In 1980, the S&L industry was deregulated which then allowed them to make a wide range of consumer loans as well as commercial real estate loans similar to commercial banks.  S&L’s, which for the most part had been state chartered, could now obtain a federal charter accompanied by less stringent regulations.  Thrifts raced to become federally chartered and obtain the advantages including deposit insurance through the Federal Savings and Loan Insurance Corporation (FSLIC).

With regulations loosened, the S&L’s soon began to engage in increasingly risky activities.  Many S&Ls lent far more money than was prudent to ventures they were not qualified to assess, especially commercial real estate according to William Seidman, former chairman of the Federal Deposit Insurance Corporation (FDIC) and later the Resolution Trust Corporation (RTC).

Risky lending practices along with widespread corruption ultimately led to the insolvency of the FSLIC.  From 1986 through 1995, the number S&Ls declined by almost 50% from 3,234 to 1,645 including 747 insolvent S&Ls liquidated by the Resolution Trust Corporation.

The Glass–Steagall Act of 1933 instituted banking reforms that were designed to control speculation.  It was a reaction to the collapse of a large portion of the commercial banking system in 1933 and separated risky investment banking activities from traditional commercial banking activities.

At the height of the S&L crisis only the US economy was in a recession as opposed to the global recession precipitated by the 2008 financial crisis.  The total loss from the S&L crisis to the FSLIC and RTC was estimated to be about $152.9 billion according to an FDIC report.  Losses from the 2008 financial crisis have been estimated to be around $3.5 trillion spread across the globe over 20 times as great.

Many believe the 1999 repeal of the Glass–Steagall Act’s provisions helped precipitate the 2008 financial crisis.  Commercial banks could now acquire investment banks giving the latter access to former’s deposits.  Consumers, corporations and governments were able to leverage up their assets even more.  What flavor CDO, CLO, CMO do you want today?  It fostered a debt super-cycle that created a mountain of debt.  When the housing market collapsed it burst the credit bubble and exaggerated the severity of the financial crisis.

It is no wonder then that two of the most prominent investment management firms, Bridgewater Associates* and Pimco**, have such a gloomy outlook for the domestic economy as well as much of the global economy.  Their assessment is that it will take some 10 to 20 years to work through the mountain of debt that has been accumulated globally.

Until the debt burden has been worked down to a manageable level economic growth will continue to be anemic.  Clearly, the Federal Reserve Board’s view is that the economic recovery remains extremely fragile and will remain so for an extended period.  This afternoon it announced that it was unlikely to raise interest rates before the end of 2014.  Previously, its position had been that it was unlikely to raise interest rates until mid-2013.

That said, all bets are off if a solution is not quickly found to resolve Europe’s sovereign debt crisis.  A default by one or more of the Eurozone’s members or other untoward action would quite likely precipitate a global recession.

 ~~~~~~

 * – Bridgewater Associates is the world’s largest hedge fund manager with $120 billion of assets under management.  It was ranked as the best performing hedge fund manager in the world in 2010 and 2011.

** – Pacific Investment Management Company, or Pimco as it is more commonly known, is one of the largest investment management firms in the US with over $1.35 trillion of assets under management.

However, as bleak as the outlook may be, there is cause for optimism.  Entrepreneurship is alive and well throughout the world and ultimately it will lead us out of this darkness by creating new companies that will create jobs.  Perhaps if it were not for the headwinds cited above it might even be flourishing.

The past two weeks have been exhilarating being surrounded by so many bright and enthusiastic entrepreneurs with an intense desire to succeed.  First it was the 7^th Annual Intel Global Challenge at UC Berkeley.  It is a global business plan competition that encourages student entrepreneurs and rewards innovative ideas that have the potential to have a positive impact on society.  Teams competed from 60 countries and were whittled down to 30 teams from 20 countries that were brought to campus.  Over a period of several days 24Silicon Valley venture capitalists and industry executives culled the group down to the 8 finalists.

