram at a time. It’s like Fight Club in that you don’t talk about. Although it’s the oppo­site of Fight Club in that it’s just a few rich guys beat­ing the snot out of the mass­es ruth­less­ly for decades on end. Either way, you’re not sup­posed to talk like that.

    Tim Gurn­er obvi­ous­ly isn’t the first ultra-rich guy to express such sen­ti­ments. But he might be the first one to do so in such a big way in the era of tru­ly impres­sive AI. The kind of AI that por­tends future AIs that could plau­si­bly replace a CEO like Gurn­er for much of the deci­sion-mak­ing of the firm. So giv­en this oppor­tu­ni­ty Gurn­er gave us to once again exam­ine the ongo­ing stealth class war that’s been wage and won with bru­tal effi­cien­cy by Gurn­er and his fel­low glob­al ultra-rich, it’s worth ask­ing the ques­tion: how much more dan­ger­ous would an AI CEO be to human­i­ty than Tim Gurn­er? Which one would exhib­it more human­i­ty and pos­sess a high­er degree of empa­thy?

    And for­get hypo­thet­i­cal future intel­li­gence AIs. How about Chat­G­PT? Which one would you rather see at the helm of the Gurn­er Group, from the per­spec­tive of a non-investor who is just try­ing to sur­vive in this world? Tim Gurn­er? Or Chat­G­PT? These are the sad ques­tions we get to ask in our sad world run by fig­ures like Tim Gurn­er. Of course, for the Gurn­er Group’s investors, the answer is clear, for now, that Gurn­er as CEO would be prefer­able to Chat­G­PT. But you real­ly do have to won­der how long it will be before an AI real­ly could per­form Gurn­er’s role with just as much pro­fi­cien­cy. Because odds are the AI will be able to do the job at a frac­tion of Gurn­er’s cost too. And with­out his pub­lic image.

    But there’s anoth­er rea­son that just took place last month that made Gurn­er’s com­ments par­tic­u­lar­ly untime­ly for the finan­cial indus­try: pri­vate-equi­ty just dodged a bul­let. Again. As always.

    Or as Axios put it in the arti­cle below, Gary Gensler, head of the Secu­ri­ties and Exchange Com­mis­sion (SEC), ‘blinked’ in the face of indus­try demands to defang the new reg­u­la­tion con­gres­sion­al Democ­rats were demand­ing. Not that there aren’t new rules and reg­u­la­tions for the sec­tor. But it was by all accounts dra­mat­i­cal­ly watered down from what was being talked about just weeks ear­li­er.

    Gensler ‘blinked’, and almost no one noticed (who knows why). And then, a few weeks after Gensler ‘blinked’ with­out any­one notic­ing, Gurn­er ‘blabbed’. The tim­ing almost could­n’t have been worse.

    And while the Gurn­er Group might be pri­mar­i­ly focused on real estate devel­op­ment, it also takes insti­tu­tion­al client mon­ey like sov­er­eign wealth fund mon­ey. In oth­er words, the Gurn­er Group is effec­tive­ly a real estate focused pri­vate-equi­ty fund. As we’re going to see, the Gurn­er Group been expand­ing heav­i­ly in Aus­trali­a’s res­i­den­tial rental mar­kets, set­ting up funds that recent got $400 mil­lion in invest­ment from Sin­ga­pore’s nation­al ‘rainy day’ sov­er­eign wealth fund of for­eign reserve invest­ments and even raised $2 bil­lion back in Feb­ru­ary from an investor its choos­ing not to name to build build-to-rent (BTR) lux­u­ry apart­ments in Aus­tralia. Because it turns out the Aus­tralian-based Gurn­er Group, much like the rest of the pri­vate-equi­ty indus­try in US, isn’t required to pub­licly dis­close their investors. And that still appears to be the case in the US fol­low­ing the new SEC rul­ing.

    Of course, none of this will actu­al­ly result in the pri­vate-equi­ty indus­try’s bul­let-dodg­ing last month gar­ner­ing a large amount of pub­lic atten­tion or out­rage. As is the case with most out­ra­geous abus­es of pow­er. The pub­lic does­n’t real­ly care, in large part because the pri­vate equi­ty take-over of the eco­nom­ic has been qui­et­ly steadi­ly build­ing for decades. It’s slow motion. Not head­line grab­bing. Plus, the indus­try known for gob­bling up entire sec­tors of the econ­o­my is on its way to own­ing the media land­scape too. Because of course that’s what hap­pen­ing. What else did we expect? Odds are all the pri­vate-equi­ty-owned media isn’t going to be super keen on report­ing about how pri­vate-equi­ty just won its show­down with the SEC two weeks before Gurn­er made these remarks. Which is why, odds are, the indus­try is going to dodge anoth­er bul­let. A very bad PR bul­let, loud­ly fired by Tim Gurn­er’s big care­less mouth that got acci­den­tal­ly hon­est and gave use a glimpse at how the world looks from on high when you’re at the top of rigged pyra­mid:

    New States­man

    This is what plu­toc­ra­cy looks like

    We should applaud Tim Gurn­er for his ghoul­ish hon­esty.

    By Sohrab Ahmari
    Sep­tem­ber 13, 2023

    Tim Gurn­er is an Aus­tralian prop­er­ty devel­op­er with a net worth north of £500 mil­lion and an obses­sion with the pseu­do­science of “anti-age­ing”. Mem­bers of Saint Haven, his pri­vate club in Mel­bourne, skin­ny-dip in ice water, take IV drips, retreat to “med­i­ta­tion caves” and par­take in some­thing called “cryother­a­py”, among oth­er steps aimed at halt­ing the rav­ages of decrepi­tude. When he isn’t fight­ing human nature, Gurn­er wages class war­fare.

    At a recent prop­er­ty sum­mit con­vened by Australia’s Finan­cial Review, Gurn­er ven­tured to explain what ails the world: name­ly, work­ing-class people’s rel­a­tive gains in terms of wages and pow­er amid tighter labour mar­kets brought about by the pan­dem­ic and its after­math.

    “We need to see unem­ploy­ment rise,” Gurn­er declared. “Unem­ploy­ment has to jump 40, 50 per cent in the econ­o­my. We need to see pain in the econ­o­my. We need to remind peo­ple that they work for the employ­er, not the oth­er way around. There’s been a sys­tem­at­ic change where employ­ees feel the employ­er is extreme­ly lucky to have them, as opposed to the oth­er way around. It’s a dynam­ic that has to change, we’ve got to kill that atti­tude, and that has to come through hurt­ing the econ­o­my, which is what the whole glob­al – the world – is try­ing to do… to increase unem­ploy­ment to get back to some sort of nor­mal­i­ty.”

    ...

    Neolib­er­al­ism is a fuzzy sig­ni­fi­er imbued with a mul­ti­tude of mean­ings by those who deploy it. Crit­ics asso­ciate it with dereg­u­la­tion, deu­nion­i­sa­tion, pri­vati­sa­tion, finan­cial­i­sa­tion and cor­po­rate-led glob­al­i­sa­tion, as well as an impov­er­ished “pol­i­tics” in which mate­r­i­al con­di­tions and the com­mon good are occlud­ed by ques­tions of iden­ti­ty and self-expres­sion. These asso­ci­a­tions aren’t incor­rect, but they don’t get at the basic pur­pose of the neolib­er­al order: what the eco­nom­ic geo­g­ra­ph­er David Har­vey calls a “restora­tion of class pow­er” that rescind­ed the class com­pro­mis­es struck, on both sides of the Atlantic, after the Depres­sion and two world wars.

    The oth­er ele­ments of neolib­er­al­ism all serve this deep­er pur­pose. Pri­vatis­ing pub­lic goods – includ­ing fire­fight­ing and emer­gency ser­vices in the US – not only opens up fresh avenues for prof­i­teer­ing, but shrinks the pub­lic realm where ordi­nary peo­ple can con­test the dis­tri­b­u­tion of social resources. The takeover of the real econ­o­my by finance trans­forms the cor­po­rate form into a pure ser­vant of short-term pri­vate gains, heed­less of any larg­er pub­lic ben­e­fit. Neolib­er­al glob­al­i­sa­tion allows cap­i­tal to play states against each oth­er in a race to the bot­tom to “attract invest­ment” – and removes deci­sion-mak­ing from pop­u­lar sov­er­eigns and into the hands of transna­tion­al bod­ies and “experts”.

    Nowhere is this neolib­er­al will to pow­er more appar­ent, how­ev­er, than in the direct assault on labour’s pow­er – the stuff of Gurner’s tirade, in oth­er words. As Gurn­er made clear, in order to ensure the dom­i­na­tion of the asset-less many by the asset-rich few, it is essen­tial to restore what he con­sid­ers “some sort of nor­mal­i­ty” in labour mar­kets. And “nor­mal­i­ty”, by Gurner’s reck­on­ing and that of his neolib­er­al con­frères, means slack labour mar­kets, in which high­er unem­ploy­ment trans­lates into low­er wages and thus a small­er wage share of the social income. Intro­duc­ing slack into labour mar­kets via high inter­est rates – “what the whole world is try­ing to do,” as Gurn­er put it – also instils a greater sense of fear and pre­car­i­ty that makes work­ers less like­ly to exert polit­i­cal or on-the-job pres­sure for bet­ter con­di­tions.

    Boost­ing inter­est rates is the clas­sic strat­e­gy for achiev­ing this, deployed noto­ri­ous­ly by the Fed­er­al Reserve chair­man Paul Vol­ck­er in the 1980s to tack­le the “stagfla­tion” that char­ac­terised the pre­vi­ous decade – caus­ing exact­ly the kind of reces­sion­ary “pain” Gurn­er fan­ta­sis­es about today. And while the Biden admin­is­tra­tion is in many ways opposed to the neolib­er­al con­sen­sus, Volcker’s cur­rent suc­ces­sor, Jerome Pow­ell, has made it clear that he views the wage-price com­po­nent of infla­tion – as clear an index of work­er pow­er as any – as the main prob­lem (not, you know, share­hold­er greed for prof­its).

    Mad­den­ing­ly, neolib­er­als and lib­er­tar­i­ans insist that employ­ers and employ­ees enjoy the free­dom to enter into and exit employ­ment agree­ments, and thus their rela­tions are ordi­nar­i­ly opti­mal and shouldn’t be inter­fered with by unions or gov­ern­ment. At the same time, they mil­i­tate against full employ­ment, pre­cise­ly to cre­ate lop­sided pow­er asym­me­tries between work­ers and boss­es.

    In the US, the results of Gurner’s “nor­mal­i­ty” have been stag­nant real wages for the bot­tom half of work­ers going back two gen­er­a­tions, and an econ­o­my in which half of fast-food work­ers and a quar­ter of adjunct col­lege teach­ers have to rely on wel­fare to make ends meet; and in which four in ten Amer­i­cans would strug­gle to come up with $400 in cash to pay for an emer­gency pro­ce­dure, accord­ing to the Fed. Under the Thatch­er-Blair-Gurn­er dis­pen­sa­tion, Britain has sim­i­lar­ly moved towards a low-wage, low-work­er-pow­er econ­o­my.

    ...

    ———

    “This is what plu­toc­ra­cy looks like” by Sohrab Ahmari; New States­man; 09/13/2023

    ““We need to see unem­ploy­ment rise,” Gurn­er declared. “Unem­ploy­ment has to jump 40, 50 per cent in the econ­o­my. We need to see pain in the econ­o­my. We need to remind peo­ple that they work for the employ­er, not the oth­er way around. There’s been a sys­tem­at­ic change where employ­ees feel the employ­er is extreme­ly lucky to have them, as opposed to the oth­er way around. It’s a dynam­ic that has to change, we’ve got to kill that atti­tude, and that has to come through hurt­ing the econ­o­my, which is what the whole glob­al – the world – is try­ing to do… to increase unem­ploy­ment to get back to some sort of nor­mal­i­ty.””

    Surg­ing unem­ploy­ment is a social good, accord­ing to Gurn­er Group founder Tim Gurn­er, because it will put work­ers back in their place. The pro­les are get­ting too uppi­ty, it seems. Sure, Gurn­er has now recant­ed those words fol­low­ing the glob­al out­cry. But the arti­cle points out, there’s no real way to deny what he said. Gurn­er was just regur­gi­tat­ing the unspo­ken rules of neolib­er­al­ism. Along with the unspo­ken goal. A goal of revers­ing the class gains of the last cen­tu­ry and return­ing to a more feu­dal era. A time when the serfs know their place. Which hap­pens be be beneath the boot of the ultra-wealthy. Wealth is for the wealthy. Work is for the poor:

    ...
    Neolib­er­al­ism is a fuzzy sig­ni­fi­er imbued with a mul­ti­tude of mean­ings by those who deploy it. Crit­ics asso­ciate it with dereg­u­la­tion, deu­nion­i­sa­tion, pri­vati­sa­tion, finan­cial­i­sa­tion and cor­po­rate-led glob­al­i­sa­tion, as well as an impov­er­ished “pol­i­tics” in which mate­r­i­al con­di­tions and the com­mon good are occlud­ed by ques­tions of iden­ti­ty and self-expres­sion. These asso­ci­a­tions aren’t incor­rect, but they don’t get at the basic pur­pose of the neolib­er­al order: what the eco­nom­ic geo­g­ra­ph­er David Har­vey calls a “restora­tion of class pow­er” that rescind­ed the class com­pro­mis­es struck, on both sides of the Atlantic, after the Depres­sion and two world wars.

    The oth­er ele­ments of neolib­er­al­ism all serve this deep­er pur­pose. Pri­vatis­ing pub­lic goods – includ­ing fire­fight­ing and emer­gency ser­vices in the US – not only opens up fresh avenues for prof­i­teer­ing, but shrinks the pub­lic realm where ordi­nary peo­ple can con­test the dis­tri­b­u­tion of social resources. The takeover of the real econ­o­my by finance trans­forms the cor­po­rate form into a pure ser­vant of short-term pri­vate gains, heed­less of any larg­er pub­lic ben­e­fit. Neolib­er­al glob­al­i­sa­tion allows cap­i­tal to play states against each oth­er in a race to the bot­tom to “attract invest­ment” – and removes deci­sion-mak­ing from pop­u­lar sov­er­eigns and into the hands of transna­tion­al bod­ies and “experts”.

    Nowhere is this neolib­er­al will to pow­er more appar­ent, how­ev­er, than in the direct assault on labour’s pow­er – the stuff of Gurner’s tirade, in oth­er words. As Gurn­er made clear, in order to ensure the dom­i­na­tion of the asset-less many by the asset-rich few, it is essen­tial to restore what he con­sid­ers “some sort of nor­mal­i­ty” in labour mar­kets. And “nor­mal­i­ty”, by Gurner’s reck­on­ing and that of his neolib­er­al con­frères, means slack labour mar­kets, in which high­er unem­ploy­ment trans­lates into low­er wages and thus a small­er wage share of the social income. Intro­duc­ing slack into labour mar­kets via high inter­est rates – “what the whole world is try­ing to do,” as Gurn­er put it – also instils a greater sense of fear and pre­car­i­ty that makes work­ers less like­ly to exert polit­i­cal or on-the-job pres­sure for bet­ter con­di­tions.
    ...

    And as Gurn­er remind­ed us with his com­ments about how, “we’ve got to kill that atti­tude, and that has to come through hurt­ing the econ­o­my, which is what the whole glob­al – the world – is try­ing to do… to increase unem­ploy­ment to get back to some sort of nor­mal­i­ty,” that class war­fare sen­ti­ment and a desire to keep the poors in their place real­ly is being pur­sued around the globe, espe­cial­ly be cen­tral banks that have long view wage infla­tion as the most per­ni­cious form of infla­tion pos­si­ble and an excuse to hike rates in the pur­suit of high­er unem­ploy­ment and low­er wages. It’s pre­sum­ably part of why Gurn­er felt the need to issue a pub­lic apol­o­gy: he was­n’t just say­ing his own ‘qui­et part out loud’. He was shar­ing the finan­cial world’s gen­er­al sen­ti­ment. Fed Chair Jerome Pow­ell has­n’t been shy about express­ing exact­ly that opin­ion. The real­ly is a glob­al elite desire to reign in the rab­ble with the threat of unem­ploy­ment. Or as Gurn­er might put it, a “return to nor­mal­cy”. The kind of nor­mal­cy an aris­to­crat might find famil­iar:

    ...
    Boost­ing inter­est rates is the clas­sic strat­e­gy for achiev­ing this, deployed noto­ri­ous­ly by the Fed­er­al Reserve chair­man Paul Vol­ck­er in the 1980s to tack­le the “stagfla­tion” that char­ac­terised the pre­vi­ous decade – caus­ing exact­ly the kind of reces­sion­ary “pain” Gurn­er fan­ta­sis­es about today. And while the Biden admin­is­tra­tion is in many ways opposed to the neolib­er­al con­sen­sus, Volcker’s cur­rent suc­ces­sor, Jerome Pow­ell, has made it clear that he views the wage-price com­po­nent of infla­tion – as clear an index of work­er pow­er as any – as the main prob­lem (not, you know, share­hold­er greed for prof­its).

    Mad­den­ing­ly, neolib­er­als and lib­er­tar­i­ans insist that employ­ers and employ­ees enjoy the free­dom to enter into and exit employ­ment agree­ments, and thus their rela­tions are ordi­nar­i­ly opti­mal and shouldn’t be inter­fered with by unions or gov­ern­ment. At the same time, they mil­i­tate against full employ­ment, pre­cise­ly to cre­ate lop­sided pow­er asym­me­tries between work­ers and boss­es.

    In the US, the results of Gurner’s “nor­mal­i­ty” have been stag­nant real wages for the bot­tom half of work­ers going back two gen­er­a­tions, and an econ­o­my in which half of fast-food work­ers and a quar­ter of adjunct col­lege teach­ers have to rely on wel­fare to make ends meet; and in which four in ten Amer­i­cans would strug­gle to come up with $400 in cash to pay for an emer­gency pro­ce­dure, accord­ing to the Fed. Under the Thatch­er-Blair-Gurn­er dis­pen­sa­tion, Britain has sim­i­lar­ly moved towards a low-wage, low-work­er-pow­er econ­o­my.
    ...

    So with Tim Gurn­er acci­den­tal­ly expos­ing him­self, and his indus­try peers, to the world, it’s worth ask­ing: so who are the Gurn­er Group’s investor clients? Pen­sion funds pos­si­bly? Oth­er ‘lit­tle peo­ple’ who need to be put in their place? It sure would be inter­est­ing to know how those types of investors feel about part­ner­ing with the Gurn­er Group.

    And that brings us to the fol­low­ing arti­cle in the Aus­tralian Finan­cial Review from Feb­ru­ary of this year about the $2 bil­lion raised by the Gurn­er Group for its ‘build-to-rent’ (BTR) invest­ment fund. A fund set up to build rental prop­er­ties in Aus­tralia. Specif­i­cal­ly, lux­u­ry rental prop­er­ties. This isn’t about address­ing Aus­trali­a’s afford­able hous­ing cri­sis. It’s about mak­ing mon­ey for Gurn­er and his investors.

    So who gave the Gurn­er Group $2 bil­lion months ago to build lux­u­ry rental prop­er­ties in Aus­tralia? We have no idea because the Gurn­er Group isn’t say­ing and they don’t have to say. Which is a reminder that Gurn­er’s ‘starve the poors’ atti­tude is oper­at­ing in an indus­try that enjoy with extra­or­di­nary priv­i­leges glob­al­ly:

    Finan­cial Review

    Rich Lis­ter Tim Gurn­er rais­es $2b for Syd­ney build-to-rent push

    Lar­ry Schlesinger
    Feb 21, 2023 – 7.00pm

    Rich list devel­op­er Tim Gurn­er and real estate financier Qual­i­tas have secured a $2 bil­lion cap­i­tal injec­tion from an off­shore insti­tu­tion­al investor to dri­ve the growth of their build-to-rent plat­form, as they look to expand its pres­ence in Syd­ney.

    The block­buster rais­ing for the sec­ond fund under the GQ Mul­ti­fam­i­ly Build-to-Rent plat­form fol­lows the joint ven­ture part­ners secur­ing $1.2 bil­lion of equi­ty invest­ments for the first fund, includ­ing a cor­ner­stone back­ing from a sov­er­eign wealth fund.

    Most of this ini­tial cap­i­tal has already been com­mit­ted to four BTR projects – three in Mel­bourne and one in Syd­ney – that are either under con­struc­tion or close to start­ing and that will yield over 1400 apart­ments once com­plete.

    Mr Gurn­er, who last year secured $400 mil­lion from Sin­ga­pore­an sov­er­eign wealth fund GIC, to grow his east coast build-to-sell apart­ment busi­ness, would not dis­close the iden­ti­ty of the new $2 bil­lion BTR investor, but con­firmed there was no Aus­tralian mon­ey involved.

    Off­shore insti­tu­tion­al investors, who already have stakes in Aus­tralian BTR projects include US pri­vate equi­ty giant Black­stone, which this month flagged fur­ther invest­ment in Aus­tralia, and GIC, which is back­ing Gro­con scion Daniel Grollo’s $2 bil­lion Home BTR plat­form.

    ...

    While not specif­i­cal­ly focused on one Syd­ney, Mr Gurn­er said he was keen to do a lot more in Syd­ney, pro­vid­ed devel­op­ment site val­ues start­ed to fall.

    “We believe that all cap­i­tal cities, but Syd­ney espe­cial­ly will expe­ri­ence a 15–20 per cent cor­rec­tion in land price in the com­ing 12 months, so we will be ready to jump on any oppor­tu­ni­ties that arise,” he said.

    With $3.2 bil­lion raised across the two BTR funds cre­at­ing a future pipeline of 3500 rental apart­ments, the GQ plat­form is on track to achiev­ing its goal of hav­ing 5000 apart­ments worth $5 bil­lion under man­age­ment by 2026.

    ASX-list­ed Qual­i­tas, which will report its half-year results on Wednes­day, has launched a fund pro­vid­ing both equi­ty and debt to the fast-expand­ing BTR sec­tor. In August, Qual­i­tas secured a $700 mil­lion invest­ment man­date from the Abu Dhabi Invest­ment Author­i­ty to grow its devel­op­er lend­ing busi­ness.

    Glob­al head of real estate and co-founder Mark Fis­ch­er said the fund man­ag­er saw “huge oppor­tu­ni­ty for the build-to-rent mar­ket in Aus­tralia” giv­en insti­tu­tion­al own­er­ship of rental units is as high as 11 per cent in the US, but only just tak­ing off local­ly.

    “Our ambi­tion is to be a dom­i­nant play­er in the Aus­tralian build-to-rent mar­ket and with this lat­est invest­ment, we are on our way to achiev­ing this,” Mr Fis­ch­er said.

    Amid an ongo­ing rental cri­sis dri­ven by record low vacan­cy rates in the cap­i­tal city mar­kets, apart­ments devel­oped by Gurn­er-Qual­i­tas won’t be at the afford­able end of the mar­ket, but will instead be tar­get­ed at young pro­fes­sion­als want­i­ng to rent lux­u­ry, inner-city accom­mo­da­tion with a pletho­ra of ameni­ties.

    ...

    ————-

    “Rich Lis­ter Tim Gurn­er rais­es $2b for Syd­ney build-to-rent push” by Lar­ry Schlesinger; Finan­cial Review; 02/21/2023

    “Mr Gurn­er, who last year secured $400 mil­lion from Sin­ga­pore­an sov­er­eign wealth fund GIC, to grow his east coast build-to-sell apart­ment busi­ness, would not dis­close the iden­ti­ty of the new $2 bil­lion BTR investor, but con­firmed there was no Aus­tralian mon­ey involved.”

    Who is that mys­te­ri­ous $2 bil­lion investor? It sure is an inter­est­ing ques­tion now that Gurn­er has turned him­self into an ene­my of the com­mon man. What kind of investors are these? Investors osten­si­bly work­ing for the com­mon man, per­haps? Pen­sion funds? Sov­er­eign Wealth funds? Gurn­er isn’t say­ing, oth­er than that it’s off­shore mon­ey. But thanks to the extreme secre­cy enjoyed by his indus­try we have no idea who it is, which also pre­sum­ably means this inter­na­tion­al investor hails from a coun­try with its own secre­cy rules in place that allow this investor to keep their own invest­ments secret too.

    Intrigu­ing­ly, this $2 bil­lion mys­tery invest­ment came weeks after reports that Black­stone was also plan­ning fur­ther BTR invest­ments of its own in Aus­trali­a’s mar­ket. Which rais­es the ques­tion: could the mys­tery investor be Black­stone’s own Aus­tralian BTR fund? We have no idea, but it’s hard to avoid sus­pi­cions giv­en the secre­cy:

    ...
    Off­shore insti­tu­tion­al investors, who already have stakes in Aus­tralian BTR projects include US pri­vate equi­ty giant Black­stone, which this month flagged fur­ther invest­ment in Aus­tralia, and GIC, which is back­ing Gro­con scion Daniel Grollo’s $2 bil­lion Home BTR plat­form.
    ...

    And just note the kind of impact the Gurn­er Group’s real estate invest­ments are going to have on Aus­trali­a’s hous­ing mar­ket: it’s exclu­sive­ly lux­u­ry hous­ing. In oth­er words, these are the kinds of invest­ments that are only going to exac­er­bate exist­ing hous­ing afford­abil­i­ty crises:

    ...
    Glob­al head of real estate and co-founder Mark Fis­ch­er said the fund man­ag­er saw “huge oppor­tu­ni­ty for the build-to-rent mar­ket in Aus­tralia” giv­en insti­tu­tion­al own­er­ship of rental units is as high as 11 per cent in the US, but only just tak­ing off local­ly.

    “Our ambi­tion is to be a dom­i­nant play­er in the Aus­tralian build-to-rent mar­ket and with this lat­est invest­ment, we are on our way to achiev­ing this,” Mr Fis­ch­er said.

    Amid an ongo­ing rental cri­sis dri­ven by record low vacan­cy rates in the cap­i­tal city mar­kets, apart­ments devel­oped by Gurn­er-Qual­i­tas won’t be at the afford­able end of the mar­ket, but will instead be tar­get­ed at young pro­fes­sion­als want­i­ng to rent lux­u­ry, inner-city accom­mo­da­tion with a pletho­ra of ameni­ties.
    ...

    And in case it’s not clear that the kind of secre­cy enjoyed by the Gurn­er Group in Aus­tralia is also rou­tine for the pri­vate-equi­ty indus­try in the US, here’s a look at a poten­tial­ly mas­sive change in how pri­vate-equi­ty was forced to oper­ate in the US. At least that’s how it looked last month when the fol­low­ing For­tune Mag­a­zine arti­cle was writ­ten and the SEC had yet to rule on the new slate of reg­u­la­tions backed by con­gres­sion­al Democ­rats like Eliz­a­beth War­ren. New rules like a require­ment to issue quar­ter­ly per­for­mance reports or con­duct annu­al audits. Along with new rules on the pub­lic dis­close of investors. Yep, pri­vate-equi­ty can legal­ly keep its investors secret under the cur­rent reg­u­la­tions. And this is still the case despite pri­vate-equi­ty eclips­ing com­mer­cial bank­ing in 2020. It’s a giant, and rapid­ly grow­ing, large­ly unreg­u­lat­ed shad­ow bank­ing sec­tor of the glob­al econ­o­my.

    Now, as we’ll see, this slate of new rules that promised to gut the indus­try’s abil­i­ty to oper­ate in the shad­ows were, them­selves, gut­ted at the last minute when the SEC made its rul­ing a few weeks ago. The indus­try dodge the bul­let again. But it’s worth not­ing that it was just last month when it looked like pri­vate equi­ty might final­ly be fac­ing a kind of moment of truth...before dodg­ing the bul­let as usu­al:

    For­tune

    The $25 tril­lion sec­tor that includes VC, PE, and hedge funds is bat­tling new rules that would shine a light on what they’re actu­al­ly up to. The clock is tick­ing

    BY Rachel Shin
    August 8, 2023 at 6:00 AM CDT

    In recent years, the val­ue of assets man­aged by the pri­vate funds indus­try has bal­looned to a stag­ger­ing $25 tril­lion, over­tak­ing com­mer­cial bank­ing in size. You know this sec­tor already: it includes hedge funds, ven­ture cap­i­tal and pri­vate equi­ty. But the clock is tick­ing down for a tough new set of reg­u­la­tions to take effect that do the one thing that “pri­vate” cap­i­tal is designed to avoid: forc­ing firms to dis­close more about their invest­ments. It could also crimp those lucra­tive prof­its, too.

    Last year, the Secu­ri­ties and Exchange Com­mis­sion pro­posed new rules for the indus­try that it may adopt as soon as this month, the Wall Street Jour­nal report­ed, cit­ing peo­ple famil­iar with the mat­ter. It would be a major change for pri­vate funds, which have, until now, enjoyed loose reg­u­la­tion. The pri­vate mar­ket has bur­geoned and drawn investors because of its lack of reg­u­la­tion com­pared to the pub­lic mar­ket, which has become increas­ing­ly reg­u­lat­ed over time, Steven Kaplan, a pri­vate equi­ty researcher at the Uni­ver­si­ty of Chica­go, said.

    “The pro­posed rule will fun­da­men­tal­ly alter the fruit­ful, long­stand­ing rela­tion­ships between pri­vate funds and their sophis­ti­cat­ed investors, who will find it hard­er to deliv­er for ben­e­fi­cia­ries,” Bryan Cor­bett, CEO of the Man­aged Funds Asso­ci­a­tion wrote in a state­ment to For­tune. “Many investors will expe­ri­ence high­er fees and decreased trans­paren­cy. Oth­ers will have reduced access to invest­ment oppor­tu­ni­ties.”

    Kaplan large­ly con­curred, say­ing, “you might decrease the returns or increase fees.” He also offered a hedged pre­dic­tion: “And you’ll have more con­cen­tra­tion among the larg­er play­ers.”

    ...

    Here’s just how much is at stake—and why the pri­vate funds sec­tor is fight­ing this change so hard they’ve even set up a non­prof­it enti­ty entire­ly devot­ed to fore­stalling the change.

    An embat­tled sec­tor

    The rules, called The Pri­vate Funds Pro­pos­al, would require pri­vate equi­ty firms and hedge funds to con­duct annu­al audits of their finan­cial state­ments and report quar­ter­ly invest­ment per­for­mance to clients. They would pro­vide guide­lines about pro­vid­ing dis­clo­sures to clients, and would also increase firms’ lia­bil­i­ty for neg­li­gence and mis­man­age­ment, and ban the now com­mon prac­tice of giv­ing “side let­ters,” or pref­er­en­tial terms, to high-pro­file investors.

