Double Cropping - A Second Bite At The Apple

It will come as no surprise to many people that banks make money in every market - regardless of whether its up or down. Venture capitalists are no different, but they may very well be more innovative.

Let's assume that you're a venture capitalist that has plenty of money floating around, but you can't seem to find anything worthwhile in which to invest. You still need to satisfy all those investors with the same, or similarly, high returns, so what options do you have? The answer, at least today, is double cropping.

Double cropping is the practice of lending back the money you just borrowed, at higher rates of course, backed by the same underlying assets. Remember that bank that lent you all that cash for your last buyout? Those banks had planned to sell your loan to other financial institutions, but when the credit crunch arrived, they found themselves holding the bag. Still wanting to unload the loans, they're now offering them at below face value. That's right, you can send the money that the banks just gave you right back into their pockets, but at less than it originally cost you in the first place. There is a catch, but it's a good one - if you're the VC, that is.

To avoid all the complications resulting from legal paperwork and taxes, you don't actually buy the debt, but rather engage in a swap; a Total Return Swap to be more precise. This is the act of paying a small portion of the total face value now and agreeing to pay some rate of return on the balance of the below-face-value asset (our own loan). In exchange, we'll get back the interest and principle promised on the original loan - yes, that's the interest and principle that we're paying them... until now! The end result is cheaper money as well as less risk.

Why less risk? The asset, the loan in our case, is backed by the venture for which the bank originally made the deal. If those loans turn out to be worthless, then it's still the bank that's on the hook for the full amount. The only thing to which we've committed is the payments on the balance of the below-face-value loan.

A great example of just such a case is Citibanks 'sale' of $12 billion of buyout loans back to Apollo, TPG and Blackstone. The firms put-up $3 billion cash and then agreed to pay a ridiculously low rate of 1% on the balance of $7.8 billion - yes, that's only a total of $10.8 billion for something with a face value of $12 billion. Can you say easy money?