Saturday, May 9, 2009

value of a toxic asset largely hinges on the default rates of the underlying loans, a figure that can’t be precisely predicted

TO BE NOTED: From Bloomberg:

"BlackRock Is Go-To Firm to Divine Wall Street Assets (Update1)

By Kambiz Foroohar and Sree Vidya Bhaktavatsalam

May 8 (Bloomberg) -- Got assets you can’t value? Call Larry Fink.

That’s what Federal Reserve Chairman Ben S. Bernanke and Treasury Secretary Timothy Geithner have done, as have many heads of banks and insurance companies, including Robert Willumstad, former chief executive officer of American International Group Inc., and current AIG CEO Edward Liddy.

Fink, 56, is CEO of BlackRock Inc., the U.S.’s biggest publicly traded asset management firm, with $1.3 trillion under management for clients that include Ford Motor Co. and Microsoft Corp. BlackRock, like many other money managers, has taken some hits in the credit crisis. It also loaded up on Lehman Brothers Holdings Inc. stock, for example, buying shares last June at $28 only three months before Lehman declared bankruptcy. One BlackRock fund that rushed in to buy distressed debt in September 2007 saw its value plunge 25 percent during the following 12 months.

More recently, mirroring results at rival firms, BlackRock’s first quarter profits fell 65 percent to $84 million after stock and bond market declines hurt its fees.


Fink has a way of making good money in bad times. A decade ago, he created a subsidiary called BlackRock Solutions, looking to capitalize on ever-more-sophisticated risk-management analytics that the firm was running for clients, including mortgage giant Freddie Mac, that needed help in assessing stressed portfolios or in deciding whether an investment made sense.

In the unfolding credit crisis, BlackRock Solutions has become the dominant player in evaluating and pricing distressed assets such as mortgage-backed securities by winning more contracts from the government, investment banks and insurance companies than other firms.

“It’s our fastest-growing unit,” says Robert Kapito, BlackRock’s president, citing revenue that doubled to $400 million last year. In the latest quarter, the unit’s revenue more than doubled to $140 million from $60 million a year earlier.

“BlackRock has established itself as the go-to firm when you have problems,” says Terrence Keeley, a managing director at UBS AG, which sold a $22 billion portfolio of subprime mortgages to a fund managed by BlackRock.

Desperate Customers

The terms -- in which UBS offered a $7 billion discount and provided $11.25 billion in financing -- demonstrate how desperate banks are to get distressed assets off their books. “It’s hard to replicate the BlackRock approach because they built their systems, tools and analytics a long time ago,” Keeley says.

The Federal Reserve and U.S. Treasury Department have awarded contracts to BlackRock Solutions to manage $130 billion in distressed debt formerly on the books of investment bank Bear Stearns Cos. and crippled financial giant AIG. The Fed called on the company in September to analyze the assets of Fannie Mae and Freddie Mac after the government took an 80 percent stake in the two mortgage giants. BlackRock is also one of four co-managers of a $500 billion Fed program, announced in November and expanded to $1.25 trillion in March, to buy residential mortgage-backed securities.

Fink began his career as a bond trader who three decades ago helped pioneer collateralized-mortgage obligations, the forerunners of the complicated derivatives at the heart of the present crisis.

Lucrative Work

Over time, Fink and BlackRock Solutions stand to earn tens of millions or even hundreds of millions of dollars in fees, primarily from lucrative private-sector toxic-asset work, according to Fink and people familiar with the contracts.

“We’re managing hundreds of billions for governments,” Fink says. Asked for details about whom else BlackRock is working for and how it actually goes about its tasks, he demurs. “I have to be opaque,” he says. “It’s hundreds of billions and not necessarily for the U.S. government.”

The Fed and Treasury, beyond confirming Fink’s contracts, also have little to say about the exact nature of the work -- a stance that worries some. Janet Tavakoli, president of Chicago- based Tavakoli Structured Finance Inc. and the author of three books on derivatives, says the government should be more forthcoming.

