Wall Street's Continuing Syndication Of Its Own "Secured" Debt Via Equity Markets

Tyler Durden's picture

In April Zero Hedge discussed the potential conflict of interest of secured lenders providing equity financing to companies in which they are the primary secured lender, with a "debt repayment" use of proceeds, in essence using the raised equity to pay down the debt on which the underwriters themselves are on the hook for. Not surprisingly, this was all occurring in the context of REITs - the same companies that face a massive credit crunch as numerous CRE loans come due for refinancing in the 2011-2014 timeframe. It seems this game of "bait and switch" continues unabated.

The most recent and blatant example of this bait-and-switch occured a two days ago, on August 12, when REIT U-Store-It, which "engages in the ownership, operation, acquisition, and development of self-storage facilities in the United States" raised $120 million of equity using underwriters Bank of America and Wells Fargo. From the offering prospectus "[we intent] to use the net proceeds from the sale of the common shares offered by this prospectus supplement to repay existing indebtedness, including a portion of the outstanding balance of the revolving loans under our unsecured credit facility, and for general corporate purposes." While as noted above, we and others have written about this very real conflict of interest, this case comes with a spin.

A cursory glance at YSI's 10-Q filed just two few days prior to the offering, on August 10, indicates that even while BofA and Wells were busy contemplating the offering, they were also working with the very same underwriters to obtain commitments for a new $450 million lender facility, consisting of a $200 million term loan and a $250 million revolver. The new facility will be used exclusively to repay existing secured indebtedness. All this begs the question of who knew what as to the company's intentions while these two critical and presumably independent processes were running concurrently.Here is the relevant part of the 10-Q.

On August 6, 2009, the Company received a commitment letter and term sheet from its lead arrangers, Wells Fargo Securities, LLC and Bank of America Merrill Lynch, with respect to a new credit facility. The Company launched the syndication process in early July and by August 7, 2009 had received $420 million of lender commitments for a new, senior secured credit facility. The syndication efforts are expected to continue through mid-August, 2009 at which time the Company will determine the appropriate size and composition of the new facility. The term sheet contemplates, and the Company expects, the facility to be comprised of a $200 million secured term loan and a $250 million secured revolving credit facility. The new credit facility will have a three-year term and will be secured by the real and personal property interests in the Company’s borrowing base properties. The term sheet provides for customary covenants including a maximum leverage ratio of 65 percent (67.5 percent during the initial year of the agreement), a minimum fixed charge coverage ratio of 1.45x, a minimum tangible net worth covenant, and limitations on certain permitted investments, dividends and distributions, and the amount of floating rate interest exposure. Pricing on the new facility will range, depending on leverage levels, from 3.25 to 4.00 percent over LIBOR, with a LIBOR floor of 1.5 percent. The Company will use the proceeds from the new credit facility to repay outstanding balances under and to replace its existing $450 million credit facility, which is scheduled to mature on November 20, 2009, and to repay the $46 million outstanding balance on the secured term loan discussed above. The new credit facility is subject to lender due diligence, formal documentation and closing requirements. The Company expects to close and fund the new credit facility on or before November 20, 2009. If the Company and its lenders are unable to reach agreement on definitive documentation for the new credit facility with the lenders or the new credit facility otherwise does not close and/or is not funded on or before November 20, 2009, then the Company will utilize its extension options described above with respect to its existing credit facility and existing secured term loan to extend the maturity dates of those loans to November 20, 2010.

So even as BofA and Wells were working diligently to secure lenders for the new facility, they were also planning on raising equity, and not only potentially giving implicit advance notice to a new lender syndicate, but also effectively taking one of the main existing lenders - Wells Fargo, out of the picture. A look at the original credit facility being refinanced indicates that the Administrative agent is none other than Wachovia Bank, now better known as Wells Fargo, while documentation agents are in addition to Wachovia, also SunTrust and... Wells Fargo and Bank of America.

It is truly strange that this kind of conflicted activity is allowed to not only persist but to generate numerous fees for the same entities in the form of syndication fees on both the debt and the equity side, but also no loss on principal due to imminent par paydown of the existing debt, which otherwise would have likely been substantially impaired. Maybe at some point the regulators will stop smiling at this practice and actually demand that there is a real separation of various underwriting activities for companies which in many people's opinion are likely to be the key  "beneficiaries" of the next major market leg down on commercial real estate comes unglued and its follow thru impacts on derivative companies such as REITs like U-Store-It.

hat tip PJ

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Anonymous's picture

unreal consumer ocnf tanks and cnbc has a flash with an optimistic forecast by fed economicst..unreal

Hondo's picture

This is and has been a scam but,  I have to say...any investor and especially an intuitional investor that is buying this crap or hired a so called REIT manager who is buying this crap deserves to lose it all........sorry, no whining.  The government has been looking for lemmings in the private sector to share their pain (TALF, PPIP) and now they found them in the CRE REIT market.  Stupid does stupid is.



deadhead's picture


Anonymous's picture

There is a sucker born every day so these suckers are buying such debt knowing how conflicted the underwriters are. I will bet there will be a lot of lawsuits next year by shareholders when everything goes underwater by early next year as reality hits. Wonder if new bank shareholders will sue the Fed for "misleading stress tests."

