The Education of a Corporate Bond Manager, Part XI

I appreciate my readers.  That doesn’t mean that I am the fastest to respond to e-mails, but I appreciate what they write, even when I don’t agree.  But here is an e-mail very relevant to tonight’s piece:

Great series, David.

If you have more posts planned, it would be interesting to know what the biggest mistake you’ve made that you learned from the most.

In my short tenure as a corporate bond manager, I had a very good run in the midst of a bad environment.  Sometimes I think my lack of formal training was a plus for analyzing a situation where little was going well.

But I did make my mistakes. One was Enron — don’t get me wrong, I urged the sale of Enron bonds, but was countermanded.  Could I have argued the cause better?

  • Fast-growing company in a slow-growing industry.
  • Management that could not take criticism.
  • Growing profits, shrinking cash flow.
  • We had a peek inside the veil, because we had financed some of their private deals.  The complexity was astounding.
  • Opaque balance sheet.

I made all of those points and still lost; my new bosses were not deep when it came to corporate credit; they were skilled in other areas of the bond market.  I eventually ended up selling the Enron bonds at an unfavorable price.  Would that I had sold on the date of the default, rather than a month later.

Then there was the Teleglobe situation, where I erred in many ways.  BCE, Incorporated had a unregulated subsidiary called Teleglobe.  Think of Global Crossing, and other marginal telecom ideas.  BCE was a sound company, and they offered verbal support for their subsidiary, but would not put it into writing, and formally guarantee their debt.

I did not know the company well, and I had no stock price to give me aid.  Stock prices are more sensitive than bond prices, and can give warnings before bond prices move dramatically.  My analyst went off to a telecom/technology conference, where the S&P analyst disclosed over dinner that she was likely to downgrade Teleglobe because of the lack of explicit support from the parent company.

Now given the broader picture, this should have been obvious.  There were too many situations where implicit support did not translate into real support, and Teleglobe, most than most, needed support.

My analyst called me after the comment from the S&P analyst, and I asked, “Should I sell?”  He said I should wait; he wanted to gather a little more data.  We had our opportunity to sell at $90, and waiting missed that.  By the time he returned, the S&P analyst indicated that a downgrade was likely, and the pseudo-price fell to $70.  But, we were now determined to sell.

So I called my favorite broker, who was at the only firm making a market in Teleglobe bonds.

DM: “What’s the market in Teleglobe bonds?”

FB: “$68/$72.”

DM: “Very good.  I sell you $XX Milllion of Teleglobe bonds at $68.”

FB: “I’m sorry, that’s not a real market, that is an indicative market.”

DM: “So where is the real market?”

FB: “We’ll take an order from you.”

DM: “You mean there is no real market?  You brought this deal to market, you have to maintain a market.”

FB: “We’ll take an order from you.”

DM: (Pause) You have an order for $XX million Teleglobe bonds at $65.

FB: “We will do our best for you.”

To this day, I have no doubt that she was serious with me.  Teleglobe bonds after that point traded in the $50s, but never at the main broker.  As I learned later, they had 10+ times more Teleglobe bonds than I did, and were trying to minimize their own exposure.  They lost a lot more than I did.

When BCE sent Teleglobe into bankruptcy several weeks later, we sold the bonds at $20.  The eventually went out as a zonk.  No value.

Lesson learned: bonds are asymmetric.  You are paid to be cautious regarding failure.  When in doubt, sell.  Also, don’t take your broker at face value always.

The fallout from the Teleglobe failure was twofold.  1) the client accused us of incompetence, because we had missed on Enron, KMart, and Teleglobe. 2) My boss asked me how I could have missed it, and I said, “I was following it and did the best I could.  But I am following over 500 credits.”

Sadly, he made the wrong decision, and hired another corporate bond manager, and we split the portfolio.  It led to poorer portfolio management.

Another error: I am not politics-sensitive.  I am more interested in doing what is right for clients, than what looks best.  So when the client proposed value destroying ideas that would benefit them directly, I argued against them.  The asset manager took me out of direct client contact, aside from actuarial risk management, but asked me to tell them what was up, because the client asked for weird things.  The same applied inside the asset manager, where my willingness to take or avoid risk was in sync with opportunity, but out of sync with the firm.

I had learned to avoid undue pessimism from the high yield manager who sat next to me, and that often made me more optimistic amid gloom than others in the firm.  I was not a pea in the pod, and perhaps that made those that had acquired my firm wonder about me.  I never did anything more than make my opinions known, but that is enough for some to take umbrage.

Maybe the point is this: you can be right in the long run, but wrong in the short run.  What eventually happened to the client?  Well, I mentioned all of the dismissals before, but as God would have it, the client was sold yesterday to hedge-fund manager Phil Falcone.  The new CEO of Old Mutual said:

But just to remind you of the background of the transaction, we bought US Life in 2001 with the aim of building a Life business in the United States. This has proved to be a poor acquisition for the Group, and we acknowledge it, largely due to taking excessive credit risk, the impacts of which came to a head in the 2008 global financial crisis. So we said in March we intended to explore the sale of the business.

Old Mutual pumped in hundreds of millions in capital, in addition to what they paid for it.  They lost badly.  But they did not list the real reason why they lost, which gives me little confidence that they will do better in the future.  They lost because their US life division sold policies at levels that did not cover the cost of capital.  In order to avoid the inevitable losses from selling policies too cheaply, they pushed those who invested for them to try to make it up by taking much more risk.  The risk didn’t come first; what came first was a bad management culture that pushed sales growth at the expense of everything else.

Hopefully, Mr. Falcone will see that and realize that sales aren’t everything, and dial back investment risk.  But who can tell?

My main errors came from mis-estimating people.  I was not strong enough to change the culture, and I should have realized that, and tried to be more incremental.  As it was, I was right, but frozen out from being able to effect change.

Final episode tomorrow, most likely…