UncleLongHair

Crystal River’s Q2 Write-Downs Could Bankrupt the Company

>>> Finally another point about the press release. The company did not disclose interest payable and other forms of very short-term liabilities, or the amount of unrestricted cash. For all we know, these may be higher and lower, respectively, than in Q1. <<<

Well they might also be lower and higher, respectively. It's pretty obvious that cash is going to be higher than Q1 for example. But really we have no idea, because we don't know what has transpired in what was certainly a very busy Q2. Clearly they are keenly aware that they need to eliminate their short-term liabilities.

In April 2008 they disclosed $100M of "unencumbered" assets, $45M of net cash, and the repo lines were down to $28M, and all of the agency MBS were gone. Some of that happened after the end of Q1, so the Q1 balance sheet doesn't reflect all of this. Surely they continued the sales into Q2.

>>> 1. Do you concede that it is likely that the equity reported as of 6/30/08 will be below $100 million? <<<

Possible, but not likely, and I don't mean that as an evasive answer, really we don't have enough data. CRZ management is all too aware of the $100M equity limitation and was clearly willing and able to sell assets at a loss to preserve equity.

You're basing your book value write-downs on the movement of the indices and the assumption that they hold much the same assets at the end of Q2 as Q1. The first assumption is maybe the best thing analysts have to go on, but is nothing more than a wild-ass guess, and some liabilities will change along with the assets. For the second assumption, I would not be surprised to find that they have sold all of their non-agency RMBS and a signficant portion of their real estate loans, about 62% of which they reclassified as held-for-sale in Q1. That could represent another $100-200M of de-levering during the quarter.

To the extent that they have a strategic focus (note that I am not really that positive on the company to begin with, I mean hey, Lou Ranieri is on the board, you just gotta love that), they seem to want to focus on agency MBS, A-credit CMBS, and direct ownership of commercial property. So that clearly puts the non-agency MBS and residential loans in the jettison category.

>>> 2. Do you concede that, to the extent that Brookfield is willing to excuse a default, it will do so on terms that are in the best interest of Brookfield rather than CRZ? <<<

Of course not. BAM is going to watch out for themselves, but as long as they feel there is some long-term value in CRZ, they're going to strike a balance between all of the respective interests.

I am more familiar with BAM than CRZ and have seen the way BAM supports its distressed offspring during rough times. If you think that CRZ has been a bloodbath, I direct your attention to Fraser Papers. The losses there have truly been awe-inspiring (or perhaps awww-inspiring), yet BAM has steadfastly supported the company. Aside from backstopping a rights offering and helping them to convert debt to equity, they've lined up financing deals to help Fraser monetize some assets and gain business from other BAM affiliates. BAM has done the same with several other companies in similar situations, and certainly has the resources to help CRZ in the same way. One advantage that CRZ already has is access to BAM's deal flow, which is world-class. This is not 100% predictive of what BAM will do with CRZ, but they have long shown the willingness to support their subs and affiliates, and have plenty of motivation to do so here.

To look at it another way, what does BAM have to gain by foreclosing? They would go from being the senior lender secured by a bunch of squishy assets to the direct owners of the same. Is their exposure diminished or accounting treatment any better after foreclosing? No. They are not dumb enough to foreclose and then try to liquidate the assets into a terrible market, and the ~$50M of debt is not meaningful to their ~$100B asset base. More likely they'll convert their debt to equity ownership so they reduce their downside risk and increase their share of the upside if and when things turn.

It is telling that CRZ has chosen to pay off the repo lines with BAM's line of credit, instead of the other way around -- clearly they believe that BAM is a friendlier party than their repo lenders.

>>> In the past, when companies with toxic real estate debt have sought to go to capital markets, the results have been horrible for common shareholders. cf TMA and BKUNA. <<<

Yes but TMA and BKUNA did not have well-heeled parent companies, nor did Homebanc, New Century, Delta Financial, or the whole host of other blow-ups. A few billion of liquidity in the hands of a friendly party can go a long way during rough times.

