Digging In

Calling the financial markets over the last year erratic is an understatement. Triple-digit swings in the major indexes were commonplace, and the near collapse of the once-mighty financial services giant Bear Stearns, combined with the ongoing subprime mortgage crisis, a weak housing market, and a lackluster mergers and aquisitions scene kept the financial markets under a gray cloud.

The equity markets finished up slightly last year: the Dow Jones industrial average gained 6.43%, the S&P 500 climbed 3.5%, and the Nasdaq composite index rose 9.8%. However, the dip in housing prices hit the debt side, with the yield on the benchmark 30-year Treasury note dropping 7.5%. To help ease recession fears, the Federal Reserve aggressively acted to revive the economy, including slashing short-term interest rates seven times from September 2007 to April 2008. The Fed also agreed to lend investment houses and banks $200 billion in securities to free up new credit.

With this backdrop, skippers at many of the nation’s largest black-owned financial services companies are turning to tried-and-true strategies to boost profits and generate business in today’s unstable business climate. Stock buybacks, cash and stock bonuses, as well as acquisitions and divestitures are among the tools the leaders of these firms are employing to increase the bottom line. These entrepreneurs are digging in to entrench themselves against uncertain equity and real estate markets, recession fears, and banking woes. Here’s how they’re doing it.

BANKS: DEALING WITH DECLINING ASSETS
The top challenges for most banks over the past year, including those on the BE BANKS list, were declining quality of assets, slowing earnings growth, and the compression of net interest margin (the difference between what banks charge on loans and pay on deposits). Buddy Howard, president and banking analyst at Equity Research Services Inc., in Raleigh, North Carolina, says these pressures are likely to persist in 2008, particularly given the recent economic slowdown. “Looking ahead, it will be critical for financial institutions to maintain sound underwriting and collection policies, to contain costs, and to seek nontraditional sources of income, such as insurance and wealth management,” Howard says.

One bank dealing with such issues was Durham, North Carolina-based Mutual Community Savings Bank. In March the bank closed a $3.7 million stock buyout deal with M&F Bancorp, parent of M&F Bank (No. 11 on the BE BANKS list with $222.2 million in assets).

Adjusting to the unstable environment, some black banks performed well — particularly those that diversified their lending. In Los Angeles, Broadway Financial Corp., parent of Broadway Federal Bank (No. 4 on the BE BANKS list with $356.8 million in assets), saw its assets grow 18% as the bank tripled its lending to churches. “In that type of environment, small community banks have to develop a niche strategy to be competitive, maintain profitability, and sustain growth,” says Paul C. Hudson, chairman and CEO. According to Hudson, the bank will continue a cash incentive program it started last year to encourage employees to sell more products and services to boost lending and deposits. For instance, a banker at Broadway can now make a commission based on products sold, such as certificates of deposit.

No bank has had more adjusting to do than Liberty Bank & Trust (No. 8 on the BE BANKS list with $328.2 million in assets). In the aftermath of Hurricane Katrina, Alden J. McDonald Jr., president and CEO of the New Orleans-based bank, has been busy rebuilding his business. Liberty Bank recently won a bid to take over the assets of Kansas City-based Douglass National Bank, formerly on the BE BANKS list. Liberty acquired an estimated $55 million of Douglass’ assets at book value, less a discount of $6.1 million. Liberty also picked up approximately 6,500 accounts, three branches, and the ATM network from Douglass, previously the Kansas City area’s only black-owned bank. Federal regulators closed Douglass because of escalating bad loans and insufficient capital. In 2007, assets at Liberty rose 9.6%.

Despite the concerns in the housing market, Milwaukee-based Legacy Bank (No. 13 on the BE BANKS list with $184.4 million in assets) realized asset growth of about 15% mainly from a jump in loans to small businesses and commercial real estate developers. Net loans grew by 11% to $144.7 million while bank deposits grew 12.7%, from $134 million to $151 million in 2007. The gains helped the bank, founded in 1999 by three African American women, post a 39.4% increase in profits, from $961,000 to $1.34 million. To motivate employees to improve efficiency, sell more products, and boost profitability, CEO and President Deloris Sims says Legacy launched cash incentive and employee stock option programs. The bank also plans to use $120 million in tax credits from the U.S. Treasury Department to make loans to small businesses. “Those tax credits will help us get through these tough times,” Sims says.