The Intel Foundation awarded $100,000 in cash prizes: first place and $50,000 went to Forward (Gaitu) which is an integrated, web based platform that enables consumers to add special effects to photos without expensive and hard to use photo-editing software.

Second place and $20,000 went to Maxygen-mobile DNA of Russia which invented a low-cost, portable DNA test solution used at the point of care to quickly identify thousands of infectious diseases.

Third place and $10,000 went to NanoDiagX of Egypt, which used gold nanoparticles to develop a virus test that can detect Hepatitis C in less than an hour at one-tenth the cost of current commercial tests.  Four other teams won special science awards of $5,000 each.

It was a remarkable evening and the keynote presentation by Dr. Genevieve Bell from Intel was absolutely fascinating.  Dr. Bell is an Intel Fellow and Director of User Interaction and Experience in Intel Labs.  I cannot remember the last time I was so riveted by a keynote speaker’s presentation.  Her compelling presentation on where technology is headed in the future is well worth watching and can be seen by clicking on this link.  The presentations of the 8 finalists follow Dr. Bell.

A week later it was the Keiretsu Forum’s annual Angel Capital Expo with some 350 angel investors, institutional investors and entrepreneurs participating.

The Keiretsu Forum is one of the largest angel investor networks inNorth America. Since its founding in 2000, members have invested over $260 million in companies in technology, consumer products, healthcare/life sciences, real estate and other industries with high growth potential. Northern Californiamembers are among the most active having funded 20 companies in 2011 and 16 in 2010.

The twelve companies that made presentations were:

Medicore Global develops advanced technology for reducing skin infections through a unique textile fiber application.

Cartelligent helps clients purchase a car, including best price negotiation, trade-in service, financing and lease analysis, and delivery of the new vehicle at any one of its locations

PaperCutz is a publisher of mass market graphic novels (comics in paperbacks) to the tween/teen audience.  The graphic novel market is the quickest growing in book publishing.

iCapEquity provides real estate owners and developers with the necessary equity capital to secure construction loans from traditional lenders.

Belveron Real Estate Partners is a secondary real estate partnership focused on creating early liquidity for institutional and individual real estate investments.

Les Concierges is a provider of global concierge services and solutions. Concierges are supported by a state-of-the-art proprietary Global Concierge Technology system.

Bucha produces Kombucha, a natural, low calorie, fermented tea with a history as a health elixir.

HydroVolts designs, builds and sells portable micro-hydropower turbines powered by water currents for distributed renewable energy generation.

Zamzee is a fun, engaging and scientifically proven movement-based incentive program to get young people and families moving more.

AMHC Inc. is a holding company that acquired two cutting edge technology firms with a strong revenue history as well as a portfolio of technology patents.

Clearly there is a bright future ahead.  It is evident that the entrepreneurial spirit with its creativity and passion is alive throughout the world.  There is little doubt in my mind that many of the presentations of the past two weeks would meet the “holy grail” test of a venture capitalist friend -it presents an elegant solution to solve a complex problem.

The August downgrade of U.S.debt by Standard & Poor’s, after the debacle over raising the nation’s debt ceiling, set the stage for a crisis of confidence in the financial markets.  With no clear resolution in sight to the Eurozone’s sovereign debt crisis there was grave concern regarding the viability of its banks – the ingredients for the perfect storm.

Financial markets internationally tumbled dramatically, volatility increased markedly and consumer confidence waned.  The Dow Jones Industrial Average fell or rose by some 400 points four days in a row.  The IPO window slammed shut.  Despite a pipeline of some 200 companies that had filed with the SEC not a single company went public in September.

The Eurozone is composed of 27 sovereign countries, each with its own separate banking system.  Despite a common currency there is no common treasury; therein lies part of the problem.  When the European Union was formed there was no political will to create such an institution.  In July, Eurozone leaders agreed to expand the powers of the EFSF in order to stabilize the Euro.  Yet it was only last week that the change was approved by all 27 nations, a cumbersome and inefficient process that does not build confidence.

