Brave New World

I do feel I ought to apologise for my tardiness in posting since I returned from California, although as I mentioned in a reply to the reader who was kind enough to take the time to ask if I was still alive, I have come across a fairly obvious downside to studying for CFA whilst working full time at the bank (and looking around for a new role) - namely I never seem to have any spare time anymore.

On that note, I have made good on my promise and have made the big jump out of investment banking! No, no, no.. I have not 'seen the light' and decided to shave my head in readiness for a life of selfless devotion to others. Instead I have sold my soul to the devil with a sideways move into private banking - which is also a useful move further towards asset management.

I cannot say that I felt much regret as I sprung the news of my resignation on the Boss, just days after my bonus reached the safety of my account. He looked surprised initially - as if I had smacked him in the face, but then quickly a look of familiarity overcame him, it is not like he has not seen it all before. As I mentioned in my last entry way back in November, despite being amongst the world's most prestigious banks, my former employers have seen an exodus in recent months.

The irony is that having turned down a role for £50,000 more per annum back in March last year, I ended up snaring almost twice that with this move. Bonuses seem to have gone out of fashion, and it's all about the base.

Anyway going back to the lack of time, I wonder if that is why 99% of blogs do dry up after a year or two. Actually I suspect it is more running out of things to discuss. Of course, I've always got more than enough opinions to foist upon the unwilling world, but thought that I would devote this entry to a review of a fascinating couple of months for General Growth Properties, some comparative analysis into its current valuation, and a quick look at the recent report into the unwinding of the TARP programme and its impact upon the markets in 2010.

GGP - Into Double Digits (Briefly)
With the share price catapulting up by another 100% at its peak since my previous mail back in late November, it is worth reflecting on the underlying reasons. After all, continual reassessment is critical for the effective management of any portfolio.

Is the market being rational to value a company in bankruptcy at over $3 billion?

Key to the rises was the positive news regarding loan refinancing negotiations with secured creditors. That included the November 19 release that GGP had secured agreements in principle, followed by the filing of a Plan of Reorganization for some $9.7 billion of secured mortgage loans.

Adam Metz ensured that the propaganda machine was running at full capacity, with misrepresentative lines about GGP exiting Chapter 11 protection by the year end grabbing the headlines. It was always an unrealistic time frame, not to mention only a partial restructuring with a great deal of the important work still to do.

Having said that, a major part of General Growth Properties problems were a loss of confidence, and so instilling that in the markets once again is important - not least in the continuing creditor negotiations. By the time that aspect of the refinancing was approved by the court in mid-December, investors were partying, with myself no exception as my unrealised profits on the trade topped £1 million for the first time.

So it was with some amusement that I read through Hovde Capital's publication of a thesis that GGP shares were in fact horribly overvalued and that common stock would soon be worthless. The fact that the fund was short GGP, and the word on the street is that they are still sitting on some major losses, made it an enormous comedy. Obviously I bought into the plummet in the share price the day after it was published - but the damage to less sophisticated investors through such cynical market manipulation makes this more serious.

To say that Hovde's flawed analysis pissed off long investors more familiar than most with valuing the company might be an understatement. It is certainly rare to see two hedge funds like Pershing Square and Hovde Capital slugging it out in a war of presentations over the next fortnight, with other noteable commentators such as Whitney Tilson adding their voices to those denouncing Hovde's analysis for its fundamental flaws.

There is no point me summarising that whole saga now, as it was reported in so much detail elsewhere. This Marketfolly page is useful for giving the whole timeline and debate that raged during this period.

Ultimately though the markets are the real judge of these things, and while down from recent peaks, General Growth quickly recovered up to around $11/share. It has since of course fallen back to lows under $9/share, although remains firmly on the upward trend since filing for Chapter 11. I expect 52 week highs to be tested as additional court proceedings progress, and further unsecured creditors agree to the mass 5 year extension template that has been proposed.