    Pri­vate funds in this sec­tor man­age the mon­ey of wealthy indi­vid­u­als, pen­sion funds, and uni­ver­si­ties. They are now the most pop­u­lar place to park big mon­ey, as they have brought big­ger returns on invest­ments than the pub­lic mar­ket, includ­ing stocks and mutu­al funds, in recent years.

    In 2020 the pri­vate funds indus­try leapfrogged over the com­mer­cial bank sec­tor, with near­ly $3 tril­lion more in gross invest­ment assets. But the SEC and pol­i­cy­mak­ers think it may be time to rein pri­vate funds in, fear­ing that a lack of trans­paren­cy could allow firms to over­charge investors and lie about the val­u­a­tions of their port­fo­lios.

    The pri­vate fund sec­tor is opaque, as cur­rent­ly there are no guide­lines for funds to val­ue their hold­ings, report invest­ment per­for­mance to their clients, and dis­close the fees that they charge clients. They’re also under no require­ment to dis­close infor­ma­tion about their clients, includ­ing their iden­ti­ties, or infor­ma­tion about how the firms raise mon­ey.

    “The pri­vate equi­ty firms in the past, some of them have not been so clear [on dis­clo­sures] and that was a mis­take on their part,” Kaplan, one of the fore­most schol­ars on pri­vate funds, said. “If the rules say they have to dis­close but give some guid­ance as to what is okay, that would actu­al­ly be a ben­e­fit with­out a lot of costs.”

    But Kaplan thinks the audit require­ments are “in some sense irrel­e­vant” and an unnec­es­sary cost. Because the firms only get paid upon sell­ing some­thing, inter­im reports between sales are a waste of mon­ey, he said.

    The new rules are main­ly being pushed by Democ­rats, who out­lined their argu­ments in a May let­ter. Signed by eight Demo­c­ra­t­ic sen­a­tors, the let­ter said that more guardrails are need­ed to pre­vent bad prac­tices. Because pri­vate funds direct­ly com­pete with banks, they deserve to be over­seen and reg­u­lat­ed in sim­i­lar ways, they said.

    “Trou­bling­ly, there is lim­it­ed data on fund size and fund activ­i­ties, and almost no data on the fees assessed by those funds,” the let­ter, co-signed by Sen. Eliz­a­beth War­ren and her col­leagues, reads. “Investors need increased trans­paren­cy, more infor­ma­tive and use­ful data, and pro­hi­bi­tions on abu­sive and con­flict­ed prac­tices.”

    Tighter reg­u­la­tions could be a blow to the indus­try just as it starts to feel the effects of last year’s finan­cial down­turn. For the first time since the finan­cial cri­sis in 2009, pri­vate equi­ty funds have report­ed neg­a­tive annu­al returns for the year end­ing March 31. The sector’s deal vol­ume also decreased 26% and its deal count fell 15%, to $2.4 tril­lion and 60,000 respec­tive­ly, accord­ing to con­sult­ing firm McK­in­sey.

    Pri­vate funds are push­ing back aggres­sive­ly on the pro­posed rules. In the 18 months since the reg­u­la­tions were first sug­gest­ed, the indus­try has band­ed togeth­er on a lob­by­ing effort against the reg­u­la­tions. As part of the lob­by­ing push, sev­er­al funds, includ­ing Mil­len­ni­um Man­age­ment and HBK Cap­i­tal Man­age­ment, cre­at­ed a non­prof­it to head off the pro­posed rules, the Wall Street Jour­nal report­ed.

    ...

    In an April 2022 let­ter from the non­prof­it, the indus­try argued to the SEC that it has a prece­dent of loose reg­u­la­tion, and that the SEC has no author­i­ty to adopt the new rules because pri­vate funds have long been exempt­ed from such restric­tions by Con­gress. The rules would also dis­crim­i­nate against pri­vate funds com­pared to oth­er mon­ey man­agers like those that rep­re­sent retail investors, the let­ter claims.

    “Because the Pro­posed Rules result in unsup­port­ed dis­crim­i­na­to­ry treat­ment of pri­vate funds and their advis­ers, they are arbi­trary and capri­cious,” the let­ter reads. “This is whol­ly con­trary to the pre­vi­ous­ly expressed posi­tions of the Com­mis­sion that pri­vate funds were appro­pri­ate only for cer­tain sophis­ti­cat­ed clients and, giv­en that such funds were not avail­able to retail investors, pri­vate funds did not need to be sub­ject to the same restric­tions as pub­lic funds.”

    But the sen­a­tors argue that if trans­paren­cy rules had been in place ear­li­er, the dam­age done by pre­vi­ous crises like FTX’s col­lapse could’ve been reduced. FTX was a lead­ing cryp­tocur­ren­cy exchange once val­ued at $32 bil­lion before it implod­ed in Novem­ber after alleged crim­i­nal mis­man­age­ment and a large vol­ume of with­drawals caused it to file for bank­rupt­cy. While the pro­posed new rules wouldn’t have pre­vent­ed the fraud and mon­ey laun­der­ing at the exchange, investors at firms that invest­ed in FTX could have accessed “crit­i­cal detail” that could have served as a “start­ing place to ques­tion those val­ues” that under­laid the fraud, the sen­a­tors said.

    For large firms, the pro­pos­al will be an annoy­ance but not an exis­ten­tial cri­sis, accord­ing to Kaplan. “The Black­stones of the world” can afford to hire new teams of lawyers and accoun­tants to tack­le the reg­u­la­tions, but small pri­vate funds might not, and it will become hard­er for new firms to enter the mar­ket because of increased fixed costs, he said. So could the pro­pos­al kill the pri­vate funds indus­try? No—but it may dec­i­mate it, shrink­ing the sec­tor and pop­u­lat­ing it with a few larg­er firms.

    ———-

    “The $25 tril­lion sec­tor that includes VC, PE, and hedge funds is bat­tling new rules that would shine a light on what they’re actu­al­ly up to. The clock is tick­ing” by Rachel Shin; For­tune; 08/08/2023

    Last year, the Secu­ri­ties and Exchange Com­mis­sion pro­posed new rules for the indus­try that it may adopt as soon as this month, the Wall Street Jour­nal report­ed, cit­ing peo­ple famil­iar with the mat­ter. It would be a major change for pri­vate funds, which have, until now, enjoyed loose reg­u­la­tion. The pri­vate mar­ket has bur­geoned and drawn investors because of its lack of reg­u­la­tion com­pared to the pub­lic mar­ket, which has become increas­ing­ly reg­u­lat­ed over time, Steven Kaplan, a pri­vate equi­ty researcher at the Uni­ver­si­ty of Chica­go, said.”

    New rules for pri­vate-equi­ty are on the way! At least that’s how it looked last year when the Pri­vate Funds Pro­pos­al was I’ll get­ting for­mu­lat­ed. Not only would pri­vate-equi­ty firms and hedge funds be forced to issue quar­ter­ly per­for­mance reports to clients and con­duct annu­al audits, and actu­al­ly dis­close to clients the fees they are charg­ing, but they could be forced to dis­close infor­ma­tion about clients too. Infor­ma­tion like client iden­ti­ties:

    ...
    The rules, called The Pri­vate Funds Pro­pos­al, would require pri­vate equi­ty firms and hedge funds to con­duct annu­al audits of their finan­cial state­ments and report quar­ter­ly invest­ment per­for­mance to clients. They would pro­vide guide­lines about pro­vid­ing dis­clo­sures to clients, and would also increase firms’ lia­bil­i­ty for neg­li­gence and mis­man­age­ment, and ban the now com­mon prac­tice of giv­ing “side let­ters,” or pref­er­en­tial terms, to high-pro­file investors.

    ...

    The pri­vate fund sec­tor is opaque, as cur­rent­ly there are no guide­lines for funds to val­ue their hold­ings, report invest­ment per­for­mance to their clients, and dis­close the fees that they charge clients. They’re also under no require­ment to dis­close infor­ma­tion about their clients, includ­ing their iden­ti­ties, or infor­ma­tion about how the firms raise mon­ey.

    ...

    “Trou­bling­ly, there is lim­it­ed data on fund size and fund activ­i­ties, and almost no data on the fees assessed by those funds,” the let­ter, co-signed by Sen. Eliz­a­beth War­ren and her col­leagues, reads. “Investors need increased trans­paren­cy, more infor­ma­tive and use­ful data, and pro­hi­bi­tions on abu­sive and con­flict­ed prac­tices.”
    ...

    And note the indus­try’s rather laugh­able defense against these rules: the SEC had no stand­ing to reg­u­late the indus­try because con­gress has exempt­ed the indus­try from these rules for such a long time. There’s a prece­dent for loose reg­u­la­tions that should be adhered to. It’s a remark­able way to express that pro­found sense of enti­tle­ment. Espe­cial­ly since it was con­gres­sion­al Democ­rats push­ing for these new rules:

    ...
    The new rules are main­ly being pushed by Democ­rats, who out­lined their argu­ments in a May let­ter. Signed by eight Demo­c­ra­t­ic sen­a­tors, the let­ter said that more guardrails are need­ed to pre­vent bad prac­tices. Because pri­vate funds direct­ly com­pete with banks, they deserve to be over­seen and reg­u­lat­ed in sim­i­lar ways, they said.

    ...

    In an April 2022 let­ter from the non­prof­it, the indus­try argued to the SEC that it has a prece­dent of loose reg­u­la­tion, and that the SEC has no author­i­ty to adopt the new rules because pri­vate funds have long been exempt­ed from such restric­tions by Con­gress. The rules would also dis­crim­i­nate against pri­vate funds com­pared to oth­er mon­ey man­agers like those that rep­re­sent retail investors, the let­ter claims.
    ...

    Also note the tim­ing of these poten­tial new rules: they were com­ing right when pri­vate-equi­ty funds are report­ing their first neg­a­tive-return year since 2009. Which rais­es the ques­tion: just how much more neg­a­tive might those returns be under these pro­posed dis­clo­sure rules? And how many oth­er FTX-like finan­cial time bombs are there wait­ing to go off the moment they are exposed to sun­light? Because it does­n’t sound like clients were nec­es­sar­i­ly oblig­at­ed to receive accu­rate infor­ma­tion under the exist­ing rules. Every­thing is allowed to remain opaque until the assets are sold. In oth­er words, the opaque­ness at risk of being lost under these rules are prob­a­bly excep­tion­al­ly con­ve­nient for the indus­try dur­ing a down year when loss­es have to be hid­den:

    ...
    Tighter reg­u­la­tions could be a blow to the indus­try just as it starts to feel the effects of last year’s finan­cial down­turn. For the first time since the finan­cial cri­sis in 2009, pri­vate equi­ty funds have report­ed neg­a­tive annu­al returns for the year end­ing March 31. The sector’s deal vol­ume also decreased 26% and its deal count fell 15%, to $2.4 tril­lion and 60,000 respec­tive­ly, accord­ing to con­sult­ing firm McK­in­sey.

    ...

    But the sen­a­tors argue that if trans­paren­cy rules had been in place ear­li­er, the dam­age done by pre­vi­ous crises like FTX’s col­lapse could’ve been reduced. FTX was a lead­ing cryp­tocur­ren­cy exchange once val­ued at $32 bil­lion before it implod­ed in Novem­ber after alleged crim­i­nal mis­man­age­ment and a large vol­ume of with­drawals caused it to file for bank­rupt­cy. While the pro­posed new rules wouldn’t have pre­vent­ed the fraud and mon­ey laun­der­ing at the exchange, investors at firms that invest­ed in FTX could have accessed “crit­i­cal detail” that could have served as a “start­ing place to ques­tion those val­ues” that under­laid the fraud, the sen­a­tors said.
    ...

    Final­ly, note that this sec­tor now eclipses the com­mer­cial bank­ing sec­tor. With almost none of the com­mer­cial bank­ing sec­tor’s reg­u­la­tions. Because we appar­ent­ly can’t learn lessons:

    ...
    Pri­vate funds in this sec­tor man­age the mon­ey of wealthy indi­vid­u­als, pen­sion funds, and uni­ver­si­ties. They are now the most pop­u­lar place to park big mon­ey, as they have brought big­ger returns on invest­ments than the pub­lic mar­ket, includ­ing stocks and mutu­al funds, in recent years.

    In 2020 the pri­vate funds indus­try leapfrogged over the com­mer­cial bank sec­tor, with near­ly $3 tril­lion more in gross invest­ment assets. But the SEC and pol­i­cy­mak­ers think it may be time to rein pri­vate funds in, fear­ing that a lack of trans­paren­cy could allow firms to over­charge investors and lie about the val­u­a­tions of their port­fo­lios.
    ...

    Yes, it was a moment of hope, not too long ago. The pri­vate equi­ty indus­try’s amaz­ing mul­ti-decade run in the US as a reg­u­la­to­ri­ly-pre­ferred sec­tor of finance was fac­ing a very real threat. But that was then, and this is now:

    Axios

    The SEC waters down new pri­vate equi­ty rules

    Dan Pri­mack, author of Axios Pro Rata
    Aug 23, 2023 — Econ­o­my & Busi­ness

    U.S. secu­ri­ties reg­u­la­tors today will vote to approve a Pri­vate Fund Advis­ers rule that’s a far cry from what was first pro­posed 18 months ago, in a major win for pri­vate equi­ty indus­try lob­by­ists.

    ...

    * In Feb­ru­ary 2022 we wrote: “The SEC is in charge of investor pro­tec­tion, no mat­ter the type of investor, and believes that pen­sion funds and oth­er lim­it­ed part­ners in pri­vate equi­ty funds aren’t always giv­en ade­quate vis­i­bil­i­ty. Pri­vate equi­ty, of course, would argue that its LP agree­ments are heav­i­ly-nego­ti­at­ed con­tracts between sophis­ti­cat­ed investors. Or, put anoth­er way, leave us alone.

    * The U.S. Secu­ri­ties and Exchange Com­mis­sion, led by Gary Gensler, appears to accept­ed the indus­try’s argu­ment.

    What’s new: The rule would require reg­is­tered pri­vate funds to dis­trib­ute a quar­ter­ly finan­cial state­ment to their investors, includ­ing infor­ma­tion on fees, and also require annu­al finan­cial state­ment audits. That’s as orig­i­nal­ly draft­ed.

    * When it comes to GP-led sec­on­daries, it would require that the GP obtain a fair­ness opin­ion or val­u­a­tion opin­ion, where­as the orig­i­nal lan­guage only per­mit­ted the for­mer.

    After that, the draft begins to dis­in­te­grate.

    * A “pro­hib­it­ed activ­i­ties rule” has become a “restrict­ed activ­i­ties rule,” with many of the under­ly­ing actions now allowed so long as there is investor dis­clo­sure.

    * For exam­ple, the ban on “fees for unper­formed ser­vices” like accel­er­at­ed mon­i­tor­ing fees is gone, although an SEC offi­cial insists that’s because staff deter­mined they were already pro­hib­it­ed under oth­er statute.

    * Funds still will be allowed to charge LPs for fees tied to reg­u­la­to­ry or com­pli­ance issues, so long as it’s dis­closed. They even can charge fees on a non pro rata basis, so long as it describes to LPs why it believes such a move is fair and equi­table. The only excep­tion is for fees tied to an SEC inves­ti­ga­tion.

    * Dis­clo­sure also is the buzz­word for a clause that would have stopped GPs from reduc­ing claw­backs by the amount of actu­al or expect­ed tax­es. So long as LPs are informed, it’s allowed.

    Key ommi­sion: There was no change made to pri­vate fund lia­bil­i­ty rules, which would made it much eas­i­er for LPs to sue GPs.

    * Fund man­agers will now be required to share any pref­er­en­tial LP terms with all prospec­tive investors, but only by the time an investor clos­es on its com­mit­ment. If they par­tic­i­pate in an inter­im close and then there are pref­er­en­tial terms on a sub­se­quent close, they can­not rescind their com­mit­ment.

    * An SEC offi­cial said that this clause would still pro­tect investors because they’d have more infor­ma­tion when being pitched by the man­ag­er on a sub­se­quent fund, although that may be a tough argu­ment for LPs to swal­low.

    The bot­tom line: Gensler blinked.

    ———-

    “The SEC waters down new pri­vate equi­ty rules” by Dan Pri­mack; Axios; 08/23/2023

    The bot­tom line: Gensler blinked.”

    Yep, the new rules basi­cal­ly got tossed. Not all of the new rules. But most of them it seems. Gary Gensler, the SEC Chair, ‘blinked’ in the face of all the indus­try lob­by­ing. Because of course he did. That’s what hap­pens. Vir­tu­al­ly always. Pow­er wins.

    So that almost con­cludes our look at how Tim Gurn­er’s sur­pris­ing­ly hon­est com­ments about the need to teach the lit­tle peo­ple to stay in their place was almost eclipsed by an end­ing of an era of the pri­vate-equi­ty indus­try. Almost. But then the same thing that always hap­pened hap­pened again. Tim Gurn­er’s era con­tin­ues.

    But, again, Tim Gurn­er was­n’t just express­ing his own per­son­al views. He real­ly was reveal­ing a wide­ly held class sen­ti­ment. A sen­ti­ment that in many ways echoed now-noto­ri­ous com­ments made by Black­stone’s CEO Stephen Schwarz­man back in 2011. As Schwarz­man lament­ed at the time, not enough poor peo­ple pay income tax­es and he wish­es all of them had to pay at least a little....so they would have ‘skin in the game’ as he put it.

    And then Schwarz­man went on to elab­o­rate by sug­gest­ing that the 45% of Amer­i­cans who are too poor to pay income tax­es aren’t real­ly “part of the sys­tem” and can’t have an “we’re all in this togeth­er, solv­ing prob­lems togeth­er” atti­tude. He real­ly said that. This was just months into the Occu­py Wall Street move­ment. That’s how firm­ly Schwarz­man held those views. He expressed them as peo­ple were camp­ing out in the streets to protest peo­ple like him. The guy who is still lead­ing the world’s largest pri­vate-equi­ty firm, a firm with almost $10 bil­lion in pub­lic pen­sion mon­ey under man­age­ment as of March 2020 as the pan­dem­ic was unfold­ing, views aver­age peo­ple as a bunch of leech­es who aren’t real­ly ‘part of the sys­tem’ or will­ing to ‘solve prob­lems togeth­er’. And in the years that fol­lowed, pub­lic pen­sion funds show­ered his firm with bil­lions.

    Keep in mind that Schwarz­man topped the list of US CEO pay in 2008, the year Black­stone went pub­lic. Which was also, of course, right before the finan­cial cri­sis cre­at­ed by Wall Street’s grotesque greed blew up the stock mar­ket, dev­as­tat­ing Black­stone’s share price. But at least the insid­ers got to get out before things went south.

    And that’s all why we have to assume Tim Gurn­er’s ultra-wealthy peers prob­a­bly weren’t very pleased with his com­ments. Because, again, Tim Gurn­er was­n’t just express­ing his per­son­al opin­ion. He was echo­ing a sen­ti­ment we’ve been hear­ing from his ultra-wealthy brethren for years as they got wealth­i­er and wealth­i­er, whether Stephen Schwarz­man prefers we remem­ber or not:

    Busi­ness Insid­er

    Bil­lion­aire Steve Schwarz­man Wish­es More Poor Peo­ple Would Pay Income Tax­es

    Julia La Roche
    Nov 30, 2011, 12:02 PM CST

    Bil­lion­aire pri­vate equi­ty tycoon Stephen Schwarz­man, the chief exec­u­tive of Black­stone Group, told Bloomberg Tele­vi­sion this morn­ing that he wants more peo­ple to pay income tax­es.

    “We have a sys­tem today in the Unit­ed States were 45% of Amer­i­cans don’t pay any income tax...You have to have skin in the game,” he said.

    That essen­tial­ly means he wants more poor peo­ple in the U.S. to pony up and pay income tax­es.

    How­ev­er, he did­n’t spec­i­fy the amount he wants them to pay.

    The issue isn’t the amount, it’s the con­cept that we are all in this togeth­er, solv­ing prob­lems togeth­er. I can’t micro­man­age what any­body pays or does­n’t pay. But the con­cept that half of the pub­lic isn’t involved with the income-tax sys­tem is some­what odd and I’m not say­ing how much peo­ple should do, but we should all be part of the sys­tem,” he added.

    ...

    ————

    “Bil­lion­aire Steve Schwarz­man Wish­es More Poor Peo­ple Would Pay Income Tax­es” by Julia La Roche; Busi­ness Insid­er; 11/30/2011

    “The issue isn’t the amount, it’s the con­cept that we are all in this togeth­er, solv­ing prob­lems togeth­er.”

    Why can’t the poors just work with us to solve prob­lems togeth­er. So said the bil­lion­aire two months into Occu­py Wall Street. It was so stu­pid on so many lev­els it rais­es the ques­tion: who got yelled at more by their ultra-wealthy peers after their laps­es in acci­den­tal hon­est? Schwarz­man in 2011 or Gurn­er in 2023? Either, it’s the same old sto­ry, just with a lot more wealth and pow­er for the indus­try in 2023 com­pared to 2011. Don’t for­get what Schwarz­man said in Decem­ber 2020: the pan­dem­ic pre­sent­ed the kind of ‘accel­er­a­tion moment’ for the indus­try that the 2008 finan­cial cri­sis pre­sent­ed for the indus­try, where it came out of it big­ger than ever. In 2011, Black­stone was already rid­ing that ‘accel­er­a­tion moment’, and it sure looks like the last few years of been anoth­er one of those ‘moments’. A moment heav­i­ly fueled by pen­sions, sov­er­eign wealth funds, and oth­er large pools of insti­tu­tion­al mon­ey lured in by the promis­es of high­er returns. Steve Schwarz­man, Tim Gurn­er, and a whole lot of oth­er extreme­ly wealthy peo­ple are a lot wealth­i­er than they were in 2011 thanks in large part to access to the pools of funds of the sav­ings of aver­age work­ing peo­ple. Aver­age peo­ple who aren’t earn­ing their keep appar­ent­ly, in the eyes of these titans of indus­try.

    Which, again, begs the ques­tion: who would be worse for aver­age work­ing peo­ple to be man­ag­ing these invest­ment firms? Fig­ure like Tim Gurn­er and Steve Schwarz­man? Or some sort of next-gen AI that will maybe be avail­able in a decade or so? The AI obvi­ous­ly pos­es risks. But are they worse risks? We’ll find out. But if it turns out that human­i­ty ulti­mate­ly seals its doom after hand­ing too much con­trol over to AIs put in charge of invest­ment funds and oth­er insti­tu­tions that keep soci­ety hum­ming along, let it be known that the guys in charge before made it very dif­fi­cult to not give Skynet a try.

    Posted by Pterrafractyl | September 18, 2023, 12:10 am
  9. Are pri­vate-equi­ty giants behav­ing like finan­cial preda­tors in today’s mar­kets? Or are they oper­at­ing more like pen­sion-fund-bloat­ed use­ful-idiot prey for for sophis­ti­cat­ed investors? It’s long been a ques­tion loom­ing over this sec­tor of finance and as we’re going to see, there’s a new twist to this ques­tion: the grow­ing trend of com­mer­cial real estate (CRE) investors turn­ing to ‘dequity’ in the search for financ­ing to fill in exist­ing finan­cial gaps. ‘Dequity’ being a term to describe the range of lend­ing tools that com­bine a mix of debt and equi­ty. High­er risk lend­ing like mez­za­nine loans that tends to charge high­er inter­est rates and come with con­di­tions that allow the lender to trade in the debt for equi­ty in the prop­er­ty. In oth­er words, the kinds of loans that bor­row­ers to typ­i­cal­ly engage in unless they have no bet­ter options. That’s the new big trend in the CRE sec­tor.

    And while pri­vate-equi­ty giants are obvi­ous­ly in a posi­tion to exploit this kind of mar­ket dis­tress and seek out oppor­tu­ni­ties for dis­tressed bor­row­ers who they can shake down with a stingy ‘dequity’ offer, we’re also implic­it­ly talk­ing about a num­ber of dis­tressed pri­vate-equi­ty-backed CRE projects if when we’re learn­ing about new lev­els of dis­tress in the CRE mar­kets. And that’s why we have to ask: is this sto­ry about the grow­ing CRE reliance on ‘dequity’ a net good-new or net bad-news sto­ry for pri­vate-equi­ty? And in par­tic­u­lar, pri­vate-equi­ty’s exten­sive list of pen­sion fund clients already deeply invest­ed in the CRE sec­tor. How is this trend going for that group CRE play­ers?

    The answer isn’t obvi­ous, at least not based on exam­ples we’re going to read about. In one case, Mas­ter­works Devel­op­ment bought a dis­count­ed note on a $61M mez­za­nine loan belong­ing to a port­fo­lio of dis­tressed Black­stone-owned hotels just last month. The $61 mez­za­nine loan was first issued in 2017, short­ly after Black­stone’s 2016 pur­chase of the hotels from Mas­ter­works for $283 mil­lion, along with an addi­tion­al $274 mil­lion loan in more tra­di­tion­al mortage-backed secu­ri­ties. So as we can see, the cur­rent pre­car­i­ty of Black­stone’s invest­ment is exac­er­bat­ed by the under­ly­ing pri­vate-equi­ty mod­el of pur­chas­ing busi­ness­es and then load­ing them up with debt. And in this case, it appears the busi­ness­es are in such poor shape that the orig­i­nal hold­er of that $61 mil­lion mez­za­nine loan decid­ed to sell it at a dis­count instead of using the option to con­vert it to an equi­ty stake in the prop­er­ties. It points towards the under­ly­ing trend dri­ving this new ‘dequity’ trend: a lot of CRE busi­ness mod­els are still bro­ken.

    It’s that bro­ken CRE busi­ness mod­el that has turned tra­di­tion­al bor­row­ing that has hand­ed lenders the kind of lever­age where ‘dequity’ is real­ly the only option for increas­ing­ly des­per­ate CRE bor­row­ers. It’s a sen­ti­ment rather frankly expressed by Geri Borg­er Urgo of New­point Real Estate Cap­i­tal — a new CRE lend­ing plat­form cre­at­ed by pri­vate-equi­ty giant Merid­i­an Cap­i­tal Group a cou­ple of years ago — who put it as fol­lows: “What I think is inter­est­ing about pref right now — and I love the term ‘res­cue cap­i­tal’ — but there is a shift, or maybe a buy­er-beware aspect to it...I don’t want to use the term preda­to­ry financ­ing, but it’s what comes to mind. So we’re see­ing a lot more pow­er being giv­en over to that pref hold­er.”:

    Bis­now

    As Lend­ing Options Get Scarcer, CRE Play­ers Turn To ‘Dequity’

    Sep­tem­ber 20, 2023 Cia­ra Long, Bis­now New York City

    With no sign that the Fed­er­al Reserve’s restric­tive­ly high inter­est rates are com­ing down any­time soon, the com­mer­cial real estate indus­try is still look­ing at ways to shake loose financ­ing as lend­ing is set to drop around 40% this year.

    One term gain­ing pop­u­lar­i­ty is “dequity,” an ambigu­ous­ly defined mix between debt and equi­ty that devel­op­ers are increas­ing­ly using to fill holes in their cap­i­tal stacks. The fund­ing car­ries increased risk for bor­row­ers — but not enough to dis­cour­age the com­mer­cial real estate sec­tor from using it to plug a gap.

    “It is the de fac­to solu­tion to every prob­lem,” Sam Fried­land, a senior vice pres­i­dent at Relat­ed Fund Man­age­ment, the pri­vate equi­ty arm of The Relat­ed Cos., said onstage at Bis­now’s 2023 Nation­al Finance Sum­mit last week.

    Dequity is sim­ply “not tak­ing the last dol­lar of risk,” Fried­land said when asked to define the term. By not being the last rung in the cap­i­tal stack, dequity hold­ers are more like­ly to see a return and are in first posi­tion to take over a strug­gling build­ing from a bor­row­er.

    “It’s an open term,” he said.

    Per­haps helped by its lack of spe­cif­ic def­i­n­i­tion, dequity is tak­ing on momen­tum as a new buzz­word, as both infla­tion­ary pres­sures and the high­est inter­est rates in over a decade are mak­ing it hard­er to hash out tra­di­tion­al loan agree­ments.

    Where bor­row­ers would typ­i­cal­ly have been able to replace one senior mort­gage with anoth­er, they are now look­ing at gap or mez­za­nine loans or pre­ferred equi­ty, which all fall under the dequity umbrel­la and give the investors offer­ing it more poten­tial con­trol over the future of their prop­er­ties.

    Infla­tion, plus increased costs for oper­a­tions, insur­ance, labor and tax­es, all are mak­ing it dif­fi­cult for tra­di­tion­al deal struc­tures to pen­cil out, Cer­berus Cap­i­tal Man­age­ment Man­ag­ing Direc­tor and Head of Real Estate Pri­vate Cred­it Neha San­ti­a­go said at the event, held at 180 Maid­en Lane in Man­hat­tan’s Finan­cial Dis­trict.

    Addi­tion­al­ly, own­ers and investors are fac­ing slow­ing rent growth across asset class­es and mar­kets. There’s also down­ward pres­sure on net oper­at­ing income, as well as more than a tril­lion dol­lars of debt matu­ri­ties com­ing due in the U.S. over the next 12 months, she said.

    “You put all those ingre­di­ents into the shak­er and shake it out, and then you pour out what is a pret­ty unsa­vory cock­tail,” San­ti­a­go said. “That is what is putting a lot of pres­sure on val­u­a­tions today.”

    Those cir­cum­stances cre­ate a ripe envi­ron­ment for dequity to step in, Geor­gette Chap­man Phillips, dean of the Col­lege of Busi­ness at Lehigh Uni­ver­si­ty and author of a 2005 paper on dequity, told Bis­now by phone.

    “What was worth $100 two years ago is worth 50 bucks now. What’s the loan-to-val­ue ratio on that?” she said. “Loans are under­wa­ter, peo­ple are walk­ing away. It’s anoth­er reck­on­ing moment.”

    There’s no recipe for what makes a dequity deal, Chap­man Phillips said. Tra­di­tion­al debt arrange­ments give lenders the pow­er to demand a cer­tain amount of pay­ment at a cer­tain point in time, while tra­di­tion­al equi­ty agree­ments give the own­er pow­er to shape a prop­er­ty’s deci­sions. Dequity means cre­at­ing a mix­ture of both, depend­ing on the par­tic­i­pants’ appetite for risk.

    Tak­ing a dequity posi­tion can be equiv­a­lent to a pre­ferred equi­ty or res­cue cap­i­tal posi­tion, experts said onstage. Dequity invest­ments can offer the best risk-adjust­ed returns in today’s mar­ket — bet­ter even than a com­mon equi­ty posi­tion, San­ti­a­go said.

