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.

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…

TALF Legacy Unveiled: Does It Impact GGP?

The eventual expansion of TALF criteria to include broader assets and older CMBS was discussed in government committees back in Jan/Feb, so this has been looking likely for some time. The TALF Legacy was finally announced last night, and the Terms and FAQ are worth taking the time to review.

On immediate reading, it would be easy to get carried away with the news, and assume this is overwhelmingly positive for GGP - it could potentially solve all of its refinancing problems!

Hold on, hold on dear. Certainly it is not negative, since it will benefit the wider credit markets: any thawing of those it to be welcomed, since it provides additional capital for refinancing other loans - the aim of the whole programme after all. In itself GGP's status in Chapter 11 is not the issue here; eligibility for TALF Legacy funding is made at an individual CMBS level, and that is what will impact GGP's ability to utilise this for refinancing of loans.

So how does GGP's CMBS portfolio stack up?

The criteria stipulated by the Fed is that: "Eligible collateral will not include a CMBS that obtains such credit ratings based on the benefit of a third-party guarantee or a CMBS that a TALF CMBS-eligible rating agency has placed on review or watch for downgrade."

Fitch has made several precautionary downgrades of GGP CMBS's since 20 April to reflect the increased potential risk. This Seeking Alpha article summarises without going into specifics, including the Fitch announcement that it downgraded the outlook from Stable to Negative on "63 properties [which] secure 58 loans in Fitch-rated U.S. CMBS transactions."

According to Fitch "the revised Rating Outlooks are in large part due to the Chapter 11 bankruptcy filing of General Growth Properties (GGP) and certain affiliates which are borrowers in CMBS transactions."

That means many are ruled out of eligibility for TALF Legacy at present, and due to the uncertainty at the time, includes all those commercial mortgage backed securities that transferred to special servicing after their inclusion in Chapter 11 - the list is too numerous, but means those collateralised by malls including:

• Boise Town Plaza and Square (Idaho)
• Newgate Mall (Utah)
• Northridge Fashion Center (California)
• Willowbrook Mall (New Jersey)

What is worth noting is that it was the uncertainty around the bankruptcy which was a key factor in the downgrades. The rating agencies may start to respond to the recent ruling for SPE's to remain within Chapter 11 with a reassessment. The primary risk factor cited was that GGP "could seek additional leverage secured by the mortgaged properties to help repay their corporate unsecured debt. The presence of additional debt would put substantial additional stress on the properties and impair the performance of the CMBS transactions."

Judge Gropper's ruling protects the integrity of CMBS pulled into Chapter 11, since the underlying collateral cannot be laden with further debt, so arguably this will require an offset upgrade in future - although rating agencies are frequently cautious, and that by no means implies they would be upgraded to the necessary AAA status required.

Fitch has stated that it "will continue to monitor the performance of the GGP assets in addition to the progress of the bankruptcy proceedings. As the developing situation becomesclearer and as property performance warrants, Fitch will take additional ratings actions as appropriate."

Meanwhile this post here includes an article with some detail around the credit industry reaction to the GGP ruling, and their presence at the ICSC conference.

Time will tell how beneficial this proves for GGP. If I were an agency, I think I would rate this development a Cautious-Positive.

Speculation Drives GGP

I have been making some positive progress on the business plan for the financial website I am planning to create (sorry, will not be discussing specifics as you would expect on a blog!) A high level plan for its initial marketing and revenue generation has been completed, and since I have brain dumped most of the site ideas, I am going to formalise those along with specifics on the design and structure this weekend in a functional spec.

I have started to look into vendors that can build the site, but am so far fairly unimpressed with the package solutions on offer - not to mention all the bullshit extras thrown in like registering the domain name (and controlling it), that presumably appeal to the average lamer they are targeting. I will be telling them exactly what I want, and otherwise will need full control over the daily content management.

It will require some time and effort to assess what is on offer, but I am looking to approach around about 10 vendors for build estimates, options and support contract costs over the next week. I need that not least so that I can complete the financial component of the business plan, including necessary start-up capital and first year trading costs.

After my last entry on Saturday, discussing my increasing confidence in GGP's prospects - not least from Bill Ackman's recent comments - the share price on Monday underwent such an unusual increase (greater than 200% at one point), that the firm issued a statement on the trading activity to confirm there was no known basis.

