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Fortress Investment Group's Junkyard Dogs
Pete Briger and the credit team at alternative-investment firm Fortress know how to turn financial trash into cash.
Its a cold, damp October morning in downtown San Francisco. Outside the Federal Reserve Bank building, a group of about 20 protesters huddles. Part of the growing Occupy Wall Street movement, the protesters are a reaction to the worsening economic malaise in the U.S. and the role the banking industry played in creating it. Unclear in their demands, the protesters are very specific in the targets of their outrage: the bankers, traders, hedge fund managers and other Wall Street executives still getting rich while so many others are struggling.
One block away, 42 stories up, surrounded by fog so dense that it is all but impossible to see across the street, a slightly rumpled Peter Briger Jr. sits slouched at his desk, peering through metal-rimmed glasses at his Bloomberg terminal. On a clear day Briger can see the Golden Gate Bridge from his window, but otherwise the corner office is a near replica of the one he left in New York a few months earlier, when he relocated to the West Coast. The Fortress Investment Group co-chairman prefers it that way. As co-CIO of the firms $11.8 billion credit business, he tries to avoid unwanted distractions that might prevent him from doing what he does best make money.
It is a safe bet that not a single one of the protesters would recognize Briger for what he is: a titan of finance. The former Goldman Sachs Group proprietary trader, who co-founded that firms extremely profitable Special Situations Group in 1998, joined Fortress in 2002 and launched its Drawbridge Special Opportunities funds. Five years later, when he and his partners took Fortress public marking the first listing by a significant alternative-investment firm in the U.S. Briger became a billionaire. His specialty: investing in distressed debt and beaten-down loans that no one else wants or that are being dumped by sellers under financial duress.
The unhappy crosscurrents that are igniting protests against capitalism and causing political dysfunction in Washington are creating the best investment opportunities that Briger and the credit team at Fortress have ever seen. The credit crisis in Europe, populist uprisings in the Middle East and the debt downgrade of the U.S. are among the economic and geopolitical factors that have set the stage for a global fire sale. Debt-laden nations like Greece and Portugal have to sell assets to raise capital. Banks and other lenders have begun the process of getting illiquid assets off their balance sheets to meet heightened capital requirements. Among the few providers of financing in the risky sectors of a capital-constrained world, Briger and his team stand to make billions of dollars for themselves and for their investors. Although members of the Occupy Wall Street movement might find that objectionable, for the capital markets to heal, the world desperately needs people like Briger.
We invest in areas where the main money flows dont go, Briger, 47, told Institutional Investor during a series of exclusive interviews over the past four months. And there you have the worlds biggest supply-demand imbalance thats ever existed in financial asset liquidations. He estimates that there have been approximately $3 trillion in asset dispersions, or sales, since 2008. And with regulatory reforms and ongoing global credit issues, he projects that the number could grow to $5 trillion, or even $10 trillion, over the next five years.
Briger calls the act of buying the unwanted assets of banks and other lenders financial services garbage collection. With canny self-mockery, he often refers to himself as a garbage collector, picking through the noncore assets that other companies are discarding. It is what he has been doing practically his entire career, first during the savings and loan crisis of the late 1980s and then in Asia during its economic meltdown a decade later. At Goldman, when Briger was buying up mortgages that no one else wanted and profiting from them, his colleagues called him a junkyard dog, says Marc Furstein, who was co-head of the opportunistic real estate business at Goldman in the late 1990s and now is president and chief operating officer of the credit funds at Fortress.
Our business is not glamorous, explains Briger. It is a business of discipline. Its closer to the banking business than it is to the hedge fund business, except that were able to be a lot more opportunistic than banks. Briger and his team consider their direct competitors to be firms like middle-market lenders CIT Group and Ally Financial, which used to be GMAC, the former asset management and lending arm of car manufacturer General Motors Corp.