ASSET MANAGERS: DODGING SUBPRIME
A trend that black asset managers benefited from last year was that many of the nation’s largest pension funds — including those managed by states, major cities, and big corporations — realized they could get better investment results and great services by broadening their focus to hire “emerging” asset managers who typically have less than $5 billion in assets under management. According to Isaac H. Green, president and CEO of Durham, North Carolina-based Piedmont Investment Advisors L.L.C. (No. 10 on the BE ASSET MANAGERS list with $2 billion in assets under management), the trend has grown steadily since the bear market of 2000-2002. However, it’s also led to a rapid increase in the number of firms competing in this business segment, making it more difficult for any of the emerging asset managers, including the black-owned firms, to distinguish themselves.

Ranked No. 8 on the BE ASSET MANAGERS list, Houston-based Smith Graham & Co. Investment Advisors L.P. grew 21.1% last year in assets under management, from $2.27 billion to $2.75 billion. Gerald B. Smith, chairman and CEO, attributes the gain to the firm’s solid performance in the bond market during the past three years. “Avoiding [subprime] issues has created new opportunities for us with corporate treasurers and other institutional investors who are looking for managers who have good returns with low risk,” Smith says.

He maintains that the firm is focusing on accountability and empowerment. It’s in the process of buying back 24% of the firm’s stock owned by Progress Level Mimic, a venture fund. The move would make the firm 100% employee-owned, giving his staff the opportunity to become stakeholders and providing motivation to boost revenues and profitability. “We realize in order to keep good people, you have to incentivize your people to show that you appreciate their value,” Smith says.

But 2007 was a more challenging year for Chicago-based Ariel Investments L.L.C. (No. 3 on the BE ASSET MANAGERS list with $13.2 billion in assets under management), which saw its assets under management fall 18.2% and revenues drop about 14% to $91.5 million. President Mellody Hobson attributed the decline to clients with a short-term investment focus as

well as a market driven by low commodity and cyclical stocks that the company avoids. A down year for small- and mid-cap stocks also contributed to the firm’s drop in assets. “Our long-term performance number remains outstanding, which is a function of looking at our performance over market cycles,” Hobson says.

One of the new additions to the BE ASSET MANAGERS list is Chicago-based real estate investment firm Capri Capital Partners L.L.C. (No. 4 on the list with $4.5 billion in assets under management). Headed by Chairman and CEO Quintin E. Primo III, the company manages a commercial real estate portfolio on behalf of
government agencies, corporations, and educational institutions. He notes that firms such as his have received huge inflows of capital as U.S. pension funds increasingly look for alternative investments such as real estate, private equity funds, and hedge funds to reduce the overall risk of their portfolios and increase returns. “A continued downturn in the economy will inevitably affect commercial real estate in the U.S.,” says Primo. “However, the fundamentals of the commercial real estate market still continue [to be] quite sound. There has not been excessive overbuilding as there was during the real estate boom in the late ’80s that caused a great glut. The commercial [construction] industry has learned from its mistakes.”

INVESTMENT BANKS BOUNCING BACK?
Donna Sims Wilson, executive vice president at M.R. Beal & Co., says 234 initial public offerings in 2007 were priced with total proceeds exceeding $54 billion, up 18% over the previous year. Black investment banks benefited somewhat from the bounce-back year for IPOs, according to Wilson. Among the IPOs with black participation were The Blackstone Group, a financial services company, and MF Global, a broker of exchange-traded futures and options, with deals worth $7.6 billion combined. BE 100s firms M.R. Beal, The Williams Capital Group L.P., Utendahl Capital Partners L.P., Toussaint Capital Partners L.L.C., Jackson Securities, and Loop Capital Markets L.L.C. participated in these offerings.

Chicago-based Loop Capital Markets (No. 2 on the BE INVESTMENT BANKS list) had a record year as it increased its total managed issues by 31.1% from 2006. Chairman and CEO James Reynolds Jr. attributed the growth to an expansion in the services provided to existing clients and the addition of new clients. Its $3.2 billion in senior-managed issues proved to be significant. “We are using these times to get closer to our clients, assisting them with taking advantage of certain opportunities in the market, and understanding as well as exploring additional ways in which we can be a value-added partner,” Reynolds says.