The European banking system differs markedly from that of theUnited States.  In large part it has been financed by short term commercial paper much of which has been raised fromU.S.money market funds chasing yield.  As the sovereign debt crisis dragged on, many money market funds became unwilling to roll over the paper.  This has created liquidity issues for Eurozone banks as this is their prime source of funding. U.S.banks on the other hand obtain a large portion of their funding from a low cost and stable depository base.

Precipitating the crisis of confidence in the European banking system was the realization thatGreecesimply does not have the economic wherewithal to repay in full the 350 billion Euros of debt outstanding.  Some 280 billion Euros is held by Eurozone banks and the remainder is held by Greek banks.  The question is not whether there will be a “haircut” but how much it will be – the July plan called for 21% but the market appears to be expecting something much larger.

The health of the European banks is now at the forefront of the drama.  If the other debt laden Eurozone countries demand the same deal asGreece, the EFSF would prove insufficient.  The IMF (Ms. LaGarde was until recently France’s Finance Minister) as well as Ms. Merkel, Chancellor of Germany, and Mr. Sarkozy, President of France, have called for recapitalizing the banks so that they will be able to absorb the likely losses.

Eurozone banks are resisting the push to recapitalize.  With their shares trading at significant discounts (50% to 60%) to book value the dilution to existing shareholders would be immense.  However, if banks do not raise additional capital to absorb the anticipated losses they will have to shrink their balance sheets and shed assets to reduce their leverage in order to meet new capital requirements.  This will translate into fewer and more expensive loans to corporations and consumers.

The impact on the European economies would be huge.  According to a recent Financial Times article, Eurozone companies derive some 80% of their financing needs from Eurozone banks as compared to the 30% that U.S.companies receive.  With the engine of growth now sputtering, is another Eurozone recession in the offing?

According to The Wall Street Journal, DealLogic recently reported that for the first eight months of 2011 there were 87 IPO’s byU.S. companies.  This compares very favorably to 2010 when there were 87 IPO’s for the entire year.  This was a nice respite from conditions in 2008 and 2009 when both the IPO and M&A markets were virtually frozen.  During the dark days of the financial crisis only 22 and then 39 companies were able to go public in 2008 and 2009 respectively according to WilmerHale’s 2011 IPO Report.

However, all good things must come to an end.  And that they did.  Along came August and market volatility increased dramatically.  Four days in a row, the Dow Jones Industrial Average fell or rose by some 400 points which in all likelihood set a record.  Almost overnight the IPO window slammed shut as companies were forced to pull their IPO’s because of the uncertainty that was rampant in the market.

It will no doubt be “wait and see” for the remainder of 2011 as financial markets abhor the uncertainty that is abundant today.  According to The Wall Street Journal, DealLogic reported that the pipeline of companies registered with the SEC to go public swelled to 115 at the end of August.  The market turmoil in August caused 15 companies to pull their offering, the most since April of 2001 when 20 were pulled.

Unfortunately, the market volatility that has plagued the market since early August is unlikely to abate anytime soon and will likely to keep the window closed.  Underwriters are very wary of launching an IPO into tumultuous markets when a stock can often sink after its debut. They are well aware that a majority of the IPO’s issued during the first half of 2011 are now trading below their issue price.

In the last several years, private equity firms have been forced to hold onto their portfolio companies longer, a consequence of the weak recovery from the recession coupled with less than robust M&A and IPO markets.  According to PitchBook’s Private Equity Breakdown report, there were over 6,000 portfolio companies at the end of June.

Without healthy M&A and IPO markets, private equity firms are unable to provide the returns they have promised their limited partners.  And without healthy returns, limited partners are likely to look askance at the asset class.

Recently Completed Private Equity Transactions

ABRY Partners acquired Masergy Communications which provides managed, secure virtualized network services to enterprises with complex needs across multiple locations.