    “When bor­row­ers — par­tic­u­lar­ly well-cap­i­tal­ized bor­row­ers — go to price those last [sub­or­di­nate] debt dol­lars, those are often pric­ing at returns high­er than what equi­ty is pro­ject­ed to make on a trans­ac­tion,” she said.

    ...

    Pri­vate equi­ty play­ers are also look­ing at acquir­ing dequity posi­tions in dis­tressed prop­er­ties to put them in pole posi­tion to take con­trol of prop­er­ties.

    Mas­ter­works Devel­op­ment last month bought a dis­count­ed note on a $61M mez­za­nine loan belong­ing to a port­fo­lio of dis­tressed Black­stone-owned hotels, The Real Deal report­ed. This month, 3650 REIT orig­i­nat­ed a $103M mez­za­nine loan to recap­i­tal­ize a joint ven­ture-owned res­i­den­tial port­fo­lio across Louisiana, South Car­oli­na, Geor­gia and Ten­nessee. The loan, pro­vid­ed to David Wern­er Invest­ments, Onyx Part­ners and Carl­ton Asso­ciates with an ini­tial 24-month term, allows the spon­sors to recap­i­tal­ize the portfolio’s exist­ing equi­ty struc­ture.

    These types of deals are becom­ing more fre­quent because under the cur­rent eco­nom­ic con­di­tions, equi­ty seems too risky and debt is offer­ing returns that are too mea­ger to attract investors, Fried­land said onstage.

    ...

    The long-await­ed dis­tress may not appear in the way that experts were pre­dict­ing last year. Instead, bor­row­ers are fac­ing cir­cum­stances where they may just need more time to help an asset that is stressed rather than a solu­tion for dis­tress, Ben­tall GreenOak Man­ag­ing Direc­tor and Head of U.S. Debt Abbe Fran­chot Borok said onstage.

    “We are start­ing to see ... an abil­i­ty to trans­act in that res­cue cap­i­tal [pre­ferred equi­ty] space — so, not true dis­tress, but assets the bor­row­er just needs some more time and to get through the volatil­i­ty,” she said. “I do think there’s going to be some inter­est­ing oppor­tu­ni­ties there.”

    But just like two cock­tails in a row might leave some with a headache the next day, dequity’s risk cock­tail might intro­duce com­pli­ca­tions down the line for bor­row­ers.

    “What I think is inter­est­ing about pref right now — and I love the term ‘res­cue cap­i­tal’ — but there is a shift, or maybe a buy­er-beware aspect to it,” said Geri Borg­er Urgo, New­point Real Estate Capital’s head of pro­duc­tion. “I don’t want to use the term preda­to­ry financ­ing, but it’s what comes to mind. So we’re see­ing a lot more pow­er being giv­en over to that pref hold­er.”

    One of the down­sides could be that a bank­rupt­cy court may have a dif­fer­ent opin­ion over what the loan’s struc­ture means for asset own­er­ship if dis­putes reach the courts, Chap­man Phillips said.

    Still, she said, it’s a tool that could ease cir­cum­stances cur­rent­ly faced by lenders and bor­row­ers alike.

    “Any­thing that allows a more flu­id exchange of val­ue is good,” she said. “The last thing you want is a rigid mar­ket, because then nobody can move.”

    ———–

    “As Lend­ing Options Get Scarcer, CRE Play­ers Turn To ‘Dequity’” by Cia­ra Long; Bis­now; 09/20/2023

    ““What I think is inter­est­ing about pref right now — and I love the term ‘res­cue cap­i­tal’ — but there is a shift, or maybe a buy­er-beware aspect to it,” said Geri Borg­er Urgo, New­point Real Estate Capital’s head of pro­duc­tion. “I don’t want to use the term preda­to­ry financ­ing, but it’s what comes to mind. So we’re see­ing a lot more pow­er being giv­en over to that pref hold­er.”

    Yes, the bor­row­ing land­scape for CRE devel­op­ers has become so unfa­vor­able for bor­row­ers that ‘dequity’ — describ­ing a form of bor­row­ing that can result in lenders gain­ing equi­ty stakes in invest­ments — has become the new buzz­word. It’s now the de fac­to ‘solu­tion’ for a sec­tor fac­ing increas­ing bor­row­ing costs and who have no oth­er option. But don’t call it preda­to­ry financ­ing:

    ...
    One term gain­ing pop­u­lar­i­ty is “dequity,” an ambigu­ous­ly defined mix between debt and equi­ty that devel­op­ers are increas­ing­ly using to fill holes in their cap­i­tal stacks. The fund­ing car­ries increased risk for bor­row­ers — but not enough to dis­cour­age the com­mer­cial real estate sec­tor from using it to plug a gap.

    “It is the de fac­to solu­tion to every prob­lem,” Sam Fried­land, a senior vice pres­i­dent at Relat­ed Fund Man­age­ment, the pri­vate equi­ty arm of The Relat­ed Cos., said onstage at Bis­now’s 2023 Nation­al Finance Sum­mit last week.

    Dequity is sim­ply “not tak­ing the last dol­lar of risk,” Fried­land said when asked to define the term. By not being the last rung in the cap­i­tal stack, dequity hold­ers are more like­ly to see a return and are in first posi­tion to take over a strug­gling build­ing from a bor­row­er.

    “It’s an open term,” he said.

    Per­haps helped by its lack of spe­cif­ic def­i­n­i­tion, dequity is tak­ing on momen­tum as a new buzz­word, as both infla­tion­ary pres­sures and the high­est inter­est rates in over a decade are mak­ing it hard­er to hash out tra­di­tion­al loan agree­ments.

    Where bor­row­ers would typ­i­cal­ly have been able to replace one senior mort­gage with anoth­er, they are now look­ing at gap or mez­za­nine loans or pre­ferred equi­ty, which all fall under the dequity umbrel­la and give the investors offer­ing it more poten­tial con­trol over the future of their prop­er­ties.

    ...

    Tak­ing a dequity posi­tion can be equiv­a­lent to a pre­ferred equi­ty or res­cue cap­i­tal posi­tion, experts said onstage. Dequity invest­ments can offer the best risk-adjust­ed returns in today’s mar­ket — bet­ter even than a com­mon equi­ty posi­tion, San­ti­a­go said.

    “When bor­row­ers — par­tic­u­lar­ly well-cap­i­tal­ized bor­row­ers — go to price those last [sub­or­di­nate] debt dol­lars, those are often pric­ing at returns high­er than what equi­ty is pro­ject­ed to make on a trans­ac­tion,” she said.
    ...

    And while we should expect deep-pock­et­ed play­ers like the pri­vate-equi­ty sec­tor to be sali­vat­ing on the side­lines wait­ing for an oppor­tu­ni­ty to play the role of a pre­ferred lender, there’s also no avoid the real­i­ty that pri­vate-equi­ty remains one of the biggest exist­ing CRE investors. In oth­er words, if ‘dequity’ is the new hot trend in CRE, that almost cer­tain­ly means a large num­ber of pri­vate-equi­ty investors are on the ‘wrong’ side of this trend too:

    ...
    Pri­vate equi­ty play­ers are also look­ing at acquir­ing dequity posi­tions in dis­tressed prop­er­ties to put them in pole posi­tion to take con­trol of prop­er­ties.

    Mas­ter­works Devel­op­ment last month bought a dis­count­ed note on a $61M mez­za­nine loan belong­ing to a port­fo­lio of dis­tressed Black­stone-owned hotels, The Real Deal report­ed. This month, 3650 REIT orig­i­nat­ed a $103M mez­za­nine loan to recap­i­tal­ize a joint ven­ture-owned res­i­den­tial port­fo­lio across Louisiana, South Car­oli­na, Geor­gia and Ten­nessee. The loan, pro­vid­ed to David Wern­er Invest­ments, Onyx Part­ners and Carl­ton Asso­ciates with an ini­tial 24-month term, allows the spon­sors to recap­i­tal­ize the portfolio’s exist­ing equi­ty struc­ture.

    These types of deals are becom­ing more fre­quent because under the cur­rent eco­nom­ic con­di­tions, equi­ty seems too risky and debt is offer­ing returns that are too mea­ger to attract investors, Fried­land said onstage.
    ...

    A mez­za­nine loan bought at a dis­count. It’s like a dis­tilled exam­ple of ‘dequity’ in action. Keep in mind that this was­n’t a new­ly issued mez­za­nine loan but instead, as we’re going to see in the fol­low­ing arti­cle, an exist­ing loan issued in 2017. And that means some­one else was already hold­ing the loan held the loan and decid­ed to sell it at a dis­count to Mas­ter­works instead of trig­ger­ing the con­ver­sion to equi­ty. It’s a poten­tial­ly sig­nif­i­cant clue as to the busi­ness prospects for these prop­er­ties.

    And don’t for­get, when we see dis­count­ed mez­za­nine loans issued on prop­er­ty held by a Black­stone real estate fund, it’s Black­stone’s clients who are ulti­mate­ly on the short-end of this deal should those loans get con­vert­ed into equi­ty. Clients that almost cer­tain­ly include Black­stone’s many pen­sion fund clients.
    Also don’t for­get that these ‘dequity’ deals may save bor­row­ers from more dras­tic mea­sures in the short-run, but at a cost to the long-term yield on the invest­ment. Mez­za­nine loans tend to be much high­er inter­est than more tra­di­tion­al forms of bor­row­ing. So we should prob­a­bly expect the long-term side-effects on invest­ment yields from this grow­ing ‘dequity’ trend to only show up years from now. Like­ly in the form of reduced future yields for pri­vate-equi­ty’s pen­sion fund clients in many case.

    And as we can see when we take a clos­er took at that ‘dequity’ deal Black­stone secured last month for its ail­ing hotels, the pri­vate-equi­ty group oper­at­ing as the preda­tor in this case, Mas­ter­works Devel­op­ment, is actu­al­ly the same pri­vate-equi­ty com­pa­ny that sold Black­stone the now-ail­ing hotels back in 2016 in a deal Black­stone financed, in part, with the $61 mil­lion mez­za­nine loan at the time.

    It’s all a reminder that the debt-inten­sive pri­vate-equi­ty strat­e­gy of using large amounts of debt to make high­ly lever­aged acqui­si­tions is an increas­ing­ly dan­ger­ous strat­e­gy as inter­est rates rise and tra­di­tion means of bor­row­ing dry up. It’s also an exam­ple of why one of the big ques­tions loom­ing over this ‘dequity’ trend in CRE mar­ket is whether or not pri­vate-equi­ty — with its deep pock­ets but also deep exist­ing expo­sure to the real estate sec­tor — is going to end up being more preda­tor or prey:

    The Real Deal

    Mas­ter­works grabs dis­count­ed stake in Blackstone’s Club Quar­ters hotel debt

    Lodg­ing chain’s affil­i­ate acquired mez­za­nine posi­tion for less than bal­ance of $61M loan

    Aug 2, 2023, 6:23 PM
    By Rachel Her­zog

    An affil­i­ate of the hotel chain Club Quar­ters is stak­ing out a new posi­tion in the lodg­ing net­work with a dis­count­ed pur­chase of the note to a $61 mil­lion mez­za­nine loan, tied to four strug­gling Black­stone-owned hotels in the down­towns of major cities.

    New York-based Mas­ter­works Devel­op­ment, an affil­i­ate of the Club Quar­ters oper­at­ing hotel brand that used to own the hotels, bought the note for the company’s loca­tions in San Fran­cis­co at 424 Clay Street and Chicago’s Loop at 111 West Adams Street, as well as Boston and Philadel­phia assets oper­at­ed by the brand.

    The mez­za­nine debt, along with a $274 mil­lion senior CMBS loan against the prop­er­ties, was bor­rowed by the Black­stone fund Black­stone Real Estate Part­ners VII in 2017, with the 1,228-room, four-prop­er­ty port­fo­lio serv­ing as col­lat­er­al. A team led by JLL’s Kevin Davis and Bar­nett Wu pro­cured Mas­ter­works as the buy­er of the mez­za­nine debt, the bro­ker­age announced Wednes­day.

    The price Mas­ter­works paid for the note was not dis­closed but was less than Black­stone owed under the orig­i­nal terms of the deal, Davis said in an email. The deal illus­trates the dif­fi­cult posi­tion hotel play­ers and their lenders — espe­cial­ly those more reliant on busi­ness trav­el — were put in by the pan­dem­ic and an incon­sis­tent lodg­ing recov­ery since it eased.

    The Black­stone fund bought the four hotels from Mas­ter­works in 2016 for $283 mil­lion.

    Blackstone’s $274 mil­lion CMBS loan on the port­fo­lio was trans­ferred to spe­cial ser­vicer CWCap­i­tal in 2020 due to the bor­row­er fac­ing immi­nent mon­e­tary default after it stopped mak­ing debt ser­vice pay­ments and request­ed pan­dem­ic relief, accord­ing to a May 25 report from DBRS Morn­ingstar.

    “Accord­ing to the ser­vicer, Black­stone has advised that it is not will­ing to inject addi­tion­al cap­i­tal to fund oper­at­ing expens­es or debt ser­vice pay­ments,” Morn­ingstar said.

    Since the first mort­gage is in default, Mas­ter­works has mul­ti­ple options to cash in on its mez­za­nine invest­ment.

    It could poten­tial­ly ini­ti­ate a UCC fore­clo­sure that could allow it to take over the Black­stone affil­i­ate that man­ages the port­fo­lio and then attempt to get the first mort­gage on track as the new prop­er­ty own­er while the hotel recov­ery con­tin­ues. Or it could pur­sue a solu­tion that low­ers Blackstone’s loan ser­vice pay­ments enough to let the cur­rent own­er stay in the deal by allow­ing it to resume reg­u­lar pay­ments on the debt pack­age. Black­stone put $8.1 mil­lion worth of equi­ty into the port­fo­lio pur­chase.

    ...

    The port­fo­lio was appraised in Octo­ber with a cumu­la­tive val­ue of $360 mil­lion, a slight bump from May 2021 when it was pegged at $330 mil­lion but still down near­ly 15 per­cent from an esti­mate of $423 mil­lion when the loan was issued in 2017, accord­ing to Morn­ingstar.

    For the 12-month peri­od end­ing Feb­ru­ary 28, the four hotels’ pen­e­tra­tion rate — a mea­sure of how the portfolio’s occu­pan­cy rate and aver­age dai­ly rate com­pare with the com­pe­ti­tion — was 77 per­cent, sug­gest­ing that the prop­er­ties are under­per­form­ing rel­a­tive to their peers.

    Still, per­for­mance met­rics have trend­ed up year-over-year since 2020, Morn­ingstar found, though “it is unlike­ly the port­fo­lio will sta­bi­lize to pre-pan­dem­ic fig­ures in the near to medi­um term.” The dis­tress reflects a famil­iar arc as hotels depen­dent on busi­ness trav­el­ers in Chica­go and San Fran­cis­co stare down a longer recov­ery peri­od than lodg­ing geared toward leisure trav­el­ers.

    The busi­ness-ori­ent­ed hotel port­fo­lio includes the 346-room prop­er­ty in San Fran­cis­co, which anchors almost 40 per­cent of the allo­cat­ed loan amount, and the 429-room Chica­go hotel, which anchors more than 26 per­cent.

    The Chica­go property’s per­for­mance had declined after the loan was issued in 2017 but before the pan­dem­ic, accord­ing to Morn­ingstar. The Loop hotel had an occu­pan­cy rate of almost 83 per­cent when the loan was issued, which dropped below 70 per­cent at the end of 2018, though it rebound­ed to more than 78 per­cent by the end of 2019.

    ———–

    “Mas­ter­works grabs dis­count­ed stake in Blackstone’s Club Quar­ters hotel debt” By Rachel Her­zog; The Real Deal; 08/02/2023

    “The Black­stone fund bought the four hotels from Mas­ter­works in 2016 for $283 mil­lion.”

    That’s quite an invest­ment per­for­mance: Black­stone buys these four hotels from Mas­ter­works in 2016 for $283 mil­lion. Then imme­di­ate­ly issues the $61 mil­lion in mez­za­nine debt on top of a $274 mil­lion loan against the prop­er­ty. It was the clas­sic pri­vate-equi­ty debt-inten­sive approach to invest­ing. And then the pan­dem­ic hap­pens and the prop­er­ties end up basi­cal­ly going into default. And here we are in 2023 with the prop­er­ties still in default and Mas­ter­works Devel­op­ment in a posi­tion where it could pur­chase that mez­za­nine debt at a dis­count and able to imme­di­ate­ly decide whether it wants to con­vert that mez­za­nine into equi­ty and take over the prop­er­ties itself, or some­how refi­nance the debt and keep Black­stone as a bor­row­er. Either way, this was obvi­ous­ly a great deal for Mas­ter­works. Not so much for Black­stone’s clients, with the val­ue of the port­fo­lio down 15 per­cent from what what it was appraised at in ear­ly 2017 when Black­stone took out that $274 mil­lion loan on its new­ly acquired prop­er­ty:

    ...
    The mez­za­nine debt, along with a $274 mil­lion senior CMBS loan against the prop­er­ties, was bor­rowed by the Black­stone fund Black­stone Real Estate Part­ners VII in 2017, with the 1,228-room, four-prop­er­ty port­fo­lio serv­ing as col­lat­er­al. A team led by JLL’s Kevin Davis and Bar­nett Wu pro­cured Mas­ter­works as the buy­er of the mez­za­nine debt, the bro­ker­age announced Wednes­day.

    The price Mas­ter­works paid for the note was not dis­closed but was less than Black­stone owed under the orig­i­nal terms of the deal, Davis said in an email. The deal illus­trates the dif­fi­cult posi­tion hotel play­ers and their lenders — espe­cial­ly those more reliant on busi­ness trav­el — were put in by the pan­dem­ic and an incon­sis­tent lodg­ing recov­ery since it eased.

    ...

    Blackstone’s $274 mil­lion CMBS loan on the port­fo­lio was trans­ferred to spe­cial ser­vicer CWCap­i­tal in 2020 due to the bor­row­er fac­ing immi­nent mon­e­tary default after it stopped mak­ing debt ser­vice pay­ments and request­ed pan­dem­ic relief, accord­ing to a May 25 report from DBRS Morn­ingstar.

    “Accord­ing to the ser­vicer, Black­stone has advised that it is not will­ing to inject addi­tion­al cap­i­tal to fund oper­at­ing expens­es or debt ser­vice pay­ments,” Morn­ingstar said.

    Since the first mort­gage is in default, Mas­ter­works has mul­ti­ple options to cash in on its mez­za­nine invest­ment.

    It could poten­tial­ly ini­ti­ate a UCC fore­clo­sure that could allow it to take over the Black­stone affil­i­ate that man­ages the port­fo­lio and then attempt to get the first mort­gage on track as the new prop­er­ty own­er while the hotel recov­ery con­tin­ues. Or it could pur­sue a solu­tion that low­ers Blackstone’s loan ser­vice pay­ments enough to let the cur­rent own­er stay in the deal by allow­ing it to resume reg­u­lar pay­ments on the debt pack­age. Black­stone put $8.1 mil­lion worth of equi­ty into the port­fo­lio pur­chase.

    ...

    The port­fo­lio was appraised in Octo­ber with a cumu­la­tive val­ue of $360 mil­lion, a slight bump from May 2021 when it was pegged at $330 mil­lion but still down near­ly 15 per­cent from an esti­mate of $423 mil­lion when the loan was issued in 2017, accord­ing to Morn­ingstar.
    ...

    So what’s Mas­ter­works going to do? Con­vert the debt to equi­ty? The last hold­er of the mez­za­nine debt obvi­ous­ly did­n’t find that to be a tempt­ing option. We’ll see, but the fact that the port­fo­lio of hotels is expect­ed to con­tin­ue to strug­gle “in the near to medi­um term” sug­gests Mas­ter­works might have the option to exe­cute an equi­ty con­ver­sion move for the medi­um term too, not that it nec­es­sar­i­ly has any medi­um term appetite to do so:

    ...
    For the 12-month peri­od end­ing Feb­ru­ary 28, the four hotels’ pen­e­tra­tion rate — a mea­sure of how the portfolio’s occu­pan­cy rate and aver­age dai­ly rate com­pare with the com­pe­ti­tion — was 77 per­cent, sug­gest­ing that the prop­er­ties are under­per­form­ing rel­a­tive to their peers.

    Still, per­for­mance met­rics have trend­ed up year-over-year since 2020, Morn­ingstar found, though “it is unlike­ly the port­fo­lio will sta­bi­lize to pre-pan­dem­ic fig­ures in the near to medi­um term.” The dis­tress reflects a famil­iar arc as hotels depen­dent on busi­ness trav­el­ers in Chica­go and San Fran­cis­co stare down a longer recov­ery peri­od than lodg­ing geared toward leisure trav­el­ers.
    ...

    Let’s hope the par­tic­u­lar Black­stone fund behind this now-trou­bled CRE invest­ment was­n’t a bunch of pen­sion funds. And if so, let’s hope the mez­zan­nine financ­ing ends up actu­al­ly help­ing the invest­ment sta­bi­lize itself and does­n’t end up just dilut­ing an already ail­ing invest­ment. Either way, this is just one of a grow­ing num­ber of num­ber of ‘dequity’-financed invest­ments in the CRE space. Invest­ments that will have reduced long-term yields on these invest­ments at best, and pos­si­bly much worse results when this all shakes out in the long run.

    It all rais­es anoth­er grim ques­tion for this sec­tor: So are any pen­sion-fund backed pri­vate-equi­ty funds play­ing the role of preda­to­ry lend­ing in this envi­ron­ment? It will be inter­est­ing to see if that ends up hap­pen­ing too, or if the pen­sion funds are most­ly just prey here. On the one hand, it will be kind of awful to learn about pen­sion funds ben­e­fit­ing for preda­to­ry lend­ing prac­tices. But on the oth­er hand, it’s arguably more awful to learn that every­one in this space is engag­ing in preda­to­ry lend­ing except for pen­sion funds who are all on the receiv­ing end. It’s a kind of moral haz­ard that should­n’t have been allowed to devel­op in the first place, but here we are, forced to hope pen­sion funds are oper­at­ing more as preda­tor than prey, while rec­og­niz­ing it’s prob­a­bly the oppo­site.

    Posted by Pterrafractyl | October 1, 2023, 6:12 pm
  10. The pain is pil­ing up. Along with the assur­ances that it’s all man­age­able and there’s noth­ing to wor­ry about. And yet the wor­ry is only grow­ing as the pri­vate-equi­ty con­tin­ues to grap­ple with what is arguably the biggest chal­lenge in the indus­try’s his­to­ry: the assump­tions the indus­try’s entire busi­ness mod­el has been pred­i­cat­ed on has gone into reverse and looks like­ly to stay in reverse for the fore­see­able future. Assump­tions like his­tor­i­cal­ly low inter­est rates, read­i­ly avail­able refi­nanc­ing options, and a seem­ing­ly end­less source of new investor funds. In par­tic­u­lar new pen­sion investor funds. All of those trends are over, and it’s not clear that the indus­try has a response beyond even more des­per­ate finan­cial engi­neer­ing options. The kind of finan­cial engi­neer­ing options that all seem to be cen­tered around buy­ing a finan­cial cush­ion now at the cost of future returns. Options that could become par­tic­u­lar­ly costs down the line should the cur­rent inter­est rate envi­ron­ment — a his­toric nor­mal­iza­tion — not go into reverse with a return to the his­tor­i­cal­ly low bor­row­ing costs that fueled the last decade and a half of the sec­tor’s growth.

    Now, of course, the pri­vate-equi­ty indus­try’s defend­ers will point to the oth­er major asset that the indus­try brings to these invest­ments: supe­ri­or man­age­ment skills. At least that’s the sale pitch the sec­tor has long used to lure in more and more investor mon­ey. But what if those supe­ri­or invest­ment skill were just ‘vapor­ware’ the entire and it real­ly was just a sec­tor based on finan­cial engi­neer­ing gim­micks that sim­ply aren’t pos­si­ble with­out his­tor­i­cal­ly low bor­row­ing costs? What if, as one mar­ket play­er puts it, “Many of the rea­sons these guys out­per­formed had noth­ing to do with skill...Borrowing costs were cheap and the liq­uid­i­ty was there. Now, it’s not there...Private equi­ty is going to have a real­ly hard time for a while ... The wind is blow­ing in your face today, not at your back.” What if that’s the real­i­ty of the sit­u­a­tion? It’s the big ques­tion fac­ing the indus­try and most espe­cial­ly all of those pen­sion fund investors now try­ing to deter­mine if they need to pull back or dou­ble down. We’ll see­ing how much addi­tion­al pen­sion fund mon­ey ends up flow­ing into pri­vate-equi­ty funds as this plays out, but as the fol­low­ing Finan­cial Times arti­cle makes clear, a lot of that mon­ey is going to spent just try­ing to pre­vent the exist­ing bro­ken busi­ness mod­el from burst­ing at the seams:

    The Finan­cial Times

    Pri­vate equi­ty: high­er rates start to pum­mel deal­mak­ers

    The firms that used the era of cheap mon­ey to become the new finan­cial titans are wrestling with ris­ing inter­est costs

    Antoine Gara and Eric Platt in New York, Will Louch in Lon­don
    Novem­ber 1, 2023 12:00 AM

    In ear­ly March, Car­lyle Group appeared close to a takeover that val­ued health­care soft­ware com­pa­ny Cotiv­i­ti at $15bn. It was just the sort of auda­cious deal that large pri­vate equi­ty firms have been pulling off for much of the past decade.

    More than a dozen pri­vate lenders, includ­ing the cred­it arms of Black­stone, Apol­lo Glob­al, Ares and HPS, were ready to sign off on a record $5.5bn pri­vate loan that would have put Car­lyle in con­trol of Cotiv­i­ti.

    But the process dragged on for weeks. Accord­ing to more than a dozen peo­ple involved in the trans­ac­tion, the key hold-up was a stun­ning set­back in an indus­try man­ag­ing $3.3tn of assets: Car­lyle, one of the most pow­er­ful pri­vate equi­ty firms, had been unable to raise all of its rough­ly $3bn equi­ty com­mit­ment from investors.

    ********

    The yield on the debt financ­ing, around 12 per cent at the time, would have been approach­ing the return Car­lyle was hop­ing to earn, sti­fling inter­est from poten­tial investors, accord­ing to one per­son involved in the deal. When Car­lyle attempt­ed to rene­go­ti­ate the $15bn val­u­a­tion, Ver­i­tas Cap­i­tal, the exist­ing pri­vate equi­ty own­er, walked away from the sale.

    “It was an extra­or­di­nary ‘fall on your face’ by Car­lyle,” the per­son adds.

    That, at least, is how it looked at the time to many in the indus­try, some of whom put the col­lapse of the deal down to com­pa­ny-spe­cif­ic fac­tors at Car­lyle or the fears that month about a bank­ing cri­sis in the US.

    But in ret­ro­spect, it was also a har­bin­ger of the sorts of pres­sures that are start­ing to bite the pri­vate equi­ty indus­try as inter­est rates remain high­er than most finance indus­try exec­u­tives had expect­ed just 18 months ago. No alter­na­tive deal has emerged since March for Cotiv­i­ti, sug­gest­ing prob­lems that go well beyond one pri­vate equi­ty firm.

    The prospect of rates stay­ing high­er for longer is hav­ing pow­er­ful rip­ple effects across the econ­o­my; com­pa­nies large and small are strug­gling to refi­nance debt, while gov­ern­ments are see­ing the cost of their pan­dem­ic-era bor­row­ings rise.

    But pri­vate equi­ty is the indus­try that surfed the decade and a half of low inter­est rates, using plen­ti­ful and cheap debt to snap up one com­pa­ny after anoth­er and become the new titans of the finan­cial sec­tor.

    “Many of the rea­sons these guys out­per­formed had noth­ing to do with skill,” says Patrick Dwyer, a man­ag­ing direc­tor at NewEdge Wealth, an advi­so­ry firm whose clients invest in pri­vate equi­ty funds. “Bor­row­ing costs were cheap and the liq­uid­i­ty was there. Now, it’s not there,” he adds. “Pri­vate equi­ty is going to have a real­ly hard time for a while . . . The wind is blow­ing in your face today, not at your back.”

    ********

    Fac­ing a sud­den hia­tus in new mon­ey flow­ing into their funds and with exist­ing invest­ments fac­ing refi­nanc­ing pres­sure, pri­vate equi­ty groups are increas­ing­ly resort­ing to var­i­ous types of finan­cial engi­neer­ing.

    They have begun bor­row­ing heav­i­ly against the com­bined assets of their funds to unlock the cash need­ed to pay div­i­dends to investors. Some firms favour these loans because they remove the need to ask their investors for more mon­ey to bail out com­pa­nies strug­gling under heavy debt loads.

    Anoth­er tac­tic is to shift away from mak­ing inter­est pay­ments in cash, which con­serves it in the short term but adds to the over­all amounts owed.

    Pri­vate equi­ty exec­u­tives insist that the present dif­fi­cul­ties will be short­lived and that peri­ods of stress are often the times when the best deals can be struck.

    “We’re not forced sell­ers of assets on the one side and yet we have the abil­i­ty to move very quick­ly when there is dis­lo­ca­tion to take advan­tage of an oppor­tu­ni­ty,” Black­stone pres­i­dent Jonathan Gray recent­ly said.

    On this opti­mistic telling, the unusu­al financ­ing tac­tics are a solu­tion to tem­po­rary chal­lenges with­in an indus­try that remains flush with about $2.5tn of uncalled investor cash, com­mon­ly referred to as “dry pow­der”.

    ********

    How­ev­er, oth­ers view the finan­cial engi­neer­ing as a symp­tom of a deep­en­ing cri­sis. They say a modus operan­di that thrived in an envi­ron­ment of low inter­est rates will look very dif­fer­ent if rates stay high­er for some time.

    The co-founder of one of the world’s largest invest­ment firms points out that almost the entire his­to­ry of the indus­try has played out against a back­drop of “declin­ing rates, which raise asset val­ues and reduce the cost of cap­i­tal. And that’s large­ly over.”

    “The tide has gone out,” says Andrea Auer­bach, head of pri­vate invest­ments at Cam­bridge Asso­ciates, which advis­es large insti­tu­tions on their pri­vate equi­ty invest­ments. “The rocks are show­ing and we are going to fig­ure out who is a good swim­mer.”

    The per­il of heavy debts

    After cen­tral banks around the world slashed inter­est rates to near zero in response to the 2008–2009 finan­cial cri­sis, pri­vate equi­ty embarked on its longest and most pow­er­ful boom. In 2021, the market’s zenith, a record $1.2tn in deals were struck, accord­ing to Pitch­Book data.

