In California, A Botched Bailout?

They were an odd couple from the beginning. Leon Black, a former head of mergers and acquisitions at Drexel Burnham Lambert Inc., had made a fortune helping Michael R. Milken sell billions of dollars in junk bonds in the 1980s. John Garamendi, California's politically ambitious insurance commissioner, rode into office in January, 1991, on a populist wave of anti-big-business sentiment, railing against the evils of junk bonds. But by the spring of 1991, Black and Garamendi found themselves allied in a $3.5 billion deal to save one of Milken's largest clients, faltering Executive Life Insurance Co.

Two years after its seizure by Garamendi, Executive Life remains unrescued and its policyholders unreimbursed. Most of the public attention on the episode has focused on Garamendi and a series of what critics claim were miscalculations that prolonged the rescue unnecessarily. "I'm not into hindsight," says Garamendi. "It was the path that worked at the time." But what's most remarkable about the Executive Life saga, and what has largely avoided notice, is the fact that Black and his management firm, Lion Advisors, have been able to insinuate themselves into the rescue process so intimately that at times they almost seem more agile in dealing with the unfolding events than Garamendi. Garamendi ended up with his reputation tarnished and his dream of running for governor in 1994 clouded. Certain Executive Life policyholder groups are likely to receive millions of dollars less than originally anticipated. But Black's adroit maneuvering enabled him and his French client, Altus Finance, a subsidiary of Credit Lyonnais, to reap what has turned into a billion-dollar bonanza: Executive Life's portfolio of junk bonds. Black and his partners have declined to comment publicly.

LION'S SHARE. Lion Advisors was involved with Executive Life months before Garamendi came on the scene. In December, 1990, news reports began to circulate that Executive Life would soon fail. Craig M. Cogut, a former Drexel lawyer and Black's key strategist at Lion Advisors, paid a call on then-First Executive CEO Fred Carr. Would Carr be interested in selling some of the nearly $9 billion in junk bonds on the company's balance sheet? Carr liked the idea and started talking deals with Cogut.

But Cogut wasn't the only one to see an opportunity. Garamendi, California's first elected insurance commissioner, saw a chance to make his mark. In April, 1991, he ordered Executive Life's seizure. Yet Black's team had been discussing restructuring possibilities for Executive Life with the new commissioner since February. To spur other bidders, Garamendi over the next four months negotiated with Cogut to come up with a bid against which all future bids for the ailing insurance company and its junk bonds were to be judged. Garamendi insisted that any bid for the junk bonds had to be accompanied by a bid for the insurance operations. There is no evidence that Black helped engineer Garamendi's strategy, but both moves entrenched his group as the front-runner.

To Garamendi and his crew, the junk-bond portfolio seemed a time bomb, as the junk-bond market was sinking fast. But where Garamendi envisioned disaster, Black and Cogut knew there was potential value--plenty of it--because their outfit had firsthand knowledge of many of the junk-bond issues. Garamendi's advice came from a team led by money manager GB Capital Management Inc., a Mill Valley (Calif.) group criticized by some Wall Streeters at the time for an alleged lack of junk-bond experience, a criticism GB Capital refutes.

Black's bid was elegant in its simplicity: Altus would pay close to $3 billion to buy all of the junk bonds, which would be managed by Lion Advisors for a percentage of the profits. And to provide policyholders with an estimated 95 on the dollar, a European group led by little-known French insurer Mutuelle Assurance Artisanale de France (MAAF) would buy the remaining insurance operations and infuse $300 million in fresh capital into the company. Cogut's team arranged for Altus to lend most of the money to the MAAF group for the capital infusion, with Credit Lyonnais providing a formal guarantee of that payment.

FEW PLAYERS. Garamendi's decision to float Black's already structured bid, ostensibly to streamline the process, backfired. A number of potential bidders contacted by New York-based Blackstone Group, Garamendi's investment bankers, weren't interested in playing, in part because they didn't want to compete with a group that had been combing the insurer's books for months and had a deal already, in effect, O.K.'d by the commissioner.

Not everyone was put off by Garamendi's approach to the sale. In August, the National Organization of Life & Health Guaranty Assns. (NOLHGA), an association of state guaranty funds, along with groups that included financier Richard Rainwater, insurance executive Eli Broad, and San Francisco-based investment firm Hellman & Friedman, announced that they wanted to bid.

