Chartering A New Course

You could say that the wedding and subsequent month off has really knocked me out of my rhythm since getting back. That has certainly been a really good thing, as there is nothing worse than letting life's undercurrents pull you along in whatever direction it chooses.

I have taken the title of my last entry (time to reassess) to heart and have been taking a long, hard look at what I want to do next both professionally, not to mention spending all of yesterday looking at houses, as I think 2010 will be the year I finally pick up a place at last.  Buying your own house (as opposed to properties to rent) are a total waste of money, and should never be viewed as investment.  

Their 'return' is largely an illusion given the multitude of hidden costs, not to mention the opportunity cost from what returns all that money tied up in a property could yield elsewhere.

Anyway, It was over drinks with a number of former colleagues that I got into some serious banker-beer analytics on why I find my current job at the bank so utterly dull these days. I think it is easy to explain: ever since the work become reactive (the Time Wasting Insolvency Initiative, which was panic fuelled by the events of October 2008), the work is not remotely analytical based.  As such my role has increased in responsibility but decreased in actual interest.

So it was that on my fifth pint with a good friend of mine, who has moved over to one of the other banks, concluded I ought to get out of what I am doing and become an investment analyst with a view to eventually trying to climb the greasy pole into full asset/portfolio management.  It was the sort of matter-of-fact statement that makes it sound like the easiest thing in the world.

Despite that, it was a bit of a lightbulb moment, as I had not seriously considered the prospect of a complete move out of my area until now.  However I am certainly never one to rule out ideas as 'impossible' simply because they might be difficult. So despite my inebriated state I filed that and mulled over it at work for the next week, eventually concluding that doing something I have been meaning to for the last 5 years would be a useful first step.  

As such I signed up for the CFA (Chartered Financial Analyst) programme a couple of weeks ago, and that is naturally going to take up a great deal of time over the next 6 months alone.

To anybody who has taken the time to read some of my previous entries, it probably won't come as a great surprise to realise that I have a passionate interest in investing, not to mention an unusual willingness (and bizarre enjoyment) in carrying out the associated due diligence and analysis required to make sure the important decisions are the right ones.  The CFA course itself looks to be largely areas I know a lot about anyway, so this should just be useful in really ensuring I fill in the knowledge gaps as I go along.

The benefit for all of you guys, is that I will start producing far more concise, better quality research and analysis over the coming months as I go forwards.  Unlike the hoards of people blogging and making recommendations ultimately to make money, I'd rather help in my own small way in the development we all undergo as investors from those first, emotion-driven small dips in the water, through to spending hundreds of thousands based on a cold, worked analysis thesis.

And on that subject, we can celebrate the first anniversary of my initial position that I took in General Growth Properties.  I have obviously been following developments with the company with a great degree of interest over the past fortnight regarding GGP's lender blueprint that it has fast-tracked with many of its major secured lenders, and of course the news the day before from Simon Property Group that they have hired Lazard Frères with a now open interest in acquiring some or all of GGP.

All excellent news for the share price of course, which has rightly repriced upward sharply into the $6 territory, and will almost certainly continue rising over the coming months as further news regarding lender settlements and takeover rumours begin to gather pace.

To anybody sitting on the sidelines, now remains a very good time to look at General Growth Properties as an investment.  Despite concerns regarding the impact of share dilution from many, this is becoming an increasingly less important factor as the company market capitalisation increases.  Limited asset sales to raise a couple of billion could easily be agreed with SPG or rivals to reduce that $6.5bn figure further, so I see this as a minor downside on the upward direction of the stock price over the next two years, as risk perceptions reduce and the market continues to reprice the stock accordingly. 

Oh, and on a final note, the job market here in the City of London has bounced back hugely in the last few months.  After screwing up the global economy, there is no irony that the sector is the first to be firmly out of recession.  The major banks are all haemorrhaging good people now - people who are generally fucked off after the last two years of being treated badly and overworked by employers that are now making plenty of money (courtesy of cheap and easy government money).

As such, the already understaffed banks are now desperately hiring - my own being no exception.  Naturally I am never one to turn down an opportunity, so have already had a couple of interviews in the last week and could take jobs with them now if I wanted based on the feedback.  It is the best market I have seen since 2005/6, and so despite the longer term aim, I shall probably use this as a moment to cash in on the prestige/name of where I work and up my earnings by 30-40%.  It would be rude not to...

Time to Reassess

What a month! Thanks to those of you who took a moment to post a comment.. it was a fantastic day and three weeks out in California, even if I did somehow come across five bears in Yosemite.

As I sat there sipping champagne on the flight over to Chicago, I did wonder whether I'd miss anything about my job. However I can safely report that with close to a month off I didn't miss anything, which only confirms that I need to look into a move over the coming months now that the job market it picking up to something more rewarding (read: hedge fund).

This is a really rough 'n ready entry, as I have not really had time yet to gather my thoughts on anything properly, much less complete detailed analysis into various companies I have been researching - hopefully you'll find some of the links below interesting.

Crime Pays?
On the subject of hedge funds, I have started taking a look through the speeches from the Value Investor Congress today, and of course started with Bill Ackman. I was amused to see that Pershing Square's latest notable stake is 9.5% in the private prison company Corrections Corp of America.

Recessions tend to fuel demand for life's vices: cigarettes, drugs, alcohol, gambling and of course crime. At the Value Investing Congress, Bill Ackman confirmed that the fund have bought in at "more than $24.50 a share." At this moment CXW is trading at that approximate level, so what is it about the stock at this price which has tempted in a hedge fund?

"This is one of the best real estate businesses in the world. The biggest risk to Corrections Corp is that people stop committing crimes, and I think that's a low probability event." Bill Ackman, Value Investing Congress Oct 2009

Looking at the business sector, crime combined with the prolonged economic downturn and unemployment provides a strong demand for this particular business in the coming years. As such, without yet having carried out any financial analysis of my own, we can see that Corrections Corp appears to be in a strong sector in the current economic cycle.

However where Pershing Square have commented that the real value lies is in the real estate. Combine that with the US government being a tenant, and you start to see why CXW has potential. This post on Market Folly provides some useful commentary on the actual presentation itself, Additionally the actual Ackman presentation is available here.

A quick summary of the main reasons cited by Ackman as to why CXW has significant potential:

1. Industry occupancy is high (94% and rising)
2. New state facilities cannot be built easily in the current climate due to budget constraints
3. Numbers of prisoners is continuing to increase
4. Company history of stock buy backs

Corrections Corporation of America (CXW)

Before just jumping to the latest earnings it is always useful to look at the prior quarter (at least), particularly to give perspective relating to any exceptionals.

The first quarter earnings release for CXW is here and is certainly going to have been a significant factor in influencing Pershing Square to buy into the stock. Earnings of $0.29/share with EBITDA up 9.6% to just under $100m are the headline figures, along with the final phase construction of a new correction centre and being awarded three new management contracts for over 3,800 inmates.

The second quarter earnings financial results for CXW are also positive with improving fundamentals and notably the purchase/redemption of $450m of senior notes due in May 2011. The third quarter earnings are due out on Friday, so now is the time to complete due diligence into this as an investment opportunity, I will let you know my thoughts later this week.

Shorting Realty Income
While looking at various Pershing Square info that has come out in the last month, I came across this presentation into the case for shorting Realty Income, which is interesting and worth reviewing. This article summarizes Ackman's reasoning why this makes a useful pair to hedge the CXW position.

So much to read and catch up upon, either way no more talk of weddings from L (aka 'Mrs EI'), which has to be a good thing...

Wedding Bells

Right, well I'm off to Chicago to get hitched. I'm sure it will all go well - as will the three weeks in California afterwards away from the tedious goings on at the bank.

