Bailouts and More Bailouts

Today's winners in the world-wide bailout ruse are:

• Dubai World, which announced a restructuring plan involving a $9.5 billion lifeline from the government. The plan will take months to implement and will require some discussion with creditors but it will involve recycling the $5.7 billion left over from the $10 billion bail-out from Abu Dhabi last year, and the remainder from "internal government sources." It's always nice to see a government use a bailout from another government to fund a bailout of its ill-timed property bets. Dubai World will receive a $1.5 billion cash injection to cover stuff like working capital and interest payments, with the remaining $8.9 billion of government funding and claims turning into equity in the government-owned businesses. Meanwhile non-government creditors will receive "100 per cent of their claims, through the issuance of two new tranches of debt with five and eight-year maturities." So, extend and pretend is the name of the game here. More details of the package in the FT article.

• Bank of America is offering to reduce principal balances by as much as 30% for troubled borrowers. As it turns out, offering mere interest rate reductions to borrowers who are upside down on their mortgages is not enough to entice them to make their monthly payments. B of A probably has no idea if this is going to work. But they are just tired of all the rejection. According to the President of Bank of America Home Loans "The whole purpose of the program is to get more customers to return phone calls." Who knew that defaulting borrowers could be so rude?

In bailout announcements we're still waiting for:

• German chancellor Angela Merkel said EU leaders were set to "specify" what "combination of IMF and bilateral aid" might be awarded to Greece, should it ask for help. Which it hasn't done. Yet. Even though everyone knows that it will have to. Meanwhile, in completely related news, the ECB has announced that it will relax its collateral requirements so that European banks could continue to shovel Greek debt to the central bank for funding beyond the end of 2010. Originally, the ECB was going to raise collateral requirements by the end of the year, before it realized that banks were in a tizzy over where to park their Greek garbage. Whew! That was easy. Problem solved. Right?

How Dumb Did CMBS Investors Get?

Even on the most boring financial news day, the WSJ Property Report always offers up a few tasty morsels of mock-worthy stories. You can skip over the tale of Istithmar World Capital, the private equity arm of the Dubai government's investment fund, which is handing back yet another building to lenders. As it turns out, buying a former hotel-turned-office building in Times Square, kicking out all the cash-flow producing tenants, in the hopes of turning it back into a high end hotel, maybe wasn't such a great idea. Must've been a bug in that excel spreadsheet that spit out the ridiculous purchase price in 2006. Then there are the continuing problems of former real estate mogul Kent Swig who used to like to do deals in just nine days because he was just so great at ripping apart the numbers and analyzing the deal "very, very quickly." Now Mr. Swig is being sued by lenders and five of his properties are listed by Real Capital Analytics as "troubled." You don't need nine days to analyze that.

No, the real juice this morning is in the article about the Biscayne Landing development (or lack of development) in Miami. Sure we've read a multitude of stories about silly CMBS issued in the 2005-2007 period secured by properties with extremely optimistic and preposterous future cash flow assumption. But this is the first time I've read about CMBS that was used to finance a land acquisition. In Florida. On landfill. That had been on the EPA's Superfund site list. Sure it was taken off the EPA's list in 1999, but still. Are you kidding me???

The developer of the project, Boca Developers, had grand visions to build 6,000 residential units, a hotel, a town center, pools and clubhouses. Oh, and they were going to cleanup the groundwater that had been contaminated by the aforementioned landfill. Credit Suisse gave the developers a $233.5 million loan, of which $163 million was repacked into CMBS secured by the ground lease and sold off to a bunch of investors who were apparently too sophisticated to read offering documents. In any event, the project is now largely unbuilt except for two condo towers that are involved in a separate foreclosure action. Furthermore, the affordable housing and the Olympic training facility that the developers agreed to help build elsewhere in the city has yet to materialize so the Mayor is pissed. "The project currently is a failure" says the angry Mayor. Ya think? Apparently the next step for the failed development is for someone to step up to take on the ground lease. Shockingly, there are few bidders that are willing to sink equity into unimproved property that doesn't throw off any cash flow. Any takers?