    But a series of rapid inter­est rate ris­es in 2022 brought this to a halt and many buy­out hous­es have been left sit­ting on large invest­ments they bought at the top of a bull mar­ket.

    High­er inter­est rates have been par­tic­u­lar­ly prob­lem­at­ic for heav­i­ly indebt­ed com­pa­nies with bor­row­ings near­ing matu­ri­ty. An exam­ple is Finas­tra.

    The pay­ments com­pa­ny, owned by Vista Equi­ty Part­ners, faced $4.5bn of debt matur­ing in 2024 but found itself shut out of pub­lic mar­kets, which have increas­ing­ly been closed to riski­er bor­row­ers. Just $3bn of risky triple‑C rat­ed US bonds and loans have been issued into the broad mar­ket this year, down 78 per cent from last year, accord­ing to data from Pitch­Book LCD and Refini­tiv. Even high­er-qual­i­ty com­pa­nies are get­ting shut out, with single‑B and single‑B minus rat­ed loan issuance in the US down more than 70 per cent from 2021 lev­els.

    Vista turned instead to the bur­geon­ing pri­vate cred­it sec­tor, push­ing over sev­er­al months for a refi­nanc­ing that avoid­ed it hav­ing to put more mon­ey into the com­pa­ny, at one point enter­tain­ing a loan with an inter­est rate approach­ing 18 per cent.

    But lenders were wary. Some firms, such as Apol­lo, Black­stone and Sixth Street, dropped out of the financ­ing alto­geth­er because of con­cerns about the strength of the lender pro­tec­tions in the doc­u­men­ta­tion, accord­ing to peo­ple briefed on the mat­ter. With lit­tle cash left in the fund that had orig­i­nal­ly invest­ed in Finas­tra, Vista turned to Gold­man Sachs for a loan secured against a group of com­pa­nies Vista owns. The firm used $1bn of the mon­ey secured to pay off some of Finastra’s debts.

    Vista’s loan — which was not dis­closed to the lenders who ulti­mate­ly did lend it $5bn to refi­nance Finastra’s oblig­a­tions — has been described as “lever­age on lever­age” because fund assets were being col­lat­er­alised to cut debt at one trou­bled com­pa­ny. The tac­tic, dubbed “defend­ing the port­fo­lio”, by lenders, is becom­ing increas­ing­ly com­mon.

    The head of one of the largest pri­vate cred­it firms describes Finas­tra as “a pre­view of the next three to five years”. Moody’s ana­lysts have warned that by year’s end, more than half of single‑B minus rat­ed US com­pa­nies will not be gen­er­at­ing enough cash to cov­er their cap­i­tal expen­di­ture while ser­vic­ing their debt. That means those busi­ness­es will be forced to dip into their cash reserves to cov­er their spend­ing.

    The inter­est cov­er­age ratio for these com­pa­nies — the extent to which oper­at­ing earn­ings cov­er inter­est pay­ments — could reach 0.91 by Decem­ber from 1.32 at the end of 2022, accord­ing to Moody’s, and could fall fur­ther still. A fig­ure below one indi­cates earn­ings are not suf­fi­cient to cov­er inter­est costs.

    That has left many firms turn­ing to so-called pay­ment-in-kind debt to pre­serve cash. Inter­est pay­ments are deferred, with the pay­ments added to the company’s over­all debt bur­den. This helps alle­vi­ate cash flow pres­sure in the short term, but it is an expen­sive form of bor­row­ing that eats into the future returns of equi­ty investors. It can also back­fire if the com­pa­ny does not grow rapid­ly enough to ulti­mate­ly cov­er its future inter­est costs.

    This year, Plat­inum Equity’s port­fo­lio com­pa­ny Bis­cuit Inter­na­tion­al raised €100mn of PIK debt at an 18 per cent inter­est rate to resolve short-term bal­ance sheet issues, accord­ing to peo­ple famil­iar with the mat­ter. Unusu­al­ly, Plat­inum itself pro­vid­ed the financ­ing, they said.

    Sol­era, anoth­er Vista-owned soft­ware com­pa­ny, swapped some of its exist­ing cash-pay debt with PIK notes this sum­mer, accord­ing to fil­ings with US secu­ri­ties reg­u­la­tors. One pri­vate equi­ty exec­u­tive, speak­ing in gen­er­al about com­pa­nies decid­ing to forego cash inter­est pay­ments, referred to these deals as a “Hail Mary”.

    ...

    In recent months, KKR, Bain Cap­i­tal, Car­lyle and Gold­man Sachs have all lost con­trol of busi­ness­es that they backed. By June next year, S&P Glob­al is pre­dict­ing the US default rate will rise to 4.5 per cent, up from 1.7 per cent at the start of 2023.

    Pay­ing back the investors

    Before com­mit­ting new funds to pri­vate equi­ty, investors gen­er­al­ly like to see returns from pre­vi­ous ven­tures. Increas­ing­ly, firms are resort­ing to finan­cial engi­neer­ing and com­plex fund struc­tures to pro­vide those returns.

    Hg Cap­i­tal, one of Europe’s largest buy­out groups, has been par­tic­u­lar­ly inno­v­a­tive, devel­op­ing a mod­el that oth­er firms includ­ing EQT and Car­lyle are repli­cat­ing. It involves hold­ing on to its best-per­form­ing assets for longer than is nor­mal, trans­fer­ring them between funds and gen­er­at­ing returns for its back­ers by sell­ing small parcels of these com­pa­nies to oth­er investors.

    Through such tac­tics, Hg has owned Nor­we­gian account­ing soft­ware com­pa­ny Vis­ma for near­ly 20 years. Dur­ing that time its val­u­a­tion has gone from about $500mn to almost $25bn, mak­ing it one of the industry’s great­est returns on paper, accord­ing to peo­ple famil­iar with the mat­ter.

    The UK buy­out group has been at the fore­front of anoth­er strat­e­gy: using the cash flow of its already lever­aged assets to bor­row more mon­ey to fund investor pay­outs, a prac­tice known as net asset val­ue financ­ing.

    The firm has tapped this type of debt to return hun­dreds of mil­lions of pounds to its back­ers, accord­ing to peo­ple famil­iar with the mat­ter and com­pa­ny fil­ings, with the loans secured against assets across mul­ti­ple funds.

    Oth­er buy­out groups are also turn­ing to NAV loans to accel­er­ate dis­tri­b­u­tions as the tra­di­tion­al exit routes from invest­ments — a sale to anoth­er com­pa­ny, or a flota­tion on the stock mar­ket — become more dif­fi­cult.

    Eye­ing an oppor­tu­ni­ty, banks are increas­ing­ly pitch­ing these loans to invest­ment firms strug­gling to sell their com­pa­nies, indus­try exec­u­tives say. Car­lyle, Vista Equi­ty and Nordic Cap­i­tal are among the firms that have tapped this mar­ket over the past year. Twen­ty per cent of the PE indus­try is con­sid­er­ing such loans, accord­ing to a recent poll from Gold­man Sachs.

    But this type of bor­row­ing has become more expen­sive. It has also drawn grow­ing investor scruti­ny because of the risk that healthy assets with­in a port­fo­lio, which have been pledged as secu­ri­ty, might need to be sold in order to repay the loans. Firms are also lean­ing on oth­er bor­row­ings to unearth cash for div­i­dends includ­ing swaps, mar­gin loans and struc­tured equi­ty sales.

    ...

    Under pres­sure

    The new inter­est-rate envi­ron­ment will be a par­tic­u­lar test for some of the buy­out firms that have grown rapid­ly over the past decade on the back of strong fund returns. A num­ber of once-small US-based buy­out groups such as Vista, Thoma Bra­vo, Plat­inum Equi­ty, HIG Cap­i­tal, Insight Part­ners and Clear­lake Cap­i­tal expand­ed rapid­ly but now face their first finan­cial down­turn man­ag­ing large pools of assets.

    Clear­lake, which last year acquired Eng­lish Pre­mier League foot­ball team Chelsea FC, became an indus­try cham­pi­on of so-called con­tin­u­a­tion funds, where a pri­vate equi­ty fund sells an asset to anoth­er fund it man­ages at a high­er val­u­a­tion. From $2bn in assets a decade ago, it now over­sees $70bn.

    uring the boom times, these deals were a quick way to realise invest­ment gains and own promis­ing com­pa­nies for longer. But scep­tics have crit­i­cised the deals because mon­ey from one fund is used to cash out ear­li­er investors at val­ues that in some cas­es now look high.

    Some of Clearlake’s deals, such as auto­mo­tive parts dis­trib­u­tor Wheel Pros, have soured due to heavy debt bur­dens and a dete­ri­o­ra­tion in their finan­cial per­for­mance. Wheel Pros com­plet­ed a finan­cial restruc­tur­ing in Sep­tem­ber that cut its debt load but made equi­ty returns more remote. Clear­lake also renamed the com­pa­ny as Hooni­gan, seek­ing a fresh start.

    Clear­lake has begun an invest­ment push to buy dis­tressed assets. Groups like Apol­lo and Cen­ter­bridge made large prof­its dur­ing the 2008 cri­sis by buy­ing such dis­count­ed bonds.

    Oth­er PE firms have grown and invest­ed at an even faster pace, rais­ing con­cerns that a flood of invest­ments made at high val­u­a­tions at the top of the mar­ket could now strug­gle.

    Thoma Bra­vo, under its bil­lion­aire co-founder Orlan­do Bra­vo, has trans­formed from a niche investor into a pro­lif­ic deal­mak­er as its assets grew from about $2bn in 2010 to $131bn at present. Since 2019, it has tak­en pri­vate more than a dozen pub­lic soft­ware com­pa­nies, spend­ing upwards of $30bn in investor mon­ey, accord­ing to Finan­cial Times cal­cu­la­tions.

    These deals often involved tak­ing large equi­ty stakes, espe­cial­ly the 2021 acqui­si­tions of cyber secu­ri­ty com­pa­ny Proof­point and real estate soft­ware spe­cial­ist Real­Page. In two recent takeovers, Thoma Bra­vo declined to use debt entire­ly due to expen­sive financ­ing costs.

    But its aggres­sive invest­ment pace as the mar­ket was near­ing its peak means the group is vul­ner­a­ble to a reset in tech­nol­o­gy val­u­a­tions in a world of high­er rates. Even with its large equi­ty cush­ion, Real­Page car­ries a size­able debt load. This year, the out­look on its cred­it rat­ing was revised low­er due to its “ele­vat­ed lever­age” ratio of 8.7‑times adjust­ed prof­its and expo­sure to large­ly unhedged float­ing rate debt.

    At a recent FT con­fer­ence, Bra­vo said his firm had not bet on ris­ing val­u­a­tion mul­ti­ples and was adapt­ing invest­ments such as Real­Page to increase their over­all prof­itabil­i­ty by both bol­ster­ing sales and cut­ting expens­es.

    Bri­an Payne, an ana­lyst of pri­vate equi­ty deals at BCA Research, says the val­u­a­tions of deals struck in recent years could dri­ve poor returns or loss­es.

    “The risk of cap­i­tal loss is high­er than it’s ever been, even when you go back to the 2007 or the 2008 vin­tages,” says Payne. “The longer the high­er-rate envi­ron­ment per­sists, the high­er the risk of cap­i­tal loss,” he says.

    With pub­lic list­ings still unat­trac­tive and deal­mak­ing cool­ing, the num­ber of pri­vate equi­ty exit trans­ac­tions is approach­ing a 10-year low. Buy­out firms are sit­ting on a record $2.8tn in unsold invest­ments leav­ing “a tow­er­ing back­log” of com­pa­nies to exit, accord­ing to con­sul­tan­cy Bain & Co. This is expect­ed to con­tin­ue into 2024.

    “I don’t see a mas­sive rebound in exits next year,” says Pierre-Antoine de Selan­cy, man­ag­ing part­ner at 17Capital.

    Some pen­sions and endow­ments have even resort­ed to sell­ing large stakes in pri­vate equi­ty funds at dis­counts to their stat­ed val­ue to raise cash.

    “We are hav­ing a lot of uncom­fort­able con­ver­sa­tions,” says Dwyer, refer­ring to meet­ings with pri­vate equi­ty firms on behalf of investor clients. “It is year three and I haven’t had a dis­tri­b­u­tion in funds that are ful­ly baked [invest­ed]. When am I going to get my cap­i­tal back?”

    ———-

    “Pri­vate equi­ty: high­er rates start to pum­mel deal­mak­ers” by Antoine Gara, Eric Platt and Will Louch; The Finan­cial Times; 11/01/2023

    ““Many of the rea­sons these guys out­per­formed had noth­ing to do with skill,” says Patrick Dwyer, a man­ag­ing direc­tor at NewEdge Wealth, an advi­so­ry firm whose clients invest in pri­vate equi­ty funds. “Bor­row­ing costs were cheap and the liq­uid­i­ty was there. Now, it’s not there,” he adds. “Pri­vate equi­ty is going to have a real­ly hard time for a while . . . The wind is blow­ing in your face today, not at your back.””

    Yikes. What if the out­sized his­toric returns of the pri­vate-equi­ty indus­try in recent decades was pri­mar­i­ly all down to low inter­est rates and finan­cial engi­neer­ing? What if these returns had lit­tle to do with the indus­try’s alleged supe­ri­or man­age­ment skills? That would sug­gest the indus­try is rather screwed in today’s nor­mal­ized inter­est-rate envi­ron­ment, would­n’t it? That’s the big meta ques­tion loom­ing over this sto­ry: is the pri­vate-equi­ty indus­try a sham that could only func­tion as long as inter­est rates were held at near-record lows? And if so, what does that bode for the indus­try going for­ward? After all, of pri­vate-equi­ty giants like the Car­lyle Group can man­age to raise cap­i­tal, what does that say about Car­lyle’s small­er com­peti­tors? The entire sec­tor appears to be in a state of dis­tress that has no signs of lift­ing soon:

    ...
    In ear­ly March, Car­lyle Group appeared close to a takeover that val­ued health­care soft­ware com­pa­ny Cotiv­i­ti at $15bn. It was just the sort of auda­cious deal that large pri­vate equi­ty firms have been pulling off for much of the past decade.

    More than a dozen pri­vate lenders, includ­ing the cred­it arms of Black­stone, Apol­lo Glob­al, Ares and HPS, were ready to sign off on a record $5.5bn pri­vate loan that would have put Car­lyle in con­trol of Cotiv­i­ti

    But the process dragged on for weeks. Accord­ing to more than a dozen peo­ple involved in the trans­ac­tion, the key hold-up was a stun­ning set­back in an indus­try man­ag­ing $3.3tn of assets: Car­lyle, one of the most pow­er­ful pri­vate equi­ty firms, had been unable to raise all of its rough­ly $3bn equi­ty com­mit­ment from investors.

    ********

    The yield on the debt financ­ing, around 12 per cent at the time, would have been approach­ing the return Car­lyle was hop­ing to earn, sti­fling inter­est from poten­tial investors, accord­ing to one per­son involved in the deal. When Car­lyle attempt­ed to rene­go­ti­ate the $15bn val­u­a­tion, Ver­i­tas Cap­i­tal, the exist­ing pri­vate equi­ty own­er, walked away from the sale.

    “It was an extra­or­di­nary ‘fall on your face’ by Car­lyle,” the per­son adds.

    That, at least, is how it looked at the time to many in the indus­try, some of whom put the col­lapse of the deal down to com­pa­ny-spe­cif­ic fac­tors at Car­lyle or the fears that month about a bank­ing cri­sis in the US.

    But in ret­ro­spect, it was also a har­bin­ger of the sorts of pres­sures that are start­ing to bite the pri­vate equi­ty indus­try as inter­est rates remain high­er than most finance indus­try exec­u­tives had expect­ed just 18 months ago. No alter­na­tive deal has emerged since March for Cotiv­i­ti, sug­gest­ing prob­lems that go well beyond one pri­vate equi­ty firm.

    The prospect of rates stay­ing high­er for longer is hav­ing pow­er­ful rip­ple effects across the econ­o­my; com­pa­nies large and small are strug­gling to refi­nance debt, while gov­ern­ments are see­ing the cost of their pan­dem­ic-era bor­row­ings rise.

    But pri­vate equi­ty is the indus­try that surfed the decade and a half of low inter­est rates, using plen­ti­ful and cheap debt to snap up one com­pa­ny after anoth­er and become the new titans of the finan­cial sec­tor.
    ...

    And note the response from the indus­try itself assur­ing investors that every­thing will be fine: Black­stone’s pres­i­dent points out how much “dry pow­der” there is in uncalled investor cash that the indus­try still has that’s avail­able when the right deals come along. But as oth­er point out, that opti­mistic out­look is pred­i­cat­ed on a busi­ness mod­el that — using mas­sive lever­age to take com­pa­nies pri­vate — is no longer viable as long as inter­est rates remain high­er for longer. Plus, those pre­dict­ed great deals on dis­tressed assets are pre­sum­ably going to be include deals offered by oth­er pri­vate-equi­ty firms try­ing to offload assets they can no longer finance. In oth­er words, the ‘good news’ of great deals that should be avail­able dou­bles as per­ilous news for the sec­tor. It’s two sides of the same coin:

    ...
    Pri­vate equi­ty exec­u­tives insist that the present dif­fi­cul­ties will be short­lived and that peri­ods of stress are often the times when the best deals can be struck.

    “We’re not forced sell­ers of assets on the one side and yet we have the abil­i­ty to move very quick­ly when there is dis­lo­ca­tion to take advan­tage of an oppor­tu­ni­ty,” Black­stone pres­i­dent Jonathan Gray recent­ly said.

    On this opti­mistic telling, the unusu­al financ­ing tac­tics are a solu­tion to tem­po­rary chal­lenges with­in an indus­try that remains flush with about $2.5tn of uncalled investor cash, com­mon­ly referred to as “dry pow­der”.

    ********

    How­ev­er, oth­ers view the finan­cial engi­neer­ing as a symp­tom of a deep­en­ing cri­sis. They say a modus operan­di that thrived in an envi­ron­ment of low inter­est rates will look very dif­fer­ent if rates stay high­er for some time.

    The co-founder of one of the world’s largest invest­ment firms points out that almost the entire his­to­ry of the indus­try has played out against a back­drop of “declin­ing rates, which raise asset val­ues and reduce the cost of cap­i­tal. And that’s large­ly over.”

    “The tide has gone out,” says Andrea Auer­bach, head of pri­vate invest­ments at Cam­bridge Asso­ciates, which advis­es large insti­tu­tions on their pri­vate equi­ty invest­ments. “The rocks are show­ing and we are going to fig­ure out who is a good swim­mer.”
    ...

    And when we see reports about how lenders are get­ting increas­ing wary about refi­nanc­ing heav­i­ly indebt­ed com­pa­nies with bor­row­ings near­ing matu­ri­ty, note the names of those big lenders: pri­vate-equi­ty giants Apol­lo, Black­stone. So when we hear assur­ances that pri­vate-equi­ty be able to finance its way out of this sit­u­a­tion, it’s worth keep­ing in mind that the cred­i­tors who are cur­rent­ly hold­ing back on lend­ing include oth­er pri­vate-equi­ty firms:

    ...
    After cen­tral banks around the world slashed inter­est rates to near zero in response to the 2008–2009 finan­cial cri­sis, pri­vate equi­ty embarked on its longest and most pow­er­ful boom. In 2021, the market’s zenith, a record $1.2tn in deals were struck, accord­ing to Pitch­Book data.

    But a series of rapid inter­est rate ris­es in 2022 brought this to a halt and many buy­out hous­es have been left sit­ting on large invest­ments they bought at the top of a bull mar­ket.

    High­er inter­est rates have been par­tic­u­lar­ly prob­lem­at­ic for heav­i­ly indebt­ed com­pa­nies with bor­row­ings near­ing matu­ri­ty. An exam­ple is Finas­tra.

    The pay­ments com­pa­ny, owned by Vista Equi­ty Part­ners, faced $4.5bn of debt matur­ing in 2024 but found itself shut out of pub­lic mar­kets, which have increas­ing­ly been closed to riski­er bor­row­ers. Just $3bn of risky triple‑C rat­ed US bonds and loans have been issued into the broad mar­ket this year, down 78 per cent from last year, accord­ing to data from Pitch­Book LCD and Refini­tiv. Even high­er-qual­i­ty com­pa­nies are get­ting shut out, with single‑B and single‑B minus rat­ed loan issuance in the US down more than 70 per cent from 2021 lev­els.

    Vista turned instead to the bur­geon­ing pri­vate cred­it sec­tor, push­ing over sev­er­al months for a refi­nanc­ing that avoid­ed it hav­ing to put more mon­ey into the com­pa­ny, at one point enter­tain­ing a loan with an inter­est rate approach­ing 18 per cent.

    But lenders were wary. Some firms, such as Apol­lo, Black­stone and Sixth Street, dropped out of the financ­ing alto­geth­er because of con­cerns about the strength of the lender pro­tec­tions in the doc­u­men­ta­tion, accord­ing to peo­ple briefed on the mat­ter. With lit­tle cash left in the fund that had orig­i­nal­ly invest­ed in Finas­tra, Vista turned to Gold­man Sachs for a loan secured against a group of com­pa­nies Vista owns. The firm used $1bn of the mon­ey secured to pay off some of Finastra’s debts.

    Vista’s loan — which was not dis­closed to the lenders who ulti­mate­ly did lend it $5bn to refi­nance Finastra’s oblig­a­tions — has been described as “lever­age on lever­age” because fund assets were being col­lat­er­alised to cut debt at one trou­bled com­pa­ny. The tac­tic, dubbed “defend­ing the port­fo­lio”, by lenders, is becom­ing increas­ing­ly com­mon.

    The head of one of the largest pri­vate cred­it firms describes Finas­tra as “a pre­view of the next three to five years”. Moody’s ana­lysts have warned that by year’s end, more than half of single‑B minus rat­ed US com­pa­nies will not be gen­er­at­ing enough cash to cov­er their cap­i­tal expen­di­ture while ser­vic­ing their debt. That means those busi­ness­es will be forced to dip into their cash reserves to cov­er their spend­ing.
    ...

    So what will the indus­try ulti­mate­ly end up doing to stay afloat? Well, there’s short-term solu­tions like pay­ment-in-kind debt, that sim­ply push off inter­est pay­ments into the future. Or as one exec­u­tive describe it, a “Hail Mary”:

    ...
    The inter­est cov­er­age ratio for these com­pa­nies — the extent to which oper­at­ing earn­ings cov­er inter­est pay­ments — could reach 0.91 by Decem­ber from 1.32 at the end of 2022, accord­ing to Moody’s, and could fall fur­ther still. A fig­ure below one indi­cates earn­ings are not suf­fi­cient to cov­er inter­est costs.

    That has left many firms turn­ing to so-called pay­ment-in-kind debt to pre­serve cash. Inter­est pay­ments are deferred, with the pay­ments added to the company’s over­all debt bur­den. This helps alle­vi­ate cash flow pres­sure in the short term, but it is an expen­sive form of bor­row­ing that eats into the future returns of equi­ty investors. It can also back­fire if the com­pa­ny does not grow rapid­ly enough to ulti­mate­ly cov­er its future inter­est costs.

    This year, Plat­inum Equity’s port­fo­lio com­pa­ny Bis­cuit Inter­na­tion­al raised €100mn of PIK debt at an 18 per cent inter­est rate to resolve short-term bal­ance sheet issues, accord­ing to peo­ple famil­iar with the mat­ter. Unusu­al­ly, Plat­inum itself pro­vid­ed the financ­ing, they said.

    Sol­era, anoth­er Vista-owned soft­ware com­pa­ny, swapped some of its exist­ing cash-pay debt with PIK notes this sum­mer, accord­ing to fil­ings with US secu­ri­ties reg­u­la­tors. One pri­vate equi­ty exec­u­tive, speak­ing in gen­er­al about com­pa­nies decid­ing to forego cash inter­est pay­ments, referred to these deals as a “Hail Mary”.
    ...

    And then there’s the “net asset val­ue” (NAV) financ­ing, that involves bor­row­ing mon­ey using things like cash flow as part of the col­lat­er­al. Bor­row­ing to pay out to the investors. It’s an exam­ple of the kind of finan­cial engi­neer­ing options that can keep the fund pay­ing out to investors as expect­ed in the short-run, but pos­es obvi­ous long-term risks that includes even­tu­al­ly forc­ing the sale of the health­i­est assets in a port­fo­lio to even­tu­al­ly repay these loans:

    ...
    Before com­mit­ting new funds to pri­vate equi­ty, investors gen­er­al­ly like to see returns from pre­vi­ous ven­tures. Increas­ing­ly, firms are resort­ing to finan­cial engi­neer­ing and com­plex fund struc­tures to pro­vide those returns.

    Hg Cap­i­tal, one of Europe’s largest buy­out groups, has been par­tic­u­lar­ly inno­v­a­tive, devel­op­ing a mod­el that oth­er firms includ­ing EQT and Car­lyle are repli­cat­ing. It involves hold­ing on to its best-per­form­ing assets for longer than is nor­mal, trans­fer­ring them between funds and gen­er­at­ing returns for its back­ers by sell­ing small parcels of these com­pa­nies to oth­er investors.

    Through such tac­tics, Hg has owned Nor­we­gian account­ing soft­ware com­pa­ny Vis­ma for near­ly 20 years. Dur­ing that time its val­u­a­tion has gone from about $500mn to almost $25bn, mak­ing it one of the industry’s great­est returns on paper, accord­ing to peo­ple famil­iar with the mat­ter.

    The UK buy­out group has been at the fore­front of anoth­er strat­e­gy: using the cash flow of its already lever­aged assets to bor­row more mon­ey to fund investor pay­outs, a prac­tice known as net asset val­ue financ­ing.

    The firm has tapped this type of debt to return hun­dreds of mil­lions of pounds to its back­ers, accord­ing to peo­ple famil­iar with the mat­ter and com­pa­ny fil­ings, with the loans secured against assets across mul­ti­ple funds.

    Oth­er buy­out groups are also turn­ing to NAV loans to accel­er­ate dis­tri­b­u­tions as the tra­di­tion­al exit routes from invest­ments — a sale to anoth­er com­pa­ny, or a flota­tion on the stock mar­ket — become more dif­fi­cult.

    Eye­ing an oppor­tu­ni­ty, banks are increas­ing­ly pitch­ing these loans to invest­ment firms strug­gling to sell their com­pa­nies, indus­try exec­u­tives say. Car­lyle, Vista Equi­ty and Nordic Cap­i­tal are among the firms that have tapped this mar­ket over the past year. Twen­ty per cent of the PE indus­try is con­sid­er­ing such loans, accord­ing to a recent poll from Gold­man Sachs.

    But this type of bor­row­ing has become more expen­sive. It has also drawn grow­ing investor scruti­ny because of the risk that healthy assets with­in a port­fo­lio, which have been pledged as secu­ri­ty, might need to be sold in order to repay the loans. Firms are also lean­ing on oth­er bor­row­ings to unearth cash for div­i­dends includ­ing swaps, mar­gin loans and struc­tured equi­ty sales.
    ...

    There’s also the grow­ing inter­est­ing in self-deal­ing, where a pri­vate-equi­ty firm basi­cal­ly sells the assets of one fund to anoth­er fund. Great in the short-run...not so much in the long-run:

    ...
    The new inter­est-rate envi­ron­ment will be a par­tic­u­lar test for some of the buy­out firms that have grown rapid­ly over the past decade on the back of strong fund returns. A num­ber of once-small US-based buy­out groups such as Vista, Thoma Bra­vo, Plat­inum Equi­ty, HIG Cap­i­tal, Insight Part­ners and Clear­lake Cap­i­tal expand­ed rapid­ly but now face their first finan­cial down­turn man­ag­ing large pools of assets.

    Clear­lake, which last year acquired Eng­lish Pre­mier League foot­ball team Chelsea FC, became an indus­try cham­pi­on of so-called con­tin­u­a­tion funds, where a pri­vate equi­ty fund sells an asset to anoth­er fund it man­ages at a high­er val­u­a­tion. From $2bn in assets a decade ago, it now over­sees $70bn.

    uring the boom times, these deals were a quick way to realise invest­ment gains and own promis­ing com­pa­nies for longer. But scep­tics have crit­i­cised the deals because mon­ey from one fund is used to cash out ear­li­er investors at val­ues that in some cas­es now look high.

    Some of Clearlake’s deals, such as auto­mo­tive parts dis­trib­u­tor Wheel Pros, have soured due to heavy debt bur­dens and a dete­ri­o­ra­tion in their finan­cial per­for­mance. Wheel Pros com­plet­ed a finan­cial restruc­tur­ing in Sep­tem­ber that cut its debt load but made equi­ty returns more remote. Clear­lake also renamed the com­pa­ny as Hooni­gan, seek­ing a fresh start.

    Clear­lake has begun an invest­ment push to buy dis­tressed assets. Groups like Apol­lo and Cen­ter­bridge made large prof­its dur­ing the 2008 cri­sis by buy­ing such dis­count­ed bonds.
    ...

    As anoth­er exam­ple of the argu­ment that the indus­try was real­ly just a one-trick-pony based on low inter­est rates and lever­age, we see the warn­ings about how many pri­vate-equi­ty firms have explod­ed in size over the last decade, which in turn implies that much of the assets owned by these firms were pur­chased near the mar­ket highs. And that includes firms like Thoma Bra­vo, which grew from around $2 bil­lion in assets in 2010 to $131 bil­lion in 2023. This is a good time to recall how Thoma Bra­vo had to deny insid­er trad­ing accu­sa­tions relat­ed to its invest­ment in Solar­Winds, where the com­pa­ny appeared to sell off a stake in its Solar­Winds invest­ment to a Cana­di­an pen­sion fund lit­er­al­ly one day before the Solar­Winds mega-hack was pub­licly announced. Which is a reminder that the self-deal­ing sale of over­val­ued assets from one pri­vate-equi­ty fund to anoth­er is prob­a­bly going to involve the sales that end up leav­ing pri­vate-equi­ty’s pen­sion­er investors hold­ing the bag:

    ...
    Oth­er PE firms have grown and invest­ed at an even faster pace, rais­ing con­cerns that a flood of invest­ments made at high val­u­a­tions at the top of the mar­ket could now strug­gle.

    Thoma Bra­vo, under its bil­lion­aire co-founder Orlan­do Bra­vo, has trans­formed from a niche investor into a pro­lif­ic deal­mak­er as its assets grew from about $2bn in 2010 to $131bn at present. Since 2019, it has tak­en pri­vate more than a dozen pub­lic soft­ware com­pa­nies, spend­ing upwards of $30bn in investor mon­ey, accord­ing to Finan­cial Times cal­cu­la­tions.

