Just Thinking...
Wachovia has a loan on Wells Timberland's lone timber property. It's a mezzanine loan (that this blog has chronicled) that needs to be down to $60 million (from $90 million at the end of August) by mid-October, or the whole amount is due. I am curious how Wachovia's failure (Citigroup took over its retail bank business this morning) will impact any negotiations on the loan. Here is an interesting section from a Wall Street Journal article on Citi's takeover:

Midday Sunday, Mr. Kovacevich dropped a bombshell. Wells Fargo had developed concerns about the health of one of Wachovia's loan portfolios. Unless Wachovia could convince it otherwise, Wells Fargo wouldn't be willing to pay any more than $10 a share.

Wachovia's advisers were surprised because the portfolio in question was smaller than many of its toxic mortgage portfolios and didn't have any obvious red flags.

For the next four hours, Wachovia's team tried to ease his concerns, but Mr. Kovacevich kept repeating: "It's not my call, it's our loan people." Behind the scenes, Wachovia's advisers began to hear from regulators that Wells Fargo was getting cold feet.

I wonder what was in that portfolio of loans that gave Wells Fargo pause, especially since they "didn't have any obvious red flags."

Rethinking The Bailout
I just saw this via The Atlantic Magazines Voices (blogs) and Ross Douthat. American's opposition to the bail out is falling dramatically. Nothing like two bank failures and an 8% drop in the Dow to make people see that it's as much a bailout of Main Street as Wall Street.

What Now?
I am not sure, which is kind of a scary thought. I think some deal gets done later in the week - hopefully not before another bank failure. Congress is playing CYA. In interviews on TV and speeches on the floor and in committees, it seems that many congressmen do not understand the severity of the situation, which is why the CYA vote makes sense. As an example, I just received an email that listed how each congressman voted, and Bob Filner (D) voted No. He is from south San Diego, which has more subprime mortgages than in any part of the San Diego County. This bill should help homeowners, so I see no reason why this guy voted against this bill. Despite the rhetoric on both sides of the aisle, congressmen put their personal interest first and the country second. If non-financial firms start to fail, or start laying off people, or people start to evaluate their 401k statements, their opinion on the bill - and their congress person - will change - fast.

More Bailout
I had a long post on the bailout that was just waiting for its passage. I will hold off on it. I think the bailout is needed. As the smart guys (no snark) are saying on CNBC, it is important to watch the credit markets not the equity markets. The equity markets are tanking, as the constant Dow Jones ticker on CNBC reminds, but the yields on Treasuries show the real stress in the financial markets.

I am hearing commentators on CNBC state that congressmen (Democrats and Republicans both) voted against the bill to keep their "careers" in politics. A career in politics is like a career as a professional athlete, and should be an oxymoron. A career in government, yes, but a career in politics, no. There should be term limits for all politicians.

Update: This post from Andrew Sullivan's website confirms my suspicions:

Nate Silver plucks out this data point:

Among 38 incumbent congressmen in races rated as "toss-up" or "lean" by Swing State Project, just 8 voted for the bailout as opposed to 30 against: a batting average of .211.

By comparison, the vote among congressmen who don't have as much to worry about was essentially even: 197 for, 198 against.

In the end, they were worried about re-election.

It's all about getting re-elected. Me first, country second. When Main Street realizes this is not a Wall Street bailout these feckless congressmen will wish they had voted for the plan.

AIG's Asset Dump
AIG is looking to sell assets to avoid its nationalization. Here is an article form the Financial Times. The article says AIG's airplane leasing business, International Lease Finance, could fetch $10 billion. I heard on CNBC before AIG's bailout that ILF could be worth $50 billion. Interesting revaluation.

I wonder what AIG is going to do with its approximately 10,000 independent financial advisors. One good thing about AIG collapsing is that its crappy ads are no longer on CNBC, at least I have not seen them.

Bailout
I guess the bailout is going to get done today - with a Congressional vote tomorrow or Saturday. Importantly, CNBC is reporting that the credit markets are reacting, albeit tentatively, in a positive manner on the assumption that the bailout will get done. This blog has stated before, and will continue to state, that the credit markets are the most important market to capital and business operations. If the bailout frees up credit it will be a success. My initial reaction is that the Government should make money on the distressed securities it acquires.

$.65 On The $1
That is what Bill Gross thinks the Government will pay for distressed mortgage debt. And he thinks it will be a good deal for the taxpayers. Here is an opinion he wrote in today's Washington Post. I agree with his assessment. I also think that when the price is set for these securities, other buyers will jump in the market and the cost to the Government may be less than is being advertised. I also think the calls for executive compensation, while populist, are missing the big picture.

Numb Nut
Some numb nut money manager on CNBC just said that the bailout will make taxes are double or triple over the next four years. What an idiot. No way taxes are going to increase that much. I would be surprised, if not shocked, if the Government does not make money on the distressed assets it's going to acquire. And, I bet the liquidation happens faster than expected. (The AIG deal is going to be a home run.) I agree with Hank Paulson's statement this morning that the cost of the bailout will be far less than the alternative.

Bailout
I am starting to think that a new RTC is what Wall Street wanted since this crisis started last year. I will post more, much more, on the bailout, but my initial reaction is that the Government will make money on its distressed assets and it will halt the slide in housing prices.

Paulson
I am sure happy that Hank Paulson is Treasury Secretary and not Paul O'Neill or John Snow. Paulson has Wall Street's respect and knows markets. Fed Chairman Ben Bernanke deserves credit, too. Bernanke is staying after November. It is time to ask who's on McCain's or Obama's short list for Treasury Secretary. I have said this before, Hank Paulson has been President Bush's best appointment by a wide margin

New RTC
CNBC's Charlie Gasparino is reporting that Hank Paulson is proposing a new RTC-type entity as part of a solution to the credit crisis. I guess when the Wall Street Journal's editorial page and Barney Frank agree on something the idea must have legs. Sen. Chuck Schumer is also going to spout some scheme, too. Gasparino just said he has had no confirmation from Treasury. My guess, and CNBC just agreed, is that Republicans want to do something quick, and the Democrats will want to wait until after the election. The initial market reaction has been positive.

AIG Loan
I was talking to a knowledgeable financial person yesterday, and he thinks the Government's loan to AIG is going to make the Government some big money. AIG has significant assets and stripping these out will easily repay the loan. I agree, and I think the loan will be repaid in less than two years, too. The loan terms show Hank Paulson's Wall Street savvy. He got a two-year loan at Libor plus 8.5%, and it controls management. What banker wouldn't like those terms. The Wall Street Journal has an article today on the unknown nature of the Government's loans and their profit potential.

TMI
There is just too much information happening now to make complete sense of what is going on in the financial markets. I don't think anyone has a complete handle on what is happening. So we are seeing panic selling. I think one thing can be said for sure. The credit default swap market is dead and gone. This was a cheap way for financial institutions to load up on risk and then off-load it under the guise that losses were insured. It skewered institutions' judgment and rendered risk management a farce. I am no insurance expert but it seems to me insurance is only as good as the insurer, and we have found out that the insurers are not that good. This, ultimately, is good for the market. Institutions that take risks should bear that risk. This leads to reasonable risk and appropriate spreads. Risk is good. Eventually proper risk management will return to the market, hopefully before it is too late.

CNBC Blogging
Some random thoughts watching CNBC:

• Richard Selby, senator from Alabama, does not get the crisis. He is worried about an $85 billion loan as a cost to taxpayers. No mention of the alternative - the cost to taxpayers of further collapse. And he is confusing AIG's insurance business with its Credit Default Swap business - too vary different businesses. He is against and RTC- like entity.
• Barney Frank (like the Wall Street Journal's editoral page) is advocating and RTC-like company to buy distressed assets.
• Maria Bartiromo is a Hank Greenberg homer.
• Rick Santelli knows what he is talking about.
• Many anchors are fanning money market fears, which is irresponsible.
• The market does not seem to like the AIG deal.
• Gold is soaring (up 10%) and Treasury yields are dropping (going to be good for housing). Falling prices and better mortgage terms are going to start helping the housing market.
• The Dow is nearing its levels when Bush took office.
• CDS focus is overblown becuase the market for CDS is so thinly traded.
  

