Write-downs, clawback reserves vex Fortress

Publicly traded alternative asset firm Fortress Investment Group blamed mark to market accounting for the $368 million in reserves it took in 2008 for potential private equity clawback obligations and write-downs. The firm, which cut 8 percent of its staff last quarter, posted an annual pre-tax distributable loss of $162 million, as compared to the $552 million in pre-tax distributable earnings it recorded in 2007.

“Our distributable earnings were negatively impacted by non-cash adjustments from a combination of write-downs in principal investments as well as reversal of incentive incomes earned on the private equity funds stemming from these unrealised write downs, or clawbacks as they’re commonly known,” chairman and chief executive Wes Edens said during an analyst call.

The firm saw its assets fall nearly 11 percent over the year to $29.5 billion; its private equity funds under management fell from $13.2 billion at the start of 2008 to $12.6 billion over the course of the year.

Edens stressed that the adjustments do not reflect a permanent loss in value but are in line with fair value accounting rules, which require assets to be held at the price they would fetch if liquidated today. “True loss of value versus mark to market values remains to be seen,” he said. “So long as your capital is patient and long-term, as it is here, the ultimate value of the investments will become evident.”

Asked by an analyst to give a worst case scenario calculation in terms of the maximum clawback amount Fortress could be liable for, chief financial officer Dan Bass said the figure is roughly $60 million net, “if we got zero from the investments we’ve taken reserves on today”. He emphasised, however, the unlikelihood of the firm’s funds failing to exceed hurdle rates. “It’s a small probability, but it’s greater than ‘remote’, so we’ve taken the reserve on it. It’s pretty low-bar.”

Wes Edens

Edens noted 2008’s global financial landscape, with capricious stock markets, declining housing prices and rising unemployment, was “the single most volatile and difficult year in the financial markets in any year since we’ve been alive”. He added that this volatility has continued into the first quarter. “These tremendous dislocations, while unnerving to us all, are of course exactly the types of markets that produce ‘once in a lifetime investment opportunities’.”

Fortress is well placed to weather the worsening economic conditions and will be able to act on opportunities as markets stabilise, he said. “Approximately 82 percent of the capital of the firm is long-term private equity capital with an average 9.2 years of remaining term, and we have several billion of remaining dry power to pursue investments in both private equity and credit.”

The firm is bullish on the US government’s troubled assets relief fund, or TALF, which has its first draw down this week. Edens said Fortress has had “very active dialogue” with the government on a number of levels.

“I do believe that TALF can play a very material role in both stabilising asset prices as well as restarting primary levels of finance,” said Edens, who also noted the financial sector is likely to produce significant opportunities. “If this is the great recession of our lifetimes, then surely what will follow is the great liquidation,” he said. “Consolidation of the banking sector will be sizeable and yield significant opportunities.”

Fortress shares were trading at around $1.60 each at press time, down more than 91 percent from its 52-week high of $16 and off more than 95 percent from its $35 per share issue price in February 2007.