“This is similar to what IndyMac and I were dealing with in 2007 and 2008 and these guys, one of the largest and most respected money managers in the U.S., had Fannie/Freddie collateral, which was made 100% whole later in 2008, when Fannie/Freddie were placed in conservatorship and bailed out by the U.S. government for something like $180 billion…
…In other words, they failed because they were highly levered with uncommitted financing from Wall Street, that could be marked-to-market at very discretionary levels and/or terminated abruptly…..so when Wall Street and the repo market panicked, these guys were out of business much faster than IndyMac, despite having “pristine” collateral and IndyMac having mostly Alt-A and other non-prime collateral and being heavily reliant on the private MBS market. Why did we survive longer than almost everyone? Because I had prudently converted IndyMac from a mortgage REIT to a thrift after the 1998 global liquidity crisis and so we were able to easily pay off all of our repo and commercial paper (and build up billions in cash reserves), because we had insured deposits and more stable and secure, committed lines of credit with the FHLB and Federal Reserve. That’s why we survived way beyond firms like this….much larger firms like Bear Stearns….up until United States Senator Schumer caused a run on the bank in June/July 2008, with his inappropriate public comments about us (why, I guess we will never know?)…..We survived until July 11, 2008. P.S. I agree with Carlyle’s statements in the article below. They did nothing wrong and their investors understood their business model and its risks, clearly. As they say in the article below, “it was just way beyond the worst case anyone could ever imagine.””, Mike Perry, former Chairman and CEO, IndyMac Bank
July 18, 2016, Margot Patrick, The Wall Street Journal
Carlyle Goes on Trial for a Financial-Crisis Meltdown
A $1 billion civil lawsuit over a failed mortgage-bond fund shows how the troubled days of 2007 and 2008 continue to reverberate
Carlyle Group co-founder Bill Conway, shown in 2014, has been testifying this month on the island of Guernsey, where he is a defendant in a civil case over the failure of Carlyle Capital Corp. in 2008. PHOTO: PETER FOLEY/BLOOMBERG NEWS
By Margot Patrick
ST PETER PORT, GUERNSEY— Carlyle Group co-founder Bill Conway was in court on this small island last week recounting one of the most bruising episodes in his private-equity firm’s history: the 2008 collapse of mortgage-bond fund Carlyle Capital Corp.
Carlyle Capital Corp., or CCC, borrowed vast sums from banks to buy $23 billion in bonds. When a deteriorating U.S. housing market spooked CCC’s lenders, investors in the fund lost their entire $945 million in capital.
Mr. Conway was summoned to Guernsey, where the fund was registered a decade ago, to testify in a $1 billion civil lawsuit by CCC’s liquidators. They allege that Mr. Conway and six other Carlyle and CCC officials acted recklessly and should have started selling the fund’s assets months before it failed. The defendants deny those allegations.
The trial, which hasn’t previously been reported on, demonstrates how fallout from the 2008 financial crisis continues to reverberate eight years on.
“We all lived through something that was worse than the worst-case scenario,” Mr. Conway said in court earlier this month. “Until March 2008, I was always convinced that CCC was going to make it.”
The 66-year-old is one of the highest-profile figures to appear at a civil trial tied to the financial crisis. Washington D.C.-based Carlyle Group manages $178 billion in private-equity and other funds.
“Carlyle always met its fiduciary obligations to CCC investors,” a Carlyle spokesman said. “We had more money at risk than anyone, having loaned $130 million in an effort to save the fund and with Carlyle individuals losing $85 million of their own money. Unfortunately, a 100-year storm overwhelmed our efforts, but we stayed focused on serving our investors.”
For six days this month, Mr. Conway answered questions from a lawyer of the liquidators about the fund’s business model, governance and funding problems. Among the specific allegations against him: that he refused to have CCC sell assets or restructure as loans dried up in the summer of 2007 because he didn’t want bad publicity from CCC to jeopardize an investment by an Abu Dhabi government fund in Carlyle Group. Mr. Conway denies that.
“I would say I always tried to do what was in CCC’s best interest,” Mr. Conway said in court.
Mr. Conway’s path to this courthouse on Guernsey, a bump of land in the waters between the U.K. and France, started when CCC was registered at a law firm’s office here in 2006. At that time, private-equity firms and hedge funds were boosting their assets by floating publicly traded investment funds. Carlyle Group came up with CCC to cash in on the trend and branch out from its business of buying and selling stakes in companies.
‘Pulling the deal will be a public black eye. On the other hand I’m at a loss to say how the whole market can be wrong about the product at this time and we are right.’
—Carlyle’s David Rubenstein wrote in a June 2007 email, according to court filings
CCC aimed to make around 12% a year buying assets including Fannie Mae and Freddie Mac bonds with a type of short-term loan called repurchase agreements. Investors were told in fund documents that the bonds didn’t have any credit risk because the two government-chartered companies, which buy mortgages from lenders, had an implicit guarantee from the U.S. government. But they were also informed that CCC was subject to risks involving its leverage, or amount of borrowed money, and funding.