Wesley Edens, Robert Kauffman and Randal Nardone founded Fortress in 1998 as a pure private equity firm. In 2002 the partners expanded into hedge funds when they brought in Briger to start the credit business and Michael Novogratz, another Goldman alum, to run macro funds (which Fortress calls its liquid markets business). Last year the firm acquired Logan Circle Partners, a traditional long-only fixed-income manager based in Philadelphia and Summit, New Jersey, with $12.9 billion in assets. As of September 30, Fortress managed $43.6 billion among its four businesses. Edens still oversees private equity, which represents $12.7 billion of assets. Novogratzs liquid hedge funds have $6.2 billion.
The idea behind Fortress was simple: to create what Edens and Briger call a business for all seasons, a firm whose different parts would perform better during different points of the economic cycle and the sum of whose parts would be greater than the whole. Initially, the approach worked extremely well. In 2004 the credit business delivered the largest distributable earnings, followed by private equity in 2005 and the liquid hedge fund business in 2006. Each business made money each year.
Fortresss diversification strategy has been far less effective since the financial crisis. In 2008 funds in all three businesses lost money in the wake of the mortgage meltdown and collapse of the credit markets. Edenss private equity funds were hit particularly hard, losing nearly one third of their value. But whereas Briger and Novogratz both bounced back with strong performance in 2009, the private equity business has only more recently seen its fortunes improve. Among the three businesses, since 2008, Brigers credit group has delivered the most revenue.
The Fortress Drawbridge funds invest mostly in private credit loans and debt that trade through private transactions though they can also invest in public bonds and structured credits, including mortgage-backed securities and collateralized loan obligations. The funds have delivered annualized returns of 10.2 to 10.7 percent since inception. Starting in 2005 the credit group began raising private equity funds. The first, Fortress Credit Opportunities I, has had annualized returns of 28.1 percent since its January 2008 inception.
Brigers investing prowess has earned him respect and friends in high places. I have great admiration for Petes commercial skills, says former Goldman Sachs partner J. Christopher Flowers, founder and CEO of New Yorkbased private equity firm J.C. Flowers & Co. He is very talented, and he has an excellent long-term track record. I have almost no money with anyone outside my own firm, but I do have money with Pete.
Brigers group should benefit from the Dodd-Frank Wall Street Reform and Consumer Protection Act and its prohibition of proprietary trading by banks, which almost certainly will limit Goldmans ability to put capital to work through its special-situations group. We are a net beneficiary of current regulation, says Constantine (Dean) Dakolias, Brigers co-CIO in credit.
Two of Fortresss main competitors, New Yorkbased CIT and Ally, have been forced to retrench and exit some businesses after overexpanding in the period leading up to the financial crisis. Last year Fortress bought the European residential mortgage business owned by Ally at a considerable discount. Even though Fortresss prognosis for the housing market in countries like Spain is not good, Briger and his team are confident that they can make money given what they paid for the businesses and their experience at servicing similar loans. Part of the day-to-day job of overseeing the Ally loans falls to Furstein, 43, who is responsible for noninvestment functions, including the all-important areas of financing and contracts. Of the 300-person Fortress credit team, about 100 report to Furstein. The other 200, responsible for deal making and managing the assets, report to Briger and Dakolias.
The way that Dean and I think about the world every day is, we are trying to look at perceived risk and actual risk; and where perceived risk is greatest and we can do our homework and understand the actual risk, thats where we want to invest money, Briger says. And you have to make sure you are getting paid the right premium.
It is an investment approach that comes with a healthy dose of paranoia. Briger expects loyalty. This summer, when he moved the credit business to San Francisco, largely for personal reasons his wife is from the Bay Area he brought about 30 members of the senior investment and treasury team, including Furstein, with him. Dakolias will likely join them within the next 12 months.
Brigers personality dominates the credit team. Employees, even the most senior, habitually refer to Petes business. Defections to other firms are rarely tolerated. But though he is strong-willed, Briger believes he works well with others. I like to think of myself as a good partner, he says.
He needs to be. Briger has a history of partnering with others, but not every relationship has gone well. Although a brief collaboration with Flowers ended amicably, Briger later fell out with another former Goldman partner, Edward Mulé, with whom he had successfully worked at that firm.
