Banks Run Out of Options in General Growth Properties

So we bought more shares of General Growth Properties (GGWPQ.PK) Friday, our first purchase since the stock passed the $2 mark. Why? Simply put, what looked like the most “reasonable” scenario in March when we first bought, now looks like the “only” one left. That is good.

Back in March (pre-Chapter 11), I said:

General Growth is not losing money. Rents are stable, occupancy rates are over 90% and FFO (funds from operations) remain healthy. What is the problem? Credit. GGP has loan due that they typically just rollover into longer maturities. With the current credit “lock down”, they cannot do that. That means bulk payment come due and the cash is not there. It should be noted that this is not an odd situation, this is what REIT’s typically do with their debt.

With a Chapter 11 debt holders are put in a room and told by a Judge, “we can pay you all 100% but we need to change and lengthen maturities OR we can liquidate and you can pick up scraps for pennies on the dollar”. Here are the new terms. The choice is rather obvious.

Now, while obvious, we also have to admit that banks are not always guilty of doing the obvious thing when it is also the smart thing. That being said, let's look at what has happened since then and why confidence in what the banks will do has grown to the point we are willing to buy shares 700%+ above our original purchase price.

What are the banks' options? Foreclose and take possession of malls, sell the debt or simply extend maturities. If anyone can come up with any others, let me know and we will address it.

Foreclose:
Let’s look at CRE prices: [click to enlarge]

If we look just at 2009, we are looking at about a 30% fall in CRE prices. Now, it should be noted that many of the loans that drove GGP into 11 are 2006-07-08 vintage which means the decline is even greater. But, let's just use 2009. At its Chapter 11 filing this year, GGP listed roughly $28B in assets and just over $26B in liabilities. If we take the “asset” side of the ledger down 30%, then we have the majority of lenders upside down (it will fluctuate on a property by property basis).

So, if lenders foreclose, they are now immediately upside down on the property and we know RE takes another leg down the second banks seize it (banks are then forced sellers). It basically means a par loan is now impaired and must be written down, perhaps by a huge margin. This is bad as they can never hope in this market to recover anywhere near their investment, meaning additional write-downs. Remember, GGP sought and was granted permission to continue making interest payments on a huge portion of its outstanding debt, thus keeping it “current” on the banks' books.

Sell the loan to PE (private equity)
I have heard this lately but the same problem as above remains for the banks. At what price is PE going to buy these loans? I think 50% or lower of par is a conservative estimate and that 25% is more likely. After all, they are going to want a cushion to ride out the storm. This scenario also means massive write-downs for the banks holding the debt. Still not good.

What is left? Extend…
There were two problems with this scenario in March. CMBS holders were not allowed to negotiate extensions until after the loan defaulted under IRS rules. This meant that when any extension was finally talked about, the loan was already impaired. This impeded any real progress on a solution.

This was altered recently saying:

“Discussions between a servicer and a holder concerning a possible modification may occur at any time and need not begin only after the loan is in default”.

The IRS also removed all previous tax penalties associated with the modifications of otherwise performing loans in this ruling.

But, what about the valuation of the loan? Surely a modified loan with a new extension and a new, perhaps negative LVT ratio must be considered impaired and written down. If that is true then in many cases it may actually be in the banks' best interest to sell the debt or foreclose.

Enter the Fed
On Friday the following was released:

The regulators have found that prudent CRE loan workouts are often in the best interest of the financial institution and the borrower. Examiners are expected to take a balanced approach in assessing the adequacy of an institution’s risk management practices for loan workout activity. Financial institutions that implement prudent CRE loan workout arrangements after performing a comprehensive review of a borrower’s financial condition will not be subject to criticism for engaging in these efforts even if the restructured loans have weaknesses that result in adverse credit classification. In addition, renewed or restructured loans to borrowers who have the ability to repay their debts according to reasonable modified terms will not be subject to adverse classification solely because the value of the underlying collateral has declined to an amount that is less than the loan balance.

Further:

Examiners generally are not expected to challenge the underlying valuation assumptions, including discount rates and capitalization rates, used in appraisals or evaluations when these assumptions differ only in a limited way from norms that would generally be associated with the collateral under review. The estimated value of the underlying collateral may be adjusted for credit analysis purposes when the examiner can establish that any underlying facts or assumptions are inappropriate or can support alternative assumptions.

