DealBook: Global Markets Continue to Plunge | Admission to the ‘Unicorn’ Club | The Rewards of Lending Boldly

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Monday, August 24, 2015
TODAY’S TOP HEADLINES

M & A Zurich Insurance Seeks More Time for 5 Billion Pound RSA Offer

PRIVATE EQUITY Africa Private Equity Group Raises $1.4 Billion

HEDGE FUNDS Trump Says Tax Code Is Letting Hedge Funds ‘Get Away With Murder’

OFFERINGS Healthy Market Needed For Samsung Biosimilar I.P.O.

VENTURE CAPITAL Big Investors Are Finding Ripe Start-Up Targets in Europe

LEGAL/REGULATORY Vague Disclosures by Highflying Mutual Funds May Put Investors in Peril

For the latest updates, go to NYTimes.com/DealBook
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By AMIE TSANG

GLOBAL MARKETS CONTINUE TO PLUNGE Stocks continued last week’s slide, led by a rout in Asia, David Jolly and Neil Gough report in DealBook. Shanghai’s stock market closed down 8.5 percent, erasing its gains so far this year.

The market plunged despite an announcement by China’s government on Sunday that the country’s pension funds would be allowed for the first time to invest in stocks. Pension funds can now invest as much as 30 percent of their holdings in the stock market. The main state-run pension fund manages about $550 billion of ordinary citizens’ retirement savings.

The concerns over China’s economic slowdown and the souring view of once-favored emerging economies have rattled financial markets in recent days and show no sign of letting up.

Stocks fell sharply at the open of trading in Europe, with the Euro Stoxx 50, a barometer of eurozone blue chips, dropping 2.2 percent in early trading. The FTSE 100 in London fell 2.05 percent and the DAX in Germany fell 2.29 percent. Trading in Standard & Poor’s 500 futures indicated that Wall Street was headed for a downturn at its opening bell.

The tumble on Monday follows the steep sell-off on Wall Street on Friday, when the Dow Jones industrial average fell 3.1 percent, threatening to end the six-year rally in United States stocks.

The gloom hung over the entire Asian region on Monday. The Nikkei 225 stock average closed 4.6 percent lower, while Australia’s main index fell 4.1 percent, and Hong Kong’s Hang Seng Index closed down 5.2 percent.

Most Asian currencies fell against the dollar, including the Malaysian ringgit, which slipped 1.4 percent in early afternoon trading. The yen, considered a regional haven currency, rose against the dollar for the fourth day in a row. Prices for commodities such as oil and copper continued their retreat.

The sharp decline in global markets has sped up as the large mutual funds that helped fuel rapid growth in developing countries have begun retreating from those investments, Landon Thomas Jr. reports in DealBook. In the last week alone, investors pulled $2.5 billion from emerging-market bond funds, the largest withdrawal since January 2014.

The selling spree has raised concerns among regulators and economists about a broader contagion that could make it difficult for individual investors to withdraw money from their mutual funds.

Although these funds do not use borrowed money, as did the banks that failed during the mortgage crisis, they have invested large sums in high-yielding bonds and bank loans that are not easy to sell – especially in a bear market.

If investors ask to be repaid all at once – as happened in 2008 – a bank run could unfold because funds would have difficulty meeting the demands of people wanting their cash back.

Because large global banks suffered significant losses during the financial crisis and were forced to rein in their lending, more nimble bond investors stepped in.

In January, economists at the Bank for International Settlements, or B.I.S., a clearing house for global central banks, highlighted in a study how fast dollar-based lending to companies and countries outside the United States had increased since the financial crisis – doubling to over $9 trillion. This growth was coming not from global banks but from American mutual funds buying the bonds of emerging-market issuers.

Large fund companies like BlackRock, Franklin Templeton and Pimco have been inundated with money from investors eager to invest in the high-yielding bonds of emerging-market corporations and countries.

For example, Pimco’s Total Return bond fund, a mainstay for investors with fairly conservative investment goals, has 21 percent of its $101 billion in assets invested in emerging-market bonds and derivatives.

Among the many beneficiaries of this largess were commodity-driven borrowers like the state-owned oil companies Petrobras in Brazil and Pemex in Mexico, the Russian state-owned natural gas exporter Gazprom, and real estate developers in China.

