Displaying items by tag: Mortgage Banking

So, thus far we have had a massive real asset bubble fueled by easy credit, low interest rates and low inflation. We have had that bubble burst, inflicting severe damage in the commercial, investment, mortgage, and shadow bankin system as well as the real asset markets. Despite this, there is still a large overhang of inventory in real assets (dead weight), low demand, and cap rates are still near historic lows.

Well, I believe a spike in inflation, hence interest rates, will force cap rates upward and do what he investment public has failed to do thus far - and that is create a realistic pricing environment for both real assets and the credit derivatives that financed them. This will absolutely wreck margninal banks and the not so marginal banks who aren't doing that well - even in the zero interest rate environment promoted by the fed. So if the banks are sick now (see The Anatomy of a Sick Bank!) imagine how they will fare with the disease of inflation creeping up their backs. Since they power the real asset market, and the real asset market is still in the throes of bubble pricing, what happens next??? Think the S&L crisis! See the following excerpts from Reggie Middleton on the Assset Securitization Crisis for my take on how we will make the S&L Crisis look like an episode on Sesame Street. For those that remember or research, it was the rise in interest rates that pushed the S&L's over the bring - althought they probably had it coming anyway.

1. Intro: The great housing bull run - creation of asset bubble, Declining lending standards, lax underwriting activities increased the bubble - A comparison with the same during the S&L crisis
2. Securitization - dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble - declining home prices and rising foreclosure
3. Counterparty risk analyses - counter-party failure will open up another Pandora's box (must read for anyone who is not a CDS specialist)
4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
5. Municipal bond market and the securitization crisis - part I
6. Municipal bond market and the securitization crisis - part 2 (should be read by whoever is not a muni expert - this newsbyte may be worth reading as well)
7. Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux
8. More on the banking backdrop, we've never had so many loans!
9. As I see it, these 32 banks and thrifts are in deep doo-doo!
10. A little more on HELOCs, 2nd lien loans and rose colored glasses
11. Capital, Leverage and Loss in the Banking System

I'm taking a closer look at GE, the industrial cum uber bank
bellweather of the Fortune 500. See the following draft overview, to be
followed up by a full forensic analysis. I apologiz, for I've had this
on my desk for a while and forgot to post it and was reminded about it
when a sell side analyst downgraded GE this morning.

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General
Electric (GE)

General
Electric share price has declined 22% in the last six months

The General Electric share price has taken
significant beating in the last six months and has fallen 22% on account of its
exposure to the financial services business and currently trades at US$29.05
per share. GE’s share price declined almost 13% on 11 April 2008 as it reported
a significantly lower than anticipated 1Q 08 results. The share price has
fallen by almost 21% since the announcement of its 1Q 08 results.

This is a little anecdotal, non-scientific snapshot of the returns 2nd
lien lenders can expect in the San Diego Foreclosure market.

From a BoomBustBlogger:

"I manage a large real
estate team in San Diego and we do a ton of foreclosures with almost
200 REO's either assigned, on the market or in escrow. We started charting the drop in prices on a webpage at www.foreclosure-hotlist.com The "previous value" includes previous sales, the foreclosure amount or the amount of the previous debt. You are right on the money with the call on the top-end HELOC's. They
are getting killed right now, there is no equity to protect them and
they are sacrificed by the Senior loan who still isn't getting their
debt covered by the sale. Add to this the problem we face on short-sales. All of these securitzed debt products mean that in some cases there is no one who can negotiate to take a smaller payoff. All they can do is accept payments, accept payoffs or foreclosure... nothing in-between."

From the reader's site (red font is my annotation):

This missive is more than probably any outside investor in GGP knows about GGP, plus some. The accuracy of the contents below is not guaranteed nor warranteed in any form or fashion. I try my best to be accurate and exact, but things do happen - thus all
contents in this post is based upon information and belief. Thus, I invite all to roll your sleeves up, and dig in to do some research for yourselves. This is the type of research that I expect to come from my local brokerage houses. It doesn't happen, thus I must do it myself. Please be aware that I have a bearish position in GGP stock. Read this complete missive, and it will be easy to understand why.

Table of Contents

• Short
  summary of the 3 elements of this report
• Background
  Information on the founding Bucksbaum Family
• Background
  Description of General Growth Properties’ Business
• Item
  1- Clear evidence that GGP is heading into a refinancing-induced liquidity
  crunch
• Item
  2- One-time items are holding up deteriorating core operational
  performance
• Item
  3- Evidence that GGP is potentially misrepresenting itself

Must read content
tie-ins

• GGP
  analyses
  

• Will the commercial real estate market fall? Of course it will.
• Do you remember when I said Commercial Real Estate was sure to fall?
• The Commercial Real Estate Crash Cometh, and I know who is leading the way!
• Generally Negative Growth in General Growth Properties - GGP Part II
• General Growth Properties & the Commercial Real Estate Crash, pt III - The Story Gets Worse
• More on GGP: A Granular View of Insider Selling and Lease Rate Growth
• GGP part 5 - The Comprehensive Analysis is finally here
• My Response to the GGP Press Release, which seems to respond to blogs...
• For those who were wondering what sparked that silly press release from GGP...
• GGP: Foreclosure vs Asset Sale
• GGP Refinancing Sensitvity Analysis
• GGP part 7 - Share value under the foreclosure analysis
• GGP part 8 - The Final Anaysis: fire sale of prime properties
• Analysis of GGP's recent Q1 results
• GGP Conference Call
• Reader's legal observation on GGP
• GGP Can't Afford its Dividend
• Press release announcing new equity financing - something that I didn't explicitly model in my own analysis, but after reviewing information without the benefit of official documentation, there were no surprise nonetheless...

• 
  We did find some surprises, and my blog readers chimed in with their expertise and opinions...

   

• The
  Asset Securitization Crisis: Selected reading. This is not a must read, but does go a long way in explaining why GGP will be more than hard pressed to obtain bank financing.
  
  • Intro:
    The great housing bull run - creation of asset bubble, Declining
    lending standards, lax underwriting activities increased the bubble - A
    comparison with the same during the S&L crisis
  • Securitization - dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble - declining home prices and rising foreclosure
  • The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
  • An overview of my personal Regional Bank short prospects Part I: PNC Bank - risky loans skating on razor thin capital, PNC addendum Posts One and Two
  • Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux
  • More on the banking backdrop, we've never had so many loans!
  • As I see it, these 32 banks and thrifts are in deep doo-doo!
  • Capital, Leverage and Loss in the Banking System
  • Doo-Doo bank drill down, part 1 - Wells Fargo
  • Doo-Doo Bank 32 drill down: Part 2 - Popular
  • Doo-Doo Bank 32 drill down: Part 3 - SunTrust Bank
  • The Anatomy of a Sick Bank!

Short summary of the 3 elements of this report

1.
There is very clear evidence that GGP is heading
into a refinancing-induced liquidity crunch.

2.
One-time items are holding up deteriorating core
operational performance.

3.
There is evidence that GGP is misrepresenting
itself and breaking securities laws.

Many themes currently
broadcast in the news directly apply to GGP – its situation is one of high
leverage in the face of a weakening consumer and an evaporating debt
market.It’s a family-run business that
tripled its size through a major acquisition when the debt markets were
healthy, and is now left scrambling.
There appears to be dissension between the founding father and his
now-CEO son over some of the tactics that they have resorted to recently, which
appear to be questionable.If the core
operations continue to deteriorate in the continued absence of a functional
debt market, the 2^nd largest mall REIT in the US will simply run out
of cash and no amount of accounting or financial gimmickry will be able to hide
that fact.

Background Information on the founding Bucksbaum Family

The Bucksbaum family
founded and has run General Growth, in various legal forms, since 1964.Martin and Matthew Bucksbaum were the
original founders, forming the General Growth Properties REIT in 1964.In 1972, General Growth was listed on the
NYSE.In 1984, General Growth sold its 19
malls to another company and liquidated the REIT, but continued to manage
subsequently.A large acquisition in
1989 made General Growth the second largest mall manager in the US,
and in 1993, General Growth did an IPO to form GGP, the legal entity we see
today.In 1999, Matthew Bucksbaum
stepped down as CEO and John Bucksbaum (‘JB’), Matthew’s son, replaced
him.In November 2004 (mid-point of the
real estate and credit bubble), GGP completed the $14 billion Rouse
acquisition, which established GGP as the 2^nd largest mall
REIT.In August 2007, MB stepped down as
Chairman of GGP, and was replaced by JB.

Background Description of General Growth Properties’ Business

General Growth
Properties is the 2^nd largest mall REIT in the US.
It buys malls, financing the purchases with equity and a combination of
secured and unsecured debt.On May 14^th
2008, GGP had $27B of net debt after adjusting for pro rata joint venture debt
and $11.3B of equity, implying a total debt to capitalization of 70.6%.Along most metrics, GGP is the most highly
levered publicly traded mall REIT. Malls are typically put in 3 categories –
Tier 1, Tier 2 and Tier 3 – based on the average sales per square footage of
the mall.As of early 2006, GGP
controlled approximately 18.3% of the regional mall market, with 5% of the Tier
1 market, 6.8% of the Tier 2 market, and 6.5% in sub-Tier 2 properties.

Unlike most of the
major mall REITs, 70% of GGP’s debt is in the form of traditional secured
mortgage debt.Most of the secured debt
comes from commercial banks, who extend commercial loans and then feed those
loans through into the CMBS market.Life
insurance companies also have been known to participate in mortgage financing,
but have traditionally been a small player due to the high amount of
administration required, cumbersome capital allocation process, and small
financing capacity.GGP’s average
interest rate is currently 5.46%, even though its senior debt ratings from
Moody’s and S&P are BB- and Ba2 – below investment grade.

GGP leases out space to
retailers, who primarily pay GGP in the form of base minimum rent.The historical relationship between tenant
sales and occupancy costs charged by GGP is shown below.

There is some
maintenance cost associated with existing mall properties.Based on an analysis of GGP and its primary
mall competitors, it appears this maintenance cost is approximately $1.9 per
square foot of ‘GLA’ (gross leasable area). While tenant contracts are
typically long term (7 to 10 years), contracts can be broken at the cost of a
lease termination fee, which tends to be around 2 years worth of rental income
up front.For accounting purposes, this
income is treated as revenue.Due to the
lack of cost associated with such revenue, it is pure profit when generated,
though non-recurring.

The trend towards rise in occupancy cost as % of sales is
expected to strengthen off declining retail sales and consumer expenditure. The
macro-economic factors clearly stand to point out that the situation is going
to worsen from the present levels. Consumer credit and retail sales have
softened due to decline in consumer spending.
As US economy continues to slowdown, many retailers are expected to
revisit their growth plans and curtail some of their existing operations
forcing further lease terminations. Also as retailer’s occupancy costs increase
steadily as % of tenant sales, rentals could face downward pressure. GGP has
witnessed higher lease terminations in the last quarter as manifested by
increase in non-recurring termination fee income to $21.0 mn in 1Q2008 from
$3.7 mn in 1Q2007, resulting in one- time non-recurring revenue for the company
in 1Q2008 at the expense of future core operating earnings. As a result the
company’s average occupancy level has declined to 92.7% in 1Q2008 from 92.9% in
1Q2007. GGP’s reported revenues from consolidated property increased 18.3% to
$798.3 bn in 1Q2008. However revenues excluding Homart acquisition and lease
termination fee increased by a marginal 0.3% to $682 mn. The rentals have
already started to witness a sign of slowdown and an increase in lease
terminations could imply lower rentals for the company going forward for the
same property under a renewed lease agreement.