    These deals often involved tak­ing large equi­ty stakes, espe­cial­ly the 2021 acqui­si­tions of cyber secu­ri­ty com­pa­ny Proof­point and real estate soft­ware spe­cial­ist Real­Page. In two recent takeovers, Thoma Bra­vo declined to use debt entire­ly due to expen­sive financ­ing costs.

    But its aggres­sive invest­ment pace as the mar­ket was near­ing its peak means the group is vul­ner­a­ble to a reset in tech­nol­o­gy val­u­a­tions in a world of high­er rates. Even with its large equi­ty cush­ion, Real­Page car­ries a size­able debt load. This year, the out­look on its cred­it rat­ing was revised low­er due to its “ele­vat­ed lever­age” ratio of 8.7‑times adjust­ed prof­its and expo­sure to large­ly unhedged float­ing rate debt.

    At a recent FT con­fer­ence, Bra­vo said his firm had not bet on ris­ing val­u­a­tion mul­ti­ples and was adapt­ing invest­ments such as Real­Page to increase their over­all prof­itabil­i­ty by both bol­ster­ing sales and cut­ting expens­es.

    Bri­an Payne, an ana­lyst of pri­vate equi­ty deals at BCA Research, says the val­u­a­tions of deals struck in recent years could dri­ve poor returns or loss­es.

    “The risk of cap­i­tal loss is high­er than it’s ever been, even when you go back to the 2007 or the 2008 vin­tages,” says Payne. “The longer the high­er-rate envi­ron­ment per­sists, the high­er the risk of cap­i­tal loss,” he says.
    ...

    And that brings us to omi­nous warn­ing at the end: pen­sions and endow­ments are already pulling out of the sec­tor and accept­ing large loss­es to do so. Keep in mind that pen­sions have been the dom­i­nant pri­vate-equi­ty investors for the past decade. So if the dom­i­nant pri­vate-equi­ty investor sec­tor ends up pulling back sig­nif­i­cant­ly, that’s only going to make the sec­tor more and more reliant on these ‘alter­na­tive’ forms of financ­ing:

    ...
    With pub­lic list­ings still unat­trac­tive and deal­mak­ing cool­ing, the num­ber of pri­vate equi­ty exit trans­ac­tions is approach­ing a 10-year low. Buy­out firms are sit­ting on a record $2.8tn in unsold invest­ments leav­ing “a tow­er­ing back­log” of com­pa­nies to exit, accord­ing to con­sul­tan­cy Bain & Co. This is expect­ed to con­tin­ue into 2024.

    “I don’t see a mas­sive rebound in exits next year,” says Pierre-Antoine de Selan­cy, man­ag­ing part­ner at 17Capital.

    Some pen­sions and endow­ments have even resort­ed to sell­ing large stakes in pri­vate equi­ty funds at dis­counts to their stat­ed val­ue to raise cash.

    “We are hav­ing a lot of uncom­fort­able con­ver­sa­tions,” says Dwyer, refer­ring to meet­ings with pri­vate equi­ty firms on behalf of investor clients. “It is year three and I haven’t had a dis­tri­b­u­tion in funds that are ful­ly baked [invest­ed]. When am I going to get my cap­i­tal back?”
    ...

    Again, the indus­try’s his­toric track record is pred­i­cat­ed on his­tor­i­cal­ly low inter­est rates, finan­cial lever­age, and a seem­ing­ly end­less flood of new investor cash. What hap­pens when all of those trends go into reverse? And what if it’s in reverse for years to come? We’ll see, but pen­sion cuts seem like a pret­ty fore­see­able out­come. Along with more yachts for the fund man­agers and part­ners. It’s that kind of bro­ken busi­ness mod­el.

    Posted by Pterrafractyl | November 2, 2023, 9:48 pm
  11. One man’s cri­sis is anoth­er’s oppor­tu­ni­ty. It’s a phrase often heard in the con­text of invest­ing. But there’s prob­a­bly a more com­plete way of putting it since anoth­er’s finan­cial cri­sis is real­ly only your oppor­tu­ni­ty if you have the cash on hand to exploit it. One man’s cri­sis is a rich man’s oppor­tu­ni­ty. It’s kind of how our sys­tem works.

    And that brings us to the fol­low­ing set of sto­ries about an unfold­ing dynam­ic in the pri­vate-equi­ty mar­kets. The kind of dynam­ic we should expect at this point: fam­i­ly offices — the invest­ment firms for the ultra-wealthy — have for the first time allo­cat­ed more of their assets in the pri­vate mar­kets vs pub­lic equi­ties. Accord­ing a sur­vey of 330 fam­i­ly offices by Cam­p­den Wealth and RBC, the port­fo­lio allo­ca­tions to pub­lic equi­ty and pri­vate cap­i­tal mar­kets were respec­tive­ly 28.5 per cent and 29.2 per cent last year in 2023. This is the first time fam­i­ly office allo­ca­tions to pri­vate cap­i­tal mar­kets have has exceed­ed the pub­licly trad­ed stocks. It also sounds like these fam­i­ly offices are stock­ing up on cash, and lay­ing in wait for the right oppor­tu­ni­ties.

    At the same time, anoth­er record was just set in the mar­kets: the top 10 per­cent of US house­holds now hold 92.5% of pub­licly trad­ed US stocks, a greater share than at any point in his­to­ry. Two decades ago, that fig­ure was around 77 per­cent, an absurd fig­ure but not as absurd as today.

    So at the same time almost all the wealth in the pub­licly trad­ed stocks are held by the wealthy, we learn­ing about how the ultra-wealthy are now increas­ing­ly piv­ot­ing their invest­ments towards the pri­vate-equi­ty space. Why the piv­ot? Well, it sounds like fam­i­ly offices smell blood in the water in terms of the assets cur­rent­ly held by pri­vate-equi­ty investors. And it’s not just the fam­i­ly offices detect­ing these deals. Glob­al reg­u­la­tors have been increas­ing­ly sound­ing the alarm in recent months on the over­in­flat­ed val­u­a­tions pri­vate-equi­ty firms are plac­ing on their assets. UK reg­u­la­tors are even report­ed­ly inves­ti­gat­ing this issue.

    How do we know these val­u­a­tions are over­in­flat­ed? Well, one exam­ple is the fact that UK pen­sion funds are being forced to sell assets at steep dis­counts would be an exam­ple, up to 40% below the val­u­a­tions on their books. In addi­tion, stakes in pri­vate-equi­ty buy out funds have been sell­ing at 85 cents on the dol­lar in recent years as cen­tral banks start­ed rais­ing their rates.

    Over­all, it appears that the prob­lems fac­ing pen­sion funds in the pri­vate-equi­ty space are big­ger than pre­vi­ous­ly acknowl­edged. And the ulta-wealthy are ready to take advan­tage of the oppor­tu­ni­ties these prob­lems are inevitably going to cre­ate, espe­cial­ly if reg­u­la­tors start get­ting more direct­ly involved. One pen­sion­er’s cri­sis is a ultra-rich man’s oppor­tu­ni­ty. Or, rather, many pen­sion­ers’ crises.

    Ok, first, here’s a look at how US stock mar­kets aren’t just dis­tort­ed by the extreme val­u­a­tions of a hand­ful of tech giants:

    The Finan­cial Times

    The Mag­nif­i­cent Sev­en is not the only con­cen­tra­tion Amer­i­ca should wor­ry about

    Own­er­ship of equi­ties sug­gests that US demo­c­ra­t­ic share­hold­er cap­i­tal­ism is more myth than real­i­ty

    Gillian Tett
    Jan­u­ary 4 2024

    Eigh­teen years ago I start­ed pon­der­ing con­cen­tra­tion risks in the Amer­i­can equi­ty mar­kets. The issue was the banks: back then there was such heady opti­mism about finan­cial inno­va­tion that the finance sector’s cap­i­tal­i­sa­tion had grown to a point where it account­ed for almost a quar­ter of the Stan­dard and Poor’s index.

    Many investors assumed this lop­sided pic­ture was nor­mal and would con­tin­ue indef­i­nite­ly. But then the cred­it bub­ble burst in 2007, and the finance sec­tor shriv­elled, cre­at­ing a more bal­anced equi­ty world in which health­care, indus­tri­als, infor­ma­tion tech­nol­o­gy and oth­er busi­ness sec­tors had sim­i­lar weights, echo­ing the econ­o­my.

    Could this saga play out again in 2024? It is a ques­tion now weigh­ing on some investors’ minds — but this time with tech, not finance. Last year the mar­ket cap of the so-called Mag­nif­i­cent Sev­en tech stocks — Apple, Ama­zon, Alpha­bet, Meta, Microsoft, Nvidia and Tes­la — jumped 72 per cent, amid wild excite­ment about tech inno­va­tion in gen­er­al and arti­fi­cial intel­li­gence in par­tic­u­lar.

    **********

    Torsten Slok of Apol­lo cal­cu­lates that this gave them a $12tn mar­ket cap­i­tal­i­sa­tion, equiv­a­lent to the entire Cana­di­an, British and Japan­ese equi­ty exchanges com­bined. It also means the IT sec­tor accounts for around 30 per cent of the S&P (or 37 per cent if you include the close­ly linked com­mu­ni­ca­tions ser­vices sec­tor).

    Some investors think — or hope — this lop­sided pat­tern will con­tin­ue. Maybe so. After all, tech com­pa­nies (unlike banks) make tan­gi­ble prod­ucts that arguably dri­ve real eco­nom­ic growth. And this pic­ture is not (yet) as extreme as it was dur­ing the dot­com bub­ble of 2000, when the IT sec­tor rose to 35 per cent of the S&P — before implod­ing.

    How­ev­er, nerves are start­ing to fray: the Nas­daq tum­bled this week after Bar­clays down­grad­ed its out­look for Apple. And the his­to­ry of 2007 — and 2001 — sug­gests that if any­thing caus­es the hype around tech inno­va­tion to crack, there could be a con­ta­gious loss of faith that hurts many investors.

    ...

    But as investors pon­der this sec­toral imbal­ance, there is a sec­ond type of con­cen­tra­tion which has also emerged, but received far less atten­tion — around the own­er­ship of equi­ties.

    The nation­al myth likes to present the US polit­i­cal econ­o­my as one based on demo­c­ra­t­ic share­hold­er cap­i­tal­ism. In some sens­es, this is true: 61 per cent of the pop­u­la­tion cur­rent­ly owns equi­ties, often via 401K retire­ment plans. And aware­ness of the mar­kets is arguably greater than in coun­tries such as the UK.

    **********

    But the dirty secret behind this myth is that, while access to equi­ties is wide­spread, own­er­ship is becom­ing more con­cen­trat­ed. Two decades ago, the wealth­i­est 10 per cent of Amer­i­cans held 77 per cent of cor­po­rate equi­ties and mutu­al funds, accord­ing to cal­cu­la­tions by Lyn Alden, a strate­gist. The poor­est 50 per cent held just 1 per cent, leav­ing the mid­dle-to-upper cohort with 12 per cent.

    Today, how­ev­er, the wealth­i­est 10 per cent own 92.5 per cent of the mar­ket — a “record high con­cen­tra­tion”, Alden notes. And while the rich­est 1 per cent owned just 40 per cent two decades ago, their share stood at 54 per cent in the most recent data from 2022.

    This is strik­ing, par­tic­u­lar­ly since the fam­i­ly offices which typ­i­cal­ly man­age the assets of America’s ultra wealthy are actu­al­ly mov­ing away from pub­lic mar­kets, in rel­a­tive terms. A sur­vey of 330 fam­i­ly offices by Cam­p­den Wealth and RBC sug­gests that their port­fo­lio allo­ca­tions to pub­lic equi­ty and pri­vate cap­i­tal mar­kets were respec­tive­ly 28.5 per cent and 29.2 per cent last year — the first time the lat­ter has exceed­ed the for­mer.

    A cyn­ic might argue that con­cen­tra­tion is just an inevitable con­se­quence of a win­ner-takes-all mod­el of cap­i­tal­ism (or, as the econ­o­mist Thomas Piket­ty not­ed, a world in which returns on cap­i­tal keep out­strip­ping real growth and wages.)

    An angry cyn­ic might also point out that nobody will care if this pat­tern means America’s wealthy bear the brunt of any future col­lapse of tech stocks, at least in gross terms. (In rel­a­tive terms it would prob­a­bly be the less wealthy who feel the most pain, since their 401Ks tend to be focused on the index, and thus less diver­si­fied and pro­tect­ed than fam­i­ly office port­fo­lios.)

    ...

    **********

    I doubt any of this will get much air­time in the 2024 elec­tion cam­paigns; Joe Biden’s White House gen­er­al­ly does not talk much about the stock mar­ket. But it would behove politi­cians to ask ques­tions about how they can cre­ate an equi­ty world in which as many peo­ple as pos­si­ble feel like they have skin in the game. And investors, for their part, should watch those Mag­nif­i­cent Sev­en — and remem­ber what hap­pened in 2007 and 2001.

    ———-

    “The Mag­nif­i­cent Sev­en is not the only con­cen­tra­tion Amer­i­ca should wor­ry about” by Gillian Tett; The Finan­cial Times; 01/04/2024

    Today, how­ev­er, the wealth­i­est 10 per cent own 92.5 per cent of the mar­ket — a “record high con­cen­tra­tion”, Alden notes. And while the rich­est 1 per cent owned just 40 per cent two decades ago, their share stood at 54 per cent in the most recent data from 2022.”

    A record high con­cen­tra­tion of stock mar­ket own­er­ship in the wealth­i­est 10 per­cent of Amer­i­cans. It would be nice if this was­n’t exact­ly the kind of record that we should expect in today’s econ­o­my.

    But that record con­cen­tra­tion of wealth in the pub­lic stock mar­kets isn’t the only wealth-con­cen­tra­tion record that’s recent­ly been set. For the first time on record, fam­i­ly offices, the asset man­age­ment option exclu­sive for the ultra-wealthy, now hold more of their assets in pri­vate equi­ty hold­ings over pub­lic stock hold­ings. So this record con­cen­tra­tion of pub­lic stocks by the wealthy is hap­pen­ing at the same time the ultra-wealthy have been increas­ing their share of pri­vate mar­ket assets. In oth­er words, the ultra-wealthy are increas­ing­ly inter­est­ed in the pri­vate-equi­ty space:

    ...
    But as investors pon­der this sec­toral imbal­ance, there is a sec­ond type of con­cen­tra­tion which has also emerged, but received far less atten­tion — around the own­er­ship of equi­ties.

    The nation­al myth likes to present the US polit­i­cal econ­o­my as one based on demo­c­ra­t­ic share­hold­er cap­i­tal­ism. In some sens­es, this is true: 61 per cent of the pop­u­la­tion cur­rent­ly owns equi­ties, often via 401K retire­ment plans. And aware­ness of the mar­kets is arguably greater than in coun­tries such as the UK.

    **********

    But the dirty secret behind this myth is that, while access to equi­ties is wide­spread, own­er­ship is becom­ing more con­cen­trat­ed. Two decades ago, the wealth­i­est 10 per cent of Amer­i­cans held 77 per cent of cor­po­rate equi­ties and mutu­al funds, accord­ing to cal­cu­la­tions by Lyn Alden, a strate­gist. The poor­est 50 per cent held just 1 per cent, leav­ing the mid­dle-to-upper cohort with 12 per cent.

    ...

    This is strik­ing, par­tic­u­lar­ly since the fam­i­ly offices which typ­i­cal­ly man­age the assets of America’s ultra wealthy are actu­al­ly mov­ing away from pub­lic mar­kets, in rel­a­tive terms. A sur­vey of 330 fam­i­ly offices by Cam­p­den Wealth and RBC sug­gests that their port­fo­lio allo­ca­tions to pub­lic equi­ty and pri­vate cap­i­tal mar­kets were respec­tive­ly 28.5 per cent and 29.2 per cent last year — the first time the lat­ter has exceed­ed the for­mer.

    A cyn­ic might argue that con­cen­tra­tion is just an inevitable con­se­quence of a win­ner-takes-all mod­el of cap­i­tal­ism (or, as the econ­o­mist Thomas Piket­ty not­ed, a world in which returns on cap­i­tal keep out­strip­ping real growth and wages.)
    ...

    And that brings us to the fol­low­ing CNBC arti­cle from a lit­tle less than two months ago about this shift by fam­i­ly offices out of stocks and into the pri­vate mar­kets. As the arti­cle describes, fam­i­ly offices have been par­tic­u­lar­ly keen on direct-deals in the pri­vate equi­ty space post-pan­dem­ic, pre­sum­ably on the hunt for dis­tressed assets and sell­ers with no bet­ter options. Along those lines, it sounds like they are sit­ting on lots of cash. Wait­ing for the right oppor­tu­ni­ty. Which will, of course, be the wrong oppor­tu­ni­ty for the enti­ties forced to sell those dis­tressed assets:

    CNBC

    Fam­i­ly offices move mon­ey out of stocks and into pri­vate mar­kets

    Robert Frank
    Pub­lished Tue, Nov 28 2023 2:57 PM EST

    * Fam­i­ly offices now have more of their mon­ey invest­ed in pri­vate mar­kets than the pub­lic stock mar­ket — even as the mar­ket ral­lies.
    * The new sur­vey results under­score a sweep­ing shift in the invest­ment prac­tices of fam­i­ly offices, the pri­vate invest­ing arms of fam­i­lies with assets typ­i­cal­ly of $100 mil­lion or more.
    * Along with pri­vate mar­kets, fam­i­ly offices are also show­ing increas­ing inter­est in alter­na­tive assets, includ­ing real estate and com­modi­ties.

    Fam­i­ly offices now have more of their mon­ey invest­ed in pri­vate mar­kets than the pub­lic stock mar­ket — even as the mar­ket ral­lies — accord­ing to a new sur­vey.

    A sur­vey of North Amer­i­can fam­i­ly offices con­duct­ed by Cam­p­den Wealth and RBC found that fam­i­ly offices had 29.2% of their invest­ments in pri­vate mar­kets, which include pri­vate equi­ty, ven­ture cap­i­tal and pri­vate debt, com­pared to 28.5% in pub­licly trad­ed stocks.

    It marks the first time in the sur­vey that fam­i­ly offices had more invest­ed in pri­vate mar­kets than pub­lic stock. Their stock allo­ca­tion has come down from 31% the year before, while their pri­vate invest­ments increased from 27%. The remain­ing assets were invest­ed in cash, bonds, alter­na­tives, hedge funds, com­modi­ties, real estate and oth­er invest­ments.

    ...

    And they plan to con­cen­trate even more heav­i­ly on pri­vate mar­kets in the com­ing months, accord­ing to the sur­vey, which found 41% of fam­i­ly offices plan to boost their allo­ca­tions to pri­vate equi­ty funds, and a third plan to put more mon­ey into direct pri­vate equi­ty deals.

    Only 23% planned to add to their devel­oped-mar­ket pub­lic stocks, while 15% plan to trim their stock hold­ings, accord­ing to the sur­vey.

    The results under­score a sweep­ing shift in the invest­ment prac­tices of fam­i­ly offices, the pri­vate invest­ing arms of fam­i­lies with assets typ­i­cal­ly of $100 mil­lion or more, even despite a recent ral­ly in stocks. The S&P 500 is up 19% so far this year.

    Over the past decade, and espe­cial­ly after the pan­dem­ic, fam­i­ly offices have rushed into pri­vate equi­ty and so-called direct deals, where they buy stakes in pri­vate com­pa­nies on their own. Fam­i­ly offices say pri­vate mar­kets offer bet­ter returns over the long term with­out the volatil­i­ty of stocks.

    ...

    It’s unclear whether the bet will con­tin­ue to pay off. Pri­vate equi­ty funds are strug­gling with tight financ­ing and expen­sive loans, along with a lack of exits giv­en the drought of IPOs.

    Mean­time, as investors expect inter­est rate cuts in 2024, stocks may con­tin­ue to ral­ly.

    When asked which asset class will give them the best returns in the com­ing years, fam­i­ly offices ranked “pri­vate equi­ty and ven­ture cap­i­tal” first, fol­lowed by pub­lic equi­ties.

    “Despite the cau­tious approach adopt­ed by fam­i­ly offices in response to the (2022) retreat of finan­cial mar­kets, their per­spec­tives on the sources of the best long-term returns remain stead­fast,” the report said. “Pri­vate equi­ty and ven­ture cap­i­tal con­tin­ue to head the list.”

    Along with pri­vate mar­kets, fam­i­ly offices are also show­ing increas­ing inter­est in alter­na­tive assets, includ­ing real estate and com­modi­ties. When asked about their invest­ment pri­or­i­ties for the com­ing year, the num­ber one choice was to “invest in alter­na­tive asset class­es.”

    ...

    Fam­i­ly offices also have a large amount of cash wait­ing for the right oppor­tu­ni­ty. They hold 9% of their assets in cash, near­ly dou­ble the lev­els in 2021.

    “They have a lot of cash on the side­lines,” said Ang­ie O’Leary, head of wealth plan­ning for RBC Wealth Man­age­ment, U.S. “They can deploy that cash on things like real estate or an acqui­si­tion or invest­ing in pri­vate mar­kets. They’re not in a hur­ry, they’re just look­ing for that great oppor­tu­ni­ty.”

    The sur­vey spanned 330 sin­gle-fam­i­ly offices and pri­vate mul­ti-fam­i­ly offices around the world, with 144 in North Amer­i­ca. The fam­i­ly offices sur­veyed had an aver­age of $1.3 bil­lion in total wealth, includ­ing pri­vate busi­ness­es.

    ———-

    “Fam­i­ly offices move mon­ey out of stocks and into pri­vate mar­kets” by Robert Frank; CNBC; 11/28/2023

    And they plan to con­cen­trate even more heav­i­ly on pri­vate mar­kets in the com­ing months, accord­ing to the sur­vey, which found 41% of fam­i­ly offices plan to boost their allo­ca­tions to pri­vate equi­ty funds, and a third plan to put more mon­ey into direct pri­vate equi­ty deals.”

    Fam­i­ly offices aren’t a posi­tion where they are forced to make deals. Quite the oppo­site, they detect oppor­tu­ni­ties on the hori­zon. At least that was the sen­ti­ment as of a cou­ple of months ago as more and more mon­ey were get­ting dumped into the pri­vate-equi­ty space:

    ...
    A sur­vey of North Amer­i­can fam­i­ly offices con­duct­ed by Cam­p­den Wealth and RBC found that fam­i­ly offices had 29.2% of their invest­ments in pri­vate mar­kets, which include pri­vate equi­ty, ven­ture cap­i­tal and pri­vate debt, com­pared to 28.5% in pub­licly trad­ed stocks.

    It marks the first time in the sur­vey that fam­i­ly offices had more invest­ed in pri­vate mar­kets than pub­lic stock. Their stock allo­ca­tion has come down from 31% the year before, while their pri­vate invest­ments increased from 27%. The remain­ing assets were invest­ed in cash, bonds, alter­na­tives, hedge funds, com­modi­ties, real estate and oth­er invest­ments.
    ...

    And note how this increas­ing inter­est in the pri­vate-equi­ty space by fam­i­ly offices isn’t new. It’s been going on for the last decade, with increas­ing­ly inter­est post-pan­dem­ic. Which rais­es the ques­tion of whether or not those ear­li­er invest­ments will pan out in this high­er inter­est rate envi­ron­ment. But, of course, those same con­cerns apply to all of the play­ers in the space, includ­ing pen­sion funds, and are pre­cise­ly the rea­son fam­i­ly offices detect the upcom­ing poten­tial for great deals. The fam­i­ly offices are set to come out ahead in the long run as long as the fam­i­ly offices have the cash on hand to secure those deals. And it sounds like fam­i­ly offices have that cash ready to go:

    ...
    Over the past decade, and espe­cial­ly after the pan­dem­ic, fam­i­ly offices have rushed into pri­vate equi­ty and so-called direct deals, where they buy stakes in pri­vate com­pa­nies on their own. Fam­i­ly offices say pri­vate mar­kets offer bet­ter returns over the long term with­out the volatil­i­ty of stocks.

    ...

    It’s unclear whether the bet will con­tin­ue to pay off. Pri­vate equi­ty funds are strug­gling with tight financ­ing and expen­sive loans, along with a lack of exits giv­en the drought of IPOs.

    Mean­time, as investors expect inter­est rate cuts in 2024, stocks may con­tin­ue to ral­ly.

    When asked which asset class will give them the best returns in the com­ing years, fam­i­ly offices ranked “pri­vate equi­ty and ven­ture cap­i­tal” first, fol­lowed by pub­lic equi­ties.

    “Despite the cau­tious approach adopt­ed by fam­i­ly offices in response to the (2022) retreat of finan­cial mar­kets, their per­spec­tives on the sources of the best long-term returns remain stead­fast,” the report said. “Pri­vate equi­ty and ven­ture cap­i­tal con­tin­ue to head the list.”

    ...

    Fam­i­ly offices also have a large amount of cash wait­ing for the right oppor­tu­ni­ty. They hold 9% of their assets in cash, near­ly dou­ble the lev­els in 2021.

    “They have a lot of cash on the side­lines,” said Ang­ie O’Leary, head of wealth plan­ning for RBC Wealth Man­age­ment, U.S. “They can deploy that cash on things like real estate or an acqui­si­tion or invest­ing in pri­vate mar­kets. They’re not in a hur­ry, they’re just look­ing for that great oppor­tu­ni­ty.”
    ...

    And in case it’s not clear what has these fam­i­ly offices sali­vat­ing over all the poten­tial pri­vate-mar­ket deals on hori­zon, here’s an arti­cle from back in Octo­ber, pub­lished about a month and a half before the above arti­cle, describ­ing how UK pen­sion funds have been forced to sell off assets as steep dis­counts. But that’s not the only sto­ry in this arti­cle. It also sounds like there could end up being a lot more steep dis­counts than the cur­rent mar­ket reflects. Why? Because the on-the-books val­u­a­tions of many of the assets held by these pen­sion funds appear to be wild­ly over-inflat­ed and not reflec­tive of real mar­ket con­di­tions. This is par­tic­u­lar­ly true for com­mer­cial real estate assets that are noto­ri­ous­ly dif­fi­cult to price. It’s appar­ent­ly such a big prob­lem that UK reg­u­la­tors are inves­ti­gat­ing. In oth­er words, there’s an account hole sit­ting on the books of pen­sion funds that has yet to be acknowl­edged in many cas­es. And should reg­u­la­tors forced these funds to acknowl­edge the much low­er val­u­a­tions for many of these assets the funds are going to be forced to sell them...presumably at a steep dis­count:

    Reuters

    UK pen­sion funds rush to ditch unlist­ed assets as reg­u­la­tors ques­tion val­u­a­tions

    By Nao­mi Rovnick and Car­olyn Cohn
    Octo­ber 9, 2023 1:04 AM CDT
    Updat­ed

    LONDON, Oct 9 (Reuters) — UK pen­sion funds are rush­ing to sell unlist­ed assets — often at a dis­count — because they are over­ex­posed to the opaque $12 tril­lion glob­al pri­vate mar­ket as reg­u­la­tors ques­tion the true val­ue of invest­ments span­ning prop­er­ty to pri­vate equi­ty, indus­try sources say.

    Glob­al watch­dogs are rais­ing the alarm about the val­ue of so-called pri­vate mar­ket assets, includ­ing big infra­struc­ture projects, the paper worth of which has yet to be adjust­ed down­wards while list­ed mar­kets, such as bonds, have suf­fered an his­toric rout due to high­er bor­row­ing costs.

    One sec­tor feel­ing the impact of own­ing hard-to-val­ue illiq­uid invest­ments as finan­cial con­di­tions tight­en is the 1.5 tril­lion pound ($1.8 tril­lion) defined ben­e­fit, or final salary, pen­sion fund indus­try — which drove a UK mar­ket sell-off a year ago.

    These pen­sion providers, which pledge guar­an­teed incomes to retirees from the pub­lic sec­tor and some pri­vate com­pa­nies, are sell­ing office blocks and pri­vate equi­ty stakes at hefty dis­counts to the val­ue marked on their books, accord­ing to sev­er­al peo­ple work­ing in the sec­tor.

    Britain’s Finan­cial Con­duct Author­i­ty is one reg­u­la­tor which is grow­ing uneasy about the mar­ket. It is prepar­ing a review of how pri­vate asset val­u­a­tions are con­duct­ed, includ­ing whether any risks of over-val­u­a­tion could have a knock-on impact on banks — the cen­tral pil­lars of the finan­cial sys­tem.

    Such assets have become tricky to price, par­tic­u­lar­ly in real estate where com­mer­cial trans­ac­tions have slumped.

    “There’s been very lit­tle mark­ing down of (pri­vate) assets,” said Con Keat­ing, head of research at Brighton Rock Group, an insur­ance com­pa­ny for pen­sion schemes. “It’s cloud cuck­oo account­ing.”

    Final salary retire­ment schemes ran into trou­ble a year ago after a surge in gov­ern­ment bond yields left them scram­bling for cash to cov­er mar­gin calls on deriv­a­tives — finan­cial bets they had placed to cov­er pen­sion oblig­a­tions assum­ing a rel­a­tive­ly sta­ble low-yield­ing bond mar­ket.

    As bond yields close in on lev­els pen­sion funds were accus­tomed to before the glob­al finan­cial cri­sis, their over­ex­po­sure to illiq­uid assets could leave them short of ready cash in anoth­er cri­sis, indus­try sources say. Sales of these assets at dis­counts also dent their fund­ing posi­tions, they added.

    ...

    RUSHING OUT

    UK final salary pen­sion funds are sell­ing illiq­uid assets at dis­counts of as much as 40% to the val­ues they held them at on their books, EY’s UK head of pen­sions con­sult­ing Paul Kit­son said.

    He said heavy sell­ing of com­mer­cial prop­er­ty and pri­vate equi­ty stakes by pen­sion schemes is rais­ing ques­tions over pri­vate cap­i­tal val­u­a­tions.

    Prop­er­ty mar­kets in Ger­many and Swe­den, for instance, have come under severe pres­sure, while Lon­don office vacan­cies are at a three decade high. Yet an index of glob­al real estate fund returns pro­duced by Bur­giss declined by just 0.7% in the quar­ter to June.

    “The real estate mar­ket is depressed,” said Ben Leach, head of pri­vate mar­kets solu­tions at invest­ment con­sul­tant Willis Tow­ers Wat­son, adding that pen­sion funds were sell­ing office build­ings at 35% dis­counts.

    ...

    Glob­al secu­ri­ties reg­u­la­tor IOSCO said in a report last month that such val­u­a­tions were “inevitably stale”, with many pri­vate funds valu­ing assets only quar­ter­ly, or even annu­al­ly, com­pared with many times a minute for list­ed secu­ri­ties.

