TRADING - Trading on the Edge

Flamboyant trader John Devaney beat long odds to build a one-man brokerage into a miniempire. Now he wants to be taken seriously.

Bond trader John Devaney has built an estimated $250 million fortune by taking risks that Wall Street firms avoided -- betting big on chancy structured bonds amid a wave of post-Enron defaults and snapping up airline debt following the 9/11 attacks. Lately, he has been buying pools of subprime mortgages in the midst of a housing market implosion.

“Bond trading is my bread and butter, and I’m very good at it,” he says.

Devaney is no less abashed when it comes to the ambitions of his tiny brokerage firm, United Capital Markets. In the eight years since he started Key Biscayne, Floridabased UCM, Devaney, 36, has made himself known to prospective clients and trading partners by throwing lavish parties at industry conferences featuring big-name entertainers like rock band Counting Crows and Tonight Show host Jay Leno. He clearly craves the spotlight. At a 1970s-themed benefit he sponsored in November for the local Boys & Girls Club of Broward County, Devaney and his wife, Selene, made their entrance in a golf cart decked out as a giant roller skate; she sported a disco diva getup, while he cavorted as the rhinestone-studded later version of Elvis.

“I’ve always been a good promoter,” says Devaney, who nonetheless remains all-but-unknown outside of the clubby asset-backed-securities market.

Devaney, who specializes in the trading of esoteric, highly risky bonds and structured-debt vehicles, has come a long way. He floundered through high school and was arrested for loitering and petty theft, then worked his way through third-tier colleges and marginal jobs with no-name brokerage houses before starting UCM from his Key Biscayne home with a kitty of $250,000. Today, UCM is a 75-employee operation boasting a collection of exWall Street star traders and a newly renovated headquarters building whose walls are festooned with French impressionist art. Devaney’s holding company, United Capital Holdings, comprises several hedge funds and a portfolio of mansions, jets and luxury yachts that Devaney uses himself and UCH leases for profit and tax benefits.

An outsider and an underdog, he wants recognition and acceptance by Wall Street, and influence that transcends the financial world, pouring money into philanthropy and politics. Since 2004 he has given more than $100,000 to Republican Party candidates and helped out in other ways, such as lending a UCM jet to Charlie Crist in October during Crist’s successful campaign for the Florida governorship. His activities are bringing him to the attention of a wider circle.

“He did a great job,” says H. Wayne Huizenga, the billionaire co-founder of Waste Management and Blockbuster Entertainment, a guest at Devaney’s Boys & Girls Club fundraiser. “He raised a lot of money that night, and people certainly noticed him.”

Devaney’s main focus these days, though, is growing UCH’s two-year-old asset management arm from its current $670 million in assets to his goal of $2 billion, in a bid for steadier revenues that will enable him to take the company public and get into other businesses, such as underwriting securities and clearing trades for other brokers.

“My big vision is to build an investment banking powerhouse,” Devaney declares.

But Devaney’s fast-forward approach to business also means he’s never too far from a potential blowup. He has suffered several big losses -- in 2003 he took a bath on the bankruptcy of insurer Conseco -- yet continues to plunge into highly risky situations. Earlier this year he weathered a close call after shares of subprime lender CompuCredit Corp. took a nosedive, but sold his position, a rare equity investment, for a slight gain. Most recently, he has loaded up on subprime mortgage debt, betting that he can identify troubled loans that won’t default, and he is one of several investors in, and the principal financier of, a $5 billion project to buy up suburban Florida mobile homes, raze them and build luxury condominiums despite a deep housing market contraction.

His focus on asset management and real estate, combined with an unwillingness to delegate, has prompted some defections: In March one of Devaney’s senior traders left for a hedge fund and last month a four-person mortgage-trading team moved to fixed-income trading boutique Guggenheim Capital Markets. Says one Wall Street rival, “You have to ask two things about John’s success: whether it’s too good to be true and whether it’s sustainable.”