{mospagebreak}

Item 1-There is very clear evidence that GGP is heading into a
refinancing-induced liquidity crunch

Summary

At the end of Q1 2008, GGP had $2.6B and $3.3B of debt
coming due in 2008 and 2009, respectively.
The refinancing “progress” that it stated it had made in Q1 was almost
entirely short term high rate debt coming due in November 2008, though they did
not state as much.They also did not
state that despite raising over $880M of equity capital in Q1 2008, their total
debt maturities in 2008 and 2009 have actually gone up.

GGP has paid off its $492M revolver due in 2011 while it
has $350M due in July 2008 which was still outstanding at the end of Q1 2008 – this is highly
suspect.An unsecured lender
reduced the principal owed by GGP by $172M, an action which is typically only
taken in bankruptcy – also highly suspect.
Finally, the magnitude of guarantees has risen materially over the past
quarter, indicative of rising lender concerns.

The primary mechanism through which they have historically
financed their operation, the CMBS market, is almost entirely shut down.Some of the biggest participants in the CMBS
market have announced they are scaling
away from the CMBS market, which does not bode well for their ability to
fund themselves through the CMBS market in the future.Prudential, Wells Fargo, Morgan Stanley
andCapmark Financial Group are examples
of large institutions that are exiting or reducing their exposure to the CMBS
market.

Life insurance companies, which GGP has mentioned recently
as a potential source of replacement capital, have been called a “cumbersome”
and highly difficult source of capital by major competitors.They are also the same companies that are now
scaling away from the CMBS market, and are in the process of announcing large write-offs
and capital raises of their own.

GGP has turned to up front lease termination income as a
source of capital it seems, based on the highly abnormal rise in lease
termination income the past few quarters.
GGP is also now turning to loans from its JV subsidiaries.GGP has repeatedly stressed that it will not
do a “fire sale” of assets, while healthy companies would never state as much.

Although GGP had
closed its CMBS operations earlier, it is now seeking to explore CMBS deals (in
addition to bank financing) which it believes would re-finance its existing
debt maturities for the remainder of 2008 and nearly 30% of debt maturities of
2009. Although CMBS market is facing drying liquidity and being scaled away by
other market participants in the light of high uncertainty in the current
credit environment, GGP plans to raise between $1.5 bn and $3.0 bn through CMBS
bonds.So far in 2008 (5 months of 2008),
the entire CMBS market has witnessed only $10.9 bn of activity compared to CMBS
issuance of $230 bn in 2007. To put this plainly, GGP is telling us that it plans
on representing roughly 7% to 35% of the entire CMBS market in the refinancing
of its debt. Looking at the CMBS market activity to date, GGP’s claim to raise between $1.5 bn-$3 bn remains highly suspect.
In addition to this, GGP is also negotiating a $1.75 bn term loan. With total
maturities of $2.8 bn and $3.3 bn in 2008 and 2009, respectively, GGP will face
some testing times ahead to re-finance its mammoth debt.

Further to the detriment
of this companies financial position, GGP is also planning to raise funds by
encumbering its existing unencumbered properties at a point of time when financial
institutions have strengthened their standards for having lower LTVs on
properties. Also the company is considering reducing its stake in joint
ventures and using the proceeds to re-pay debt. Such actions under the current
deteriorating capital market conditions might result in under realization of its
investments, or to put it plainly the sacrificing of shareholder value by
selling into an unfavorable market.

Wait and see
approach of big lenders, probably Citigroup, only extending January 2008
maturities out to November 2008.

In a March 2008 press
release, GGP stated that it had raised $1.3B, generating $658M of excess
proceeds for GGP.However looking in
detail at GGP’s loan activities, it appears that the most important debt
maturity in Q1 2008, $650M of debt on the Fashion Show mall, was merely
extended 10 months to November 2008, and at a rate 180 basis points higher than
its old interest rate no less.This is
hardly a vote of confidence, and it does not remove the near term credit risk
associated with such debt.

Similarly, $250M of new debt was raised on GGP’s recent
$290M initial payment on the Palazzo.
Like the $650M of Fashion Show debt, this $250M is high cost debt which
matures in November 2008.Thus, in
November 2008 alone, GGP now has $900M of debt which is coming due.This is probably the lender taking a wait and
see approach – if conditions improve over the next few months, and the markets
clear up, then maybe the lender will put his feet back in the water.If not, the lender will call his loans. If
one has followed my comments on the banking sector via Reggie
Middleton on the Asset Securitization Crisis, it is plain to see that the
banks are fearing insolvency and would rather not take in additional real
assets if they have to, but have few choices as customers are having severe
solvency problems of their own, ala GGP.

This
lists in detail all recent and upcoming debt maturities on consolidated and
unconsolidated properties.It also lists
other notable debt.It lends further
credence to the view that lenders are taking a wait and see approach.

Only 2
consolidated malls, Provo Mall and Spokane Valley Mall, were successfully
refinanced with more than their prior debt balance.One unconsolidated mall, Altamonte, was also
successful in this regard.However these
malls are very small relative to total debt coming due, and negligibly small
relative to the Palazzo and Fashion Show data points above.

Wait and see
approach of the senior bridge facility lender seems more like a desperation
move on a failing investment than anything else.

GGP had a serious problem with their Senior Bridge
Facility.In Q1 2008, after an $882M
equity offering and presumably a concerted refinancing effort, GGP still had
$522M due on the Senior Bridge Facility alone, coming due in July 2008. (Click to enlarge)

According to GGP’s
Q1 2008 note on their Senior Bridge Facility, GGP was able to amend the
terms on the bridge facility to reduce the principal from $522M to $350M,
"substitute previously unsecured properties for the pledge within the
collateral pool", and acquire the right to extend the maturity date for
another 7 months, to January 31 2009. Why is this lender simply accepting a
materially worse loan agreement at a time when GGP is obviously in a financing
bind?

Whatever the case may be, this activity appears very
peculiar, and is very much out of the ordinary – what lender reduces the
principal on a very large loan? Typically,
principal is lowered in distressed/workout/bankruptcy situations in which the
lender is attempting to salvage what could be partial or total loss, not while
the company is still very much alive, trading at a relatively high multiple off
of its normalized free cash flow.
Needless to say, reducing principal is something we see only at
companies with very weak balance sheets, and supports the notion that GGP’s
balance sheet is in dire straits.

{mospagebreak}

What we do know is that Citigroup appears to be entangled
with GGP on multiple levels already – they loaned the Bucksbaum family $88M to
buy stock in the recent equity offering, then removed the third party pledge on
the Bucksbaums' shares as collateral.
Whatever is prompting Citigroup to accept a weaker position there could
be prompting Citigroup to accept a weaker position here – lowering the
principal amount on a bridge facility by $172M, AND providing a debt extension
of 7 months.My belief is Citigroup has
a lot to lose, economically and reputationally, if GGP were to fall into
bankruptcy.Citi was 1 of 2 companies who
bought into the $1.5B convertible debt offering, and is probably earning large
fees off of banking relationships and fees associated with GGP’s debt
issuances.Citi may own a substantial
portion of GGP’s secured loan portfolio, but this information is not readily
available.Citigroup clearly would lose
economically, and get bad press for being associated with another failed
institution.

On
November 9, 2004, MB Capital Partners III entered into a loan agreement with
Citigroup Global Markets to provide credit facility of up to $500 mn. Although
initially the loan agreement was to finance the exercise of warrants for
financing the acquisition of The Rouse Company, it was subsequently amended to
finance purchase of shares by MB Capital. On October 31, 2007, Citigroup
extended the loan to MB Capital at a very nominal rate of interest of LIBOR
plus 50 basis points suggesting the possibility that Citigroup might be helping
MB Capital finance purchase of GGP’s shares. In addition to abnormally low rate
of interest being charged for the transaction, the loan agreement was amended
subsequently terminating third party pledge of shares of common stock held by
John Bucksbaum and Matthew Bucksbaum further raising concerns about the entire
financing deal between Citigroup and MB Capital.

Another peculiarity is the lack of mention of this very
important detail.GGP had $522M coming
due in a mere 4 months, and was able to reduce that principal payment by $172M,
but gave no mention to this fact in the conference call or press release.And no rationale for this was stated in the
10Q.This is a very material lack of
disclosure which GGP needs to clear up.

Apparently, though
GGP has not stated as much, their revolver got effectively pulled.

GGP had $429.2M drawn on its revolver as of Q4 2007.Even though the revolver expires in February
2011, GGP paid it down to $0 this Q for an unannounced reason (look to the
bottom of this
table for data on the revolver).

Given
that the interest rate was a fairly reasonable 6.6%, the only logical rationale
is that GGP had to – that it had effectively gotten pulled.Again, this is not a vote of confidence, and
further constrains GGP’s already strained balance sheet.

This further complicates the issue regarding the Senior
Bridge Facility.Why would GGP pay down
the revolver by $429M and leave the $522M Senior Bridge Facility untouched,
when the revolver matures in 2011 and the Senior Bridge Facility matures in
July 2008?There are clear red flags
here which have not been explained, but have been given zero disclosure.

GGP in its last
press release on March 21, 2008 related to financing activity had promised investors
to provide an update of its major financing transactions as and when they occur.
However, the company has not come out with any press release since then
suggesting it has not negotiated any financing deals. As per the company’s last
press release, it had raised a debt of $1.3 bn towards properties which had
existing debt of $0.6 bn thus generating excess proceeds of $0.7 bn to purchase
The Shoppes at Palazzo, to make contributions to JV’s, to repay existing debt
and for general operating expense leaving the company to raise additional
financing of $2.2 bn and $3.3 bn in 2008 and 2009, respectively.

It appears that
someone got nervous enough to force GGP to post a lot of additional guarantees

This
graph unambiguously implies that something happened in Q1 2008 which
prompted counterparties with GGP to force additional collateral and guarantees to
be posted.Exactly what has not been
stated.

Below is a table which provides historical perspective:

GGP mentioned having to post an appellate bond of $134M in
Q1 2008, which is basically the money they had to set aside because they lost a
lawsuit which requires them to pay $90M.
As a side note, they had to put up cash of $67M as collateral. Even when
adjusting for the appellate bond though, we clearly see additional forces are
at work which have prompted a 54% increase net of the appellate bond.

Once again, little disclosure.Reading between the lines though, it is clear
that counterparties are tightening standards with GGP.

{mospagebreak}

For all that GGP has
said it has done, there is MORE debt due in 2008 this quarter than there was
last quarter.

At the end of Q4 2007, GGP had $2.6B of debt maturing in
2008.At the end of Q1 2008, GGP had
$2.8B due. Debt due in 2009 was $3.3B at the end of Q4 2007 and Q1 2008.Even though GGP spoke highly of the progress
it has made on the refinancing front, and even though it raised $821 in equity
capital in the Q, there was literally negative progress during Q1 2008.

