LIBERTARIAN SUPERHERO: The Success of a Banker Who Said No
April 5, 2009 2 Comments
ATLANTA— As Congress and the Obama Administration tighten their grip on the U.S. financial industry, it is refreshing to me to read stories about the success of banks that have avoided de facto government control by managing their businesses well during the debt-fueled boom of this decade and avoiding the TARP trap. Copied below is an article form Forbes.com about D. Andrew Beal of Beal Bank in Texas, a self-described libertarian, who has made a fortune by having bet against the credit markets.
This story fascinates me for several reasons. First, Mr. Beal provides a sound argument in it that government involvement in the credit markets was a major player in fueling the excesses. I have long believed that implicit government guarantees were a big part of why the big banks and financial institutions took on so much credit risk. Namely, I believe those institutions did not perceive the risk as excessive precisely because of the government guarantees. The quick money and profits they were making, coupled with government guarantees against losses, helped fuel excessive behavior. Secondly, Mr. Beal notes that government regulatory agencies during the middle of this decade seemed more concerned about people like him with his counter-intuitive behavior for not participating in the excessive lending than they were concerned about the behavior of the big banks that were over-leveraging themselves. I find this point fascinating, because it exposes one of the inherent short-comings of regulators: they can be blinded by market distortions just as easily as market participants can be.
At any rate, I have posted this for the enjoyment of our regular readers. This is a very interesting article.
The Banker Who Said No
Bernard Condon and Nathan Vardi
Standing outside the glass-domed headquarters of his Plano, Texas, bank in March, D. Andrew Beal presses a cellphone to his ear. He’s discussing a deal to buy mortgage securities. In just a few minutes, the deal’s done: His Beal Bank will buy $15 million of face value for $5 million. A few hours earlier he reviewed details on a $500 million loan his bank is making to a company heading into bankruptcy–the biggest he’s ever done. A few floors above, workers are bent over computer screens preparing bids for chunks of $600 million in assets dumped by two imploded financial firms. In the last 15 months, Beal has purchased $800 million of loans from failed banks, probably more than anyone else.
Andy Beal, a 56-year-old, poker-playing college dropout, is a one-man toxic-asset eater–without a shred of government assistance. Beal plays his cards patiently. For three long years, from 2004 to 2007, he virtually stopped making or buying loans. While the credit markets were roaring and lenders were raking in billions, Beal shrank his bank’s assets because he thought the loans were going to blow up. He cut his staff in half and killed time playing backgammon or racing cars. He took long lunches with friends, carping to them about “stupid loans.” His odd behavior puzzled regulators, credit agencies and even his own board. They wondered why he was seemingly shutting the bank down, resisting the huge profits the nation’s big banks were making. One director asked him: “Are we a dinosaur?”, while many of those banks struggle to dig out from under a mountain of bad debt, Beal is acquiring assets. He is buying bonds backed by commercial planes, IOUs to power plants in the South, a mortgage on an office building in Ohio, debt backed by a Houston refinery and home loans from Alaska to Florida. In the last 15 months Beal has put $5 billion to work, tripling Beal Bank’s assets to $7 billion, while such banks as Citigroup and Morgan Stanley shrink and gobble up billions in taxpayer bailouts.
Beal has barely got a dime from the feds. A self-described “libertarian kind of guy,” Beal believes the government helped create the credit crisis. Now he finds it “crazy” that bankers who acted irresponsibly are getting money and he’s not. But he wants to exploit their recklessness to amass his own fortune. “This is the opportunity of my lifetime,” says Beal. “We are going to be a $30 billion bank without any help from the government.” (A slight overstatement: He is quick to say he relies on federal deposit insurance.) Not much next to the trillion-dollar balance sheets of the nation’s troubled banks, but the lesson here might be revealed in the fact that this billionaire is not playing with other people’s money–he owns 100% of the bank and is acting accordingly.