I was not entirely surprised to see speculation growing from institutions and others that GGP has significant potential for common shareholders. A 98% discount alone tells you that it is clearly not a fair reflection of value. The price as of today has predictably dropped back to around 85 cents since the highs of $1.35 earlier this week - since I was waiting at around 75 cents for falls to buy more, I am happy to hold and continue waiting for a better buying opportunity (ideally somewhere under 50 cents).

In the meantime, additional support for the notion that GGP will eventually complete negotiations with lenders and file for a prepackaged bankruptcy came in the form of real estate magnate Sam Zell, who commented:

"I do not believe GGP will be liquidated," Zell said at a recent New York University real estate investment trust conference. "I expect the company to file bankruptcy. It will do a prepackaged. It will be reorganized and it will be taken public."

The net impact of this would be a controlled bankruptcy application with a pre-agreed plan of restructuring - this would enable the firm to sort that out under Chapter 11 protection in much less time, and theoretically with less court interference. It would then emerge from this and should see a huge increase in share value.

At the same time, the existing evidence points to TALF funding continuing to trickle down through the system and have an increasingly positive impact on the credit markets throughout the remainder of 2009 and into 2010.

Everything right now seems to point towards GGP being an excellent long hold for anybody not risk averse. Consider this final point: the consensus view in and outside the US government now is that the commercial real estate sector is a huge and vital component of the US credit market that must be supported. As well as CRE being more viable than the multitude of small home owners in the domestic market, many have also commented on the devastating impact that a Chapter 7 (liquidation) of GGP would have - not just on the firm and its shareholders, but more importantly on the wider market.

Too big to fail? I think people are soon about to work out that this doesn't just apply to the banks, and that the major REIT's are also in that same boat.

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.

Coping with Investment Nerves

It is interesting how, on a reasonably substantial trade such as my long position in GGP, even after so many years of investing I still myself effected by emotion. Having steadfastly held since early December 2008, and increasing my position as the stock fell to $1, until now I have had few concerns. However with global markets continuing to fall hard this week, GGP now sits priced at a mere 45 cents - back to near its lowest ever price. I made the mistake of calculating my paper loss: currently about £54,000.

Of course being an unhedged trade is the root cause behind that figure; I have equal upside and downside exposure here, which is never desirable. However without access to short facilities or options (outside the bank I work for), my choices here are limited. Enough to make me look at that unrealised loss and think the usual: "ouch, my net worth is lower by x amount", "God, I wish I had never got into this" and "if only I had waited until now, I could have bought TWICE as many shares for my money!"

Falling prey to such thoughts is a fallacy. Nobody can 'know' the short-term movement of stocks (despite confident assertions by junior trader). With hindsight my only wish is that I had acquired my position in GGP more gradually to give a wider spread position - that would have given me a better opportunity to take advantage of its steady falls to date. Still, to put it into context, should the price move back to where it was 5 weeks ago now, I would be sitting on an unrealised £35,000 profit.

That is a big 'if' of course. At present the reason for the increasing decline is that other investors are acting upon their own fears that GGP will probably file for Chapter 11 and that common shareholders will lose everything. I have to constantly remind myself of my previous analysis on this, and that fundamentally nothing has changed to date.

As such, I am not going to do anything - although I am toying buying another £10k's worth of stock at these low levels. An RBC Capital analyst summarised the situation GGP faced relating to the credit market seizure and refinancing the Las Vegas malls:

"Basically we had a very large, very successful company asking banks, insurance companies, anyone who is interested, 'Please lend me money on two very, very good retail properties.' And the lending community simply said, 'No.' "

I recall mulling over the psychological aspect of all this some time ago; that when GGP stock cooled off again from the period in which I first purchased, that fear would possibly reassert itself and push the price back down. I toyed with selling in the January rise - which turned out to be from the hedge fund Pershing Square making further substantial purchases - but decided the $2.25 price was too far below my target exit price.

Of course with hindsight, I should have sold then and bought now, but if we could see the future we would all be millionaires very quickly. It seemed quite possible that the price would stay in the same range as December, and at any moment could increase significantly. Quarterly earnings are on Monday, mall purchase deals are still potentially out there, and there is potential for government refinancing of the CMBS market through the starting up (at last) of the Term Asset-Backed Securities Loan Facility (TALF).

One thing's for sure - the GGP pressure pot is close to boiling now, and something is going to blow and start to move this whole situation further. I am inclined to believe now that it will be through government intervention, given the entire commercial real estate sector faces these same refinancing issues in 2009/2010.