Anonymous's picture

The Fed *is* a private corporation. I can't see why they couldn't be sued.

agrotera's picture

NOW we're talking! 

23Trillion dollars ( in less than a year bankheist bonanza) later, but better late than never, and while we're at it, let's get the Federal Reserve Act repealed so the owners are out of their 96 year old and long, money train.

Their X-Enron lobbyist is in full bloom sending Bernake on a road show, and getting ready for something like this coming soon.

Anonymous's picture

Exactly who is hurt by this? YSI shareholders avoid BK, the buyers of the follow-on offering get an immediate 10% gain and the lenders get paid. Except for the shorts, everybody wins. No harm, no foul.

Anonymous's picture

>Exactly who is hurt by this?

There is fundamental lack of disclosure and transparency. Is this a good thing?

>YSI shareholders avoid BK

But get massively diluted in the process

>the buyers of the follow-on offering get an immediate 10% gain

To get the "immediate gain," they need to be part of the REIT mafia. Folks like CGM, Cohen Steers. Conflicted insiders profit, vast majority of public has no access to this gain. Great...

Your reasoning is weak.

H Baskerville's picture

I don't understand how REITs and their crazy cousin variants manage to still exist.  It's a business structure that in theory should work but in the real world it's being applied wrong.  All the REITs I ever looked into were in growth mode.  Can't finance growth internally when you're required to pay out 90% of your profits in dividends so they continuously sell mucho stock, take on more large debt.  But they paid such great dividends!  Just a great big complicated Ponzi scheme. 

lizzy36's picture

Maybe at some point the regulators will stop smiling at this practice and actually demand that there is a real separation of various underwriting activities for companies.....

Regulators have been smiling at each and every practice aimed at allowing the TBTF banks to earn there way out of the mess that they earned their way into.

The extent to which the rule of law has been denigrated, over the course of this crisis, while only be truly understood in hindsight.

Anonymous's picture

I'm sure there is a "Chinese Wall" between the various segments of the banks. We know how "straight up" all the players are.

Anonymous's picture

Can you say TYING?

This practice of winning investment banking business (such as a follow on offering) by "tying" it to a traditional commercial banking practice (of lending) is supposed to be ILLEGAL.

Yet another commonplace practice of the big "universal banks" that goes unenforced by the regulators and unpunished by the big banks.

The major media ignores this scandal. You can't blame them to some extent, it's hard to conclusively prove (plus they're conflicted, as their antiquated business model depends on large banks to advertise their mortgage and CD rates, especially about to fail banks chasing deposits with above market CD rates (see Wachovia, summer 2008)).

Keep fighting the good fight Tyler

agrotera's picture

William K. Black, in the interview posted last week here, said basically, there aren't enough FBI agents to deal with all the crime...we live in Gotham City! And unlike "Gotham City" all of our politicians(except for a few, Ron Paul, Alan Grayson, Darryl Issa, and maybe a few others) are friends of the gangsters (banksters).

Anonymous's picture

As I understand it, the borrower needs to refinance an unsecured facility. Nobody wants to refinance the borrower on an unsecured basis, so the borrower has to raise new equity. The new equity provides potential secured lenders enough of a cushion they are comfortable lending on secured basis. The secured lenders now have collateral pledged from the borrower and a big cushion of equity support, so they have a vastly improved credit. The use of proceeds and the fact WFC and BAC stand to get taken out of their unsecured lending positions is disclosed. So what if they stand to make underwriting fees in the new secured deal and the equity offering? Someone has to arrange the deals, why not WFC and/or BAC?

I don't get the conflict.

Anonymous's picture

Never mind. I just saw 36691's response. I get it now.

fedusw's picture
fedusw (not verified) Aug 14, 2009 1:18 PM

Power junkies want to go off it slowly but cold turkey is the only way to do it. Time for them to take authoritative action and watch everyone just blink and stare at them coldly.

good articles; good articles 4 slow news day ..http://www..
hat tip: finance news & finance opinions

deadhead's picture

Tyler...this is an outstanding piece.  some time ago, i would say that this deserves to be in the main stream media.  right now i would say that zh is becoming the main stream financial media.

excellent job sir.


Anonymous's picture

ain't gonna happen