Bill Simon’s Alchemy Court Documents Shed Light on How Former Treasury Chief Can Make Hefty Profits on Problem S

Former Treasury Secretary William E. Simon earned a sizable personal fortune and an even larger reputation as king of the leveraged buyout on Wall Street in the early 1980s. But these days his sights are set on a far greater, and potentially more lucrative, target--the Pacific Basin.

At 59, Simon envisions himself as master of a vast international merchant bank reaching from headquarters in Los Angeles to the emerging profit centers of Japan, Hong Kong and Australia. In a recent interview, he likened his nascent empire to the potent Hong Kong merchant banking houses portrayed in James Clavell’s epic novel “Noble House.”

It all sounds grandly philosophical. But information emerging from court records in Hawaii demonstrates how the creation of his new empire reflects the same hard-headed, practical theory that Simon employed in leveraged buyouts--risk as little personal money as possible and exploit any weakness or advantage to ensure the greatest potential profit.

Information generated in three civil lawsuits related to Simon’s takeover of Honolulu Federal Savings & Loan last year portrays Simon and his partners as savvy investors who exploited opportunities in the troubled savings and loan industry to ensure a profit of as much as $100 million in the deal by undervaluing the thrift’s real estate holdings.

In one lawsuit, a former executive of Honolulu Federal said that he was ordered to work with a firm hired by Simon to slash appraisals on property owned by the thrift by more than $100 million, which dramatically reduced the price that the Simon group had to pay.

The former executive also claimed that the Simon partner in charge of scouting for acquisitions among troubled thrifts had confidential government information on more than 50 savings and loan firms in the group’s Beverly Hills offices.

Simon and two of his partners said in interviews that the reappraisal process for Honolulu Federal was strictly routine and approved by federal regulators. They strongly denied receiving any government documents to which they were not entitled.

The first public word of Simon’s grand design came almost precisely a year ago when he and his partners, chiefly Los Angeles lawyers and developers, announced the acquisition of Honolulu Federal, known as Honfed, and unveiled plans to acquire more financial institutions.

Since then, the group has bought three additional savings and loans and control of a bank, all in Los Angeles, and is negotiating for several other institutions. In the case of Honfed, the partners got an institution with assets of $1.7 billion for $17.5 million. In buying a failing $1-billion thrift earlier this year, Southern California Savings & Loan in Beverly Hills, they put up $5 million and raised another $35 million from Italian and Australian investors. Federal regulators anted up $217.5 million in cash.

Simon and his partners have also invested $50 million in 11 real estate ventures in California, purchased 28% of Hawaii’s third-largest bank, and started a fledgling merchant bank in partnership with an Australian firm, which has made $200 million available to start.

In an interview earlier this month, Simon said he ultimately plans a full line of financial services under the umbrella of a giant merchant bank. The operation would provide venture capital, finance leveraged buyouts and takeovers, fund huge real estate developments and offer every other financial service, from banking and insurance to securities trading.

The sheer scope of the plans and the involvement of Simon guaranteed the group a high profile. And the publicity surrounding their opening gambits has been positive and profuse.

Most of the actual acquiring, however, has been done within the secrecy that hides most transactions involving private investors and the agencies that regulate the nation’s financial industry. But the information from the three lawsuits provides a rare look inside one of the deals, and possibly represents a blueprint for other transactions.

File Unsealed

Much of the information is contained in the lawsuit filed by David H. Lacy, a former executive vice president of Honfed, against his ex-employers. Lacy’s lawyer, Jerry Hiatt, refused to discuss the lawsuit. But the voluminous files connected with the suit remain public, despite the efforts of lawyers for Honfed to seal the court record as part of a settlement of the lawsuit.

In exchange for an undisclosed sum of money, Lacy and Hiatt settled the suit, agreed not to discuss the matter with anyone and accepted a proposal by Honfed’s lawyers to seal the entire court record. For unknown reasons, the file has not been sealed yet and the material was available recently in the state courthouse in Honolulu.

Lacy, a former vice president of Crocker National Bank in San Francisco, was hired in April, 1985, as a senior vice president at Honfed for $85,000 a year. The thrift had deep problems with its real estate investments and Lacy was instructed to sell them off at the highest possible prices. He said he was told by Kenneth S. Fujinaka, Honfed’s president, that the assets had “enormous hidden value.”