This table allows us to see the evolution of debt due in
2007, 2008 and 2009.It also allows us
to compare how the debt due in the following 2 years considerably more
difficult now than it was a year ago:

This
link extends these figures backwards to Q3 2005, and further substantiates
these views (numbers above have been adjusted as reported by GGP, the numbers
below are from a 3^rd party and are unsubstantiated – but then again
so are the reported numbers!).

GGP has since then stated that it raised $325M in mortgage
refinancing.This leaves a lot of short
term debt still on the table, primarily due to the large amount of debt which
was extended to November 2008.

GGP was funneled
$64M in “loans” from unconsolidated affiliates this Q, and now has $164M of
“retained debt” which is in excess of GGP’s pro rata share, but doesn’t show up
on GGP’s balance sheet.

GGP is liable for $163M of debt in its unconsolidated
affiliates in excess of GGP’s pro rata share through the normal course of
business. This debt is labeled "Retained Debt" and is indeed real
debt for GGP, but is instead recorded on GGP's balance sheet as a reduction in
the net carrying value of the unconsolidated affiliates. Thus, the balance
sheet under-represents the debt that GGP has.

As stated in GGP’s Q1 2008 10Q:

‘In certain
circumstances, we have debt obligations in excess of our pro rata share of the
debt of our Unconsolidated Real Estate Affiliates (“Retained Debt”). This
Retained Debt represents distributed debt proceeds of the Unconsolidated Real
Estate Affiliates in excess of our pro rata share of the non-recourse mortgage
indebtedness of such Unconsolidated Real Estate Affiliates. The proceeds of the
Retained Debt which are distributed to us are included as a reduction in our
investment in Unconsolidated Real Estate Affiliates. In the event that the
Unconsolidated Real Estate Affiliates do not generate sufficient cash flow to
pay debt service, by agreement with our partners, our distributions may be
reduced or we may be required to contribute funds in an amount equal to the
debt service on Retained Debt. Such Retained Debt totaled $162.7 million
as of March 31, 2008 and $163.3 million as of December 31, 2007, and
has been reflected as a reduction in our investment in Unconsolidated Real
Estate Affiliates.’

Somehow, Retained Debt remained flat in Q1 2008 while GGP
received $64.4M in loans from its subsidiaries in this Q alone.Whatever the case may be, GGP is receiving
liquidity from its own subsidiaries, which is not something a healthy company
would do.

Cutting its
development expenditures but already very fully exposed to construction loans
risk.

GGP cut its future development expenditures by $600M – a
very considerable sum of money – and will be spending a revised $1.5B through
2012.GGP is now trying to conserve as
much cash as it can.

As a result of likely difficulties
in meeting its re-financing needs, we expect GGP to slowdown on its capital
expenditure towards maintenance and development activities which could result
in loss of future expected revenue stream. This is serious in view of the fact
that future revenue stream is being sacrificed due to current liquidity problem
the company is facing. And this is only going to prolong the recovery process
for the company, if one is to sound a little optimistic under the current
scenario.

GGP has $1.35B in loans for numerous projects in
development right now. Bernie Freibaum says “we
currently anticipate that during the fourth quarter of this year, and
continuing into the beginning of 2009, we will obtain construction financing.”However it has been made abundantly clear in
the press and by the FDIC that construction loans will come under heavy
pressure as commercial banks scale away from this lending. If that doesn’t
convince you, then just remember that Reggie Middleton sounded the alarm on
construction lending. Here's a few snippets from the Asset Securitization Series on my blog .

Large exposure in Construction and Development (C&D) loans: Of
its total loans of $386 bn, Wells Fargo (WFC) had $19 bn exposure in
construction and development loans in 1Q2008. WFC’s exposure was the
fourth largest among all US banks in absolute amount after Bank of
America, Wachovia and BB&T, comprising nearly 36% of its
shareholder’s equity (this is unadjusted for bullsh1t).In
1Q2008, C&D loans witnessed the highest stress with NPA to loan
ratio of 2.32%, followed by real estate 1-4 family first mortgage with
NPAs to loan ratio of 1.91%. C&D NPAs (Non-performing or dead
assets) witnessed a 114% increase over 1Q2007 and 38% increase over
4Q2007. In Wells Fargo loan portfolio, as of December 31, 2007
California represented nearly 32% of total C&D loans, Florida
represents 5%. These areas are experiencing extreme stress due to thier
high (the highest in the country) residential delinquency, foreclosure
and REO rates.

We can compare WFC to Popular Bank:

{mospagebreak}

This is the nitty gritty on Sun Trust Bank:

Increasing NPAs and charge-offs are on a very strong uptrend in
just the one past year, one that cannot and should not be ignored:

STI's nonperforming assets (NPAs)
as a percent of loans have been increasing consistently over the last
few quarters, having gone up to 1.88% in 1Q08 from 0.64% in 1Q07 - considerable 294% increase.

Non-performing loans in real estate construction category have
recorded the most significant upward movement from 0.39% of total real
estate construction loans in 1Q07 to 4.01% in 1Q08 - a NIGH UNBELIEVEABLE 1,028% increase!

Basically, every regional lender with significant exposre to C&D thoroughly regrets it. Banks such as Corus look even worse. This segment went into OVERKILL mode to communicate the point that the aforementioned statement rings false. Let's replay it for the sake of effect: GGP has $1.35B in loans for numerous projects in
development right now. Bernie Freibaum says “we
currently anticipate that during the fourth quarter of this year, and
continuing into the beginning of 2009, we will obtain construction financing.”

Exactly who will they be getting these construction loans from????!!!

The head of the OCC and the FDIC have both basically said
there will be rising failures in the industry. Says Dugan, the head of
the OCC: "There will be more frequent interaction between supervisors and banks with concentrations in CRE loans that are declining
in quality," he said. "There will be more criticized assets;
increases to loan loss reserves; and more problem banks.
And yes, there will be an increase in bank failures (link).”He has also said
that US
bank failures could rise above “historical norms” due to a weakening economy
and poorly underwritten loans.Sheila
Bair, the Chairwomen of the FDIC, says these construction and development
(‘C&D’) loans are “one of the chief risks to the banking industry” (link).Commercial real estate (‘CRE’) loans have
risen rapidly as a percentage of bank Tier 1 capital, especially for mid-sized
banks.Dugan himself states some of the more
startling loan exposure statistics –

·
Over 33% of community banks have CRE
concentrations exceeding 300%+ of capital.

·
More than 60% of Florida banks have CRE exposure exceeding
300% of capital.

·
50% of Florida
banks have C&D loans alone which are over 100% of their capital.

Even David Simon, CEO of Simon Property Group, has said “there are a
lot of broken projects out there,” and that “the floodgates … are just going to
begin to open… we’re going to end up dealing with the construction
lender.”

According to Taubman Centers, these commercial banks have
been the primary source of funding for mall REIT’s.Taubman is glad that they don’t have to tap
the market at this time because it is almost completely frozen.

According to the FDIC, the number of insured institutions where
construction loans exceed total capital has more than doubled from 1,179 in 1Q
03 to 2,368 in 4Q 07. This indicates that financial institutions have
relied on external finance to achieve the level of growth in lending, which
multiplied the concerns at the time of the crisis.

Source: FDIC

Increased loan charge-off and
rising NPAs of commercial losses is indicating at increasing squeezing
liquidity conditions in the credit market. The problem appears to only aggravate
from the present level given that even consumer and construction loans, once
considered to be untouchable by subprime and financial crisis, have been
confirmed to come under the scanner of current financial market turmoil. Many
commercial banks, which have not witnessed increases in their net interest
margin over the last few months of declining Fed interest rate, could face
testing times if Fed decides to raise interest rate to combat inflation.
Insolvency could become a real scenario for banks facing declining asset value and
rising charge-offs on their loans.

Bernanke comes to the rescue that doesn't, and it bodes ill for C&D banks, and even worse for GGP!

Federal Reserve chairman Ben Bernanke has spearheaded the most
aggressive rate cutting and monetary policy action in the history of
this country. He has reduced the effective federal funds rate by nearly
50% in just 5 calendar quarters, from an already relatively low 5.3% to
2.6%.

History's most aggressive rate cutting does nothing to help sick
banks. As a matter of fact, some of the banks got sicker after the rate
cuts.
Click any graph to enlarge to a full page, print quality presentation.

The primary reason why the Fed's lowering of the interest rates is not
helping the banks is because monetary stimulus via discount windows and
low interest rates can solve liquidity issues, which the banks have -
but the banks liquidity issues stem from INSOLVENCY,
and illiquidity. Thus, all the Fed is doing is taking a pricey, risky
(inflation and weakening currency that pisses off our trading partners)
and volatile band aid and applying it to deep and gushing wound. Those
band aids with the pretty colors do indeed tend to make Mama's baby's
little boo-boo feel better, but from a scientific perspective do very
little in regards to addressing deep puncture wounds. Hopefully, the message has been conveyed that there are no intelligent bankers currently giving C&D loans at a level that will satisfy GGP's needs. If banks are insolvent, and GGP is overleveraged and choking on debt coming due, who will come to the aid of GGP?!

{mospagebreak}

Generating all the
cash it can from lease termination income.

Lease termination has been accelerating rapidly the past 3
quarters in a row.This
table details the evolution of lease termination income.Note that back in 2006 there was 1 quarter
which matched the current high level of LTI.
Back then, GGP was proud that they were boosting income and churning the
portfolio.Now, we have seen 3
consecutive quarters of increasing LTI, with no commentary until Q1 2008.

In Q1 2008, LTI was $21M, up 462%.In Q4 2007 it was $17.2M, up 360%.In Q3 2007 it was $10.9M, up 265%.All figures are healthily larger than the
comparable fees at TCO and at SPG.
Moreover, fees went down for TCO and SPG in Q1 2008 while they went
dramatically up for GGP.If GGP did
indeed have a liquidity crunch on its mind, it would make sense for GGP to push
as hard as it could on lease termination income, because these fees are large
up-front payments that typically represent 2 years worth of rent.

While lease termination income
could contribute to ease liquidity problems for GGP in the short-term, it would
also mean lower recurring rental income in the future. Further, new lease
arrangements, which are most likely to be entered at lower rentals amid
declining consumer spending and lower retail sales, would only lead to decelerating
rental income growth which is its core income and primary value driver (read lower equity valuations). Put simply, GGP is robbing Paul to pay Peter.

Peculiar repetition
from the CFO about GGP’s “not doing a fire sale.”

Bernie Freibaum has now stated 3 times that GGP will not do
the equivalent of a fire sale.In the Q1
2008 conference call he said:
“There is no fire sale being conducted,
there is no need to do a fire sale.”
In a recent interview in the Wall Street Journal, he said "there are no distress sales going on”
when referencing a potential de-leveraging deal.However, why would GGP specifically state
that it is not doing a fire sale if it truly had no fears about a fire sale?Here are my team's analyses of GGP in an asset sale scenario and foreclosure scenario:

• GGP: Foreclosure vs Asset Sale
• GGP Refinancing Sensitvity Analysis
• GGP part 7 - Share value under the foreclosure analysis
• GGP part 8 - The Final Anaysis: fire sale of prime properties

This talk of fire sales and distress sales follows on the
heels of a press release put out by GGP on Saturday January 19^th
2008 at 9:19pm titled “General Growth Responds to Recent Statements in the
Press and Blogs”, in which GGP states: “The
Company is absolutely not in any danger of having to contemplate a bankruptcy
filing, and the Company unequivocally has no intention of doing so.”A company which is in a healthy financial
condition would not say something like this.