Then:

Classification of Loans

Loans that are adequately protected by the current sound worth and debt service capacity of the borrower, guarantor, or the underlying collateral generally are not adversely classified. Similarly, loans to sound borrowers that are renewed or restructured in accordance with prudent underwriting standards should not be adversely classified or criticized unless well-defined weaknesses exist that jeopardize repayment. Further, loans should not be adversely classified solely because the borrower is associated with a particular industry that is experiencing financial difficulties. When an institution’s restructurings are not supported by adequate analysis and documentation, examiners are expected to exercise reasonable judgment in reviewing and determining loan classifications until such time as the institution is able to provide information to support management’s conclusions and internal loan grades.

Basically any loan modified in such a way that the borrowers' ability to repay is sound shall not be “adversely classified” (written-down).

So, now we have the IRS removing any tax implication for loan workouts and the Fed saying no write-downs are necessary for doing so even should those workouts result in a new loan that is technically “under water”.

So for those who doubt the GGP investing thesis, let me throw the question back to them. Why would the banks do anything other than extend the loans given what has transpired the last couple weeks? If the only thing that will happen is a simple maturity extension, then no (minimal, possible for unsecured creditors) equity dilution occurs and current shareholders emerge very happy indeed.

Now it is clear not everyone either believes this or is willing to accept it. If they did, the stock would be double digits right now. There is a window before news of these modifications start coming out in which the overall CRE market news will take precedence. That is ok, if everyone saw what we saw, “value investing” would never exist, right?

Disclosure: The author owns shares in General Growth Properties.

Comments

[a fat panda:]

"What are the banks' options? Foreclose and take possession of malls, sell the debt or simply extend maturities. If anyone can come up with any others, let me know and we will address it."

Here is another option, one that you won't like. Tell the company to pony, or give the it the option to extend the debt in exchange for warrants. That would seriously dilute the existing shareholders should any profits arise. Then sell the warrants to PEs.

Nov 03 09:02 AM

[6 Moves Ahead:]

Todd,

Because I work for a financial institution, I am not going to elaborate too much on the discussion above. However, I do need to say that your perception is not accurate in some areas.

While a lending institution may not be required to write down large sums if they provide a loan extension to a borrower in this position, they may still be required to place the loan on their "watchlist". If that happens, depending upon the magnitude of the note the lender could suffer dings to its credit rating. That doesn't work.

Secondly, the Fed is taking a close look at values and how cap, LTVs, and DCRs are impacting numbers. I've seen it first hand, and they have been requiring the majority of these instruments be written down. I think most institutions are being asked to re-value the assets in their portfolio and the results have not be favorable.

Still, there is no way out for lenders. If the foreclose, they will get just pennies on the dollar for the asset. If they extend terms, they should be in a good position. As you noted GGP is performing well. But still, there is the concern of the unknown....how this will all pan out.

Nov 03 10:31 AM

[Roger C. Wren:]

Such warrants would indeed dilute the present shareholders. The devil , of course, is in the details. Two dollar warrants would dilute and hurt shareholders. 15 dollar warrants would offer possible value to debt holders in addition to repayment of the debt but would not worry present shareholders to any great degree.

Nov 03 10:36 AM

[Lew Richards:]

There is yet another aspect of this discussion to consider. The discussion treats all of the lenders as equals when that is simply not the case. Of the $26B in debt, some of that is secured directly by assets (which may, or may not, hold sufficient value to pay off the debt upon sale) and some of that is unsecured corporate debt. Further, since most of the debt is CMBS, different lenders may have various forms of exposure; that is, they may be on an "A" tier on a loan that is secured by property that's value has held and, at the same time, may be on a bottom tier of some of the unsecured corporate debt. I think that the interplay between all of the interests, and the balancing of varying interests among single lenders, makes this situation decidedly more complicated than this analysis would indicate. At the end of the day, the "logical" thing to do for the lenders would seem to be to extend the loans (at closer to market rents and/or with some form of hard lock box and/or amortization). The hard part of this thing, for GGP, may well be the tremendous reduction in cash flow that will be necessary for the Banks to be able to swallow the extensions. I would also wonder what, if anything, that loss of cash flow (as opposed to income) would do to their ability to remain a REIT.

Nov 03 11:20 AM

[User 289836:]

A well managed REIT has no corporate guarantees except on construction loans. All permanent first mortgages should be non-recourse which means that if the shopping center does not generate enough cash flow after paying real estate taxes, common area charges and TI for new tenants or renewals, to cover mortage interest & and ammortization, then the Owner tells the holder of the mortgage to either take a deed in lieu or that all the owner will continue to manage the property and all the cash flow will be paid to the lender.
The the Maquire (MPG) properties were structured this way which is why they have been able to dispose of office buildings with large writedowns and still stay out of XI.

