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Hi all,

I thought I'd try here, at my old haunt, first to see if Dr. T. or someone can help me understand something, or if not suggest a board that might help.

The question mark after my OT is because if a municipality issues GO bonds to invest in a highly speculative development project, as does happen, we're talking a municipality in deep doodoo, and even if it doesn't default, credit rating/value of existing bonds go down the tubes. Credit agencies seem oblivious to this risk and even more oblivious to municipalities contemplating such speculative investments, so anyone thinking of investing in munis should make checking out what is up public-private development-wise part of due diligence.

Anyway, the developer in question was facing foreclosure on a $3.5 million loan from a bank about 18 months ago on the property in which the municipality plans to invest. He refinanced with a $10.5 million bridge loan/mezzanine financing.

I have a rudimentary understanding of mezzanine financing (I don't know details about when balloon payment is due or anything like that). But I can't figure out why even a high risk lender would provide that much financing for a property that was theoretically worth $3.5 million (in reality, I'm guessing $2 million max). Might this be secured by multiple properties (though I can't for the life of me figure out what else this developer owns that could be used as collateral)? I'm guessing the developer wanted a lot more capital than needed to pay off the original loan (I doubt even with delinquent interest more than $5 million), because we're talking less than zero cash flow (and needless to say suspicions of where the cash flow is ending up).

Also, what happens when the balloon payment comes due and can't be met? I read something that suggested, because mezzanine financing is a kind of equity, the lender gets first in line picking the pieces, meaning in this case getting the property.

Anyway, any insights appreciated.

Loki
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Lokicious,

You wrote, I have a rudimentary understanding of mezzanine financing (I don't know details about when balloon payment is due or anything like that). But I can't figure out why even a high risk lender would provide that much financing for a property that was theoretically worth $3.5 million (in reality, I'm guessing $2 million max). Might this be secured by multiple properties (though I can't for the life of me figure out what else this developer owns that could be used as collateral)? I'm guessing the developer wanted a lot more capital than needed to pay off the original loan (I doubt even with delinquent interest more than $5 million), because we're talking less than zero cash flow (and needless to say suspicions of where the cash flow is ending up).

My understanding of Mezzanine financing is that the lender tends to loan you money at a high interest rate for a limited period with an option on [a stake in] your business. Should you fail to meet the terms of the lender or should the lender choose to exercise his option, the Mezzanine financing effectively allows the lender to come take over your business and liquidate it to satisfy the debt.

In this case, the builder probably had to put up his business as the collateral.

In 2008 I worked for a high tech startup that collapsed. After meeting payroll on September 31st, 2008, they could no longer meet the terms of their Mezzanine financing and were forced to shut down and turn over the business to the lender for liquidation.

- Joel
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Thanks Joel. Got a look at the actual deed, and turns out my informant missed a step, which was this is a second round of mezzanine financing, with a new lender, so the jump occurred a couple years earlier, so that explains why he doesn't have any cash left over. But I can't imagine assets even close to $10.5 million, and there is no business to take over.

Also saw the man and his wife signed as guarantors for the company. Does that mean they would actually pay from their own money when this goes belly-up? I can't imagine someone less likely to put himself at risk—basic assumption has been put little into company and been skimming lots off.
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OCD:

I wrote, After meeting payroll on September 31st, 2008 ...

I meant October 31st, 2008 - Halloween.

- Joel
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Sounds like "The Producers."
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Lokicious,

You wrote, Also saw the man and his wife signed as guarantors for the company. Does that mean they would actually pay from their own money when this goes belly-up? I can't imagine someone less likely to put himself at risk—basic assumption has been put little into company and been skimming lots off.

Yes, as guarantors they are co-signers to the loan - a common requirement for small business loans, especially if the company has few assets and it is incorporated. Such a guarantee circumvents the separation of assets and liabilities between the company and the owner.