The press mentioned in the late night weekend release referred to the
journalist Hank Greenberg and the blog reference was aimed at the most
handsome, the most knowledgeable, yours truly:

• My Response to the GGP Press Release, which seems to respond to blogs...
• For those who were wondering what sparked that silly press release from GGP...

GGP’s specific use of the phrase ‘fire sale’ is
interesting.On April 7^th
2008, Centro Property Group was mentioned a similar phrase in a Wall Street
Journal article:“At least
five suitors have submitted preliminary bids to purchase the entirety of Centro
Properties Group, but the cash-strapped retail-property concern isn't resigned
to selling itself at a fire-sale
price, according to people familiar with the situation.”This does not put GGP in good company.

The CMBS market,
GGP’s primary source of capital, has completely shut down.

Much has been written about the complete shut-down of the
CMBS market.This
provides a summary of some of the many market participants that have reduced
their CMBS exposure (including companies that have been featured in here, particularly Wells Fargo and the Street's Riskiest Bank - both of which I stated have outsized CRE exposure).Prudential has
stated that they have left the conduit-related CMBS business. Wells Fargo
suspended originating commercial real estate loans for securitization until the
market improves. Morgan Stanley has been actively reducing its CMBS and
commercial real estate exposure.As this WSJ article
notes, the inability of commercial banks to sell into the CMBS market at a
reasonable price has forced the banks to simply hold these loans on their
books.

Problems in the CMBS market have been
deeply aggravated over the past 4-5 months. Although the company has announced
its plan to fund its debt refinancing needs from CMBS issuances, one can only raise
more doubts than gather assurance over the plan.

GGP’s focusing on
life insurance companies, which, according to TCO, are not a capital source you
want to be relying on.

Taubman Centers, a competitor to GGP, has called life
insurance companies a cumbersome source of capital with fixed capacities for
real estate deals.It has also been said
that anything north of $100M is simply too large for life insurance
companies.In these market conditions, it
may be a little bit of a stretch to expect life insurance companies to expand
their allocation to real estate, implying GGP would have to muscle its way into
the market by grabbing market share.

AIG on May 8^th 2008 announced that it would take
an $8B writedown and do a $12B capital raise.
They are clearly not on sound financial footing, so are we to expect
them to dramatically increase their activity in CRE?

Again, Prudential
Financial is exiting the conduit-related CMBS market – they are moving away
from the market, not towards it.Wells
Fargo suspended originating CRE loans for securitization.Merrill sold its CRE lending business.Morgan Stanley is actively reducing its CMBS
and CRE exposures, with Lehman facing a near run on the bank and Bear Stearns has already collapsed!The funding
environment is evaporating - quickly!

GGP co-invested $88M
using money borrowed from Citigroup, potentially to compel others to participate in an $880M
equity offering.

While the mechanics and legality behind this transaction
are discussed in further length later in this analysis, this act is peculiar
purely from a fundamental business standpoint.
It is often the case that executives co-participate in offerings to
signal confidence in the stock at the time of the offering.That being said, why would GGP’s management
term borrow $88M, from Citigroup in relatively short term debt no less, to
co-participate in a rights offering?

On March
24, 2008 GGP announced the sale of 22.9 mn shares at $36 per share with total
proceeds of $821.9 mn to repay its revolving credit facility and other debt,
and for general corporate purposes. The above offer which was closed on March
28, 2008 included sale of 2.4 mn shares sold for total proceeds of $88 mn to MB
Capital Partners III, an affiliate of and John Bucksbaum, CEO of GGP, and
Matthew Bucksbaum, the company’s Chairman Emeritus. Using the credit facility
provided by Citigroup, MB Capital had purchased 10.09 mn GGP shares
in open market between August 3, 2007 and August 20, 2007. Subsequently in
March 2008, MB Capital used the loan to finance the purchase of $88 mn worth of
GGP shares, bringing into serious questioning the motives of Citi group's financing of the share
purchase agreement.

GGP’s operations
were not self funding in Q1 2008.

GGP generated FFO of $223M.
It spent $151M on dividends, and another $88M on maintenance capital
expenditures.Reversing out $16M of
excess lease termination income and we are left with negative $32M.It is only fair to reverse out $3M of excess
bad debt expense relative to historical averages in 2005 and 2006, which puts
GGP’s normalized cash outflow at $35M per quarter right now, without any
further possible deterioration in operating fundamentals or interest rates.

It is also apparent that GGP will have a run on its income orientated investors, for GGP Can't Afford its Dividend! The divident is currently being financed, and cannot be paid out of insufficient operating capital.

{mospagebreak}

Item 2 - One-time
items are holding up deteriorating core operational performance.

Summary

From a number of standpoints, it appears clear that GGP’s
core operations are deteriorating.

The Rouse Company, which GGP acquired in 2004, is far less
profitable than it was last year at the operating level.Occupancy costs as a percentage of its
tenants’ trailing twelve months sales are trending upwards, which will
increasingly exert downward pressure on rates.
Lease termination income, peculiar land assessments and fluctuations in
bad debt expense artificially propped up profitability in Q1 2008, but FFO
growth will slow to 0% in Q2 2008.This
does not bode well for the future.
Finally, the business model of shopping malls is getting attacked on
multiple fronts.

The Rouse Company,
which tripled GGP’s size in 2004, is far less profitable than it was last year
at the operating level.

At the end of the Q1 2008 10Q, GGP provides the performance
of The Rouse Company ('TRC'). As we can see, revenue decreased from $354M to
$348M. Operating income was slightly up, from $102M to $120M, but because the
operation is not self funding (like GGP as a whole), TRC was forced to borrow
more. Total debt in this Q alone rose from $9.5B to $9.7B, prompting interest
expense to rise from $108M to $124M. As a result, net income dropped from $295M
to a mere $5M.

REIT investors may scoff at actually reading the balance
sheet and income statement, but even adjusting for D&A, this was still awful
performance. Net income plus D&A plummeted from $394M in Q1 2007 to $91M in
Q1 2008.

This is the asset that tripled the size of the company in
2004? What is especially peculiar is that this entity has total assets of
$15.9B and total revenues in the Q of $348M, while GGP as a whole has total
assets of $29.5B and total revenues in the Q of $830M. TRC, then, is
responsible for 54% of GGP's assets, but 42% of its revenues. This is clearly a textbook example of investors binging during an asset bubble on cheap and easily available credit, only to find they grossly overpaid and made a strategic mis-step.

Artificial benefits
from land value assessments, lease termination income and bad debt expense.

It just so happens that lease termination income was up
$17M year on year, bad debt expense was down $3M year on year, and the value of
GGP’s land was revised upwards by approximately $21M in the quarter.All helped boost GGP’s stated financial
performance in the Q, but were extraordinary in nature.

The peculiar upward revision of the value of GGP’s land
position, which includes a heavy chunk of business in Las Vegas, was cited in the Q1
2008 conference call.This
explanation does not appear to be particularly convincing, given its heavy
reliance on “long term projections”, even if they are at the expense of the
current weakening operating environment.

‘Michael
Gorman - Credit Suisse

Thank you. Bernie, actually, I had a
question on the NPC business. Could you just walk me through some of the
adjustments in the estimated value of the assets there? I guess I was a little
bit surprised to see it go up given the impairment charge that you took at Columbia last year. Can
you just talk about, was that entirely offset by Texas? What is your view on Vegas at this
point? Was that flattened evaluation? And I guess where are the numbers are
going there?

Bernard Freibaum - Executive Vice President
and Chief Financial Officer

The valuation of land that's being
developed over 30 years is very different process than valuing unsold homes for
example, if you're a builder or even lots owned by a builder who has obviously
got them in inventory. So the valuation process involves a long-term cash flow
model with numerous assumptions (think level III accounting for REITs), and this is what we use both for this annual
evaluation as well as a re-valuation and effect every quarter to determine how
much of our cost is attributable to land that it sold for booking profit. We
did have a write down in Columbia
and Fairwood fairly significant one but the total holdings there and the book
value attributable to that land is low. So, the land in Vegas and Houston did
make up for the reduction in the value of Columbia
and Fairwood. Houston,
the Woodlands and Bridgeland are two of the best projects in the city… And, the
way the model works, if you do a 20 or 30 year long-term projection and you
consider the net price of value of all that activity, you get a number and
despite the soft current environment for housing including in Summerlin because
builders have excess inventory.”

Reggie's take: This is Bullsh1t, to the sh1tieth degree! I am flabbergasted that no analysts took them to term on this. I guess I will have to attend the next conference call in person! Think about this... You buy up a bumch of property in the desert at record prices that was dirt cheap (no pun intended!) just last decade, then as the market totally collapses you decide to use long term forecasting and subjective assumptions in an attempt to wring "theoretical" value out of "real" land losses. Tell, me, why can't the home builders do this with their rental, condo and community properties? All they need to do is say they are going to sit on it long enough and hope the market turns around hard enough and long enough to recoup their losses. The banks have tried this with their MBS and CDOs, and it just didn't work. Land is a lot less complex than theoretical math model based CDOs and derivatives, hence the bullsh1t should be easier to smell.

Occupancy is
trending downwards, while comparable sales were almost flat.

For the first time in at least the last 4 quarters, year on
year occupancy decreased while tenant sales have remained flat.As a result, occupancy cost ascended as a %
of sales to the highest levels GGP has ever recorded, at 12.8%.This table provides historical context:

The outlook on retail sales for the remainder of 2008 does
not appear to be good as we are heading into a recession, if not already in one. This does not bode
well for GGP’s ability to raise rents further, or even hold them steady for there is already tangible evidence of weakening rents in both the stronger and weaker markets.

FFO growth will slow
to 0% in Q2 2008.

GGP has stated that they expect Q2 2008 FFO to be flat
relative to Q2 2007.As Bernie Freibum
stated: ‘Please note that in the first
quarter of 2008, we produced $0.11 of the total estimated range of $0.55 to
$0.61 of full-year 2008 core FFO per share improvement. Due to timing
differences, we currently expect a flat second quarter.’Bernie doesn’t elaborate into what these
timing differences actually are, leading me to believe that this flat sales performance
is not extraordinary in nature.This
lends further support to the one-time nature of the growth that we saw in Q1
2008, and is not reflective of core fundamental strength.

Mall REITs are
pulling back on development plans

As stated in recent
articles, the long lead time involved in the construction of malls has
created a large amount of supply which will be hitting the market in 2008.This may prove to be untimely, and does not
bode well for absorption of the space.

At the same time, executives at some major mall REITs have
become markedly more cautious in their guidance and outlook.At a recent conference, the CEO of Glimcher
Realty Trust was quoted saying "I'm not afraid for '08 [results], … Where
you get nervous is thinking about '09. Retailers are clearly opening fewer
stores, and they're being more aggressive" in negotiations with landlords.