The current GGP problem may be the Hughes heirs who cannot fall back on an income stream from Summerlin and may do somethng rash with Judge Gropper this month.
[e-mail]

Nov 03 04:48 PM

[Jeffrey Hot...:]

ggp should of let that guy help them, with their mall sales.


On Nov 03 09:02 AM a fat panda wrote:

> "What are the banks' options? Foreclose and take possession of malls,
> sell the debt or simply extend maturities. If anyone can come up
> with any others, let me know and we will address it."
>
> Here is another option, one that you won't like. Tell the company
> to pony, or give the it the option to extend the debt in exchange
> for warrants. That would seriously dilute the existing shareholders
> should any profits arise. Then sell the warrants to PEs.

Nov 03 09:38 PM

[Soldalma:]

Still, if everything Todd says is true then GGP's assets are worth less than its liabilities (negative net worth). In this case the stock is an out-of-the-money call whose valuation is tricky (B-S formula, but which vol?). Not clear it's worth more than the current valuation, although in some scenarios it could be worth much more.

Nov 04 08:21 AM

[DinNYC:]

Todd

Its almost satirical at this point to still see individuals doubting your premise that GGP is not only going to survive bankruptcy but shareholders will come out winners (comparatively) as well. I read over the reactions to your posts and I cant help but want to look back and see if its these same people who were telling you how off you were when GGP was at 60cents. It has now spent the last four months trading consistently above $2 and the last two months consistently above 4$. I can't help but feel that there is an inordinate number of individuals who are short positions in this market and have taken to message boards and SA to talk down stocks. If there is some way for you to provide a historical perspective of your coverage of GGP it might be helpful to other investors looking for a chance to take part in this turn-around story; so as to not have them chased away by what seems like a number of individuals staring down the barrel of a potential short squeeze.

I am hoping you will post your thoughts soon on their recent earnings release. I was heartened to see them maintaining, and even slightly increasing their occupancy rate (even if it was short-term rental). Tenant sales were down as to be expected but the retail sector has rallied as of late and if GGP can continue to hold it together as they are until the consumer returns, they are poised for a nice recovery. Again, your overall premise that their bankruptcy was due more to a failure of the accessibility of credit markets for refinancing than to their core business still seems salient to me.

I am curious if an impressive movement in GGWPQ ahead of a bankruptcy could be a potential trap, in that the anticipated value available for shareholders after restructuring could somehow be affected by a mitigating factor, such as a court ruling. Are there any potential snags of that nature that could be lurking at the end of a successful restructuring? I am not too familiar with bankruptcy law.

Cheers
DinNYC

Nov 05 10:37 PM

[davidbdc:]

While I wish you well with your investment, I'm not convinced that the equity holders are going to win in this case.

I still firmly believe that there are properties in BK that shouldn't be since they were set up as seperate entities. Those lenders have to be steaming mad to be blunt. If I were one of those lenders, 1. I'd be appealing, and 2. I'd play hardball to the extreme. I'd bring in my own appraiser and get a value for the single entity that was stupid low and then I'd go after the entire property plus claims on any other asset that comes out of BK. And I'd refuse to negotiate from that position - I'll be happy to liquidate since my loan is against a special entity and thats what I'll walk away with as I have first claim on that property.

I have to believe that the holders of debt are hard at work negotiating with SPG for all the A class malls that GGP owns. And if I'm SPG I view this as my opportunity to grab many top flight malls and finish off my main competitor....leaving really only smaller regional players to compete.

However, as I said good luck with your bet on GGP.

Nov 06 08:11 PM

[Brian McMorris:]

DinNYC: Absolutely spot on. I post quite a bit on Seeking Alpha. I post as I see it. Two years ago, I was very negative on the market and financials specifically (hadn't found SA at that time, but my website has all these old posts in the archives). Since early this year, I have been very positive on the market. There has been a huge over-reaction to negative aspects of the economy and it shows up in stocks like GGP (which I have owned since April at $0.60/share).

SA has become a place where short sellers can bash posters with something positive to say. It matters not how well your thesis is researched and substantiated with factual data. The shorts will come out of the wood-work to put down the post because it threatens their positions.

If not panicked short sellers, then these doom-and-gloom posters are from fringe elements that generally are looking forward to anarchy and / or the fall of the Western World. I find all of this very reinforcing of the potential of this market. Such posters just create the "wall of worry" that every stock market recovery must climb.

