Remembering Fred Joseph
IDD sat down with Fred Joseph early this year.
November 30, 2009
Editor's Note: To mark the passing of Fred Joseph, IDD is republishing its Feb. 9, 2009 cover story about the Wall Street veteran, who worked in finance for nearly five decades. Joseph discussed, among other topics, his relationship with Michael Milken, the fall of Drexel Burnham Lambert, and his humble beginnings in Boston.
Fred Joseph (Photo: Alanfil)At 72, Frederick Joseph could have retired years ago. In fact, the former CEO of Drexel Burnham Lambert and co-founder of Morgan Joseph & Co. pretty much did. He cut and split 25 cords of firewood on his farm and took up blacksmithing, getting so good that local farmers had him fix their farm implements. He hunted with a bow and taught his grandchildren how to hunt and track game.
But brushing aside more than four decades on Wall Street is no easy task, especially for a consummate dealmaker, and Joseph soon found himself back in investment banking.
He'd enjoyed the outdoors--or as he calls it, "lumberjacking"--but missed the intellectual stimulation of banking. "I intend to do deals as long as my brain will allow it and I hope I know when that changes," says Joseph, now a managing director at the New York-based boutique he co-founded.
In some ways, Joseph is fortunate to be doing anything at all. Five years ago, he was diagnosed with multiple myeloma, an aggressive and incurable blood cancer which, then, offered a three-year average life expectancy. Joseph decided to keep up with his profession as a dealmaker, continuing client visits as an investment banker. "I am doing what I am doing because I love to do it," he says, adding that he would rather be out in the workplace than sitting at home worrying about his illness.
"He has the most fun working with deals and clients. He loves thinking about these things," says Steve Joseph, Fred's younger brother, who is a managing director at Sandler O'Neill.
Boston's nuclear automotive engineer
The Joseph family grew up on the cusp of Dorchester and Roxbury, working class neighborhoods in Boston. Joseph's father worked in the Bethlehem Shipyard during World War II and then as a cab driver. His mother was a dental technician.
The neighborhood's high school had a mix of Jewish, Irish, Italian and African-American kids. It was, Joseph says, a tough neighborhood with street gangs. "There was lots of fighting. That's why I learned to box, because I was not big," says Joseph, who boxed for Harvard University, where he won the light-weight championship for three consecutive years.
In junior high, Joseph delivered orders for a grocery store and he pumped gas during his high school years. "I learned to be a mechanic. Not a great mechanic, but a good mechanic," he says.
Back then, Joseph had no real interest in business, but he did love cars. "I decided, 'Wow, they're going to power everything with nuclear power.' So, I wanted to become a nuclear automotive engineer. I figured if they can make nuclear engines for subs, why not make them for cars?"
Wanting to do something with "nuclear powered cars" spurred Joseph to improve his grades in high school. He went from a 'C' to an 'A' student, was accepted to MIT and Harvard, and opted for Harvard on the advice of an uncle who said its education offered more career alternatives.
Navy ROTC helped Joseph pay his way through school and after two years with the Navy he decided to study at Harvard's business school. His classmates included Frank Lorenzo, Reuben Mark of Colgate and Charles Ellis of Greenwich Associates. While examining a case study--an IPO for a ski company--Joseph found his calling.
"I loved the case. What is the company? What do they do? What are they going to do? How does the market evaluate the most comparable companies and how do you price this issue so that it will sell?" recalls Joseph. "That one night on that one case I decided I wanted to be an investment banker. I'd never heard the words investment banking before I went to b-school."
He found his calling in business school, but Joseph credits the US Navy for its lessons about managing people. On his first day on a mine sweeper in the North Atlantic fleet, he remembers having members of the crew assemble and explaining to them what he had in mind for that day's duties.
"I explained to 20 sailors 'paint this, straighten this, and clean this,' being authoritative," he says. Soon after, the ship's chief bosun pulled Joseph aside and offered tips on how to more effectively deliver orders to the crew.
In his office at Morgan Joseph with its prints of racing yachts, Joseph's New England accent emerges as he recalls what the bosun said to the young officer from Harvard: "'It is your deck force. We'll do it how you want. You can tell the fellas what you want done as you did this morning or you can tell me what you want them to do and I'll tell them.'"
Joseph pauses and then says: "I got it instantly. It was [about] trusting the guys, which is what managing an investment bank is all about. Running a professional organization ... your peers are your partners."