I'm sure you all agree I look particularly handsome in this photo I took last night, wish me luck!

Business Valuation In Chapter 11

Pershing Square's much anticipated second quarter letter finally leaked onto Dealbreaker recently, and it was interesting getting some perspective from Bill Ackman on the fund's performance, successes and candid admission of mistakes and missed opportunities during that period.

I won't reiterate the various comments made in the section around General Growth Properties beyond two quotes. Firstly the final comment:

"..GGP is a highly leveraged company and there continues to be substantial uncertainty about the potential outcomes for GGP security holders." Pershing Square Q2 2009 Shareholder Letter

It was good to see an appropriately cautionary note raised around General Growth Properties share valuation, and to make sure that those currently looking at recent returns remember that this remains a risky investment. However that is also why in theory despite large rises to date, it still remains potentially excellent value.

The headline $40/share figure that everybody has latched onto comes from Ackman making a very high level statement that the REIT most comparable to GGP is Simon Properties. That is definitely true in terms of size, portfolio quality and overall market position, although obviously not in terms of risk. Ackman uses this purely to demonstrate that assuming GGP risk reduces as Chapter 11 negotiations proceed, and clarity is gained relating to shareholder dilution, then we should look at General Growth eventually trading at an equivalent cap rate.

That gives a $40/share figure based on the current portfolio and capital structure, but crucially assumes a best case scenario of zero dilution for shareholders. It merely highlights potential, and is not intended to be some sort of predication of future value. Anybody reading the report and assuming otherwise would be wise to consider further this comment:

"The balance of GGP's value should inure to the benefit of the company's shareholders. As a result, the company's valuation will likely play an important role in determining recoveries for shareholders." Pershing Square Q2 2009 Shareholder Letter

Determining Value In Chapter 11
So what are the crucial factors that will determine GGP company valuation within Chapter 11, and how is this process going to work?

This e-zine article on determining value within Chapter 11 does make a number of interesting points about factors that could impact GGP. To my mind the key factors are as follows:

1. Valuation Experts
There will be various external specialists within the commercial real estate sector able to provide an accurate market assessment of the current asset valuations of General Growth Properties. Representatives will be put forwards behalf of the creditors and debtor (GGP).

2. Valuation Methodologies
Methodologies will need to be applied, and will be scrutinised by the Court in detail to ensure impartiality and accuracy. These typically consider a wide number of factors: potential competitors available to purchase assets (i.e. market demand), industry trends (i.e. falling property values, occupancy rates and profitability) and general valuations of comparable rivals - this goes back to SPG.

3. Assumptions
Any disagreements will be submitted to the Court for resolution. One example in the article is a case where valuation cited by the creditors applied a 'bankruptcy taint' impairment if the company remained whole - presumably due to reputational damage. In GGP's case I do not think this will apply due to market conditions and the business continue to operate meantime.

4. Asset Liquidation vs Going Concern
Here valuation experts will give an assessment on which scenario maximises value, and will account for extenuating factors such as exceptional market conditions. It may be within this that some sell off of assets is agreed and included in the plan to reduce leverage.

"The premise of value utilized in the valuation process assumes either a 'going concern' or 'liquidation' of the subject. The Bankruptcy court utilizes the outcomes of these different assumptions-based approaches to make its determination."

Company specific risk will be the main consideration here, and in the case of GGP, there is a particularly strong case for its viability as a going concern: i) positive cashflow generation, ii) ability to raise DIP financing in a distressed market, and iii) voluntary servicing of creditors despite an automatic stay.

The coming months will see some interesting discussions around the above points, and it will be this determination of value and willingness to extend maturities that will ultimately decide how much or little equity value is retained by common shareholders.

Cyclical Investing - Prost!

Firstly a quick word on my pre-wedding Stag weekend at Oktoberfest: excessive.. Bavarian.. fantastic! I was fortunate to go with a large group of bankers from the City (mostly Australian), who made the whole experience far better as many had been before. As such we had a great hotel just minutes from the festival, and they ensured we weren't one of the throngs without a table on the opening day.

It's a wonderful affair that despite attracting too many tourists, due to the numbers of Germans who also attend it manages to retain its cultural identify. I thought the sheer number of locals who turned up wearing traditional costume was magnificent: there is just no way we Brits would be able to take ourselves seriously wearing leather shorts.

From the singing (I challenge anybody not to have learned the lyrics to Ein Prosit by the time they leave) to the continuous shouts of 'Prost!' (cheers/bottoms up) - it was all about fun.

Oh, and for some reason I really liked the traditional Bavarian costume for the girls... I can't work out why but I'm dreaming about L wearing it now...



Champagne Tarts
On the subject of drinks, I had a few with some more senior bankers last week that was an interesting look at changing behaviour as they get older. Being mostly in their 40's and 50's they chose an old school City bar that I had never even heard of - apparently it has been around for 30 years or more, so I was informed by one fossil.

I arrived late (I still work for a living) to discover them all sprawled around several tables, reminiscing over the days when everything was charged to expenses, the Lehman Brothers collapse and generally what a complete fuck up the last year has been.

What caught my eye immediately was the lack of champagne or wine. I discounted them all vying for the first male pregnancy despite several looking due. It seems that the banker equivalent of contributing to the new Age of Austerity was everybody drinking bottled Guinness of all things. Presumably this is the 'new Champagne' in these cash strapped times - you heard it here first people, and when Diageo's shares soar on the news you know who to thank.

Still it did remind me how the days of 2005 are long gone, when amongst other bankers I had occasionally got through champers on a night out without a second thought. The bar in question was called Harry's near Cannon Street, and must hold the title of Seediest Bar In The City. On appearances, it's quite a nice little underground cellar conversion which serves good everything.

However by the time I left at 10pm the place was awash with a sea of tarted up slappers, who all clearly had arrived to play 'bed a banker'. You get the equivalent with teenage Essex girls for bankers in their 20's, so I suppose this is what they look like 20yrs on.

I watched various aforementioned tarts wander in, add another layer of foundation to cover themselves before boldy striking up conversations with the various fat bankers in their 40's and 50's dotted around the bar. What struck me were the number of single men drinking alone, and I noticed these women seemed to almost be cycling between them until they got a hit. Presumably that's my future if I stay in banking for another 20yrs - put on 40lbs and start frequenting seedy bars for illicit affairs. Yuck, what a thought.

So Many Opportunities
My thoughts are now increasingly turning to where the next big opportunity will lie after GGP as an investment. The biggest mistake many amateur investors make is to make a decision for the sake of it. Reading back I notice making that same point as I sat on significant losses on the General Growth trade back in February and March this year.

It usually takes getting burned through a couple of rash decisions before you start to realise that one of the most intelligent things you can often (but not always) do when not sure is to do nothing at all.

Buffet himself is a master at sitting on his hands when no opportunities are apparent. Berkshire Hathaway hoarded cash during the boom years, with many questioning the value of this for investors - but note how much he has been busy spending in the last 18 months by contrast. So the same of course should apply for the smaller investor, and right now the markets are like taking a walk through an orchard with trees laden with fruit. The big question however, is which will be the first to ripen, and hence which to hold as opposed to watch?