Garamendi pushed aside the French bid and tentatively tapped NOLHGA's proposal. But he placed several conditions on approval of their plan. Arthur O. Dummer, chairman of the Executive Life Task Force of NOLHGA, says he now thinks "the conditions were designed not to be met." He contends that Garamendi only picked NOLHGA's plan to force up the price being offered by the French and other groups. Garamendi responds that "we did not use NOLHGA as a stalking horse."

The bid by NOLHGA shook up the Black camp. When it appeared that the NOLHGA bid had won, Cogut frantically tried to work with the group to get some role for his French client in the deal. Garamendi, though, rejected the NOLHGA bid on the grounds that the insurance group was unable to meet his conditions. He opened the bidding once again, and 10 days later, Black's group won by upping their offer for the bonds by $250 million and getting MAAF to sweeten its half of the deal by an estimated $150 million.

The additional cash, though, paled beside the profits that Black's group reaped. In March, 1992, the Black group acquired Executive Life's junk portfolio for $3.25 billion. Thanks in part to a rally in the junk market, the portfolio, according to some estimates, has grown by as much as $1.3 billion, a gain people close to Black dispute.

The Black group's effort to complete the deal was hampered by court battles involving holders of $1.8 billion in municipal bonds linked to Executive Life. The proceeds of the muni offerings had been invested in Executive Life guaranteed-investment contracts, or GICs. In his quest to get the most money for policyholders, Garamendi attempted to freeze out the bondholders. Attorneys acting on behalf of the muni-GIC holders filed suit. Instead of working out a settlement with the muni-GIC holders when it appeared that he had the upper hand in court, Garamendi stood fast.

A year later, the California Court of Appeal rejected the French bid, ruling that the muni-GIC holders were to be treated like any other policyholder. That meant giving them a cut of the $7.2 billion pie of assets that was to be divvied up among the regular policyholders, thus reducing what some policyholders had been promised.

NEW ENTICEMENTS. These maneuvers ended up posing big problems for the Black forces. Buoyed by their victory, attorneys representing the muni-GIC interests filed a motion to undo the $3.25 billion sale of the junk-bond portfolio. As the legal wrangling has dragged on, Cogut has had to scramble to hold the deal together. Since August, 1991, three of the original seven members of the MAAF Group have dropped out over frustration with the delay. Cogut has burned up the phone lines to Europe, keeping an increasingly impatient MAAF from backing off as well.

To regain the initiative, the Black forces submitted a new bid for Executive Life on June 9. The new plan offers an additional $80 million in potential settlement payments and promises that policyholders will get all profits--currently about $150 million--from a portfolio of largely illiquid assets still on Executive Life's books. Under the previous plan, those dollars went to the MAAF group. These enticements forced a number of the plan's former opponents to sign on grudgingly to the deal.

The Black group has also headed off another potential roadblock to the deal. Eli Broad, chairman of Los Angeles-based insurer SunAmerica Inc., notified Garamendi in early June that he might make a bid. Rather than risk further delay or a complete collapse of the deal, Black cut Broad in for a 33% stake in the new insurance holding company.

Hearings on the sweetened French bid are now being held in Los Angeles. It's far from clear how Garamendi, Executive Life's policyholders, and the many other interested parties will emerge from the fracas. Putting one's money on Black, though, is probably not a bad bet.

      APRIL, 1991 California Insurance Commissioner John Garamendi seizes 
      near-insolvent Executive Life Insurance. 
      AUGUST, 1991 Garamendi tentatively accepts bid from French investors led by 
      Altus Finance, a subsidiary of Credit Lyonnais. But he invites others to top 
      the bid.
      OCTOBER, 1991 Garamendi tentatively accepts bid from association of state 
      insurance-guaranty funds.
      NOVEMBER, 1991 Garamendi rejects state guaranty-fund bid. He reopens bidding, 
      then accepts new French bid.
      MARCH, 1992 Sale of Executive Life's junk-bond portfolio to Altus is completed, 
      raising $3.25 billion.
      MARCH, 1993 After hearing challenge by Executive Life bondholders, the 
      California court of appeals rejects details of the French plan, rules it 
      unfairly restricts what bondholders can recover.
      JUNE, 1993 State court opens hearings on a revised French plan in downtown Los 
      Angeles. Angry policyholders drop their criticism, while bondholders raise 
      further objections.
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