Thirteen months later, in May, 1986, Fujinaka gave Lacy unusual new orders: He was to work with an outside accounting firm to “revalue Honfed’s assets in order to get them as low as possible,” according to the suit.

At the time Lacy said his orders were changed, the Simon group had just signed a formal letter of intent to purchase Honfed after several months of secret negotiations with the thrift’s management and representatives of the Federal Home Loan Bank in Seattle. The outside firm Lacy was to work with was Kenneth Leventhal & Co., a Los Angeles-based accounting firm hired by Simon’s group to analyze Honfed’s assets.

As part of the purchase, the regulators had agreed to order Honfed to cut its real estate values by $38 million and put the thrift into insolvency.

The insolvency was important because it allowed the regulators to arrange the acquisition of Honfed by the Simon group without triggering regulations that would have required competitive bidding or made ownership of the thrift available to its depositors.

But the name of the game in acquiring a sick thrift is to make sure that its real estate values are lowered as much as possible, and Simon and his partners were not satisfied that even the conservative appraisal by the regulators went far enough.

So, based on Leventhal’s evaluation, the value of Honfed’s real estate holdings was slashed further, by more than $100 million, before the purchase was made final.

In the fall of 1986, as a result of the new value of Honfed’s assets created by the writedowns on real estate, Simon and his partners bought the thrift for $17.5 million plus a promise to issue up to $40 million in subordinated debt, or junk bonds, to raise new capital.

Critics see the huge writedown as a means of ensuring a substantial profit for Honfed’s new owners: List an asset on the new books for less than its actual worth and record a healthy profit when it sells for the real value. For instance, if a property is worth $5 million and an institution lists its worth as $1 million, the institution will make a profit of $4 million when it is sold.

“By simply devaluing the properties, they built in a certain profit of $40 million to $100 million,” said James F. Ventura, a Honolulu lawyer who represents a developer suing Honfed and its new owners.

But appraising is a subjective craft and Honfed, like many savings and loans across the country, found itself in trouble largely because it overvalued its real estate assets.

So Simon and his partners contend that the new appraisals merely reflected the market value of the property. They said the new values were reviewed by the regulators. The right to reappraise the assets, they said, was part of the price of persuading them to inject new capital into the ailing thrift.

Further, they said, the $100-million writedown will be counted against earnings at the rate of $4 million a year for the next 25 years. They also said the regulators will have the opportunity to review the validity of the writedowns as the properties are sold.

The fact that the current boom in Hawaiian real estate has allowed them to sell some property at well above the appraised value and to return Honfed to profitability--the thrift posted a profit of $11.6 million in the first six months of 1987--is simply testament to their business acumen and willingness to take a risk, they say.

“Suppose the market had gone down?” asked Simon in the interview in Los Angeles. “I wonder what those fellows would be saying then. Anybody could have done the same thing we did.”

‘Ahead of Schedule’

Whether that is true or not, engineering the acquisition of 100% of Honfed was the first vital step in fulfilling Simon’s grand vision and he is enormously pleased with the group’s progress.

“It would be immodest for me to say our progress was terrific,” Simon said. “But I truly believe that we’re way ahead of any schedule that I might have had when one looks at what we’ve acquired as a budding merchant bank over the last year and three quarters.”

And this progress has come with the blessing and cooperation of the federal regulators who govern the thrift industry.

“To have people of this caliber focusing on the savings and loan industry is without question a great help,” said James R. Faulstich, president of the Federal Home Loan Bank in Seattle, which worked out the Honfed deal with the Simon group. “It’s caused other people to take a second look at investing in this industry. Our phones have been kept quite busy as a direct result of the Honfed transaction.”

Faulstich said regulators in Seattle are talking with the Simon group about acquiring additional thrifts. Preston Martin, who joined the partnership as chief of its savings and loan wing after resigning as vice chairman of the Federal Reserve Board in April, 1986, confirmed that negotiations also are under way with regulators in San Francisco on additional California thrifts and that the group is eyeing thrifts elsewhere in the country.

In mid-September, the partners gathered in the Beverly Hills offices of another of their holdings, the World Trade Bank, for two days of meetings to map strategy for their next acquisitions and review the current holdings, which the partners agreed show potential for enormous profit.

