The global financial crisis highlighted the important role Christopher Flowers played as an advisor to financial institutions and government officials, but it also cast his track record as a private equity investor in a rather unflattering light.
JC Flowers Fund II, which raised $7 billion in 2006, has been plagued by a number of issues since its launch. Most notably, the firm’s investments in lender Hypo Real Estate, HSH Nordbank, Shinsei Bank and broker MF Global, which account for more than 60 percent of the fund, have dragged down returns.
As of 30 June, Fund II was generating a 0.33x investment multiple of invested capital and a negative 29 percent internal rate of return, according to Regents of the University of California documents.
“Fund II’s not going to recover,” one limited partner told Private Equity International, adding that key holdings like Hypo, HSH and Shinsei have depressed performance so much that the fund’s more successful holdings won’t be enough to generate returns.
The collapse of MF Global in late 2011 is the most recent of the fund’s string of busted investments. Flowers had tapped former colleague and New Jersey Governor Jon Corzine to lead the commodities broker, in which Fund II had $87.4 million invested, according to documents seen by Private Equity International.
Under Corzine, the broker implemented a strategy that invested heavily in European sovereign debt. On 25 October, only months after the firm had valued the company as generating a 1.9x gross multiple on invested capital, MF Global reported losses of $191.6 million – in large part because of its massive exposure to Europe. MF Global declared bankruptcy six days later.
Fund II in the crisis
The firm’s problems with Fund II did not begin with MF Global, however. JC Flowers has struggled with the fund since the onset of the economic crisis in 2007, when the global meltdown overwhelmed some of the portfolio’s investments in financial institutions.
For example, Hypo Real Estate was generating a 0.1x return multiple after the firm was forced to exit in 2009 when the German government nationalised the troubled lender, according to financial documents seen by Private Equity International.
The real estate lender had struggled in 2007 amid concerns over the sub-prime mortgage market, and was eventually bailed out by the German government only months after JC Flowers acquired its minority stake. A year later, Germany used its new status as a majority shareholder to force the firm to exit Hypo at €1.30 per share – 5 percent of the firm’s original purchasing price.
Fund II’s largest holding, German regional bank HSH Nordbank, was generating a zero multiple as of 30 June, according to two people with knowledge of the investment. JC Flowers has invested $1.94 billion in the bank through the fund.
Shinsei Bank, which Flowers had invested in prior to launching his firm, has also fared poorly. Although Shinsei has performed better in 2011 – its net income rose by 31 percent compared to the same period in 2010 – its stock price has never fully recovered from the effects of the financial crisis. The bank’s earnings and share price were buffeted by the turbulent market in the fall of 2008, and remains well below the firm’s ¥425 per share purchase price agreed in 2008. As of 26 January, shares in Shinsei were trading at ¥84, or 19.8 percent of Fund II’s original investment.
The future of the firm likely rests on the performance of Fund III, which raised $2.3 billion in 2009, well short of its $3.5 billion target.
Fund III was generating around a 1.3x multiple on total costs of press time, according to a source with knowledge of the fund. Among its investments are IndyMac, the California mortgage lender that Flowers and other investors purchased for $13.9 billion in 2009, after it had failed and been seized by the Federal Deposit Insurance Corp. In 2010, it also picked up a stake in Brazilian bank BTG Pactual for $1.8 billion alongside other investors.
How these and other investments in Fund III turn out will play a large role in the firm’s future. As one market source said, it will take “off the chart” returns for JC Flowers to attract anything close to the amount it raised for Fund II.
Private Equity International takes a closer look into the struggles of Flowers’ second fund in the February issue.