Credit Default Swaps
I am not afraid to admit that I am not sure what they are, but I know they are some kind of insurance for financial firms that allow them to off put some of their risks. Unfortunately, not many others know what a credit default swap is or how to value one. The imploson of AIG's CDS exposure lead to AIG's takeover by the Government. CDSs are not traded and tied in large part to a firms' credit rating. When AIG's rating got cut it had to raise cash to cover its CDS requirements. There is no market for CDSs, so if a firm runs into trouble the market and ratings agencies have no have not clue about how to value the CDSs, and assume the worse.

Rick Santelli of CNBC, is making great points today. There needs to be market for CDSs. This would eliminate the need for regulation. This is a great idea. It would also get rid of the black box nature of many financial corporations' balance sheets. These black box financial statements have helped the current problems.

Fallout for TICs
The CMBS market for TIC transactions has been dead for nearly a year. It was the standard for the previous four years. After reading this article, I don't think the CMBS option for TIC deals will be available anytime soon. Here is a long quote describing the impact of Lehman's bankruptcy on the CMBS market:

Lehman's collapse was the most dramatic sign so far that the financial crisis sparked by residential real estate is spilling over into office buildings, strip malls, hotels and other commercial real estate. The firm was one of the most aggressive lenders on Wall Street, making whole loans, bridge loans and packaging debt into commercial mortgage-backed securities, or CMBS.

About $4.3 billion of Lehman's $30 billion portfolio consists of securities. The prospect of that getting liquidated sparked the latest selloff in the CMBS market, as evidenced by widening spreads between the benchmark U.S. Treasury notes and the CMBX, a credit-market index that tracks the value of the bonds.

Apartment-building investors also are likely to feel significant pressure to sell as Lehman unloads its debt and equity pieces of the $22 billion purchase of Archstone, the large multifamily company with buildings concentrated in Washington, D.C., California and New York City. For months, Archstone had tried to sell assets to reduce debt, but met mixed success. It resisted for months lowering its prices, even as buyers balked. It has sold some complexes but not as many as it hoped, according to a person familiar with Archstone.

Prices are now likely to soften. In markets with apartment buildings that compete with Archstone, "there is no question that if you need to sell assets, you will try to get ahead" of the Lehman selloff, said Jeffrey Spector, a real-estate analyst at UBS. "Every day that goes by there will be more pressure on pricing."

I think that while caution is warranted, the fear of a CMBS meltdown is overblown, at this point - unless the banks cause it. Most of the CMBS defaults have occurred in development projects and many of these were residential developments. My concern is that unwarranted fears by otherwise willing lenders will accelerate problems in the commercial real estate market. Many loans in CMBS portfolios will need to be refinanced over the next few years, and a reluctance on the part of lenders could put strong properties in jeopardy. Bankers need not be lemmings (oxymoron), but TIC sponsors better start looking for alternative financing sources.

Fed Steps in to Save AIG
Goldman and Morgan Stanley could not put together a $75 billion loan, so the Government steps in with an $85 billion loan to save AIG. I have read several articles on the loan but am still not clear what the end plan is for AIG. I am guessing its various business will be sold. AIG may need Hank Greenberg just to figure out what it owns.

The Fed and an Intervention
The Fed left interest rates unchanged, and at this point the market has reacted positively. The 10-year Treasury has been wild today. At one point it was below 3.30% and is now approaching 3.50%.

Hank Greenberg is trying save AIG. Kind of like a parent intervening to save a child. AIG's stock has been wild today, too.

Thoughts on a Wild Day
This has been an unbelievable few days. The next few look to be more of the same. Here are some thoughts:

• It is strange day when the Wall Street Journal's editorial page calls for a new Resolution Trust Corporation to takeover and liquidate troubled assets.
• Lehman looks like it may be bought after all, sort of. Barclay's is in advanced talks to buy the "good" assets and hire most of Lehman's employees. The "bad" mortgage assets will stay in the bankrupt Lehman shell company. (I wish the press would stop calling Lehman a 160-old firm. It merged with other firms in the 1970s and was acquired by American Express in the 1984 and only spun of again as an independent company in the early 1990s.)
• This blog has been hard on AIG over the years, and today it proved why. I wonder what Warren Buffet saw that he did not like. Lucky Goldman and JP Morgan Chase who Hank Paulson strong-armed into providing up to $75 billion in emergency credit. I guess this is financing to allow an orderly liquidation of AIG assets.
• The market was down 500 points, and a big chunk of the loss happened in the last hour (when the amount of financing AIG needed was made public). I would not have been surprised with a 1,000-point drop, but the end of the session was disturbing.
• Asian markets are horrible this morning.
• Oil is approaching $90. I guess that whole speculator argument, which I always thought was BS, was just that - BS.
• The dollar is tanking, too.
• The market is now expecting a Fed rate cut tomorrow, possibly as much 50 basis points. This will add downward pressure on the dollar. Falling oil prices have given the Fed breathing room on rates.

AIG
The market seems dependent on AIG (which is a scary thought). AIG is well off its lows and is trading above $6 (but still off 50%). CNBC just flashed that AIG just got a bridge loan from New York State (20 billion) and is in some kind of talks with Warren Buffet. Markets are amazing animals, in that Lehman's collapse has been priced into the market and it has already moved on to AIG.

Update, 9:50 am pst: From CNBC, Buffet is out of AIG talks. Fed has hired Morgan Stanley to examine AIG's books in preparation of a Fed loan. The loan will allow AIG time to liquidate assets.

Market Thoughts

• The market is only down about 300 points at just before 9:00 pst, and it's off its lows. I was expecting a bigger blood bath. I would not have been surprised with a much larger sell-off.
• AIG is off more than 70% and is trading below $4 per share. This is approaching bankruptcy levels. If the smart firms, like Lehman and Merrill, could not avoid bankruptcy or selling themselves, I can't see AIG, without the brain power of other Wall Street firms, surviving.
• The ten-year Treasury is below 3.50%. This is going to help housing, especially since Freddie's and Fannie's problems seem to have been solved.
• Oil is off about 4% to under $97 a barrell. This not only helps consmers, if price reductions stick, but will ease inflation pressure and allow the Fed flexibility in cutting interest rates.
• Speaking of the Fed, it was not expected to cut rates this week, but the market is now pricing in a 33% chance of a rate cut.

WOW!
Treasury secretary Paulson could not pull a rabbit out of his hat this weekend. I just heard on CNBC that Lehman filed bankruptcy, and AIG, if it does not get a huge Fed loan ($40 billion), will likely follow Lehman's path. The situation is very fluid, but Monday is going to be a wild day for global stock markets. I saw Alan Greenspan on ABC's This Week this morning and he said the current crisis is the worst financial crisis he has ever witnessed. He should know because his blind eye over the few years of his tenure is, in part, responsible for today's mess. Unfortunately, I think the problems today are going to lead to more regulation.

The Clock's Ticking
It's Sunday morning and the Lehman sale or breakup has not been resolved. The New York Times, Wall Street Journal and Financial Times are all reporting that talks are moving forward but that no buyer has emerged, but Barclay's appears to be the front runner. There is interest in Lehman's "good" assets, but the current plan has Lehman's $30 billion of "bad" assets being spread across various Wall Street firms. And here is the rub. The Wall Street firms are not willing to take on these "bad" assets (mostly real estate related) without Government assistance. This gaffe from the Financial Times may be the key:

Hank Paulson, Treasury secretary, has been adamant that no government money would be involved this time. The US authorities may offer other help, including flexibility on regulatory issues, such as treatment of private equity firms involved in a deal.

If the government loosens the regulatory constraints it may get the deal done. It may set a precedent and allow private equity firms and hedge funds to help banks. This reminds me of the saying "Be careful for what you wish for, you just may get it." If a deal is not done today, tomorrow is going to be a wild day across the world. The Asian markets will give us a preview if a deal is not done before they open.

P.G. Wodehouse
When the going gets tough, the tough turn to PG Wodehouse - well, at least I do. There has been so much bad and discouraging news lately that I am getting fatigued. A constant read of news and blogs - where I get a great deal of news - is draining. I enjoy P.G. Wodehouse and his Jeeves and Wooster characters. Wodehouse's writing is hilarious and clever. It is the perfect antidote for the ills of the market and the news cycle. Reading a Jeeves and Wooster story improves my mood and is good for several real laughs. When markets start crashing Bertie Wooster's antics are an enjoyable escape, and mentally restorative. I try to keep a collection of Wodehouse's Jeeves and Wooster stories within reach of my nightstand.