Brynwood Partners has acquired Pearson Candy Company which manufactures and markets confectionery such as Pearson’s Salted Nut Roll, Pearson’s Mint Patties, Pearson’s Nut Goodies and Pearson’s Bun.

Clearview Capital has acquired Child Health Holdings from Harbert Private Equity, the firm announced. Tampa-based Child Health, which does business as Pediatric Health Choice, provides health care services for medically complex, technology-dependent and behaviorally challenged children.

CounterPoint Capital Partners has acquired Tomich Brothers Fish Company which processes wetfish and other seafood for distribution and Standard Seafood a seafood wholesaler and processor.

Energy Capital Partners acquired CoaLogix which provides clean coal technology and services for coal-fired electric utility power plants.

Frontenac Company recapitalized Wenner Bread Products a wholesale bakery that makes frozen, par-baked and fully-baked dough, breads and rolls.

GTCR has completed its acquisition of BankServ which provides software-as-a-service banking and payments systems.

Golden Gate Capital acquired EP Minerals, a producer of diatomaceous earth and perlite filter aids, functional additives and absorbents.

Graham Partners has purchased Chelsea Building Products, a manufacturer of vinyl lineals and accessories for the window and door fabrication market.Chelsea also provides specialty cellular PVC moldings and exterior wall cladding.

H.I.G. Capital acquired Next Generation Vending and Food Service which provides vending and refreshment solutions for corporate and institutional environments.

J.H. Whitney acquired Autospliced which provides electronic interconnect solutions that include connectors, precision metal pins and stampings, integrated connector modules, shape memory alloy assemblies and printed circuit board assemblies.

JMH Capital has acquired Tri-Star Protector which services upstream oil and gas companies through the collection, refurbishment and resale of pipe thread protectors.

Mangrove Equity Partners has acquired North American Aircraft Services which provides aerospace services with a focus on fuel tank maintenance and repair.

MidCap Equity Partners acquired National Educational Music which sells and rents out band and orchestra musical instruments, primarily for use in educational programs.

Revolution Capital Group has acquired a majority stake in the Capital Exchange which provides a networking website for professionals throughout the financial community.

Saturday Capital acquired Code Red which provides first aid and automated external defibrillator training to companies.

The Riverside Company has acquired Sunless, which manufactures spray tanning booths, airbrush equipment and other products for salons.

The Sterling Group has acquired Stackpole International which manufactures and supplies oil pumps and powdered metal components to automotive original equipment manufacturers.

Transom Capital Group has acquired Ritz Camera & Image, a specialty retailer of camera and imaging products and services.

Veronis Suhler Stevenson has acquired Strata Decision Technology which provides web-based financial analytics and performance management software tools used primarily by hospitals and healthcare systems.

Mezzanine debt, which is often referred to as subordinated debt, is a layer of junior capital that is considered to be quasi-equity as it has some of the traits of equity.  For accounting purposes it is recorded as a liability and will be found beneath the senior secured debt on a company’s balance sheet but above the stockholders’ equity section hence the term mezzanine debt.

Typically unsecured, mezzanine debt receives a significantly higher yield than senior secured debt.  Generally the current pay coupon for mezzanine debt is a fixed rate of about 12%.  Mezzanine lenders look for an annual return of 18% to 19% and usually bridge the gap with warrants or other equity like features. The warrants represent far less dilution than issuing common stock would and let the owner maintain control of the business.   Another extremely attractive feature is that there is no amortization of principal over the life of the loan which usually has a term of five to seven years.

For larger transactions there may be a payment in kind (PIK) component option available to the borrower.  This is a periodic form of payment in which the interest payment is not paid in cash but rather by increasing the amount of principal outstanding equivalent to what the lender would have received if it had been paid in cash.  The following is an example to illustrate:

Loan principal – $10,000,000

Cash coupon – 12%

PIK – 4%

Monthly cash payment – $10,000

Loan principal at the end of the year – $10,400,000

Typically, a company with a proven track record and good prospects can obtain three to four times (during the height of the financial crisis it was half that!) its cash flow in senior secured debt. Mezzanine debt generally will be able to provide another one to one and a half times cash flow for total leverage of about four to five and a half times cash flow.