GGP Valuation
As a mark of how long it has taken me to get around to completing this entry, I finished this comparative analysis of GGP versus its peer group several weeks ago, based upon an extract of sector FFO estimates using data from 21 Jan 2010.

As you can see, the all important price / FFO multiple estimates for General Growth Properties when its share price was $1.50 more than current are still the lowest in the entire sector. That is one of the key indicators of value, quid pro quo. Of course there are a multitude of other factors to take into account, but without going back over old ground and remaining on pure, technical analysis I am confident that General Growth remains the best hold in the sector at this time.

Unwinding TARP - Challenges & TALF
A key factor that will impact the markets in 2010 and beyond is the withdrawal of the quantitative easing policies that have buoyed the markets. I recommend taking a look at this report by the Congressional Oversight Panel as the section on TALF (page 106) conclusion is interesting - in summary that unwinding will have a minimal impact upon the commercial real estate market, and should provide comparatively few issues.

That's all for now campers, I'll do my best to get another entry together soon. Meantime I will be busy in Knightsbridge with my new colleagues, around the international travel that will apparently be making up a significant part of my role going forwards.

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.

Exploiting Loopholes

The golden rule with tennis, as with finance, is to always put your money on the Swiss. Tough luck on poor old Andy Roddick though, the guy was rightly gutted and is too good to only win a single major in his career so let's hope he comes back and wins another.

So the final legal submissions have now been made - this includes General Growth's post-hearing submissions against MetLife and against ING Clarion and Wells Fargo. The Committee of Unsecured Creditors, and the unsecured lenders ING Clarion, Helios AMC, and of course MetLife. They are really just summarising the arguments already put forwards, although additionally MetLife submitted a motion to dismiss evidence submitted by GGP because the "Movants [MetLife] were not provided with a copy to review."

The evidence itself is a summary of the MetLife Debtor groups that own the two malls in question in this appeal. Ultimately they were included to provide evidence of the consolidation benefit to GGP that would come about from their inclusion in Chapter 11. Again, whether this is accepted or rejected is arbitrary and will have little bearing on the overall decision.

Additionally I recommend reviewing two interesting analysis papers discussing the impact of the GGP bankruptcy on the CMBS industry. The first is entitled The GGP Bankruptcy So Far: Grounds for Concern, Sources for Hope, (thanks to GGP Freak for bringing that to my attention - you mentioned it is from a post on one of the boards so perhaps you could post the link). Either way, the article provides an interesting additional summary from legal experts.

It agrees that the notion of 'bad faith' is unlikely to stand up to analysis and sway the impending decision, although here the authors focus on the eleventh hour dismissal of independent directors as the other key factor instead of GGP's ability to prove its decentralised structure and hence requirement to include SPE's in Chapter 11 not directly in default. As I have said previously, many of the arguments being made in this case are being made for the cameras, and this view is clearly shared:

"in the GGP bankruptcy, it seems that the independent director issue may not be fully pursued because of the practicalities of the situation. In the view of some, even if the motions to dismiss are not granted, it is important that these arguments are made, if only to force a decision that will at least provide a benchmark against which lenders can attempt to structure and price transactions going forward."

Also interesting is this observation on the impact of the agreed DIP financing loan from Farallon Capital Management, part of which will be used to pay off the Goldman Sachs loan: "Using the $400 million DIP loan to retire the Goldman Sachs facility effectively increases the leverage on these assets by almost 100 percent."

The second article 'CMBS Bankruptcy Remote Structuring and the Recession: Revisiting the Benefits', was published last week by the Bureau of National Affairs. It provides a much more detailed analysis of CMBS structuring, and crucially an analysis on how the GGP rulings to date are impacting the industry. One telling remark is that the SPE bankruptcy remote structure has been "largely untested" to date, and only once these are resolved will the credit markets be able to move forwards with confidence and accurately rate and price risk into credit investments.