It’s hard to imagine Beal fitting in at a bankers’ convention. He walked into the Las Vegas Bellagio in 2001 and challenged the world’s best poker players to games with $2 million pots–the highest stakes ever. Donning large sunglasses and earphones, Beal held his own against the poker stars, once winning $11 million in a single day, although he shrugs that he lost more than he won. At the track he’ll drive one of his nine race cars (costing as much as $100,000 each) at 150 mph. On city streets he cruises in a huge Ford Excursion, the vehicle that has made him feel safe since a drunk driver punctured his lungs in 2000. When Ford Motor discontinued the Excursion a few years ago, Beal bought an extra one for storage.
A math whiz who left Michigan State to dabble in real estate, Beal has offered a $100,000 prize to anyone who can solve a number-theory puzzle. Beal launched a rocket company that built the largest liquid-fuel engine since the Apollo missions. After spending $200 million over four years he shut the venture down, saying it was impossible to compete with NASA’s subsidies.
In the last 15 years Beal says he has bought only one stock. If he ever thinks of investing in hedge funds or private equity, he says, “Just shoot me.” The blunt-spoken Beal shuns publicity and is uncomfortable in the public eye. He concedes he can seem “unprofessional.” After 20 years in the business he attended his first bankers’ conference last year.
The son of a mechanical engineer, Beal grew up in Lansing, Mich. He ended up in Texas after buying an apartment complex in Waco. He founded Beal Bank in Texas in 1988, opening the first branch next to a Wendy’s, and started purchasing distressed real estate loans from failing banks. Years later he also opened a bank in Las Vegas. Beal Bank has long been a unique animal, mostly buying loans in the secondary market instead of originating them. It was a successful model: In 2000 American Banker declared Beal Bank the most profitable bank in the nation as measured by its five-year return on equity of 50%.
By September 2004 Beal Bank’s assets had climbed to $7.7 billion. Then Beal stopped buying, letting his loans run off. By September 2007 assets had shriveled to $2.9 billion, one-fifth of which was cold cash. He was worried that consumers had taken on too much debt and money was being lent to companies for next to nothing. “Every deal done since 2004 is just stupid,” Beal says.
He began by pulling back from home loans–even those guaranteed by Fannie Mae and Freddie Mac. Beal thought the two quasi-government agencies were over-leveraged. When staffers mentioned their guarantees in deal presentations he would fire back that these guarantees were “worthless.”
Outsiders thought it was Beal who didn’t get it. Despite its aversion to credit then, the bank occasionally had to buy mortgages to meet federal low-income-lending requirements. Jonathan Goodman, then head of loan purchases, recalls salesmen from Countrywide laughing at him on the phone when he refused to buy iffy condo paper backed by the two agencies. “Countrywide, Bank of America, Washington Mutual … every single [mortgage seller] thought we were insane,” Goodman says. “They didn’t know why we cared. They thought Fannie and Freddie guarantees were as good as Treasuries.”
Beal also stopped making commercial loans. “If I see another office condo in Las Vegas or Phoenix, I’m going to throw up,” he said at the time. He started selling, too. At a price of 115 cents on the dollar he unloaded a $75 million pool of loans that had been extended to Kmart, exercise chain 24 Hour Fitness and Regal Cinemas. That translated into a yield for the buyer of a mere 1.35 percentage points over Treasuries. “They were great loans at 85 cents,” says Beal, referring to the price he had paid for them years earlier. “They’re stupid at 115.”
With fewer assets, he began laying off staff, cutting down to 200 people from a peak of 400. “Escorting all those people out the door was awful, the worst moments of my life,” says Jacob Cherner, who oversees Beal’s lending and debt purchases. Half of the 270,000-square-foot polished wood and Brazilian granite headquarters went dark. (Beal hastens to add he bought the building from an oil company desperate to move only because it was selling at a discount.) He hired agents to rent out the space.