Blogging Bonanza
I have made numerous posts this week on the credit crisis. I am doing this because I believe this is the worst financial situation the US economy has seen since the Depression. The stock market crash of 1987 and the Dot Com crash of 2000 through 2002 were equity problems. And while those were painful, the current debt crisis has much larger ramifications. The deleveraging process is wiping out equity as borrowers sell and write-0ff assets to meet credit requirements. The entire global economy operates on credit and without it the global economy will slow. Equity builds wealth, but day-to-day business runs on credit. If credit is permanently altered, so to will long-term wealth accumulation through equity. The next few weeks are the key to the credit crisis - resolution or implosion - and will set the tone for the future of financial markets for at least the next five to ten years.

No Bailout, But....
The Fed and Treasury are not going to bailout Lehman with taxpayer money, but they are doing everything else to try to save it, or at least get a buyer for it that will minimize the market impact. New York Fed President, Timothy F. Geithner, along with Hank Paulson and Christopher Cox (head of the SEC) convened a meeting this afternoon with Wall Street's largest banks, including Goldman Sachs, JP Morgan, Morgan Stanley, Citigroup and Merrill Lynch, where:

Mr. Geithner told the participants that an industry solution was needed, no matter what, and that it was not about any individual bank, according to two people briefed on the meeting but who did not attend. They said he told them that if the industry failed to solve the problem their individual banks might be next.

The Fed told the bankers to rescue Lehman and develop a plan to end the credit crisis. A link here, here, and here describe the meetings in further detail. All three articles describe the talks as similar to ones ten years ago to save the hedge fund Long Term Capital Managment. I think this is significantly different (and not in a good way), and the articles touch on this, in that Lehman is in the same business as the other bankers, not a credit client like LTCM. The bankers then had a common interest, now many may have a self interest or survival interest that might supersede the common interest.

The credit crisis is entering a key phase and the next few weeks hold the key. If Lehman and AIG go away I am not sure what it means for Wall Street in the short and long term, but it is not good.

AIG - The New Lehman
AIG's stock is off nearly 30% today and is trading below $13 per share.

Update: AIG closed just above $12 and is holding a conference call Monday to discuss asset sales.

No Fed Bailout for Lehman
It looks like the government is not going to bailout Lehman. The markets have not tanked in response, which is also probably playing into the government's decision.

Echo Chamber
The Wall Street Journal today echos my concerns from last night. The government's attempts to stop the credit crisis have not stopped it, and its options are shrinking. Here is a long segment from the article detailing what the government is up against:

U.S. officials are not powerless to confront the crisis. But they are far more constrained than they were a year ago, after taking a series of steps to bolster financial markets, including slashing interest rates.

The Fed now has facilities in place to provide short-term funding to firms such as Lehman if it runs into a liquidity crisis. As of Wednesday, no firms had used the Fed's lending facility for investment since late July.

"A number of markets remain disrupted and illiquid," the Fed's Mr. Kohn said Thursday. "But I believe that they would have been even more illiquid and the risk of disruption runs even greater without our various facilities."

Doing more could lead to other problems. Fed officials are wary of pushing short-term interest rates lower. At 2%, the federal-funds rate is 3.25 percentage points lower than it was a year ago, and looks likely to stay on hold because the Fed worries that more rate cuts would worsen inflation. What's more, other interest rates, such as mortgage rates, remain elevated as previous rate cuts have been counteracted by the force of the credit crunch. It's not clear that further cuts would have much effect in bringing down other rates.

Officials are also acutely aware of the problem of "moral hazard." Bailing out too many firms, the reasoning goes, would encourage more risk taking in the future. That makes officials reluctant to be seen as rescuing another institution. The Fed made a $29 billion loan to help J.P. Morgan take over Bear Stearns. It's not clear that it would be willing to do that for another firm.

Treasury Secretary Henry Paulson has said that institutions must be allowed to fail and that markets can't expect the government to lend money or support every time there's a crisis. "For market discipline to constrain risk effectively, financial institutions must be allowed to fail," Mr. Paulson said in a speech in July.

I think the problems lie in two areas - housing and credit. If the Fed lets interest rates fall this will help the housing market, which in part, will ease the deleveraging process. I think lower rates, at this point, out weigh inflation concerns because the falling dollar and declining oil prices should ease inflation. I have said this before, but any home loan today is going to be a heck of a lot better in terms of asset quality and borrower credit quality than most loans banks made from 2002 through 2007 .

The second part, credit, is institutions lending to other institutions, individuals and corporations. The lemming mentality has inflicted the financial world. The world's business runs on credit, much of it short-term. Banks and other credit sources have constrained the credit process. The inability to rollover short-term debt, or get other sources of credit, is and will have profound impacts on the economy. This was proved in the whole auction rate debacle when banks suddenly stopped rolling over a credit facility used by many municipalities. It made no sense. While I don't see a return of the free flowing credit, some level of normalcy would help ease the credit crisis.

More Lehman
It looks like the Treasury's and Fed's assist to Lehman won't be a bailout or involve taxpayer money. They seem to be playing the role of facilitator.

Feds Helping Lehman
The Washington Post is reporting that the Fed and Treasury are helping Lehman Brothers sell itself. This blog does not normally post breaking news, but I find this surprising. After bailing out Freddie Mac and Fannie May, I thought the Fed was going to let the market take care of Lehman. I guess not. In its typical late week into weekend fashion, Fed and Treasury:

officials are hoping a deal will be in place this weekend before Asian markets open on Monday, according to sources familiar with the matter.

Hopefully this will help markets, but one has to wonder how many more tricks the Fed and Treasury have up their sleeves. The presidential candidates need to stop worrying about what pig is wearing lipstick and start talking about financial markets that may soon start to mirror Fannie, Freddie, Bear and now Lehman.

Buffet Bets Against Banks and Housing
Here is a below the fold article from the front page of today's Wall Street Journal's Money and Investing section. It states that a Berkshire Hathaway subsidiary will stop giving deposit insurance to banks above FDIC levels. I am surprised this news did not get more air play today. Buffet is clearly saying that bank failures are going to increase and this is a direct result of a housing market that continues to deteriorate. Investors should note Buffet's bearish stance on banks and housing.

Fannie and Freddie
I will be the first to admit that I am not sure of the full ramifications of the Federal takeover of the two mortgage giants. I do know that it is huge news. And I do know that the next Presidential administration and Congress will be left to fix the two firms, if there is anything left to fix. (It does not give me comfort having politicians of any political party involved.) My first impression is that if the takeover lowers mortgage rates it may not be such a bad thing given the state of the housing market. If lower rates spur home buying that will be good, too, because any loans made today will likely be of higher quality in terms of borrowers and asset valuations than loans that are going bad on Freddie's and Fannie's books. Whether this takeover is good or bad won't be known for at least six to nine months. The market's reaction (up and down) shows it has not quite figured out the takeover either.

Hedge Fund Implosions
The Ospraie commodity-based hedge fund closed earlier this week and markets today were roiled, in part, by rumors surrounding another hedge fund. It is strange that despite the artificial increase in commodity prices, "smart" money was still fooled. The commodity bull market was a combination of speculation, a commodity bubble and a weak dollar. How could commodities continue to rise when the whole global economy is slowing. Even a causal observer of the economy could see that a continued increase in commodity prices made no sense. Prices are ultimatey demand driven, and when demand drops so do prices. Something had to give, and it did. But still, some of the "smart" money got caught on the wrong side of commodity bets.

Wells Timberland Class B Preferred Stock
On Friday, August 29, 2008, Wells Timberland REIT issued 10,700 shares, at $1,000 per share, of Class B preferred stock to Wells Real Estate Funds, Inc. This is a $10,700,000 cash contribution by Wells to Timberland. This presumably allowed Timberland to get its outstanding mezzanine loan down to the required $90 million. The Series B shares are on the same terms as the Class A preferred shares. Timberland issued 32,128 shares ($32,128,000) pf Class A preferred shares to Wells Real Estate Funds, Inc. in connection of Timberland's acquisition of its lone timber property in 2007.

The Series A and B preferred stock accrue interest at 8.5%, with the first interest payment not due until September 2010, and then payable each subsequent September. The first payment coincides with the maturity date of the senior loan. The preferred shares can be redeemed at any time along with any accrued interest. It is unlikely that any redemption would occur before the repayment or refinancing of Timberland's senior mortgage on its property that had an outstanding balance of $209 million earlier in August.