Citi, Dubai, and Other News

Equity futures are higher on some bullish headlines:

• Dubai received $10 billion from Abu Dhabi, which will pay part of the debt held by Dubai World and its property unit Nakheel. $4.1 billion of the bailout will be used to repay Nakheel's bonds that mature today. The rest of the money will be used to finance Dubai World's needs up until the end of April 2010. So, if you were confused about whether Dubai World was going to get a bailout, (and why wouldn't you be? What part of "investors understand nothing!" did you not understand?) this should help clear things up. At least until the end of April.
• Citigroup has finally negotiated its partial exit from the TARP. However, the government is requiring that the bank raise $20.5 billion in equity to replace the $20 billion in TARP funds its wishes to repay. Additionally, the US Treasury will sell up to $5 billion of the common stock it holds in a secondary offering at the same time. The rest of the government's 34% stake will be sold "in an orderly fashion," or in a frenzied panic, whatever the case may be. Here's hoping Citi's efforts to escape the claws of the government is worth all the dilution shareholders will suffer.
• Speaking of dilution, Exxon Mobil will spend $31 billion in stock to acquire XTO Energy in a bid to boost its presence in the natural-gas industry. The bid represented a 25% premium to Friday's closing price. The market still loves a good M&A deal, particularly on Monday morning. You know, because all of those huge M&A deals are always such value creating opportunities. Like all of those big bank mergers from the past ten years, not to mention AOL-Time Warner. That one worked out really well...for the investment bankers.

Got $2 Million For a Manhattan Hotel?

The glitzy W Hotel in Manhattan was sold to the highest bidder in a foreclosure auction on Tuesday. The winning bid was $2 million. That's a far cry from the $282 million ($50 million in equity and $232 million in debt) that Dubai World's private-equity arm Istithmar World Capital ponied up in 2006 for the prestigious property. Oh sure, Dubai has some financial issues and many high profile real estate investors are losing properties left and right, so what's the big deal? Well, Istithmar World Capital has $20 billion in private equity investments, much of it spent in 2006-2007. As evidenced by the loss taken on the W, any or all of those investments can go to zero in a hurry. And you thought Nakheel was Dubai World's biggest problem...

The $232 million in debt on the W was divided into $115 million in senior debt, now in CMBS, and $117 million in mezzanine debt. The mezzanine debt defaulted in October and the most junior of the three mezzanine investors, LEM Mezzanine, pushed the property into foreclosure and won the auction with the $2 million bid. It is now LEM's responsibility to bring current any defaulted debt that is senior to it ($97 million of mezzanine debt senior to LEM's original $20 million piece) as well as keep the first mortgage current. Istithmar made a last ditch effort to keep the property by throwing out a $2.1 million bid contingent on not having to pay anything to bring the hotel's senior debt back to current status. That whole "we don't feel like keeping our debts current" thing might work in Dubai, but not in the US. Unless, of course, you are a systemically important financial institution and can get the Fed to bail you out.

Headlines 12/8/2009

• Both Fitch and Moody's out stating the obvious today, with massive downgrades of both Greece and Dubai. The Dubai downgrade is patently ridiculous. If there is anyone left out there that doesn't know that Dubai World defaulted on its debt and the Dubai government refused to step in to bail it out, Moody's is here to educate and protect those investors about to make a foolish decision. Maybe word hasn't reached those sitting in debtor's prison in Dubai? Who knows? Oh, and also, in a completely shocking development, Nakheel, Dubai World's real estate development subsidiary that owns all those half-built buildings on man-made palm shaped islands, lost a boatload of money, $3.65 billion in the first half of 2009 to be exact. As for the Greek downgrade? Rumors abound about the country's troubled finances. But don't worry. The Dubai crisis, much like the subprime crisis, is contained.
• US consumer credit shrank for the ninth month in a row, by 1.7% in October. A couple of interesting highlights from the WSJ article: In 2005, over six billion credit-card offers were sent out to consumers. This year just 1.4 billion have been sent out. Also, Visa reported earlier this year that people for the first time were using their debit cards more than credit cards. The trend lower is likely to continue for some time in order to reverse the absolute explosion in consumer credit over the past few decades. What's shrinking along with consumer credit? The probability of a strong V-shaped recovery. Good chart at Calculated Risk.
• Citigroup and Wells Fargo are getting in on the "We wanna pay back the TARP" action, according to the WSJ. The banks are wrestling with the US government over how much capital they need to raise to exit from the program so they too can "compete" with all the other large banks that have managed to negotiate an exit. The problem is that issuing more stock is expensive. Of course, with the strong market rally looking like its finally petering out, they'd better pick up the pace before it gets even more expensive. I'm all for paying back the TARP. Get on with it. Just as long as everyone agrees that there is no next time if you were wrong about your balance sheet being strong.
• As if you needed yet more evidence that the government employees in charge of protecting our TARP dollars are a bunch of spineless twinkies, the Pay Czar actually caved in to AIG's general counsel's demands for no pay cuts for her and her cronies. It seems that the five employees who threatened to quit so they could collect a fat severance package will get to keep their over-$500,000 salaries. That's right, because without the right general counsel, there's no way that AIG will ever crawl out of that $100 billion hole.