Need for Transparency

“The Federal Reserve and the Treasury would do the world a favor by giving us more transparency on AIG and Bear Stearns assets,” she says. “The regulators have just given up and are just throwing the assets with BlackRock and saying ‘Manage this.’” (Bloomberg News filed a Freedom of Information Act lawsuit in November asking a federal judge to require the government to disclose data about the Bear Stearns assets.)

Not content to be a manager of toxic assets with no transparent value, Fink is also planning to buy them. He says BlackRock Inc. wants to raise $5 billion to $7 billion from investors to participate in a government plan, announced March 23 by Geithner, to finance up to $1 trillion of such purchases. BlackRock intends to apply to become one of the five managers under the plan, known as the Treasury Department’s Public- Private Investment Program. Fink says he sees no conflict of interest in being one of the Treasury’s managers and participating in the plan.

“I don’t get any inside information, and it’s a competitive auction pool,” he says.

Rescue Plans

In theory, BlackRock Solutions has competition. Goldman Sachs Group Inc., for example, has its own risk management teams. Pacific Investment Management Co., the world’s largest bond manager, has a risk management component, as does Legg Mason Inc., a Baltimore-based asset management company.

As Bear Stearns collapsed during a frantic weekend in mid- March 2008, JPMorgan Chase & Co. called on a BlackRock team of 50 analysts and number crunchers who worked around the clock to assess Bear Stearns’s most illiquid assets.

At the end of the weekend, Geithner, then chairman of the Federal Reserve Bank of New York, called Fink personally to ask him to oversee $30 billion in soured mortgage debt that had been cleaved from Bear Stearns’s books before its viable assets were sold to JPMorgan.

Likewise, the Fed considered no other company for managing an additional $100 billion in AIG assets that the government steered Fink’s way last November, according to comments from an investigator for U.S. Senator Charles Grassley.

BlackRock had also undertaken a crash mission at the behest of AIG’s Willumstad during his four-month run as CEO, in a last- ditch effort in the summer of 2008 to avoid a government takeover of the firm.

Advanced Analytics

He had them run analytics on his company’s portfolio of collateralized-debt obligations and credit-default swaps. The government intervened before Willumstad could put together a rescue plan. That drama unfolded shortly before the government began injecting huge amounts of taxpayer capital --$182.5 billion as of April of this year -- to keep AIG afloat.

“We had the expertise; we had already evaluated the assets,” Fink says. “It’s not that we’re being opportunistic. We’ve been in this advisory business since 1994.”

During hearings in Congress in January, Grassley, an Iowa Republican and ranking member of the Senate Finance Committee, questioned the no-bid government contracts awarded to BlackRock. “Why is it that BlackRock is the only firm qualified to manage the assets of special-purpose vehicles?” he asked.

Geithner supplied the answer. “They come with a world- class reputation,” he said. “We thought the interest of the American taxpayer would be best served by having them there on our side as we made those consequential judgments.”

Distressed Debt Losses

BlackRock’s asset management unit, which accounted for 87 percent of the company’s revenue last year, has stumbled by investing in assets similar to those the government is now calling on BlackRock Solutions to manage.

In April 2008, after the collapse of Bear Stearns, Fink said U.S. Treasuries had become too expensive and investors should put money into riskier debt such as MBSs. Merrill Lynch & Co.’s U.S. High Yield Master II index, which tracks corporate bonds, fell 30 percent between March 31 and year-end.

On June 13, 2008, as Lehman Brothers’ troubles began to unfold, Kapito, BlackRock’s president, said, “We have confidence in the firm, in the leadership.” On Sept. 15, Lehman filed for bankruptcy.

The $3 billion BlackRock Credit Investors LP fund, created in September 2007, sank hundreds of millions of dollars into distressed bank loans that continued to plummet as the credit crisis deepened. Investors, including pension funds, saw the value of their holdings shrink by 25 percent during the next 12 months, according to the New Jersey State Investment Council.

‘Good Money After Bad’

BlackRock remained bullish and urged investors to increase their holdings, and many did. In October 2008, the NJSIC added about $144 million to the $400 million it had originally put in. The Oregon Investment Council added $72 million to its $200 million investment in the same fund.

