The Banker Who Said No

i thought this was an interesting read.

The son of a mechanical engineer, Beal grew up in Lansing, Mich. He ended up in Texas after buying an apartment complex in Waco. He founded Beal Bank in Texas in 1988, opening the first branch next to a Wendy's ( WEN - news - people ), and started purchasing distressed real estate loans from failing banks. Years later he also opened a bank in Las Vegas. Beal Bank has long been a unique animal, mostly buying loans in the secondary market instead of originating them. It was a successful model: In 2000 American Banker declared Beal Bank the most profitable bank in the nation as measured by its five-year return on equity of 50%.
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By September 2004 Beal Bank's assets had climbed to $7.7 billion. Then Beal stopped buying, letting his loans run off. By September 2007 assets had shriveled to $2.9 billion, one-fifth of which was cold cash. He was worried that consumers had taken on too much debt and money was being lent to companies for next to nothing. "Every deal done since 2004 is just stupid," Beal says.

He began by pulling back from home loans--even those guaranteed by Fannie Mae ( FNM - news - people ) and Freddie Mac ( FRE - news - people ). Beal thought the two quasi-government agencies were over-leveraged. When staffers mentioned their guarantees in deal presentations he would fire back that these guarantees were "worthless."

Outsiders thought it was Beal who didn't get it. Despite its aversion to credit then, the bank occasionally had to buy mortgages to meet federal low-income-lending requirements. Jonathan Goodman, then head of loan purchases, recalls salesmen from Countrywide laughing at him on the phone when he refused to buy iffy condo paper backed by the two agencies. "Countrywide, Bank of America ( BAC - news - people ), Washington Mutual ... every single [mortgage seller] thought we were insane," Goodman says. "They didn't know why we cared. They thought Fannie and Freddie guarantees were as good as Treasuries."

Beal also stopped making commercial loans. "If I see another office condo in Las Vegas or Phoenix, I'm going to throw up," he said at the time. He started selling, too. At a price of 115 cents on the dollar he unloaded a $75 million pool of loans that had been extended to Kmart, exercise chain 24 Hour Fitness and Regal Cinemas. That translated into a yield for the buyer of a mere 1.35 percentage points over Treasuries. "They were great loans at 85 cents," says Beal, referring to the price he had paid for them years earlier. "They're stupid at 115."

With fewer assets, he began laying off staff, cutting down to 200 people from a peak of 400. "Escorting all those people out the door was awful, the worst moments of my life," says Jacob Cherner, who oversees Beal's lending and debt purchases. Half of the 270,000-square-foot polished wood and Brazilian granite headquarters went dark. (Beal hastens to add he bought the building from an oil company desperate to move only because it was selling at a discount.) He hired agents to rent out the space.

Beal started coming to work at 10:30 and leaving at 2:30. He challenged colleagues to backgammon games and took hour-long lunches, complaining of being "bored stiff," recalls one frequent meal companion, real estate investor Steven Houghton. Then Beal would head home to walk a nearby creek with the youngest of his six children. He took up car racing, too. "I thought it would end in six months, and sanity would return," he says. "If I knew it would last nearly four years I would have thought of something else to do."

In late 2006 he sold $74 million of preferred stock although he had no immediate use for the proceeds. He says he couldn't resist the "stupidly mispriced" terms--as low as Libor plus 1.7 percentage points for 30 years. He wanted as much money available when the boom turned to bust. With the extra money the bank could pay off nearly all its depositors with capital on hand--nearly unheard of in the history of banking.

Then came a shocker: Amid one of the most reckless lending sprees in history, regulators focused on the one bank that refused to play along. Beal's moves confused and worried them, and so they began to probe him with questions. "What are you doing?" he recalls them asking. "You're shrinking yet you're raising capital?"

Says Beal about the scrutiny, "I just didn't fit into any box." One regulator, the former head of the Texas Savings & Loan Department, Charles Danny Payne, says, "I was skeptical at first, but I've gained a lot of confidence over the years," adding that Beal has an "uncanny ability to sniff out deals."

Next, the credit rating agencies started pestering him about his dwindling loan portfolio. They never downgraded him but scolded him for seeming not to have a "sustainable" business model. This while their colleagues were signing off on $32 billion of bum collateralized debt obligations issued by Merrill Lynch.

Then came the summer of 2007, and Wall Street's securitization machine began to break down. Prices on pools of mortgages were falling. Beal was tempted but insisted on inspecting individual loan files. Wall Street refused. Still, he knew his time was coming. To prepare bids he locked himself in his office to write a computer program with 50 variables (now 250), ranging from home price changes by neighborhood to interest rates to origination dates.

By 2008, Wall Street started letting Beal peel off individual loans. He bought a bit, then in earnest when Bear Stearns collapsed. He concentrated first on whole single family residential loans, buying $1.8 billion of those. He has hired 160 people to service residential mortgages, arranging the employees in rows of cubicles one floor below his office. His payroll has more than doubled to 450.

Lately he's been spending on a broad range of assets. Beal just bought a $465 million loan to bankrupt chemical maker Lyondell. He's extended tens of millions to utilities, manufacturers, convenience stores, hotels, casinos--"everything you can imagine, in every state," he says. Many of those assets have come from 15 failed banks, including First Integrity in Minnesota, Arkansas National and First Priority in Florida. Since November he's bought $2 billion (face value) of home loans bundled into securities, too. But he says he's still just picking off loans with a "rifle" not a "shotgun," buying only 3% of what lands on his desk while waiting for the financial system to further "unravel."

To fund his purchases Beal has relied on brokered deposits, known as hot money in the banking business. A year ago Beal Bank had $49 million, but by dangling relatively generous rates on certificates of deposit (0.88% for a six-month CD) brokers have since funneled $1.2 billion into the bank. To replace the brokered funds Beal is building 28 branches from Miami to Seattle, up from 7 at the end of last year.

very intresting