The early days
Joseph started work in 1963 as an associate at E.F. Hutton, where he worked on initial public offerings and mergers and acquisitions. In the early 1960s the corporate finance departments were very small and, as Joseph recalls, they were "elitist, mostly Harvard MBAs. Back in those days they had a sidebar tagline that said they were a Jewish firm or a WASPy firm. There were very few firms that had the kind of ethnic balance you see today."
In those early days, much of the work was in M&A and IPOs. There was very little private equity unless it was venture capital, and debt financings were only done for investment grade corporations. At E.F. Hutton, Joseph worked for John Shad, a partner at the firm who went on to become vice chairman of Hutton and later chairman of the Securities and Exchange Commission. Shad shaped Joseph's thinking about investment banking on a wide range of issues. "He was a demanding boss. He and I got along just wonderfully. Opinionated, but you could change his mind with facts," recalls Joseph.
After his work as SEC chairman, Shad was US ambassador to the Netherlands and then was brought to Drexel by Joseph as chairman. Today, a yellowed, laminated memo hangs in Joseph's office. The note, written in 1964, offers tips on how to write a simple deal prospectus for would-be investors, advising that bankers eschew industry vernacular. The note calls for measured outlooks on a company's earnings and recommends the use of fewer words to describe a business in a prospectus.
Drexel days
After E.F. Hutton, Joseph decamped for Shearson Hammill in 1970. He started in corporate finance and worked his way up to COO. Shearson Hammill was eventually sold to CBWL-Hayden Stone. Initially, Joseph coveted the role of COO, but also remembers thinking that he wanted to get back to investment banking.
So, when Shearson completed its merger, Joseph looked for work at another investment bank. He knew that a major firm doing well was unlikely to hire someone as young as he was from a non-major firm to run its investment bank. So, he talked to four major investment banks that were not doing well and chose Drexel Burnham Lambert.
In his wallet Joseph carries a 4-by-6 inch piece of paper. He calls it his "gyp" sheet. "This is very ancient history but I was really proud of it," says Joseph. On the sheet of paper are columns of figures tracking the progress of Drexel's investment banking division from 1974 until 1986, years when Joseph ran the business unit. In 1974, Drexel's investment banking revenues totaled $1.2 million but saw no profit. In 1986, revenues totaled $1.1 billion and profit was at $500 million.
In 1977, the year that high-yield paper was introduced into the mix, the investment bank posted $4.24 million worth of revenues. The first new issue high yield deal, a $30 million transaction for Texas International Oil, paved the way for debt-financed mergers, not only among corporations but--later--private equity financiers.
"They were part of the overall debt revolution that started to occur in the late 1960s," says Charles Geisst, professor of finance at Manhattan College. Geisst notes that Drexel helped change the perception of leverage. Suddenly, it was no longer considered bad. Investors, meanwhile, took on debt of risky companies because yield premiums were so generous that they could make up for any losses.
"Traditionally, the M&A revolution was one-sided. The healthier companies--the S&P 500 in the late 1960s--did most of the buying. Drexel helped companies on the high end of junk and allowed them to merge among themselves, sometimes resulting in a stronger company," says Geisst.
Drexel clients included Carl Icahn and Ted Turner and the firm helped finance Kohlberg Kravis Roberts' bid for RJR Nabisco.
In 1975, Drexel had 18 professionals--one of the new hires included Leon Black--and it had 22 transactions with 28 clients. (After Drexel, Black went on to found Apollo Management). By 1986 the corporate finance team had 313 professionals, had 805 clients and completed 422 deals. Speaking of Drexel's high yield specialist, Michael Milken, Joseph remembers that "his distribution capability was an immensely valuable asset. It's hard to replicate. Almost nobody has been able to replicate it."
What was behind Milken's success with high yield debt?
"He was the smartest guy I ever worked with. He is the hardest working guy I have ever worked with. He is a great credit analyst. After 12 years of working with him he would still be teaching me things," Joseph recalls. "And he is a wonderful salesman. The combination of that brain power, that work ethic, that knowledge and that sales ability was overwhelming."
Drexel's downfall started with charges of insider trading leveled against an investment banker. The company fought off the SEC for two years until regulators sued the company. At the same time, Rudy Giuliani, then a US attorney for the Southern District of New York, launched an investigation of the firm, which was forced to declare bankruptcy in 1990. Until Lehman Brothers' bankruptcy last year, Drexel's was the largest bankruptcy on Wall Street.
