Holy Halabi! Worst Caisse Scenario?

Submitted by Leo Kolivakis, publisher of Pension Pulse.

Bloomberg reports that the Caisse is at risk of losing $462 million on Halabi loan:

Caisse de Depot et Placement du Quebec, Canada’s biggest pension-fund manager, may lose 285 million pounds ($462 million) on debt secured against investor Simon Halabi’s London properties after their value fell about 50 percent, according to two people familiar with the situation.

Caisse de Depot holds the junior portion of a 1.45 billion- pound loan secured against Halabi’s nine office properties, said the people, who declined to be identified because the information isn’t public. The senior portion of the loan, 1.15 billion pounds, was packaged into commercial mortgage-backed securities in 2006. Holders of the bonds, which are in default, rank first when the debt is repaid. Interest payments to the junior lender have already stopped.

U.K. commercial property values have slumped 44 percent since their mid-2007 peak, according to Investment Property Databank Ltd. About 230 billion pounds of loans are outstanding against U.K. commercial properties, according to research from Leicester-based De Montfort University.

“The senior loan itself is already underwater,” Gioia Dominedo, a director in Fitch’s CMBS team in London, said in an interview yesterday. “Property values would have to recover even for the senior to make a full recovery, let alone the junior loan.”

MCR, a corporate restructuring firm, was appointed on Aug. 21 to liquidate Halabi’s London-based property-advisory company, Buckingham Securities Holdings Plc. Kamlesh Bathia, Buckingham’s finance director, didn’t return calls or an e-mail seeking comment.

Francois Gaboury, a Montreal-based spokesman for Caisse de Depot’s real-estate debt unit, declined to comment.

JPMorgan Buildings

Halabi’s properties, which include JPMorgan Chase & Co.’s offices at 125 London Wall and 60 Victoria Embankment, were valued at 1.8 billion pounds when the senior loan was packaged into bonds. In June, they were appraised at 929 million pounds.

Interest payments on the junior portion of the loan were halted after the senior loan became due for repayment on July 15, CB Richard Ellis Group Inc. said in an Aug. 24 statement. Halabi’s trusts can’t refinance the debt and the properties are likely to be sold, Fitch Ratings Ltd. said in June.

“We are obtaining all relevant and necessary advice to formulate a strategy to maximize recoveries,” CB Richard Ellis Inc., the debt’s manager, said in the statement. “We have met and are liaising with the borrower.”

Caisse de Depot had an unrealized first-half loss of C$5.7 billion ($5.2 billion) on real estate, wiping out a 5 percent gain by other investments, according to an Aug. 11 statement. The Montreal-based fund manager said it plans to exit its subordinated-loans business.

There was about 285 million pounds outstanding on the junior loan, Standard & Poor’s said in a June 29 note. David Martin, director of special servicing at CBRE, declined to comment.

The first thing that went through my mind is who is Simon Halabi (that's him above)? The second thing that went through my mind is who is the idiot at the Caisse that structured this deal? I mean who would agree to terms where the Caisse would hold the junior portion of a 1.45 billion- pound loan?

Something really stinks with this deal and I suspect there is a lot more to this than what we know. Anyone who agrees to secure that amount of junior debt should be fired and so should the risk officer and investment committee who approved the deal.

Importantly, there should be a full investigation to see if there were any bribes taken to accept these ludicrous terms. Bring in the best certified fraud examiners to go over all the Caisse's fraud policies and procedures for allocating to external funds, including real estate, private equity and hedge funds.

On August 11th, the Caisse's President and Chief Executive Officer, Michael Sabia, announced changes aimed at repositioning the Caisse’s Real Estate group to focus on its core businesses.

These adjustments are part of the action plan launched by the Caisse last April to concentrate on key operations and streamline its structure.

The organizational and strategic changes include:

• integration of the Cadim division into the SITQ subsidiary;
• cessation of investments in the mezzanine and other subordinated loans sector.

Mr. Sabia also announced the appointment of René Tremblay to the position of Executive Vice-President, Real Estate, and President of the Caisse’s Real Estate group.

“These changes were necessary to ensure the success of the Real Estate group in the context of a weakened global real estate market, especially in the United States. They will allow us to focus our efforts in the businesses that have produced excellent long-term returns: 11.9% over 5 years and 12.1% over 10 years,” said Mr. Sabia.

In 2009, prevailing global market conditions significantly contributed to unrealized declines in value of the Caisse’s less liquid investments. At June 30, decreases in the value of real estate investments amounted to $4.0 billion, while those of other less liquid investments totalled $1.7 billion. The overall decline of $5.7 billion offset the 5% return that the Caisse earned during the semester.