The 8-K does not state this, but the proceeds of the preferred stock had to be used to get the outstanding amount on the mezzanine loan down to $90 million. It is important to note that the mezzanine loan needs to get down to $60 million by mid-October or the entire balance is due. Based on its capital raising track record, Timberland appears unlikely to raise $30 million (plus offering costs) in six weeks, so it's going to need additional capital. As part of the issuance of the preferred stock, Timberland amended its charter to limit Wells' ownership in Timberland to 45%. The 8-K does not state Wells' current ownership amount, but Timberland has raised approximately $100 million and has issued $42.8 million in preferred stock to Wells. Based on these amounts, the use of Wells for further contributions appears unlikely.

I find the additional preferred shares puzzling. This is essentially more debt on an already highly leveraged acquisition. Wells has just committed its capital for at least two years. Timberland was expecting a large cash infusion from a new German Fund that will co-invest with Timberland. I wonder how the new preferred shares will play in Germany, because as I understand the German Fund, while a separate offering, it is investing on the same terms as Timberland's common shareholders, so it too now has more senior securities (although not directly). If the mezzanine debt is not down to $60 million by mid-October, Timberland has to come up with $90 million (as of Friday), which it doesn't have. I can only speculate about Timberland's scenarios at that point if capital is short.

Timberland must be in talks with Wachovia, the lender on the mezzanine and senior debt. The preferred shares investment, to me, indicates that the negotiations are not proceeding smoothly. I have to guess that some other form of financing is in the works. Wells is smart, and I do not see it dropping $10.7 million down a hole, (which is what will happen if Timberland does not get that mezzanine debt retired and it loses its lone property), unless it is confident it can get the mezzanine debt retired.

Timberland is still twisting in the wind until it can get that mezzanine debt retired and the preferred stock is just another stay of execution, while effectively adding to its debt load. If the German Fund does not come through with sizable capital in a short period, Timberland's options narrow.

Timberland
Wells Timberland REIT just filed an 8-K. It does not look like the German capital has arrived. Timberland issued $10.7 million in Series B preferred stock to Wells Real Estate. I will summarize and comment on the 8-K over the weekend. You can access the 8-K on the SEC's website.

Housing Market and the GSEs
The most recent Case-Shiller housing data is out today with some mixed messages. The bad news is that home prices in twenty markets dropped 15.9% from a year earlier, and the second quarter's 15.4% decline was worse than the first quarter's 14.2% drop. The good news is that declines in later months in the quarter have slowed and inventory declined, which indicate that housing declines may be easing. Nine of the twenty regions showed positive returns. The areas that continue to look bad are Miami, Phoenix and Las Vegas.

The article in the Wall Street Journal (linked to above) says that one issue holding back housing is uncertainty around Freddie Mac and Fannie Mae, the two Government Sponsored Entities (GSEs) that buy the vast majority of mortgages. The market's reluctance about the two companies has caused their cost of capital to increase that has kept mortgage rates high, as overall interest rates have declined in recent months. Until the GSEs' financial situation is resloved mortgage rates are going to stay high and the housing market is going to muddle along. I suspect that a .50% decline in mortage rates would give the housing market a boost, maybe more so than the recent housing bill that was passed. Solid GSEs, acquiring mortgages, would also allow banks to resume lending.

Housing Bust
Here is a good article summarizing the housing bust. The housing downturn is going to be longer than anticipated. It is worth reading the entire article. It is funny how no one, still, takes responsibility. Lenders were lemmings and relaxed their standards, borrowers thought home values could only increase and did not worry about payments, and builders did not pay attention to economics or demographics (or speculators buying homes). Here are a couple of standout points from the article:

“Owning a home is the American dream,” says Jamie Schrole, a Merced real estate agent. “Everybody was just trying to live out their dream.” The belief that this dream could be achieved with no risk, no worry and no money down was at the center of the American romance with real estate in the early years of this decade, and not just in Merced.

As Merced goes, so might go much of the nation. With as many as 2.5 million homes in the United States entering foreclosure this year and, at best, sales of only five million existing houses, the foreclosure price is becoming the rule in many areas. In Los Angeles County, whose 10 million people make it the most populous county in the United States, a third of the sales are foreclosures.

Ouch. Here is one final point that epitomizes the easy finance that lead to the current days of reckoning:

Mr. Seivert is going after a house that the owners bought 13 years ago for $86,000 and refinanced six times, taking advantage of rising values to get cash that, in part, they spent on the house. It has a pool with a small waterfall, a TV room in the converted garage, a deluxe outdoor barbecue setup and a kitchen with all the latest gadgets. The owners, who owe $350,000, can no longer make their mortgage payments. Mr. Seivert is negotiating to buy the house for $170,000 and then rent it back to the couple, who have jobs in the area. (Bold added.)

Where is the incentive to keep a house out of foreclosure when all the equity is gone? Hopefully, the people getting deals on foreclosed homes will have some equity in the homes they buy, and a stabilized housing market will help preserve this equity. This will end the housing crisis.

Big Week For Timberland
Next week is a big week for Wells Timberland. It needs to have its mezzanine debt down to $90 million by August 29th, and it may have its first capital infusion from its new German fund a day or two before. I don't think it will have the capital to reach the $90 million without the German infusion. If the German capital comes up short - I am guessing Timberland needs $10 million to $20 million - Timberland's discussion with Wachovia should be interesting.

Not Going to End Well - Part II
(or, AIG Alum Joins WP Carey)
I was alerted to this news late last week, and got this from Investment Advisor's website:

Mark Goldberg, the veteran independent broker/dealer executive who most recently ran AIG’s Royal Alliance B/D, has landed at W.P. Carey as president of Carey Financial, the real estate company’s broker/dealer subsidiary. In his new position, Goldberg will be responsible for sales and marketing to B/Ds of the firm’s series of non-traded REITs called Corporate Property Associates.

I don't see the fit, and will leave it at that.

AIG Bucks The Trend
Most other financial firms posted better than expected quarterly results that has lead to a rise in stock prices over the past few weeks. Not AIG. It posted a $5.4 billion loss after yesterday's market close, which lead to today's 220-point market decline. AIG's stock dropped 18% and the ratings agencies are looking to cut its credit rating. AIG's new CEO is feeling the heat for not addressing AIG's problems fast enough and dumping assets.

When Accomodators Go Bad
Here is an article on a 1031 accomodator who stole investor money. This is the third story like this I have heard in the past two years. The article details the principals' shady past and how they used short-term 1031 proceeds for personal use and nepotism. This is just horrible. One negative point about the article is that it blurs the line between the viability of an exchange and criminal accomodators. It quotes a woman who likely has lost significant sums:

"If I would have known any of this, I would have paid my taxes instead" of attempting a 1031 exchange, she says.

It is important not to mix the viability of an exchange and bad accomodators. Everyone who sells a piece of investment real estate, at minimum, needs to evaluate the benefits of paying the taxes versus the exchange, the exchange property's investement time horizon and the investor's time horizon, and potential estate tax issues. Only reputable accomodators, like large escrow companies, should be used, and sellers need to demand this.

Not Going to End Well
Here is a link to the Dallas Business Journal and an article on Behringer Harvard's Opportunity REIT I's investment in Eastern Europe. The fund is:

"investing in a portfolio of 15 retail and industrial properties located in the Czech Republic, Poland and Slovakia."

I have not reviewed this REIT, but if I was an investor this move would give me pause, especially with such a weak dollar and November's Presidential elections that will give a new Administration. With the mortgage crisis, one would think there is enough opportunity in the United States, rather than looking for deals in developing countries in Eastern Europe. Lone Star sure found some domestic opportunities.

Mervyn's Files for Bankruptcy
Not surprising.

It's About Time
This should have happened years ago. I bought Lucent when tech stocks were crashing thinking it would be a conservative way to play any tech rebound. What a moron. I still own the stock although I think it is pretty much worthless, at least based on what I paid for it. It is hard to imagine why the two heads of Alcatel-Lucent, or whatever it's called, kept their jobs for so long. This company has been abysmal for so long I don't see it ever turning around.