Where this article is useful is in summarising key ways in which SPE's "theoretically mitigates" risks:

1. Independent Directors to vote/approve the commencement of bankruptcy proceedings - the controversial one that we know about from its alleged 'misuse' during GGP's filing, which illustrated contractual holes.
2. Limits Debt that an entity can incur - both secured and unsecured, the court rulings have upheld this concept and ensured that GGP will not be able to load them up with additional debt as a result of their inclusion in Chapter 11.
3. Ensure that SPE assets/liabilities are not consolidated with those of a parent or affiliate that is involved in a bankruptcy - in reality this has not taken place in GGP's case from their inclusion in Chapter 11 either, although there would be a significant benefit from consolidation of net cash flows and of course negotiations.

As if anybody needed confirmation that the markets were being presumptuous about CMBS's, the article comments: "CMBS sponsors and lenders, supported by many of the credit rating agencies, relied heavily on the assumption that the remote bankruptcy provisions, specifically the independent director provisions, in the SPE’s governing documents would provide protection against an SPE borrower filing for voluntary bankruptcy."

Where the article becomes much more interesting is an examination of the circumstances in which GGP has been able to utilise cash flows as a collateral. Normally it would not be allowed, unless the lender consents, or the debtor convinces the court that "the lender’s interest in the cash collateral is ‘adequately protected.' "

This notion of 'adequate protection' means proving to the court that "the collateral is not being dissipated to the ultimate detriment of the lender. Typically this condition is satisfied if the property continues to generate cash flow and the lender is given a lien on post-petition income to replace the cash collateral that is expended." Despite the turbulence in commercial real estate valuations, it is fair to assume that the value of the assets exceeds debt in all cases before the court at present.

As such this is precisely what the Courts have awarded all of GGP's lenders who have appealed for their respective malls to be removed from Chapter 11. Despite a lien on cash collateral not being as appealing to lenders than instant access to the cash flows from the malls, income is safeguarded by the decisions made by Judge Gropper, by ensuring they are serviced and repaid in the event of liquidation.

The article concludes a summary of ways in which the GGP rulings to date are impacting the industry and a realistic assessment of the next steps relating to restructuring. Ultimately the ability of GGP to control the independent directors of its SPE's is seen as a key weakness in the current structure of SPE's. The legal authors point out that despite this it is very much legal, :

"Despite the fact that the removal and replacement of the independent directors may have violated the spirit of the original agreement with the lenders, GGP’s actions were permitted under state law and do not appear to have been prohibited by the organizational documents of the SPE borrowers."

In fact, the article even advises lenders able to who have the opportunity to "revisit the governance terms of borrower SPEs, would be well advised to consider modifying the 'remove and replace' provisions relating to the independent directors."

In many ways this suggests that GGP's bankruptcy is unique in another sense, due to timing and its ability to exploit weaknesses in the contracts that will be closed in the future. That being the case, any investors contemplating on taking positions in other REIT's in a similar position to GGP should exercise caution. It would be unwise to simplistically assume that other companies will necessarily be able to exploit this loophole for long, and so need to investigate the underlying SPE structures and contracts.

And finally:

"As the GGP bankruptcy progresses, given the uncertainties in the valuation of commercial real estate in the current markets, it will be interesting to see whether GGP attempts to reduce required interest payments based on the current market value of its properties and, if it does, how the bankruptcy court will determine the valuations of these properties and how reduced values will affect the commingled use of cash collateral."

Bear in mind how early into the bankruptcy process this all is - decisions made now can be amended throughout GGP's period in Chapter 11 on appeal. Meantime all of the information is before the court, suggesting a ruling is impending.

Addendum: just tidied up this post - you could tell I wrote and posted it during the Wimbledon Final, what a bloody mess it was...

NAREIT Annual Investor Forum

What a week. Excessive work, excessive socials, and excessive wedding drivel courtesy of L. I just cannot summon up enthusiasm for all these preparations around cakes, colours, invitations and seating arrangements. After all, I'm just turning up to merge my assets with her liabilities and stamp on a glass.