DEVANEY CAME TO HIS SUCCESS the hard way. Born into a comfortable, upper-middle-class family in Key Biscayne, John admired his father, Neil, a Williams College swimming star and Georgetown Law School graduate who rose to partner with law firm Welbaum, Zook, Jones & Williams in nearby Coral Gables. But his world fell apart when his father and mother, a schoolteacher named Dorothy, divorced. Neil Devaney quit work, drank and struggled with depression. Young John began to skip classes and was kicked out of a succession of public and private high schools; his older brother, Neil Jr., dropped out of school altogether. In 1988 the Dade County police charged Devaney with loitering and petty theft, according to his NASD BrokerCheck report. The charges were dismissed, but the young man clearly was not headed in the right direction.

“I was depressed,” recalls Devaney. “My dad, who was the leader of the whole family, quit. We had no money. My mom was struggling to take care of us, and my brother was doing drugs and alcohol.”

After barely graduating from Coral Gables High School, Devaney finally decided to stop waiting for his father to put the family back together and took responsibility for his life. Ashamed that his 1.8 grade point average kept him out of the prestigious universities his friends were going to, he sheepishly enrolled at Tallahassee Community College.

“I was so embarrassed,” he says. “My mom was a teacher.”

Devaney buckled down and after a year transferred to Colorado State University. Getting by on student loans and financial aid, Devaney became obsessed with making money -- fast. He printed his own business cards and devoured get-rich-quick books. He bought a home near campus with no money down, lived in one of the five bedrooms and rented out the others to students. He also had a side job selling his classmates vacation packages to spring break destinations like Cancún, Mexico.

“He was a cut above the average student, both in terms of personality and intellectual ability,” recalls John Olienyk, a finance professor at Colorado State’s College of Business.

Devaney fell in love with trading. In a finance class he learned about options, and he turned $3,000 from his student loan account into $12,000 with a wager on Motorola. By the time he graduated, Devaney says, he had doubled down on that bet several times, predicting that the handset maker would beat quarterly earnings expectations as the cell phone market took off. He claims to have amassed $200,000 -- using the gains to purchase expensive toys like motorcycles, a boat for waterskiing and a hot tub for his house.

When Devaney graduated in 1994, he knew he wanted to work in finance, but not having a degree from a top school hurt him. He took a job with Miami-based Capital International Securities Group, a small brokerage house that soon had him pitching stocks to retail clients. Devaney struggled in the job and with his own trading, losing $125,000 on another Motorola options transaction.

By June 1995 he had moved to a better-paying gig with Suncoast Capital Group, a Fort Lauderdale, Floridabased bond broker that specialized in more-complex financial instruments, such as collateralized mortgage obligations and mortgage-backed securities. He learned quickly and moved from a research job into trading and institutional sales, says Todd Cohen, a co-founder of the firm who is now president of Community Capital Management, a Fort Lauderdale money manager with $850 million in assets. Devaney also loved being the center of attention. One day during happy hour at a nearby watering hole, he let colleagues shave his head for $1,000.

“He was a very funny, entertaining guy,” says Cohen.

But personal troubles followed him. In 1996 his brother died of a drug overdose at 27. The next year his father, who never went back to work, also passed away, at 57.

Devaney became more serious about his career. He began researching high-yield asset-backed securities and, Cohen says, pushed to establish a desk to trade them. When Cohen declined, Devaney went back to Capital International, where he started an ABS desk with his own money. Lacking an established client base, he relied on mass e-mails offering to buy virtually any structured debt product. Within a year he expanded the desk to six traders. Then came a break: In 1998 and 1999 banks forced many of their investor clients to reduce leverage after the collapse of hedge fund Long-Term Capital Management. This caused many funds to dump securities, including asset-backed bonds, often at discounted prices. Devaney jumped in, betting that he would be able to sell the bonds for big profits when the markets recovered. There was one problem, though: Capital International was in deep financial trouble owing to a series of failed investment banking transactions. Devaney left to start his own firm in February 1999; Capital International shut down by year’s end.