This commentary from 10 months ago is interesting, because from this you can look back and compare its accuracy:

"Even in depressed markets, it is typical for the market to stage significant bear market rallies, as witnessed in the 1930s and in Japan during the 1990s. Perhaps the best example was seen in the aftermath of the 1929 stock market crash, in which the Dow Jones Industrial Average (DJIA) rallied close to 50% from its November low to an April peak. Comparing the present day S&P/TSX with the DJIA circa 1929-1930, it is interesting to note very similar price patterns, plus seasonality which would suggest that the stock market could stage a bear market rally through the year end, as is typical at this time of year. " First Trust Quantitative Research - Dec 2008 Monthly Commentary

Not a bad observation to have made back in December 2008 I would say. So the post-1929 crash then saw a 5 month rally with a near 50% increase. Since March we have seen close to a 6 months rally now with an approximate 50% increase, but what about the future? What the commentary does not go into detail on is then pointing out that after this peak, the Dow Jones dropped back again (hence why it is referred to as a 'bear rally').

Investment Cycle
At a high level it is always useful to look at this old illustration of the investment cycle produced by Merrill Lynch Investment Management years ago:

Although it simplifies hugely, what this does also do is give a good sense of the need to make sure money flows regularly into different areas and sectors of the economy throughout the cycle to maximise returns. Before anybody objects or points out the danger of constantly investing/reinvesting, note I am referring to the economic cycle - which typically follows a 10-15yr cycle between peaks of each boom, so you can allow (very approximately) 2-4yrs per quarter depending upon severity.

This time, the cycle was skewed quite spectacularly after the dot com boom and crash by the flood of cheap credit, which effectively fast tracked back into a second boom. However that was exceptional, and in future it is reasonable to assume we will revert to the more standard cycle.

So firstly let's look at where we are right now - clearly in the red of recession. Looking back a year ago, you would have expected defensive sectors such as healthcare, consumer staples and utilities were the best places to put money. That would not be too far off, although the extraordinary nature of the credit crisis meant that financials have undergone an early return to favour - at least for now - with some amazing returns in the last 9 months. I would argue that this has gone beyond fair at this stage in the cycle.

In these times, this illustrates that investors should have been focusing their search for the best opportunities in the last 6 months on growth stocks above all else. I have a long term hold in the South American company Mercardo Libre for example, which has been posting very high growth levels right through the recession, and yet took a major hit on its share price during the October 2008 crash despite no rational justification.

Sure enough, its growth has continued, and has seen a 94% rise in stock price over the last 6 months, which illustrates the returns out there. In my case, I bought into MELI long ago but looking back I bought in at the wrong time in the cycle - hence why I moved into a loss through the downturn, and am only up a modest 30% after several years. A useful illustration of the power of timing however.

My view is that small caps should remain the focus for now, although investors should be increasingly eyeing up the early cycle sectors, which include consumer discretionary (financials already covered). The late cycle sectors include materials, energy, industrials and technology, and defensive include consumer staples, healthcare, utilities by the way. There is plenty of time for further analysis and I will be drawing up a candidate list to complete detailed analysis soon - just that small matter of a wedding looming on the horizon...

Tax Is A Four Letter Word

Golden Exuberance
Gold prices have surged in recent days, with the price pushing up above $1000 per troy ounce, and close to its all time high. I have expected strength throughout 2009 and so have been looking for a rise like this, which is why I took a fairly signficant position back in January. Additionally it has served as a useful hedge against both inflation and my substantial US dollar holdings.

As of this morning I took the decision to realise my gains - a fairly modest 12% but not bad over 9 months. I am not alone in believing the recent rises are unsustainable, as this article on gold prices from the Daily Telegraph outlines.

"London's leading gold forecaster has advised clients to liquidate holdings of gold and silver until the latest speculative fever abates."

I still adamantly believe that inflation is a near certainty in 2010 and beyond, as this is the easy way for politicians to offset the enormous debt that all the government support has lead to over the last year. As such I will be watching the gold price carefully over the coming months, with an aim of buying in once there is a fall back. On that note, I have continued to be surprised by the strength of the wider market recovery since March - it seems to have gone beyond rational, and a correction is necessary.

Investors seem to have become inebriated on the 6 month returns, a classic sign a bubble is forming that will surely deflate once institutions take a cold look at the economic fundamentals in the coming dark months of autumn.

Addendum: just logged back in today (Sep 18) and noticed this video linked to the right under CNBC: Commodities also discussing gold stocks losing their lustre which is worth a watch.

Capital Gains
Inevitably a significant question for any investor is when to realise profit (or loss - the latter is equally important). Like all investment decisions, that should never be taken rashly and certainly never based on emotion.

With GGP up around 600% now since bankruptcy, and for me around 300%, I am sitting on an unrealised profit of around £250,000 (approx $400,000) at present. You might think I would also contemplate cashing in, however I consider this investment between 6 and 24 months away from reaching fair value. Additionally realising a gain of that level requires careful planning, so I am beginning to look at ways of reducing the tax level payable. Sorry Gordon, I am already 'contributing' enough to the UK's recovery.

On the subject of GGP, its spectacular rises in recent days will also likely see a correction back soon enough, although the upward trend should continue. It has been fuelled partly by the wider market reassessing the firm as a value prospect, institutional buyers returning and crucially the belief that existing shares have a significant chance of retaining value.

That has been helped by further comments on Bloomberg by David Simon of Simon Property Group yesterday, describing SPG as a "logical buyer" of General Growth Properties assets. Limited asset sales at the right price are in everybody's interests here so a deal with some of the major REIT's is looking increasingly likely to be announced over the coming months.

Deleveraging GGP is important, and is rather like selling a holiday home to reduce the mortgage on a main house: it might seem a shame, but ultimately is the route to being financially healthier in years to come through lower debt. Of greater significance to me however is this news that the US Treasury has taken on board the significant criticisms of the tax rules that penalised those seeking to manage distressed debt.

Of course, this was cited as a major factor in the inevitability of General Growth Properties needing to restructure within Chapter 11. The removal of this sends a powerful message to the credit markets that renegotiating in these times is not just possible but expected. That benefits all REIT's, but also GGP for those loans in the joint venture SPE's that are outside bankruptcy.

It also benefits General Growth by providing further evidence that equivalent extension deals will be being agreed on the wider market when included in the restructuring plan and submission to the court. I would be surprised if we did not see GGP's share price at $8/share or higher by next spring based on the current news and developments.

G20 Truffle Hunters

Oktoberfest Awaits

What better way to ready myself for a long weekend of Germanic excess later this month than to start drinking as much beer as possible in my evenings going forwards? In truth this is going to be one of several legs of my stag do (aka bachelor party), although doubtless the messiest if everything I have heard about Munich is true.

Meanwhile the pace of life has accelerated significantly, hence the lengthening gaps between entries - although with the wedding just a month away now, perhaps that is not too surprising. Bloody hell, there's a thought - I suppose I ought to put some effort into listening to what L's talking about now as it's getting so close.

Bonuses: Political Truffles

The G20 meeting of finance ministers in London last weekend has proven as pointless as I expected, with politicians continuing to mine the rich seam of public resentment around banker bonuses that has always been there - good times or bad. Of course, the fundamental problem with this is that the political focus remains on the symptoms rather than underlying causes.

Bonuses are a small part of the problem that lead to where we are now. Certainly traders need to be deincentivised to ever make short-term decisions, hence the idea of performance assessment relating to any bonuses is a good idea. Additionally if I am being entirely honest (and I can be here), an awful lot of the financial products devised in the last 30 years are not as wonderful or essential to economic growth as bankers would like to pretend.

There is nothing new about packaging up of debt and selling onto multiple counterparties to enable the efficient flow of investment capital to where it is needed. The value of related products that enable speculative trading to take place on such processes is an entirely different point however. Do products that do not create wealth but only transfer it from one party to another serve any real purpose? Arguably they help markets determine value, but in many cases, as with speculative short selling, can instead skew valuations or undermine confidence in otherwise healthy companies.