>>> Since you are the only person commenting here who has made any intelligent bullish comments, I'd love to also hear your general case for this stock. <<<

Well really I am neither long nor short, but I've been following cRZ pretty closely for about 4-6 quarters looking for an oppotunity to go long. When the fit first hit the shan, they had a fair amount of "dry powder" in the form of agency securities that I thought could be sold and redeployed into higher yielding assets, but that didn't really pan out so well, because agencies didn't hold up as well as anyone thought they would. Then things really started to go pear-shaped, and they started to sell agencies for survival rather than redeployment.

However, the market should be rife with opportunities for those with capital to deploy, and many participants are talking about mid-teen unlevered yields in A or higher rated securities. Of course an A or even AAA rating doesn't mean what it used to, and maybe it's all crap at this point.

Generally, I don't like MREIT's of any type or variety because they don't have any balance sheet to them, and generally don't add any economic value -- they are just a passive portfolio. I prefer REITs that are direct owners and operators and those that add value through expertise and redevelopment. Even moreso, I like property management companies that are not obligated to pay out all of their income as a dividend so they have more balance sheet and liquidity (examples are BPO and FCE). So, in light of all that, I'm never going to get excited about going long CRZ unless the situation is more stable than this one is, though the discount is starting to look pretty compelling. I'll definitely wait for the Q2 report to come out before making any calls.

Uncle

Crystal River’s Q2 Write-Downs Could Bankrupt the Company

>>> The mere fact that they can borrow the 70MM means that Q2 equity didn't drop below 100MM. <<<

Actually I thought of that too. The timing of that release is interesting -- after the end of Q2, but before the Q2 numbers are released. They specifically said that the revolver "can be used to address" the other liabilities (i.e. present tense). Could they make that statement knowing that their book value is already below the covenant? Can they accurately estimate their book value at this point? Many tantalizing questions... but no answers yet.

Uncle

Crystal River’s Q2 Write-Downs Could Bankrupt the Company

>>> Regarding your other point, I again don't see why a company in this environment would allow a $100 million loan to save an illiquid investment of $5 million. <<<

First of all, to use accurate numbers, the company announced that they had $70M of undrawn capacity on the revolver, implying that they are now $30M drawn. There are $22M of repos coming up, plus CDO swap exposure of $3M, totaling $25M. If they drew down their revolver to cover these liabilities, they'd be $55M drawn, not $100M, and would then have no other pressing liabilities.

Now let's say for argument's sake that this happens, and book value comes in below $100M, let's say $75M just to have a number to discuss. Would Brookfield force a margin call on $55M loaned out against a company with book value of $75M, when they also have a 7.5% equity interest? I suppose they could, but they'd lose their equity investment, and then go from being a lender to direct owner of the assets. Would this put them in a better situation? I don't think so. Remember that the assets are already managed by a subsidiary of theirs, and the three management teams (BAM, CRZ, and Hyperion) have many people in common. They'd certainly make no friends by forcing the margin call.

Instead they'd almost certainly amend the terms of the agreement to give CRZ some more breathing room, but they'd want something in exchange for that. A higher interest rate would only exacerbate the liquidity problems, so the obvious solution is equity of some kind.

I dunno, a whole lot of unlikely things have to happen in a row for them to hit the liquidity wall. I think they still have plenty of room. If the secured revolver were not with an affiliated party, I think that would be a major risk. It is usually a margin call on the medium-term financing that puts the MREIT's under. But in this case they don't have that risk.

Crystal River’s Q2 Write-Downs Could Bankrupt the Company

>>> unless you have some reason to think the % of the writedown in assets that will be offset by a M2M in liabilities is going to be dramatically higher in Q2 <<<

They de-levered substantially during Q2, which you're also omitting. I think extrapolating Q1 results to Q2 doesn't make sense for this reason. I agree that they're cutting it a bit close if they want to stay above $100M since they only have $32M to spare. But there are a lot of moving parts. We should know soon as they put out their quarter. Again, I'm here for the analysis, since I don't have a bet on the table, but I don't think book value is going to change much at all.