Enormous profits are nothing new to Bill Simon. In the 1960s, he established himself as one of Wall Street’s most successful traders at the New York investment house of Salomon Bros. He then distinguished himself in Washington as the first energy czar under President Richard M. Nixon and Treasury secretary under President Gerald R. Ford.

After leaving government in 1976, he reportedly lost a bundle in the commodities market, recouped some and then struck it rich in a highly leveraged transaction that created his persona as an investor with a Midas touch.

The deal began in 1982 with the purchase of Gibson Greetings, an old-line greeting card company, from RCA by Simon and partners in a firm called Wesray Capital. The price was $80 million, all but about $1 million of it borrowed.

When Wesray sold the company’s stock to the public 16 months later, it was valued at $350 million--a return of more than 300 to 1 on the original investment of $1 million. Simon’s share of the profit was $66 million.

The transaction had been spotted and structured by Simon’s partner in Wesray, Raymond G. Chambers, but virtually all of the public credit was lavished on Simon, who became the public symbol for Wesray and its success.

Wesray never had to use Simon’s capital again and the firm continued to acquire and restructure corporations--and earn a ton of money. Estimates of Simon’s personal wealth rose to $200 million and more, and he fueled the gossip by claiming not to count his money.

One deal that illustrated Wesray’s adeptness at making money involved Wear-Ever, a pots and pans producer, and Proctor-Silex, a household appliance maker. Wesray bought the companies, combined them and sold them to the public for a profit of about $90 million.

But first, Simon and Chambers collected money from Wear-Ever-Proctor-Silex through a variety of entities, according to a prospectus issued Aug. 8, 1986, when the companies were preparing to go public.

Their affiliated companies collected $2.9 million in management fees between 1983 and 1985, $812,000 in brokerage fees for placing property and health insurance in the same period, and $163,000 for handling the advertising. A food service company in which Simon and Chambers held an interest even used Wear-Ever trademarks without paying a fee, a practice that stopped three months before the public offering.

By the fall of 1985, Simon was eager for Wesray to diversify but ran into resistance at the investment firm. He began to sever his ties with Wesray and telephoned a former aide and old friend from his Treasury days, Los Angeles lawyer Gerald L. Parsky. To Parsky he broached his new idea.

“He called and said that he had a desire to build a major financial services organization that he felt should be based in Los Angeles,” said Parsky, a senior partner at the law firm of Gibson, Dunn & Crutcher.

Simon was eager to exploit what he believed was the emerging financial dominance of the Pacific Basin--Japan, Hong Kong, Australia and the West Coast of the United States. After discussing various possibilities over several weeks, ranging from creating a merchant bank to buying a commercial bank, they narrowed their focus to troubled savings and loan firms and Simon commissioned an analysis of the industry by a New York consulting firm.

Simon proudly calls himself an opportunist, and the prospect of buying thrifts fit with what he described as his basic investment theory: “Put up as little capital as possible.”

Savings and loans offered an attractive entry point in part because there was a need for capital and that could translate into an opportunity for acquisitions on an attractive basis.

“You could buy a healthy S&L; for under book value,” Parsky explained. “On an unhealthy basis, there was a way to structure an acquisition where you created your own book value.”

Book value is essentially the value at which assets are carried on a balance sheet. And creating an entirely new book value is precisely what the Simon group would do with Honfed.

Before proceeding, however, they needed to round out the team. So Parsky called on two Los Angeles businessmen with whom he had been dealing for several years--developer Roy Doumani and Larry B. Thrall, a lawyer with broad experience in real estate financing and management.

They decided to search for an ailing thrift in California or Hawaii in keeping with the focus on the Pacific Basin. In January, 1986, Thrall and Parsky met with officials from the Federal Home Loan Bank in San Francisco, who have jurisdiction over California thrifts, and their counterparts in Seattle, who regulate S&Ls; in Hawaii.

Parsky said the meetings, plus the group’s own analysis, resulted in a list of troubled savings and loans available to investors with sufficient capital. One was Honfed, and Parsky and Thrall contacted the thrift’s management for exploratory talks that February.

No Favorable Treatment

Some critics have questioned whether Simon and Parsky--Martin did not join the group until June of 1986--had an inside track with regulators as former senior federal officials. Both denied it in interviews, and Simon emphasized the point by saying that he never spoke with any regulators until after the Honfed deal was completed.