From the start, Carlyle anticipated that its connections with Wall Street banks—which were making around $500 million a year in fees from the firm’s buyouts and other business—would help CCC secure favorable funding terms, according to documents in court and Mr. Conway’s testimony.
It hired John Stomber, a former Merrill Lynch treasurer, as CCC’s chief executive. David Rubenstein, one of Carlyle Group’s three co-founders, legendary for his fundraising ability, started talking CCC up to clients across the globe, according to court filings. Mr. Stomber, who is a defendant in the lawsuit, started testifying Wednesday. Mr. Rubenstein isn’t a defendant and isn’t testifying.
Mr. Stomber didn’t respond to a request for comment through a representative. He denied the liquidators’ allegations against him in a court filing. Mr. Rubenstein declined to comment through a Carlyle spokesman.
In testimony that provided flashes of Carlyle Group’s rarefied perch in the investment world, Mr. Conway said the Angolan government, CCC’s biggest investor, considered putting $500 million in the fund. The West African country ended up taking a $150 million stake.
Several CCC investors, including former Republican U.S. congressman Michael Huffington and Kuwait’s National Industries Group, later brought lawsuits against Carlyle Group, but only the liquidators’ case made it to trial. The other suits were all thrown out or dropped and are no longer active.
The liquidators were appointed by the Guernsey court in 2008 as part of the island’s insolvency procedures.
After raising $600 million privately in late 2006 and early 2007, CCC prepared to offer shares on Euronext Amsterdam in the summer of 2007. But alarm bells began to sound on U.S. subprime mortgages, and other mortgage-related assets were hit. It was touch and go whether CCC’s initial public offering would go ahead, according to emails shown in court.
CCC’s Fannie Mae and Freddie Mac bonds had fallen in value, and banks wanted more cash and collateral to keep providing loans. CCC borrowed around 30 times its equity to increase returns and had little wiggle room.
“Pulling the deal will be a public black eye,” Mr. Rubenstein wrote in an email to Mr. Conway at the end of June 2007, according to court filings. “On the other hand I’m at a loss to say how the whole market can be wrong about the product at this time and we are right,” he wrote.
The shares were listed on July 4, 2007, at $19 apiece. By the time CCC threw in the towel 252 days later, on March 12, 2008, they traded for pennies.
A retired U.K. judge now living in Guernsey will decide the case, which centers around whether the defendants broke their duties to shareholders by not selling CCC’s assets and reducing its reliance on borrowed money.
After the IPO, it became even harder for CCC to get cheap, regular loans, the court heard. Markets melted down in August 2007 as fears grew over the U.S. housing market and banks’ exposure.
“I am afraid,” Mr. Conway wrote to Mr. Stomber and CCC Chairman James Hance on Aug. 10, 2007, according to an email shown in court. By the end of August, Carlyle Group lent CCC $100 million to cover margin calls, and Mr. Conway and Mr. Stomber called on Wall Street executives to try to lock in affordable funding for CCC, according to Mr. Conway’s testimony and documents shown in court.
Mr. Conway testified that he “was in shock” when Steve Black, then co-head of J.P. Morgan Chase & Co.’s investment bank, advised immediately selling a big chunk of CCC’s assets.
Selling around $4 billion in bonds was explored, but it would have meant swallowing big losses and CCC’s board and management decided not to proceed, according to a filing by the defendants.
Instead, CCC limped on for a few more months before defaulting on its loans. Banks liquidated its assets in March 2008.
July 18, 2016, Margot Patrick, The Wall Street Journal
Markets Emails and Testimony Go Inside Carlyle Group During the Financial Crisis
Evidence in civil trial over failed mortgage-bond fund shows how pressure mounted on firm in 2007
By Margot Patrick
From June 2007 to March 2008, Carlyle Capital Corp., or CCC, went from a company planning an IPO to one that had run out of options. The fund, which had borrowed 30 times or more its capital to buy mortgage-backed securities, couldn’t keep functioning when its borrowing rates suddenly rose.
Carlyle Group co-founder Bill Conway in an August 2007 email as its mortgage-bond fund struggled to get financing: ‘Maybe panic is appropriate’ PHOTO: SIMON DAWSON/BLOOMBERG NEWS
Excerpts from emails shown this month in a Guernsey court recount exchanges between executives of Carlyle Group and CCC as conditions worsened in the lead up to the July 2007 IPO and through August 2007. Carlyle Group in late August provided emergency funding to CCC, but ultimately it wasn’t enough.
“Carlyle always met its fiduciary obligations to CCC investors,” a Carlyle spokesman said. “Unfortunately, a 100-year storm overwhelmed our efforts, but we stayed focused on serving our investors.”