DEVANEY HAD PICKED A GOOD TIME to strike out on his own. During the next several years, an array of structured debt -- bonds backed by everything from mortgages to credit card receivables and aircraft leases -- cratered in value. The Wall Street firms that had underwritten most of the debt were in turmoil, laying off thousands amid tough economic times and selling off their positions. UCM became a buyer of last resort for mutual funds, insurance companies and other investors that needed to unload these structured bonds. Devaney could all but name his price, then wait for the market to turn around and reap huge profits.

“John was an unbelievable provider of liquidity,” says Olivier Cojot-Goldberg, vice chairman of Ellington Management Group, the Old Greenwich, Connecticut, hedge fund firm that specializes in mortgage-backed securities.

The first sector to hit the wall, in 1999, was high-loan-to-value mortgages, so called because the amount of the loans typically was higher than that of the collateral backing them. But by the end of the decade, Wall Street underwriters, who packaged the loans for sale to institutions, warned about borrowers’ ability to repay; they stopped buying the loans from originators, several of which declared bankruptcy. The value of outstanding high-LTV bonds plummeted. Devaney looked past the problems with the lenders and concluded that the borrowers mostly had high credit scores and would repay the loans. He bought as much as he could afford with his relatively low capital base, often at prices as low as 45 cents on the dollar, then persuaded other investors -- mostly hedge funds and wealthy individuals -- to buy the securities at substantially higher prices, often close to par.

Devaney says he earned $5 million his first year in business, almost solely from these high-LTV trades; he immediately began diversifying, setting up United Real Estate Ventures. Today the unit’s holdings include houses in the Bahamas and Key Biscayne; among them is the art deco manse used in the filming of the 1983 remake of gangster film Scarface. The Devaneys plan to move into it once it’s renovated.

Looking for bigger paydays, Devaney switched his clearing in 2001 to Dutch bank ABN Amro to obtain greater leverage, borrowing up to five times the amount of his trading positions to amplify profits. That year he bought a 100-foot motor yacht and named it Positive Carry, a term used to describe the easy money earned by borrowing at low interest rates at the short end of the yield curve and investing it at higher rates at the long end.

Also in 2001, Devaney made what he regards as a critical nonbusiness decision -- giving up alcohol when his wife became pregnant with the first of the couple’s three children.

Devaney pounced on another wave of bankruptcies in 2002, when manufactured-housing lenders were going bust, triggering panic selling of the asset-backed securities they had issued during the previous several years. Devaney researched the securities, bought them at deep discounts and persuaded other investors to take advantage of a buying opportunity, while also holding some of the bonds for himself.

By 2003, UCM’s capital base had grown to more than $100 million, and Wall Street started to notice the firm, whose traders had moved from picnic tables in Devaney’s home to a tiny nearby office suite but still wore shorts and T-shirts to work. Devaney took risks: He routinely went to sleep at night carrying an inventory of $500 million in distressed bonds on his books. Aghast, skeptical traders at mainstream firms sniped that it was only a matter of time before he fell.

“Every year people thought he was going to blow up,” says the head of distressed asset-backed trading at a major investment bank.

Devaney did court disaster. “We were always owning the riskiest and most esoteric assets,” he recalls. “It could have put me out of business.”

In 2003 it nearly did. Devaney had spent much of the previous year building a $100 millionplus position in the preferred shares of Conseco. The troubled Carmel, Indiana, insurer was well on its way to a $7 billion, December 2002 bankruptcy filing, but Devaney reasoned that if Conseco converted its bank debt to equity, a common practice in corporate reorganizations, it could generate enough cash to stay afloat for years to come and that the value of the preferred would soar.

But things went far differently during negotiations to reorganize Conseco. Because the insurer’s $2.1 billion of preferred shares were junior in its capital structure to its $4.6 billion of bank loans and bonds, Devaney found himself at the mercy of the banks and hedge funds that held the senior debt. Under a plan devised with the help of David Tepper, founder of Chatham, New Jerseybased hedge fund Appaloosa Management and owner of a majority of Conseco’s bonds, the senior debt would be converted to equity, but the preferred would be rendered worthless.

