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

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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