Current economic
realities will challenge the shopping mall business model

Consumer spending in shopping malls has a few pre-requisites:

1. ·
   It often requires individuals to drive long
   distances for the sole purpose of going to the mall
   
2. ·
   It requires discretionary income, given how
   large apparel sales are as a percentage of total mall sales
   
3. ·
   It requires consumers to pay a premium for the
   mall experience and the enclosure itself, as goods in shopping malls command a
   premium to comparable goods that can be purchased through other distribution
   channels
   
4. ·
   It is predicated on retailers being able to
   source their goods, often manufactured overseas in countries like China,
   cheaply
   

This business model is coming under attack on multiple
fronts.

1. ·
   The high price of gas makes it a lot more
   expensive to take that trip to the mall, especially if the sole original
   purpose was mall shopping
   
2. ·
   Discretionary income is getting hit on multiple
   fronts – labor wages aren’t keeping up with inflation in the price of necessity
   goods, unemployment as defined by total hours worked is on the decline, the financial
   system is in the process of de-levering itself and tightening its ability to
   fund consumer borrowing
   
3. ·
   Consumers may have been more willing to pay a
   premium for the mall experience when times where good, but that proclivity is
   attenuating as discretionary income shrinks
   
4. ·
   Weakness of the dollar relative to our major
   trade partners, and inflation in the cost of goods for our trade partners, is
   causing the price of the goods they export to the US to rise
   

On top of this, as noted above, the un-levered returns
associated with mall properties is such that large amounts of leverage are
required for a reasonable return on equity.
As the CMBS market has shut down and credit tightens, the ability to tap
the debt markets also lessens.

On multiple fronts, the shopping mall business model is
coming under attack.

{mospagebreak}
Item 3 - Evidence
that GGP is misrepresenting itself and breaking securities laws

The analysis below
supports the conclusion that GGP may have misrepresented itself.

Abstract

General Growth
Properties (‘GGP’), the 2^nd largest mall REIT in the United States,
appears to have withheld very material, necessary financial information from the public
while engaging in a number of peculiar or financially aggressive
transactions.This apparent lack of disclosure is in direct contravention to conservative securities practices, to say the least and there may even be even serious violations
which have been masked by non-disclosure.
The incentive structure in its current state encourages risky behavior.

As an outsider, one can not know for sure, but it is plausible to assumet that the primary goal behind
the alleged non-disclosure and financial aggressiveness is to inspire artificial
confidence within the capital markets, to aid their capital raising needs over
the next 2 years.GGP has been the subject of 4 prior SEC
comments¹, so this would
not be the first time GGP has been questioned over its accounting
disclosures.

The primary questionable
or aggressive financial actions are as follows:

(1)
Beginning
in August 2007, the family which founded and has run GGP started borrowing
heavily against tax-advantaged family trusts with non-recourse debt from
Citigroup Global Markets (CGM) to directly purchase GGP stock.
As of March 2008, total borrowings by the family trusts in question
amount to $588 million, implying a debt to capitalization of approximately 22%
at current non-distressed price levels.
This very aggressive behavior has been a red flag in the past –
precedents include WorldCom, Global Crossing, Safeguard Scientific, Benton Oil
and Stamps.com². The founder, the Chairman, the CEO, and the
20% majority owner of GGP all originate from this one family, which makes this
leverage all the more troubling
due to its high level of concentration.

GGP had 266.8 mn
shares outstanding as of March 28, 2008. Of this the three trusts, GTC, MB
Capital Partners III and MB Capital Units, together hold nearly 26.8 mn shares
taking their aggregate voting rights to 10% of outstanding shares. In aggregate
Bucksbaum Family along with its trust own 12.1% of GGP’s common stock. In
addition, above trusts collectively own 45.2 mn units fully convertible units
for one-for-one basis taking their aggregate potential voting rights to 24.8%.

(2)
Matthew
Bucksbaum (‘MB’) – GGP’s Chairman Emeritus, founder and ex-CEO – appears to
have legally distanced himself from this financial arrangement. He divided the trusts which name him as the
President or Trustee from all other trusts when GGP borrowed its first $500
million to buy GGP stock in August 2007.
He stepped down from the Chairman position 2 weeks later. In March 2008, when MBCP borrowed an additional
$88 million to buy more GGP stock in an equity offering, he pulled these
entities directly associated with him completely out of the trust structure
doing the borrowing on a one-for-one basis.
It is unclear why he would distance himself in this fashion, and appears
to be a red flag.

(3)
CGM
appears to be engaging in non-arms length transactions with GGP. The
original $500 million loan that CGM extended to GGP in August 2007 was at an
interest rate of LIBOR plus 50 basis points, which itself seems cheap given the
debt to capitalization, the lack of diversification of the underlying
portfolio, and the lack of collateral.
The terms got substantially laxer when MBCP borrowed an additional $88
million 7 months later. Given the higher
risk associated with the additional loans in addition to the extreme financial straits that Citibank itself is in, it is very peculiar that CGM would
materially ease the lending terms, implying there are undisclosed complicating
factors.

The primary material items which
have not been disclosed are as follows:

(1)
Omitted
loan agreement in their April 1^st 2008 13D/A, which was supposed to
be filed as an exhibit.GGP states
in the 13D/A itself that it will include the revised Loan Agreement as an
exhibit.That exhibit was not included
in their filing with the SEC.Without
this information, public shareholders are left in the dark on a transaction
with has materially diluted their residual claim on GGP’s cash flow.

(2)
Very
opaque information regarding the counterparties that bought 6.9% of the diluted
shares outstanding in an equity offering completed in March 2008.It is extremely unusual for a company to
be so opaque regarding participants in an equity offering, which leads one to
question why they have chosen the path of non-disclosure.

(3)
In GGP’s
press release over the March 2008 equity financing, GGP’s CEO emphasized his
co-participation in the offering but did not disclose the low-cost loan from CGM
mentioned above.

(4)
Bernie
Freibaum (‘BF’), GGP’s CFO, and his wife have bought an unexplainably large
amount of GGP stock personally since December 2001, at $82.3 million.Purchases of this size are unexplainable
through a reasonable look at Bernie Freibaum’s historical income streams, implying a
material lack of disclosure of the vehicle or method through which he financed
the purchases.

Below each of
these points in are supported in further detail.

Background Information – Summary of Events and Facts Around the Time of
the Claims Made Above

The Bucksbaum family
owns substantial amounts of GGP stock within a series of trusts, most of which
collectively fall under MB Capital Partners III (‘MBCP’).On April 1^st 2008, this share
ownership totaled 69M shares, or 22% of the outstanding stock.

In early August 2007,
GGP had received an SEC comment inquiring about line items in GGP’s latest
10K.GGP had also missed guidance in its
latest earnings release.On August 2^nd
2007, GGP’s management amended a prior agreement with CGM so that it could
borrow $500 million and invest it directly in GGP’s stock.This debt carried an interest rate of LIBOR
plus 50 basis points, and was collateralized with GGP stock and a third party
pledge on Matthew and John Bucksbaum’s (co-founder and Chairman Emeritus of
GGP, and CEO, respectively) share ownership, maturing in November 2009.The loan had no recourse to Matthew and John
Bucksbaum’s other assets.

At that time, the
family trusts were divided into 2 divisions – Division A and Division B.The President and Trustee of the Division B
entities was Matthew Bucksbaum (‘MB’), while Division A represented trusts that
did not have MB in an executive capacity.
15 days later, MB stepped down as Chairman of GGP.

By early 2008, articles
began circulating regarding GGP’s large debt load.In response to the allegations that GGP could
end up like the recently defaulted Centro Properties Group, GGP put out a press
release on Saturday, January 19^th 2008 at 9pm, titled “General
Growth Responds to Recent Statements in the Press and Blogs”.Subsequent to this press release, GGP
re-doubled its efforts on de-leveraging itself³.On March 19^th
2008, it put out a press release stating it had refinanced $1.3 billion of
mortgage notes and was in discussions on alternative methods of financing.On March 25^th 2008, GGP announced
an $822 million equity offering with an unnamed counterparty, representing 7.7%
of the then-current common shares outstanding.
GGP announced that John Bucksbaum (‘JB’) would co-participate in the
equity offering, contributing $88 million of his own funds.Without mention in the press release, JB
amended the terms to the expanded loan agreement with CGM.The March 2008 amendment allowed MBCP to
borrow another $88 million at LIBOR plus 50 basis points from CGM.The third party pledge of MB and JB’s shares
was terminated, even though the credit risk of the position presumably was
going up.Even though 6.9% of the
diluted outstanding stock was sold to a counterparty, there have been no
subsequent filings revealing the identity of that counterparty.MB also removed the Division B entities from
the trust collateralizing the CGM loans, MBCP, in a one-for-one stock swap for
the same shares outside the trust.

1- Aggressive financial action – Borrowing against MBCP

Background Information on Credit Received from CGM

MBCP originally
received a loan from CGM to finance the exercise of warrants issued in
connection with the financing of GGP’s $14 billion acquisition of The Rouse
Company in November 2004⁴.MBCP received $500 million through an
amendment on August 2^nd 2008.
It then borrowed an additional $88 million through an amendment on March
24^th 2008.MBCP now has 69
million shares, as of April 1^st 2008.Based on GGP’s stock price at market close on
April 21^st 2008 of 39.69, this implies a market value of $2.74
billion.Thus, MBCP now has a debt to
capitalization ratio of 21.5%.

Large Borrowings, Coupled with Large Acquisitions and Symbiotic
Relationships have been Problematic for Large Companies in the Past!

In the past, borrowing
heavily with stockholdings as collateral has been a red flag for corporate
malfeasance.

Bernard Ebbers, CEO of
WorldCom, borrowed heavily against his stockholdings.He ended up borrowing over $1 billion in
mortgage notes from Travelers, a subsidiary of Citigroup, and $183 million in
margin loans from Bank of America to finance the purchase of 500,000 acres of
timberland, a ranch, WorldCom stock, and other hard assets⁵.These loans
were secured against the assets themselves, in addition to Ebbers’
stockholdings⁶.Citigroup and Ebbers had a symbiotic
relationship, with Citigroup making large amounts of money off of fee income
generated by deal flow at WorldCom.Off
of the WorldCom / MCI deal alone, Citigroup earned $32.5 million in advisory
fees.Mr. Ebbers, in turn, was given
preferential access to profitable IPO allotments.Both parties had a vested interest in keeping
WorldCom’s stock price up.When the tech
bubble burst, Bank of America lost confidence in Ebbers’ ability to make good
on his margin debt.It issued a margin
call which forced immediate repayment of the outstanding debt.Ebbers’ position in the company was
substantial enough that selling the shares necessary to pay back the loan would
have inflicted additional damage to WorldCom’s stock price, creating a negative
feedback loop.This prompted him to
instead take out corporate loans from WorldCom, which led to the creation of
Section 402 of Sarbanes Oxley, prohibiting the use of corporate loans to
executives.
{mospagebreak}

There are a few
parallels between GGP and WorldCom.

-
GGP now,
like WorldCom then, is a mature, well established company within its industry.GGP is now the 2^nd largest mall
REIT in the US.WorldCom , after their takeover of MCI, was
the 2^nd largest US
long distance company.