A loss of that magnitude stood to seriously damage Devaney’s capital base. Working tirelessly to protect his interests, he rallied preferred holders, including Francis Poli, then general counsel at Allianz Global Investors, whose Oppenheimer Capital subsidiary owned a big chunk of the securities. He also discovered a private investor, Paul Floto, who had obtained power of attorney on behalf of a large group of retail investors who owned the interest-bearing shares and stood to lose substantial sums under Tepper’s plan. With about 10 percent of the preferred outstanding, the threesome successfully petitioned the trustee overseeing Conseco to recognize the preferred holders as an official committee with a say in the reorganization -- a power rarely granted to equity holders.

According to bankruptcy court documents, Conseco then offered the preferred holders $16 million, a tiny fraction of the roughly $200 million in shares they owned. Devaney refused those terms -- as well as a subsequent $40 million offer. His holdout delayed Conseco’s emergence from bankruptcy, costing it extra legal and advisory fees.

Finally, in July 2003, Devaney squared off with Tepper at the midtown New York office of law firm Davis Polk & Wardwell. Devaney says he learned that the preferred securities had largely been offered in $1,000 denominations to individual investors, including Floto. He argued that such risky securities should not have been sold to small investors, who deserved more compensation as the company exited bankruptcy. The company ultimately agreed to give the preferred holders a 1.5 percent equity stake in the reorganized Conseco, along with stock warrants and other consideration that brought the value of the package to $85 million. In exchange, Poli and Devaney agreed not to sue the insurer on behalf of the retail investors. (Tepper and Conseco didn’t respond to repeated calls seeking comment about the episode.)

“Devaney did his homework, and he grabbed on and would not let go,” says an impressed Poli, who now works for investment manager Cohen & Steers and had never heard of the UCM chief before the Conseco battle. “He’s obviously ambitious and smart. But he’s one of those guys who has street smarts too.”

Though he trimmed his losses, Devaney left tens of millions on the table (he won’t say exactly how much) and describes the Conseco investment as disastrous. The only consolation is that he learned the ins and outs of the reorganization process and helped some small investors get a bit of their money back.

“I lost so much money in this whole situation, but I felt good about what we did,” he says.

Despite the Conseco debacle, 2003 proved to be another banner year for UCM as Devaney branched out into esoteric sectors, including collateralized debt obligations -- bonds backed by diversified pools of corporate loans, bonds and other credit instruments. Corporate defaults had been surging, fueled by accounting scandals and a burst bubble in the debt of telecommunications companies. By the end of 2002, more than one in eight loans and bonds was in default, nearly three times the 30-year average of 4.6 percent, according to Edward Altman, a finance professor at New York University’s Stern School of Business. The defaults drove down the prices of hundreds of CDOs, and Devaney made big bets. Unlike today, few big banks made markets in these instruments. When the sector recovered in 2005, Devaney cashed in.

“The market overreacted,” says Christopher Ricciardi, CEO of Cohen Brothers, a $20 billion-in-assets New York money manager specializing in CDOs. “Buying distressed CDOs went on to become one of the best investments of the time.”

Devaney also made a contrarian bet on the airline sector, buying bonds backed by aircraft leases for 40 cents on the dollar in 2003, following a prolonged downturn brought on by 9/11, SARS in Asia, the invasion of Iraq and the bankruptcies of United Airlines and other carriers. By the following year the market had recovered, enabling him to sell the paper for 80 cents on the dollar.

Devaney began to experiment with underwriting, repackaging $233.4 million of small business loans into a private CDO placement. Overall, in 2003, United Capital Holdings brought in $135 million in revenue; Devaney took home some $89 million.

DEVANEY’S GROWING fortune lets him indulge his appetite for the spotlight and his ambition for broader influence. Whether courting clients, recruiting star traders or donating money, he goes all out.

In 2004, Devaney wanted to hire Wachovia Securities trader Randall White, who had made a name for himself trading CDOs and pooled aircraft leases. White offered to discuss a move after he received his year-end bonus. On February 18 his bonus check cleared; at 11:00 p.m. his phone rang.

“Okay, that’s done,” said Devaney. “Now you’re working for me. I’ll pick you up tomorrow at home.”