For well-managed middle market companies that have strong and predictable cash flows along with good business prospects, mezzanine debt can provide a viable solution for a company’s liquidity or expansion needs.  Mezzanine debt is not suitable for every company and should be evaluated carefully in conjunction with a company’s professional advisors.

Juan has cooked at many of the Napa Valley’s notable restaurants including Bistro Jeanty, Domaine Chandon and Saketini to name a few.  His deft touch is reflected in the lightness, freshness and quality of the food.  If you don’t see it on the menu ask Juan and he will prepare it if he has the ingredients available.

While perusing the menu you will be served some very good fresh salsa and tortilla chips made at the restaurant.  Then, sit back and  enjoy generous portions of authentic Mexican food made to order – carnitas, carne asada, chile rellenos, chimichangas, fish tacos and much more.  Everything is delightfully fresh and not heavy as Mexican food can often be.

Now for the real story.  My wife and I have now been going to Las Palmasfor about 8 years.  For the first four we ate nothing but the Mexican food because it was so good.  Traditional American meat and seafood dishes listed on a blackboard were also available but were ignored.

One night out of the blue we both decided to order seafood dishes and what a treat!  The seafood was absolutely exceptional.  It was some of the freshest and best prepared seafood we have ever eaten.  Clearly, this presented a problem as to what to order on subsequent visits.  Happily, the predicament was resolved by sharing one of the Mexican dishes as an appetizer followed by the spectacular seafood.  Maybe we’ll try the meat some day.

Some of our favorites are the seven mares soup (full of assorted shellfish and fish – this can be a meal unto itself), black and blue tuna, roasted wild Alaskan halibut, Dungeness crab enchiladas and sweet & sour prawns with roasted scallops – don’t think for one minute that these are the sweet & sour prawns you have had in a Chinese restaurant as this is totally different.  If there are three or four of you consider ordering the seafood tower which has three or four plates full of assorted seafood on a special stand.

This is a local’s place with unpretentious atmosphere and the dress is casual.  The service is very friendly and efficient.  Prices are moderate for the NapaValley. The wine list is minuscule so plan on bringing your own wine unless you want cold beer with your meal.  There is a modest corkage charge.

The restaurant is located off the beaten path about a mile from downtown Napa at 1730 Yajome Street- 707.257.1514.  On Friday nights there is a guitarist who looks like a refugee from Haight Ashbury singing pop songs of the 60′s & 70′s. 

S&P also concluded that the outlook for the long-term rating was negative.  Not surprisingly, the primary reason cited for the downgrade was the Congressional gridlock over raising the debt ceiling and the lack of a plausible plan to reduce the budget deficit.  There has been much debate as to whether the downgrade was warranted and that debate will no doubt continue for some time.

What was clear though, was that the bond market did not downgrade the U.S. Treasury market. There was a flight to safety as money flowed into U.S. Treasuries, raising prices and causing interest rates to fall.  The 3 month and 6 month Treasury Bills are yielding .01% today.  The 2 year and 5 year Treasury Notes are yielding .18% and .93% respectively.  And, the 10 year Treasury bond is yielding 2.19%.

More than likely the flight to safety can be attributed to worries about the global economic outlook as well as the long running financial crisis inEurope.   During the last few years, many yield-starved domestic money market funds had been buying the dollar denominated commercial paper of the large European banks.  Lately, however, with the uncertainty surrounding the financial soundness of European banks the appetite for these securities has declined sharply.

