CalPERS, CalSTRS at risk in new credit squeeze?

The nation’s two biggest public pension funds, CalPERS and CalSTRS, were big investors in debt-laden private equity during the boom years. Now some worry that a wave of debt coming due in two years could limit borrowing needed for refinancing.

A page-one New York Times story this month said massive corporate and federal government debts are coming due at the same time, causing worry that “some companies will have trouble getting new loans, spurring defaults and a wave of bankruptcies.”

A three-year period of debts coming due begins in 2012, the end of a 5,000-year calendar used by the ancient Mayans associated in popular culture with a prophecy of worldwide cataclysm.

“The period from 2012 to 2014 represents payback time for a Who’s Who of private equity firms and the now highly leveraged companies they helped buy in the precrisis boom years,” said the Times story.

The newspaper has a less alarmist view of the debt than a book published last fall, Josh Kosman’s “The Buyout of America,” which is subtitled “How Private Equity will Cause the Next Great Credit Crisis.”

The Times story has some disturbing language: “a potential financial doomsday.” But the story also quotes experts who think that if the economy remains stable most companies will be able to refinance, even if they have to pay higher interest rates.

Asked to comment on the private equity risk mentioned in the story, the California Public Employees Retirement system said it tracks the debt of private equity partners, but does not disclose company information.

The California State Teachers Retirement System said private equity debt is being refinanced and restructured now and the risk continues to decline.

“We recognize there is an overhang of leverage, but we also believe the article overstates the likelihood of major failures,” a CalSTRS spokesman, Ricardo Duran, said via e-mail.
Private equity is increasingly important to the two big public pension funds. Last year, CalPERS increased its private equity target from 10 to 14 percent of total investments, while CalSTRS went from 9 to 12 percent.

The private equity investments are expected to yield more than less risky investments in publicly traded stocks, helping the big pension funds get the earnings needed to avoid higher annual payments from government agencies.

Private equity is a broad term that includes “venture capital” investments in startup or expanding firms and other things. But most of the CalPERS and CalSTRS private equity investments are in “leveraged buyouts.”

Often, Kosman said in his book, private equity firms put up about 2 percent of the purchase price, pension funds and other investors about 30 percent, and the rest is borrowed by the company being purchased.

During the height of the boom, much of the corporate debt was handled in the same way as subprime mortgages, sliced into pieces that were repackaged with parts of other loans and resold as “collateralized loan obligations.“

Leveraged buyouts nationwide soared to $475 billion in 2007 before dropping after the crash to $34 billion last year, a CalPERS consultant, the Pension Consulting Alliance, said in a report this month.

“The buyout sector, the portfolio’s largest exposure, continues to face significant challenges as it struggles with highly leveraged portfolio companies purchased at the peak of the market in 2007 and 2008,” said the report. “It is anticipated that many of these companies will have to refinance material amounts of debt in a tight credit market if current market conditions persist.”

A CalPERS staff report on private equity last month mentioned “concerns over companies acquired between 2006-2008 at high prices with high leverage.” The report said the private equity portfolio was valued at $24 billion at the end of last September, with $22 billion of unfunded commitments.

The roughly $20 billion of “dry powder,” as a consultant called it, is available for what some think could be rare investment opportunities to “buy low” as the economy recovers from a deep recession.

Some of the biggest CalPERS and CalSTRS losses during the crash were in private equity. But over the long term, the main focus of pension funds, private equity earnings have been above average.

The CalSTRS private equity program lost 9.4 percent in the year ending last Sept. 30, but still has average annual earnings of 8.4 percent over the last decade, said a Pension Consulting Alliance report prepared for a board meeting next month.

The market value of the CalSTRS private equity investment was $16.5 billion, with 71 percent of the value in leveraged buyouts. The report said large private equity firms had trouble borrowing for buyouts last year.

“The lack of leverage is believed to have hit the largest firms the hardest as investors have greater concerns about how funds will operate in the market environment going forward,” said the report. “In addition, debt loads (and pending maturities) of existing portfolio companies are causing concerns for how a firm’s most recent fund will perform.”

The big private equity firms have a number of separate funds. The biggest CalPERS private equity investment, $3 billion, is in Leon Black’s Apollo Management funds. The biggest CalSTRS investment, $2.4 billion, is in TPG Capitol funds.

As the pension funds plan to put more money into private equity, a columnist writing in the Wall Street Journal last week, Brett Arends, gave individual investors five reasons for not investing in private equity funds.

He said Apollo and Kohlberg Kravis Roberts are planning to join Blackstone and Fortress in selling shares to the public. In the past, he said, private equity investments were only available to wealthy individuals and institutions.

Arends said insiders willing to sell are unlikely to be expecting large profits, Wall Street firms give most of the money to star employees, and private equity follows boom-bust cycles and is hard to understand.

More importantly, he said, private equity firms did well in the 1980s and 1990s because they were few, did not have a lot of money to invest, and had their pick of the deals. Now the field is too crowded.

“A flood of cash has poured into private-equity funds in recent years,” said Arends. “And regardless of what the hype or consensus may tell you, that means returns are unlikely to come anywhere near what they were in the past. The laws of supply and demand are not complex.”

Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at http://calpensions.com/ Posted 30 Mar 10