One of the more extreme cases of this bond market frenzy was in Mongolia. In 2012, with expectations high that the relatively tiny economy would reap the benefits of China’s ceaseless appetite for raw materials, the government sold $1.5 billion worth of bonds, with demand from investors reaching $10 billion. That meant, in effect, that the country was in a position to borrow twice its $4 billion gross domestic product.

Three years later, the International Monetary Fund is warning that Mongolia may not be able to make good on these loans – 14 percent of which are owned by Franklin Templeton, according to Bloomberg data – and the yields have shot up to about 9 percent from 4 percent.

Brazil, China, Malaysia, Russia, Turkey and others have sold more than $2 trillion in bonds, mostly to American mutual fund companies, since 2009. As this money flowed in, financing skyscrapers in Istanbul and oil exploration in Brazil, economies and currencies strengthened.

Now as that money heads for safety, local currencies are plunging.

B.I.S. economists warned this month that because bond funds have become so large and own so many of the same securities (many of which tend to be hard to sell), a bond-selling panic can spread quickly.

What worries many regulators and economists is how much mutual fund money is now tied up in hard-to-sell bonds – an amount that far exceeds the exposure investors had to these markets in earlier emerging-market crises.

ADMISSION TO THE ‘UNICORN’ CLUB The $1 billion valuation metric was popularized two years ago by the venture investor Aileen Lee. She noted that the start-ups that reaped the hugest riches for venture capital investors, like Facebook, often reached a valuation of $1 billion while they were privately held. She referred to them as “unicorns" because they were so rare, Katie Benner writes in The New York Times.

Since then, many start-ups have attained this status and topped it. Uber received a valuation of around $51 billion, while Airbnb is pegged at about $24 billion. There are at least 131 “unicorns" galloping around the private market, and they are worth $485 billion to investors, according to the research firm CB Insights.

To see which companies might be next to hit the billion-dollar mark, CB Insights analyzed dozens of factors, including the amount of money raised, employee turnover, the overall health of the sector and the quality of investors. Of the 50 companies on its list, about half of the companies are based in San Francisco and Silicon Valley, and 10 are international, with several hailing from China and India.

Many are also part of the hot tech sectors of the moment. Investors are pouring money into service-oriented start-ups that let consumers get food, razors, handymen or piano teachers at the touch of an app. A satellite company and two drone companies also appear on the list.

Many of the start-ups identified by CB Insights may never hit a billion-dollar valuation. The current members of the unicorn club all reached that status in less than eight years, according to data from Pitchbook, a private equity and venture capital research firm.

Ms. Lee said there were more $1 billion private companies these days partly because big industries like hotels and taxis were now considered fair game for start-ups. The thing to watch, she said, is whether companies meet the expectations and goals they set when they became unicorns before they burn through the money they raised. “If they don’t do that, they’re in a dangerous position," she said.

ON THE AGENDA Marc Benioff, the chief executive of Salesforce, is a guest on Bloomberg Television at 4:25 p.m. Dennis Lockhart, the president of the Federal Reserve Bank of Atlanta, will address the 2015 Public Pension Funding Forum in Berkeley at 3:45 p.m.

THE REWARDS OF LENDING BOLDLY You have substantial assets, but your income is erratic and your finances are referred to in private company as “complex." Your credit history may contain a smudge or two. Yet you would like to buy one more luxury apartment. Major banks like Wells Fargo and JPMorgan Chase are not eager to give you the $3 million mortgage you need. If that’s your profile, Gregory Garrabrants may be your man, writes Peter Eavis.

Mr. Garrabrants leads the San Diego-based Bank of Internet USA and has been issuing big mortgages to high earners that haven’t been welcomed with open arms by other lenders. Bank of Internet has been turning heads and setting off alarm bells with its spectacular performance.

The bank has made loans to people who were later found to have run afoul of the law, and Mr. Garrabrants has had to reassure investors that the bank has good relations with regulators.

Bank of Internet’s loans have increased fivefold, to nearly $5 billion, over the last five years. Its losses from bad loans are practically nonexistent and profit are surging, in part because it charges a much higher interest rate than other banks in the market.

The bank’s stock has risen a staggering 1,600 percent since Mr. Garrabrants came on board in 2007 as chief executive of BofI Holding, the parent of Bank of Internet. He left IndyMac, a large lender that collapsed under the weight of its mortgage losses less than a year later.