“We were throwing good money after bad,” says Jim Marketti, retired president of the Communications Workers of America Local 1032, who sits on the board of New Jersey’s Division of Investment. “They say these investments will perform well in the long run. Well, in the long run, we’re all dead.”

BlackRock was hardly alone in racking up losses. One fund set up by rival Pimco to buy troubled mortgages lost 38 percent last year, according to investors in the fund who declined to be named. (Pimco declined to comment.) “Even with the best and brightest, BlackRock missed what has been a glaring risk,” says Michael Herbst, an analyst at Chicago-based investment research firm Morningstar Inc.

Long-Term Optimism

Fink, while contrite, maintains his long-term optimism. “Clearly, I’ve been early in calling for clients to take more risks, as our balance sheet losses show,” Fink says. “In the long term, they’ll be good investments.”

For BlackRock’s fans, there’s no mystery as to why the government picked BlackRock Solutions to analyze -- without competitive bids -- distressed portfolios. The company’s more than a decade of experience coupled with its advanced analytics give it an edge over rivals, says Peter Federico, Freddie Mac’s treasurer.

You won’t get an argument from Morgan Stanley.

After Lehman’s bankruptcy, Morgan Stanley shares went into free fall, declining 74 percent in four weeks. The investment bank founded by Henry Morgan -- the grandson of J. Pierpont Morgan -- and Harold Stanley needed a lifeline. Mitsubishi UFJ Financial Group Inc. was chewing over a possible $9 billion investment.

‘Proctology Exam’

Lazard Ltd., Mitsubishi’s adviser, called BlackRock to analyze Morgan Stanley’s most illiquid commercial-backed securities, since Mitsubishi, Japan’s largest bank, wouldn’t act without reliable data on these assets’ values.

One Morgan Stanley executive described the experience as a “proctology exam,” yet after BlackRock delivered its results, Mitsubishi went ahead with the $9 billion investment.

Cleaning up a tainted balance sheet is complicated. Bad assets have to be identified and isolated from viable ones, removed from a financial institution’s books, somehow valued and eventually sold off into a secondary market. While that process unfolds, the assets also have to be managed. Some are securities that still throw off cash in the form of dividends. “The computations are complex and time-consuming,” Federico says. “BlackRock has the most sophisticated and widest range of expertise across all fixed income.”

Lack of Ostentation

In a photo gallery of archetypes, Laurence Douglas Fink would stand out as the middle-aged banker that he is: the tailored suits spiced up with the occasional flashy tie, the receding hairline and a demeanor rendered slightly professorial by his glasses. At a lectern, he tends to gesture a lot with his hands.

Save for the oblong A. Lange & Sohne watch he wears -- an artsy German brand whose intricate models can cost $40,000 --and a fondness for San Pietro, a pricey Manhattan power eatery, Fink shuns most of the trappings of Wall Street.

It’s not like he can’t afford them. He earned $21 million in 2008, down 26 percent from $26.4 million in 2007, according to company filings.

There have been no John Thain-style million-dollar office renovations for Fink. He holds forth in a modest, light-filled, fifth-floor office sporting a couch, a heavy rosewood-colored desk and a mundane view of 52nd Street in midtown Manhattan. A green china vase filled with striking purple orchids graces a filing cabinet.

Shoe-Store Experience

His prized adornment is a framed platinum CD by Maroon 5, a Grammy-winning Los Angeles band signed to the record company that Fink helped to fund. It leans against a wall. Acquaintances trace Fink’s lack of ostentation to his roots in Van Nuys, a working-class town in California’s San Fernando Valley, where he grew up counting laces and stacking polish in his father’s shoe store.

His brother Steven B. Fink, now a Los Angeles venture capitalist, helped out in the store, too. He recalls Larry as a trenchant observer of customers and what they wanted. “That’s a skill that Larry learned: being cognizant of other people’s needs and desires,” he says.

After attending public school in Van Nuys, Fink majored in political science at the University of California, Los Angeles. He stayed on at UCLA to earn a Master of Business Administration in 1976 from what’s now known as the Anderson School of Management.