It's possible the owner and his wife do not understand this. Also if the owner resides in Texas or Florida [so-called dead-beat states], he may be unconcerned by it because it is so difficult to seize assets held by residents of these states. Also it's very difficult to garnish wages from a person if they're self-employed so if their only real assets are a house, car, a few grand in the bank and this business it can be very difficult to find anything the court would let you seize...

- Joel
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Hi Loki-

I enjoyed your contributions to this board in the past.

Do you have a CUSIP number for these GO bonds? Or are they just a possible future issue?

Mezzanine financing is high risk and often an equity piece is part of the deal. Personally, I would expect a pretty good reward for putting money into a highly speculative venture which is what mezzanine finance does. Equity is always last in a liquidation, other than interests that have been subordinated for bad behavior.

If you want to learn about mezzanine lending, start with Einhorn's book about Allied Capital. But remember that he was wrong about the value of the portfolio when he first went short.

To answer one of your specific questions, if the balloon can't be met (i.e. refinanced) it's workout time or bankruptcy.

You can't really say anything more specific without a lot more details than you have provided. Who would know what the personal guarantee is worth without access to the financials of the guarantor?
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NO CUSIP, because so far no GO Bonds, and the point is to make sure there are none. Wish I had more specifics. Bottom line is bankruptcy of this developer. Only question is whether it happens before the morons in city hall bankrupt the city with him. You'd think "this guy has $10.5 million and counting mezzanine financing" ought to warning enough. The developer knows what he's gotten into with the personal guarantee. I'll eat my hat if he hasn't got a way out. Florida sounds interesting. Just surprised if the lender is as easily conned as city hall (unless they're in on it, of course).

Just trying to make sense of this and figure some smart people around here. THanks.
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What do you mean by "Florida sounds interesting"? You seem a bit more incoherent than usual.
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Sorry, writing quickly. There is a Florida connection with this developer, so the possibility of his relocating to Florida to avoid paying debt personally is interesting. Quite frankly, seeing that he was guarantor on the deed comes as a huge surprise, given everything we know about this dude and prior projects that he walked away from scot free, leaving bodies strewn behind him. So, naturally, I assume he's got some kind of get out of jail free card. I'm just curious on this angle, because it really isn't relevant to us whether the mezzanine financier gets stuck, as long as taxpayers don't.
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Lokicious, sometimes credit will be initially extended without a sponsor guarantee if the project has enough equity or the lender is foolish enough. However, if a deal runs into trouble and the sponsor wants to extend maturity or otherwise get some concessions from the lender, an almost certainty is that the lender will require a personal guarantee from the sponsor in order to play ball. Although it is notoriously difficult to actually chase sponsors through the courts to get them to pay up, the mere fact that the lender has recourse to the sponsor means that they have a hammer to use when things get rough.

Without knowing all the facts and circumstances about this deal, it is really hard to know what is going on. So I would reserve judgement. But if the politicians want to put municipal money on the line, you should publicly and loudly ask questions.
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This sounds like a pretty good plot for a noir mystery story (such as "Chinatown").

A few tweaks and you have a ready-made screenplay.
Wendy
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Hi Wendy, how ya been?

This mezzanine financing is just one twist in a mystery plot, sans bodies (as yet), that writes itself. Actually, the plot would need to be toned down, because it is too unbelievable.

Been yelling and screaming at politicians for years (not just me). I'm trying to understand this latest find about mezzanine financing to throw in their faces and finally turn the local press against them. Problem is, they were warned years ago not to get into this, especially not with this developer, but they went ahead. Giving up means admitting they were wrong, with likely repercussions (politicians out of power, more importantly, top city employees fired), plus dealing with losses in the $2 million range (as opposed to tens of millions if they issue the bonds and the development never happens, which I consider 100% probability).

This would actually be fun, except it is deadly serious.
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<Hi Wendy, how ya been?>

Having fun teaching college, like you :-). I miss you on the Bonds Board.

How are you?

<Giving up means admitting they were wrong, with likely repercussions (politicians out of power, more importantly, top city employees fired), plus dealing with losses in the $2 million range (as opposed to tens of millions if they issue the bonds and the development never happens, which I consider 100% probability).