The Globe and Mail reported last week that:

Another sign of trouble in the real estate unit emerged last month when the head of Cadim, the Caisse division responsible for the property mortgages, suddenly left the pension fund manager. No reason was given for Richard Dansereau's departure at the time.

Did Mr. Dansereau structure the Halabi loan while he was the head at the Caisse? Why did he leave the Caisse a month before these announcements were made?

Let's take a closer look at Cadim's investments while Mr. Dansereau was at its helm. If you look at this January 2008 Forum newsletter, you'll see some of Cadim's investments. Skip to page 7, where you see Cadim made commitments to several funds in the most recent quarter to the time that newsletter was published (January 2008):

• A total of US$1.5 billion will be invested in two new Lone Star funds, namely Lone Star Fund VI and Lone Star Real Estate Fund, which will focus mainly on Japan, Europe and the United States;
• In partnership with PSP Investments and Stonehenge, Cadim will invest US$237.5 million in Stonehenge III, which will acquire multifamily residential, office, retail and industrial buildings in the states of New York, New Jersey and Connecticut;
• US$400 million will be invested in daVinci Corporate Opportunity Partners’ Fund V, whose mandate will be to purchase interests in publicly traded Japanese companies that hold mainly real estate assets.

From these commitments, Lone Star funds garnered the most by far, a total of $1.5 billion just for Lone Star Fund VI.

Now, let's stop for a second here to introduce Loan Star funds. Most of you have heard of Donald Trump, but he is a midget compared to real estate's top investors like Tom Barrack of Colony Capital and John Grayken of Lone Star funds.

Barrack is considred to be the world's best real estate investor and he cashed out before the crisis hit. John Grayken is also among the world's best real estate investors. His fund focuses on distressed debt. He made a splash last year following Lone Star Funds' $6.7 billion dive into mortgage-backed assets dumped by Merrill Lynch & Co where got a great deal for Merrill's trash.

But for all his success, Mr. Grayken has dealt with his share of controversies. In April 2006, Lone Star apologized for allegations of embezzlement and other controversies that surround its multibillion-dollar investments in South Korea. Lone Star then said it was donating 100 billion won, or about $106 million, in an apparent move to assuage widespread public sentiment against an estimated $4.4 billion profit it stands to make when it unloads its stake in Korea Exchange Bank.

In January 2008, Mr. Grayken appeared in a South Korean court to refute allegations of stock manipulation in a case that is delaying HSBC Holdings plc's $6.3 billion acquisition of the fund's Korea Exchange Bank.

In March 2009, AltAssets discussed capital returns in private equity, noting the following:

Capital returns are now a rare commodity within the private equity industry. Lone Star Funds (‘Lone Star’) has first-hand experience from its lengthy attempts to extract cash from Korea Exchange Bank, after failing to seal a deal with Kookmin Bank and subsequently HSBCHoldings last year.

In late January, the board of directors of Korea Exchange Bank declared a dividend of 125 won (US$0.09) per share which would see Lone Star add an additional 41.1 billion won to its coffers. Since taking control of the lender in 2003, Lone Star had invested more than 2.1 trillion won in Korea Exchange Bank.

So far, it has been able to returned an estimated US$2 billion to its coffers. With South Korea’s economy set to contract in 2009 and the country’s largest bank, Kookmin Bank, recording its first quarterly loss in four years, the prospects for Lone Star to dispose of Korea Exchange Bank does not appear to be all that encouraging.

A July 2008 article in the Dallas Morning News focused on Grayken's ability to spot value but also noted the following:

Lone Star's acquisition of the Korean Exchange Bank in 2003 brought the most headlines of late – and not good ones.

South Korean prosecutors accused Lone Star and its South Korean head, Paul Yoo, of manipulating the share price of the bank to get a cheaper price. They also accused Lone Star and Mr. Yoo of spreading rumors about the bank's credit card unit in a similar attempt to buy it for less.

A South Korean court found Mr. Yoo guilty and sentenced him to five years in prison in connection with the credit card rumor accusation. An appeals court overturned the verdict late last month; the country's highest court has yet to rule.

Regardless, the legal skirmishes threaten Lone Star's July 31 deadline to sell the bank to HSBC Holdings Inc.

Some wonder if Lone Star might find itself in trouble because of its aggressive subprime investments as well.

Mortgage deals

The October purchase of Accredited Home Lenders, a San Diego-based subprime mortgage lender, coincided with a subprime meltdown that wiped out nearly all the originators for the risky loans.