Brigers ability to play well with others has rarely been under more scrutiny than it is now. Though Briger might be king of his own empire, Fortress is a polyarchy dominated by three powerful personalities: Briger, Edens and Novogratz. The contrast between Edens and Briger is particularly striking. Edens is tall and polished; Briger is stocky and brusque. Edens, who this past summer climbed the Matterhorn, may once have been a trader in the same markets as Briger, but he has the lets-make-a-deal skills and upbeat demeanor common to private equity.
Edens is unstinting in his admiration of Briger. The Pete Briger I knew 20 years ago and the Pete Briger I know today are actually the same person, he says. He is one of the most consistent people I have ever met in my entire life. He wears his heart on his shirtsleeves, and that is one of his great strengths. I think the world of him.
Novogratz, known as Novo, is charming and charismatic. After graduating from Princeton University, he enlisted in the army, where he flew helicopters. His schoolmate Briger went to Goldman, where he traded mortgages. Although Novogratz and Briger have been friendly since Princeton, they view the world very differently. Someone will come into my office, and after they leave Ill think, What a nice guy, says Novogratz, 46. They walk into Petes office, and Pete is thinking, How is this guy going to screw me?
Daniel Mudd, 53, who took over as CEO of Fortress in August 2009, describes the relationship among the partners this way: The businesses are like siblings. They share DNA, but they are also intensely competitive siblings. And like any siblings, Mudd adds, they have different personalities. Wes is naturally an optimist, saying, What can I do to expand; what can I see over the horizon? Youngest sibling Novogratz is the realist, Mudd continues, and middle sibling Briger is by nature a pessimist, and his team is a reflection of that.
The potential for tensions among the partners has been heightened by the dismal performance of Fortress as a publicly traded company, although, to be fair, its problems have been far from unique in the financial services industry. Its shares have been decimated since the financial crisis. At a recent price of $3.40, Fortress is down more than 90 percent since February 2007, when it started trading at $35 a share, as are the holdings of its founders, who have not sold a single Fortress share since the IPO.
Briger grew up the eldest of three children. His father, Peter Sr., was a tax attorney, and his mother, Kathy, was a senior executive in the credit department at Chemical Bank. At a time when few women were well known on Wall Street, Kathy Briger whose job it was to decide which loans the bank would finance had a wide reputation as the person at Chemical with the power to say no.
Briger attended a private grammar school in New York. Keen on sports, he persuaded his parents to let him go to the Groton School in Groton, Massachusetts. Following high school he majored in history at Princeton. Novogratz was one year behind him and lived in his dorm.
When Briger graduated from Princeton, in 1986, problems in the U.S. savings and loan market were just coming to a head. Savings and loan associations, called thrift banks, had overexpanded. Between 1986 and 1995 nearly one quarter of the 3,234 S&Ls went bankrupt; a further 1,600 banks failed or received Federal Deposit Insurance Corp. assistance. As a result, some $25 billion to $30 billion of assets, mostly distressed mortgages, needed to get sold, creating a great opportunity for the young Briger, who started as an analyst trainee with Goldman in New York. He then moved to Dallas to sell bonds as part of the mortgage group covering banks. After about a year he relocated to Philadelphia, covering the banks there. In 1990 he returned to New York to become a mortgage trader. (Briger would go on to get his MBA from the University of Pennsylvanias Wharton School, attending classes on weekends.)
Furstein worked in New York for Goldmans vaunted financial institutions group, run by Flowers. Much of the groups effort was spent advising banks on how to clean up their balance sheets. As a proprietary trader, Briger was interested in banks hard-to-value assets: the loans made to bodegas, lumberyards and other noninstitutional borrowers. He would figure out their worth, buy them and turn a profit. Furstein and Briger started working together. We were looking at the things no one else wanted, says Furstein, who spent a year building what would become the infrastructure for Goldmans Special Situations Group. Pete hasnt changed.