Thankfully L has gone off to Chicago for the next week for something called a 'Bridal Shower' - it seems to be some sort of American fad that involves the Bride getting even more gifts ahead of the wedding. Don't get my wrong: she's the one, I love her to bits, but I can't wait to just get all these months of preparation over with.

Either way, it makes for a very pleasant weekend for me, and I might even have a rare chance to use my evenings productively this week and finish off the functional spec, which is taking longer than I had intended.

On a side note, it has been another spectacular week for GGP's share price, which ended the week near $3/share, and is now close to 400% up on the opening price on April 16, when it first opened after moving into Chapter 11 protection. This may well be bolstered further next week by the announcement yesterday that Bill Ackman is finally about to join the board.

That has some limited significance for common shareholders; Ackman was already a powerful champion for preserving value. Pershing will now undoubtedly be taking a more central role, helping General Growth to shape a reorganisation plan that pushes towards loan extensions, and possibly limited asset sales to reduce unsecured credit levels.

The annual NAREIT Investor Forum took place this week in Manhattan, and I thought those following the fortunes of General Growth Properties would be interested in the key themes that came up. None of it is particularly surprising, but then these events are mostly an opportunity for industry execs and analysts to get together for drinks.

1. Mergers and Acquisitions
At the conference there was plenty of discussion on the impact of asset sales, particularly at attractive cap rates. This was fueled by the REIT Macherich, which announced at the conference that it plans to raise capital through selling three joint ventures with cap rates of 7-8.5% on NOI. The key point there is the cap rate pricing, as these provide a viable route for raising significant capital for reducing unsecured debt.  

This gives an indication of which assets GGP may also look to sell as part of its restructuring plan.  

2. Deleveraging / Restructuring REIT Balance Sheets
It is worth bearing in mind that despite the state of the credit markets, the commercial real estate sector has managed to issue over $10 billion in equity and refinance over $10 billion of loans in the last 4 months. The price to funds from operation (FFO) ratio across the sector has markedly changed during this period to reflect these changes, having moved from lows of 6x up towards the longer term trend level of around 10x.

Various analysts have continued to emphasise the obvious: that options in the capital markets remain limited for those REIT's perceived as most at risk from leverage. Current levels are around 8.5x debt to EBITDA, and need to fall towards the long-term trend of around 5x. I think the only takeaway is that the entire sector will be continuing to deleverage balance sheets strongly throughout 2009/10 in particular.

3. Poor REIT Yields
Historically REIT's have yielded around 100 basis points above the 10yr US Treasury. Looking at the sector as a whole, there is still widespread concern that the (necessary) decision to reduce REIT dividends or payout in stock instead of cash will seriously impact the inflow of new investment capital for the foreseeable future. This may hamper the efforts of those REIT's not in Chapter 11 as they attempt to deleverage, and force others to seek protection.

4. CRE Fundamentals 
Occupancy rates are expect to fall by 3-4% by the end of 2010; along with rental declines of up to 30% for the lowest quality malls gives some indication of the pressure that will continue to build. That will act as an offset as the capital markets continue to unfreeze, and as I have mentioned in my previous assessment of the TALF legacy, while criteria are set at AAA assets only, this is going to have a limited impact on relieving the sector.

5. Raising Additional Capital
Focus at NAREIT has also been on ways of generating sufficient market interest beyond dedicated REIT investors, to enable the commercial real estate sector to recover. From what I have been able to determine so far, there does not seem to be any particular strategy beyond time and the fact that as income levels stablise, generalist investors will return.

Increasing Confidence

Another fine, relaxing weekend is in prospect - L is doing what she does best and having a lie-in as I write, and that leaves me with a spare moment to write a quick entry.

So G20 this week was every bit the anti-climax I expected. I wonder how much of that $1tr package was pre-negotiated - all of it I expect, with some hand shaking and breast beating for the cameras. GGP has been equally unexciting in its lack of progress over the last month, although major shareholder and activist Bill Ackman has spoken out again in favour of the company filing Chapter 11 soon and a pre-packaged bankruptcy.