Excerpts from Emails
June 13, 2007 email from CCC Chief Executive John Stomber to Carlyle Group co-founder Bill Conway and other Carlyle and CCC executives:
“Last night we made the decision to postpone the IPO of CCC as a result of volatile market conditions. We are having a major liquidity event so I invoked emergency powers on the balance sheet.”
June 14 email from Mr. Stomber to investment banks working on the IPO:
“Tomorrow is a new day—assuming all goes well—we plan to file on Monday with the [market regulator] and proceed with the IPO.”
June 23 email from Mr. Stomber to Mr. Conway and other executives:
“My bottom line is we should press forward and get this IPO done at a discounted price to reflect the (mark to market) depreciation/discount … to protect existing investors.”
June 25 email from Carlyle Group co-founder David Rubenstein to Mr. Conway:
“Pulling the deal will be a public black eye, particularly juxtaposed with the successful Blackstone IPO. On the other hand, I’m at a loss to say how the whole market can be wrong about the product at this time and we are right.”
Aug. 9 email from Mr. Stomber to Mr. Conway and CCC Chairman James Hance:
“We are now fully in uncharted territory. I suspect more funds to fall in the next 10 days….ECB actions today are unprecedented. The Fed is playing a dangerous game. We will watch our repo lines closely….This is making ’98 look like a walk in the forest, not the Amazon jungle.”
Aug. 10 email from Mr. Stomber to Mr. Conway:
“Biggest worry—availability of repo lines as banks allocate balance sheet—banks pulling or increasing haircuts on our repo lines.”
Aug. 14 email from Mr. Stomber to Mr. Conway and other executives:
“All we want to do is survive the market. 1. No new purchases. 2 … negotiate repo lines 3. Push TCG relationship as well as CC’s relationship to the point of being a total pain in the “a—.” 4. Never show weakness (these guys are still greedy and can be bluffed) or a lack of confidence and respect. Remember, repo dealers are full of sh—. I once had repo reporting to me at Deutsche Bank. They will lie any time for any reason. We will smartly fight every mark.”
Aug. 14 email from Mr. Stomber to Mr. Conway and other executives:
“Yes things got worse. UBS—silly prices and $7M margin call. Bear called about 8/25 roll, talked haircuts. Contagion is not about to happen. It has happened. It has happened for anything with risk. … Worst I’ve seen since the 70s An extra % is $230M of funds.”
Aug. 14 response from Mr. Conway to Mr. Stomber’s email: “Maybe panic is appropriate.”
Aug. 15 email from Mr. Stomber to Mr. Conway and other executives:
“Between today and August 25 will make us or break us depending on dealers. I hate to say it but we should start thinking about whether a back-up rescue package can be put together to cover our worse case.”
Aug. 2007 email from Mr. Stomber to Mr. Conway, Carlyle Group co-founder Daniel D’Aniello, Mr. Rubenstein and Mr. Hance:
“Thanks for your support and $100M injection….Yes, CCC will do things different on funding RMBS in coming years. A subject for a board meeting. We made mistakes assuming the repo market would work as it did in ‘98—but that was a Greenspan Fed.”
Aug. 17 email from Mr. Stomber to Mr. Conway and other executives:
“Bill has asked if I can still digest solid food? Wish that was my problem. I will likely have to listen to my taped speeches of Churchill during WWII for inspiration….Bill C. and I are meeting with the six investment banks Monday to present our proposal….We were margin-called last night to the point where we have about $5M in cash left.”
Excerpts from Testimony
Mr. Conway, a Carlyle Group co-founder, testified for six days between July 4 and July 12 before the Guernsey court hearing the civil case involving the failed mortgage-bond fund. Here are some of his answers to the liquidators’ lawyers about decisions made by Carlyle and CCC.
On the repurchase agreements with Wall Street banks and brokers that CCC relied on: “Most repos are overnight, they’re not even 30 days. In the scheme of things, this was 30 times longer than what was typical. On the other hand it was pretty short.”
On CCC’s use of 30 times or more borrowed money: “It was highly leveraged but I didn’t think the risks were going to happen, the risks that led to the downfall of CCC, the systemic market collapse.”
On 2007’s credit crunch: “I certainly did not think it was something that was going to lead to the end of Lehman Brothers, the end of Bear Stearns, the end of Wachovia, the end of Merrill Lynch as companies.”
On the allegation CCC should have sold bonds in August 2007: “What could we do, default? Dump repos in the market? Ask investors for more money? We had just gone public a month before that. In the heat of the battle who was going to put more money in?”
On his clout with Wall Street banks: “I don’t want to act like I’m some big hitter. I started Carlyle and we paid them a lot of fees. I wouldn’t say I have extensive contacts on Wall Street. I mean the people that work for me have pretty good contacts with the people on Wall Street. I wish I had all the power that people think I have, actually.”