Merrill's Mortgages
Merrill Lynch announced more write-downs yesterday and a dilutive plan to raise $8.5 billion in new capital. The market is trying to make sense of this deal, as Merrill's stock was down early this morning but has now turned positive. I think the market is seeing that despite Merrill selling a $30.6 billion portfolio of mortgages for $6.7 billion there was a buyer for the securities. Buyers have been absent for a year and the tentative return is encouraging. I think it's important to watch (and I don't know if this will be possible) the resale of the securities by the private equity firm. It bought the mortgages for $.22 on the dollar, and I am sure its expects higher resale prices, probably in the near future. These transactions will give buyers, sellers and other market participants important valuation information.

Bitten
I don't know anything about Crocs, Inc., the maker of those funny clog-type shoes. A year ago its stock was incredibly hot and now it's in the tank. Looking at its stock chart (from the Wall Street Journal), you'd think it's a supbrime lender:


Last summer people wearing Crocs were everywhere, this summer I can't remember seeing anyone wearing them. People probably looked in the mirror and realized how ridiculous they looked.

Private Equity Follies
Here is an article on Mervyn's problems. It was bought by several private equity firms in 2004 and the seller was Target. The retail executives at Target must have laughed their a#$ off dumping dog Mervyn's to the brilliant private equity financiers. The private equity firms did one thing correct when they bought Mervyn's:

That is because when they bought the company they structured the $1.2 billion deal as two separate transactions -- one for the retailer and a second one for the retailer's real estate.

The real-estate arm has been a lucrative investment, according to people familiar with the deal. It leased many of the stores to Mervyn's and has sold and leased certain properties to other retailers. And through sale-leaseback transactions and the appreciation of real-estate values over the past several years, the buyers have more than doubled their money on the real-estate investment. Those profits have far exceeded losses on the retailer, according to these people. In a bankruptcy of the store operations, the real-estate arm would become a creditor.

Not to get philosophical, but I do not see how the private equity purchase improved the business. The firms that bought Mervyn's were supposed to be a turnaround specialists but appear to have been better financial engineers than retail experts. The stores are going to close and employees are going to lose their jobs. Mall owners and other tenants will be hurt. Wal-Mart will benefit, but it likely already has. Other private equity acquisitions of retailers have also soured, and expect more to come.

Ich Bin Timberlander
Wells Real Estate may have pulled one out of its hat. Wells Timberland REIT has entered into an agreement with a German fund to raise up to an additional $500 million in equity. The fund will be sold by a German bank to its clients, mostly retail investors. Wells expects big money from this new selling group member, although nothing is assured. This deal is just in time, as Timberland's second and third payments on its mezzanine finance loan are due in late August and mid October. More information on the transaction is available through an 8-K.

I Have To Link To It
A snappy, snarky title eludes me for this story. This guy had a Scottsdale mortgage business where he syndicated loans and raised capital through private individuals. Loans soured and before his little empire collapsed he offed himself. The Wall Street Journal hints that this is a indicative of wider trouble in the commercial lending market. Not knowing anything about this company except what I just read, I bet that when the loans are examined it will show poor loan decisions and possibly affiliated dealings, or at least dealings with associates. More an instance of one guy thinking he was smarter than the market than widespread commercial loan troubles. And I bet that many of the soured loans were residential construction loans, not existing commercial property loans. This is not to say that trouble in the commercial mortgage market is not coming. As long as banks are not lending, even good borrowers with solid properties that need to rollover their loans are going to have trouble.

More Mortgage Meltdown
The headlines for Freddie and Fannie sure are different in the Wall Street Journal and The New York Times. The Journal headlines imply a Treasury and Federal Reserve "bolster" of the two agencies, while the Times implies a government "bailout." The Treasury is increasing the two mortgage companies' line of credit and may buy stock in the two struggling firms. I guess we'll know in a few weeks whether it was a bailout or a bolster. It's kind of like that old song, "You call it bailout, I call it bolster, let's call the whole thing off."

IndyMac is getting the press with its government takeover, but hot on its heals is another pending Orange County banking disaster. Downey Saving's stock closed Friday at $1.69 per share, down from nearly $7o per share at the end of May 2007. At a price of $1.69 per share, I am going out on a limb and guessing that Downey's future looks dismal.

More GBE
I posted in February when Thompson left Grubb & Ellis that I thought it was strange that he would walk away from a company where he owned so much stock. Based on the news that came out Friday, my initial instinct was correct. He has been paying close attention and he's now trying to get control.

OC Real Estate Moguls
Who needs OC Housewives when you have the real drama unfolding in Santa Ana. Scott Peters resigned from Grubb & Ellis today, likely he was fired. According to this blog (which is really good) Tony Thompson has been highly critical of Grubb & Ellis' performance since he left it in January. He is now trying to get reinstated to Grubb's board of directors. Here is Thompson's letter to Grubb's board that was filed with the SEC. Grubb's board met earlier this week, but made no announcement about Thompson's request. It apparently did decide on Peters.

Real Estate Novella
Here is a wild article on Grubb & Ellis. Scott Peters has resigned as CEO, and Tony Thompson, who owns 13.9% of Grubb, has filed a complaint with the SEC about Grubb's recent poor performance. Grubb's stock is at three bucks, down nearly 80% since the Grubb & Ellis / NNN Realty reverse merger was announced just over a year ago. I (and am sure thousands) received a glowing marketing piece several weeks ago about Grubb's prospects - what a bunch of baloney. I am guessing broker / dealers will be reassessing their selling agreements.

Freddie, Fannie and Indy
I am trying to make sense of the collapse of IndyMac and the near collapse of Freddie Mac and Fannie Mae. This does not look good for the mortgage market. I don't see how the government can avoid saving Freddie and Fannie. I suspect it will be another long weekend on Wall Street and in Washington as capital is raised for Freddie and Fannie, and the Treasury and other regulators decide the extent of government's role.

The mortgage market, it seems to me, could get much worse than it is now. Housing prices have dropped and, I suspect, the mortgages causing problems for Fannie, Freddie and Indy are the most recent mortgages. With prices now at 2004 levels, the next wave of trouble will be the mortgages made earlier in the decade.

I would not be surprised by a national home saving plan to prevent a further meltdown of the housing market. Bill Gross (and I'm sure others) think the government needs to step in. Here is a blurb from his most recent newsletter, which was formed as an open letter to Obama with the assumption Obama is elected president:

In addition, you’ll need to provide some immediate relief to homeowners in the form of FHA (Federal Housing Administration) subsidies and low mortgage rate loans that somehow have been studied and studied in Congress for the past six months yet still haven’t been passed into law. By January, home prices will be down another 10 percent or so and our Japanese-style property deflation will be in full stride.

The newsletter assumes that congress will not act until January. The way things are moving, January may be too late for the economy.

TIC Article
Here is an article on a failed TIC program from today's Wall Street Journal. I thought the article was evenhanded. (I think the author got some of her figures wrong by confusing investor equity with the total price (debt plus equity) of the transaction.) The deal seemed doomed from the start, and it signified the type of deal that is going to get in trouble - i.e. deals to weak credits or deals that should not have been in a TIC structure. I had heard of this deal before today's article, and it has become the poster child of a deal gone bad in the TIC industry. It seems to me that the sponsor did a stand-up job in trying to help investors. One thing the article drives home, and at least the investor interviewed for the article seemed to understand, was that the TIC investment was real estate, not a bond, and in real estate when a tenant goes bankrupt it's not good, and when the property only has one tenant, it's bad.

Here is one part of a sentence that stood out to me:

All but one of the investors was over age 65

I don't this this is unique to the deal in the article.

Swift Energy
Below is a chart from the Wall Street Journal showing Swift Energy's (SFY) five-year stock performance - a rise of almost seven times. Swift used to syndicate oil and gas partnerships with the objective to provide steady income over a long period. Most, if not all, of these long-term oil and gas investments struggled to return investors' initial capital and produced inconsistent income. I have not checked their status lately, or even know if they are still in existence. (It'd be a nice story if somehow these deals were exchanged for SFY stock.)


You can bet that none of the investors in a Swift partnership made seven times their money over five years. To be fair to Swift, none of the oil and gas syndicators of the 1980s and 1990s had great deals. The oil and gas deals back then were viewed through a prism of their ability to return investor capital. This is a pitiful benchmark for success. The under performance of the oil and gas partnerships from the '80s and '90s offer a cautionary tale for today's investors scrambling for oil investments.