Dubai "Reassures" Investors

The ruler of Dubai on Tuesday attacked the media for coverage of Dubai World's debt default and blamed investors for misunderstanding the situation. In response to questions related to Dubai World, Sheikh Mohammed bin Rashid Al Maktoum said that international investors "do not understand anything." He went on to call the media's reaction as "exaggerated." It was quite an interesting attempt to reassure markets, and ahem, investors, after two days of rather strong sell-offs in the regional equity markets. But then maybe Dubai doesn't have a particularly developed PR industry.

While I totally agree that investors often overact and behave in mysterious way, I'm not sure how investors misinterpreted the phrase "we don't want to pay our debt obligations for at least six months, give or take" coming out of Dubai World. And sure, maybe investors shouldn't have expected an explicit guarantee from the Dubai government, or the UAE, but then maybe the subsidiary should've been named something other than Dubai World. But sure, you can blame that on investors. As for the "media uproar" over a large debt default of a quasi-government guaranteed subsidiary in the Middle East right before the holiday weekend? Totally shocking. The news rightfully should've been buried in the lifestyle section of the New York Times.

In any event, Dubai World is in talks to restructure $26 billion of its debt with its stupid investors. International markets have moved on to misunderstanding other events and rallied back nicely. The media awaits other news to exaggerate.

The Problem With Dubai

Dubai World, builder of man-made palm tree shaped islands and lover of other absurdly ostentatious and expensive property development projects, has run into a bit of a problem. Lacking oil, or any other valuable commodities, it fueled its building ambitions by issuing debt, piles of it, roughly $60 billion or so. Banks were eager to lend because government-backing of Dubai World's debt was implied. So when Dubai World came out with its shocking announcement right before the Thanksgiving holiday that it just wasn't in the mood to pay its debt investors anymore, markets around the world were miffed and sold off. They regained their composure a bit when all those savvy analysts and commentators assuredly pointed out that a $60 billion debt default was no big deal. The markets had overreacted blah blah blah.

But this is a big problem: it's not the size of the debt but the wider implications of a sovereign nation defaulting on its debt. This morning, the Government of Dubai said that it would not stand behind its wholly-owned subsidiary Dubai World. So much for that implied government guarantee. For the past year, vast government guarantees have boosted markets around the world on the belief that sovereign nations don't default. There's no need to actually do any due diligence into the value of the assets backing the debt if the government is just going to step in and bailout the lenders. Except that sometimes, governments change their minds. Certainly emerging markets have been guilty of this in the past, so you'd think investors would have learned their lesson. But with near-zero interest rates permeating the globe, it's that much easier to ignore these risks and plow head-first into risky investments, some with a host of massive unfinished construction projects around the world, just because some government is supposed to bail you out. Not all bailouts will stand the test of time. Defaulting on your debt is theoretically supposed to make it extremely difficult for you to borrow money at reasonable interest rates in the future, if at all. But if a few adventurous sovereigns start to do it, then the stigma related to default might just go away. So how does that make you feel about Fannie and Freddie's debt? GE Capital's? How about GMAC?