‘Brilliant Mind’

Fred Weston, a professor who taught Fink at the management school, was so impressed with him that he put a note in his file predicting future business triumphs. “He had an unusually brilliant mind,” Weston says. “I predicted that he’d be a great success.”

After getting his MBA, Fink took a job selling bonds at New York-based investment bank First Boston Corp. (now a part of Zurich-based Credit Suisse Group AG), rising to managing director by the age of 28. Bond trading, say colleagues who knew him then, made Fink rich but didn’t affect his West Coast affability.

Fink’s diplomatic skills were on display in 2003, when as a director at the New York Stock Exchange, he worked out a deal to persuade then Chairman Richard Grasso to step down during a controversy over Grasso’s $140 million pay package.

“He’s very sensitive to the fairness of what he does,” says Kenneth Langone, a founder of Home Depot Inc. who served with Fink on the NYSE board and was a vocal supporter of Grasso. “Fink is a voice for reason.”

Scolding Congress

That doesn’t mean he can’t get riled up. On Sept. 29, 2008, as the Dow Jones Industrial Average was falling more than 700 points, Fink lashed out at the rhetoric coming out of Congress as it debated the need for the government to rescue the banks.

“It’s abhorrent that Congress is trying to say that this is a bailout of Wall Street,” Fink said during an interview on CNBC. “This package is a bailout of Main Street, and if we don’t solve this, Main Street is going to feel some very ill effects.” He went on to suggest that the Congressional naysayers -- almost all of them at that point Republicans -- ought to be fired in the next elections.

Fink has remained married for 34 years to his high-school sweetheart, Lori Weider. They have three grown children, including one who runs a hedge fund. Fink lives in a co-op on Manhattan’s Upper East Side in the same neighborhood as other Wall Street leaders such as private equity tycoon Henry Kravis.

Maroon 5 Gold

And while hedge fund managers and stock traders who play in garage bands are a dime a dozen, Fink in 2000 took his baby boomer affection for rock-and-roll and along with eight colleagues provided $5 million in startup capital for an independent record label called Octone Records. The company, now known as A&M/Octone, scored big when it signed a pop band known as Maroon 5.

The group has recorded four CDs and sold 15 million albums worldwide. Maroon 5 played at BlackRock’s 2006 holiday party for 4,000 people at the Jacob K. Javits Convention Center in Manhattan.

Fink’s rocketlike rise at First Boston was largely a result of his creative work with MBSs: the then novel idea of slicing and pooling mortgages and selling them as bonds. Fink took his concept to Freddie Mac, where he sold the mortgage company’s board on a $1 billion package of what became known as collateralized-mortgage obligations, or CMOs. The $1 billion was three times what he was expecting to sell, he says. “What Fink did was a tremendous success and created a huge market,” says Richard Roll, a professor of finance at the Anderson School.

Swings in Fortune

By 1986, a decade into his First Boston stint, Fink was among the firm’s rainmakers, along with mergers and acquisitions specialists Bruce Wasserstein and Joseph Perella. In the first quarter alone, Fink’s team made $130 million by amassing a huge position in securities known as Z-tranche CMOs: zero-coupon bonds whose value is driven down if interest rates fall and prepayments on the bonds climb.

Fink’s hero status was short-lived. The next quarter, interest rates fell, and he was hammered. His group posted a loss of $100 million.

“Fink vowed never to be in that situation again,” says Gregory Fleming, a former president of Merrill Lynch who first met Fink in the mid-1990s and who helped BlackRock go public in 1999. “Larry has an appropriate sense of paranoia. He thinks bad things can happen and often do.”

A Form of ‘Communism’

In 1988, Fink joined forces with Ralph Schlosstein, a friend and managing director at Lehman Brothers, to start the firm that would become BlackRock. It began life as Financial Management Group within private equity firm Blackstone Group LP. Blackstone provided an office, a telephone line and a $5 million line of credit in return for a 40 percent stake in the company. In its early days, the firm was an egalitarian place. For the first two years, the six original partners drew the same salary.