According to the Bank for International Settlements, large European banks, particularly those ofFranceandGermany, hold a vast amount of European sovereign debt. Greeceis effectively bankrupt and will not be able to repay its debts in full. IrelandandPortugalare in similar straits.  While certainly not in as dire condition, interest rates forItalyandSpainhave increased appreciably.  Recently, the European Central Bank began purchasing bonds ofItalyandSpain,  the third and fourth largest European economies, to stabilize the market from the fear of contagion.  The lack of confidence for a quick solution has caused the cost to insure French sovereign debt against default to jump to record levels.

Most analysts are of the opinion that European banks will need to raise capital in the near future.  During the depths of the financial crisis,U.S.banks were forced to raise significant amounts of capital to repair balance sheets that were riddled with troubled assets.  European banks, on the other hand, did not act swiftly and will soon have to pay the piper for their dalliance.  The lack of aggressive action has provided the momentum that is leading the market downward in an economy clearly weakening.

Financial markets detest uncertainty.  Expect the volatility of recent weeks to continue until such time as the European Union leaders put in place a comprehensive plan to resolve once and for all the sovereign dept crisis.  The crisis has festered for the past two years without a credible solution.  If not resolved soon the nascent economic recovery will in all likelihood continue to be muted – at best.  At worst – it might be tipped into another recession.

The Federal Reserve Bank’s Open Market Committee also weighed in at its meeting earlier this month noting that “Information received since the Federal Open Market Committee (FOMC) met in June indicates that economic growth so far this year has been considerably slower than the Committee had expected.  Indicators suggest a deterioration in overall labor market conditions in recent months, and the unemployment rate has moved up.”  It reaffirmed that it would keep the target range for the federal funds rate at 0% to .025%

More important though was the significant change in language in the statement concerning the duration.  The FOMC stated that it “currently anticipates that economic conditions – including low rates of resource utilization and a subdued outlook for inflation over the medium run – are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.”  This was a marked departure from the language in June’s statement which read “are likely to warrant exceptionally low levels for the federal funds rate for an extended period.”

This turn of events should come as no surprise.  One does not need to have an advanced economics, finance, accounting or other degree to ascertain that all is not well with the economy and hasn’t been for some time.  One only needs to be observant of what is going on around them to see the many signs of illness.  The following are two examples of many that I use to gauge what’s happening with the economy.

When traveling toSan Francisco, which I normally do two or three times a month, I take the ferry in fromVallejoas it is much more convenient than driving.  From 2000 through 2007 the 5:30 AM ferry would depart as early as 5:15 AM or so as it had boarded its capacity of 300 passengers.  Today it departs promptly at 5:30 AM with perhaps 100 passengers.  Departures throughout the day have now been reduced some 20% to 25% and in several cases buses have replaced ferries.

From 2005 through 2010 I would fly out ofOaklandairport once or twice a month.  It is 53 miles to the parking lot inOakland.  From 2005 through mid-2008 it would take on average about 80 to 90 minutes to get to the airport by 5:45 AM and 10 to 15 minutes to get through security.  In 2009 and 2010 the trip would take 55 to 60 minutes and one could walk right up to the TSA’s initial checkpoint.

But you get the point.  There are many sign posts along the way; you just need to be looking for them.  Unfortunately, the political “elite” inWashingtonare so detached from reality there is little likelihood to be any credible solutions to the serious economic problems confronting our nation.  Holding the debt ceiling hostage was proof positive that our elected leaders are anything but leaders.  The uncertainty created by this debacle created a lack of confidence and was reflected in the stock market with the S&P 500 tumbling almost 17% in the last 30 days.   Suck it up; there is a long hard slog ahead.

An asset based loan, or ABL in the parlance of its practitioners, is a loan secured by the assets of a company and includes accounts receivable, inventory and often machinery and equipment.  Since the financial crisis of 2008 ABL’s have seen remarkable growth among middle market companies that have had difficulty meeting the increased underwriting standards instituted by commercial banks.

An ABL lender relies principally on the value of a company’s collateral to ensure repayment of the loan as opposed to sustainable cash flow and credit ratings used by commercial banks.  The lender calculates a borrowing base from the company’s eligible collateral assets to determine how much it will be able to lend.