-
Both
companies rose to prominence through acquisitions – GGP’s total assets went
up by a factor of 3.5x, from $7.3 billion in 2002 to $25.4 billion in
2004.A $14 billion acquisition in 2004
drove most of the growth.Similarly,
WorldCom’s $37 billion takeover of MCI (a company 3 times WorldCom’s size) was
the largest takeover in history.Both
companies clearly rose to prominence through acquisitions.

-
Both companies
made major acquisitions near the peak of the market cycle of their respective
markets (ex. at the top of the bubble).WorldCom’s major
acquisition was made in 1997, 3 years before the tech market popped.GGP’s major acquisition occurred in 2004, 2
years before the market popped.

-
Like Mr.
Ebbers, the Bucksbaum family is well established at the helms of their
respective companies.

-
Both
CEO’s borrowed very heavily against their stock holdings.

-
Citigroup
has a symbiotic relationship with GGP now as it did then with WorldCom.As can be seen on Citigroup’s conflict of
interest webpage, CGM has investment banking-related, securities-related, and
non-banking / non-securities-related business with GGP⁷.CGM was 1 of
the 2 Initial Purchasers associated with GGP’s $1.55 billion convertible
offering on April 16 2007⁸.As noted in the S-3 GGP filed on August 15^th
2007 when the convertibles were registered for resale, GGP noted that it had
ongoing relationships with some of the convertible holders - some are lenders,
and some provide commercial banking services on mortgage loans.It is fair to believe they were primarily
referring to CGM, who was generating fees off of GGP’s mortgage note deal flow,
fees from offerings like the convertible offering done in April 2007, and
interest income from mortgage notes it has directly extended to GGP.

Large personal
borrowings and large acquisitions, coupled with a symbiotic relationship with a
large financial institution skews the incentive structure of management
teams.GGP suffers from this combination,
as WorldCom did then.

2- Questionable financial action – MB distances himself from this
financial arrangement

Background Information on the Bucksbaum Family

The Bucksbaum family
founded and has run General Growth, in various legal forms, since 1964.Martin and Matthew Bucksbaum were the
original founders, forming the General Growth Properties REIT in 1964.In 1972, General Growth was listed on the
NYSE.By 1984, General Growth fell into
a financially disadvantageous position.
It sold 19 malls to another company and liquidated the REIT, but
continued to manage subsequently.A
large acquisition in 1989 made General Growth the second largest mall manager
in the US,
and in 1993, General Growth did an IPO to form GGP, the legal entity we see today.In 1999, Matthew Bucksbaum stepped down as
CEO and John Bucksbaum (‘JB’), Matthew’s son, replaced him.In November 2004, GGP completed the $14
billion Rouse acquisition, which established GGP as the 2^nd largest
mall REIT.In August 2007, MB stepped
down as Chairman of GGP, and was replaced by JB.

Background Information on MBCP

MBCP is a general
partnership with three primary general partners – (1) trusts for which the
General Trust Company (‘GTC’) is the trustee, whose president is Marshall Eisenberg;
(2) Matthew Bucksbaum Revocable Trust (‘MBRT’), whose trustee is Matthew
Bucksbaum (‘MB’); (3) General Growth Companies (‘GGC’), whose president is
Matthew Bucksbaum.MBCP represents a
collection of 21 individual trusts through which the Bucksbaum family has
partial ownership in GGP.

Details of the Separation of Interests within MBCP

On August 1^st
2007, the MB Capital Agreement was formed.
Through this agreement, MB Capital was divided into 2 parts – Division A
and Division B.Division A represented
the trusts which had the General Trust Company as the trustee. Division B
represented MBRT and GGC.It was agreed
that Division A was entitled to 97.375% of the assets and liabilities as of
August 1^st 2007, and 100% of the assets and liabilities thereafter⁹.By removing any pecuniary interest in the
assets associated with the August 2007 borrowings, MB’s Division B entities
took one step away from the lending agreements.

On March 1^st
2008, in conjunction with the $88 million of additional loans from CGM, a
Redemption Agreement was formed.Through
this agreement, MB removed the Division B assets from MBCP.Each share owned within MBCP was swapped for
the same amount of shares outside of MBCP.
This completed the separation of interest.

Rationale Behind the Separation

Given there was no
substantive change in share ownership and no shares were monetized or taken out
of a trust, its plausible and seems fair to believe the trusts were taken out because of
another confounding factor.One
reasonable confounding factor is that this financial arrangement exposes its
trustees to legal liability and ‘headline risk’.Another is the creation of credit risk within
the family trusts due to excessive leverage and concentration.Yet another is a
differential risk proclivity between the older Matthew Bucksbaum, who is now
retired, and his younger, more ambitious son John.It seems fair to believe that some
combination of all of these reasons may have played a part in this decision.

3- Questionable financial action – CGM engaging in non-arms length
transactions with GGP

Original Loan Terms

The original $500
million loan that CGM extended to GGP in August 2007 was at an interest rate of
LIBOR plus 50 basis points with expiry in November 2009.The loan was collateralized by MBCP’s
stockholdings, in addition to a third party pledge of the shareholdings of MB
and JB.

Compared to the
approximately 6% effective interest rate GGP itself is getting, the 3.4% rate
MBCP is currently getting is quite favorable. One would think that if managment could arrange this level of financing for concentrated collateral on a non-recourse basis for their trusts, it would be able to do so for the overall corporation, unless there are other factors involved.

Revised Loan Terms

MBCP had to revise the
original loan agreement to increase its borrowing capacity.Yet the revised credit terms got weaker, not
stronger - despite the fact that the overall credit market was much worse, the overall equity markets (collatera) got much worse, the overall CRE market was much worse (the assets behind the collateral), and the financial condition and headline risks to the lender (Citibank) was much worse off than when the first terms were negotiated. Something smells more than fishy!When MBCP went to borrow
another $88 million from CGM, the third party pledge of MB’s and JB’s shares
was terminated.Also, as noted in a
summary of the agreement, not even the entire stockholding of MBCP is held as
collateral: “Advances under the Loan
Agreement for the Purchased Shares are collateralized by certain Common Stock held by M.B. Capital, including the 2007
Purchased Shares.” [emphasis mine]
Finally, 1.5 million shares were removed from MBCP altogether as a
result of the above-mentioned redemption of Division B.Taken together, CGM (Citigroup Global Markets) has accepted a
substantially worse deal at a time when it appears they should be much, much more stringent with their lending and terms.

Note further that the
stock price performance, CRE outlook and macro environment over that time period had deteriorated, not improved,
implying that this change of terms had little to do with a change in the
fundamental outlook for GGP.The
dividend-adjusted stock price at the time of the original loan on August 2^nd
2007 was 45.27, but that the stock had dropped to 40.46 by the time of the
March 2008 offering.

A 3.4% interest rate
loan when the collateral is 1 stock, at a debt-to-capitalization of 21.5% off
of a non-distressed stock price appears to be below-market.Given that the underlying stock has the
highest leverage of all publicly traded mall REITs reinforces the perception
that this is a below-market rate.

Conclusion

Based upon this data,
it appears clear that this March 2008 transaction was not done at arm’s length,
for undisclosed reasons.This supports
the view that there is a symbiotic relationship between CGM and GGP, prompting
financial decisions which are not explainable purely through fundamental supply
and demand.

{mospagebreak}

1- Nondisclosure of required material information: Revised Loan
Agreement, April 1^st 2008

As is noted from the
13D/A: “This summary of the terms of the
Loan Agreement is not intended to be complete and is qualified in its entirety
by reference to the Loan Agreement attached as an exhibit to the
Schedule 13D.”There were 3
exhibits filed with the SEC – (1) MBCP’s Amended Partnership Agreement, (2)
MB’s Redemption Agreement, and (3) the Purchase and Sale Agreement.I have discussed at length the former 2.The latter exhibit discloses the details
driving MBCP’s purchase of 2.445 million shares of GGP stock at $36.The Loan Agreement is simply not disclosed,
even though GGP clearly states it was supposed to be disclosed.

This agreement is
important.Among other things, it fully
discloses the revised terms between CGM and GGP, including the details of the
revised collateral.This is material
information which is supposed to be available to the public, but is not.

2- Nondisclosure of required material information: Opacity on offering
counterparty

Based on news released
to the public, the counterparties in GGP’s equity offering bought 7% of the
diluted shares outstanding.Yet for some
reason, the buyers were not disclosed in the original press release.Subsequently, there were two mentions of the
counterparties – (1) in the Q1 2008 10Q, GGP stated that one of the
counterparties was FMR; (2) in the Q1
2008 conference call, GGP stated that they did the deal with ‘large
existing shareholders’, without naming names.

The equity offering as
a whole diluted the existing shareholders by 8% at a discount to the then
current price, so this was a very material transaction.I personally cannot think of any company
which has been so intentionally indirect with an equity offering.

Two questions that come
to mind are (1) why would GGP have such a policy of non-disclosure? (2) What
might have happened?At this point it is
hard to say exactly, but this does cause one to wonder.

3- Nondisclosure of required material information: Unmentioned
borrowing to fund co-participation

In GGP’s March 24^th
2008 press release over their equity financing, GGP’s CEO heavily emphasized
his co-participation in the offering: “This offering includes 2,445,000 shares
of Common Stock that are being sold to MB Capital Partners III, which is an
affiliate of Matthew Bucksbaum, our Chairman Emeritus, and John Bucksbaum, the
Chairman of the Board of Directors and our Chief Executive Officer.¹⁰”

No mention was made of
the borrowings used to fund the purchase until 1 week later, in a 13D filing
for the General Trust Company.Once
again, very important information is put in the footnotes, if at all.

4- Nondisclosure of required material information: Bernard Freibaum’s
large stock purchases

Background

$82 million of stock
were purchased by BF and his wife since December 2001.$53.9 million were purchased since August
2006.Given a reasonable view of BF’s
historical income streams, it appears that BF has in all likelihood used large
amounts of borrowed funds to purchase stock.
If true, this presents two problems.

(1)There
has been no disclosure of any borrowings made by BF, even though this is
material information.

(2)For
the same reason that borrowed funds skews the incentive structure for the CEO,
it would also skew the incentive structure for the CFO.

Historical Insider Buying

BF’s historical
purchases can be found in the Form 4’s that he has filed with the SEC.

{mospagebreak}

Historical Income Streams

We can get a fairly
reasonable view of BF’s earnings by looking at his past jobs and his
compensation history at GGP.

Compensation at GGP

All compensation back
to 1995 is publicly available in GGP’s proxy statements.It is reproduced below:

Dividends at GGP

Based on BF’s stock
ownership records, we can also approximate the dividend payments he has
received over the past 8 years.These
figures are presented below:

For the last 4 years, the CFO's dividend income from his financial transactions outside running the company has easily outstripped the income receieved from direct corporate comensation. Earlier in this missive, I claimed that GGP can't afford its current dividend! The continuation of the dividend despite the fact that it must be financed through internal sources can now be sourced to a potential conflict of interest posed by the compensatory income streams of the CFO. Do we do what's best for the company or do what's best for my brokerage accounts.