In 1996, Briger was promoted to partner. By then the investment opportunities created by the fallout from the S&L crisis were coming to an end, and he was ready to move on to the new hot spot: Asia. The financial crisis started there in July 1997 with the devaluation of the baht after the Thai government decided to cut the currencys peg to the U.S. dollar. The contagion quickly spread to other Asian countries, including Hong Kong, Indonesia, Laos, Malaysia, the Philippines and South Korea. The ensuing deleveraging created plenty of intriguing investment opportunities.
In Hong Kong, Novogratz was heading up Goldmans trading and risk management for fixed income, currencies and commodities. Briger had gotten Novogratz a job interview at Goldman after his former college schoolmate left the army. Novogratz started working on April Fools Day 1989 as a money markets salesman in New York. A few years later he moved to Tokyo, eventually getting into trading. In 1997, Novogratz made a fortune for the bank during the Asia crisis. He could see that the next opportunity was going to be in distressed credit, and he wanted in. I remember telling Pete I wanted to run that business, he says. He looked at me and said, You would not know how to run this business. And he convinced me that the way he did distressed investing was a lot more complicated.
Briger arrived in Asia in early 1998, bringing with him deputies Mark McGoldrick and Robert Kissel. Initially, McGoldrick and Briger shared an apartment in Tokyo. Today, McGoldrick, who runs alternative-investment firm Mount Kellett Capital Management in New York, remains one of Brigers closest friends and is a godfather to his children. (Kissel stayed in Hong Kong; in 2003 he was murdered by his wife.) Briger, who split his time between Tokyo and Hong Kong, immediately commandeered the large corner office that had just been assigned to Novogratz. Pete said, I got you your damned job; after this we are even, Novogratz recalls.
Briger proceeded to fill that office with 20 to 30 traders, all hustling to make money from distressed loans. His approach was much more granular than that of the macrominded Novogratz. Goldman launched the Goldman Sachs Special Opportunities (Asia) Fund, which Briger co-ran with Goldman partner Mulé. Operating out of New York, Mulé provided corporate credit expertise. The proprietary trading operation they ran became known as the Special Situations Group.
It was a great time and place to be investing in distressed credit. In one particularly innovative deal, Briger and McGoldrick teamed up with GE Capital Corp. and its then president for the Asia-Pacific region, current Fortress CEO Mudd, to snap up 400,000 Thai auto loans at 45 percent of face value for $500 million. They reportedly doubled their money in less than two years.
In 2000, Briger briefly quit Goldman and joined Flowers, who had left the bank in 1998 and gone into the private equity business. Although Briger returned to Goldman after less than a month, he still felt it was time to move on. Goldman had gone public in May 1999, an event that signaled the end of an era for many of the banks then partners. Briger returned to New York to join Michael Mortara, his mentor and close friend, at GSVentures, a new Goldman initiative set up to invest venture capital in financial services companies. In November 2000, Mortara suddenly died from a brain aneurysm. Briger resigned three days later. (Mortaras son Matthew works for the corporate credit team at Fortress today.)
Furstein had decided not to go with Briger to Asia. Instead, in January 1998 he had moved to San Diego and teamed up with
Dakolias. The two had known each other since they were undergraduates at Columbia University in the late 80s. Dakolias, who majored in physics, had found his way into finance advising banks on how to sell their mortgage portfolios during the S&L crisis. That sometimes put Dakolias in deals involving Briger and Furstein and honed his expertise at pricing risk.
Dakolias, Furstein and a third partner formed a broker-dealer and a specialty finance company. In early 2001 they sold both businesses to Wells Fargo & Co. Briger asked them to meet him in San Francisco. There, at Brigers hotel, they mapped out a plan for what would become Drawbridge Special Opportunities and the Fortress credit business.