Beal started coming to work at 10:30 and leaving at 2:30. He challenged colleagues to backgammon games and took hour-long lunches, complaining of being “bored stiff,” recalls one frequent meal companion, real estate investor Steven Houghton. Then Beal would head home to walk a nearby creek with the youngest of his six children. He took up car racing, too. “I thought it would end in six months, and sanity would return,” he says. “If I knew it would last nearly four years I would have thought of something else to do.”
In late 2006 he sold $74 million of preferred stock although he had no immediate use for the proceeds. He says he couldn’t resist the “stupidly mispriced” terms–as low as Libor plus 1.7 percentage points for 30 years. He wanted as much money available when the boom turned to bust. With the extra money the bank could pay off nearly all its depositors with capital on hand–nearly unheard of in the history of banking.
Then came a shocker: Amid one of the most reckless lending sprees in history, regulators focused on the one bank that refused to play along. Beal’s moves confused and worried them, and so they began to probe him with questions. “What are you doing?” he recalls them asking. “You’re shrinking yet you’re raising capital?”
Says Beal about the scrutiny, “I just didn’t fit into any box.” One regulator, the former head of the Texas Savings & Loan Department, Charles Danny Payne, says, “I was skeptical at first, but I’ve gained a lot of confidence over the years,” adding that Beal has an “uncanny ability to sniff out deals.”
Next, the credit rating agencies started pestering him about his dwindling loan portfolio. They never downgraded him but scolded him for seeming not to have a “sustainable” business model. This while their colleagues were signing off on $32 billion of bum collateralized debt obligations issued by Merrill Lynch.
Then came the summer of 2007, and Wall Street’s securitization machine began to break down. Prices on pools of mortgages were falling. Beal was tempted but insisted on inspecting individual loan files. Wall Street refused. Still, he knew his time was coming. To prepare bids he locked himself in his office to write a computer program with 50 variables (now 250), ranging from home price changes by neighborhood to interest rates to origination dates.
By 2008, Wall Street started letting Beal peel off individual loans. He bought a bit, then in earnest when Bear Stearns collapsed. He concentrated first on whole single family residential loans, buying $1.8 billion of those. He has hired 160 people to service residential mortgages, arranging the employees in rows of cubicles one floor below his office. His payroll has more than doubled to 450.
Lately he’s been spending on a broad range of assets. Beal just bought a $465 million loan to bankrupt chemical maker Lyondell. He’s extended tens of millions to utilities, manufacturers, convenience stores, hotels, casinos–”everything you can imagine, in every state,” he says. Many of those assets have come from 15 failed banks, including First Integrity in Minnesota, Arkansas National and First Priority in Florida. Since November he’s bought $2 billion (face value) of home loans bundled into securities, too. But he says he’s still just picking off loans with a “rifle” not a “shotgun,” buying only 3% of what lands on his desk while waiting for the financial system to further “unravel.”
To fund his purchases Beal has relied on brokered deposits, known as hot money in the banking business. A year ago Beal Bank had $49 million, but by dangling relatively generous rates on certificates of deposit (0.88% for a six-month CD) brokers have since funneled $1.2 billion into the bank. To replace the brokered funds Beal is building 28 branches from Miami to Seattle, up from 7 at the end of last year.
He’s getting scant help from the government. The Troubled Asset Relief Program does not accommodate a guy like Beal because the maximum amount available is 3% of 2008 assets. Had Beal leveraged up his capital to $25 billion and made toxic loans in the last few years, he would now qualify for $750 million. As things stand he can get only $150 million, hardly worth the trouble given the strings attached.
Beal is amply using the Federal Deposit Insurance Corp. to attract small deposits; he isn’t approved for the wholesale version of deposit insurance, which goes by the name of Temporary Liquidity Guarantee Program. Launched in October, this federal giveaway has the government backing senior unsecured bank debt. Banks that got too big, like Citigroup, have flocked to the cheap funding, issuing $200 billion. The FDIC’s stated purpose is to “encourage liquidity in the banking system,” and Beal would love the extra capital, but FDIC staffers have told him, without providing details, that the program was not designed for him. “We must be the only bank that has tripled in size in the last eight months, but we aren’t eligible for nothing,” says Beal. “The crazy thing is guys who weren’t real responsible are eligible.”