Lone Star tried to back out of the deal in June 2007, but Accredited sued to enforce the purchase agreement, and Lone Star eventually bought it for millions of dollars less than it originally offered.

"Lone Star stepped in too early on Accredited," said mortgage industry analyst Bose George of Keefe, Bruyette & Woods in New York.

Lone Star probably isn't interested in servicing the loans it buys, he said, but it will try to squeeze return from the homes backing the bad loans by re-selling them.

In Lone Star's latest mortgage deal, it agreed this week to pay $1.5 billion in cash and to assume $4.4 billion in debt for a $9.3 billion portfolio of mortgages and related servicing operations owned by CIT Group Inc., a New York-based financial company.

In addition, Lone Star also recently took on some of former Wall Street stalwart Bear Stearns' mortgage portfolio as that firm dissolved.

Given Lone Star's track record of producing solid double-digit returns for its private equity funds, its big bet on distressed loans suggests to some that the housing market may have hit bottom.

"If you have enough understanding of the industry, what assets are valuable and what are garbage and junk, there's clearly some high value assets in this group and they're getting it at deep discounts because of the overall paranoia in the market," said David Lykken, president and managing partner at Mortgage Banking Solutions, an Austin consulting firm.

But were home prices to fall further or interest rates to rise, there's a chance Lone Star's newly purchased assets would lose even more value.

"That's the point at which people buying mortgages now will wish they waited," said Mr. Dotzour.

Global reach

Mr. Grayken isn't used to regret. Whether betting on flagging restaurants such as Shoney's or being one of the largest holders of bad German loans, Lone Star has earned respect by posting annual returns of 9 percent to 28 percent, according to a Bloomberg Markets magazine profile of the firm three years ago. A variety of state pension funds have eagerly invested with Lone Star Funds.

The company has about 1,000 employees worldwide, most on North Harwood Street in Dallas, but its investment reach is global. Mr. Grayken isn't even an American citizen, having given up that status in 1999. He travels extensively on an Irish passport to find the next undervalued deal, according to the Bloomberg profile.

By no means is Lone Star alone in buying the bad loans. Big names such as Warren Buffett and other huge private equity firms such as the Blackstone Group have bought in as well. But whether Mr. Grayken's latest bets will turn against him hedges on the economy, most think.

"That's the entrepreneurial risk these companies are taking now," said Mr. Dotzour. "Every day that goes by where gasoline is over $3 a gallon is another day in which gasoline is just sucking the life out of the American consumer."

I checked out Lone Star's global affiliates and was surprised to see they opened up an office here in Montreal:

Montreal
800, de la Gauchetiere West
P.O. Box 1458
South East Portal - Suite 9400
Montreal, Quebec H5A 1K6
Canada
514-879-6310

Now, Montreal isn't exactly considered a hotbed of distressed real estate activity. Why did a sharp guy like Mr. Grayken open up an office here? And let me ask flat out, does PSP Investments' former First Vice-President of Real Estate, André Collin, and his buddy Richard Dansereau, the former head of the Caisse's Cadim, now work for Mr. Grayken?

Here is another question. Does anyone else from the Caisse and PSP Investments now work for Lone Star Funds? I ask this question because I heard Joanne Tosini, a former Vice-President at PSP's Real Estate team, left PSP after receiving over $1 million in total compensation in FY2008:

(click on image to enlarge)

Ms. Tosini left a year after Mr. Collin left PSP Investments after he received a total compensation of $1,439,300 in FY2007:

(click on image to enlarge)

You do not walk away from cushy jobs at a public pension fund paying you that type of money unless you got a much better gig lined up. For full disclosure, PSP Investments should state why these individuals left the organization, where are they now and what relationship does PSP have or had with their current employer.

[Note: Someone sent me an email, confirming that Ms. Tosini now works at Lone Star Funds.]

Finally, Bloomberg reported that Mr. Grayken is securing pledges toward his goal of raising $20 billion to invest in distressed commercial real estate and securities:

Grayken may garner as much as $2 billion by the end of August, said one person, who asked not to be identified because the information is private. Dallas-based Lone Star last year raised $10 billion to buy real estate assets.

Lone Star is doubling the size of its funds as the deepening crisis in commercial real estate increases opportunities to buy at discounts. U.S. commercial property prices fell 35 percent from their peak through May 31, Moody’s Investors Service said last week. Falling rents and occupancies will accelerate defaults and delinquencies in mortgages sold as bonds, pushing the rate of late payments to the highest since at least 1991, Reis Inc. said yesterday.