    PRIVATE EQUITY

    Real estate is not the only sec­tor under scruti­ny.

    The Bur­giss index of pri­vate equi­ty buy­out per­for­mance, which mea­sures cash gen­er­at­ed and val­ue, shows glob­al man­agers of these funds report­ed a 2.8% gain in both the first and sec­ond quar­ters of 2023.

    But in deals where pri­vate equi­ty firms and investors buy and sell port­fo­lios of invest­ments, assets are being val­ued at less.

    Wil­fred Small, senior man­ag­ing direc­tor at pri­vate equi­ty house Ardian, said stakes in buy­out funds have been sell­ing at around 85 cents on the dol­lar in the sec­ondary mar­ket since “ear­ly 2022”, when cen­tral banks began rais­ing rates, with sell­ers accept­ing dis­counts in return for liq­uid­i­ty.

    UK-list­ed invest­ment trusts that hold pri­vate equi­ty port­fo­lios are trad­ing at a larg­er 27% dis­count on aver­age to the net asset val­ues they report for their port­fo­lios, accord­ing to Numis Secu­ri­ties.

    The aver­age dis­count across the invest­ment trust sec­tor is 15%.

    ———-

    “UK pen­sion funds rush to ditch unlist­ed assets as reg­u­la­tors ques­tion val­u­a­tions” By Nao­mi Rovnick and Car­olyn Cohn; Reuters; 10/09/2023

    Glob­al watch­dogs are rais­ing the alarm about the val­ue of so-called pri­vate mar­ket assets, includ­ing big infra­struc­ture projects, the paper worth of which has yet to be adjust­ed down­wards while list­ed mar­kets, such as bonds, have suf­fered an his­toric rout due to high­er bor­row­ing costs.”

    This isn’t just a UK issue. Glob­al watch­dogs are rais­ing the alarm. Or as Glob­al secu­ri­ties reg­u­la­tor IOSCO report­ed back in Sep­tem­ber, the val­u­a­tions on the books for pri­vate­ly held assets have become “inevitably stale,” due, in part, to the lack of time­ly report­ing require­ments in this space. So when we read about UK pen­sion funds sell­ing office blocks at hefty dis­counts, keep in mind that this is a glob­al issue:

    ...
    One sec­tor feel­ing the impact of own­ing hard-to-val­ue illiq­uid invest­ments as finan­cial con­di­tions tight­en is the 1.5 tril­lion pound ($1.8 tril­lion) defined ben­e­fit, or final salary, pen­sion fund indus­try — which drove a UK mar­ket sell-off a year ago.

    These pen­sion providers, which pledge guar­an­teed incomes to retirees from the pub­lic sec­tor and some pri­vate com­pa­nies, are sell­ing office blocks and pri­vate equi­ty stakes at hefty dis­counts to the val­ue marked on their books, accord­ing to sev­er­al peo­ple work­ing in the sec­tor.

    ...

    Such assets have become tricky to price, par­tic­u­lar­ly in real estate where com­mer­cial trans­ac­tions have slumped.

    “There’s been very lit­tle mark­ing down of (pri­vate) assets,” said Con Keat­ing, head of research at Brighton Rock Group, an insur­ance com­pa­ny for pen­sion schemes. “It’s cloud cuck­oo account­ing.”

    ...

    Glob­al secu­ri­ties reg­u­la­tor IOSCO said in a report last month that such val­u­a­tions were “inevitably stale”, with many pri­vate funds valu­ing assets only quar­ter­ly, or even annu­al­ly, com­pared with many times a minute for list­ed secu­ri­ties.
    ...

    And these aren’t triv­ial dis­counts. Pen­sion funds have been sell­ing assets at dis­counts as much as 40% to the val­ues held on the books, accord­ing to EY’s UK head of pen­sions con­sult­ing. A 40% dis­count that will be painful for pen­sion­ers but a steal for those fam­i­ly offices with the cash on hand to swoop in and score a deal:

    ...
    Final salary retire­ment schemes ran into trou­ble a year ago after a surge in gov­ern­ment bond yields left them scram­bling for cash to cov­er mar­gin calls on deriv­a­tives — finan­cial bets they had placed to cov­er pen­sion oblig­a­tions assum­ing a rel­a­tive­ly sta­ble low-yield­ing bond mar­ket.

    As bond yields close in on lev­els pen­sion funds were accus­tomed to before the glob­al finan­cial cri­sis, their over­ex­po­sure to illiq­uid assets could leave them short of ready cash in anoth­er cri­sis, indus­try sources say. Sales of these assets at dis­counts also dent their fund­ing posi­tions, they added.

    ...

    RUSHING OUT

    UK final salary pen­sion funds are sell­ing illiq­uid assets at dis­counts of as much as 40% to the val­ues they held them at on their books, EY’s UK head of pen­sions con­sult­ing Paul Kit­son said.

    He said heavy sell­ing of com­mer­cial prop­er­ty and pri­vate equi­ty stakes by pen­sion schemes is rais­ing ques­tions over pri­vate cap­i­tal val­u­a­tions.

    Prop­er­ty mar­kets in Ger­many and Swe­den, for instance, have come under severe pres­sure, while Lon­don office vacan­cies are at a three decade high. Yet an index of glob­al real estate fund returns pro­duced by Bur­giss declined by just 0.7% in the quar­ter to June.

    “The real estate mar­ket is depressed,” said Ben Leach, head of pri­vate mar­kets solu­tions at invest­ment con­sul­tant Willis Tow­ers Wat­son, adding that pen­sion funds were sell­ing office build­ings at 35% dis­counts....

    Final­ly, note how it’s not even just pri­vate­ly held real estate assets that are sell­ing at a dis­count these days. Stakes in pri­vate-equi­ty buy­out funds have been sell­ing at around 85 cents on the dol­lar since “ear­ly 2022”, with UK-list­ed invest­ment trusts trad­ing at a 27% dis­count on aver­age com­pared to the net as set val­ues report­ed in their port­fo­lios. It’s a sign that ‘the mar­ket’ has been oper­at­ing since ear­ly 2022 — when rates start­ed ris­ing — as if the asset val­u­a­tions on the books are bogus:

    ...
    Real estate is not the only sec­tor under scruti­ny.

    The Bur­giss index of pri­vate equi­ty buy­out per­for­mance, which mea­sures cash gen­er­at­ed and val­ue, shows glob­al man­agers of these funds report­ed a 2.8% gain in both the first and sec­ond quar­ters of 2023.

    But in deals where pri­vate equi­ty firms and investors buy and sell port­fo­lios of invest­ments, assets are being val­ued at less.

    Wil­fred Small, senior man­ag­ing direc­tor at pri­vate equi­ty house Ardian, said stakes in buy­out funds have been sell­ing at around 85 cents on the dol­lar in the sec­ondary mar­ket since “ear­ly 2022”, when cen­tral banks began rais­ing rates, with sell­ers accept­ing dis­counts in return for liq­uid­i­ty.

    UK-list­ed invest­ment trusts that hold pri­vate equi­ty port­fo­lios are trad­ing at a larg­er 27% dis­count on aver­age to the net asset val­ues they report for their port­fo­lios, accord­ing to Numis Secu­ri­ties.
    ...

    As the report warns, there are a num­ber of sur­pris­es sit­ting on the books of investors in the pri­vate-equi­ty space. A space that has been increas­ing­ly dom­i­nat­ed by pen­sion funds over the last decade. A cri­sis for pen­sion­ers becomes an oppor­tu­ni­ty for the wealth­i­est fam­i­lies on the plan­et. Because of course. That’s the only way this real­is­ti­cal­ly could have played out. The sys­tem is bro­ken. And also work­ing as intend­ed.

    Posted by Pterrafractyl | January 18, 2024, 8:25 pm
  12. It’s time for anoth­er round of dis­turbing­ly pre­dictable updates. It appears, with inter­est rates more or less capped out for the time being and the expec­ta­tion of rate cuts lat­er this year, the cred­it mar­kets are engag­ing in a bit of what we might con­sid­er irra­tional exu­ber­ance. At least the pri­vate cred­it mar­kets in the pri­vate-equi­ty space. Yes, bor­row­ing by pri­vate-equi­ty-owned firms has explod­ed over the last month in response to those change rate expec­ta­tions and in increas­ing appetite for cor­po­rate bonds by lenders look­ing to lock in high­er rates before they fall.

    Now, on the sur­face, this should be good news for pri­vate-equi­ty-owned cor­po­ra­tions in gen­er­al that there’s so a robust demand for their debt. Unless, of course, they take the mon­ey raised by that debt and just burn it. Which is kind of what they’re doing: pri­vate-equi­ty owned firms are increas­ing­ly bor­row­ing in order to pay out div­i­dends to pri­vate-equi­ty investors. In oth­er words, the “div­i­dend recap­i­tal­iza­tion” play is back on.

    Recall how, back in pan­dem­ic-afflict­ed months of 2020, these div­i­dend recap­i­tal­iza­tions were all the rage in the pri­vate-equi­ty space as investors des­per­ate for high­er-yield­ing cor­po­rate bonds were will­ing to accept excep­tion­al­ly risky bonds like pay­ment-in-kine (PIK) bonds that allow bor­row­ers to pay inter­est with addi­tion­al bor­row­ing. Also recall how this demand for high­er yield­ing cor­po­rate bonds even­tu­al­ly led to a surge in the issuance of cor­po­rate junk bonds in order to finance these div­i­dend recap­i­tal­iza­tions in 2021. That debt-for-div­i­dends trend start­ed to fiz­zle in 2022 and 2023 as rates rose. But it appears that right now, after rates have risen to an appar­ent medi­um-term peak with expec­ta­tions they’ll fall lat­er this year, has rekin­dled the div­i­dend recap­i­tal­iza­tion play. Quite sim­ply, lenders are more than hap­py to make loans they know will be pri­mar­i­ly used to pay div­i­dends — and there­fore will weak­en the under­ly­ing health of the com­pa­ny and increase the risk of default — because that’s just the kind of risk these investors are will­ing to make as it appears rates make be peak­ing for now.

    But the bor­row­ing binge by pri­vate-equi­ty to pay div­i­dends is just one half of this sto­ry. There’s, of course, the oth­er side of this trend. Some­one is will­ing to make these risky loans. And, increas­ing­ly, that some­one is oth­er pri­vate-equi­ty firms. Yep, “pri­vate cred­it” is the oth­er big hot new trend in the pri­vate-equi­ty space, as tra­di­tion­al banks have tend­ed to pull back from the lend­ing mar­kets. And all expec­ta­tions are this pri­vate cred­it lend­ing by pri­vate-equi­ty clients — and pen­sion funds in par­tic­u­lar — is expect­ed to con­tin­ue ris­ing in com­ing years.

    Final­ly, keep in mind the oth­er big sto­ry in the back­ground here: all these div­i­dend recap­i­tal­iza­tions would­n’t be nec­es­sary if firms were able to offload their assets like com­mer­cial real estate. But they can’t in many cas­es. The mar­ket sim­ply isn’t there. In oth­er words, this div­i­dend recap­i­tal­iza­tion trend is, in part, cov­er­ing up the fact that a lot of pri­vate-equi­ty firms’ big bets in the CRE space haven’t panned out so well. The pri­vate-equi­ty indus­try is effec­tive­ly financ­ing its own cov­er up. For now:

    Finan­cial Times

    Pri­vate equi­ty own­ers pile on debt to pay them­selves div­i­dends

    Spon­sors under pres­sure from investors to return cash but are find­ing it hard­er to offload com­pa­nies

    Har­ri­et Clar­felt and Antoine Gara in New York
    Feb­ru­ary 5, 2024 10:47 am
    ††
    US pri­vate equi­ty firms are rush­ing to take advan­tage of low­er bor­row­ing costs by load­ing debt on to their port­fo­lio com­pa­nies and using the cash to pay div­i­dends to them­selves and their investors.

    Cor­po­rate bor­row­ers sold $8.1bn worth of junk-rat­ed US loans to fund pay­ments to share­hold­ers in Jan­u­ary, more than six times December’s total and the high­est month­ly fig­ure in more than two years. Most were issued by com­pa­nies backed by pri­vate equi­ty firms, accord­ing to data from Pitch­Book LCD.

    With weak deal vol­umes and slug­gish demand for ini­tial pub­lic offer­ings mak­ing it hard­er to offload exist­ing invest­ments, pri­vate equi­ty firms are turn­ing to such so-called div­i­dend recap­i­tal­i­sa­tions to paci­fy investors eager for a return on their cap­i­tal.

    *****

    ...

    Com­pa­nies that have done such deals so far this year include tech­nol­o­gy group IntraFi Net­work and chem­i­cals dis­trib­u­tor Uni­var Solu­tions — backed by pri­vate equi­ty giants War­burg Pin­cus and Black­stone, and Apol­lo respec­tive­ly.

    The oppor­tu­ni­ty pro­vid­ed by the sharp drop in bor­row­ing costs in recent months has come at a wel­come time for pri­vate equi­ty firms.

    Many are fac­ing pres­sure from their own investors to return some cash, which is impor­tant in attract­ing investors to any new funds they launch.

    ...

    Div­i­dend recaps surged in pop­u­lar­i­ty dur­ing the ear­ly stages of the coro­n­avirus pan­dem­ic after the US Fed­er­al Reserve cut inter­est rates to near zero, but fell out of favour in 2022 and ear­ly 2023 as bor­row­ing costs rose.

    *****

    Debthold­ers are often wary of large vol­umes of div­i­dend recaps, as they typ­i­cal­ly bur­den com­pa­nies with high­er degrees of lever­age and may back­fire if a borrower’s growth expec­ta­tions fall short or inter­est rates rise.

    In the deals that have tak­en place over the past month, Uni­var bor­rowed $450mn in new term loans to pay a div­i­dend to its pri­vate equi­ty own­er Apol­lo, which had closed a more than $8bn takeover of the com­pa­ny six months ear­li­er.

    War­burg Pin­cus and Black­stone have bor­rowed about $800mn since Decem­ber against InfraFi Net­work to pay them­selves a large div­i­dend. Last month, 1–800 Con­tacts, owned by KKR, bor­rowed $565mn in senior debt to repay a high­er-cost $315mn junior loan and fund a $250mn pay­out to itself.

    Debt mar­kets ral­lied strong­ly at the end of last year, after the US Fed­er­al Reserve sig­nalled that it had fin­ished its cam­paign of aggres­sive inter­est rate ris­es and was expect­ing to make three quar­ter-point cuts in 2024.

    Pri­vate equi­ty-backed com­pa­nies have used the Fed’s piv­ot as an oppor­tu­ni­ty to refi­nance and low­er their inter­est bur­dens.

    UKG, a large soft­ware com­pa­ny backed by investors includ­ing Hell­man & Fried­man and Black­stone, in Jan­u­ary refi­nanced more than $7bn in term loans, cut­ting its inter­est rate, part­ly by increas­ing the use of senior debt.

    *****

    The high num­ber of loans trad­ing above par last month also allowed more bor­row­ers to nego­ti­ate with investors to reduce the inter­est rates on exist­ing debt. So-called repric­ing vol­umes for US junk loans soared to $91.2bn in Jan­u­ary, the high­est month­ly total in four years.

    ...

    ———–

    “Pri­vate equi­ty own­ers pile on debt to pay them­selves div­i­dends” by Har­ri­et Clar­felt and Antoine Gara; Finan­cial Times; 02/05/2024

    “With weak deal vol­umes and slug­gish demand for ini­tial pub­lic offer­ings mak­ing it hard­er to offload exist­ing invest­ments, pri­vate equi­ty firms are turn­ing to such so-called div­i­dend recap­i­tal­i­sa­tions to paci­fy investors eager for a return on their cap­i­tal.”

    Can’t sell your pri­vate-equi­ty invest­ments but still need to pay out div­i­dends? No prob­lem, just bor­row the mon­ey. That “div­i­dend recap­i­tal­iza­tion” strat­e­gy is increas­ing­ly pop­u­lar in the pri­vate-equi­ty space. A strat­e­gy that, as we saw, was increas­ing­ly pop­u­lar in the ear­li­er months of the pan­dem­ic, before falling out of favor in 2022 as rates rose. And here we are, with bor­row­ing rates sub­stan­tial­ly high­er than they were in 2020 and 2021, but seem­ing­ly poised to fall lat­er this year, and a new dynam­ic has emerged where investors look­ing to lock in high­er rates appear to be more than hap­py to finance a dra­mat­ic growth in this kind of a bor­row­ing:

    ...
    Cor­po­rate bor­row­ers sold $8.1bn worth of junk-rat­ed US loans to fund pay­ments to share­hold­ers in Jan­u­ary, more than six times December’s total and the high­est month­ly fig­ure in more than two years. Most were issued by com­pa­nies backed by pri­vate equi­ty firms, accord­ing to data from Pitch­Book LCD.

    ...

    The oppor­tu­ni­ty pro­vid­ed by the sharp drop in bor­row­ing costs in recent months has come at a wel­come time for pri­vate equi­ty firms.

    Many are fac­ing pres­sure from their own investors to return some cash, which is impor­tant in attract­ing investors to any new funds they launch.

    ...

    Div­i­dend recaps surged in pop­u­lar­i­ty dur­ing the ear­ly stages of the coro­n­avirus pan­dem­ic after the US Fed­er­al Reserve cut inter­est rates to near zero, but fell out of favour in 2022 and ear­ly 2023 as bor­row­ing costs rose.

    *****
    ...

    And note one of the details in this new dynam­ic: part of the incen­tive to investors in these deals is the use of senior debt which, if these com­pa­nies run in trou­ble, make it more much like­ly the bond investors will get their mon­ey back, as opposed to junior debt which has a high­er default risk:

    ...
    Debthold­ers are often wary of large vol­umes of div­i­dend recaps, as they typ­i­cal­ly bur­den com­pa­nies with high­er degrees of lever­age and may back­fire if a borrower’s growth expec­ta­tions fall short or inter­est rates rise.

    In the deals that have tak­en place over the past month, Uni­var bor­rowed $450mn in new term loans to pay a div­i­dend to its pri­vate equi­ty own­er Apol­lo, which had closed a more than $8bn takeover of the com­pa­ny six months ear­li­er.

    War­burg Pin­cus and Black­stone have bor­rowed about $800mn since Decem­ber against InfraFi Net­work to pay them­selves a large div­i­dend. Last month, 1–800 Con­tacts, owned by KKR, bor­rowed $565mn in senior debt to repay a high­er-cost $315mn junior loan and fund a $250mn pay­out to itself.

    ...

    UKG, a large soft­ware com­pa­ny backed by investors includ­ing Hell­man & Fried­man and Black­stone, in Jan­u­ary refi­nanced more than $7bn in term loans, cut­ting its inter­est rate, part­ly by increas­ing the use of senior debt.
    ...

    So with div­i­dend recap­i­tal­iza­tion bor­row­ing the new hot trend for pri­vate-equi­ty firms unable to offload their invest­ments in a time­ly man­ner, how much longer can we expect investors to keep financ­ing it all? Well, that brings us to the oth­er side of this dis­turb­ing sto­ry: pri­vate-equi­ty’s explo­sion in pri­vate lend­ing. Yep, buy­ing cor­po­rate bonds is anoth­er hot new area for pri­vate-equi­ty investors. In fact, since 2010, the pri­vate cred­it mar­kets on Wall Street have grown from $250 bil­lion to $2.7 tril­lion. And as the fol­low­ing piece notes, the mon­ey financ­ing this explo­sion of pri­vate cred­it comes from the kinds of investors we should at this point expect to be financ­ing this: pen­sion funds, endow­ments and foun­da­tions, insur­ance com­pa­nies, retail investors, and sov­er­eign wealth investors:

    CNBC

    How pri­vate cred­it became one of the hottest invest­ments on Wall Street

    Chris­t­ian Nun­ley
    Pub­lished Mon, Jan 22 2024 10:51 AM EST

    Pri­vate cred­it has quick­ly become one of Wall Street’s most pop­u­lar invest­ment class­es in 2023. Alter­na­tive data plat­form Pre­qin projects this asset class will reach $2.7 tril­lion by 2027.

    Sev­er­al firms such as Apol­lo Glob­al and Ares Man­age­ment have grown this mar­ket from just $250 bil­lion in 2010.

    This hap­pened in part due to banks retrench­ing from the lend­ing mar­ket after the Great Finan­cial Cri­sis in 2008 with new reg­u­la­tions. It also has roots in the Fed­er­al Reserve’s mon­e­tary pol­i­cy of hold­ing inter­est rates near 0% for a decade.

    ...

    How­ev­er, this asset class is not with­out risk and is not eas­i­ly investable. You won’t find pri­vate cred­it funds on Robin­hood.

    “It comes from pen­sion funds, endow­ments and foun­da­tions, insur­ance com­pa­nies, retail investors, sov­er­eign wealth investors,” Dwin said. “So it is loans from a source oth­er than deposits, usu­al­ly to pri­vate­ly held busi­ness­es.”

    ———–

    “How pri­vate cred­it became one of the hottest invest­ments on Wall Street” by Chris­t­ian Nun­ley; CNBC; 01/22/2024

    “It comes from pen­sion funds, endow­ments and foun­da­tions, insur­ance com­pa­nies, retail investors, sov­er­eign wealth investors,” Dwin said. “So it is loans from a source oth­er than deposits, usu­al­ly to pri­vate­ly held busi­ness­es.””

    Yes, at the same time we’re see­ing an explo­sion of new pri­vate-equi­ty bor­row­ings to help finance div­i­dend recap­i­tal­iza­tions, we’re also learn­ing about an explo­sion of new pri­vate-equi­ty cor­po­rate lend­ing, includ­ing firms like Apol­lo Glob­al, one of the same firms we saw above that was engag­ing in div­i­dend recap­i­tal­iza­tions. In oth­er words, the pri­vate-equi­ty space appears to financ­ing its own div­i­dend recap­i­tal­iza­tions. What could pos­si­bly go wrong?

    ...
    Sev­er­al firms such as Apol­lo Glob­al and Ares Man­age­ment have grown this mar­ket from just $250 bil­lion in 2010.
    ...

    And as the fol­low­ing Reuters piece notes, expec­ta­tions are that this kind of pri­vate cred­it lend­ing by pri­vate-equi­ty — and in par­tic­u­lar pen­sion funds — is expect­ed to con­tin­ue grow­ing in com­ing years at the same time reg­u­la­tors are grow­ing increas­ing­ly con­cerned with the sta­bil­i­ty of this “shad­ow bank­ing” sec­tor in gen­er­al:

    Reuters

    Canada’s top pen­sion funds pile into pri­vate cred­it as banks retreat

    By Maiya Kei­dan, Pablo Mayo Cerqueiro and Iain With­ers
    Jan­u­ary 24, 2024 7:26 AM CST Updat­ed

    TORONTO/LONDON, Jan 23 (Reuters) — (This Jan. 23 sto­ry has been cor­rect­ed to say 2023, not 2022, in para­graph 11)

    Six of Canada’s biggest pen­sion funds man­ag­ing C$1.3 tril­lion ($965.47 bil­lion) in assets have begun a major expan­sion into pri­vate cred­it, mov­ing into an area pre­vi­ous­ly dom­i­nat­ed by banks.

    Cana­da Pen­sion Plan (CPP) Invest­ments, Ontario Teach­ers’ Pen­sion Plan (OTPP), Ontario Munic­i­pal Employ­ees Retire­ment Sys­tem (Omers), OPTrust, Health­care of Ontario Pen­sion Plan (HOOPP) and British Colum­bia Invest­ment Man­age­ment Cor­po­ra­tion (BCI) told Reuters they intend to increase their expo­sure to pri­vate cred­it — typ­i­cal­ly tai­lored loans to com­pa­nies under­writ­ten by non-banks.

    CPP Invest­ments, which man­ages C$576 bil­lion, will dou­ble its over­all cred­it port­fo­lio to around C$115 bil­lion, said Andrew Edgell, who over­sees the port­fo­lio, with pri­vate cred­it a key part of the expan­sion.

    ...

    CPP Invest­ments man­ages most of its C$62 bil­lion cred­it book in-house.

    Pen­sion plans OTPP and OPTrust told Reuters they saw oppor­tu­ni­ties to plug gaps left by banks. OPTrust said it expect­ed to grow in pri­vate cred­it in Europe, includ­ing in Britain.

    Banks glob­al­ly have been squeezed by high­er cap­i­tal require­ments, forc­ing a retreat from some lend­ing.

    Omers said it sought the kind of oppor­tu­ni­ties across cred­it mar­kets, includ­ing in pri­vate cred­it, that it had not seen “in many years”.

    Michael Wis­sell, chief invest­ment offi­cer at HOOPP, agreed. “It’s an attrac­tive time in the eco­nom­ic cycle to com­mit cap­i­tal to pri­vate cred­it,” he said. “Increas­ing­ly, the price gap is clos­ing and we’re see­ing pri­vate cred­it returns priced very tight­ly to the equi­ty, but with low­er risk.”

    ...

    BCI’s pri­vate debt pro­gram grew 11% over six months to more than C$15 bil­lion as of Dec. 31, 2023, from C$13.5 bil­lion on March 31, 2023.

    ...

    Pri­vate cred­it has become pop­u­lar among pen­sion schemes and insur­ers because it offers high­er returns than tra­di­tion­al fixed-income prod­ucts and typ­i­cal­ly bet­ter down­side pro­tec­tion than equi­ties.

    Once a niche asset class, data provider Pre­qin pre­dicts assets under man­age­ment will hit $2.8 tril­lion glob­al­ly by 2028 from $1.5 tril­lion in 2022.

    “Pri­vate cred­it is an attrac­tive prod­uct right now, and the struc­tur­al shift from banks to pri­vate lenders con­tin­ues,” said Nick Jansa, OTP­P’s exec­u­tive man­ag­ing direc­tor for Europe, the Mid­dle East and Africa.

    Reg­u­la­tors have raised con­cerns about the sec­tor’s rapid growth as part of a bur­geon­ing “shad­ow bank­ing” indus­try, par­tic­u­lar­ly as the spike in bor­row­ing costs and eco­nom­ic weak­ness mean greater risks of busi­ness­es default­ing.

    The over­all non-bank finance sec­tor is worth $218 tril­lion and accounts for near­ly half of finan­cial assets glob­al­ly, accord­ing to the Finan­cial Sta­bil­i­ty Board.

    OPTrust, which last year made a “size­able” increase in its cred­it expo­sure from 10% of its assets in 2022, said its cred­it investmen\ts were pri­mar­i­ly han­dled by exter­nal man­agers.

    ...

    ———

    “Canada’s top pen­sion funds pile into pri­vate cred­it as banks retreat” By Maiya Kei­dan, Pablo Mayo Cerqueiro and Iain With­ers; Reuters; 01/24/2024

    “Pri­vate cred­it has become pop­u­lar among pen­sion schemes and insur­ers because it offers high­er returns than tra­di­tion­al fixed-income prod­ucts and typ­i­cal­ly bet­ter down­side pro­tec­tion than equi­ties.”

    It’s not sur­pris­ing to see pri­vate lend­ing grow in pop­u­lar­i­ty as a way of chas­ing yield in what had been a his­tor­i­cal­ly low-inter­est envi­ron­ment, espe­cial­ly if it offers high­er yields than tra­di­tion­al fixed-income invest­ments. But, of course, that high­er yield is tied with the high­er default risk, which is pre­sum­ably part of what has glob­al reg­u­la­tors increas­ing­ly con­cerned about this grow­ing “shad­ow bank­ing” trend. But for now, it appears that pen­sion funds have found a new favorite invest­ment:

    ...
    Cana­da Pen­sion Plan (CPP) Invest­ments, Ontario Teach­ers’ Pen­sion Plan (OTPP), Ontario Munic­i­pal Employ­ees Retire­ment Sys­tem (Omers), OPTrust, Health­care of Ontario Pen­sion Plan (HOOPP) and British Colum­bia Invest­ment Man­age­ment Cor­po­ra­tion (BCI) told Reuters they intend to increase their expo­sure to pri­vate cred­it — typ­i­cal­ly tai­lored loans to com­pa­nies under­writ­ten by non-banks.

    ...

    “Pri­vate cred­it is an attrac­tive prod­uct right now, and the struc­tur­al shift from banks to pri­vate lenders con­tin­ues,” said Nick Jansa, OTP­P’s exec­u­tive man­ag­ing direc­tor for Europe, the Mid­dle East and Africa.

    Reg­u­la­tors have raised con­cerns about the sec­tor’s rapid growth as part of a bur­geon­ing “shad­ow bank­ing” indus­try, par­tic­u­lar­ly as the spike in bor­row­ing costs and eco­nom­ic weak­ness mean greater risks of busi­ness­es default­ing.
    ...

    You have to won­der how many of those pen­sion funds are effec­tive­ly engaged in some sort of mutu­al back-scratch­ing at this point. A kind of “I’ll buy your debt (to finance your div­i­dends) if you buy my debt( to finance my div­i­dends)” kind of arrange­ment, per­haps? It’s not quite a pyra­mid scheme, but the par­al­lels are hard to ignore. Time will tell how this ends. Per­haps in the form of pen­sion funds simul­ta­ne­ous­ly falling into cri­sis. Or, who knows, maybe in anoth­er round of div­i­dend recap­i­tal­iza­tions. The shenani­gans only have to end when the new mon­ey runs out, after all.

    Posted by Pterrafractyl | February 6, 2024, 10:38 pm
  13. Uh oh. It appears pri­vate-equi­ty has a new invest­ment strat­e­gy of choice. Look out world.

    It’s not an entire­ly new invest­ment strat­e­gy. As we’re going to see, it’s real­ly just an exten­sion of what has long been the sec­tor’s go-to real estate-based invest­ment strat­e­gy it’s had for years. But with a few twists. Includ­ing a poten­tial nuclear twist. Yes, pri­vate-equi­ty appears to have iden­ti­fy an area of sup­ply and demand imbal­ance ripe for exploita­tion. And all signs point to it becom­ing more and more imbal­anced going for­ward: Data cen­tres. The large com­plex­es hous­ing racks and racks of servers that have becom­ing increas­ing­ly in demand as the cloud com­put­ing indus­try con­tin­ues to explode. As we might imag­ine, data cen­tres hold A LOT of real estate. But not enough real estate to keep up with the grow­ing demand.