At 7:30 the next morning, a black stretch limousine pulled up in front of White’s home in Charlotte, North Carolina, where Wachovia is based, and Devaney popped out. The pair strolled to a Starbucks down the street, where Devaney put forward an attractive package, including the prospect of living by the beach in Key Biscayne. White insisted that UCM buy the positions he had been maintaining for Wachovia, so as to not leave the firm hanging with distressed trades. Devaney agreed, White called Wachovia to resign, and within an hour the two traders and White’s dog, Champ, were aboard the UCM Gulfstream IV jet en route to Miami. During the flight Devaney released news of the hire through a securitization wire service. (Wachovia wound up keeping most of White’s positions but sold some to UCM.)

“He does not do anything half-assed,” says White, 34, who left UCM in March for a hedge fund job.

Devaney is just as aggressive in his pursuit of social and political influence. In April 2004 he promised to match up to $1 million in donations to fund Key Biscayne scholarships and cultural events. His November fundraiser for the Boys & Girls Club, held at the tony resort of Fisher Island, took place over four days and featured disco music by KC & the Sunshine Band and an address by conservative economist and actor Ben Stein. The take: $5 million.

“He left me shaking my head with amazement,” says Stein. “Smart, disciplined, creative, hardworking, deeply charitable -- a truly impressive human being.”

Then there is Devaney’s business entertainment. In 2004 he traded in his first yacht for a 142-foot craft, also named Positive Carry, which he uses to wow prospective trading partners and clients of his money management arm. In November he paid $16.25 million for Aspen, Colorado’s Sardy House bed and breakfast, which is the site of the nation’s largest living Christmas tree. He plans to use it as a vacation home and another place to entertain clients and employees. (UCM sponsors a celebrity ski race for charity in Aspen every winter.) In December the Devaneys kept up the tradition of lighting the tree in a grand public ceremony for local residents.

Devaney’s purchase of a corporate jet a few years back brought him to the attention of the country’s political elite. (Until the passage of recent lobbying reforms, members of Congress often sought out jet owners to sponsor fundraising trips and other travel.) In 2004 he became friendly with thenSenate majority leader Bill Frist, through a UCM attorney who once worked on the senator’s legislative staff. Devaney invited Frist to spend an afternoon on Positive Carry. Later Frist invited the UCM chief to a December 2004 dinner with President George W. Bush and a small group of donors at Frist’s Washington home. While other business leaders were trying to talk to the president, Devaney struck up a conversation with Kendrick Wilson III, vice chairman and head of financial institutions investment banking at Goldman, Sachs & Co. Intrigued by Devaney’s story, Wilson invited him to meet with Goldman bankers in New York to discuss how to grow his business.

In January 2005, Devaney visited Goldman’s lower Manhattan headquarters, where Wilson’s team suggested he sell shares in United Capital to the public. Devaney instead asked whether Goldman could raise up to $500 million of unsecured corporate debt for UCM, a way to acquire long-term capital and reduce his reliance on short-term bank credit. The bankers, however, advised him that selling debt would be too expensive because Devaney’s business was overwhelmingly dependent on a single, highly volatile revenue source -- making markets in distressed debt. Exhibit A in their argument: UCM’s 2004 earnings fell from $89 million to $70 million as defaults eased and the economy picked up. Goldman suggested he diversify revenues by starting an asset management business and doing more underwriting. Devaney had been managing accounts for about 70 friends and family but wasn’t charging fees. He decided to build a formal money management arm from that base and in April 2005 launched United Capital Asset Management, starting with two hedge fund portfolios specializing in distressed debt. One early outside investor was John Dasburg, a Key Biscayne neighbor who was CEO of Northwest Airlines from 1991 to 2001 and then ran Burger King for two years.

“The more I heard, the more impressed I became with the fact he found a niche that made intuitive sense to me,” says Dasburg, now chairman and CEO of Astar Air Cargo and an investor in several hedge funds. “In all of business we are constantly trying to differentiate ourselves. In my judgment he has a differentiated product, and that’s one I wanted in my portfolio.”