One of the fundamental issues of the economy is it propensity to the 'boom and bust' cycle. As an asset bubble begins to form, the existence of these speculative trading instruments now enables traders to move in to capitalise on this very quickly. That would be fine if the markets rationally assessed value and pulled back, but instead the ability to hedge such strategies gives traders an incentive to 'bet' on how long the bubble will go on and to make as much profit from it as possible.

My view has long been that government and regulatory failure have actually been the root cause of the situation we find ourselves in. Banks need controls around their behaviour, and it is somewhat naive to expect such a large industry to all have the high level of morals and ethics to make the right decisions at all times if they have a choice not to. The quest to make money is an overriding factor that guides many if not most into finance after all, and unlike in politics at least bankers don't try to pretend otherwise.

What About GGP?
I know, I know - it's not like I could actually go an entry without mentioning it could I? Well, actually nothing visible is going to happen for some time now, so anybody sitting around watching daily charts would find the time better spent looking into other investment opportunities (and holding, I might add).

However there have been a couple of quite interesting commentaries that I recommend taking a look at. This commentary by Goodwin Procter on the GGP ruling provides an interesting expert summary on perceived weaknesses in the SPE structuring exposed by Judge Gropper's ruling last month. The most pertinent of these is that independent directors going forwards should rightly also be considering the interests of the parent entity shareholders, despite the theoretical silo within which SPE's are designed to operate, external from such concerns.

Much more interesting is this detailed critique of Judge Gropper's ruling by Alston & Bird. This is definitely worth some comment, as there are a couple of points I disagree with them on, although the conclusion in particular is excellent.

The commentary firstly notes the "unsettling" impact of the decision on the CMBS market, in particular several assumptions that lenders had previously made. It then moves onto the Court's assertion that its responsibility is to be viewing the issues at the corporate rather than individual entity level. Alston and Bird do not appear to agree with the one-sided slant to Gropper's reasoning, stating:

"The response of a secured creditor (of an SPE) might be to wonder why it suddenly must bear the burden of the parent’s financial difficulties. The court, however, sees an alignment of interests between the parent and the SPEs, asserting — wrongly perhaps — that the inability of the parent to restructure would inevitably impair the financial situation of the SPEs."

They go on to conclude:

"In reaching this conclusion, the court stops short of the full discussion one would expect in applying, and arguably expanding, the 'corporate family' doctrine to the GGP case... the corporate family doctrine should apply when the parts are worth far less than the whole, or, put another way, when the unity of interest protects not just the entities, but more importantly the underlying asset value.

It is not clear that this logic is sound as applied by GGP. The GGP SPEs, while part of a large, complicated corporate structure in one sense, were (or at least could be) operationally distinct, in that the malls could have been operated or managed independently from one another and the parent, either by GGP or another shopping center company or a sophisticated institutional investor. As such, the parts were not worth less than the whole—many healthy performing shopping centers could continue to operate successfully without the corporate parent."

Alston & Bird's analysis ignores several key factors. On the notion that assets could be sold off to rivals, it does not seem to account for a far from normal commercial real estate market. Where valuations of low volume, high value assets cannot accurately be reached, there is a significant scarcity of both credit and confidence, along with an industry wide requirement to deleverage. That being the case, any decision that had lead to a significant number of assets reaching the market in a short space of time would have been very unlikely to secure sufficient buyer interest to attain what could be deemed fair value in a functional market, and instead we would return to the 'fire sale' conditions reserved for companies forced to accept an uncompetitive price on an asset due to extenuating circumstances.

As for allowing the malls to be separately managed - that ignores the centralised management model that GGP operates under, as well as key functions around mall management that presumably the individual mall would have to pay for separately. While that might be coverable by the cashflows generated on that asset, there is no doubt that this would be inefficient and indeed would only ever be taken by creditors with interests unaligned with the underlying asset or wider collective.

"While the emphasis on preserving value for the collective enterprise is clearly the court’s focus, it seems unduly dismissive not even to discuss the contrary position, namely that separate loans to separate entities by separate lenders on separate properties should be treated separately."

I think it is for the reasons I have touched on above that Judge Gropper chose to not even entertain them in the ruling. It was quite intentionally dismissive, because to even hint at this avenue being viable would be to encourage activity that is detrimental to Chapter 11.

Keep Your Eye On The Horizon

A crucial part of investing is to look in all directions towards the horizon. By that I means forwards as well as backwards, since it is both anticipation and retrospective understanding that enable us to increase our ability to make the best decisions.

The best traders and investors are those who adapt fastest from mistakes - and learn from them. It is not about selling when an unrealised loss reaches a huge number for example, but determining whether that situation will recover, or if it is indeed time to cut your losses and analyse what went wrong.

"Indeed one's faith in one's plans and methods is truly tested when the horizon before one is the blackest." Mahatma Gandhi

Hence why my focus on General Growth Properties intensified as its stock price fell throughout Q1 2009. As we know, everything so far has gone well for GGP as an investment recently, but it is well worth spending time re-assessing the stock now.

How exactly does it stack up relative to its peers on current valuations? What are the likely prospects regarding securing advantageous terms with lenders ahead of submitting a reorganisation proposal to the Court? What are the primary risk factors remaining (e.g. dilution), and what is the likely price range in 12 months? Take a look at this table of the American REIT Peer Group, which details the share price performance of GGP relative to its peers over the last 3-12 months.

The statistics speak for themselves as to which has been the best hold over the last 6 months, with GGP up a massive 403.20%. Having said that, this is in no small part due to its enormous discount due to bankruptcy risk - hence the 87.90% year-on-year fall.

For a selected group I have added in some analyst FFO estimates for 2009/10; firstly note the zero 6 month dividend yield - a shame for those of us with plenty of shares. One of the most striking observations is when we look at the forward NAV (Net Asset Value), this reflects GGP's market value based on its real estate properties, and the figure is derived from the total number of shares. At just 3.5, this is a massive 14.8x lower than Simon Property Group, and 8.4x lower than Regency. Why is GGP so much lower? The primary reason remains the uncertainty forward priced due to its status in Chapter 11, and its ability to secure asset prices or cap rates.

However looking at the sector as a whole, commercial real estate has gone through a rally that has pushed up valuation levels to near previous peak levels. If we take a benchmark (EV/EBITDA is more accurate the P/E ratios for REIT's) then the sector average is at a multiple of 14 right now. That gives an implied cap rate in the 6-7% range. However that also means that as on average, REIT's are now averaging 12.8X the 2010 Funds From Operation (per share) estimates - strikingly that is a 23% premium to long-term average multiples.

That actually suggests that for short term traders, now is not necessarily a good time to be entering commercial real estate. However if we go back to GGP, the enormous discount to the sector becomes apparent. At just a 1.5x 2010 FFO/share estimate, it sits markedly as by far the cheapest in the sector, and suggests that should restructuring complete without excessive share dilution - something I will come back to another time - then this clearly remains THE choice in the sector for value investors.

This recent commentary has suggested that the recent ruling on GGP should be considered a one off "largely because [the whole company] has filed for bankruptcy." I think one off is the wrong phrase, what they actually mean is that given most defaults are not at the parent entity level, therefore single entity defaults will not provide any opportunity for debtors to push for the kind of ruling that has just taken place with GGP.

However many other companies operate with a centralised cashflow model, and so could conceivably see similar group wide liquidity problems, so to claim this is a one off is not correct. In fact, this view is shared by the legal firm Wachtell, Lipton, Rosen & Katz, which notes:

"..the GGP ruling may herald a trend towards bankruptcy filings by highly structured commercial real estate enterprises which today find themselves vastly over-levered."