This would actually be fun, except it is deadly serious. >

The well-known spy novelist, John le Carre, was actually a spy before he began to write. He made espionage "fun" in his fictional spy books. But of course it was deadly serious, because spies got killed in those days...still do (e.g. recently in Pakistan).

The real estate shenanigans you describe just about writes itself as a script. It's mostly a question of who should be the main voice(s). Actually, it might be fun to use several voices, because then the hypocrisy, self-justification, corruption and greed would speak for themselves. Are there any good guys? Maybe a local college prof whose hands are tied?

Go ahead. Have them issue the bonds, put in a few kickbacks, murders and racy scenes of greed and lust. Let fiction be stranger than truth, for a change ;-).

Wendy
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Hi Loki,

Not sure I could make sense of that. Mezzanine financing is sorta between debt and equity in the capital structure and can really be structured with a little of both or lean one way or the other. Sounds like the developer had something the lender thought was attractive enough besides the property, maybe the development company or the actual development rights to the property. One mans Mezzanine is another mans equity or convertible debt.

Not knowing the project or the stage, it may be some temp financing that the development company lined up to "get the project started" and then it would be more attractive for the municipality to fund the specific build you are looking at. Say it is a parking garage, and he knows if he starts a mixed used commercial/retail building on half the property, then the garage looks more like a winner for the municipality. Or maybe develop part of the parking to show its effectiveness and then expansion is tied to new bonds. The mezzanine lender gave him enough to take out the bank and start on the building for a good chunk of the equity of the company but would be hard pressed in todays environment to think the lender only had one source of repayment on the deal unless that source was rock solid.

Welcome back old friend! Sorry I don't know the specific on this one - sounds like a real good mystery. Follow the money - it will some how point to a politician I'm sure - Just hope we didn't provide the financing....

d(Mezzanine)/dT
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Thanks Dr. T and Wendy (I've forgotten how to do italics for quotes, so I won't try).

Wendy, during my afternoon exercise, I thought through a pretty good murder plot to go with the actual details. Better setting, though, and more interesting detective (have a different mystery partly written with him) than a college prof—how dull can you get.

Dr. T. Doubt you folks got into this one, but a lot to learn from what I've been finding out when it comes to public-private developments (or for-profit public ones). I've been reading up on a lot of cases around the country (not to mention Olympics, World Cup, etc.). What you tend to get is local governments and state governments enthusiastically embracing tax incentives, tax increment financing, and the like as the solution to stressed local government finance, plus for-profit public works, like parking garages. Consistently the local press jumps on the bandwagon, at least until the wheels start to fall off (our local press is still on the bandwagon with no wheels and dead horses). So it pays to try and find out what "the people" have to say about projects—letters to the editor, even online comments on news stories, sorting through the "corporate welfare," "crooks," shrieks to find smart responses from people who seem to know what they are talking about. I doubt the financier for our boondoggle would have touched it if someone had read what critics had to say in council minutes, etc.

As best I can figure out, after having become good enough at tracking shell companies to apply for a job at the SEC, is that this mezzanine financing was to refinance a mortgage that was pending foreclosure and that by now what the developer owes on the mezzanine financing is at least 3x the original mortgage, while the property has certainly declined significantly in value, I'm guessing by at least 50%. So the property is worth maybe 15%.

The developer no longer has any other assets, except maybe one that had its own mezzanine financing (I found a hidden body this morning). When the mezzanine financing for our boondoggle was made, there were a couple of other developments in the works or completed (and half empty), but it would have taken little effort to have figured out they were in trouble.

So, I'm guessing the financier figured getting in on the development was a good alternative to being paid back. The smoke and mirrors has fooled a lot of people and probably fooled the financier. The development is not going to happen, so unless our beloved leaders hand over some GO bond money to the developer to pay off the mezzanine financing, barring actually getting cash from Mr. snake in the grass (he's not as clever as he thinks), I think they've looking at a write-off.
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Loki-

Sorry, I didn't intend to be rude.
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