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Real estate adds to losses in JC Flowers’ second fund

Poor investments, including a big stake in Hypo Real Estate, have played havoc with JC Flowers’ $7 billion Fund II.

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.

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 said privately, adding that key holdings like Hypo, HSH and Shinsei had depressed performance so much that the fund’s more successful holdings won’t be enough to generate returns. 

Hypo Real Estate is 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. The real estate lender had struggled in 2007 amid concerns over the sub-prime mortgage market and eventually was 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 – just 5 percent of the firm’s original purchasing price. 

Fund II’s largest holding, however, is German regional bank HSH Nordbank, which 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.

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 as 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.