Cars and Oil
The oil companies and the auto industry are clearly moving in opposite directions. Oil hits new highs every day and GM is at lows not seen since the 1950s, and today closed below $10 per share. Exxon is near historic highs. Here is a chart showing the two stocks, GM since 1962 and Exxon since 1970:


You need to look no further than the period from 2000 to 2008 to know the interests of the auto makers and the oil companies are no long aligned. Ultimately this will be good for consumer and the auto makers. The United States is a car country, and Americans are going to drive cars. We will adapt to electric, hydrogen or whatever technology powers our cars. GM is leading the way with its new Volt. GM leading in a new technology seems surprising giving GM's stodgy reputation, but not when it's viewed in terms of its survival. I would not be shocked to see a reversal of recent stock performance - GM up and Exxon down - as viable car technology weans us off our reliance on oil. Of course GM has to survive for this to happen.

Interesting Way To Source Deals
Today I received a blast e-mail from a TIC sponsor looking for properties. It's interested in student housing and multi-family properties. I wonder if the sponsor got any response. Maybe another sponsor can off-load a couple of crap deals, because its obvious these guys are not the brightest stars in the sky. Besides the odd premise of the email, I was surprised that the sponsor wanted student housing. Several years ago many sponsors were lulled by the high cap rates of student housing apartments and have since found out why those cap rates were so high.

Sound Idea
Here is a post on the flat tax that makes sense. Every income classification needs to get taxed, whether its dividend income, capital gains or wages. I heard that Steve Forbes, under his tax plan, would not have to pay any taxes. If I get taxed, Steve Forbes gets taxed. The only deduction that should be kept is the deduction for interest on a home. If this was eliminated the price of home would drop by an amount that would approximate the deduction. This would be tough on a weak housing market.

United
I am a frequent traveller who has empathy with the airlines. With fuel at all-time highs I know profitability is tough. By the time many travellers get to their plane they are grumpy having had to endure added security checks and the general inconvenience of today's travel. Despite gloomy profit forecasts, I have only been on one flight in the past year that was not full (a late afternoon flight to Salt Lake City). Packed flights, limited service, reduced airline staff make for an unpleasent mix. Through all this the airlines, in my opinion, try hard.

Even with my empathy for the airlines, I try to avoid United. If this is not the worst US domestic airline, it has to be close. The seats that are not the upgraded coach are awful. They are so close together it is hard to do anything but listen to an iPod. Forget trying to work on a laptop or even read a newspaper, and if someone in the seat in front you puts the seat back all you can do is sit. Many United employees have had the bulk of their retirements wiped out over the past eight years and have to work out of necessity, which makes many surly. Now I read that United will require a stay over for its cheapest fares (on top of its me-too $15 per checked bag charge) starting in October. My empathy is turning to anger. I am not sure why this helps profitability. I try to schedule most of my business travel as one-day trips, and United is saying that it does not want this business. Well, I don't want United either.

Franchise Follies
Earlier this week, the Wall Street Journal had an article on struggling Cold Stone franchises. The story confirmed my suspicions about the dangers of franchises. The franchisees get locked into buying inflated supplies and equipment from the parent company that, in part, puts them into a financial bind. It's like those real estate infomercial schemes that are good for the sellers but bad for the buyers. I guess this is why two small ice creams at the Cold Stone nearest my house cost $10. I haven't been back since.

Fire Me - Please!
AIG's Ex-CEO Martin Sullivan to get $68 million.

Regional Delusions
Fifth Third Bank announced today that it is cutting its dividend and raising capital. Last week Key Corp made a similar announcement and Ohio's National City Corp made a made a similar announcement in April. I had thought that regional banks would fill some of the void in tenant in common financing caused by the mass exit of conduit lenders. The problems facing regional banks have squashed this notion. An informative presentation at the Orchard Conference confirmed that regional banks will not rush to the TIC space. Regional banks have a large exposure to residential developers, and the developers' problems are becoming the regional banks' problems. TIC sponsors need to look to other lending sources.

Orchard Update - Tony Thompson
I went to the Orchard Conference late last week. Orchard puts on a good meeting. I did not learn much from keynote speaker Tony Thompson. His speech was a ramble, with references to Martin Luther King, Thomas Edison, The Beatles and George Washington. (I wondered whether he secretly pictures himself with this pantheon.) I guess he is doing some sort of vulture fund, but more for troubled sponsors. Most real estate is not yet troubled (unless purchased in a frenzy in early 2007) and thinly capitalized sponsors are feeling the pinch more so than their deals. Development deals caught in the midst of the credit crisis are the exception and he has hired a development expert. I suspect the broker / dealer community will be hearing more detail from Tony's extensive organization soon.

Another One Bites The Dust
Martin Sullivan of AIG resigned over the weekend. Sub-prime mortgages are the gift that keeps giving - kinda like syphilis. This was a slow motion train wreck. His replacement, Robert Willumstad, has already extended an olive branch to Hank Greenberg.

Not Right
Disturbing article about people who own a home, then purposely buy new home and let the first home go into foreclosure. This is fraud. The people doing this probably think they are so smart that they have found a way to job the system, but my guess is that the banks will catch up soon enough. The people doing this are the same ones that were caught up in the housing frenzy and just had to buy a home regardless of cost, refinanced it multiple times and now have little equity. They were probably long-time renters, too, before they bought during the frenzy. Realtors that assist in this deception should be de-licensed, or whatever the real estate broker penalty is called. Shame on the realtors that say halting "buys and bails" will put more downward pressure on the housing market. These guys are idiot crack whores that need any transaction.

Windfall Tax
I just heard on NPR that Congress is debating a windfall tax on oil companies. I can't find an on-line reference. I hate high gas prices as much as the next guy as I drive a huge SUV. But a windfall tax is bad news. This is a knee-jerk reaction and populous politics. If Congress wants to do something, it needs to prod the White House and Fed to help bolster the dollar.

Update: Senate kills the windfall tax.

AIG Turmoil - Here Come The Smart Guys
I have posted before on my perception that AIG's brain power is not up to other top Wall Street firms. Here is a front page article in today's Wall Street Journal detailing the dissent of three top AIG shareholders - Eli Broad, Shelby Davis and Bill Miller. These three have no shortage of brain power and combined with Hank Greenberg, and I don't see AIG's current management team in place much longer.

Thompson - Poised for Big Things
I received a blast email from a TIC industry veteran who is joining Tony Thompson's new real estate venture, Thompson National Properties, LLC. I had heard he had started a boutique real estate firm and looked at the website. This is not boutique - the staffing is incredible. The website shows seventeen professional staff and twelve senior executives, including Thompson. This is amazing. I don't know his plans, but he is staffed to raise billions. He is the keynote speaker at the Orchard Securities conference I am attending this week, and I am interested to hear what he has to say. I like the fact that he is not resting on past successes and has dived head first back in to the business.

Priorities
Today was a wild financial day - the stock market dropped nearly 400 points, unemployment had its largest jump in 22 years, oil jumped 9% to nearly $140 per barrel, the dollar tanked and corn hit a record high. The White House's response (via the Wall Street Journal's Washington Wire blog) was as expected:

White House spokeswoman Dana Perino said the White House is considering options to address the slowdown, but didn’t offer specifics. At HUD, Bush renewed his calls for an increase in domestic energy production, permanent tax relief, and reform of the regulation of Fannie Mae and Freddie Mac.

“There are a range of things that we continue to look at, but at the moment we would ask Congress to act on the things we think would have an impact — not necessarily an immediate impact, but an impact, nonetheless, so that the future of our economy can continue to grow,” Perino said.

The tax cuts do not expire until the end of 2011, the third year of a McCain or Obama presidency. I want these tax cuts extended as well as the estate tax thresholds increased, but it is silly to think that an extension of the tax cuts would have any immediate economic impact. (How strange that the tax cuts were never made permanent with six years of Republican Congress.) If Bush wants to do something he should put an immediate end to ethanol subsidies and stop the charade of ethanol as a viable fuel alternative. A legitimate strong dollar policy would end the commodity surge and bring the cost of oil down, but it's probably too late for him to do anything effective for the dollar.

Stock Slump
Today, AIG's stock dropped to levels not seen since the summer of 1997. That's unfortunate.

Catching Cold
Soured residential loans keep increasing. All real estate is now a dirty word. I am still of the opinion that commercial real estate should fare OK despite the credit strains. So much money went to residential real estate that commercial did not get over built. If the economy really goes in the tank, my opinion will change.