PRIVATE EQUITY: FEELING THE CREDIT CRUNCH
U.S. buyout activity broke records in 2007 for private equity deals, according to Sandy Anglin, a research analyst at Thomson Reuters, mainly because of M&A activity worldwide in the first three quarters of the year. There were $467.2 billion of private equity acquisitions, up from $438.7 billion in 2006. Top industries included media and entertainment, technology, energy and power, real estate, materials, telecommunications, and industrials. But due to the tightened credit markets, Anglin says, Thomson Reuters expects fewer deals to be completed this year. “The availability of cheap and easy financing is limited,” she says.

That tightening of lending conditions prompted Hartford, Connecticut-based Smith Whiley & Co. (No. 9 on the BE PRIVATE EQUITY FIRMS list with $270 million in capital under management) to be more aggressive in managing the company’s portfolio risk. “Our approach

is to dig deeper, perform regression analysis on prospective companies, and make sure there is ample liquidity to address any potential capital gaps,” says Gwendolyn Smith Iloani, president and CEO.

The method boosted the firm’s deal activity 20% through March over the same period last year. The firm is securing investors to raise $250 million for a third fund that would invest nationally in small- to medium-sized companies in consumer products, industrial, healthcare, technology, and food and beverage.

Iloani says the challenges facing private equity firms include connecting and effectively working with other providers of capital, such as large commercial banks. “Bank financing typically represents the lion’s share of the capital structure, and when the credit crisis deepens, investors at the bank level tend to pull back and tighten credit,” she says. “This directly impacts a company in that it restricts their ability to grow or manage in a downward or cyclical cycle.”

Samuel Boyd Jr., president and CEO of the National Association of Investment Cos., says over the past 15 years, NAIC members have witnessed two growth trends: a growing number of black-owned private equity firms and an increase in the deal flow for those firms. But Boyd concedes that the amount of capital that firms have raised from institutional investors has not been commensurate with the growth trends.

The effects of the subprime debacle on the financial markets and the erratic movements of the major stock indexes aren’t expected to go away anytime soon. But as the markets change, the CEOs of the BE 100S will adapt — and we will adjust how the companies on our lists are ranked.

Why We Changed Our Rankings
The ever-changing financial markets are reflected in this year’s rankings. To better capture the way Wall Street firms measure financial transactions and trends in the investment community, BLACK ENTERPRISE has made several changes to our financial services lists. First, we’ve changed the methodology for our BE INVESTMENT BANKS list to rank the companies by the more lucrative senior-managed issues. In addition, our BE PRIVATE EQUITY FIRMS now include those companies that invest primarily in residential and commercial real estate. Also, we’re including firms that invest in real estate assets on our BE ASSET MANAGERS list. BE feels that this will provide readers with the most accurate snapshot of the financial services industry and African American participation within it.

B.E. 100s Financial Services Eligibility
All financial institutions must be at least 51% black-owned, with the exception of banks — which must be classified by the
Federal Reserve as black institutions — and have been fully operational for the previous calendar year.
Banks
Financial ranking is based on total assets as of Dec. 31.
In addition to receiving surveys, we have consulted the Federal Reserve, state banking commissions, and industry associations.

Investment Banks
Financial ranking is based on total dollar amount of senior-managed issues (including co-senior managed issues) derived from the underwriting of municipal and corporate bonds and equities.

In addition to receiving surveys, we ranked firms based on information provided by Thomson Reuters Corp. data, which tracks investment bank transactions, reviews SEC filings, and serves as the industry standard for measuring such activities.

Asset Managers
Financial ranking is based on total dollar amount of managed assets derived from equities, fixed-income and tax-exempt investments, real estate, and cash.
In addition to receiving surveys, we have consulted federal and state regulatory agencies and industry associations. All firms on our list are registered with the Securities and Exchange Commission and had filed their annual assets under management at the time of publication.

Private Equity Firms
Financial ranking is based on total managed capital as of Dec. 31.
In addition to receiving surveys, we consulted regulatory agencies and industry associations.