I agree with the approach, provided common shareholder value is left in tact, which it ought to be given (and Ackman stresses), that GGP's problem is the unusual case of insolvency. Issuing shares as a means of raising capital is almost impossible for a company that has seen its share price fall by 98.5% in a year. Combined with the increasing signs that the US government will be stepping in to directly support the US commercial real estate sector, and specifically the REIT's, I am planning to increase my stake in GGP at these bargain prices.

"Bernanke said the eligible collateral for the Fed's $1 trillion Term Asset-Backed Securities Loan Facility, or TALF, will likely expand to include commercial mortgages and securities that aren't newly issued."

Some patience is required to hopefully buy at a really good price on a dip in the coming weeks, but I am looking to buy another 100,000 shares should the right opportunity arise.

Is Quantitative Easing The Answer?

I have read a couple of interesting, contrasting views this week in the Telegraph on the subject of quantitative easing between Roger Bootle, the founder of Capital Economics, and Liam Halligan, the economics editor of the Telegraph.

Bootle's article in favour is here, whereas Halligan's exactly opposing viewpoint today is here. For the record, I am in favour of quantative easing, which for me has been highlighted starkly by the plight of General Growth Properties (GGP), and its urgent need for refinancing in order to service its debt load. As I have stated previously, GGP is a healthy company in terms of its asset base versus liabilities, and would be fine servicing its current debts before the credit crunch. Instead it is now left struggling to repay loans as they come due, because of the seizure of the CMBS market and a chronic loss of confidence in its financial viability.

Whilst Liam Halligan gives a useful perspective and balance to those calling for quantitative easing, I was left finishing his column still asking the question 'what precisely are we to do to ease the current credit crisis in that case?' He appears to suggest there is a rabid group of lobbyists suggesting any other viewpoint is held up as a heresy, which unless I am missing something is nonsense. Certainly it has become the consensus opinion amongst government and businesses, but I am quite open to alternatives if a convincing argument can be constructed.

The question is whether it is better to do nothing at all and to let banks and businesses all fail in order to avoid the spectre of inflation and short-term (significant) public debt.

Going back to the commercial real estate sector in the US, and Commercial Backed Mortgage Securities (CBMS) being near completely frozen as a going market. It would be like all banks suddenly refusing you when your fixed term mortgage deal expires, and instead demanding you sell your property at the worst possible moment in the economic cycle. It would lead to huge individual suffering for homeowners, and in the same way will see all manner of otherwise viable companies going to the wall throughout the economy - that means job losses, financial losses, and pain for many.

The US alone has a vast $200bn of such loans coming due in 2009/10 - without QE to fuel the TALF lending that will enable such businesses to refinance and ride out this period, they will simply go under. Why is that better than QE to buy those assets, and eventually sell them back onto the private sector as it thaws (and in effect 'undo' QE, reducing the money supply and trying to avoid inflation being controlled)? I fail to see why targeted action is not better than simply doing nothing.

It is one more week to go until GGP reaches its critical deadline for loan extensions on March 16 - this coincides with the repayment due to Rouse bondholders, who are a group owed money after GGP bought Rouse back in 2004. This ought to see some movement through meaningful announcements - the options being either GGP is forced to file for Chapter 11 due to Rouse bondholders, extensions being announced while TALF funding is still on the near horizon (the whole process is predictably dragging and will take months yet to take effect), asset sales ($400m has been offered for 3 properties on the market for example) to pay off key loans, or a GGP takeover/joint venture.

All are possible, to my mind all will benefit GGP's shareprice significantly. My only wish is that I had bought in now rather than in December, but I expect to see a huge improvement in my position on this trade in the next 6 weeks.

A Glimmer of Substance Behind The Rhetoric

After my tongue-in-cheek, but undeniably slightly malicious, rumour spreading regarding the date for the next round of job cuts here, various people have wandered past my desk this morning looking both relieved and pissed off that my 'source' (aka 'my imagination') was wrong. Hey, I might still be right - I did say cover myself by saying today *or* tomorrow...