What the trio came up with did not look like any other hedge fund at the time. In addition to buying up credit, the fund would make direct loans. Its closest competitor outside the Goldman business that Briger had left behind was Ableco Finance, a specialty lending business formed by New Yorkbased alternative-investment firm Cerberus Capital Management. Briger was uncertain whether the trios plan would work in a hedge fund structure. He had run across Edens when the latter was working on the loan desk at Lehman Brothers Holdings and gotten to know him when he was running private equity at BlackRock. I thought Wes was the smartest guy in my business, Briger says. I still think that.
By 2001, Fortress was managing $1.2 billion in private equity. Edens extended an attractive offer to Briger: Buy in as a founding partner and build his business there. Briger, who joined the firm as co-president alongside Edens, figured that if the hedge fund model did not work, he and his team could become part of the private equity group.
Fortress also wanted to bring Novogratz on board as a principal to build a macro hedge fund business. Novogratz had ended his Goldman career as head of Latin America in 2000, and by late 2001 he was anxious to start working again. He and Briger had talked about sharing office space. And Novogratz and Edens had sketched out almost identical ideas for a multibusiness alternative-investment firm whose collective whole would be worth more than its parts.
Dakolias and Furstein joined Fortress first; Briger arrived in March 2002. The early days were hectic, remembers Leslee Cowen, an executive in the corporate and public securities group. We were going at 60 miles per hour from the very first month, she says. For the first two months, they did not have capital. We spent the time looking for investment opportunities, says Cowen, the fourth employee in the credit group. Among the early transactions was a rescue loan to Williams Cos. that was arranged by Lehman Brothers and included Warren Buffetts Berkshire Hathaway as a lender. The loan, secured by a substantial portfolio of assets, allowed the Tulsa, Oklahomabased energy company to avoid filing for Chapter 11. Fortress also extended credit protection to Kmart vendors when the discount retailer was in bankruptcy.
Mulé had left Goldman at about the same time as Briger. The two former colleagues had planned to go into business together and started making some joint investments. But Mulé and Briger failed to agree on the economics of the business and parted ways. Mulé went on to form Greenwich, Connecticutbased credit-focused hedge fund firm Silver Point Capital with Robert OShea, another exGoldman partner. Silver Point and Brigers group at Fortress had an unwritten agreement that they would not hire from each other. According to sources, when Mulé hired a junior investment professional from Fortress, Briger felt it was a violation of that agreement. The two have barely spoken since.
Andrew McKnight joined Fortress in 2005 from New Yorkbased hedge fund firm Fir Tree Partners. He had previously worked on the distressed-bank-debt trading desk at Goldman. In addition to the opportunity to work with Briger, he says he was attracted to the scale of the Fortress operation. You can go after more-attractive risk-adjusted returns, says McKnight, who is a member of the investment committee, with responsibilities for distressed corporate credit. What you have is the ability to organize loans and offer solutions and refinancings, which if you were a hedge fund with just five guys and a Bloomberg terminal, you just could not do.
McKnight, 34, also came to appreciate how easy it is to get an investment idea heard by Briger and Dakolias. The relatively flat reporting structure within the credit group means that even the most junior employee can suggest an investment at the weekly sector meetings. We are on a short list in the private markets as someone who can move quickly and get deals done, says Furstein. You can get Pete and Dean and the investment team to listen to the basics of a transaction. They can sit down right there and then and tell you the terms of the deal. Then if the due diligence proves accurate, you are done.
Dakolias, 45, says having a rich pipeline of deals and good relationships with strong sourcing partners is critical to Fortresss success, as is the firms focus on details. Were maniacal, he adds. We work 24-7 in terms of understanding our assets, understanding our liabilities, understanding how everything is structured.
Of course, its easy for something to go wrong when lending to lower-quality borrowers. For a firm like Fortress, its very important to have good legal documents and vigilance. We build these customized documents; we come at the loan business from a very structured, experienced way, says Furstein.
The team does not always get things right. One of its most embarrassing and bizarre missteps was an investment in structured notes. Starting in 2004, Marc Dreier, a New Yorkbased attorney and founding partner of his eponymous law firm, began offering structured notes he claimed were being sold by Solow Realty & Development Co., the real estate firm operated by Sheldon Solow, his longtime client. The only problem was, Solow knew nothing about the notes and had not authorized the attorney to sell them. It was a fraud.