Prior Jobs

We also know BF’s prior
jobs, dating back to when he was at the beginning of his career.

-
From age 40 to the present, BF has been at GGP
as the CFO.

-
From age 39 to age 40, BF was at Ernst and Young
as a consultant.

-
From age 32 to age 39, BF was the CFO and
General Counsel of Stein and Company, a real estate development and service
company.

-
From BF’s early 20’s to age 32, BF was in
various positions at Ernst and Young, American Invesco Corporation and Coopers
and Lybrand LLP.

While serving as the
CFO and General Counsel of Stein and Company, BF received an equity stake in
the company.This, plus his cash
compensation at each of these jobs, can be conservatively estimated.A conservative assumption is that his equity stake
in Stein and Company was sold for $5 million after-tax.

Summing up BF’s Compensation

Based on the above
information, in conjunction with conservative assumptions on his pay at earlier
firms, his tax rate, and his average consumption per year, it is extremely
unlikely that BF has generated more than $32 million in post-tax,
post-consumption income.And yet he
appears to have bought $82 million worth of stock at an average cost of
47.3.There is a $50 million difference
between these two figures.While
individual assumptions may very well vary, this differential is inexplicably large.

$50 million is
substantial relative to his cash on hand.
It is also very large relative to his total net worth, even when
factoring in the value of his current share ownership in GGP.It implies that he has borrowed at least 20%
of his net worth, and probably more, to buy GGP stock.BF will be in dire financial straits if
anything was to happen to GGP’s stock, and he is already underwater on his
purchases. Thus, even if there is no nefarious plans underfoot, the CFO is under immense pressure to maintain the auspices of a healthy stock, even at the expense of true shareholder value. If there is a true lack of disclosure regarding funding sources, well then that is a totally different story with a plethora of additional and probably negative consequences.

Lack of Disclosure is a Problem

It is clearly very
material information for the public shareholders if BF has indeed borrowed 20%
of his liquid net worth to buy GGP stock.
Yet no disclosures have been made.
It is also unknown how BF has structured his ownership of GGP stock –
whether it is in a trust, or in some other vehicle.That information would be helpful to better
understand the recourse nature of any debt obligations BF may have.While the Bucksbaums have disclosed both the
vehicle through which they own their stock, as well as the leverage they have
employed (unless they have omitted other loans), BF has done neither.This is a very material lack of disclosure
which the investing public deserves to know more about.

References:

1.
SEC comments are listed below:

a.Steven
Jacobs: http://sec.gov/Archives/edgar/data/895648/000000000006031014/filename1.pdf

b.Linda
van Doom: http://sec.gov/Archives/edgar/data/895648/000095013707000165/filename1.htm

c.Robert
Telewicz:http://sec.gov/Archives/edgar/data/895648/000000000007031093/filename1.pdf

d.Pam
Howell: http://www.sec.gov/Archives/edgar/data/895648/000000000007041058/filename1.pdf

2.
‘Uneasy Money – What’s Wrong?’ Wall Street
Journal, August 1^st 2002: http://www.pulitzer.org/year/2003/explanatory-reporting/works/wsj2.html

3.
‘General Growth Shops for Partners’ – Wall
Street Journal, April 16 2008: http://online.wsj.com/article/SB120831674586718783.html.“We’re telling the market that we’re going to
reduce our leverage.”

4.
Reference Link from 13D/A filed 4/1/2008: http://yahoo.brand.edgar-online.com/displayfilinginfo.aspx?FilingID=5841123-1487-50552&type=sect&TabIndex=2&companyid=5306&ppu=%252fdefault.aspx%253fcik%253d895648

5.
Timeline of events at WorldCom: http://www.pbs.org/wgbh/pages/frontline/shows/wallstreet/wcom/cron.html

6.
Description of problem loan from Bank of
America: http://www.pbs.org/wgbh/pages/frontline/shows/wallstreet/wcom/players.html

7.
Citi Investment Research Disclosures – General
Growth Properties: https://www.citigroupgeo.com/geopublic/Disclosures/GGP.html

8.
“On April 16, 2007, GGPLP issued $1.55 billion
aggregate principal amount of Notes pursuant
to a purchase agreement (the "Purchase Agreement") with Citigroup
Global Markets Inc. and Morgan Stanley & Co. Incorporated (collectively,
the "Initial Purchasers") under which GGPLP agreed to sell the
$1.55 billion principal amount of Notes (plus up to an additional $200 million
principal amount of Notes at the option of the Initial Purchasers) in private
offerings exempt from registration in reliance on Section 4(2) of the
Securities Act. The Purchase Agreement contemplates the resale by the Initial
Purchasers of the Notes to qualified institutional buyers in reliance on Rule
144A under the Securities Act, at a price equal to 98% of the principal amount
of the Notes.” – 8K, filed 4/17/2007
[emphasis mine]

9.
“M.B. Capital
invests in the Common Stock and Units pursuant to the Second Amended and
Restated Agreement of Partnership of M.B. Capital Partners III dated as of August
1, 2007 (the “M.B. Capital Agreement”). The M.B. Capital Agreement provides for
two divisions of M.B. Capital. Division
A, which consists of trusts of which GTC is the trustee, is entitled to 97.375%
of the assets and liabilities of M.B. Capital as of August 1, 2007 and 100% of
the assets and related liabilities acquired by M.B. Capital from and after
August 1, 2007. Division B, which consists of the Matthew Bucksbaum
Revocable Trust and GGC is, entitled to 2.625% of all assets and liabilities of
M.B. Capital as of August 1, 2007.”
- 13D, filed 8/22/2007 [emphasis mine]

10.
“General Growth Prices Offering of Common
Stock”, March 24^th 2008.
Link: http://www.ggp.com/Company/Pressreleases.aspx?prid=410

[r1]The reported figure is $1105

[r2]The
reported figure is $2816

[r3]The reported figure is $2067

[r4]The
reported figure is $3540

[r5]The reported figure is $3403

So, how safe is your Doo-Doo? This installment of Reggie Middleton on the Asset Securitization Crisis (part 17) is more consumer orientated, and attempts to reveal who the riskiest banks are in the Doo-Doo 32 list that I have compiled. This should be telling, for the list itself is comprised of banks that are basically knee deep in Doo-Doo, hence the moniker (for those that didn't get it). Below is where we stand in the Asset Securitization Crisis as of this article (this may even be the makings of a best seller in the fact is stranger than fiction department of Amazon, publishing companies - you know what to do ).

The Asset Securitization Crisis Analysis road-map to date:

1. Intro: The great housing bull run - creation of asset bubble, Declining lending standards, lax underwriting activities increased the bubble - A comparison with the same during the S&L crisis
2. Securitization - dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble - declining home prices and rising foreclosure
3. Counterparty risk analyses - counter-party failure will open up another Pandora's box (must read for anyone who is not a CDS specialist)
4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
5. Municipal bond market and the securitization crisis - part I
6. Municipal bond market and the securitization crisis - part 2 (should be read by whoever is not a muni expert - this newsbyte may be worth reading as well)
7. An overview of my personal Regional Bank short prospects Part I: PNC Bank - risky loans skating on razor thin capital, PNC addendum Posts One and Two
8. Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux
9. More on the banking backdrop, we've never had so many loans!
10. As I see it, these 32 banks and thrifts are in deep doo-doo!
11. A little more on HELOCs, 2nd lien loans and rose colored glasses
12. Will Countywide cause the next shoe to drop?
13. Capital, Leverage and Loss in the Banking System
14. Doo-Doo bank drill down, part 1 - Wells Fargo
15. Doo-Doo Bank 32 drill down: Part 2 - Popular
16. Doo-Doo Bank 32 drill down: Part 3 - SunTrust Bank

This installment in the series is a little different. Here's why.

This series was started as a check and balances macro study to either support or debunk my wide ranging shorting of the US, Asian and European banking system (that's right, I believe global banking is F@#$%@, and I am willing to put my money behind my convictions, not to mention publish them across the web) and real asset related companies. The series became quite popular, and a few people have asked me if I thought their particular bank was safe, should they withdraw their funds, etc. I, as a rule, absolutely do not give out advice to the public. Even if I did I don't think anyone should be taking that type of advice from a blog, but I don't give it anyway. I even shy away from giving my opinions on certain matters because I don't want to be responsible for yelling "Fire!" in a crowded theater. Then I came across this article in the WSJ: Memorandum Agreement With Regulators Effectively Puts Banking Unit on
Probation, excerpted below -

National City Corp.'s
banking unit, which has been buffeted by rising bad loans, has recently entered
into a "memorandum of understanding" with federal regulators, effectively
putting the bank on probation.

The confidential agreement with the Office of the Comptroller of
the Currency was entered into over the past month or so. It illustrates the
growing regulatory pressure some financial institutions are under as they
struggle to deal with fallout from the credit-market turmoil.

Under such agreements, which are entered into privately and
aren't publicly disclosed, banks are given an opportunity to work with federal
regulators to address serious financial problems without triggering alarm among
depositors.

The terms of the agreement with National City aren't known.
However, regulators usually urge banks to maintain adequate capital and improve
lending standards...

... National City probably isn't alone in operating under such a
memorandum of understanding. Regulators, hoping to fend off a wave of bank
failures, have been pushing lenders to raise more capital, curtail their growth,
and improve their risk-management and underwriting practices. Banking experts
estimate that a handful of midsize banks recently have entered MOUs.

Such MOUs are agreements between regulators and bank management.
They are considered serious and are fairly rare, though it is even less common
for a bank to face a public enforcement action. If a bank receives a nonpublic
enforcement action and then resolves all of the issues in a timely manner,
regulators would likely never disclose the sanction publicly.

If a bank fails to comply with an informal enforcement action,
regulators can bring more-severe penalties -- often publicly -- to clamp down on
a company's management or operations...

I pointed out to my regular blog readers that this bank and most likely quite a few others touched by the OCC (federal oversight agency for banks) are on my Doo-Doo list . I received a few more inquiries, and thought to my self, "If it were my money in the banks, I would want to know if it was in trouble." So, after blogful ruminations, I decided to approach this from more of a consumer perspective than an investment one.

I warned on Key Corp when I posted the Deep Doo-D00 32 List. 6 days before they announced their not so surprising news, and 6 days before the stock lost 12% in a day. If you missed that article, don't worry. There is a lot more to come. But you have to be a regular on my blog to catch this stuff.

From Reuters:

KeyCorp, a large U.S. Midwest regional bank, said mounting loan losses could cause net charge-offs to double from its prior forecast, causing its shares to tumble to a new year-low.

The bank's shares were down $2.65, or 12.1 percent, at $19.30 in afternoon trading on the New York Stock Exchange. The KBW Bank Index .BKX, which includes KeyCorp, was down 3.2 percent.

In a filing late Tuesday with the U.S. Securities and Exchange Commission, the Cleveland-based bank projected full-year net charge-offs in the range of 1 percent to 1.3 percent, up from its prior forecast of 0.65 percent to 0.90 percent.

KeyCorp said net charge-offs in the second quarter and possibly the third quarter could be higher than the new range, citing exposure to residential homebuilders, and in its education and home improvement loan portfolios.