The article is well worth reviewing, as it provides some observations around how the complexity of debt tiers acts in itself as an incentive to file for Chapter 11 due to problems restructuring:

"Further fueling potential bankruptcies, many of the highly structured, multi-tranche capital stacks that were set up in the last few years present significant barriers to consensual restructuring outside of bankruptcy. For one, master servicers and special servicers are often constrained in their ability to modify loans because of restrictions under the relevant pooling and servicing agreements and adverse tax consequences under applicable REMIC tax rules."

So with GGP remaining excellent value, I think the right balance of caution about GGP's future is struck with this final passage:

"While this round went to GGP and against the SPE and CMBS lenders, it remains to be seen where the balance struck by the GGP court between creditors’ rights and the interests of equityholders leads when thorny issues such as cramming down secured lenders to extend maturities and alter pricing and other terms to the benefit of equity are presented to the court, or how negotiation and settlement discussions – both in formal bankruptcy proceedings and in consensual non-bankruptcy restructurings – will play out in the post-GGP era."

Another legal commentary by Davis Polk of the recent court ruling is also available here which gives a good summary.

Gropper Decides 'Enough Diversions'

Delicious. It was like waking up to find a fine pie and chips, with a large pint of ale in a country pub waiting for me. That's really the only way I can describe my morning, as L dried her hair and woke me up, but knowing I was 'working' from home today AND then finding out that Judge Gropper has finally made his decision on whether the disputed SPE's should be included.

As I am sure anybody long on GGP is already well aware, the Court has published its memorandum of opinion on this issue, and has ruled in favour of General Growth Properties.

Despite the multitude of other arguments put forwards by the Creditors, Judge Gropper rightly centred on the issue of 'bad faith' as "the primary ground on which dismissal is sought is that the Subject Debtors’ cases were filed in bad faith. It is also contended that one of the Subject Debtors was ineligible to file." Page 4, MEMORANDUM OF OPINION

While other arguments were raised relating to some malls not having other significant creditors, and the alleged need to include entities due to the centralised nature of the GGP business model (despite other entities such as the Joint Ventures not being included), these really were in there to flesh out the argument. The central premise of this filing has always been around the issue of proving 'bad faith'.

I mentioned in previous analysis that this was highly unlikely to be upheld based on Wells Fargo's own definition of this as:

"...a balancing process between the interests of debtors and creditors which characterizes so many provisions of the bankruptcy laws and is necessary to legitimize the delay and costs imposed upon parties to a bankruptcy."

Gropper's submission gives a useful summary of the GGP group structure including its loan structures - this includes detail on how the underlying CMBS are sold onto the wider market as re-REMIC's: something those who have been reading my recent posts will be familiar with. This demonstrates that the Movant arguments for dismissal of SPE's with a single creditor are actually nonsense:

"The REMIC in turn sells certificates entitling the holders to payments from principal and interest on this large pool of mortgages." Page 10, MEMORANDUM OF OPINION

In effect, negotiations relating to such SPE's can be extraordinarily complex under situations requiring an exceptional extension or refinancing agreement, and can realistically only be achieved with consortium consent, a cramdown or through Chapter 11.

As part of the court justification for the decision, the memo of opinion goes into some detail outlining the plight of General Growth Properties, explaining how its previously industry-standard CMBS refinancing model was left at the mercy of the credit crisis. The submissions goes into detail explaining the refinancing and debt restructuring efforts made:

"...but the lenders were unwilling to consent to additional forbearance, which in turn led to defaults and cross-defaults. Furthermore, the GGP Group was generally unable to sell any of its assets to generate the cash necessary to pay down its debts, as potential purchasers were themselves unable to acquire financing." Page 15, MEMORANDUM OF OPINION

This includes confirming GGP's inability to renegotiate loans set to mature by January 2010 due to the refusal by the master servicers to allow them to communicate with the underlying creditors. This has all been covered previously in GGP's own submissions, but clearly won over the Court as a convincing reason behind its need to move into Chapter 11.

The memo breaks down its ruling by addressing each of the key objection reasons put forward by the creditors.

Bad Faith Dismissal
The first point made is that 'bad faith' filings are "a judge-made doctrine" and not an absolute that can be proven by lawyers citing previous cases in their arguments. Gropper notes that dismissal of the SPE's from Chapter 11 on these grounds should only be granted "if both objective futility of the reorganization process and subjective bad faith in filing the petition are found.” Page 19, MEMORANDUM OF OPINION

Additionally Judge Gropper concludes that no one factor on this issue can be determinative - the Court cites a previous ruling and states:

"It is the totality of circumstances, rather than any single factor, that will determine whether good faith exists... Case law recognizes that a bankruptcy petition should be dismissed for lack of good faith only sparingly and with great caution." Page 19, MEMORANDUM OF OPINION

In other words, this goes back to previous legal analysis of Court submissions that ultimately GGP and the Court needed to consider what is in the best interests of everybody here, not just the few secured creditors that would benefit from liquidation. The Court dismisses comparisons cited with bad faith rulings made on single-assets real estate debtors, and slaps down MetLife in particular by pointing to the fact that both ING Clarion and Helios even concede that GGP do intend to reorganise and emerge from bankruptcy protection.

Objective Bad Faith: Prematurity
The court answers the allegation that GGP filed for bankruptcy 'prematurely' on entities with a maturity date beyond March 2010, as the prospect of liability was too remote. The Court answer is that this is irrelevant, the question is "whether the Subject Debtors were in actual financial distress on the Petition Date", and of course that is undeniable.

Ultimately this issue cannot be upheld because "the goal of the 1978 Bankruptcy Code to incentivize a debtor to file earlier rather than later, so as to preserve the value of the estate." Page 26, MEMORANDUM OF OPINION

This ruling is summarised that it "...is not to assert that every stand-alone company with ample cash flow would necessarily act in good faith by filing a Chapter 11 petition three years before its only debt came due. However, contrary to Movants’ contentions, the Court is not required in these cases to examine the issue of good faith as if each Debtor were wholly independent." Page 27, MEMORANDUM OF OPINION

Gropper finishes off by pointing to a weakness in the creditor's arguments on this: namely not explaining "how the billions of dollars of unsecured debt at the parent levels could be restructured responsibly if the cash flow of the parent companies continued to be based on the earnings of subsidiaries that had debt coming due in a period of years without any known means of providing for repayment or refinance." Page 30, MEMORANDUM OF OPINION

In other words, General Growth Property had no choice to take the decision it did in filing for Chapter 11 protection, because it had no realistic prospect of refinancing at a group level and that was the only criteria it could make when choosing to bring the wider structure with it in the filing.

Inability To Confirm A Plan
Another of MetLife's more absurd arguments was the suggestion of bad faith because a plan could not be confirmed in advance of filing for Chapter 11, and that they would never be able to confirm a plan over its own opposition! The logic to this was clearly flawed, and Judge Gropper devotes an appropriately short space to citing previous case law that proves this is utter rubbish with no basis in the Bankruptcy Code.

Subjective Faith
The arguments here were around not negotiating prior to filing and the firing of several independent managers / directors of SPE's ahead of the Chapter 11 filing. The Court confirmed that actually Bankruptcy law does not require negotiations to begin prior to any filing - this is certainly not sufficient for proof of bad faith. Gropper adds his views on this:

"On this record, there is no evidence that pre-filing talks would have beenadequate to deal with the extent of the problem. Indeed, there is no evidence Movants would have been willing to work with the Subject Debtors." Page 36, MEMORANDUM OF OPINION

Again Judge Gropper reserves additional criticism for MetLife, who despite having some mortgage loans as well as the unwieldy CMBS structures that caused so many problems with negotiations of loans further out, revealed some fascinating views via their internal documents called for examination by the Courts:

"...there is no indication that it [MetLife] would have readily agreed to a refinancing of any of its loans." Page 37, MEMORANDUM OF OPINION

"In December 2008, the head of real estate investments at Metlife identified its debt exposure to GGP (as a group) as a 'lessons learned opportunity.' A director and member of the research group responded, 'We wouldn’t do a loan with GGP now, given their problems.'" Page 37, MEMORANDUM OF OPINION

That's what you call 'the Smoking Gun' regarding MetLife's intentions and hence need for General Growth to file for Chapter 11.