Dreier used the money to expand his practice and fuel his opulent lifestyle. Fortress was one of about 15 hedge fund firms that had money with Dreier. It invested about $100 million with him before the fraud was exposed in late 2008. Dreier was arrested in Canada after he was caught impersonating a Canadian pension official to a Fortress investment executive. The former lawyer is now serving 20 years for fraud at the Federal Correctional Institution at Sandstone, Minnesota.
It was clearly a mistake, says Briger of the Dreier investment. Although the Fortress credit group did a significant amount of due diligence (the process is a good process, he says), we made a bad judgment. Still, Fortress managed to recover 70 cents of every dollar it lent to Dreier more than any other hedge fund creditor because it had structured protections into the original investment and aggressively pursued its claims. We havent tried to brush [the situation] under the rug, says Briger. We care a lot about getting that money back.
By 2007 alternative-investment firms were riding high. There was a huge amount of ambition to turn these entrepreneurial businesses into something more permanent. The 2004 purchase of hedge fund firm Highbridge Capital Management by JPMorgan Chase & Co. had shown one way, but another tantalizing option was to do a public share offering. Fortress was the first U.S. alternative-investment firm of any size to take the plunge, debuting on the New York Stock Exchange on Friday, February 9, 2007. Fortresss listing was followed by those of Blackstone Group, which went public that June, and Och-Ziff Capital Management Group, which had its IPO in November.
The principals who took their alternative-investment firms public made themselves very rich indeed. When Fortress went public, Briger, Edens, Kauffman, Nardone and Novogratz became billionaires on paper overnight. But Briger dismisses the financial motivation, pointing out that all of the partners were already very well off. He says the real appeal was creating a firm that would last. We thought that having that public name would give us branding more quickly and do more things and potentially make more money for the business, he explains.
Edens was a big proponent of the IPO. Given his teams background, he felt confident they could get the deal done. We have a lot of experience in capitalizing companies publicly, and we have had a lot of success doing it, Edens says. We had strong views about what we wanted to accomplish with Fortress. We thought if it made sense to us, it was a sensible thing to do.
From December 31, 2001, shortly before Briger and Novogratz joined Fortress, through the end of 2006, the firms assets grew from $1.2 billion to $35.1 billion, a 96.4 percent compounded annual growth rate. Private equity accounted for the lions share of the assets $19.9 billion, including some $2 billion in credit funds followed by hedge funds, with $10.5 billion (split roughly evenly between the hybrid and liquid funds), and $4.7 billion in publicly traded alternative-investment vehicles called Castles.
The original economic arrangement among the founding principals of Fortress was very informal. I dont think we had a signed partnership agreement for at least the first five years, says Edens. Sometime after Briger and Novogratz joined, the five principals began to revise the partnership agreement approximately once every two years, negotiating payouts based on where the businesses were at the time. With the IPO came a much more formal agreement: For the next five years, the principals would each get a flat salary of $200,000. The only additional compensation theyd receive would be through dividends and stock-price appreciation effectively tying their financial fates to the success of the companys shares.
The IPO was swiftly followed by what Briger calls the worst financial crisis in history. But he saw the storm coming. It eats at him that he did not short subprime mortgages the trade a few hedge fund managers, most notably John Paulson, put on in 2006, allowing them to reap billions of dollars during the collapse of the real estate market. Given his background, Briger should have seen the opportunity, but the Drawbridge funds rarely if ever short.
Investment professionals in the Fortress credit group are paid according to what both their funds and the firm make, and although they are assigned to sectors, they can move to other areas of the business. The idea is that the team is not stuck making deals in bad markets, and, at least in theory, no one has an incentive to invest if the opportunity set is not there. By late 2007, Fortress was doing less and less in commercial lending, and it had little presence in the mortgage market. In corporate credit the firm was taking positions that were very senior in the capital structure, making it less vulnerable in the likelihood of a default.