“Bill Simon never talked to the regulators,” Simon said emphatically.

But Faulstich of the Federal Home Loan Bank in Seattle remembered it differently, saying in a telephone interview, “I talked to Simon personally while the deal was taking shape several times.”

Despite the discrepancy, Faulstich said Simon and his group did not get any favorable treatment in their acquisition of Honfed.

As Hawaii’s largest savings and loan, with assets of $1.7 billion, Honfed had been a major player in development associated with the tourist economy, financing many resort and condominium developments, along with the traditional home mortgages and commercial lending.

But when the islands’ economy went sour in the early 1980s, Honfed was left holding some real estate of dubious value and losses began to mount. A rumor that Honfed was going to close its doors led to a run in February, 1983, that drained $24 million in deposits. The following year Honfed posted an operating loss of $25 million.

Beginning in 1985, however, Honfed’s management issued a series of public statements claiming its problems were behind it and that the institution had returned to profitability. A Jan. 29, 1986, press release declared an after-tax profit of $5.7 million for 1985 and said it represented “a dramatic turnaround.”

It was a strategy that would continue right up until the acquisition agreement with Simon became public in September, 1986, and Hawaiians learned for the first time that Honfed was insolvent and being bought by mainlanders.

Despite the public pronouncements of fiscal health, regulatory examiners felt that Honfed had a surplus of assets that were not earning a return, chiefly risky, overvalued real estate ventures. From early 1985 on, the regulators pressed Honfed to account for the potential losses in its financial statements. They also wanted the thrift to seek new capital.

So Honfed was on the list of the Seattle regulators when Parsky and Thrall came calling in early 1986. But soon after discussions began, an impediment arose.

Honfed was a mutual association, meaning that its owners were its depositors. In the event of a change of ownership, federal regulations required Honfed to first offer its stock to the depositors. Also, if the regulators labeled the thrift “failed,” federal law required that they seek competitive bids for its purchase.

Competition was something the Simon group wanted to avoid, and the partners made that clear to the management and the regulators. “We did say that we did not want to have a bidding war with anyone,” recalled Parsky.

Under federal rules, if Honfed were “insolvent” but not “failed,” the regulators would be free to negotiate an acquisition agreement without the required offering to the depositors or other bidders.

So in May, 1986, the supervisory examining agent for the Federal Home Loan Bank instructed Honfed to reduce the value of its real estate assets by $38 million, a step that reduced the thrift’s capital to a negative $500,000. Honfed was insolvent.

At the same time, the Leventhal appraisers hired by the Simon group were scouring the books for additional reductions in the real estate value. That search led to what Lacy, the former Honfed executive, said were his instructions to help cut the values as far as possible.

During the months of secret negotiations with the Simon group, Lacy met frequently with Larry Thrall, the partnership’s point man for analyzing the real estate holdings of Honfed and other prospective targets.

In a sworn affidavit, Lacy said he was in Thrall’s offices in the World Trade Bank building in Beverly Hills when he noticed a pile of loose-leaf binders on a conference table. When he examined the binders, Lacy said, he discovered that they contained “highly confidential commercial information” prepared by the Federal Home Loan Bank on more than 50 savings and loans.

Such information would be extremely valuable to anyone trying to evaluate which thrifts might be good takeover targets. But federal regulations prohibit the disclosure of such material, even to potential investors.

Controversial Evaluation

In an interview, Thrall acknowledged that Lacy had visited his office. But he strongly denied receiving any confidential government documents to which the partnership was not entitled, a denial echoed by Simon and Parsky in separate interviews.

Faulstich said potential investors often receive extensive documents after signing a confidentiality agreement, but he said he had no knowledge of the Simon group receiving information on such a large number of institutions.

Lacy filed his lawsuit earlier this year, partly as a result of what he said was mistreatment at Honfed after he complained that responsibility for four major real estate projects was taken away from him during the reappraisal process.

After his complaints, he said he was banished to a small, windowless room, stripped of his duties and forced to surrender the elevator key that gave him access to the executive floors of Honfed’s headquarters in the Honolulu financial district. He eventually resigned.

Two other lawsuits in the state court in Hawaii make similar claims about the methods used by Honfed in valuing its assets in connection with the takeover last year.