“We could focus on building the company without worrying about individual incentives,” says Susan Wagner, one of those partners and now BlackRock’s chief operating officer. “Larry and Ralph thought it was communism but agreed.”

In 1994, BlackRock parted company with Blackstone. Fink and Blackstone co-founder Stephen Schwarzman had a falling-out over how much equity should be awarded to new BlackRock hires. (Schwarzman didn’t return calls seeking comment.) PNC Bank Corp. of Pittsburgh bought Fink’s group for $240 million.

Turning Point

A turning point in BlackRock’s fortunes came the next year, when it helped General Electric Co. dispose of $10 billion in distressed MBSs left over after the Fairfield, Connecticut, company’s sale of its Kidder, Peabody & Co. brokerage unit to PaineWebber Group Inc. GE’s financial unit, GE Capital, had tried to sell the assets, only to get low-ball bids from investment banks.

BlackRock was convinced that it could run its sophisticated computer models to more accurately assess the value of GE’s distressed assets.

“We said, ‘We’ll analyze the risks and auction the assets,’” Fink recalls. “‘That way, you are not dependent on one price.’”

It was BlackRock’s analytics that allowed the company to accomplish this, says Charles Morris, a New York banker, lawyer and financial writer who wrote a book on the global credit crisis called The Trillion-Dollar Meltdown (Public Affairs, 2008). “They had every security on a real-time system so they could see what each portfolio was doing every minute,” Morris says.

Biggest Payday

Within six months, BlackRock had disposed of the portfolio for far more than GE expected -- saving GE $1 billion. Fink, says Dennis Dammerman, who was then CEO of GE Capital, had no idea how to price the service he had just rendered. “If you think we did a good job, pay us what you think,” Dammerman remembers Fink saying.

The result was a $7 million payday -- the biggest fee BlackRock had ever received, Fink recalls.

By 1998, as the use of derivatives and other arcane instruments spread throughout finance, Fink saw an opportunity to turn BlackRock’s risk management services into a separate business.

Today, BlackRock Solutions occupies three floors of its own Manhattan high-rise, directly across the street from the asset managers. There, amid arrays of open offices and banks of computers, Charles Hallac, head of BlackRock Solutions’ day-to- day operations, oversees an army of 950 analysts, programmers, economists and other number crunchers.

Parsing Complexity

The group includes 18 Ph.D.’s in such areas as mathematics, nuclear physics and aerospace and electrical engineering. BlackRock Solutions’ client list includes companies and pension funds, such as the California State Teachers’ Retirement System, that collectively control about $7 trillion of assets. The Solutions team is in the business of parsing complexity.

In 1983, when Fink sold the first CMO to Freddie Mac, it had only three tranches, or portions, that paid a different interest payment. It took a First Boston mainframe a whole weekend to model the payment scenario.

By the 1990s, some of the CMOs contained 125 tranches that were almost impossible to understand, Morris says. Those instruments seem simple compared with the collateralized debt obligations, or CDOs, that are at the heart of the global meltdown. CDOs are pools that bundle high-yield subprime mortgages with high-yield loans. The hitch: higher-than- -anticipated default rates among the subprime mortgages in the CDOs prompted rating firms to downgrade CDOs to sub-investment- grade debt, causing their values to plunge.

Daunting Task

Analyzing pools of CDOs to determine which are toxic and which aren’t is a daunting task requiring computing power that simply wasn’t available 10 years ago. Each CDO may consist of 1,000 loans. BlackRock technicians say they have to run 500,000 computer models, in many cases tracing a mortgage or a loan back to the homeowner or to the property’s zip code.

“We can model every single item on a balance sheet and project cash flows,” says Mark Wiedman, managing director of BlackRock Solutions’ advisory group. After running the numbers, BlackRock assigns a “fair value” to each CDO, a value that’s supposed to represent the up-to-date value of the loans.

That doesn’t mean people will be willing to buy the assets at that price. “There is a big difference between the fair value of toxic assets and their market value,” says Gregg Berman, co-head of New York-based RiskMetrics Group Inc.’s Risk Management unit.