Each of the new vehicles will have about $10 billion, the people said. Lone Star Fund VII will invest in distressed financial institutions, collateralized debt obligations, residential mortgage-backed securities, corporate debt and consumer loans, according to one person.

The other fund, Lone Star Real Estate Fund II, will invest in assets including commercial mortgage-backed securities and distressed commercial real estate, one person said. A Lone Star spokesman declined to comment.

Pension Funds

Distressed funds take advantage of financial crises by buying debt at deep discounts with the goal of selling it for a profit, or converting it to equity to control a target company.

Lone Star’s investment strategy sets it apart from other real estate investors. The state of Oregon pension fund, which pledged $1.5 billion to 10 new real estate funds in 2008, has had calls by fund managers for less than $500 million of that, according to a presentation on July 29 to the state pension trustees.

“Most of what was drawn was Lone Star doing distressed debt, which is the only strategy that’s been an active, viable strategy,” said Brad Child, senior investment officer for real estate at Oregon, in the presentation to the Oregon Investment Council. “Everyone else has been defensive.”

Many property managers are staying on the sidelines, anticipating better chances to make purchases as prices decline, Child said. Lone Star got $600 million in pledges from Oregon for its 2008 funds and has drawn about three quarters of that.

Grayken’s Investments

Mining for gold amid financial wreckage is familiar territory for Grayken, 53, a former adviser to Texas billionaire Robert Bass who made his name finding value among distressed properties in the early 1990s after the savings-and-loan crisis.

Lone Star was one of the largest buyers of bad loans during the Asian banking crisis starting in the late 1990s. The firm later moved to capitalize on economic woes in Europe, buying property assets in Germany.

Investing in distress has risks. Lone Star has been beset by legal wrangles over some Asian investments. Three of its companies, Accredited Home Lenders Holding Co., Bruno’s Supermarkets LLC and BI-LO LLC, filed for bankruptcy protection this year.

Lone Star last April won the bidding to take over New City Residence Investment Corp., Japan’s first failed real estate investment trust. Creditors of New City rejected Lone Star’s receivership plan on July 15, opening the way for a rival bid.

Lone Star may begin talks to sell Korea Exchange Bank to the California Public Employees’ Retirement System, the Seoul Economic Daily reported July 27. Legal disputes scuppered Lone Star’s previous attempts to sell Korea Exchange Bank.

Sat on Sidelines

When the real estate market peaked in 2007, Lone Star largely sat on the sidelines, limiting its activities to a handful of sales. As the credit crunch set in, the firm bought Accredited Home Lenders for $299 million.

The firm picked up its pace in 2008, buying $30.6 billion of Merrill Lynch’s collateralized debt obligations at a 78 percent discount.

Lone Star also agreed to buy CIT Group Inc.’s home-lending unit for $1.5 billion and take on $4.4 billion of debt and other liabilities. In May 2008, Grayken bought part of a Bear Stearns Cos. unit that made U.S. mortgages through brokers for an undisclosed amount.

Fund managers such as Lone Star raise money by securing capital pledges in multiple closings over several months from investors such as pension funds. A fund usually must be completed one year after the first close.

I wonder how many Canadian pension funds have made commitments to this new Lone Star fund and how many will be increasing their allocation to it. Mr. Grayken has a solid track record but he is taking huge risks to generate those outsized returns.

Moreover, as noted in this Private Equity Real estate article on Lone Star:

Distressed prices are attracting a plethora of investors to the real estate asset class, especially in mature markets such as the US and Europe, however raising funds has been extremely difficult. Roughly $13 billion of value-added and opportunistic vehicles were closed in the first half of 2009 – compared to a total of $68.9 billion and $85.2 billion for the whole of 2008 and 2009 respectively, according to PERE data.

In response to the difficult fundraising environment, many firms have lowered their original targets or allowed institutional investors to shrink previously agreed commitments. In February, New York-based Westbrook Partners allowed investors in its $2.5 billion Fund 8 to reduce their commitments by up to 10 percent without penalty.

So maybe that's why Lone Star opened up an office here in Montreal, to help them raise the money they need to withstand any protracted downturn in the market. Again, that begs the question, who is in charge of the Montreal office? This presentation to Fresno County Employees' Retirement Association did not have the Montreal office in it (it was made in 2005 and the office was not open yet). 

But no matter who is running that office, the rules of the game have changed and raising funds has become a lot tougher in real estate private equity, even for superstar managers like John Grayken.

Comments

[Anonymous]

This is good! Caisse is a very big player that delved into basically every tradeable product there is...

