Monday, September 1, 2008

The “2008: American Idle” winner is the U.S. Banking Community. Despite write- downs, asset sales and a yawning window at the Fed to provide liquidity, the U.S. Banks continue to hibernate during the best risk adjusted lending cycle in recent memory. Banks, that a year ago eagerly provided staple financing, will not, today, even consider offering post-it financing. The contraction of credit, an understandable consequence of the prior irrational exuberance, is greatly contributing to the lack of domestic economic expansion. Rather than return to their traditional mission as lenders, banks continue to position themselves to be ready to act as investment banking fee machines if the markets return to bullish behavior.

Despite the obvious errors in lending and in acquisitions in recent years, the announcements of the changes required today are buried in spin rather than in simple prose declaring “We erred”. Citicorp is ever ready to serve as an example of this self delusion. Old Lane, aka New Pain, a few month old hedge fund, was purchased in July 2007, by Citi for $800 million to recruit The Pandito, Vik Pandit, as their new CEO. Due to poor performance, the exiting of Old Lane employees and a tsunami of redemptions, the asset value remaining was negligible. Rather than simply announce the closing of this disaster, Citi announced it would “restructure” Old Lane. One might have said the U.S. “restructured” the Bikini Atoll, but that would restructure the truth. Admittedly, it might require some verbal gymnastics for the CEO to proclaim Citi overpaid, by about $800 million, to acquire him, yet the candor would be refreshing.

In 1942 the cigarette Lucky Strike, formerly marketed in a dark green package began to advertise patriotically, “Lucky Strike Green has Gone to War” implying the green dye in its package was needed for the war effort to paint tanks. In truth, the package was being changed to modernize its look and to attract more women to the brand as focus groups revealed women did not like the dark green color. Ironically, professional business education continues to bless spin as a practice. It is not uncommon today to sit in the back of a class at a leading business school to see students playing Buzzword Bingo. Each student has a bingo card where buzzwords like synergy or optimize appear in each square. Each time a professor uses a buzzword you mark your card until a student has five in a row and declares victory by muttering Bingo loud enough to tell others, but sufficiently sotto voce to avoid the professor’s attention. Citicorp’s announcement on Old Lane’s closure “These steps will maximize the synergies and talent that are housed within Old Lane and are consistent with Citi’s continuing effort to optimize resources across Citi” was the mother lode for Buzzword Bingo.

Spin Cycle Off Each of us resorts to spin at moments of vulnerability: When my recent weight gain has been pointed out to me I usually mention how short I am for my weight. The last twelve months have caused Private Equity managers to spin like Katarina Witt. CEO’s continue to leave “to spend more time with their families” Filing Chapter 11 – “Lets our company get an appropriate balance sheet for its business” Failed Fund Raising – “due to market conditions” Fund raising with no history of exits – “a unique window exists in our target market” Deviation from core strategy – “ We have long contemplated the use of our network and skills in spaces of opportunity”

Investors are left panning for investment gold in water made muddy by spin. How does an institution build a sluice capable of sifting out the gold? It is easy to suggest that one ignore an overload of press and marketing materials intended to focus the investor on brand rather than on investment results as the key criterion. Look carefully at a manager’s track record to determine the portion that is realized versus the portion that is due to subjective unrealized valuation. Assess the relative risk taken to achieve the record: Has the performance been the result of 30% spectacular deals coupled with 70% write-offs/weak performers or have the results been the sum of 90% quality investments? Have the managers been able to sustain the performance over a long period of time or are the excellent results highly correlated with external phenomena such as the 1999 Internet Bubble or the 2005-7 recapitalization rodeo? Determine if the manager has actually earned real money as opposed to real IRR. Look at net multiples of capital over time to determine if the manager is generating cash needed for pensions or for college tuitions. Are they a one fund story or is each fund profitable? Are there any disingenuous press stories that say “The Managers don’t usually speak to the Press” that then quote the Manager? Put all of your findings on a chart next to your existing successful managers’ results for the same categories. Do not include the name of the manager on this chart. Ask a colleague to identify the results and characteristics that are most impressive without the bias of brand awareness. This blinded test may eliminate several managers most often seen in the media, but it is more likely to make you money.

“When You Come to the Fork in the Road – Take It” (1) In the recently published “The Middle-Class Millionaire” the authors describe a population of hard working entrepreneurs who became single-digit millionaires by dint of their own efforts. Sadly, when this group is surveyed by the authors half of them attribute their wealth to “believing you have to be Machiavellian to succeed” and to “taking advantage of weakness in others.” Certainly there is a segment of visible successful people in business who reached financial success by swinging sharp elbows or by having low coefficients of ethical elasticity. There is a much longer list of those that have fallen from grace as their styles (See Chainsaw Al Dunlap) or felonies (See Sam “suicide is painless” Israel) caught up with them. The great fortunes have been more often built on great ideas (the telephone, the auto, the ipod, soap on a rope) coupled with the hard work of many. It is naive to suggest their success came without tough-minded decisions, but the opportunity to earn great wealth the old fashioned way, through ingenuity and effort, still prevails.

I’m Rob Morris and I approved this blog. (1) Yogi Berra

The "2008: American Idle" Winner Is The U.S. Banking Community.