    That imbal­ance in data cen­ter real estate is part of the allure the sec­tor pos­es to pri­vate-equi­ty sec­tor. But only part. There’s anoth­er mas­sive sup­ply and demand imbal­ance form­ing in this sec­tor: elec­tric­i­ty. Data cen­tres don’t just take up lots of space. They are mas­sive pow­er con­sumers, ever more so thanks to the explo­sion of gen­er­a­tive AI tech­nol­o­gy. In fact, it’s that explo­sion of inter­est in AI that appears to be dri­ving the cur­rent explo­sion in demand for data cen­tres in gen­er­al, with more and more tech giants turn­ing to data cen­tres to give them the AI com­put­ing capac­i­ty they need. On top of all that, AI com­put­ing con­sumes about four times as much elec­tric­i­ty as tra­di­tion­al cloud com­put­ing. So at this point it’s becom­ing a race to secure both the land and pow­er for data cen­tres, with the win­ners in a posi­tion to charge increas­ing­ly prof­itable rents.

    But elec­tric­i­ty isn’t the only resource get­ting pushed to the lim­it with the explo­sion of AI com­put­ing. The water required to cool off the sys­tems oper­at­ing in these kinds of cen­ters is enor­mous. And that’s not includ­ing water that might be involved in the under­ly­ing elec­tric­i­ty gen­er­a­tion. Which brings us to what is pos­si­bly the most omi­nous part of this new trend: pri­vate-equi­ty firms are appar­ent­ly increas­ing­ly inter­est­ed in build­ing micro-nuclear reac­tors that could make these data cen­tres no longer reliant on the local grid. Now, on the one hand, not putting these kinds of strains on the local grid is gen­er­al­ly a good thing. But at the cost of a new micro-nuclear plant in the area. It’s not nec­es­sar­i­ly the best trade­off.

    Also keep in mind that sto­ry about invest­ments in the devel­op­ment of micro-nuclear plants by some­one who might have a keen inter­est in data cen­tres and AI: Bill Gates. Recall the invest­ments by Gates and War­ren Buf­fet in the devel­op­ment of cheap­er, small nuclear pow­er plants that rely on molten salt instead of water. Part of the advan­tage is the much small­er build­ings that would need to be built to house the reac­tors. But the tech­nol­o­gy comes with a catch: it relies on Ura­ni­um enriched enough to poten­tial­ly build a nuclear weapon. So this explo­sion of elec­tric­i­ty demands from AI could be cre­at­ing the kind of eco­nom­ic incen­tives that could lead to a pro­lif­er­a­tion of Bill Gates’s micro-nuclear plants. Oh goody.

    And don’t for­get anoth­er recent sto­ry that ties into all this: the US intel­li­gence com­mu­ni­ty’s increas­ing inter­est in using AI to parse those the vast vol­ume of open source data. It’s a reminder that the mil­i­tary indus­tri­al com­plex could be a major dri­ver for these trends. Mine-nuke-pow­ered AI data cen­tres for the MIC. What could pos­si­bly go wrong? We’ll find out, pre­sum­ably with enor­mous prof­its for the pri­vate-equi­ty sec­tor regard­less of how it goes, melt­downs or not:

    Bloomberg

    Black­stone is build­ing a $US25b empire of pow­er-hun­gry data cen­tres

    The pri­vate equi­ty giant says its $US10 bil­lion takeover of data cen­tre oper­a­tor QTS could be one of the best invest­ments in its his­to­ry.

    Dawn Lim
    Jan 29, 2024 – 5.26pm

    Off a high­way in Phoenix, Ari­zona, cranes tow­er over a stretch of land larg­er than 60 foot­ball fields. The first of five hulk­ing bunkers are under con­struc­tion.

    Near­ly 50 kilo­me­tres away, engi­neers are plot­ting anoth­er com­plex on 160 hectares, some three times the foot­print of the Mall of Amer­i­ca, all but eras­ing the land’s farm­ing roots. If all goes as planned, both sites will be home to thou­sands of com­put­ers churn­ing moun­tains of data, pow­ered by the ener­gy need­ed for hun­dreds of thou­sands of homes.

    This is Blackstone’s bet on the AI rev­o­lu­tion.

    After its $US10 bil­lion takeover of data cen­tre oper­a­tor QTS in 2021, the world’s largest pri­vate equi­ty firm is fuelling rapid growth at one of the top land­lords for tech giants. It’s bankrolling the devel­op­ment of mas­sive struc­tures that will han­dle cru­cial com­put­ing needs, while also reshap­ing com­mu­ni­ties across Amer­i­ca.

    It’s part of the clas­sic Black­stone play­book for real estate, the largest piece of its $US1 tril­lion ($1.52 tril­lion) empire. The firm iden­ti­fies where there’s a ris­ing need for prop­er­ties but too few to meet demand. It then directs bil­lions of investor dol­lars to build giant land­lords poised to cap­ture big rents and mar­ket share, a move it has deployed in every­thing from ware­hous­es to sub­ur­ban homes.

    In this case, the short­age cen­tres on the build­ings need­ed to sus­tain the dig­i­tal work­ings of mod­ern life – and since the deal, demand has explod­ed. With the arti­fi­cial intel­li­gence boom tak­ing hold, the Metas and Microsofts of the world are increas­ing­ly rely­ing on land­lords for the space, and crit­i­cal­ly, elec­tric­i­ty to run machines that train soft­ware to pre­dict pat­terns from a del­uge of text, images and videos. Black­stone now says QTS could be one of the best invest­ments in its his­to­ry.

    The com­pa­ny has par­layed its land reserves to prof­it on a short sup­ply of space and pow­er in key mar­kets. QTS has $US15 bil­lion of prop­er­ties in devel­op­ment, up from $US1 bil­lion at the time of its acqui­si­tion. It’s become North America’s largest provider of leased data cen­tre capac­i­ty based on megawatts under con­tract, after rank­ing No. 4 just three years ago, accord­ing to research firm dat­a­cen­ter­Hawk.

    ...

    Pow­er is already strained in key parts of the coun­try. QTS esti­mates that its projects, once com­plete, will tap into six gigawatts of elec­tric­i­ty, equal to the needs of rough­ly 5 mil­lion homes. Some cam­pus­es will need new pow­er lines, threat­en­ing high­er costs to oth­ers on the grid. And the eco­nom­ic impact of the cen­tres isn’t dis­trib­uted equal­ly, pit­ting neigh­bour against neigh­bour over who ben­e­fits from vast indus­tri­al parks filled with com­put­ers, rather than prop­er­ties such as hotels and shop­ping cen­tres that draw a steady flow of vis­i­tors and jobs.

    “Peo­ple are will­ing to make larg­er invest­ments on data cen­tres,” says Bri­an Pry­or, Houli­han Lokey’s North Amer­i­can data cen­tre lead banker. But “there can be pub­lic back­lash if you suck up pow­er and resources with­out clear and direct ben­e­fits to the local com­mu­ni­ty.”

    Already, QTS has faced chal­lenges win­ning approvals. The biggest recent­ly played out in Man­as­sas, Vir­ginia, where res­i­dents and con­ser­va­tion­ists fought a pro­posed multi­bil­lion-dol­lar, 360-hectare devel­op­ment with tracts next to a state for­est and a Civ­il War bat­tle­field. Hun­dreds of peo­ple showed up to speak at a coun­ty vote on approv­ing land for an 850-hectare data-cen­tre cor­ri­dor, with sup­port­ers and oppo­nents lob­by­ing for 27 straight hours.

    It’s a pre­view of the fights that lie ahead as the AI indus­try gives rise to more data cen­tres all over the coun­try, accel­er­at­ed by the often dis­rup­tive force of pri­vate equi­ty.

    ...

    Blackstone’s bet

    Black­stone pres­i­dent Jon Gray, the firm’s for­mer real estate chief and now heir appar­ent as CEO, has cor­ralled the com­pa­ny into the the­mat­ic bets where demand is run­ning up against con­straints. He now sees AI mak­ing a data cen­tre short­age all the more acute – and says those with land and cap­i­tal will be at an advan­tage.

    “QTS is a lens into a very impor­tant part of the econ­o­my that has a lot of momen­tum,” Gray says in an inter­view. “AI will be a pow­er­ful force to make lives bet­ter.”

    So-called gen­er­a­tive AI, where algo­rithms crunch troves of data and use it to spit out new con­tent, has led to an inten­si­fy­ing need for new tech­nol­o­gy and infra­struc­ture. Serv­er racks for AI com­put­ing can con­sume four times the pow­er cur­rent­ly used in cloud process­es, accord­ing to New­mark Group. That calls for data cen­tres that can sup­port surges in work­loads, and more advanced cool­ing sys­tems to han­dle the heat emit­ted.

    Pri­vate equi­ty firms are rac­ing to fund this picks-and-shov­els gold rush. Investors from Brook­field Infra­struc­ture Part­ners to KKR & Co have done $US43 bil­lion worth of US data cen­tre deals between 2021 and 2023, more than five times the pri­or three years, accord­ing to Dealog­ic. Tech giants also are build­ing their own com­plex­es.

    Back when Black­stone was explor­ing a QTS pur­chase in 2020, the AI oppor­tu­ni­ty wasn’t as appar­ent. Deal­mak­ers faced point­ed ques­tions from exec­u­tives includ­ing Gray. They’d been on the hunt for a data cen­tre deal in the past two years, but not every­one was con­vinced win­dow­less mon­strosi­ties should be the firm’s next big bet.

    Some ques­tioned if the firm was late catch­ing up to rivals. Rents hadn’t increased for years as tech firms drove a hard bar­gain.

    A trio of deal­mak­ers stood firm. Greg Blank, Mike For­man and Tyler Hen­ritze, from the infra­struc­ture and real estate groups, made the pitch. Big Tech would need infra­struc­ture to sup­port a surge in com­put­ing process­es as more of the econ­o­my migrat­ed online – an idea Black­stone had been bull­ish on for years. Cloud giants would go from run­ning their own data cen­tres to leas­ing more. Because data cen­tres were hard to build, land­lords would be able to com­mand prices they want­ed. The abil­i­ty to cap­i­talise on a pow­er crunch also was com­pelling to some of the peo­ple eval­u­at­ing the deal.

    Black­stone says that pow­er con­straint wasn’t a key part of its orig­i­nal the­sis. A “$10 bil­lion trans­ac­tion in a new space gets heav­i­ly scru­ti­nised at the firm,” For­man says. The com­pa­ny ulti­mate­ly was drawn to fac­tors includ­ing QTS’ large land bank and lead­er­ship team.

    Black­stone went on to take QTS Real­ty Trust pri­vate in a deal that val­ued the com­pa­ny at more than 20 times earn­ings. Mar­quee funds invest­ed in lock­step, includ­ing Black­stone Real Estate Income Trust, the firm’s $US61 bil­lion fund for indi­vid­u­als.

    QTS is now help­ing to lift BREIT at a time com­mer­cial real estate is depressed by high inter­est rates and the trust has been forced to lim­it redemp­tions. As BREIT sold stakes in prop­er­ties such as lux­u­ry hotels, it plunked down more cash into data cen­tres, which are now 8 per cent of the fund. Black­stone exec­u­tives told investors in August to put mon­ey in BREIT if they want to invest in the “AI rev­o­lu­tion”.

    QTS, like peers, has locked in ris­ing rents in major mar­kets. Its val­u­a­tion has more than dou­bled since the acqui­si­tion to $US25 bil­lion by the end of 2023, as Black­stone com­mit­ted more mon­ey to its future projects. BREIT redemp­tions are eas­ing, and the firm said on its Jan. 25 earn­ings call that it would stop lim­it­ing with­drawals in the first quar­ter if that trend con­tin­ued.

    ...

    For Kansas-based QTS, the Black­stone takeover marked a turn­ing point. Chief exec­u­tive Chad Williams had found­ed the com­pa­ny in 2005 and stitched it one deal at a time into a pub­lic enter­prise. An heir to a car-sal­vage busi­ness, he’s known to some­times pray in team meet­ings and has walls ded­i­cat­ed to the armed forces and Amer­i­ca across his prop­er­ties. Near­ly a quar­ter of the com­pa­ny is made up of cur­rent and for­mer mil­i­tary ser­vice mem­bers.

    With Blackstone’s arrival, Williams start­ed telling staff that QTS would be the biggest com­pa­ny of its kind. Some data cen­tre employ­ees in work gear whis­pered among them­selves at the mon­ey men in suits and loafers at the hard-hat sites. Quar­ter-mile sprints are over, QTS man­agers said; pre­pare for a marathon.

    QTS snapped up land and pro­cured pow­er faster and sped up plan­ning time­lines. It grew head­count by rough­ly half, to more than 1000, in the past year and a half. Some staffers voiced unease among them­selves that as the firm read­ied more mega-cen­tres, it would tie the company’s prof­its too close­ly to cloud giants. In its state­ment, QTS said its data cen­tres were designed for a range of uses.

    Then came last year’s AI mania. Hyper­scalers are now pay­ing data cen­tre oper­a­tors month­ly rates of more than $US100 per kilo­watt, from $US70 to $US80 per kilo­watt three years ago, in some areas. In top-tier mar­kets, it’s as high as around $US150 per kilo­watt, bro­kers say. (As data cen­tres pro­vide access to pow­er, rents are often mea­sured by watts instead of square metres.)

    At QTS, exec­u­tives have told col­leagues that if they make the case for more cash from Black­stone, they will all but get it. Black­stone said it sees data cen­tres as a way to deploy cap­i­tal at attrac­tive devel­op­ment yields.

    ...

    Lim­it­ed resources

    Even if data cen­tres are esti­mat­ed to take just a small frac­tion of the nation’s total elec­tric­i­ty con­sump­tion, they’ve been stress­ing some mar­kets more than oth­ers. Domin­ion Ener­gy paused con­nec­tions to new data cen­tres at one point in 2022 for a crit­i­cal tech cor­ri­dor in North­ern Vir­ginia and sped up the build-out of trans­mis­sion lines. Some Black­stone exec­u­tives have warned the firm and QTS could attract atten­tion for caus­ing more strain to the grid.

    “There is a lot of data cen­tre growth hap­pen­ing and that growth is not even­ly dis­trib­uted across the US,” says Arman She­habi, a sci­en­tist at California’s Lawrence Berke­ley Nation­al Lab­o­ra­to­ry, who is study­ing data cen­tre pow­er needs for the gov­ern­ment. “It’s con­sol­i­dat­ing in cer­tain loca­tions, and this could cre­ate a pow­er crunch in those areas.

    One of QTS’ big growth areas is in Ari­zona, where its 34-hectare cam­pus near the cen­tre of Phoenix is seen as a crown jew­el. It’s ful­ly leased before it’s even com­plete, with Microsoft as one of its ten­ants. Else­where, QTS says it has con­tract­ed all the pow­er it needs to meet mul­ti­ple years of demand on a 160-hectare plot just north-west of down­town that would cement the desert valley’s rise as a data cen­tre des­ti­na­tion.

    Data cen­tres’ water needs have made them a hot-but­ton issue in arid cities such as Phoenix. In the part of Ari­zona QTS is eye­ing, a data cen­tre can’t rely on water because years of farm­ing have deplet­ed ground­wa­ter in the area, caus­ing huge cracks in sur­round­ing land to emerge.

    Joseph Cook, who has stud­ied the area as a research geol­o­gist with the Ari­zona Geo­log­i­cal Sur­vey, says a data cen­tre that sucks up sub­stan­tial water could lead to new fis­sures. “The data cen­tre might not be affect­ed, but it could be destruc­tive to roads and homes,” he says. Near­by Luke Air Force Base, home of the 56th fight­er wing, looms large to the local econ­o­my and nation­al secu­ri­ty.

    QTS says the cool­ing sys­tem it has devel­oped will cut water usage at the site by hun­dreds of mil­lions of litres each year. More broad­ly, staffers have also dis­cussed devel­op­ing data cen­tres with micro-nuclear reac­tors to wean them off local grids.

    Black­stone has been work­ing to help QTS find sites out­side the most pow­er-con­strained mar­kets. It’s also facil­i­tat­ed con­ver­sa­tions between QTS and ener­gy providers the firm backs.

    Bat­tle in Vir­ginia

    In North­ern Vir­ginia, a long­time tech hub that con­nects to inter­con­ti­nen­tal fibre-optic cables, both QTS and Brook­field Infra­struc­ture-backed Com­pass Dat­a­cen­ters are plan­ning projects clus­tered in a 850-hectare stretch in Man­as­sas. Locals and preser­va­tion­ists have said the plans would destroy his­to­ry and tourism because of its prox­im­i­ty to a Civ­il War bat­tle­front – and also strain pow­er grids and spawn new trans­mis­sion lines.

    But home­own­ers in the area had few oth­er options besides sell­ing, says Mary Ann Ghad­ban, a res­i­dent and real estate bro­ker. She led the charge in mobil­is­ing sev­er­al farms and house­holds to ask the coun­ty to turn the area into a data cen­tre cor­ri­dor. With high-volt­age pow­er lines already snaking through people’s yards, their homes stood to fall in val­ue as the area rapid­ly changed, she says.

    ...

    As 130 peo­ple took the mic at the meet­ing, sev­er­al tout­ed tax rev­enue to sup­port schools and police, and the park trails accom­pa­ny­ing the devel­op­ment. Oth­ers warned of the con­se­quences on the envi­ron­ment, and stress on the grid. QTS’ project would require rough­ly one gigawatt of pow­er, the equiv­a­lent of 100 mil­lion LED light­bulbs.

    Coun­ty staff said the devel­op­ers’ plans lacked detail on where pow­er lines would run. The mas­sive projects are expect­ed to call for new trans­mis­sion infra­struc­ture, but that com­plex under­tak­ing will require the trans­mis­sion provider and local elec­tric util­i­ty to co-ordi­nate first.

    After start­ing at 10am, the meet­ing went into the night and next day. Just before the vote, the devel­op­ers pledged to have data cen­tre users draw 10 per cent of ener­gy from clean or renew­able sources. Anto­nio Cal­abrese, the DLA Piper land-use attor­ney rep­re­sent­ing QTS, rushed out of the room and returned moments lat­er with a con­ces­sion: The devel­op­er would reduce the den­si­ty of devel­op­ment bor­der­ing the bat­tle­field.

    At around 1pm the day after the meet­ing began, the plan passed with a 4–3 vote, with one offi­cial abstain­ing.

    That’s not the end of the fight. Res­i­dents and a con­ser­va­tion­ist group sued the coun­ty board and enti­ties tied to the devel­op­ers this month, say­ing a lack of pub­lic notice of the hear­ing and changes QTS and Com­pass made on the fly vio­lat­ed zon­ing laws.

    A Com­pass spokes­woman says the com­pa­ny is aware of the legal chal­lenge but “we remain focused on imple­ment­ing the county’s vision for the Dig­i­tal Gate­way.” Cal­abrese says QTS looks for­ward to being a part­ner to the com­mu­ni­ty and that the com­pa­ny made minor refine­ments at the county’s request.

    Black­stone and QTS, mean­while, are con­sid­er­ing bold­er bets. Williams isn’t rul­ing out buy­ing a rival. QTS is eager for an acqui­si­tion to plant more flags in Europe, peo­ple close to the mat­ter say.

    In Decem­ber, Black­stone paired up with Dig­i­tal Real­ty Trust to devel­op $US7 bil­lion in data-cen­tre cam­pus­es in Frank­furt, Paris and North­ern Vir­ginia. Pow­er is large­ly secured.

    ———–

    “Black­stone is build­ing a $US25b empire of pow­er-hun­gry data cen­tres” by Dawn Lim; Bloomberg; 01/29/2024

    It’s part of the clas­sic Black­stone play­book for real estate, the largest piece of its $US1 tril­lion ($1.52 tril­lion) empire. The firm iden­ti­fies where there’s a ris­ing need for prop­er­ties but too few to meet demand. It then directs bil­lions of investor dol­lars to build giant land­lords poised to cap­ture big rents and mar­ket share, a move it has deployed in every­thing from ware­hous­es to sub­ur­ban homes.”

    Yes, on one lev­el, the aggres­sive moves into the data cen­tre space is just an exten­sion what is at this point a clas­sic invest­ment strat­e­gy for Black­stone. A strat­e­gy focused on iden­ti­fy sup­ply and demand imbal­ances in real estate and using the vast resources of the pri­vate-equi­ty giant to exploit those imbal­ances to max­i­mal effect. And all indi­ca­tions are that Black­stone is just get­ting start­ed, with AI mak­ing the sup­ply and demand imbal­ances around data cen­tre stronger than ever. And Black­stone is just one of pri­vate-equi­ty play­ers rush­ing into this mar­ket:

    ...
    The com­pa­ny has par­layed its land reserves to prof­it on a short sup­ply of space and pow­er in key mar­kets. QTS has $US15 bil­lion of prop­er­ties in devel­op­ment, up from $US1 bil­lion at the time of its acqui­si­tion. It’s become North America’s largest provider of leased data cen­tre capac­i­ty based on megawatts under con­tract, after rank­ing No. 4 just three years ago, accord­ing to research firm dat­a­cen­ter­Hawk.

    ...

    Black­stone pres­i­dent Jon Gray, the firm’s for­mer real estate chief and now heir appar­ent as CEO, has cor­ralled the com­pa­ny into the the­mat­ic bets where demand is run­ning up against con­straints. He now sees AI mak­ing a data cen­tre short­age all the more acute – and says those with land and cap­i­tal will be at an advan­tage.

    “QTS is a lens into a very impor­tant part of the econ­o­my that has a lot of momen­tum,” Gray says in an inter­view. “AI will be a pow­er­ful force to make lives bet­ter.”

    ...

    Pri­vate equi­ty firms are rac­ing to fund this picks-and-shov­els gold rush. Investors from Brook­field Infra­struc­ture Part­ners to KKR & Co have done $US43 bil­lion worth of US data cen­tre deals between 2021 and 2023, more than five times the pri­or three years, accord­ing to Dealog­ic. Tech giants also are build­ing their own com­plex­es.

    Back when Black­stone was explor­ing a QTS pur­chase in 2020, the AI oppor­tu­ni­ty wasn’t as appar­ent. Deal­mak­ers faced point­ed ques­tions from exec­u­tives includ­ing Gray. They’d been on the hunt for a data cen­tre deal in the past two years, but not every­one was con­vinced win­dow­less mon­strosi­ties should be the firm’s next big bet.

    Some ques­tioned if the firm was late catch­ing up to rivals. Rents hadn’t increased for years as tech firms drove a hard bar­gain.

    A trio of deal­mak­ers stood firm. Greg Blank, Mike For­man and Tyler Hen­ritze, from the infra­struc­ture and real estate groups, made the pitch. Big Tech would need infra­struc­ture to sup­port a surge in com­put­ing process­es as more of the econ­o­my migrat­ed online – an idea Black­stone had been bull­ish on for years. Cloud giants would go from run­ning their own data cen­tres to leas­ing more. Because data cen­tres were hard to build, land­lords would be able to com­mand prices they want­ed. The abil­i­ty to cap­i­talise on a pow­er crunch also was com­pelling to some of the peo­ple eval­u­at­ing the deal.

    ...

    Black­stone went on to take QTS Real­ty Trust pri­vate in a deal that val­ued the com­pa­ny at more than 20 times earn­ings. Mar­quee funds invest­ed in lock­step, includ­ing Black­stone Real Estate Income Trust, the firm’s $US61 bil­lion fund for indi­vid­u­als.

    QTS is now help­ing to lift BREIT at a time com­mer­cial real estate is depressed by high inter­est rates and the trust has been forced to lim­it redemp­tions. As BREIT sold stakes in prop­er­ties such as lux­u­ry hotels, it plunked down more cash into data cen­tres, which are now 8 per cent of the fund. Black­stone exec­u­tives told investors in August to put mon­ey in BREIT if they want to invest in the “AI rev­o­lu­tion”.

    QTS, like peers, has locked in ris­ing rents in major mar­kets. Its val­u­a­tion has more than dou­bled since the acqui­si­tion to $US25 bil­lion by the end of 2023, as Black­stone com­mit­ted more mon­ey to its future projects. BREIT redemp­tions are eas­ing, and the firm said on its Jan. 25 earn­ings call that it would stop lim­it­ing with­drawals in the first quar­ter if that trend con­tin­ued.
    ...

    But it’s not just the sup­ply lim­its on the real estate need­ed to house these data cen­tres. There’s also the sup­ply and demand imbal­ance on the elec­tric­i­ty need­ed to pow­er these cen­tres, with AI being a par­tic­u­lar­ly pow­er-inten­sive form of com­put­ing:

    ...
    Pow­er is already strained in key parts of the coun­try. QTS esti­mates that its projects, once com­plete, will tap into six gigawatts of elec­tric­i­ty, equal to the needs of rough­ly 5 mil­lion homes. Some cam­pus­es will need new pow­er lines, threat­en­ing high­er costs to oth­ers on the grid. And the eco­nom­ic impact of the cen­tres isn’t dis­trib­uted equal­ly, pit­ting neigh­bour against neigh­bour over who ben­e­fits from vast indus­tri­al parks filled with com­put­ers, rather than prop­er­ties such as hotels and shop­ping cen­tres that draw a steady flow of vis­i­tors and jobs.

    “Peo­ple are will­ing to make larg­er invest­ments on data cen­tres,” says Bri­an Pry­or, Houli­han Lokey’s North Amer­i­can data cen­tre lead banker. But “there can be pub­lic back­lash if you suck up pow­er and resources with­out clear and direct ben­e­fits to the local com­mu­ni­ty.”

    ...

    So-called gen­er­a­tive AI, where algo­rithms crunch troves of data and use it to spit out new con­tent, has led to an inten­si­fy­ing need for new tech­nol­o­gy and infra­struc­ture. Serv­er racks for AI com­put­ing can con­sume four times the pow­er cur­rent­ly used in cloud process­es, accord­ing to New­mark Group. That calls for data cen­tres that can sup­port surges in work­loads, and more advanced cool­ing sys­tems to han­dle the heat emit­ted.
    ...

    And notice how the price these data cen­tres can charge is based on the ener­gy costs, not the square footage of real estate space. In oth­er words, the more expen­sive it is to pow­er these cen­ters, the more the data cen­tre oper­a­tors can charge. And since data cen­tres tend to be clus­tered in the same regions, we should expect even greater ener­gy sup­ply and demand imbal­ances as this sec­tor con­tin­ues to grow. It’s a recipe for not just price goug­ing but also ruin­ing the grid reli­a­bil­i­ty for the every­one else liv­ing in these areas:

    ...
    With Blackstone’s arrival, Williams start­ed telling staff that QTS would be the biggest com­pa­ny of its kind. Some data cen­tre employ­ees in work gear whis­pered among them­selves at the mon­ey men in suits and loafers at the hard-hat sites. Quar­ter-mile sprints are over, QTS man­agers said; pre­pare for a marathon.

    QTS snapped up land and pro­cured pow­er faster and sped up plan­ning time­lines. It grew head­count by rough­ly half, to more than 1000, in the past year and a half. Some staffers voiced unease among them­selves that as the firm read­ied more mega-cen­tres, it would tie the company’s prof­its too close­ly to cloud giants. In its state­ment, QTS said its data cen­tres were designed for a range of uses.

    Then came last year’s AI mania. Hyper­scalers are now pay­ing data cen­tre oper­a­tors month­ly rates of more than $US100 per kilo­watt, from $US70 to $US80 per kilo­watt three years ago, in some areas. In top-tier mar­kets, it’s as high as around $US150 per kilo­watt, bro­kers say. (As data cen­tres pro­vide access to pow­er, rents are often mea­sured by watts instead of square metres.)

    ...

    “There is a lot of data cen­tre growth hap­pen­ing and that growth is not even­ly dis­trib­uted across the US,” says Arman She­habi, a sci­en­tist at California’s Lawrence Berke­ley Nation­al Lab­o­ra­to­ry, who is study­ing data cen­tre pow­er needs for the gov­ern­ment. “It’s con­sol­i­dat­ing in cer­tain loca­tions, and this could cre­ate a pow­er crunch in those areas.
    ...

    And that poten­tial for pow­er crises cre­at­ed by the enor­mous data cen­tre elec­tric­i­ty demand brings us to anoth­er con­straint: water demand. Data cen­tres have mas­sive water needs for their cool­ing sys­tems. It’s a very seri­ous poten­tial lim­it on the abil­i­ty of this sec­tor to expand at the rate it appears to want to expand. New cool­ing tech­nol­o­gy that isn’t so water depen­dent is going to have to be devel­oped:

    ...
    One of QTS’ big growth areas is in Ari­zona, where its 34-hectare cam­pus near the cen­tre of Phoenix is seen as a crown jew­el. It’s ful­ly leased before it’s even com­plete, with Microsoft as one of its ten­ants. Else­where, QTS says it has con­tract­ed all the pow­er it needs to meet mul­ti­ple years of demand on a 160-hectare plot just north-west of down­town that would cement the desert valley’s rise as a data cen­tre des­ti­na­tion.

    Data cen­tres’ water needs have made them a hot-but­ton issue in arid cities such as Phoenix. In the part of Ari­zona QTS is eye­ing, a data cen­tre can’t rely on water because years of farm­ing have deplet­ed ground­wa­ter in the area, caus­ing huge cracks in sur­round­ing land to emerge.

    Joseph Cook, who has stud­ied the area as a research geol­o­gist with the Ari­zona Geo­log­i­cal Sur­vey, says a data cen­tre that sucks up sub­stan­tial water could lead to new fis­sures. “The data cen­tre might not be affect­ed, but it could be destruc­tive to roads and homes,” he says. Near­by Luke Air Force Base, home of the 56th fight­er wing, looms large to the local econ­o­my and nation­al secu­ri­ty.
    ...

    And then we get to these poten­tial­ly omi­nous plans for deal­ing with the pow­er sup­ply chal­lenges that are only going to get worse: micro-nuclear reac­tors. Just what the world needs. This is a good time to recall the invest­ments by none oth­er Bill Gates in the devel­op­ment of exact­ly this kind of tech­nol­o­gy. It’s the promise of cheap, small nuclear pow­er plants that rely on molten salt instead of water. But with the catch that the tech­nol­o­gy relied on Ura­ni­um enriched enough to poten­tial­ly build a nuclear weapon. Are we going to see Bill Gates’s mini-nuclear plant tech­nol­o­gy deployed to pow­er the AI-data cen­tres of tomor­row? That appears to be where the sec­tor is head­ing:

    ...
    QTS says the cool­ing sys­tem it has devel­oped will cut water usage at the site by hun­dreds of mil­lions of litres each year. More broad­ly, staffers have also dis­cussed devel­op­ing data cen­tres with micro-nuclear reac­tors to wean them off local grids.
    ...