[TeresaE]

I think the monied ones are going to be shocked when they find out how overvalued their real estate truly is.  Even considering a 78% discount.   And the tax man of course.  Bet they aren't counting on the upcoming hit to sales that taxes are going to be.

I'm in my 6th year of this "downturn" and I can tell you that at a minimum we have lost 25% of this country's customers since then.  In Michigan it is already at 50%.

Why can't people see the empty buildings?

Why can't people realize their customers have been bankrupted by rich guys just like him?

But, I think this guy/group /companies run is coming to an end for awhile.  They bought high as much of the destruction hasn't even occured.  Bankruptcies, business closing and layoffs continue to increase.  More homes, and business properties, are entering foreclosure than were before the crisis started.

Apparently, even very "savy" investors can't see that their tenants and buyers can't get financing.  How can they not know that the banks won't aren't lending money to the very people that buy their properties?

The possible emmensity of the upcoming "shoes left" is going to wipe out so many people, I just don't see much upside as we refuse to see the truth.  Ah well.

[taraxias]

Good stuff, Leo. Thanks for posting.

[Anonymous]

Unusual story in that it goes off-road from the original discussion and never really returns. Kind of loses effectiveness. Oh well. The LSF stuff is way old news.

[texpat]

I hope this shit finds its deserved audience in Canadian pension law-enforcement.

What a cesspool.

[ZerOhead]

If by "What a cesspool" you are referring to Canadian law enforcement I would have to concur.

When the head of the R.C.M.P. is involved in pension fraud and cover-up where do you go?

Please tell me.

http://www.theglobeandmail.com/news/national/article750391.ece

By the way... Zaccardelli got a nice promotion to Interpol of all places... apparently he is now fighting corruption and crime in Africa...

Good luck with that Africa...

[Anonymous]

I hope nobody's putting faith in Sabia to fix anything. He famously left BCE after helping orchestrate its ultimately doomed C$34.8 billion buyout to Ontario Teacher's Pension Plan (another dubious org) that ended up being a huge fiasco.

He did fine with that though, collecting a $21M payout.

He was also the douchebag behind the much-loathed GST brought in under Mulroney that at the time charged a 7% tax on EVERYTHING.

Canada has the most sycophantic press in the world when it comes to business 'leaders' so all this stuff isn't that widely known.

An older post, when he was still with BCE: http://101people.blogspot.com/2007/02/57-michael-sabia.html

[TeresaE]

"...Canada has the most sycophantic press in the world when it comes to business 'leaders' so all this stuff isn't that widely known...."

Apparently you don't watch much American "news" or see who the people of influence are here.

Mainly celebrities whose claim to fame is either lying (for that is exactly what actors do) convincingly, or politicos & the rich that are turned into celebrities.  This is what America pays attention to, not following the dollar back to a few people that are growing more corrupt by the day.

Our news consists of beautifully staged pictures of our President and the latest push, under guise of "news," to get us to take more pharmaceuticals that are largely untested and untried.  With worse side effects than the original "disease."

Then the "news" breaks to commercials for the Democratic Party, GE and two or three drugs. 

THAT  is the definition of sycophant. 

Follow the news and its supporters/advertisers, that is who determines what is "proven" and what is sold to us.

Don't you think that is a worldwide situation and not isolated in Canada?

I do.  We the serfs have been lied to for centuries while a handful, and their purchased politician/leaders pulls our strings and empties our pocketbooks.

[Leo Kolivakis]

Note: Someone sent me an email, confirming that Ms. Tosini now works at Lone Star Funds.

[Leo Kolivakis]

Note: Someone sent me an email, confirming that Ms. Tosini now works at Lone Star Funds.

[Leo Kolivakis]

Note: Someone sent me an email, confirming that Ms. Tosini now works at Lone Star Funds.

[Cognitive Dissonance]

When everyone is culpable, no one is culpable. At worst, the head of the rat pack gets fired and the rest of the rats scurry away with plausible deniability intact.

This is how the game is played in the big leagues. Get used to it because it won't change much.

When everyone fingers are dirty, it's in every one's interest for no one to take the fall. It's called a silent conspiracy or better yet, the culture of corruption.

[Anonymous]

“Fired” did you say “fired”..you sir are being too merciful…as you correctly say, which idiot authorized this pathetic loan…to justify such as investment the return would have to of been astronomical…but to the point at hand, pension fund managers are not idiots, they may be other “things” but no stupid. I assure you that as a PDO at Canadian brokerage house, I can tell you that this event fails the “stench test” I further say that if there is such a thing as a textbook case of when the RCMP white collar criminal division needs to be summoned this would be it.