Well since I've got rather more of a sense of job security than them, L and I have opted for some sunshine in Sharm El-Sheikh in Egypt for a spring break next month. Frankly the unrepentent drizzel of London rain, and bad news from the press, are enough to make even an optimist like me start to contemplate whether it is time to pack it all in and buy a beach hut.

There has been some interesting announcements from the new US Treasury Secretary, Tim Geithner, relating to the proposed $2 trillion update to the TARP (now rebranded the Financial Stability Plan, presumably to reassure us by removing horrible words like 'troubled').

"It's been a long time coming, but tonight, because of what we did on this day, in this election, at this defining moment, change has come..."

Exactly as I expected, the programme so far seems to be a direct implementation of the skilled rhetoric with which Barack Obama has stormed the global political stage in the last 15mths. Broad in scope, inspiring hope, but with few actual specifics. However people, I think we can all quite definitely say that change has come.

Quite why the markets were expecting some kind of all-encompassing answer to this wide range of problems so soon is beyond me. Desperation most likely. The Financial Stability Plan was only a framework when the bill passed through the Senate a couple of days ago. Those buying in to capitalise on some kind of bounce are a fine example of why many lose money on the markets: were I into short selling, I would have been fully loaded up before yesterday.

Of most interest to my GGP trade is that the plan now includes the proposed relief for the Commercial Real Estate sector. In theory it will provide a means for lenders to either receive capital specifically for refinancing distressed REIT's, or roll those loans into some kind of 'bad bank' fund that reduces their own risk and exposure. Either way, once the market stops sulking, it actually has some potential to help unlock a situation where otherwise viable businesses are on the verge of bankruptcy due to the frozen commercial mortgage-backed security (CMBS) market.

Anyway, I have a fabulously quiet afternoon in prospect at the office. One of the final round interviews I had lined up with another bank was supposed to be later, but that has just been cancelled due to new hires currently not being 'commercially viable at present'. That translates into the bank realising they cannot really justify hiring when they are about to fire more employees.

Either way, given I am lucky enough to seemingly be secure for the foreseeable future I couldn't care less.. now which hotel in Sharm El-Sheikh shall I go for...

Banking on Bankruptcy

The situation with my GGP trade is continuing to progress (slowly), and looks to be gradually moving towards some significant news. That will bring a resolution to this period of financial limbo, which has seen continual loan extensions that only prolong the uncertainty and depressed share price.

On Friday, GGP announced that they were cancelling their quarterly analyst call outright, and postponed their earnings release by a fortnight.

There are a range of possibilities why, but this article gives some detail into one - namely the expiry this week on a forebearance agreement (this is an effective extension to a loan while the lender promises not to force a default and the borrower negotiates and is unable to comment in public). If GGP were to file for Chapter 11 this week, its quaterly earnings becomes "a sideshow" by comparison.

Hopefully GGP will file for Chapter 11 bankruptcy protection. As I have said before, I believe this scenario will also work well for GGP and its shareholders. It just may take 3-12mths before I start to realise the gains, which is unfortunate but as I have said - a key rule of investing is patience.

As this article illustrates in some detail, the prospects from an REIT going under are considerably different from a normal company - particularly one with assets that exceed liabilities. To quote an unnamed source from a Reuters article: "General Growth has problems with liquidity [i.e. servicing refinancing its debts] rather than solvency [i.e. operating cashflow]." With assets that exceed liabilities on its balance sheet (ignoring marking to market that should improve that further), and a positive cashflow, it all points to this being very profitable for shareholders when it emerges from Chapter 11 in the future.

Two interesting quotes:

"Bankruptcy experts, however, say that many of the worries may be unfounded. The sector may not have been tested by a big bankruptcy yet, but enough is known about how the companies are structured and how a bankruptcy proceeds that experts think the industry should emerge fine, even from a series of bankruptcies. Further, there is reason to believe that because REITs control a tangible base of assets through large portfolios of real estate, these firms may be more likely to survive bankruptcies than other companies that’s value is harder to pin down or could be subject to liquidation."