Hard to Value

To determine a fair-value price, analysts look at the underlying collateral and the various tranches and their interest rates. They prepare mathematical models to determine default rates, percentages of prepayments and interest-rate changes. Different models produce different valuations, Berman says.

The value of a toxic asset largely hinges on the default rates of the underlying loans, a figure that can’t be precisely predicted, even with the most sophisticated of models, he says.

“It’s almost impossible to figure out the prices of these things,” says Marshall Blume, a professor of finance at the University of Pennsylvania’s Wharton School.

Investors who bought into Fink’s vision for BlackRock early have been rewarded. Fink took the firm public on Oct. 1, 1999, at $14 a share. BlackRock’s shares climbed an average of 38 percent a year to a high of $230.75 on Aug. 11, 2008, before tumbling to $90.57 on March 3, hit by the drubbing financial stocks have received in the credit crisis. The stock has since staged a rally of 60 percent, closing at $144.48 on May 7.

Fink now finds himself with a new major shareholder: Bank of America Corp. It wasn’t an alliance he’d planned.

Looking to Expand

Fink, seeking to expand his firm, began hunting for a partner in 2005. In January 2006, after weeks of merger talks with Morgan Stanley deadlocked when the two firms couldn’t come to terms, Stanley O’Neal, then Merrill Lynch’s CEO, came calling on Fink to talk about a deal.

By February, Fink had snapped up Merrill Lynch Investment Managers, Merrill’s asset management business, for $9.5 billion -- the largest asset management deal ever. In return, Merrill ended up with 49.8 percent of BlackRock. (PNC reduced its stake to 34 percent.) The deal doubled BlackRock’s assets under management to $1 trillion, Fink says.

In October 2007, Merrill’s mounting subprime troubles forced it to take an unprecedented $8 billion write-off and prompted the board to push out O’Neal.

Merrill Contender

Fink emerged as one of a handful of front-runners for the job. Fink wanted a look at Merrill’s books before deciding but never got a chance; the board appointed John Thain. In September 2008, having reported a $19.2 billion loss, Merrill was sold for about $50 billion in stock to Bank of America. Thain, O’Neal’s replacement, would himself soon be fired by Bank of America CEO Kenneth Lewis. That leaves Bank of America holding Merrill’s 47 percent stake in BlackRock, a position the company says it plans to keep. BlackRock on May 6 emerged as one of the bidders to make a preliminary offer to buy Bank of America’s mutual-fund unit, according to people familiar with the situation.

Fink hasn’t been bashful about using his BlackRock platform to offer advice on fixing the financial crisis. Toward the end of U.S. President George W. Bush’s administration, Fink counseled then Treasury Secretary Henry Paulson on the original rollout of the $700 billion Troubled Asset Relief Program, suggesting Paulson use TARP funds to buy banks’ toxic assets, Fink says.

Paulson opted instead to acquire equity stakes in banks, and Fink, on Dec. 11, publicly called the decision a “mistake,” a position he says is unchanged.

‘Major Mistake’

“The major mistake was not putting money in assets,” Fink says. “You can not stabilize equity until you stabilize balance sheets.”

Fink has since made the same appeal to the administration of Barack Obama, talking up the purchase option to both Geithner and Bernanke before Geithner made his March announcement. Fink says he’s known both men for several years, though only through the professional circles they all travel in. Politically, Fink is a registered Democrat and says he voted for Obama and raised $30,800 at a fundraiser for the Democratic Party.

BlackRock Solutions looks like a terrific investment for Fink. Besides its government contracts, the company says that in the last four months of 2008 it ran analytics on $1.5 trillion of new assets for its private clients. “The phone was kinda ringing off the hook,” Wiedman says. “Great for business. Not so good for weekends.”

Published in the June issue of Bloomberg Markets Magazine.

To contact the reporters on this story: Kambiz Foroohar in New York at; Sree Vidya Bhaktavatsalam in Boston at

Last Updated: May 8, 2009 13:14 EDT "

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