I would also assign a very high probability to Brookfield NOT delivering the death blow. If book value goes below $100M, they will just amend the credit agreement. As I mentioned, this might mean dilution for CRZ, but ensures survival.

Crystal River’s Q2 Write-Downs Could Bankrupt the Company

>>> If Brookfield is like just about every other financial institution these days, it does NOT have spare capital to throw tens of millions of dollars away at a mere LIBOR + 2.5% at a troubled company, just to save a very small investment in the borrower's common stock. <<<

The best thing to do in this situation is to convert the debt to equity, which both protects the debt-holder's investment and also gives the investee more breathing room, and allows them both to experience upside if and when the market recovers.

Aside from Fraser Papers which I mentioned earlier, Brookfield did the same with Maax. One of their bridge lending funds held a senior debt position, and in a restructuring they converted that to a control equity position. There are numerous other examples of similar transactions.

This makes good business sense, but part of the motivation is not direclty tied to short-term results. If Brookfield gains a reputation for leaving its children out in the cold during a storm, they will be in a decreased negotiating position when trying to make new acquisitions.

Crystal River’s Q2 Write-Downs Could Bankrupt the Company

>>> Our master repurchase agreements with Credit Suisse First Boston, LLC and Credit Suisse First Boston (Europe) Limited and our secured revolving credit facility *each contain a restrictive covenant that would trigger an event of default if our stockholders' equity declines ... below $100.0 million.* <<<

The 10-Q goes on to say:

"If our stockholders' equity decreases below $100.0 million, we would be in default under these borrowing arrangements and *if we were unable to obtain a waiver or an amendment of those terms*, the lenders under those facilities would have the right to accelerate the maturity of the indebtedness and we could be forced to repay such indebtedness..."

The $100M secured revolver is provied by an affiliated party (Brookfield Asset Management, publicly traded as BAM). CRZ is managed by Hyperion Brookfield, a subsidiary of BAM, and BAM holds 7.5% of CRZ equity. If BAM were to force a margin call on their revolver with CRZ, they would further jeopardize their own investment in CRZ.

Much more likely is that they would provide a waiver or amendment, and I would guess converting some or all of their indebtedness into equity. This might mean dilution for CRZ but would also mean survival. BAM did the same thing for Fraser Papers, another of their small subsidiaries who is struggling.

In any event, IMHO the major hole in your analysis is that CRZ's liabilities are likely to be marked down along with the market indexes along with their assets, so the hit to book value is going to be a lot less than you predict. Generally, any impairments to the assets that are primarily market driven are likely to be matched with impairments to the liabilities (this was the whole point of the new accounting treatment after all), resulting in minimal change to book value. The hits to book value would have to come from asset-specific write-downs such as defaults at specific properties. Which isn't to say that there won't be any, but that is likely to be far less than you estimate.

I don't have a dog in this fight though, I'm neither long nor short CRZ, though I'm familiar with it and have been following it for a year or two.

Uncle

Crystal River’s Q2 Write-Downs Could Bankrupt the Company

I wonder if anyone is still reading this thread. Hopefully, any posters will stick to analysis instead of fighting with one another.

The company put out a statement about a half hour ago:

"As of July 7, 2008 Crystal River had approximately $70 million of undrawn capacity on its secured revolving credit facility. The available capacity under the revolving credit line can be used to address any maturing debt including the outstanding repurchase debt balance of $22 million and the Company's remaining non-cash collateralized credit default swap exposure of approximately $3 million."

This seems directly in response to Greg's questions about liquidity. This secured revolver was provided by Brookfield, a party affiliated to CRZ, and seems secure. Brookfield owns CRZ equity and isn't going to force a margin call on this line or they lose their own equity investment. More likely they would recap and convert their debt interest to equity.