Relating to GGP's activities with its somewhat dubious late dismissal of Independent Directors of many SPE's ahead of voting in favour of joining Chapter 11, Judge Gropper surprised me by not just agreeing that this was contractually allowed and hence legal, but also largely agreeing that in many cases this was right and proper.

This was justified by GGP President Thomas Nolan, who explained that the issues requiring their dismissal arose from certain directors who were less experienced with restructuring environments and the challenges the project entities were facing, and who incorrectly agreed with lenders and "thought the independent managers were obligated to protect their interests alone." Page 39, MEMORANDUM OF OPINION

Gropper goes on the record as stating that the firing of two 'Independent Managers' was "admittedly surreptitious", but falls back on the holes in the CMBS legal contracts, which gave GGP full control over such actions. You could say GGP got away with that one, although indications are that this would never have been a dealbreaker on the wider decision of bad faith, given the need for the Court to consider the wider interests - which is clearly a Chapter 11 restructuring.

Poor Old MetLife
I had long thought that MetLife in particular was whinging more than most of the creditors, with its plethora of largely unjustified complaints submitted to the courts. Perhaps over that bottle of fine 10-year single malt Scotch that should have arrived at the Court last week, the same occurred to Judge Gropper as well.

The Court acknowledged that as a consequence of Chapter 11, "creditors are now only receiving interest on loans, and have been deprived of current amortization payments, and Metlife complains that it is not even receiving interest on its mezzanine loan, which is secured only by a stock interest in its borrower’s subsidiary." Page 41, MEMORANDUM OF OPINION

However the court concludes that no additional adequate protection has even been sought by the creditors, who have full rights to recover both the principal (original loan amount) plus interest and post-petition interest once a restructuring plan is confirmed.

"Movants complain that Chapter 11 gives the Debtors [GGP] excessive leverage, but Metlife asserts it has all the leverage it needs to makesure that its rights will be respected." Page 42, MEMORANDUM OF OPINION

Let me translate from legalese: shut up and stop whinging.

Summary
Judge Gropper sums this up with true 'third glass of the good stuff at 1am and tired of writing 40 pages to justify himself' style:

"These Motions are a diversion from the parties’ real task, which is to get each of the Subject Debtors out of bankruptcy as soon as feasible. The Movants assert talks with them should have begun earlier. It is time that negotiations commence in earnest." Page 42, MEMORANDUM OF OPINION

Impact On Other Rulings
This bodes badly for Citi's ill-timed filing yesterday of a motion to grant relief from the automatic stay under Chapter 11 of its Oakwood Shopping Center. On paper Citi have a strong argument with precedent in their favour: GGP was undersecured by $10million upon entering Chapter 11 in April 2009, and crucially now after an asset revaluation (the accuracy of which is questionable in this market), there is arguably no longer any equity remaining within the property.

"Using KTR Realty's appraised value, the Lenders [GGP] are now undersecured by more than $19 million, or approximately 20.3% of the principal amount of the Loan."

Of course, millions of homeowners around the world are in negative equity right now, and without the support of an enormous REIT. However because they continue to service their loans they are not having a forced repossession.

When put like that, Citi's claim seems equally difficult to justify, as precedent rulings previously have not been in cases where loans have continued to be serviced at pre-filing levels, hence no actual material loss suffered by the creditor.

Given the arguments already put forwards above by Judge Gropper in dismissing other such cases, this one looks likely to be swiftly dismissed as well. With General Growth Properties share price now at a new 52 week high as I finish this, I look forwards to unrealised profits climbing ever higher.

Risk Mananging Asset Backed Securitization

GGP Q2 Results
General Growth Properties Q2 results were better than the markets expected. When you strip out exceptionals, many of which are related to Chapter 11 costs, the fundamentals are encouraging, and have rightly been reflected in a significant rise in the share price.

Taking a look at the breakdown, the immediate comparisons appear poor: Funds From Operation (FFO) are down by 73.8% year on year, Core FFO is also down 43.9%. However of much great importance is GGP's Net Operating Income (NOI) - down a much more modest 11% in total, and a very good figure both in comparison to GGP's major peers and market expectations. In fact, excluding the main drag from the MPC's (Master Planned Communities) - with those stripped out we reach the headline figure reported for the main Retail businesses, with NOI down a mere 2.1% on the previous year.

Relatively strong fundamentals adds further credibility to the GGP business model. The increasing market capitalization of the firm is a direct reflection of growing confidence across the market in its ability to successfully restructure without excessive equity dilution.

Bubbles & Risk Management
I fully admit to not seeing the credit crunch coming until it was too late, and if most people are honest they did not either. In fact, nor did most of the noted commentators - it was a rare few who warned of the dire effects of a credit withdrawal with the years in advance required to avoid these problems.

I thought the dot com and recent housing bubbles were both glaringly obvious, and stayed well out of both. However as I discovered with the credit crunch, bubbles are not always so clear - they have to be hard to spot to enable them to build up.

Risk management was a dirty word on the Street a few years ago. On a few occasions, I remember sneering with the best of them, as calls from risk management about positions being taken were viewed as unnecessarily cautionary. And consistently unnecessary as the high earners and income generators within my former bank confidently dismissed them as overly conservative. I was naively a believer in the pure capitalist argument that too much collateral tied up money that could and should be actively and productively used as part of the development of the 'new economy'. The financial instruments now in use were different; these managed risk as inherent in their design.

Whenever anybody starts justifying practices that generate extraordinary profits and inserts the word 'new' in the context of economics, it is time to beware. Things really weren't different this time of course, just as recessions and crises have occurred with startling regularity throughout the last century. My take on this is that it is the different generation of investors ultimately ensures that reoccurrence. Much like investment, few take the time to research before jumping in, and hence do not learn the lessons of history.

Additionally throw in the less sophisticated consumers in the emerging markets and bubbles in India and China in particular are a virtual certainty – that means the potential to exploit significant, quick profit in the coming years ahead for those willing to take the time to invest in these markets and not play safe at home (much more on this theme another time).

Risk Management of Asset Backed Securities
The one plus of this learning process for our generation is that the regulators have been taking a hard look at the woeful risk management practices in many of the large banks - particularly in the context of asset backed securitization.

The US government is proposing several key legislative changes, which are worth understanding for those inside and outside the industry:

1. Any bank, non-bank issuer or underwriter of an asset-backed security must retain at least a 5% interest of the credit risk in such assets for an as-yet unspecified period or form. Crucially that would be without hedging - the theory being that if firms are themselves exposed to what they are trading, they as shareholders and owners of the banks will take the issue of risk a great deal more seriously.
   
2. Requirement to continue reporting by issuers of asset-backed securities even if the number of holders falls below 300 - this has relevance to the low level issuance/ownership of Structured Purpose Entities (SPE's) that we have seen in General Growth Properties bankruptcy, whereby some creditors have effectively been the sole lender. At present these structures escape under the reporting radar, but soon no longer.


3. Requirement to disclose standardised asset-level or loan-level data and standardised compensation and risk retention information. This really does not have much bearing on risk management, and seems to have been inserted to placate those wishing to have some disclosure of bankers compensation.
   