"Experts say REIT shareholders are more likely to retain some value simply because of a REIT’s underlying assets. “Most shareholders get nothing in a bankruptcy because most companies have no assets, and that’s not the case with REITs,” Jerome says. “It all comes down to valuation of the real estate assets. Even if those valuations have decreased, it’s going to come back up. And, if the REIT has to go into bankruptcy, it’s not the end of the story for shareholders as long as the company still has something of value.”"

I remain confident that GGP is hugely undervalued. Its share price is so depressed at present due to shareholder fears that Chapter 11 would wipe out the value of their holdings. However given that GGP ought to have a share price of around $20/share by my valuation (half what it was at its peak in the summer), and is currently at a mere 80 cents, you get a sense of just how low it is right now. Certainly $10/share within 2 years is very realistic.

Therefore it will not require even much excess value of assets versus liabilities to remain on its balance sheet for common shareholders to see a huge increase in the stock price and their returns. Another possibility would also be that GGP is bought out during the process, which again would mean big returns for me as it would doubtless be at a share price upwards of $7/share. To put that into context, I would be looking at a £250k profit in such a scenario.

There are other factors to stir into the mix - opportunisim and political. There remains a distinct possibility that one of its rivals will take advantage of the huge discount to merge (or buy outright) GGP. One candidate would be Developers Diversified Realty Corp (DDR), which has a market capitalisation approximately twice that of GGP at present, due to it having less issues around solvency. A combined entity would instil all-importance confidence in lenders and would realistically lead to GGP shareholders receiving a shareprice in the $5-10 range I would estimate.

The political element comes from the extension of the TARP for funding commercial real estate lending, and the progress of Barack Obama's current funding bill through the Senate. I need to complete more research into this as I am not particularly up to date, but it is possible that lenders are receiving indications that funding will be made available at some point in the future, which would enable refinancing.

That would certainly explain why there have been continual extensions without apparent resolution - an effective delay until the TARP situation is clarified, as that is obviously the preferred solution for all parties. If so then there may be another extension again with regards to loans due on 12 February for the two Las Vegas malls mentioned in the Forbes article.

So much to consider, and all you can do with a trade of this complexity is complete analysis, stick to your strategy and remain detached from emotion throughout. If I were to lose my entire stake on this trade (around £80,000) then so be it and I will have learned a huge amount along the way. However all my analysis points towards my acceptance of this risk yielding a significant reward in the future.

Investing for a Recession (Part II)

Having outlined how I have made some useful money from the recession to date, it would be worth now moving to my current main investment at present, so that there is some context when I update on this going forwards.

Apart from putting a proportion of my funds into a gold ETF, which is an excellent hedge both against recessionary worries, a devaluing dollar and future inflationary concerns from all the quantitive easing taking place, I have also placed a significant sum into something that is much less obvious in these turbulent times: US commercial property.

You might think that is insane, and is totally contrary to what everybody else is putting their money into at the moment. But part of investing is looking for value, and sometimes that means looking beyond the conventional wisdom. I have bought into something called a Real Estate Investment Trust (REIT) - these are essentially US commercial property companies, which by and large have plunged by enormous amounts in the last 6 months.

As such, several are rumoured to be on the verge of bankruptcy, and one in particular is down a staggering 97% since the summer of 2008. When you factor in a fall of that magnitude, you have to start looking at the price and ask why, and whether this is rational or fueled by other factors. The underlying reason is the credit crunch, combined with investor fear of a Chapter 11 bankruptcy filing.

To give some background here, REIT's have by and large used a previously acceptable business model, whereby they were highly leveraged and routinely took out large levels of debt to increase their asset base and buy up more property. They then serviced this debt, steadily paying it off while periodicially refinancing this - without problems in a normally functioning credit market. Of course, everybody now sees US property as having been in a huge bubble, and all associated loans as necessarily toxic. As such, suddenly some enormous commercial property companies are on the brink of bankruptcy - including the particular REIT I have invested in called General Growth Properties (GGP).