Bank of Internet is an intriguing reminder of the money that can be made when a bank dares to take a chance on borrowers and then keeps those loans on its books, Mr. Eavis writes. It is a test case: Can bankers venture beyond the guardrails to make riskier loans without getting into serious trouble?

Some investors are already betting that Bank of Internet’s run will fizzle. The bank makes large mortgages to wealthy foreigners, a practice that requires meticulous controls to comply with federal regulations aimed at stopping money laundering. Critics wonder whether its compliance department is up to the task. They also argue that it is too dependent on customer deposits that could evaporate if turbulence returns to the banking world.

Mr. Garrabrants says the bank is as judicious as any other lender in picking its borrowers. “It’s about being thoughtful about what risks you take and watching them and being careful," he said, adding that Bank of Internet’s deposits are a reliable source of funding.

Bank of Internet recently closed another fiscal year, reporting net profit of $83 million, nearly 50 percent higher than in the previous one. Those earnings were equivalent to 18 percent of the bank’s shareholder capital, an astonishing return in these humdrum times in banking.

“It’s a great business," Mr. Garrabrants said, “and the sole thing that keeps us from growing it more is that we’re just trying to make sure that we don’t make mistakes."

MERGERS & ACQUISITIONS »

Zurich Insurance Seeks More Time for 5 Billion Pound RSA Offer RSA is likely to ask Britain’s Takeover Panel to extend Tuesday’s deadline for Zurich to make a firm bid or withdraw for six months, The Financial Times reports, citing people familiar with the matter.

GVC Still Finalizing Takeover Offer GVC Holdings said it is still working with Bwin.party Digital Entertainment on a $1.6 billion takeover offer as it seeks to break up 888 Holding’s agreement to acquire the online gaming company.

For the latest updates, go to NYTimes.com/DealBook
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PRIVATE EQUITY »

Africa Private Equity Group Raises $1.4 Billion Abraaj Group, a Dubai-based company, has amassed the largest pool of private equity capital yet for investments across Africa.

HEDGE FUNDS »

Hedge Funds ‘Getting Away With Murder’ Because of Tax Code, Trump Says The Republican presidential front-runner Donald Trump blasted hedge fund managers on Sunday as mere “paper pushers" who he said were “getting away with murder" by not paying their fair share of taxes.

Hedge Funds Exit Crop Markets Bumper global harvests and slowing demand will push combined inventories of corn, soybeans and wheat to a record. This has prompted money managers to lower their bets on higher prices for a fifth straight week.

I.P.O./OFFERINGS »

Healthy Market Needed For Samsung Biosimilar I.P.O. While biosimilars – which are biotechnology drugs similar to generics – are in their early days, Samsung would only need to capture a small portion of the sales to generate significant revenue. The one problem is timing, Charley Grant writes in Heard on the Street.

VENTURE CAPITAL »

Big Investors Are Finding Ripe Start-Up Targets in Europe Venture capital, private equity and other big investors are increasingly finding technology start-up investment targets in Europe.

Intel to Invest Heavily in Software That Enhances Cloud-Computing Capabilities An expected $100 million in funding to be directed to cloud-computing software and a related start-up reflects the company’s view of its own future.

Uber Says Tencent Blocking Its Accounts in China Uber says Tencent, a backer of the local car-booking app Didi Kuaidi, had banned or frozen all of Uber’s accounts on WeChat.

One of Tech’s Best Investors Says Valuations Are Too High Jeremy Levine, a top venture capitalist at Bessemer Venture Partners, invested in Pinterest, LinkedIn, Yelp and Shopify well before they reached peak popularity, but has led just one new investment over the last 20 months.

LEGAL/REGULATORY »

Vague Disclosures by Highflying Mutual Funds May Put Investors in Peril Leveraged loans, a kind of obligation held by floating-rate income funds, carry risks that are often not fully disclosed to investors.

Soaring Art Market Attracts a New Breed of Advisers for Collectors Consultants to wealthy clients now play a deal-making role for commissions that are sometimes worth millions of dollars.

The Fed Looks Set to Make a Dangerous Mistake Raising rates in the near future would be a serious error that would threaten all of the Fed’s major objectives, Lawrence Summers argues.


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