Down Market Realities
Realtors would never have agreed to sharing commissions in a strong market. But in a moribund housing market, realtors have come to realize that working with discount brokers is not such a bad idea. Realtors will not block the discount brokers' access to the Multiple Listing Service (MLS). On the surface, this is good for consumers, but of course my jaundiced view is that traditional realtors will somehow co-opt the discounters and commissions will not drop that much. Commissions are high and many realtors don't do work commensurate with the level of compensation, but many realtors discount their commission if asked. If the new sharing helps start transactions, then it is a good thing. The justice department should be looking at all the additional fees charged with getting a loan and buying a home. These are the fees that annoy me.

10-Q Release
The 10-Q for Wells' Timberland REIT was released last week. A quick read confirmed my previous conversations with Wells. Timberland should have enough offering proceeds to make its first $40 million payment on the mezzanine debt at the end of June. I estimate that Timberland needs to raise over $14 million a month in investor equity to get the mezzanine debt down to $60 million by mid-October 2008. This would extend the mezzanine debt to February 2009. If Timberland's equity effort comes up short, the entire outstanding balance of the mezzanine piece is due in mid-October 2008.

Don't Eat Their Own Cooking
American Airlines' management must not fly on American's planes. American's brilliant scheme to add a $15 per checked bag charge means that few bags will get checked. More bags in the cabin means frustrated passengers and stressed-out flight attendants as they struggle with the added bags. Airlines have stopped food and cut in-plane staff, and now this indignity. Flying is going resemble a bus trip in South America.

Cracks?
The Wall Street Journal had an article yesterday on the departure of a Wachovia real estate executive. The executive built Wachovia's real estate lending business, and one of his specialties was the mezzanine loan on top of a more traditional real estate loan. This is exactly how the Wells Timberland REIT financed its lone timber transaction - first loan and mezzanine loan (in additional to the issuance of preferred stock that can be viewed as more leverage) and no initial equity. The REIT is struggling to repay its mezzanine debt and needs to get it down to $60 million by mid-October to extend the final payment to February 2009. Based on Timberland's filings, I estimate that the REIT has approximately $125 to $135 million outstanding at the end of April on its original $160 million mezzanine loan. I wonder how the departure of this executive will impact Timberland REIT if the REIT's equity comes up short and it needs to extend or refinance. The executive's departure does not change the facts and terms of the transaction but may have repercussions for investors.

Opps
From today's (Wednesday 4/23) Wall Street Journal's Plots and Ploys column:

Sharing the Pain

While the stocks of most real-estate investment trusts have fallen sharply in the past year, few have been clobbered as hard as Phoenix-based Feldman Mall Properties Inc., which owns four malls and holds partial interests in three others.

Feldman's shares have fallen nearly 83% to $2 and weren't helped a bit last week when the company reported disastrous results for its fourth quarter.

It suffered a decline of $2.1 million, or 15 cents a share, in funds from operations for 2007. A key factor was a near doubling of Feldman's operating expenses to $16.5 million, including an extra $1 million provision for missed payments by tenants and $2 million in severance for two departed executives.

But the pain from Feldman's losses isn't limited to its investors. Another victim is Inland American Real Estate Trust, another REIT, which in the past year bought two million preferred shares in Feldman for $25 a share. Starting June 30, 2009, Inland can begin converting its preferred shares to common shares at a ratio of 1.77. Trouble is, Feldman's stock has fallen; if Inland were permitted to convert its shares at today's prices, it would get stock worth only $7.1 million. An Inland spokesman declined to comment.

The loss is 85% of the original $50 million investment. In terms of Inland American's big picture, this is not much more than a blip. It has raised $6 billion in investor equity. It has not released its 10-K yet. Inland American's 10-K will be another interesting read because its whole strategy is to buy shares of REITs rather than individual properties. The decline in REIT prices due should make for interesting valuations and its valuation methods need scrutiny.

Black Swan
This is the new financial term. It means that large unpredictable, unexpected events have big impacts on the markets. I just saw a numb-nut on CNBC stating that two Black Swans are pending, one the unpredictability of LIBOR and the other is inflation. LIBOR has been out of whack since last summer and is the subject of a front page Wall Street Journal article this morning. Commodity prices have been hitting highs for months and food shortages and related riots are well reported. I have read numerous articles that the large cut in interest rates will lead to inflation - plus, this is Econ 101. Neither event, therefore, fit the definition of a Black Swan. When known events and conditions are called Black Swans the term is irrelevant. Here is a good article from the Financial Times discussing Black Swans.

IHM
The IMH 10-K was released two weeks ago. Again, like Timberland, there is significant data to digest. A post will have to wait as other work is pressing. The amount of loans in default shot up in the fourth quarter - which to me, was not unexpected. There have been substantial redemption requests already this year. Defaults and redemptions - yikes. More details soon....

S@%t Rolls Downhill
Linens n Things is preparing to file for bankruptcy. There are multiple Tenant in Common deals with Linens as a tenant. This chain was taken private by Apollo Management in early 2006. Linens was not the only retailer that was taken private by hedge funds or private equity firms. Toys R Us, Petco and others were bought during the era of cheap credit. I imagine the hedge funds and private equity firms leveraged the companies and paid themselves huge dividends. Now this leverage is leading to bankruptcy. I will watch how the bankruptcy impacts the TIC deals I saw.

Pet Peeve
I hate when restaurants serve food in baskets. I don't eat from a basket at home and I don't want to eat from one in a restaurant.

If A Deal Falls In A Forest.....
I don't have time to probe the Timberland 10-K in depth. I think I have enough information - I have to wait for the 10-Q (due in mid-May) for more relevant data. An anonymous reply says about Timberland:

"It might be hard to sell stock in a black box. That's almost six months without pertinant (sic) financial data."

This is a perfect summation. This deal needs to raise substantial equity over the next six months just to keep its one property, and its current run rate is not encouraging. Timberland has become a high risk, high leverage, speculative investment. The investors and advisors that look to Wells do not, generally, look for high risk, high leverage, speculative investments.

Thornburg Mortgage
This is good news. It looks like Thornburg is going to make it through the credit crisis. Thornburg's equity investors got wiped out but at least it stays in business.

Digesting Timberland
I am wading through Wells Timberland's 10-K. There is a significant data to digest. The one parcel of Timberland was acquired in mid-October 2007, so the 10-K reflects one quarter of operations. I have questions that need answers before I can make sensible comments on Timberland's status, especially in terms of timber sales and operations and interest expense.

One item that does not need clarification is that in January and February the REIT raised $12.4 million, and had raised a total of $55.5 million of investor capital. At a $6 million per month run rate, by the end of June Timberland should have an additional $24 million ($6 million for March, April, May and June). At year-end, the mezzanine debt had been paid down by $10.4 million. At the current run rate, it looks like the first $40 million payment (which at year-end was $29.6 million) at the end of June looks likely. The second payment of $30 million in August needs a ramped up run rate.

Too Smart
Dividend Capital's Total Realty Trust is expected to release its 10-K on Monday, March 31, 2008. This non-traded REIT began its offering period in early 2006 at the height of low cap rate real estate. To off-set the low yields on real estate, the REIT purchased high yielding debt securities. These include CDOs and CMBSs, but no subprime securities. These are the type of securities that are giving the large banks trouble, due to their uncertain valuation. I want to know how the REIT is valuing these hard-to-value securities. Dividend Capital has a leveraged closed-end mutual fund , Dividend Capital Realty Income Allocation (DCA), which owns similar-type debt securities. This fund has lost half its value since last summer. DCA has all its assets invested in debt and income producing securities and is leveraged. The REIT has about 20% of its assets in securities, and I don't think it borrowed to acquire them, so the impact is much smaller, and the securities are performing. But it is an item that needs analysis.

The Waiting Is The Hardest Part
I am waiting for 10-Ks and a 10-Q. IHM Secured Loan's 10-K should be out in a week or so and I'll get to see how its mass of fourth quarter maturities fared. Due to the implosion in housing development, I am not optimistic.

The Wells Timberland REIT's 10-K should be available soon and will give a good picture of its one timber property's operations. The first quarter 10-Q should give the impact of the higher interest rates on its mezzanine loan. Until these are released, not much new information will be known on the REIT.