What everyone who is sincerely interested in GGP should follow is the cash flow or FFO. This is the only metric that matters. GGP does not sell its malls, so CRE valuation is almost irrelevant. The court does not look like they will throw GGP assets to the wolves, but will instead stand by and make sure that the malls are protected and continue to function as they are.

Have any of these doomsdayers noticed that retail numbers are steadily improving?


On Nov 05 10:37 PM DinNYC wrote:

> Todd
>
> Its almost satirical at this point to still see individuals doubting
> your premise that GGP is not only going to survive bankruptcy but
> shareholders will come out winners (comparatively) as well. I read

Nov 08 07:06 PM

[Brian McMorris:]

So call it that then. What does the label matter? This has been a heck of an "OTM" call without expiration which is a big plus) since early this year. I buy lots of DITM calls, too. It is a great way to invest in out-of-favor stocks.


On Nov 04 08:21 AM Soldalma wrote:

> Still, if everything Todd says is true then GGP's assets are worth
> less than its liabilities (negative net worth). In this case the
> stock is an out-of-the-money call whose valuation is tricky (B-S
> formula, but which vol?). Not clear it's worth more than the current
> valuation, although in some scenarios it could be worth much more.

Nov 08 07:10 PM

[DinNYC:]

I thought I would revisit this article 2 weeks after I posted it, and naturally I was spurred to that by GGP's 1 dollar move to the upside today. I am remiss to say that I bought some more under $4 and chickened out, selling at 4.50. We are going to look back on history and consider the point from the Lehman Collapse to our close at 1150/1200 on SPX on dec 31 2009 (thats tight, im calling it!) and historians will it the "lost year". A year where panic and NOT fundamentals drove the market into a tailspin. Notice how the shorts like to quote "fundamentals" when they want to rail against a bull market, but never consider the fact that the downturn after lehman's collapse was NOT driven by fundamentals - it was driven by fear (and stupidity in my opinion). GGP is a company that never shouldve had to go into bankruptcy, and that reality is coming to the surface now in the pps. My biggest regret is that I am a daytrader, and one of my hard and fast rules is if I get a dollar move in a position, I have to sell. The only remaining GGP shares I hold are the 200 I bought at 5$ and the 100 I bought at ::GASP:: 15.

I only wish I had even MORE faith in Todd's position on GGP to have put my rules aside and give GGP the time it needed to shine. My 60cent shares were sold at 2.50 :-(

Again Todd, I ask if you can answer the question I stated 2 weeks ago. Should the shareholders of GGWPQ hold on to their shares as the company exits bankruptcy or is there some potential setback looming for the common shareholders that could result is us having a smaller share in the new company than we have now in the pink sheets.

PS- I love how quiet the shorts have become. Silence is golden!

Nov 18 10:12 AM

[Brian McMorris:]

Todd, Good earnings and revenue news from GGP last night has propelled the stock much higher ($6.19 as I write). Will you be doing a review of their 10Q filing? If not, I can get to it this weekend.

Nov 18 10:53 AM

[Brian McMorris:]

Hey David...did you see the GGP earnings reports last night? (11/17?) It looks pretty good. 91 cents / share FFO (cash flow) which puts the company at a multiple of less than 2x of FFO, ridiculously low. Performance is better than Q3 2008 and the outlook is positive. GGP has lots of room to the upside as retail comes back and the questions over their mortgages are cleared by the court.

So, you are hanging your thesis on a hope that the courts will for some reason decide to punish GGP and allow the lenders to steal their properties at some low-ball price? Why would the courts do that? Don't you think a judge would like to be seen as part of the economic solution rather than part of the problem? At least that is what your post suggested. And you invest this way? On a wing and a prayer?

Your entire argument is about lenders being "steaming mad" and that "1. I'd be appealing, and 2. I'd play hardball to the extreme. I'd bring in my own appraiser and get a value for the single entity that was stupid low and then I'd go after the entire property plus claims on any other asset that comes out of BK. And I'd refuse to negotiate from that position"

I take it you are not a professional investor. Those sentiments would get you fired and/or lose your clients a bunch of money. And how do you plan to "refuse to negotiate from that position" of some extreme low-ball bid. If the court orders it, would you then be prepared to go to jail for contempt of court?

Try using logic rather than emotion (anger) when discussing investing strategy. It works much better to invest with fact and data, rather than anger.


On Nov 06 08:11 PM davidbdc wrote:

> While I wish you well with your investment, I'm not convinced that
> the equity holders are going to win in this case.
>
> I still firmly believe that there are properties in BK that shouldn't
> be since they were set up as seperate entities. Those lenders have
> However, as I said good luck with your bet on GGP.

Nov 18 11:08 AM