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Tariq, from the excellent StreetCapitalist, asked my thoughts on why Third Point sold his Maguire Properties (NYSE:MPG) position last year. Dan Loeb did not disclose his reasons, it could be part that he did not see use for his activist role in the current turnaround situation or that we wanted to leave a bad chapter behind. And to tell you the truth, I did not look much into it given that others are buying.

However, Tariq’s question reminded me of a third possibility: that he was surprised that MPG’s inherited problems were worse than expected. Third Point probably started buying at the beginning of 2008 before Robert Maguire’s resignation. You can retrace most of the history through Market Folly’s posts. Robert Maguire at that time rejected a couple of offers in the $20+ range, and the company was subject to pressure from other activist investors. To give you an idea of their thesis at the time here is a report on JMB Capital Partners efforts:

However, from those reports you do not get a feelling of the cash flow and recourse obligation problems. Even Robert Maguire in October 2008, well after his resignation, fired an open letter and a 13D complaining that it was all the market’s fault, that it was under appreciating his baby, without himself giving proper balance to the not easily available recourse problems.

I write these words as I watch like a nervous father from the sidelines while a company I founded, nurtured and once ran as CEO, Maguire Properties Group, struggles each day with a Wall Street that seems to have lost its confidence in the resilience of the American economy and its workers, and is seemingly oblivious to the significant progress that I believe has been made to right the Maguire Properties ship.

A good cautionary tale on recourse debt surprises is Meruelo Maddux Properties (OTC:MMPIQ.OB), a case brought to my attention by good friend Valuestocks. MMPIQ is another dominant Angelino developer and the largest residential landlord in downtown LA. To give you a taste of the quality of its properties here is a map from their 2007 IPO prospectus.

So let’s move forward in time to the August 2008 earnings call

Jack Ripstein – Potrero Capital Research Hi. Good morning. Thanks for taking my call. Question on the debt side, are there any properties or any changes in the debt associated with the new financing that are recoursed back to the company? Or is it all still projects and – either projects or land specific?

Andrew Murray All our debt is non-recourse.

Jack Ripstein – Potrero Capital Research Okay. So each piece that we can go through, the supplemental is attached to the actual project proposal next to it and nothing else?

Andrew Murray As you know, our construction loan is recourse, but that’s normal with a construction loan. But all the loans that we refinanced are secured by first trustees. We have one of our acquisition loans that we’re going to be doing with Overland terminal is a recourse loan, but that’s primarily because it’s a bridge loan.

Jack Ripstein – Potrero Capital Research Okay. You would replace that when possible?

Andrew Murray Yes.

Jack Ripstein – Potrero Capital Research Okay. Great.

Andrew Murray Generally speaking, we’re still in a non-recourse marketplace.

Jack Ripstein – Potrero Capital Research And that hasn’t started to change with some of the changing landscape out there?

Andrew Murray No.

Jack Ripstein – Potrero Capital Research Okay. Great. Appreciate it. Thank you.

So what would be your thoughts after that performance? Probably that even if the market was deteriorating there was still downside protection. Only those nasty construction loans could be some of a problem but if things got to the worse you could start handing back the keys of not performing properties.

Just six months later, March 2009 earnings call, we get the following Chapter 11 surprise:

Analyst for Jordan Sadler – Keybanc Capital Markets I just want to try to better understand your process and strategy and so what exactly would be the benefit in declaring Chapter 11? I see several properties that are 100% occupied or about six or seven that are over 90% occupied and so I guess first, what loans exactly are recourse to the company? And then second, why wouldn’t you essentially hand the keys back to the lender on the vacant buildings or underperforming assets, reduce your expense load and just continue operating the remaining assets?

Richard Meruelo The great majority of our loans are either directly or indirectly recourse to the operating partnership or the company and so handing back keys is not enough of a solution.

Analyst for Jordan Sadler – Keybanc Capital Markets So most of the loans are recourse in some form or another? Were they non-recourse and now because of non-payment or a trigger of some sort of default they are recourse?

Richard Meruelo No but, many of them from the beginning had some form of recourse and as they’ve been modified over the last year it’s continued to increase the level of recourse. We’ve been modifying these loans now for over a year in short term extensions and recourse issue has become most prevalent in all of our loans except in just a few.

Analyst for Jordan Sadler – Keybanc Capital Markets On the non-recourse loans, when you say a few, can you just give a better sense of maybe what the NOI on those are which ones?

Richard Meruelo We have amount of non-recourse debt is how much Andrew?

Andrew Murray $74 million.

Richard Meruelo $74 million of our debt is non-recourse.

Andrew Murray We haven’t calculated the NOI on those properties but our overall strategy though is to continue to work with four of our lenders again, as we mentioned in our press release and in our comments to come up with an agreement with these four lenders that should deal with our cash flow matter, the cash flow issues we have in the company. We’re in advanced discussions with these four lenders. We’ve been having conversations with them daily now for several weeks and we continue to work towards a solution with them. That’s our primary focus right now.

Analyst for Jordan Sadler – Keybanc Capital Markets So the properties that are 100% occupied or in the 90% range, those are likely recourse or have some form of recourse to the company?

Andrew Murray If we have a performing property and it has recourse we want the relationship with that particular lender on that property to be in good standing.

From MMPI to MMPIQ in two years is almost a dotcom performance. From the beginning many of the properties had some form of recourse obligation. And some developers have this habit of shooting for all or nothing, so they compromise other properties in the refinancing. So be careful with developers with large pipelines and potential undisclosed recent obligations. I speculate that this may have been part of the issues with MPG for some value investors last year.

NOTE: If there is any lawyer or investor interested in bankruptcy plays with access to Pacer I would very much appreciate his help to get to the bottom of Meruelo Maddux Properties given my interest in Maguire Properties (MPG).

Author's Disclosure: Long MPG, and I hope not to get an angry activist letter on why all these speculations are bullocks

Source: Meruelo Maddux Properties: A Cautionary Tale