Financial Services
Summaries
Banks

Â	2007	2006	% Change
Employees	1,900	1,832	3.71
Assets*	$5,887.299	$5,726.349	2.81
Capital*	$490.520	$455.918	7.5 9
Deposits*	$4,667.138	$4,603.331	1.39
Loans*	$4,173.896	$3,876.343	7.68

*IN MILLIONS, AS OF DEC. 31. PREPARED BY B.E. RESEARCH. REVIEWED BY THE CERTIFIED PUBLIC ACCOUNTING FIRM EDWARDS & CO.

 

Asset Managers

Â	2007	2006	% Change
Employees	435	396	9.85
Assets Under Management*	$83.593	$80.860	3.38

*IN BILLIONS, AS OF DEC. 31. PREPARED BY B.E. RESEARCH. REVIEWED BY THE CERTIFIED PUBLIC ACCOUNTING FIRM EDWARDS & CO. SOURCE: SEC FILINGS.

Investment Banks

Â	2007	2006	% Change
Employees	390	377	3.45
Senior-Managed Issues*	$12.127	–	–
Co-Managed Issues*	$809.117	–	–
Total Managed Issues*	$821.244	$577.936	42.10

*IN BILLIONS, AS OF DEC. 31. PREPARED BY B.E. RESEARCH. REVIEWED BY THE CERTIFIED PUBLIC ACCOUNTING FIRM EDWARDS & CO. SOURCE: THOMSON REUTERS CORP.

Private Equity Firms

Â	2007	2006	Â
Employees	279	96	Â
Capital Under Management*	$28,343	$4,499	Â
Number of Funds	44	34	Â
Total No. of Portfolio Companies	591**	255	Â

*IN MILLIONS, 2007 FIGURES REPRESENT EXPANDED LIST WITH FIVE ADDITIONAL FIRMS. AS OF DEC. 31. PREPARED BY B.E. RESEARCH. REVIEWED BY THE CERTIFIED PUBLIC ACCOUNTING FIRM EDWARDS & CO. **INCLUDES REAL ESTATE PROPERTIES

Building Blocks of Commercial Real Estate
While the economy has suppressed gains in the residential space, commercial real estate investors are continuing to generate returns — albeit mainly in underserved (sometimes called emerging) markets in the U.S. or in international markets such as India or the United Arab Emirates. Generally speaking, investment options consist of four major categories:

1. Real estate developers such as The Peebles Corp. (No. 18 on the BE INDUSTRIAL/SERVICE 100 list with $245 million in revenues) and RLJ Development (No. 5 on the BE INDUSTRIAL/SERVICE 100 list with $704.3 million in revenues) use investors’ money to complete a real estate project. They typically want to get in, manage the project to be constructed, and then sell it off upon completion. Since developers generally have a minority interest in the projects (the principal investors get the majority), their returns are generated when the property is sold. Developers are generally not looking to hold properties for long periods of time. Because they typically oversee construction projects for a fee, these firms remain part of our BE INDUSTRIAL/SERVICE 100 list.

2. Real estate private equity firms such as MacFarlane Partners (No. 1 on the BE PRIVATE EQUITY FIRMS list with $20 billion in capital under management) typically raise institutional capital and try to leverage that capital as an equity investment in real estate assets. Over the years, they’ll manage those assets and get to an exit strategy that allows them to either sell or refinance to enable their investors to gain a return. Similar to private equity firms that invest in operating companies, these firms raise money, acquire properties, and generate ongoing fees for managing that real estate.

3. Real estate asset managers such as Capri Capital Partners (No. 4 on the BE ASSET MANAGERS list with $4.5 billion in assets under management) function in many ways similarly to banks. As opposed to the private equity firms that raise capital and acquire properties, real estate asset managers fund the projects. They’re involved in the financing of the real estate transaction rather than being involved in the hard assets. Their return is generated by fees and interest on the investment (similar to a bank loan). Like other asset managers, they can hold, increase, or sell their investment stake in a project.

4. Real estate investment trusts (REITs) are corporations or trusts that own or operate income-producing real estate. Publicly traded REITs function like closed-end mutual funds. However, rather than being backed by the value of a pool of stocks or bonds, REITs are backed by the value of their portfolio of properties or mortgages on properties.