Advance rates are decided for each class of asset based upon its quality. The primary determinant will be the lender’s evaluation of how quickly the assets could be converted into cash in the event of default and the assets are seized to repay the loan.

Generally, advance rates to support the revolving line of credit are 80% to 85% for eligible accounts receivable and 65% to 70% for eligible inventory.  Term loans for machinery and equipment are usually 75% to 80% of the orderly liquidation value as determined by an independent third party.  If the inventory is deemed to be readily and easily marketable advance rates can often be higher.

For companies with a better credit profile, intangible assets can sometimes be used as collateral to support what is known as an over-advance or a stretch loan that combines elements of a traditional cash-flow loan with an ABL.

There are drawbacks to an ABL.  The secured lender holds a first lien on the assets and has the right to take the assets if the borrower defaults.  There are additional costs for auditing the collateral as well as for the third party appraisal of the machinery and equipment.  Loans require monthly reporting of accounts receivable aging, inventory and sales.

Loans tend to be more expensive than a commercial bank.  However, intense competition and a surfeit of capital available in the credit markets have narrowed interest rate spreads considerably.  “Today the interest rate may be lower than the commercial bank rates, but all-in cost may be higher.” commented Glenn S. Burroughs, Senior Vice President at Key Bank’s Asset Based Lending Group.

Drawbacks aside, ABL’s are especially attractive for asset intensive businesses such as manufacturers, distributors and retailers.  They provide a number of very valuable benefits:

1.  Greater credit availability and financial leverage

2.  Greater flexibility in use of proceeds to capitalize on opportunities

3.  Minimal financial covenants – typically limited to the fixed charge coverage ratio

4.  Interest only for the term of the loan; principal amortization required for term loans

Burroughs noted that “In these turbulent economic times asset based lenders are a consistent source of capital.”  The financial crisis and the ensuing disruption of the credit markets should have amply demonstrated to middle market companies the importance of having a dependable financial partner at their side.

One probably wonders how we arrived at our view of the state of the market.  Actually it’s quite simple.   During the unprecedented “go-go” year of 2007 our firm probably received two to three tombstones a day from private equity firms. And that was for 365 days a year.

Then came 2008.  First it was Bear Stearns and then Lehman Brothers collapsed and we all thought the apocalypse had arrived.  By the time the first half of 2009 rolled around we were lucky to receive two tombstones a week.  The recession was declared over in 2009 and in the fourth quarter there was a modest uptick in activity.

Enter 2010 and things continued to improve modestly until the fourth quarter when activity spiked sharply upward.  The rush was on to avoid the expected expiration of the Bush tax cuts.  Tombstones were probably coming in at the rate of one a day at the end of the quarter and continued on into January.

Well, we’ve finally made it to 2011 and guess what.  You’re right, the volume of tombstones has fallen appreciably since January to three or four per week.

The following table demonstrates the roller coaster ride the private equity industry has been on the past five years.  The statistics are from the latest PitchBook report.  As we all know the zenith for the industry was reached in 2007.

Year                Number

2006                 2,520

2007                 3,016

2008                 2,240

2009                 1,393

2010                 1,731

2011                    811

Annualizing the first six months of 2011 suggests that there will be slightly over 1,600 transactions completed in 2011.  That is probably overly optimistic given the just announced GDP growth numbers for the second quarter which was a very anemic 1.3%. More worrisome was the massive downward revision of the first quarter from 1.9% to .4%.

Even before the release of the latest GDP numbers, the casual observer realized the economic recovery was by no means robust nor is it likely to be for the foreseeable future.  The economic growth leading up to the financial crisis was driven by an unsustainable availability of cheap credit.  It will take years before the resulting excesses have been wrung out and for private equity to realize their investments in portfolio companies.

P.S.: The Triago Quarterly report for June 2011 is also worth reading for additional insights.