    Time will tell how this plays out, but it sounds like the pri­vate-equi­ty sec­tor is view­ing this as one of the most poten­tial­ly prof­itable types of invest­ments its ever engaged in, hence all the enthu­si­asm and mas­sive new invest­ments. At the same time, it’s hard to think of a big­ger poten­tial invest­ment dis­as­ter than a lit­er­al nuclear dis­as­ter. So it’s going to be inter­est­ing to see how the indus­try ends up struc­tur­ing these deal in a way that min­i­mizes the pow­er down­side of mis­man­age­ment of these enti­ties. After all, one of the biggest long-stand­ing com­plaints about the pri­vate-equi­ty equi­ty is the incen­tives for gross mis­man­age­ment and a flout­ing of all pre­cau­tions in the search of prof­it. An indus­try sort of pred­i­cat­ed around mak­ing as much mon­ey as quick­ly as pos­si­ble and leav­ing a giant mess for the suck­ers and rubes to clean up. How is that kind of busi­ness mod­el going to mesh with the real-world con­se­quences of micro-nuclear reac­tors? Again, we’ll find out. Pos­si­bly in the form of some very dif­fi­cult to clean up real-world con­se­quences.

    Posted by Pterrafractyl | February 8, 2024, 10:14 pm
  14. It’s offi­cial: Tay­lor Swift is the hottest thing in the NFL. Sil­ly right-wing para­noia aside, not only has Swift’s rela­tion­ship with Kansas City Chiefs tight end Travis Kelce earned the team over $300 mil­lion in addi­tion­al rev­enues in 2023, but the NFL as a whole had its high­est view­er­ship among women since it start­ed track­ing in 2000. In oth­er words, she’s made the bil­lion­aires who own all those NFL fran­chis­es a lot of mon­ey. Every­one is a win­ner.

    Of course, ful­ly cash­ing in on the Tay­lor Swift/NFL hon­ey­moon would entail not just increased view­er­ship and tick­et sales but actu­al­ly sell­ing the team. Strik­ing while the iron is hot. Which isn’t so easy to do for the NFL, with its noto­ri­ous­ly strict own­er­ship rules that require a sin­gle wealthy indi­vid­ual to be the pri­ma­ry enti­ty behind a team’s own­er­ship. It’s a prob­lem that grows as the already stratos­pher­ic val­u­a­tions of NFL fran­chis­es con­tin­ue to show no ceil­ing. The NFL fran­chise mar­ket has almost become like the high-end art mar­ket: it’s obvi­ous these things are worth a for­tune but it’s not clear who has the kind of for­tune, and inter­est, to buy them.

    So with that Swifty-update in mind, here’s a fun Super Bowl Sun­day pri­vate-equi­ty sto­ry: Guess which indus­try is cur­rent­ly pon­der­ing open­ing its doors to the pri­vate-equi­ty indus­try? Yep, the NFL is seri­ous­ly con­sid­er­ing it. And as none oth­er than Kansas City Chiefs own­er Clark Hunt recent­ly put it, “I don’t want to pre­dict one way or anoth­er whether we will ulti­mate­ly adopt it...But I do think it is avenue that can be help­ful from a cap­i­tal stand­point.” And open­ing up NFL own­er­ship to insti­tu­tion­al investors isn’t just just on Hunt’s per­son­al wish list. The league set up a com­mit­tee to assess the poten­tial impact of such a move.

    Nor is it an unthink­able move on the NFL’s part. If any­thing, the league is behind the times. As Hunt describes, “It’s a sub­ject that we’ve been dis­cussing for a cou­ple years...Private equi­ty own­er­ship is allowed in the oth­er four big US sports so we’ve had a chance to observe that unfold and it’s a top­ic we’re going to con­tin­ue to dis­cuss.” In a world where the NBA allows sov­er­eign wealth funds to buy stakes in teams, how long can the NFL’s rel­a­tive­ly strict own­er­ship rules hold out when so much poten­tial investor cap­i­tal is there for the tak­ing and already shap­ing oth­er pro­fes­sion­al sports? It seems like a mat­ter of when, not if.

    And, yes, Clark Hunt is the grand­son of H.L. Hunt, a rather noto­ri­ous his­tor­i­cal fig­ure with ties to the assas­si­na­tions of both JFK and MLK. And let’s not for­get the rather inter­est­ing his­to­ry around the own­er­ship of the San Fran­cis­co 49ers. As we described in FTR#304, the De Bar­to­lo fam­i­ly has long been sus­pect­ed of hav­ing orga­nized crime con­nec­tions, includ­ing a 1982 Cus­toms Depart­ment report that alleged the De Bar­to­lo orga­ni­za­tion had suc­ceed Mey­er Lan­sky as the finan­cial wiz­ard for orga­nized crime. And that’s just the fam­i­ly his­to­ry of own­ers of two teams in this year’s Super Bowl. Which is a reminder that insti­tu­tion­al investors aren’t the only kinds of own­ers with dif­fi­cult back­grounds.

    But let’s not for­get anoth­er part of what makes some­thing like pri­vate-equi­ty a dif­fi­cult own­er for any sort of pro­fes­sion­al sport: the asset-strip­ping short-term nature of the busi­ness mod­el. Great in the short-term, not so much in the long-run. That’s kind of indus­try’s track record at this point and it’s unclear why the NFL would want to invite that into its own­er­ship ranks. But with fran­chise val­u­a­tions already sky-high, there’s only so many bil­lion­aires out there who can pos­si­ble buy one of these teams.

    And that brings us to a fit­ting fun fact about the NFL’s own­er­ship: the recent sale of the Wash­ing­ton Com­man­ders for a record high price of $6 bil­lion was to Josh Har­ris, the co-founder of pri­vate-equi­ty giant Apol­lo Glob­al Man­age­ment. He’s like a walk­ing pin­na­cle of the indus­try’s ‘heads I win, tails you lose your retire­ment’ busi­ness mod­el. Also recall how it’s Apol­lo that has been pio­neer­ing the ques­tion­able strat­e­gy of using that pen­sion fund mon­ey to pur­chase insur­ance com­pa­nies so they can gam­ble with the assets back­ing the annu­ity poli­cies, with the gam­ble of choice being cor­po­rate bonds.

    So the Wash­ing­ton Com­man­ders are now fac­ing the ques­tion of what hap­pens when a lit­er­al pri­vate-equi­ty giant buys the team. Will asset-strip­ping ensue? Har­ris hap­pens to also own the Philadel­phia 76ers and the New Jer­sey Dev­ils, so he’s not actu­al­ly an unknown enti­ty as a pro­fes­sion­al fran­chise own­er. But after the NFL opens its doors to the entire indus­try that’s no longer going to just be a ques­tion for the Com­man­ders.

    And, again, if the cur­rent own­ers want to find new own­ers will­ing to pay the exor­bi­tant val­u­a­tions of today, let alone the more exor­bi­tant val­u­a­tions of tomor­row, they are going to have to find mar­kets with very deep pock­ets. There’s lim­it to the num­ber of indi­vid­ual bil­lion­aires inter­est­ed in own­ing a team, and there­fore only so much com­pe­ti­tion to bid up those val­u­a­tions and pay­outs.

    So in terms of real-world Swifty impacts, by increas­ing the over­all pop­u­lar­i­ty and val­u­a­tions of the NFL, Tay­lor Swift has made the NFL even more like­ly to be forced to open its doors to the pri­vate-equi­ty indus­try’s vast pools of cash. That’s the only way to tru­ly unlock that Swifty-cre­at­ed val­ue is with pri­vate-equi­ty mon­ey. And there we have a it. A under­pin­nings for the real Tay­lor Swift/NFL con­spir­a­cy. Tay­lor Swift is soft­en­ing the own­ers up with swollen val­u­a­tions so pri­vate-equi­ty can go in for the kill. We should have seen it com­ing.

    So while Clark Hunt is only indi­cat­ing that the NFL’s own­er­ship is only think­ing about the whole pos­si­bil­i­ty of open­ing the doors of own­er­ship to insti­tu­tion­al investors like pen­sion fund-fueled pri­vate-equi­ty firms, keep in mind that they’re prob­a­bly also think­ing about how to ful­ly tap the NFL’s new Swifty-super-sized fran­chise val­u­a­tions:

    Bloomberg

    Kansas City Chiefs Own­er Sees Pri­vate Equi­ty as Option for NFL

    * NFL has com­mit­tee look­ing at allow­ing insti­tu­tion­al cap­i­tal
    * Super Bowl LVIII is set to be played this Sun­day in Las Vegas

    By Ran­dall Williams
    Feb­ru­ary 6, 2024 at 8:16 AM CST

    With val­u­a­tions of NFL teams soar­ing, Clark Hunt, the own­er of the Kansas City Chiefs, sees pri­vate equi­ty investors as a poten­tial source of cap­i­tal for fran­chis­es.

    “I don’t want to pre­dict one way or anoth­er whether we will ulti­mate­ly adopt it,” Hunt said in an inter­view with Bloomberg News pri­or to the Super Bowl in Las Vegas. “But I do think it is avenue that can be help­ful from a cap­i­tal stand­point.”

    The NFL last year set up a com­mit­tee to assess whether to allow insti­tu­tion­al cap­i­tal to invest direct­ly into fran­chis­es, and is expect­ed to put for­ward rec­om­men­da­tions before the league’s annu­al meet­ing in March. Hunt is chair­man of the NFL’s finance com­mit­tee, and a mem­ber of the own­er­ship group.

    “It’s a sub­ject that we’ve been dis­cussing for a cou­ple years,” Hunt said. “Pri­vate equi­ty own­er­ship is allowed in the oth­er four big US sports so we’ve had a chance to observe that unfold and it’s a top­ic we’re going to con­tin­ue to dis­cuss.”

    Pri­vate equi­ty firms have been mak­ing a big­ger push into sports, led by firms includ­ing Arc­tos Part­ners, Ares Man­age­ment, and Blue Owl Cap­i­tal. The Nation­al Bas­ket­ball Asso­ci­a­tion has been steadi­ly open­ing up to insti­tu­tion­al investors, and in late 2022 allowed sov­er­eign wealth funds, pen­sions and endow­ments acquire pas­sive stakes in its teams.

    The NFL remains off lim­its to pri­vate equi­ty investors, instead rely­ing on ultra-high-net-worth indi­vid­u­als to offer bil­lions to buy fran­chis­es.

    In July, the Wash­ing­ton Com­man­ders were bought by Josh Har­ris for $6 bil­lion, the largest ever sale of an NFL team. The co-founder of Apol­lo Glob­al Man­age­ment, with a net worth of more than $8 bil­lion, Har­ris bought the team with a large con­sor­tium of investors with Wall Street con­nec­tions.

    The sig­nif­i­cant val­u­a­tions of NFL teams have reduced the num­ber of poten­tial buy­ers, with NFL rules stat­ing that the lead investor of an own­er­ship group needs at least a 30% equi­ty stake, and no bor­row­ing over $1.1 bil­lion to buy the team.

    ...

    Bloomberg report­ed last year that a group of Nation­al Foot­ball League own­ers pushed to allow pri­vate equi­ty firms and insti­tu­tion­al investors to buy stakes in clubs.

    ———–

    “Kansas City Chiefs Own­er Sees Pri­vate Equi­ty as Option for NFL” By Ran­dall Williams; Bloomberg; 02/06/2024

    “Pri­vate equi­ty firms have been mak­ing a big­ger push into sports, led by firms includ­ing Arc­tos Part­ners, Ares Man­age­ment, and Blue Owl Cap­i­tal. The Nation­al Bas­ket­ball Asso­ci­a­tion has been steadi­ly open­ing up to insti­tu­tion­al investors, and in late 2022 allowed sov­er­eign wealth funds, pen­sions and endow­ments acquire pas­sive stakes in its teams.

    Is the NFL going to fol­low in NBA’s lead and open its doors to the real­ly big mon­ey? Insti­tu­tion­al mon­ey? Pen­sion-fueled pri­vate-equi­ty and sov­er­eign wealth funds? Kansas City Chief’s own­er Clark Hunt, grand­son of H.L. Hunt, sure sounds inter­est­ed. Because of course he’s inter­est­ed. A team as valu­able as the Chiefs might run into a chal­lenge when it comes to find­ing a buy­er under the NFL’s cur­rent own­er­ship rules. There’s only so many bil­lion­aires with that kind of mon­ey lay­ing around avail­able to buy a team. Insti­tu­tion­al investors with that kind of mon­ey, on the oth­er hand, aren’t so rare. By open­ing up the NFL own­er­ship to insti­tu­tion­al investors, not only does the mar­ket sud­den­ly become far more liq­uid but the val­u­a­tions poten­tial­ly jump too as the num­ber of poten­tial buy­ers sud­den­ly explodes. From a return on invest­ment stand­point, open­ing up to insti­tu­tion­al investors is the next log­i­cal choice for the NFL. It’s how ultra-expen­sive fran­chis­es can be sold off to new investors in the hopes they’ll be super-ultra-expen­sive enter­prise that can be re-sold in the future:

    ...
    The NFL last year set up a com­mit­tee to assess whether to allow insti­tu­tion­al cap­i­tal to invest direct­ly into fran­chis­es, and is expect­ed to put for­ward rec­om­men­da­tions before the league’s annu­al meet­ing in March. Hunt is chair­man of the NFL’s finance com­mit­tee, and a mem­ber of the own­er­ship group.

    ...

    The NFL remains off lim­its to pri­vate equi­ty investors, instead rely­ing on ultra-high-net-worth indi­vid­u­als to offer bil­lions to buy fran­chis­es.

    In July, the Wash­ing­ton Com­man­ders were bought by Josh Har­ris for $6 bil­lion, the largest ever sale of an NFL team. The co-founder of Apol­lo Glob­al Man­age­ment, with a net worth of more than $8 bil­lion, Har­ris bought the team with a large con­sor­tium of investors with Wall Street con­nec­tions.

    The sig­nif­i­cant val­u­a­tions of NFL teams have reduced the num­ber of poten­tial buy­ers, with NFL rules stat­ing that the lead investor of an own­er­ship group needs at least a 30% equi­ty stake, and no bor­row­ing over $1.1 bil­lion to buy the team.
    ...

    It’s also rather notable that Josh Har­ris, the co-founder of Apol­lo Glob­al Man­age­ment, was the per­son who pur­chased the Wash­ing­ton Com­man­ders for $6 bil­lion, the largest sale ever of an NFL team. Apol­lo is, of course, one of the pri­vate-equi­ty equi­ty giants that’s grown enor­mous­ly through pen­sion fund clients over the last decade. So when we look at Har­ris’s $8 bil­lion val­u­a­tion, it’s kind of hard to ignore that his firm achieved that val­u­a­tion by devel­op­ing a mas­sive inflow of fees and bonus­es from clients like pen­sion funds. The ‘Heads I win, tails you lose your retire­ment’ busi­ness mod­el. Also recall how it’s Apol­lo that has been pio­neer­ing the ques­tion­able strat­e­gy of using that pen­sion fund mon­ey to pur­chase insur­ance com­pa­nies so they can gam­ble with the assets back­ing the annu­ity poli­cies, with the gam­ble of choice being cor­po­rate bonds. You have to won­der if Har­ris is going to be bring­ing the clas­sic pri­vate-equi­ty asset-strip­ping men­tal­i­ty to his new team.

    But con­cerns about the vul­ture-like nature of pri­vate-equi­ty obvi­ous­ly should­n’t be lim­it­ed to the Com­man­ders once the doors are opened to the entire indus­try. You could have the sov­er­eign wealth funds of monar­chies own­ing large stakes in a num­ber of teams. All the kinds of investors look­ing for a return on their invest­ments. These aren’t tro­phy pur­chas­es. How is the open­ing of the own­ers club to the mas­sive pools of insti­tu­tion­al­ly man­aged wealth going to change the league, both insti­tu­tion­al­ly and from a fan expe­ri­ence per­spec­tive? Could this be a recipe for one own­er­ship-relat­ed headache after anoth­er? Clark Hunt may be open to the idea but we have yet to see how the rest of the own­ers feel. Although we should find out soon:

    The New York Times

    The New N.F.L. Own­ers?

    As team val­u­a­tions sky­rock­et, the league is weigh­ing whether to relax own­er­ship rules that pro­hib­it invest­ment from pri­vate equi­ty funds.

    By Lau­ren Hirsch, Kevin Drap­er, Michael J. de la Merced and Sarah Kessler
    Feb. 10, 2024, 8:00 a.m. ET

    The biggest upcom­ing foot­ball event for many of the N.F.L. own­ers and busi­ness exec­u­tives who will pop­u­late lux­u­ry box­es at the Super Bowl this week­end is not, per­haps sur­pris­ing­ly, the game. It actu­al­ly won’t take place until six weeks lat­er, in Orlan­do, Fla., when foot­ball exec­u­tives gath­er for the Nation­al Foot­ball League’s annu­al meet­ing — an event that has par­tic­u­lar sig­nif­i­cance this year.

    At the meet­ing, the league is expect­ed to address a long-sim­mer­ing ques­tion: whether to allow pas­sive invest­ment from pri­vate equi­ty firms, which work with mon­ey sourced every­where from sov­er­eign wealth funds to pen­sion funds to wealthy indi­vid­u­als.

    Major League Base­ball, the Nation­al Bas­ket­ball Asso­ci­a­tion and the Nation­al Hock­ey League have already relaxed their own­er­ship rules. But the N.F.L. both pro­hibits pri­vate equi­ty mon­ey and has some of the strictest rules for invest­ing, requir­ing gen­er­al part­ners to buy at least a 30 per­cent stake in the team and lim­it­ing the use of debt to $1.2 bil­lion. Allow­ing insti­tu­tion­al investors to own teams could vault already high-fly­ing val­u­a­tions high­er and change the cul­ture of team own­er­ship.

    ...

    Indus­try insid­ers have been whis­per­ing about the meet­ing and have a lot of ques­tions. Among them:

    Would the N.F.L. allow sov­er­eign investors? Soon after the N.B.A. allowed pen­sion and sov­er­eign funds to invest in its leagues, the Qatar Invest­ment Author­i­ty bought a 5 per­cent stake in three Wash­ing­ton, D.C., teams. Sau­di Arabia’s wealth fund, which struck a splashy (though far from cer­tain) deal with the PGA Tour last year, has also been eye­ing ten­nis.

    Insid­ers who spoke to Deal­Book said they doubt­ed the N.F.L. would allow direct sov­er­eign invest­ment into the sport. “They have the lux­u­ry, real­ly, to set what­ev­er terms of this insti­tu­tion­al cap­i­tal that they want,” Lyle Ayes, the founder of Ver­ance Cap­i­tal, told Deal­Book. “They will be the last, if ever, to allow sov­er­eign wealth.”

    But would any restric­tions also pro­hib­it team own­er­ship by pri­vate equi­ty funds that have sov­er­eign investors as lim­it­ed part­ners?

    How would investors cash out? Pri­vate equi­ty funds are usu­al­ly look­ing for invest­ments they can flip after sev­er­al years. But sports teams infre­quent­ly change hands. So some firms, like Arc­tos Cap­i­tal and Dyal Cap­i­tal, have raised funds focused on buy­ing small stakes in sports teams as an asset class, seek­ing out investors who are com­fort­able with that mod­el. In Dyal’s case, its stake in N.B.A. teams sits in a pub­licly trad­ed vehi­cle that offers some liq­uid­i­ty. But it’s not clear whether the N.F.L. would allow invest­ments in the league to be a part of a sim­i­lar struc­ture, or how firms would oth­er­wise speed­i­ly return cap­i­tal to their investors.

    Try­ing to guess when a team will next sell is also dif­fi­cult, Ayes told Deal­Book. “There’s a lot of smart peo­ple — bankers, lawyers, etc. — who fol­low the space, and no one real­ly knows.” Still, he not­ed, sports leagues are not tra­di­tion­al­ly cor­re­lat­ed with the mar­ket, and thus could be a way to diver­si­fy invest­ments.

    What kinds of deals would be allowed? Would pri­vate equi­ty firms be able to invest in mul­ti­ple teams, or would the league see that as a con­flict of inter­est? Insid­ers say the N.F.L. would like­ly set a lim­it on how large of a stake a pri­vate equi­ty firm could buy in a team. For exam­ple, a sin­gle pri­vate equi­ty fund can own up to 15 per­cent of an M.L.B. team, which can only sell 30 per­cent of its shares to insti­tu­tion­al investors.

    How would buy­ers be vet­ted? The N.F.L. is known for the rig­or­ous vet­ting process through which it puts its poten­tial new own­ers. But pri­vate equi­ty firms are often large insti­tu­tions with many employ­ees and mul­ti­ple hold­ings. So what are the stan­dards the N.F.L. should apply when weigh­ing these deals? Should there be extreme due dili­gence on the chief exec­u­tive? The board?

    The pres­sure to answer these ques­tions is grow­ing as team val­u­a­tions sky­rock­et. In July, the Wash­ing­ton Com­man­ders were sold to a group led by Josh Har­ris for $6 bil­lion, top­ping the $4.65 bil­lion the Den­ver Bron­cos notched a year pri­or. Those high val­u­a­tions are com­pli­cat­ing not just for estate tax­es — but also for the abil­i­ty to sell a team: even Har­ris, a multi­bil­lion­aire, need­ed to bring in addi­tion­al lim­it­ed part­ners to get the deal over the line.

    “There aren’t that many peo­ple that can write a giant $3, $4 bil­lion check and then raise a whole bunch of mon­ey to make up the dif­fer­ence,” said Sal­va­tore Gala­tioto, whose com­pa­ny has advised investors on buy­ing and sell­ing pro­fes­sion­al sports fran­chis­es. “That’s the real­i­ty of the world.”

    ———

    “The New N.F.L. Own­ers?” By Lau­ren Hirsch, Kevin Drap­er, Michael J. de la Merced and Sarah Kessler; The New York Times; 02/10/2024

    ““There aren’t that many peo­ple that can write a giant $3, $4 bil­lion check and then raise a whole bunch of mon­ey to make up the dif­fer­ence,” said Sal­va­tore Gala­tioto, whose com­pa­ny has advised investors on buy­ing and sell­ing pro­fes­sion­al sports fran­chis­es. “That’s the real­i­ty of the world.””

    There sim­ply are not that many indi­vid­u­als on the plan­et who can afford an NFL team. Val­u­a­tions that, have risen to stratos­pher­ic heights in recent years. That’s how much of a lux­u­ry good NFL teams have become. The mar­ket­place for NFL teams lacks the pool of ultra-rich indi­vid­u­als need­ed to cre­ate mar­ket­place liq­uid­i­ty. The increase in val­u­a­tions for NFL teams has, incred­i­bly, out­paced the his­toric re-con­cen­tra­tion of wealth that’s tran­spired post-Rea­gan Rev­o­lu­tion. Even with wealth more con­cen­trat­ed than ever in the mod­ern era, there’s still not enough bil­lion­aires wealthy enough to afford all these teams.

    And that’s the state of affairs at today’s val­u­a­tions. What about decades from now, when these teams will the­o­ret­i­cal­ly be worth bil­lions dol­lars, per­haps tens of bil­lions, more in val­ue? Hence the con­ver­sa­tions now tak­ing place. Quite sim­ply, if the NFL’s own­ers want poten­tial buy­ers they’re going to have to relax the rules, much like the NBA has done. But that also means an era of new, poten­tial­ly con­tro­ver­sial, own­er­ship. Like Mid­dle East­ern sov­er­eign wealth funds. Or pri­vate-equi­ty, per­haps backed by pen­sion fund mon­ey. Or pub­licly trad­ed enti­ties with shares any­one can buy that, in turn, own shares of dif­fer­ent teams. Does the NFL want to invite sov­er­eign wealth funds, pri­vate-equi­ty, pen­sion funds, and the gen­er­al pub­lic into the club? That’s where things seem to be head­ed. Because that’s where the real­ly big mon­ey is:

    ...
    Would the N.F.L. allow sov­er­eign investors? Soon after the N.B.A. allowed pen­sion and sov­er­eign funds to invest in its leagues, the Qatar Invest­ment Author­i­ty bought a 5 per­cent stake in three Wash­ing­ton, D.C., teams. Sau­di Arabia’s wealth fund, which struck a splashy (though far from cer­tain) deal with the PGA Tour last year, has also been eye­ing ten­nis.

    Insid­ers who spoke to Deal­Book said they doubt­ed the N.F.L. would allow direct sov­er­eign invest­ment into the sport. “They have the lux­u­ry, real­ly, to set what­ev­er terms of this insti­tu­tion­al cap­i­tal that they want,” Lyle Ayes, the founder of Ver­ance Cap­i­tal, told Deal­Book. “They will be the last, if ever, to allow sov­er­eign wealth.”

    But would any restric­tions also pro­hib­it team own­er­ship by pri­vate equi­ty funds that have sov­er­eign investors as lim­it­ed part­ners?

    ...

    What kinds of deals would be allowed? Would pri­vate equi­ty firms be able to invest in mul­ti­ple teams, or would the league see that as a con­flict of inter­est? Insid­ers say the N.F.L. would like­ly set a lim­it on how large of a stake a pri­vate equi­ty firm could buy in a team. For exam­ple, a sin­gle pri­vate equi­ty fund can own up to 15 per­cent of an M.L.B. team, which can only sell 30 per­cent of its shares to insti­tu­tion­al investors.

    How would buy­ers be vet­ted? The N.F.L. is known for the rig­or­ous vet­ting process through which it puts its poten­tial new own­ers. But pri­vate equi­ty firms are often large insti­tu­tions with many employ­ees and mul­ti­ple hold­ings. So what are the stan­dards the N.F.L. should apply when weigh­ing these deals? Should there be extreme due dili­gence on the chief exec­u­tive? The board?

    The pres­sure to answer these ques­tions is grow­ing as team val­u­a­tions sky­rock­et. In July, the Wash­ing­ton Com­man­ders were sold to a group led by Josh Har­ris for $6 bil­lion, top­ping the $4.65 bil­lion the Den­ver Bron­cos notched a year pri­or. Those high val­u­a­tions are com­pli­cat­ing not just for estate tax­es — but also for the abil­i­ty to sell a team: even Har­ris, a multi­bil­lion­aire, need­ed to bring in addi­tion­al lim­it­ed part­ners to get the deal over the line.
    ...

    But the ques­tions about this path for­ward don’t just loom large for NFL own­ers. These poten­tial new investors who are going to be pay­ing these exor­bi­tant prices pre­sum­ably want a return on their invest­ments too, right? Does some­thing as illiq­uid as an NFL team make sense as an invest­ment? Sure, sports leagues aren’t nec­es­sar­i­ly cor­re­lat­ed with the broad­er mar­ket so they might seem to fit in well as a kind of invest­ment hedge. But Isn’t the same “who do we sell to?” prob­lem going to fol­low? Is it going to be mass NFL IPOs next? It’s a weird con­flict of pri­or­i­ties. After all, it’s not hard to imag­ine an indi­vid­ual bil­lion­aire view­ing their per­son­al­ly owned team as more of a showy hob­by than a mon­ey-mak­ing enter­prise. Prof­it may not be the top pri­or­i­ty. But we can’t expect pen­sion funds and sov­er­eign wealth funds to pri­or­i­tize any­thing oth­er than prof­its. Nor can we nec­es­sar­i­ly expect them to care about the long-term health of the team or impacts on local com­mu­ni­ties. Espe­cial­ly when pri­vate-equi­ty is involved. What will pri­vate-equi­ty’s asset-strip­ping men­tal­i­ty do to an NFL fran­chise? What kind of new cor­po­rate sleaze fac­tor is the NFL intro­duc­ing into its man­age­ment cir­cles? These are the kinds of ques­tions that have to be com­pli­cat­ing the NFL’s upcom­ing deci­sion on the mat­ter. But what choice do they have if they want to retain the abil­i­ty to sell these ultra-expen­sive enter­pris­es? Ultra-bil­lion­aire club conun­drums:

    ...
    How would investors cash out? Pri­vate equi­ty funds are usu­al­ly look­ing for invest­ments they can flip after sev­er­al years. But sports teams infre­quent­ly change hands. So some firms, like Arc­tos Cap­i­tal and Dyal Cap­i­tal, have raised funds focused on buy­ing small stakes in sports teams as an asset class, seek­ing out investors who are com­fort­able with that mod­el. In Dyal’s case, its stake in N.B.A. teams sits in a pub­licly trad­ed vehi­cle that offers some liq­uid­i­ty. But it’s not clear whether the N.F.L. would allow invest­ments in the league to be a part of a sim­i­lar struc­ture, or how firms would oth­er­wise speed­i­ly return cap­i­tal to their investors.

    Try­ing to guess when a team will next sell is also dif­fi­cult, Ayes told Deal­Book. “There’s a lot of smart peo­ple — bankers, lawyers, etc. — who fol­low the space, and no one real­ly knows.” Still, he not­ed, sports leagues are not tra­di­tion­al­ly cor­re­lat­ed with the mar­ket, and thus could be a way to diver­si­fy invest­ments.
    ...

    And who knows, maybe hav­ing a bunch of teach­ers unions own­ing large stakes in the NFL will actu­al­ly be good from a pub­lic rela­tions stand­point. Kind of like the Tay­lor Swift effect, but instead of tun­ing in a new audi­ence of young teens it’ll be all their teach­ers. Heck, since so many pub­lic pen­sion funds are for a sin­gle state, you could even imag­ine the state pub­lic pen­sion funds invest­ing in their own state’s pro­fes­sion­al sports teams. There are some strange, and not nec­es­sar­i­ly bad, paths for­ward for the NFL with this Pan­do­ra’s Box they’re plan­ning on open­ing. It does­n’t have to be bad.

    Well, except with pri­vate-equi­ty, it does have to be kind of have to be bad. For some­one. That’s the busi­ness mod­el. Some­one has to pay the piper. Or, more specif­i­cal­ly, some­one has to pay Josh Har­ris. So he can buy anoth­er pro­fes­sion­al sports team. And now, thanks to the real Tay­lor Swift/NFL con­spir­a­cy — the con­spir­a­cy to make the fran­chis­es worth so much they can’t help but open up to pri­vate-equi­ty invest­ments — Josh Har­ris and all the oth­er pri­vate-equi­ty prin­ci­pals can make even more mon­ey as their firms charge what­ev­er man­age­ment fees they make up for run­ning an NFL team. It’s real­ly quite dia­bol­i­cal when you think about it.

    And the worst part is, Tay­lor prob­a­bly does­n’t even real­ize it. For her, it’s just anoth­er zany pub­lic romance. Because that’s how pri­vate-equi­ty rolls. Behind the scenes, pulling strings. Or at least that’s how pri­vate-equi­ty gets to roll until Tay­lor finds out she’s been used. The bal­lad of the real NFL/Swift con­spir­a­cy is far from over.

    Posted by Pterrafractyl | February 11, 2024, 1:34 am

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