Banks Options in General Growth Properties Case Down to One

So we bought more shares of General Growth Properties (GGWPQ) 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, lets 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:

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, lets 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 hav heard this lately but the same problem as above remains for the banks. At what price in 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 loan 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 “underwater”.

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?