4. Regulations on the use of representations and warranties in the asset-backed securities market that would require credit rating agencies to include additional analysis in their reports - this would require disclosure permitting investors to identify originators with clear underwriting deficiencies.


5. Elimination of the offering exemption for certain real estate mortgage notes and related participation interests.

If these proposals are adopted, the impact on the securitisation market will depend on the nature and scope of the regulations that are ultimately developed. However it is that first proposal relating to forced exposure which knowing the banks will be the most effective means of ensuring responsible behaviour.

As the cocky young traders I describe in my last entry have long proven, it is easy to play dice with other people's money – and in the right period for the economy a total muppet can make money. However put your own money on the table, and you think about the risk far more seriously. This links back to what bonuses are meant to be about - a performance linked assessment that incentivises traders to trade as effectively as possible – it is that glaring short-termist flaw in them that has been exposed and is rightly attracting criticism.

Bonus reforms remain another vital change that needs to be imposed on the sector, and if I can recognise that then you know there is no excuse for those disagreeing.

Trader Territory Marking

As expected, the motion filed by Hugo Boss for a relief from the automatic stay (see previous entry for link to the motion) was roundly rejected by Judge Gropper last week. Otherwise this story is doing the rounds today, and illustrates how the 'sword' of Chapter 11 can be used as a threat:

"[GGP] said it was considering ways to treat some of its subsidiaries as a single debtor and override their status as separate companies."

This is actually going over old ground, although it would be useful to clarify there is an apparent difference in how substantive consolidation is being used. The major concerns of the credit industry lie in CMBS being substantively consolidated into wider loans such that the agreed collateral is no longer secure - this been addressed in court submissions and will be protected by the replacement lien and order for GGP to provide 'adequate protection'.

There is however a desire and incentive by GGP to consolidate lender negotiations where possible through the Chapter 11 process to assist in restructuring - the two are not necessarily incompatible, although GGP is clearly using this as a threat.

A sign of the changing tide perhaps - our first new trader since 2008 joined the Desk on Monday morning. Somehow we coped after Junior Trader's departure earlier in the year - we lost a character, but not a revenue generator. However increasing volumes and opportunities are encouraging the bank to pick up some people again.

I always enjoy watching new traders when they join a Desk.. the verbal rutting with the old hands an be highly entertaining as they attempt to establish their place in the team. In fact, for those who don't work for banks, just pop on Animal Planet when you get home tonight and you'll get the idea - replace the hogs and territorial scent marking with traders crude humour.

He might have turned into a pious, hypocritical waste of time now, but back in 2007 the columnist Cityboy gave this old example of trade floor dynamics, which plays out in various forms every week:

"Why are you such a fat bastard?" said the posh salesman to the barrow-boy trader, who admittedly did look like he'd been on the notoriously unsuccessful 'all pie diet'.

The recipient of this rather innocuous insult slowly swung around in his seat and with perfect comic timing delivered the oft-used but still classic response: "Because every time I shag your wife she gives me a biscuit".

It is how well a new arrival can handle themselves and fit in with the Desk dynamics that plays a major role in their success at a bank. Obviously though, that only goes so far. Exceptional sales contacts, or an innate talent to manage large portfolios and hence bring in huge amounts of cash make those further up happy and that is what counts most of all.

I've seen some real arses turn up over the years though, and not all have been the 19 year old Essex boy sterotypes - although on that subject, many of them are a particularly special blend of twat. With a stated aim of doing their trading exams straight out of school, these kids are often very average – not even skilled numerically - but to their credit they don't waste their time or money following a route of higher education – and with hindsight I don’t blame them.

I recall an Irish guy who arrived at a former bank I worked for, and made the mistake of continually boasting about senior roles at Morgan Stanley and Goldman Sachs previously. He also made the mistake of looking down on the rest of us and making sure everybody knew it – I think in a misguided attempt to establish himself as the alpha trader.

Unfortunately that sort of attitude doesn't endear, and within a week the team had dug the dirt on him via ex-colleagues, and confirmed his overstated role and habit for bullshit. On his first day off, the team took some time out in the morning to ceremoniously unveil a sign above his monitor reading 'Little Fella' for him to find upon his return. A reflection of his small stature in more ways than just his height.

Interestingly that was a name which stuck for the remainder of his time there..

Anyway so far our new boy seems fairly quiet - listening and learning about the non-standard systems and what portfolio's he's inheriting. Let's see whether he starts pissing off anybody over the next month or two as he comes out of his shell.

Small Bang Time as GGP Takes Control

I have got far too little time at the moment with the Time Wasting Insolvency initiative nearing its crescendo - hence the lack of entries. Still it's the weekend, it's not like L had plans that might involve taking up more time with wedding preparations surely...

General Growth Properties Extension
A very big plus this week was the news on Tuesday that GGP got the hoped for time extension for the exclusion period to file a restructuring plan, along with a less important extension to the time allowed to file schedules of assets and liabilities.

So what does this actually mean? To Absolutely Confidential's question, yes the commentator you mention did get carried away with regards to General Growth Properties now spending the next six months piling up cash.
General Growth proposed in the original cash collateral motion back in mid-May to continue their prepetition cash management practices. Unless the SPE inclusion decision is overturned - still no formal news on this, but the extension suggests this has been made - then this means GGP has committed to the following as part of the ruling:

• continue the practice of a centralised cash sweep from its various sub-entities into the central firm accounts
• provide 'adequate protection' of creditors cash collateral by providing a replacement lien on intercompany loans - this is the notion of ensuring there is no substantive consolidation of CMBS
• continue to pay interest on CMBS loans at the non-default contract rate
  

It looks like somebody else made the same point in the comments, including referencing back to the Cadwalader court commentary. Sullivan's response: "correct but there is approx. $5B in default that is now another 7 months from being resolved and I believe another $8b that will fall into default during that time frame.."

Just because more loans will fall into default during the next period does not mean they will be treated differently from those pre-bankruptcy. Presumptuous at best, although in most cases firms within Chapter 11 cannot service debts and so do use this period as an effective 'breather' (a significant criticism of Chapter 11, since it can provide weak companies with an unfair competitive advantage during the process).

However GGP have committed to not doing so, partly to illustrate the viability of the existing business model and add credence to extensions being a viable solution.

Regardless this is excellent news for the stock in increasing incentives of creditors to negotiate - and was rightly reflected in a 10% upturn in share price since the announcement. It is striking that every bit of news since General Growth filed for Chapter 11 has been positive.

Industry Changes to Structured Credit Products
Related to changes in the credit markets that I have mentioned previously are the industry protocol updates made by the International Swaps and Derivative Association (ISDA) for restructuring events of credit derivatives. Firstly there was the release of the Big Bang protocol in April 2009, which has been designed to add certainty for investors when defaults occur. Something as we are seeing in recent months has been a significant grey area with existing products when finally tested with a default event.

Big Bang was the final step in a process known in the industry as 'hardwiring', which has crucially incorporated auction settlement terms into standard CDS documentation for the first time. The big bang protocol includes the following:

1. Introduces auction settlement as a means of settling transactions - eliminates the need for defining credit event protocols for every potential scenario to cash settle Credit Default Swaps.
2. Makes resolutions of the Determinations Committees binding by adding into standard CDS contracts - for issues including i) dispute on whether a credit event has occurred, ii) whether obligations are deliverable, iii) whether an auction should be held.
3. Adds credit and succession events (aka backstop 'look back' provisions) into the CDS documentation - to provide a common standard effective date for CDS transactions.
   

Further refinement to resolving restructuring disputes has been added by Small Bang, which took effect on Friday, details of which are covered in this ISDA web presentation. Key additions are to provide buyers with a five day window (sellers with two days) to trigger a credit event after a restructuring has taken place. Once triggered the evidence is then presented to the Determinations Committee to argue the case - a combined arbitrator and judge in the process.