Robert E. Bjerke, a Honolulu businessman, accused Honfed of breach of contract in the financing of a regional shopping center he developed on the island of Hawaii. Bjerke said the center was 80% complete and profitable when Honfed foreclosed on its $29.5-million construction loan in 1986.

The lawsuit said Honfed blocked Bjerke’s attempt to refinance the loan through other lenders “in order to acquire the asset for themselves at below market cost.”

Lawyers for Honfed responded in court with harsh language, labeling the charges “conscious prevarication” aimed at smearing “nationally respected figures.”

The Bjerke lawsuit has evoked at least one interesting sidelight.

Simon was removed from the suit as a personal defendant when a judge determined that he did not have sufficient dealings in Hawaii to give the court jurisdiction. In an effort to demonstrate Simon’s role in Hawaii, Bjerke’s lawyer came up with a novel plan.

After learning that Simon and his partners would pay an early morning visit to the shopping center on a Sunday last January, the lawyer dispatched a photographer to capture Simon’s presence and the photographer, John L. Wilson III, dutifully found the Simon group and began to take photographs.

“As I began taking pictures, several of the gentlemen ran to cover Mr. Simon from the camera, and all of them then proceeded to run out of the shopping center quickly,” Wilson said in an affidavit.

Simon said he had no recollection of the event and Parsky, who accompanied him on the visit, said the group was never even aware of the photographer’s presence.

In August, Honfed’s lawyers reached a tentative settlement with Bjerke that allowed him to search for a buyer for the shopping center at a minimum price of $29.5 million, the amount of Honfed’s construction loan on the property and more than double the appraised value of the center on Honfed’s books--$13.8 million.

His lawyer, Gary V. Dubin, said a few days ago that negotiations were under way with a prospective buyer and he expected a completed transaction in the next few weeks.

Still unsettled is a suit filed by Gerald E. Kremkow, a Honolulu businessman and former head of real estate development for E. F. Hutton & Co. He is trying to stop Honfed from terminating a development agreement and selling off 3,000 acres of land on the island of Hawaii.

In 1982, Kremkow got an option from an oil company to buy the parcel, which consists of rolling hills and tree-lined pasture overlooking the Pacific Ocean from 5,000 feet above sea level. Kremkow envisioned luxury homes on 115 lots, ranging from 10 to 40 acres on the site.

Honfed and Kremkow entered a joint venture agreement, with the thrift agreeing to buy the land from the oil company for $8.4 million and invest the $6 million or so needed to develop the property. Kremkow would head the development, which was called Waikii Ranch.

The early results were promising. A 4,200-foot water well, believed to be the world’s deepest, was a gusher and promised more than enough water for the project. By last June, 46 of the lots with a total price of $15.8 million had been reserved under a pre-sale program in which buyers placed small amounts of money in escrow pending completion of the infrastructure.

But last year Honfed stopped funding the improvements, such as roads and utilities, and took steps to terminate the joint venture. The institution said it would sell the land in bulk, without regard to the existing reservations.

Kremkow’s lawsuit claimed that Honfed’s actions represented an attempt by its new owners to value the property at a low price in connection with the purchase and then sell it “at a substantial profit.”

Kremkow’s lawyer, James Ventura, said Honfed told Kremkow in March, 1986, when the Simon group was in the early stages of its purchase negotiations, that he could not seek new financing to complete the project. Ventura believes that the action was part of a pattern at Honfed.

“From February or March of 1986, we are going to contend that they were killing projects,” Ventura said. “They were doing that either for the purpose of preserving the temporary insolvency or for the purpose of keeping assets low to justify the $17.5-million purchase price. Whichever the reason, the idea was not to queer the deal for the purchase.”

Even an appraisal prepared for Honfed a year later by a Honolulu firm appeared to contradict the Leventhal appraisal, which cut the value of the land to $5.6 million from $13.5 million.

The local firm of Hallstrom Appraisal Group told Honfed in January, 1987, that development on Hawaii was strong and the lowest price of vacant land at eight similar developments surveyed was $19,790 per acre. The $5.6-million value for Waikii Ranch is $1,880 an acre--less than one-tenth that average.

“Particularly in light of the ongoing strength in the competitive marketplace, we remain very bullish regarding the overall prospects for Waikii Ranch,” said the 1987 appraisal.

