Fooling Some of the People All of the Time, a Long Short (And Now Complete) Story, Updated With New David Einhorn (best classic books of all time .TXT) 📖

collateral. One example: A gas station loan, in which the station contaminated the well water used by the people living nearby. Remediation cost was $1 to $2 million and exceeded the collateral value of $750,000. BLX couldn’t foreclose on the gas station because it would have opened them up to legal liability to the people using the poisoned water. Instead, BLX abandoned the property.

Williams thought the Colorado loans were particularly noxious. There was a loan where the loan officer was Richard Ronci, who temporarily acted as the CFO of the borrower during the loan process. BLX’s defense to this obvious conflict of interest was that it was disclosed. The borrower sued, and a BLX executive flew to Colorado to settle. When I later looked at the records, this may have been the loan that Brickman discovered that revealed the $9 million loan transfer between BLX and Allied.

Williams was curious about the significance of the $9 million. “That is the first thing everyone asks me.” He didn’t see what was special about them. He said there were about fifty such loans between Allied and BLX with a total value approaching $50 million.

Williams explained how the SBA monitored the workouts. BLX would prepare a liquidation plan and submit it to the SBA for approval. Williams’ team would always follow that plan. Many times, BLX would list a workout property for sale at too high a price. It wouldn’t sell. Sometimes the company would simply sit on a loan with a higher appraisal, not foreclose, and the SBA would let it sit forever. Because the company told the SBA what they were doing in advance, and the SBA had approved the plan, there was nothing the SBA could do about it.

The SBA would scrutinize the liquidation efforts by BLX, but almost never seemed to question the original underwriting. Williams said this wasn’t always the case. Before BLX got preferred (PLP) status, there was more oversight. The USDA did a better job than the SBA of questioning BLX originations. He said when BLX got a PLP license, apparently the SBA was supposed to review all the existing loans as part of the transition, but it never did.

Auerbach said McGee, the previously convicted felon who was the head of the Richmond office, had voting authority in the credit committee. The former BLX employee who contacted me by e-mail in 2002 had told me the same thing. When Jesse Eisinger from The Wall Street Journal confronted Allied about McGee’s role, they vehemently denied he was on the credit committee. Auerbach said McGee was treated differently. In one instance, Auerbach was told “never to contact McGee.” One of the loans in Auerbach’s portfolio was a 7-Eleven in Richmond, Virginia. Auerbach was working out the loan and wanted to send someone to look at the furniture and fixtures to buy. He called McGee, who told Auerbach he would take care of it. A bit later, David Redlener, a senior BLX executive, called Auerbach and told him to forget about the liquidation, that McGee would take care of it. The loan just sat on Auerbach’s list.

BLX held quarterly reviews of the workout loans. We were surprised to hear that Allied CFO Penni Roll usually participated by phone and Joan Sweeney usually appeared in person. During these meetings, Williams’s team produced binders of documents, and everyone discussed individual loans, reserves, and valuations.

Williams suggested we try to get the “Loan Loss Allowance Valuation” binders. Those books would contain all the detail behind the workout loan valuations. He told us that after the review meeting, Redlener would prepare a valuation report, which Williams and Auerbach did not see, used for setting reserves in BLX’s financials. Williams believed the reserves would not match the recommended valuations from the workout team in the Loan Loss Allowance Valuation binders.

Williams said the financial statement values were inflated, in part, because Roll had a concept of a “person value” for each borrower, because each borrower personally guaranteed the loans. This value acted as a valuation floor when there was inadequate collateral in the loan. Williams understood that if the person had any money, he wouldn’t default on the loan in the first place, and BLX almost never collected anything on the personal guarantees, but gave them value for accounting purposes.

At the time Williams and Auerbach were there, BLX had three categories of loans: SBA, USDA, and “Bobby family” loans. When working out a loan, “Bobby’s [Tannenhauser] family always got paid. It was all right for the SBA to get nothing.” We pressed them for details about the “Bobby family” loans. Williams and Auerbach had few, as those loans all had happy endings.

We believed that one or both of them had spoken to Carruthers years earlier and abruptly broken-off conversations with him around the time Allied stole its critics’ phone records. We asked Williams and Auerbach about this, but they recalled only minor contact with Carruthers and had vague memories on that subject.

Obviously, we were in no position with the government to broker an immunity deal for Williams and Auerbach. After our lunch, we tried to figure out how to help them. However, when we tried to follow-up with Williams to discuss matters, he didn’t return our calls.

One week after the Auerbach/Williams meeting, Allied announced that it agreed to sell Mercury Air Center to Macquarie Infrastructure Company. Mercury operated terminals for private jets. This sale generated a realized gain of $240 million for Allied. Based on our analysis, this was the last identifiably ripe flower left to pick in Allied’s garden.

On May 8, 2007, Allied released its first-quarter earning results. Net investment income fell to only 26 cents per share. The overall yield on the interest-bearing portfolio fell to only 11.6 percent. The results were hurt by higher nonperforming assets (6.4 percent of the portfolio compared to 5.3 percent at the end of the year, despite strong credit markets), lower deal-origination fees and higher investigation expenses. Allied invested $19.2 million in BLX (inclusive of the $12