Looking back at the regulatory fallout, Joseph says "at the end of the day, I got a fair shake. At the end of the day, no one said I did anything wrong but there was a supervisory breakdown. And, [while] the supervisory breakdown happened on my watch and I don't think I knew about it or could have known about it, it is still my responsibility. I'm not complaining about getting a fair shake. I'm fine. I think they went after the firm with an excessive zeal that was counterproductive."
Joseph adds: "The firm had 10,978 employees. At the end of the day, the government accused four or five [people] of doing something wrong. The size of the fines and changes in capital rules they applied to us ... the firm was destroyed. I just think they could have been much less punitive to the firm and still accomplish what they felt they had to accomplish."
Joseph still sees Milken a couple of times a year. "We had some aspects of a public divorce, but that was 20 years ago. I still think he's brilliant," says Joseph, noting that Milken offered tips regarding cancer specialists when the former Drexel CEO was diagnosed with his cancer. Milken fought off prostate cancer and has raised money for prostate cancer research.
Regulators banned Milken from dealmaking for life. So, does Joseph believe Milken misses dealmaking?
"I would think, probably. He was awfully good at it and enjoyed it," says Joseph, adding that "he's got himself more than occupied with his efforts to support prostate cancer education and research, the Milken Institute as well as his own investing."
Milken declined to comment for this story.
Life beyond Drexel
After Drexel filed for bankruptcy, Joseph stayed and helped manage the wind-down of the fallen Wall Street giant. He worked for Clovebrook Capital as an investment banking advisor and at ING Baring, where he was a managing director.
In 2001, he co-founded Morgan Joseph. The firm has brought together many his former Drexel colleagues: John Sorte, CEO, was co-head of the corporate finance department at Drexel and was Drexel's CEO during its bankruptcy. Also, the firm's co-head of investment banking, Mary Lou Malanoski, and Mathew Stedman, its head of sales and trading, are from Drexel.
Last week, James Schneider was brought on to help advise companies on debt exchange offers. Schneider, among the first bankers to be hired by Joseph at Drexel in 1975, headed a group that specialized in exchange offers.
Since it opened its doors, Morgan Joseph has completed $27 billion worth of transactions. These include over 120 M&A and restructuring assignments as well as over 90 financings--private equity and debt. Many of them are for longtime clients that--like Jules Kroll--go back to Joseph's days at Drexel.
Morgan Joseph advised Kroll on the sale of his firm, Kroll Inc., to Marsh & McLennan in 2004.
So, what brings Drexel people together? "It is mutual respect in terms of intellectual and market knowledge and enjoying each other's company," says Joseph. "I tell people when I'm recruiting them that 'at the end of the day you will spend more time with people in the office than you will at home. You don't want your stomach squirting acid every time the guy in the next office says something to you. Don't join that firm.'"
Sorte, who has worked with Joseph for over 25 years, says the draw to Morgan Joseph may be that former Drexel professionals trust each other. "This business is built on trust. People have to trust the people they are building a firm with."
Also, some of the draw may be that these bankers had been through good times and bad times together at Drexel. Sorte and Malanoski stayed behind with Joseph to work on the wind-down of the junk bond powerhouse after it filed for bankruptcy. "It is similar to going to war. You come out with shared experiences," says Sorte.
Morgan Joseph's focus is the middle market. The idea is to grow with the middle-market businesses, a strategy used effectively at Drexel Burnham. There is likely to be a rise in defaults, so more companies will need advice on restructurings in addition to equity and debt financings. Joseph says investors should not be surprised by an 8% to 12% default rate. Amid the expectations of higher defaults, Joseph notes that yield premiums for high yield debt may have widened too much. "The premiums being charged in the market recently, where the premium-to-Treasuries for high yield bonds is 22%, are excessive."
Despite the severe slump on Wall Street, Joseph remains confident that his firms and others like it are survivors.
Not only are companies like Wachovia, Lehman Brothers and Bear Stearns no longer in the picture, many large firms just don't view the middle market as profitable enough, fee-wise, to merit attention. More professionals are also shifting to smaller firms to avoid bureaucracy and issues about compensation.
"There will be more middle-market and smaller firms," says Joseph. For an increasing number of dealmakers, he says, the smaller firm is a "very nice way to make a living for a handful of people."
(c) 2009 Investment Dealers' Digest and SourceMedia, Inc. All Rights Reserved.
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