Thursday, June 24, 2010

"Stuy Town - Who got 'stuffed'"

The story that follows my post below is clear enough if you understand a bit of finance. But for those who don't, here's the 'friendly' neighborhood analogy.

Imagine, if you will, Franny Maeck, a real estate investor in a run-down, broken town. The town mayor is offering "housing credits" - basically payments, to the investor to incentivize her into putting money into real estate in the town.

Franny agrees, and her investments take the form of loaning out funds to people to buy houses in the town. Franny has no problems raising funds, because she has the mayor himself backing her, so she can borrow at very favorable interest rates in the market. We'll leave aside the thorny issue of why the mayor, who is backing Franny, doesn't just invest in the real estate himself.

Back to the real estate investor. Now of course, Franny wants to get other investors on board to spread the risk and increase the investment pool of funds. So she ropes in Gullible InCorporated, from a faraway town that is swimming in wealth, but nonetheless has citizens that scrounge in trash bins for metal cans to sell.

Gullible InCorporated is only too happy to invest, thinking that Franny is an expert at these things, and what's more, Franny has put her own money in this. She has skin in the game!

Too bad for Gullible InCorporated though, that Franny knows only too well that the particular houses that they're investing in are run-down, prone to collapse, and could spontaneously burst into flames at any time.

Franny has wisely bought insurance on the houses, so she can collect when, not if, the houses burn down. So her money's safe. She didn't mention this to Gullible though, who's still blissfully unaware. Until, that is, months after the houses have already burnt down. In the meantime, she's toting up her insurance gains on her Abacus.


Good thing we don't have something called Gullible InCorporated here. It's such a relief we have really competent people looking after our money. After all, these are the people that keep our streets free of floodwater, our public transportation system secure, and limping, incapacitated would-be terrorists safely locked up. And if they didn't manage to do all these things, our nation-building press would certainly call them out on it and subject them to the strictest scrutiny.

And our very, very competent people certainly are worth every penny we pay them. Heck, if we want things cleaner and safer, just like our town councils, we should definitely pay them even more.

Stuy Town – Who Got “Stuffed”?
Via: zero hedge Posted: 2010-06-22

Stuyvesant Town in NYC is possibly the worst RE deal in US history. This 2006 vintage mega ($5.4b) deal finally went bust in January. Fannie and Freddie together hold $1.5 billion of the $3.0b senior mortgage bonds. The equity and mezzanine lenders have been wiped out. The WJS did a piece on this horrible deal back in January. In that article they had an interesting quote from a Freddie Mac spokeswoman:

"Freddie Mac doesn't expect any losses"

I thought at the time that this was one of those things that might come back and bite them in the ass. It was not clear to me that the senior mortgage was money good. If it were, then the mez. and equity guys would not have folded as fast as they did.

The Fannie and Freddie mortgage bonds were equal in legal status (parri passu) to a $1.5 mortgage loan provided by Wachovia. After the deal closed Wachovia put this debt into a much larger CMO. Fitch did an analysis of the CMO in April. The report concluded that the Wachovia/Stuy Town mortgage was not money good. I called Fitch and got a confirmation. The Fitch assessment of the property value is $1.8b. This value was based on a discounted analysis of the rent and future Capex requirements. (See 4/1 Fitch report, Wachovia C-30)

This information was in direct conflict with the Freddie claim back in January that they expected no loss. I thought I had a “gotcha” story. To confirm it I asked the FHFA some questions. Consider this exchange:

BK: Comment on Fitch value of 1.8B?
FHFA: This is Fitch’s estimate. Other firms estimates place the values between $1.6 and $2.2 billion depending on the cap rate.

BK: Did F/F put the securities in a larger CMO transaction?
FHFA: No, they did not put the securities into a CMO. The GSEs approached this as typical investors.

BK: Did F/F have other credit enhancement?
FHFA: F/F had enhancements for this deal that were typical for large loan deals. Other investors had the same enhancements.

BK: Did F/F do this to get low-income housing credits?
FHFA: They did receive housing goals credits and did so in the context of meeting their standard securities investment criteria.

Some thoughts on this.

-The market will ultimately determine the value of Stuy Town, but for the FHFA to provide a range of estimates that are all below the mortgage value is a confirmation that this deal is upside down.

-Consider the second and third comments together. They did not put the bonds in a CMO transaction where they would take back the highest rated tranches. They chose instead to obtain other “enhancements”. This means they bought a form of single name CDS protection. This information confirms the Freddie statement that they would not incur a loss. Color me shocked at this.

-F/F were arbitraging their balance sheet. They were able to borrow at spreads over treasuries back then. They bought risky Stuy Town bonds that had a fat coupon with taxpayer guaranteed money. But then they paid away most of that premium buying CDS protection. They did not trust the deal from the get go. So why did they do it? The answer is in the last response. A motivating factor for Fannie and Freddie to participate in a highly leveraged RE deal was to get housing credits. There is a lesson in this. These housing credits are ass backwards. They do not encourage low-income housing. They encourage speculation.

-The statement, “Other investors had the same enhancements” is interesting. The question comes to mind, “What other investors had the credit enhancements”? This is the list of suspects.

Wachovia Bank
Government of Singapore
Florida State Pension Fund
Church of England
S/L Green
Black Rock
Tishman Speyer
DG Hypo Bank
Hartford Financial
Allied Irish Bank

I am willing to put long odds that it was not Wachovia that bought the protection. They tried to enhance their position by putting the mortgage and a bunch of other crude in a CMO. It was not the Government of Singapore (GIC). They have confirmed that they have written off their investment of $675 million.

Someday we will know who those “other investors” are. I wonder if Singapore was aware of the fact that F/F was buying enhancements on their senior position at the time the deal was struck. If the senior guys were nervous, then the mez. guys should have been quaking. But that is not they way this played out. This disclosure issue is somewhat like the problem Goldman has with Abacus. Did everyone in the deal fully understand the interests/objectives of the other participants? Would any of the other investors backed out if they understood F/F were hedging their bets? Did everyone have the same objectives for participating?

-Having two government agencies provide $1.5b (25%) to a transaction gives the deal credibility. But the evidence suggests that the anchor lenders did not believe in the transaction. I’m sure the Singapore government is upset with the results. I wonder how they will feel knowing that some of the investors are getting out whole while they took a bath.

-I would love to know who was the provider of the CDS that enhanced the F/F Stuy Town bonds. Back in 2006 it could have been anyone. One name that comes to my mind is AIG. I hope it's not them. We have had enough financial Greek tragedies.

-F/F have no loss. Wachovia split its share of the mortgage up and sold it a hundred ways. The old mez debt and equity have tossed in the towel. A question to ask at this point is: why not resolve this problem by condoizing Stuy Town? The pricing would reflect the current value of ~$2b. The long-term renters would be able to benefit from this. Others would be able to find housing at an acceptable cost. Stuy Town was never worth $5.4b. F/F should move to get this off their books without loss. That way the people of NYC would be the beneficiaries of the worst RE deal ever.

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