Devaney seeded UCAM with $40 million of his own money and now, he says, has more than $100 million invested in its funds. He says he takes a more conservative approach to managing client money than to making markets as a broker-dealer. About one third of the 60 bonds UCAM holds are investment-grade, and the funds are leveraged two and a half times -- half the debt he uses on the brokerage side. He also has hired senior operational and investing personnel, including chief operating officer Wesley Pritchett, formerly a board member of BNY Capital Markets.

Devaney can’t comment on the performance or strategy of the funds because of securities regulations. But according to investor documents for UCAM’s funds, its main fund was up 40 percent in 2006 and is up almost 110 percent since inception.

The ambitious trader believes that if he can quadruple UCAM’s assets under management, to at least $2 billion, he will generate enough fees to balance his firm’s revenue, enabling him to tap the public debt and equity markets. He will then use that capital to expand into underwriting and better attract and retain employees.

But running hedge funds alongside a brokerage operation presents serious potential conflicts of interest. Brokerage clients may worry that Devaney’s hedge funds will step ahead of them to buy and sell at the most attractive prices or otherwise profit from knowledge of their intentions. Another issue is how Devaney prices the esoteric securities owned by the hedge funds. The market for these instruments is typically quite illiquid, with prices frequently quoted by just one or two brokerages -- including UCM. The brokerage arm, as a result, might have an incentive to buy or sell certain securities at prices that help the funds show gains or minimize losses.

Devaney is unfazed by these concerns. In fact, he sees the asset management arm as key to the success of his brokerage, and vice versa. UCM can source bonds from UCAM accounts, and the funds can buy and hold securities when the brokerage side may not have immediate buyers, he says.

“Any hedge fund that is running without an affiliated broker-dealer is at a giant disadvantage,” he asserts. He dismisses the potential for conflicts by adding, “We have proved how ethical we are.”

There are other obstacles on the road to a bigger, more mainstream operation. One is the cyclical nature of the distressed-brokerage business. With defaults at historic lows -- just 1.5 percent of high-yield debt is currently in default, according to Moody’s Investors Service -- buying opportunities are scarce and profits are harder to come by. Competition in structured-debt trading is also stiffer today. Big Wall Street firms are now aware of the profits that can be made in the inefficient markets where Devaney once operated virtually by himself. Deutsche Bank, for instance, helped boost its most recent quarterly earnings by 29 percent with a well-timed bet on a subprime-mortgage-bond index known as the ABX.

“The markets are significantly more liquid today than they were in the past,” notes Ricciardi of Cohen Brothers.

Devaney says a more crowded field has so far not been a problem; rather, it gives UCM more counterparties to trade with, decreasing risk. He points out that the firm earned more than $100 million last year, up from $29.5 million in 2005.

For Devaney, the greatest comfort is that people always seem to overextend themselves. He had railed at industry conferences for months that the subprime sector was due for a fall, but he wouldn’t jump in until enough damage was done. Now he’s buying bonds for both UCAM and UCM that are backed by interest-only mortgages and option ARMs -- highly risky adjustable-rate loans that were extended en masse to homeowners over the past several years and are now defaulting in large numbers. Devaney has purchased the lowest-rated bonds referencing these risky mortgages at deep discounts. He expects many of these to default over the next few years but believes the interest payments on the ones that don’t will see him through when the market recovers.

AT AN AUCTION IN NEW YORK last year for the Robin Hood Foundation, a charity founded by hedge fund manager Paul Tudor Jones II, Devaney bid $610,000 and won ten lunches with an assortment of powerful executives, including digital media impresario Barry Diller, Hollywood producer Harvey Weinstein, Citicorp executive committee chairman and former Treasury secretary Robert Rubin, and hedge fund kingpins Tudor Jones and Steven Cohen.

So far he’s sat down with Rubin and Tudor Jones; the latter shared some wisdom about success.

“He gave me great advice about having balance between family, philanthropy and trading,” says Devaney. “He said trading wasn’t everything, and these other areas will help you succeed.”

That’s easy for a multibillionaire like Tudor Jones to say, and an important lesson to absorb for Devaney, who aspires to the same rarefied status but is following a riskier path to get there.

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