When Brigers group takes risks, it is cautious. Take its dealings with billionaire property developer Harry Macklowe. In February 2007, at almost the very top of the real estate market, Macklowe decided to roll the dice by buying a $6.8 billion portfolio consisting of seven Manhattan skyscrapers. To do so, he needed a loan, and he needed it fast. He turned to Briger. Fortress lent Macklowe $1.2 billion, but Briger insisted that he give a personal guarantee, unusual at the time, meaning that Macklowes own multibillion-dollar fortune was on the line, as was his greatest asset: the General Motors Building, which occupies an entire block on New Yorks Fifth Avenue.
By February 2008, Macklowe needed to refinance the loan, but the credit market for commercial real estate had largely dried up. Sensing Macklowes vulnerability, some of his rivals approached Fortress and offered to buy the loan, a move that could have given them control of the property developers empire. Briger just wanted Fortresss money back. He would not sell the loans, but he made it clear to Macklowe that he had to sell the GM Building in the worst economic environment anyone could remember.
It was a painful process for Macklowe. In May 2008 he agreed to sell the building for $1.5 billion plus the assumption of $2.5 billion in debt. But the developer has not given up on the idea of using Fortress as a future lender.
They are straightforward, and they do what they say, says real estate attorney Jonathan Mechanic, who represented Macklowe during the deal. They stepped up and provided financing for Harry through a very difficult time. Harry paid them back. The fact that they are prepared to do business with one another again is huge.
Before 2008, just as it hadnt been a problem for homeowners with poor credit scores to get a loan, it was very easy for hedge funds to borrow money. Briger locked up billions of dollars in inexpensive, nonrecourse secured bank loans. Kenneth Wormser helped arrange financing for Fortress and other hedge fund managers over this period. Fortress never touched mark-to-market financing; they wanted something much safer, says Wormser, who was working at Natixis Capital Markets in New York at the time and is now co-launching an investment banking venture, GreensLedge. It was always painful to get the deals done because of the requirements they had.
Fortresss disciplined approach to financing paid off in September 2008 when Lehman Brothers filed for bankruptcy, convulsing markets around the world. The Fortress credit funds didnt receive margin calls or have to mark down collateral. The firm actually had fresh capital it could draw on to take advantage of the massive repricing of risk assets that was suddenly under way. Briger even borrowed more, getting well in excess of $1 billion of nonrecourse financing from Wells Fargo to buy residential-mortgage-backed securities.
When Pete came to us with the idea of providing financing for RMBS, it could not have been at a worse time in the market, because everyone hated RMBS and it felt like the world was ending for the asset class, says Wells Fargo CFO Timothy Sloan. The subsequent trade turned out to be extremely profitable for both Fortress and Wells Fargo.
With credit markets falling, and hurt by mark-to-market pricing, the main Drawbridge Special Opportunities fund was down 26.4 percent in 2008, but it bounced back to return 25 percent in 2009 and 25.5 percent in 2010. Novogratzs macro fund lost 21.88 percent in 2008 and briefly put up gates, blocking investors from getting their money back, but it rebounded the next year, delivering a return of 24.18 percent, and was up 10.7 percent in 2010.
Meanwhile, Edenss private equity business was struggling. The majority of Fortresss private equity investments are in financial services, leisure, real estate, senior living and transportation all of which were directly or indirectly affected by the financial crisis, in particular the collapse of the housing and commercial real estate markets. In the fall of 2008, the private equity group needed to refinance two key acquisitions not long after Lehman filed for bankruptcy and temporarily shut down the high-yield debt market to new issuance. Fortress was further hurt by the investments it had made in its own funds.
In 2007 the firms private equity business made $312 million in pretax distributable earnings; the macro hedge fund business, $161 million; and Brigers hybrid hedge fund business, $61 million. The groups, respectively, had $16 billion, $9.5 billion and $7.1 billion in assets under management. In 2010 the private equity business made $145 million, the liquid hedge fund business $64 million and the credit business $168 million; they had assets under management, respectively, of $15 billion, $6.4 billion and $11.6 billion.