He thinks the government is going to be “disappointed” by its various programs to revive lending. He says Treasury Secretary Timothy Geithner’s new plan to guarantee loans to buyers of toxic assets won’t lead to many sales because the problem isn’t liquidity but price. They are not low enough. Half the country’s banks–4,000 in all–would be bust, he says, if they marked their loans to what the loans would fetch in an auction. He says banks are fooling themselves by refusing to mark busted assets down.
“Banks are on a prayer mission that somehow prices will come back and they won’t have to face reality,” Beal says. And that reality, according to Beal, is going to get a lot worse. “Unemployment is going over 10%, commercial real estate hasn’t even begun collapsing and corporate credit defaults are just getting started,” he says. His prediction: depression, without bread lines this time, thanks to the government safety net, but with equal cost to society.
As for the cause of this mess, Beal points a finger at the government for giving its imprimatur to just a handful of credit rating agencies, then insisting that money market and pension funds buy only paper with top grades. He also blames government for luring people into debt by backing everything from bank deposits to Fannie and Freddie to student loans.
A sign in Beal’s office reads: “Often wrong, but seldom in doubt.” His tenacity led him on a six-year seemingly quixotic quest suing his own regulator, the FDIC, over thousands of terrible subprime loans Beal bought after it seized a failed Pritzker-family-owned bank in 2001. Beal claimed the FDIC made loans to unqualified buyers that did not meet the representations the agency made to him. In December the FDIC settled by agreeing to cough up $90 million.
Now Beal is taking on the IRS. Earlier this year he concluded a trial over big loss deductions he took on nonperforming Chinese loans. He sold them for $9 million less than he paid but used a loophole later closed by Congress to shelter 90% of the $1.2 billion of income he personally earned from the bank between 2002 and 2004. The government disallowed the deductions and was not amused when Beal sued to recover them and tens of millions in penalties imposed. Beal says he was deferring taxable income that he recognized in 2007 and was merely following the tax code. “I am a good guy made to look like a bad guy for doing what every taxpayer does–appropriately use the law to minimize my taxes,” he says.
A decision is expected this summer, but don’t expect a chastened Beal if he loses. After New York state’s highest court ruled against him in a contract dispute in 2007, Beal took out a full-page ad in The Wall Street Journal asking: “When is a contract NOT enforceable according to its clear terms? When it is in the state of New York.”
Beal is putting in full days now, much of it spent reviewing loans in his office, which overlooks a construction pit for a new garage to accommodate his expanding staff. One March afternoon a credit officer walks in with a report on a possible $224 million loan at a fat 12% interest rate that an airline needs to buy eight Boeing 737s. Beal peppers him with questions: How much are other airlines ordering? How many similar planes are parked in storage? The staffer mentions that the airline was balking at paying the bank a 1% fee just to get it to formally review the loan. Beal sends the staffer away with these instructions: no fee, no loan.
Next, a guy in charge of bidding for failed bank assets pops his head in the door to update Beal on loans he’s recently bought for as low as four cents on the dollar. “[FDIC Chairman] Sheila Bair doesn’t like the prices,” says Beal, but “you need a margin of error.” Then an analyst walks in with details on a $130 million loan to a battery maker for sale in the secondary market. Beal fires off a half-dozen questions probing some vague language in the original loan contract about collateral in case of default, and his face curls in disgust. “This had to be originated in the stupid times,” he says, before ruling against making an offer. Then there’s something worth a bite. A loan to a power producer was selling at par a year ago. Today a $25 million piece of it is offered at 72 cents, and Beal is buying.
“All these guys were stumbling over each other 18 months ago to pay over par,” he says. “Now they can’t sell fast enough at a discount. Why do people not do the great deals and do all the stupid ones? It’s crazy.”