To put it into context, GGP is the second largest mall owner in the US. That is not an insignificant statistic in itself, and should it fold there would be enormous ramifications for the US retail sector, not to mention a political backlash. I would actually not mind if it did file for Chapter 11 within the next few weeks, for reasons summarised well in this Reuters article.

Estimates suggest that GGP's assets exceed liabilities on the balance sheet by several billion dollars already. Additionally it has no problems servicing its actual debts, just refinancing them. In effect the problems of GGP are not with solvency, as with normal bankruptcy risk, but liquidity - this is a direct result of the banks own liquidity issues that have made them more risk averse.

What is most interesting with GGP is also that the balance sheet is not fully marked to market, which means that if its assets are valued at today's prices instead of when purchased there will be a change. Many properties on its books were bought years ago and have never been revalued, so it is reasonable to expect many will be worth more than marked, even with the current woes of the US property market. As such, assuming GGP were to go bust, what does that mean for ordinary shareholders? Normally it is a disaster and means no money, but in this case it should mean that the US courts would order the banks to agree refinancing terms, after which GGP would emerge out on the other side without that perceived stigma. Meantime the shares will continue trading on the stock exchange.

Since the Reuters article, all indications are that GGP will not file for Chapter 11 however, with its banking consortium of lenders bending over to give multiple loan extensions (including one over the weekend through to mid-March). There are many factors at play in whether full refinancing of the loans due in 2009 will take place - that is what would remove the market risk of bankruptcy that has so severely depressed the share price.

The main sticking point for lenders is several billion dollars of loans that are currently unsecured (i.e. have no assets backing them up), which are due for refinancing. Understandably the banks want assurances they would have some collateral to offset should GGP go under at a later date, and at present the unsecured loans are not acceptable to them. As such GGP is looking to either sell assets to pay those off, or negotiate terms. Both are possibilities, but at this stage it is unclear which is the more likely.

Another factor is the recent extension of uses for the Troubled Asset Relief Program (TARP) by Barack Obama, to now explicitly include money for Commercial Real Estate. This bill has passed through congress, and the campaign is continuing - again it provides political pressure on the banks to lend and not push under a company as significant as GGP.

Once terms are agreed, or GGP manages to sell off a number of assets to enable refinancing, I expect there to be significant upwards movement on the stock price. I have gradually increased my long position on GGP from $1.61 down to $1.03 in the last 2 months, although it is worth adding that a recent sell off last week on fears ahead of the loan deadline (prior to extension again) lead to a sharp fall back to around 55 cents a share. As of yesterday, GGP's share price bounced up 30% on the news of the loan extension, and is now currently at around 80 cents a share as I type.

So I am sitting on an unrealised loss at present. Since I bought into this REIT in December, the share price has risen by 80% at its peak, and fallen by 50% from where I entered at its lows. I turned down the chance to cash in a £50k profit in early January because I am more interested in the bigger picture here. That's how trading works - I have a strategy which does not include day trading this stock, because I do not know when the news will be announced that will make the crucial difference.

To give you an idea of the potential rewards at stake here, if the share price were to rise back to just $3.50, where it was in October, I would make in the region of £150k from the trade.

I should add a cautionary note that this is considered a speculative play. I am speculating on the most likely outcome based on extensive research - what makes this unusual is that there appears to be significant upside regardless of whether GGP files for bankruptcy protection or not. To me the share price of GGP is significantly undervalued, and at some point the market is going to realise that.

Most people are not prepared to accept this level of risk, and that is entirely right, although it is worth pointing out that you can take a zero off the figures and it could easily be you making (or losing) these amounts. In my case, if everything goes as well as I expect, I could make over £1 million from the trade. Admittedly that is unlikely and would require me holding for a couple of years. I am looking at cashing in £250k as a more realistic profit, but it gives you an idea of how risk vs reward works in the markets.

I will keep you updated on the progress of this particular hot potato in the coming months. Anyway back to work.