During the years leading up to the IPO, Edenss private equity business had been a big profit driver. In 2006 and 2007, Novogratzs funds had a strong run. With their high margins, low risk and low leverage, Brigers funds were always slower and steadier. Petes business is like the tortoise, says Novogratz. Right now he is a very strong tortoise.
The Friday before Fourth of
July weekend this year, Chris Flowers was playing squash and ruptured his Achilles tendon. Realizing that the best medical treatment was going to be hard to come by, with doctors, like everyone else, heading out for the holiday, Flowers called Briger not because his fellow Goldman alum has any special medical expertise but because Briger is a board member of Manhattans Hospital for Special Surgery. Flowers knew Briger would help him locate a top surgeon quickly, and he did. Briger had done the same four years earlier for Wormser when he fell and broke his pelvis. Pete offered to make sure I got the right doctor, says Wormser.
The ultracompetitive Briger finds himself in an interesting dilemma: Can he live in a world where he is succeeding but remains tied to a private equity group that is not doing as well, under the scrutiny of being a publicly traded company in a sector blighted by the same trends benefiting his business?
The business model of private equity is not the same, certainly, as when we went public, Briger says. But these are people businesses, and we want to have an entity that sticks around for a long time. You have to look at all of these businesses as cyclical. If you want to run out every time somebody is involved in a cycle, it is a mistake.
Characteristically, Edens is extremely optimistic about the prospects for his private equity portfolios going forward. The last three investments we made in Fund V are going to be some of the best investments we have ever made, he says, referring to the fund that Fortress launched in 2007.
The private equity business is improving. Between the first quarter of 2009 and June 30 of this year, valuations of Fortresss private equity investments went up 77 percent. The private equity group has refinanced more than $12 billion in debt and has extended 85 percent of the debt maturities on its portfolio companies past 2012. Edenss team has completed three successful IPOs and is back in the market raising capital for new funds.
Fortress has taken steps to improve the business at the corporate level. Bringing in Mudd as CEO was a significant event, removing the burden of management responsibility from Edens, who had held the position previously, and the other principals. As of September 30 the firm had reduced the amount of debt on its balance sheet to $270 million from $800 million in 2008. In August, Fortress announced that it would be reinstating its dividend payment, which had been suspended in 2008. It remains a source of frustration to Edens that Fortresss net cash and investments in its own funds represent about 60 percent of the total market capitalization of the company.
The valuation of the company right now I think is ridiculously low, I really do, insists Edens. I think how we are being valued right now is ridiculous, and over time we hope these valuations are a lot better.
Fortress isnt the only alternative-investment firm whose share price has taken a beating. Today, Blackstone trades at about $14 a share, having gone public at $31, and Och-Ziff is at about $10 after a high of $32. Fortress did have discussions in the aftermath of the crisis with at least one financial institution about taking the company private. The talks, though serious, eventually went nowhere. The principals are committed to making Fortress a success, says Mudd: Pete, Wes and Mike all left successful firms. They came here to start something and to run a firm exactly the way they thought it should be run.
In August the principals signed a new five-year partnership agreement. Going forward they will receive payments based on the performance of their existing fund assets as well as on their success at raising new assets so if one business grows at a faster rate than another, the principals associated with those funds will be rewarded commensurately.
We wanted to make sure that the people who are doing well on a forward-going basis are compensated in a manner that is consistent with that, says Edens. It is human nature to want to have some of your rewards be tied in some portion directly to what you are doing. With no relief in sight for the global markets, financial conditions continue to benefit the credit group. Now is a great time for what Pete does, says Mudd.
Brigers group has been busy. In addition to the purchase of the Ally mortgage business last year, Fortress bought CW Financial Services, the second-largest special servicer of commercial-mortgage-backed securities in the U.S. It also paid $156 million for a $751.4 million student loan portfolio from CIT. That means Briger probably owns the loans of some of the Occupy Wall Street protesters who are camped out a block away from his office.