The Hallstrom appraisal said the project would be worth $30.7 million upon completion of the infrastructure, and that is part of the rub.

Thrall, who conducted the negotiations for Honfed and is the Simon partner most familiar with the deal, denied that any projects were killed or that values were set at anything except the market value of property.

“Waikii Ranch is a very specialized development that only a few developers in the world could complete successfully,” Thrall said. “It would not be in Honfed’s interest to put in the additional $16 million required to finish the project. That’s not the kind of deals we want to be doing there anymore. We’re going to sell in it bulk and it probably will bring the price of agricultural land.”

Thrall said the $15.8-million worth of lot reservations was “a lot of hype.”

Kremkow said in an interview that the project can be completed for less than $10 million and that he was rebuffed when he tried to buy the land from Honfed at the appraised value of $5.6 million.

“No one has ever projected a loss for Waikii Ranch,” Kremkow insisted. “The profit projected in a worst-case scenario is now $20 million and I expect to make substantially more.”

The Waikii Ranch controversy embodies many of the larger issues about the purchase of Honfed by Simon and his partners.

Lawsuits filed by Kremkow and others contend that the mainland group got too good a deal by undervaluing the thrift’s assets. Simon and his partners argue that they bought when the real estate market was at the bottom and now stand to benefit from the upswing.

“It’s just like with Gibson Greetings,” Simon said. “When I bought it, everything was in the ashcan--inflation in double digits, the stock market way down, interest rates high. A year and a half later, interest rates were down, inflation was down, the market was tripling and we could go public. We marked the assets of Honfed to market, and the market has gone up.”

And the criticism raised in the lawsuits has not daunted the former Treasury secretary who, when asked what he plans to buy next, responded quickly, “The world.”

After a pause, he said: “No, no. Don’t print that. Somebody will take it seriously.”

THE SIMON GROUP EMPIREH.F. Holdings Delaware corporation formed in June, 1986, to acquire savings and loans. William Simon and Gerald Parsky each hold one-third interest and two Los Angeles businessmen, Roy Doumani and Larry B. Thrall, split the remaining third. It is headquartered in San Francisco and run by Preston Martin, former vice chairman of the Federal Reserve Board. Honolulu Federal Savings & Loan Hawaii’s largest thrift, with assets of $1.7 billion, was acquired in 1986 by H.F. Holdings for $17.5 million in new capital and $40 million in subordinated debt arranged by the Simon group. Westcoast Savings & Loan Pacific Palisades-based firm was started in December, 1985, with assets of $20 million and acquired by H. F. Holdings in 1986 for $4.4 million with permission of the regulators as part of the Honolulu Federal deal. The thrift now has assets of $57 million. Southern California Savings Beverly Hills-based institution, with assets of $1 billion, was acquired through bidding with regulators in the spring of 1987 for $40 million. Ariadne Australia Ltd., a Brisbane takeover firm, and Italian investors provided $35 million and Simon’s group put up $5 million. The Federal Savings and Loan Insurance Corp. provided $217.5 million in aid because SoCal was a failing thrift. It is run through its own holding company. World Trade Bank Simon group acquired controlling interest the Beverly Hills-based commercial bank for $7 million in 1986. Bank has assets of $75 million. Group uses second-floor of bank’s Santa Monica Boulevard headquarters as its offices. First Interstate Bank of Hawaii Group acquired 28% interest in Hawaii’s third-largest commercial bank for $9.7 million in August. Securities filing left open possibility of seeking control. C.A. Partners Real estate development venture invested roughly $50 million so far in 12 California residential and commercial projects purchased from troubled savings and loans. Run by partner Craig Gosden, a Los Angeles real estate lawyer. Int’l Merchant Banking Services With start-up capital of $200 million, this is a partnership between a subsidiary of Ariadne Australia Ltd. and WSGP International. WSGP is a 50-50 partnership of Simon and Parsky, with added staff for general merchant banking operations. Western Federal Savings & Loan Group announced intention to acquire Marina del Rey-based S&L; in August for about $150 million, pending approval by regulators and Western stockholders. A healthy thrift, with $2.1 billion in assets, the institution would be run through existing Western Fed holding company and be used as a vehicle for acquiring additional thrifts.