It is all about clarifying how credit derivatives will work in future, and ensuring that buyers and sellers have a clearer idea of what protection (and liability) they are entering into. For those interested in finding out more about what credit companies companies will be entering into over the coming years, and how disputes will be handled, take a look at this analysis.

Additional Reading on re-REMIC's
For recommended additional reading on how structured products are evolving and what are impacting the recovery of the credit market this Bloomberg article illustrates how re-REMIC's are being used by the banks to refinance real estate. This article by Deloitte into re-REMIC's is dry but provides a very detailed examination of how these function and their impact.

Finally this report by Andrew Cuomo into bankers bonuses has to be the least surprising set of observations since the credit crisis of October 2008 plunged the world into recession, although this is the choice quote:

"When the banks did well, their employees were paid well. When the banks did poorly, their employees were paid well. And when the banks did very poorly, they were bailed out by taxpayers and their employees were still paid well."

Welcome to my world Andy...

Credit Markets and Rating Agency 'Refinement'

This is a follow on from my analysis in May into the credit markets and rating agencies, when Fitch assured that it would continue to monitor GGP assets in the context of bankruptcy proceedings (although the implication was for further downgrades).

Rating Agency Antics Fuel Uncertainty
This process continued last month when Standard & Poor's began to tighten their criteria for rating CMBS, with figures quoted as high as $235bn worth of commercial bonds under threat of losing their AAA status.  Now in the WSJ today, Standard & Poor announced that it has just reversed "its evaluation of a clutch of mortgage bonds backed by commercial property." It has re-rated a number which are part of the GG-10 benchmark securitization back to the crucial AAA status required for TALF legacy eligibility - and all just a week after downgrading them.

GG-10 is a large $8bn commercial mortgage backed security bond, that has large numbers of loans resecuritized each year across the market by dealers - so ratings on this baby serve as a bellwether for the health (or problems) of the wider commercial credit market. Looking into S&P's published methodology refinement in more detail, the Fed's desire to support commercial real estate is certainly a possible factor in this turnaround.

If so then that should come as no surprise - the impartiality of rating agencies has always been questionable. Note: for more on this, I highly recommend reviewing this great commentary by Linda Lowell of Housing Wire, on the ratings agencies and their impact on CMBS markets (particularly how S&P could not provide any meaningful backing to JP Morgan analysts regarding their previous change that lead to the downgrades). 

Suffice to say that the late June rally in CMBS resecuritizations was impacted by the ratings downgrade rumours and counter-rumours, as dealers were unable to price with certainty, unsure that triple-A paper classes at the time still would be so for much longer.

What Are S&P Changing?
So behind all this, quoting from the S&P methodology changes announced, the following key aspects are being amended:

• Amending how losses and recoveries resulting from 'AAA' rating scenarios for super-senior classes in US conduit/fusion CMBS are assessed.
• Differentiating the timing of losses from 'AAA' term and maturity default tests when cash flow modelling transactions.
• Spreading out losses that are applied to a transaction's certificates over a longer period of time.
  
  

The latter is the most meaningful change, since it allows for exceptional short-term losses to be effectively averaged, and hence to smooth out rating changes and thus reduce the occurrence of short term rating changes that are subsequently reversed.

S&P Methodology Outlined
For those interested, from Standard & Poor's own paper is the refined 3-step approach that they will be using for rating conduit and fusion transactions:

1. Aggregate recoveries from defaults in the 'AAA' scenario and credit impaired assets up to the crossover date. [NB Crossover date is the time where allocation of principal and losses to the super seniors change to pro rata from sequential]
2. For cash flow modelling, assume loans will not default for 3yrs and apply a 24mth recovery period before losses up to 30% would be applied (at the end of the fifth year). Any additional losses applied the following month, expect losses due to maturity.
3. Use Trepp's cash flow model to apply recoveries through the capital structure of the transaction to determine which certificates had an ending balance of $0, and would therefore retain their 'AAA' ratings.

Credit Market Evolution
This report on Sribd from Deutsche entitled 'The Future Refinancing Crisis in CRE' is another one worth reviewing, to understand the refinancing challenges within CRE right now. 

On a side note, the markets have been changing the structuring of resecuritisation in the last few years, in order to juice up tranches and create more AAA-rated bonds as assets became distressed.  How?  By moving away from the much maligned CDO to re-REMIC's (REsecuritization of Real Estate Mortgage Investment Conduits).

To see how these can be misused, take a look at this crap published by Fannie Mae back in December 2007 - see page 2 for the re-REMIC's section in which they state:

"Market participants know that almost any type of MBS can be used as collateral for Fannie Mae REMICs."

I think we're starting to see part of the problem Fannie, when you openly state almost any MBS will do. How to mortgage the future of the next generation in America through incompetence in one easy step. Let's take a look back at how the process used to work for the banks in the good old days...

"So, if I offer you this enormous stash of our sub-prime mortgage backed securities, you'll give me REMIC's in exchange?", asks the disbelieving banker.

"Sure, we luuurve you guys - you're one of our biggest clients, and we just keep on buying these.. cos.. hell, I don't know but we do. Anyway, the government wants us to buy 'em." replies the Fannie Mae redneck employee.

"I love this job.. ok fine in that case here's $50bn of our worst shit we couldn't sell to Bernie Madoff, and in exchange we'll have those nice AAA-rated Fannie re-REMIC's and sell them onto clients. As a sweetener, we'll even throw in vouchers for you and your family to have a 3 course meal at Cracker Barrel." 

"HELL YES!" replies the Fannie Mae redneck. "If there's Cracker Barrel in the deal, then you've got yourself one."

However back to reality, and re-REMIC tranches are attained in a different way to the particularly special blend of bullshit that the banks came up with previously to produce AAA-grade paper from sub-prime toxicity. Rating levels now are attained with a heavy emphasis on collateralisation - hence why rating changes like today increase uncertainty and problems.

For example, triple-A paper in recent offerings has had the most extraordinary 50% subordination levels; in English that means these would still be AAA rated if half the underlying properties burned down and none of them were insured (which they are). At least in theory, these CMBS are almost unnecessarily safe, thus should not ever be downgraded.

A trader is quoted in a Commercial Mortgage journal as stating that: "The life insurance companies are driving this. For regulatory capital reasons, they benefit from holding bonds that have more ratings stability."

Credit Future
This activity had lead to tighter spreads in the resecuritization market for super-senior bonds, leading to increases in their prices on the market and a general upturn in activity at last. However the junior tranche CMBS going out onto the market still have a significantly higher 30% subordination rate, which is a lot better than the triple-A class deals of old.

To me that is a sign that the quality of the bonds is improving to instill genuine confidence in the AAA-rating once again, and rightly so. Going back to the rating agencies, these sorts of problems then derail such progress by increasing the spreads.

GGP
Despite this, looking back at GGP, this is all part of wider series of moves by the government towards improving the credit markets and is to be welcomed by shareholders as a further means of assisting the firm in restructuring.

Indications continue to be reported that the government is open to reassessing TALF terms and conditions, but these mostly are around an extension to the scheme time frame, not a meaningful change to the criteria. Talking of GGP, there has been little going on besides some arguing between GGP and Hugo Boss relating to the latter wishing to terminate a signed lease early due to delays. Boss are likely to have that dismissed and are just trying their luck with a filing like this.

Otherwise the rulings today are largely unimportant, or have already been made (e.g. around the Success Fee). Somebody needs to slip a bottle of whisky to the good judge and tell him to hurry up and make his decision on the SPE inclusion issue…