TIC Sponsor to Cut Distributions
A large TIC sponsor is stopping distributions on three of its deals and cutting distributions on a fourth. All four are office buildings. Actual operations are not meeting projections due to higher than projected vacancies. I read through the operational summaries on the four deals and it appears to me that the problems are management related and not market specific. The lease expirations and corresponding lower revenue that are behind the distribution cuts were known and reserved, but leasing efforts have been poor. (One property had a lease buyout that added to reserves, but another deal is attempting to get a loan to help with leasing costs as its reserve estimates were insufficient.) To the sponsor's credit (or maybe it's to the lender's credit) at least distributions are not being paid from reserves.

The summaries were poorly written, but it appears that the markets where the four properties are located appear solid with increasing rental rates, increased absorption and limited new construction. One point not addressed in the summaries is the debt coverage ratios and the possibility of technical default on the mortgages. I would bet that the mortgages are conduit loans that were sold into Commercial Mortgage Backed Securities. These loans have debt coverage ratios that must be maintained or the loans go into technical default. Higher vacancies and lower Net Operating Incomes drop the coverage ratios. If the loans had an interest-only period and have not started their amortization, the deals may be in for another set of problems as this will lower their debt coverage ratios.

My opinion on this sponsor, based on the limited number of its deals that I saw, was that it had good properties and poor properties. Each deal needed to be reviewed and it was not enough to approve deals based on the sponsor. This sponsor had a steady flow of product and some of that product would take months to sell in a market where product had a shelf-life of days or weeks. Now we are seeing why the market was giving pause to some of this sponsor's deals.

One Hundred-Year Floods Every Ten Years
After Long Term Capital Management's financial melt down in 1998 I remember "experts" talking about the situation being a one hundred-year flood - i.e. so bad it could only happen every one hundred years. Talk then was of some risk measure called VAR (Value at Risk) that was supposed to measure risk and help prevent financial implosions. I did not understand VAR then and have not heard much of it since. VAR or not, Long Term Capital Management was a case of outsized leveraged bets that went wrong and it impacted the credit markets for a short, unpleasant period. Today's credit crisis is similar, outsized leveraged bets that went wrong - but its on a much bigger scale. From home owners to hedge funds to investment banks, leverage was cheap and easy for an extended period that led to complacency about ever increasing asset values that collateralized the debt. The de-leveraging of financial markets is painful and shows no signs of abating and has led the Fed to make moves it has not used since the Depression and to even invent new ways to add liquidity to markets.

The one hundred-year flood analogy needs to be modified to a ten-year flood, because significant market upheaval seems to happen every ten years. (The ten-year flood is as bad as the one hundred-year flood it's just occurring on a more frequent basis.) The flood of 2008 was preceded by the flood of 1998 caused by LTCM (the stock market declines of 2000 to 2003 were not a one hundred-year flood), the stock market crash of 1987, the hyper-inflation of the late 1970s and the market declines and financial upheaval of 1973 and 1974.

Markets recover after each flood and the brains on Wall Street concoct new products to prevent the next one hundred-year flood. The products getting stressed today are all the derivatives and securities (i.e. CDOs) designed after 1998 to take risk away from banks. I am sure Wall Street is working on the next wave of products that will "prevent" the next flood. Of course it will be impossible to test these products until 2018.

Green - The New Refuge of Scoundrels
The old saying is that patriotism is the last refuge of scoundrels. It looks like patriotism is being pushed aside for the green movement. The sponsor who wants to roll-up its TIC deals registered a real estate investment trust late last year that will focus on sustainable real estate. Good luck. I think the registration's track record section needs updating.

How Do You Spell Stupid? S-P-I-T-Z-E-R
The idiot was reckless and foolish on so many levels and the revelations are just beginning. The stupidest thing - so far - has to be overpaying for services and having a credit with the agency. The stupidity almost defies belief. A credit with a hooker?!? Did they guy think he was shopping at Target? I bet he'd try to return a service he didn't like. The retard is toast.

WSJ Gets Back to Reporting
Here is a good article on the commercial real estate market. It states that the downturn will be tempered. Most of the development dollars went to the construction of condos, which are classified as commercial developments during the construction phase. The commercial market did not suffer overbuilding. I looked at existing office properties in South Florida in 2004 and 2005 that were selling for approximately $200 per square foot. When compared to new condo developments that were selling for near $300 per square foot there is no mystery as to why so few commercial properties were built. This dichotomy was repeated in many markets. Some markets missed out altogether, I was in Denver last year, a city that had limited condo development, and it had no office construction either because the market was still weak. I tend to agree with this article more than this one from last week that I thought was shrill.

Roll-Up
I was on a conference call Friday held by a prominent Chicago-based TIC sponsor. It has a mish-mash of TIC-owned properties (office, industrial, multi-family and retail) that are mostly master leased and mostly underwater. Apparently many of the properties are not generating the cash to make the master lease payments and the sponsor is reaching the point where it cannot meet its obligations under the master leases. Plus, some of the properties are in technical default on their debt by not meeting their required coverage ratios.

I am unclear on how the sponsor will effect the roll-up. The sponsor wants to somehow roll the deals into a public entity, but each property is owned by tenant in common investors, not a fund, and any sale will require approval from all investors, not just a majority. Plus, on the call it was stated that the public company (unnamed on the call) that would acquire the properties is not a REIT. The sponsor said that the roll-up would not be an immediate taxable event. I called an executive at a public company that seemed to match the description on the call, but was told that it was not the purchaser. The person I called knew details of the troubled sponsor and the contemplated roll-up, which was surprising coming from this executive, especially since news of the roll-up was released on the call. I am not sure I believe this executive's denials.

Foxified
This article from today's Wall Street Journal has a scary headline, but the content does not support it. "Wall Street Braces for Its New Pain" prepares the reader for imminent trouble in the commercial real estate market. The headline is based on a study by Goldman Sachs that says the commercial real estate values are going to drop by 21% to 26% over the next few years and banks holding mortgages are in trouble. The problem is that banks are holding real estate mortgages and did not package them fast enough in to Commercial Mortgage Backed Securities (CMBS). (This is just the opposite of all those subprime loans the banks packaged and sold. The banks can't win for losing. They can sell the crap and have to write it down or keep the crap and write it down. )

The article states that write-downs in the CMBS market will be similar to those in the CDO and leveraged-loan markets. The current default rates on CMBS are .4%, but this is expected to rise if loans coming due cannot be refinanced. This makes sense but it has not happened. The headline implies that a shaky market is about to implode. It article does not read that way to me. The real estate market still appears solid and the default rates are near historic lows.

Reprieve - Maybe...
Wells Timberland REIT's first principal payment on its $160 mezzanine loan through Wachovia Bank was due yesterday. The REIT filed an 8-K yesterday detailing an amendment to the mezzanine loan. (The mezzanine loan is part of the REIT's financing of its first acquisition, a $400 million purchase of timberland in Georgia and Alabama.) The $40 million payment that was originally due yesterday was the first of three payments that were due over the course of 2008. The second payment of $24 million was due by the end of April and the remaining balance was due October 17, 2008. The REIT couldn't make its first payment and has negotiated an extension and amendment to the terms of the loan. The first $40 million payment is now due on June 30, 2008, the second payment is now $30 million and due August 29, 2008. If the outstanding principal is reduced to $60 million by October 17, 2008, the due date is extended to March 2, 2009.

These amendments have come with a price. The interest rate has been increased to 11% from the previous 9%. The 8-K further states that Wells Real Estate Funds, Inc. has agreed to make a substantial principal payment on a separate outstanding loan issued by Wachovia to Well Real Estate Funds, pay additional fees to Wachovia in connection with such loan and increase the collateral supporting its guaranty of the REIT's mezzanine loan. I guess there was a reason Leo Wells eschewed debt for so many years.

It is good that Wells negotiated the extension. It's anyone's guess whether the extension can save the REIT. Capital raised through the REIT's offering is the source for principal repayments on the mezzanine debt and the REIT's offering has obviously not met expectations and debt service requirements. Its cost of borrowing has just increased, which will put further pressure on the money raising efforts. The REIT's capital raising efforts might be impacted if the renegotiation of the mezzanine loan gives the impression of financial problems for the REIT. I don't suspect many advisors will recommend an investment that has a hint of financial trouble.

The REIT's first acquisition was like a python trying to eat an elephant. (The REIT had raised less than $10 million when it announced the $400 million acquisition.) The python has the elephant in its mouth and the battle to digest or die could go either way.