"The disclosure is bad news," wrote Scott Siefers, an analyst for Sandler O'Neill & Partners LP. "Key simply happens to be among the first so far to increase its net charge-off guidance, and as time goes on, we would expect similar deterioration to impact many others."

Many U.S. banks have struggled with mounting credit losses as the economy slowed and housing market slumped, making it more difficult for many borrowers to keep current on their debts.

This is the first of several drill downs into the list of 32 banks in deep doo-doo. Before I go on, let's outline the articles in this series thus far...

The Asset Securitization Crisis Analysis roadmap to date:

1. Intro: The great housing bull run – creation of asset bubble, Declining lending standards, lax underwriting activities increased the bubble – A comparison with the same during the S&L crisis
2. Securitization – dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble – declining home prices and rising foreclosure
3. Counterparty risk analyses – counterparty failure will open up another Pandora’s box
4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
5. Municipal bond market and the securitization crisis – part I
6. An overview of my personal Regional Bank short prospects Part I: PNC Bank - risky loans skating on razor thin capital, PNC addendum Posts One and Two
7. Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux
8. More on the banking backdrop, we've never had so many loans!
9. As I see it, these 32 banks and thrfts are in deep doo-doo!
10. A little more on HELOCs, 2nd lien loans and rose colored glasses
11. Will Countywdiw cause the next shoe to drop?
12. Capital, Leverage and Loss in the Banking System

Well, the first bank on the drill down list will also be 2nd of the banks that I will deliver a forensic analysis on (the first was PNC Bank). That bank is,,, (drum roll in the backgroud, crescendo.... I know some of you hate it when I do this........) Wells Fargo! I can hear a few of you naysayers cackling behind your computer screens as I type this. Wells Fargo is a big name brand bank (cackle, cackle)! Wells Fargo has Warren Buffet as its largest investor (cackle, cackle)! Wells Fargo this and that and blah, blah and (cackle, cackle).... All I can say is, beware of name brands (I actually felt compelled to address this in earlier posts). I have made more than a couple of dollars benefiting from name brand hubris and smaller investors who would rather be told what to do than read a balance sheet! Time will tell if I am right or not on Wells Fargo, just be forewarned - several of the banks on teh Doo-Doo 32 list have already taken a trip to the confessional! The score card for the credit crisis to date, Reggie Middleton - 10, big name brand investors - 0 (not to toot my own horn, I'm sort of a modest guy and I know I have a big mistake/loss coming soon, it just isn't going to be this one).

I actually have a lot of respect for Buffet, though. Hell of a fundamental investor and cash flow king, and charming public persona as well as being modest (at least he's got me beat). My appreciation differs from that of many, though. His investment track record is quite impressive for it stands the test of time as consistent. As a smaller, unknown investor, he was the most impressive, but now he is an icon and his very words and even a scent of investment from him actually moves markets. Even though he has a much larger capital base to work from (which makes it harder to generate large proportionate returns), his influence can be confused for investment acumen. All in all, he is one to be admired, but the investment results stemming from alpha have to be seperated from the ability to manipulate and move the market (unless that actual ability can be defined as alpha - topic for another day). We all make mistakes though, and Wells Fargo is a mistake waiting to happen. Let's walk through this company as I see it. Of course, since Wells Fargo failed to cooperate with me in releasing their numbers, I used statistical data to back into their probable delinquincies where they weren't directly available from their public filings.

Hat tip to Johnny Lay for pointing this out to me. From the Tom Brown's Bankstocks.com :

Permit me to point to some seemingly arcane (but in fact highly significant) numbers we have lately received as evidence that the worst-case scenarios concerning cumulative subprime losses being thrown around by the rating agencies, among others, are exaggerated.

Yes, you heard that right: the housing world has big problems, but it’s not coming to an end, after all.

The piece you are about to read is a follow-up to an article we posted here in February that noted, first of all, that if you want to get an early read on changes in credit quality in subprime, don’t pay attention to the number too many mortgage-industry watchers obsess over: the past-60-day delinquency rate. It is a lagging indicator of changes in credit quality.

Instead, look at two other metrics: 1) the inflows, in dollars, of newly delinquent loans, and 2) the roll-rates of problem loans from early-stage delinquency, to later-stage, to foreclosure. And on those numbers, I said at the time, the subprime picture seems to be showing signs of improvement. In particular, I made the point that dollar inflows to early-stage delinquency buckets had been falling for months.

One obvious answer to this dilemma in the "alleged" decline in subprime default metrics, as pointed out by Johnny Lay in his comment, is that "they just ain't makin' em (subprime loans) anymore". Duhh!

Well, make no mistake about my position. I am a super bear and a short seller, for now. I am also a full time investor. I will not short stocks that I feel won't go down in price. It's bad for the net worth, if you know what I mean. As for my opinion on Mr. Lay's opinion... Too many pundits harp on today's credit crisis being caused by the subprime debacle, or even worse yet calling it the "subprime crisis". It is far from such a thing. It is an asset securitization crisis, and far more shoes are dropping other than subprime. Thus, even if subprime were to get better, the banking industry will not, at least for the time being. See the full backgrounder on this top here:

Intro: The great housing bull run – creation of asset bubble, Declining lending standards, lax underwriting activities increased the bubble – A comparison with the same during the S&L crisis and here Securitization – dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble – declining home prices and rising foreclosure.

Now, as for the actual merits of the arguments set forth, I have found evidence to the contrary. Banks are not reporting late payments, delinquincies and charge offs at the rates that they were because, well,,,,, they are just not reporting them. That doesn't mean they are not occurring. The banks would rather not take the accounting and valuation hit. That does not make the bank more valuable for the loan is still defaulting, it is just that it looks a whole lot better on paper. Unethical??? Maybe. Factual??? You can bet your sensitive little tush!

Here is a little quip from the fine print in the reporting of my 32 bank Doo-Doo list : From April 1, 2008 onwards, "this particular bank on the doo-doo list has changed its home equity charge-off policy to 180 days from 120 days previously (the widely accepted industry standard). Amid current deteriorating credit markets with residential sector showing no signs of recovery, it is quite understandable that the bank has changed the policy in a bid to defer recognition of provision and charge-offs.

You see, sometimes you have to get past the indices, graphs and charts and dig down a bit deeper. My next post will be the start of the drill down into the banks of the doo-doo list. Stay tuned.

This is the 10th installment of Reggie Middleton on the Asset Securitization Crisis - a comparison of today's credit crisis to the S&L debacle.

The Asset Securitization Crisis Analysis roadmap to date:

1. Intro:
   The great housing bull run – creation of asset bubble, Declining
   lending standards, lax underwriting activities increased the bubble – A
   comparison with the same during the S&L crisis
2. Securitization – dissimilarity between the S&L and the Subprime Mortgage crises, The bursting of housing bubble – declining home prices and rising foreclosure
3. Counterparty risk analyses – counterparty failure will open up another Pandora’s box
4. The consumer finance sector risk is woefully unrecognized, and the US Federal reserve to the rescue
5. Municipal bond market and the securitization crisis – part I
6. An overview of my personal Regional Bank short prospects Part I: PNC Bank - risky loans skating on razor thin capital, PNC addendum Posts One and Two
7. Reggie Middleton says don't believe Paulson: S&L crisis 2.0, bank failure redux
8. More on the banking backdrop, we've never had so many loans!
9. As I see it, these 32 banks and thrfts are in deep doo-doo!
10. 
    A little more on HELOCs, 2nd lien loans and rose colored glasses

Will Countrywide be the next shoe to drop?

We have started on Countrywide counterparty research and are looking carefully into both BAC and CFC’s latest financial statements trying to find details on the CDS agreements which could throw some light on the counterparties and the ones who have significant credit exposure to CFC.

From BAC’s perspective, many market participants are now expecting it to renegotiate the proposed $4 billion deal for CFC acquisition at $0-$2 per share. In the first quarter of 2008, BAC’s first quarter profit declined 77% to $1.21 billion, or 23 cents a share against the market expectations of 41 cents per share. In 1Q 08, the bank has written down $1.47 billion of collateralized debt obligations (CDOs) and $439 million of loans. Furthermore, the bank increased its provision for credit losses to $6.01 billion in 1Q 08 from $1.24 billion as credit costs increased in the home-equity, small-business and homebuilder portfolios. The bank’s net charge offs almost doubled to $2.72 billion in 1Q 08 as compared to $1.43 billion in 1Q 07. These delinquincies and charge offs are understated for many banks. Those who are
feeling too much heat are doing things such as purposely
under-reporting delinquincies and charge offs, preferring instead to
let people live in their houses without paying rather than take the
accounting hit of reporting the bad news, exstending the period in
which accounts are qualified as charge offs, knowingly allowing
servicing companies to operating at a decided lag in reporting
delinquincies, etc. So far, BAC has written down $14.8 billion in credit losses and is working to replenish the capital base. In the month of April and May 2008, the bank sold almost $6.7 billion in perpetual preferred stocks which includes $2.7 billion of preferred stocks in May 2008 at a coupon rate 8.2%, and $4.0 billion in April 2008 at a coupon rate of 8.125%. The bank had also sold $6.0 billion of preferred stock in January 2008 at a coupon rate of 8.0%.

On the other hand, CFC has credit risk on its balance sheet in the form of loan portfolio, subprime securities, home equity line of credit (HELOC) securities, warranties on loans sold, and loans held outside of banking operations. At the end of 1Q 2008, CFC had a $95 billion loan portfolio comprising $28 billion of option Adjustable rate mortgages (ARMs), $14 billion in Home equity line of credit (HELOC), $20 billion in second liens, and $19 billion of hybrid ARMs

BAC, in a recent filing with the SEC mentioned that there was no assurance that any of CFC's outstanding debt would be redeemed, assumed or guaranteed.. Paul Miler, an analyst with Friedman, Billings, Ramsey, in a recent note said that BAC is likely to renegotiate the purchase price the deal in the range of $0-$2 per share, as CFC’s loan portfolio continues to deteriorate so much that it currently has negative equity. Considering that BAC is already having enough trouble to handle on its own books, it is highly likely that it may renegotiate or walk out of the proposed deal. (http://www.housingwire.com/2008/05/05/bofa-countrywide-deal/)

If the deal does not go through, a number of market players will suffer - such as the monoline insurer I analyzed a few months back (see Reggie Middleton on Assured Guaranty) as well as MBIA and AMBAC, both of whom I have performed extensive analysis and shorts on last year and the beginning of this year. See:

1. A Super Scary Halloween Tale of 104 Basis Points Pt I & II, by Reggie Middleton.
2. Ambac is Effectively Insolvent & Will See More than $8 Billion of Losses with Just a $2.26 Billion Market Cap
3. Follow up to the Ambac Analysis
4. Bill Ackman of Pershing Square - How to save the Monolines

for more info. The additional writedowns of the investment banks and their excessive leverage
puts them at risk to suspect counterparties. This was illustrated using
hedgefunds (Banks, Brokers, & Bullsh1+ part 2) and monolines. I actually used the list of Ambac clients to (successfully) look for short candidates. Assured Guaranty is highly exposed to Countrywide through HELOCs. AGO, in its 1Q 2008 report mentioned that it has a net par outstanding of $2.0 billion for transactions with CFC of which $1.4 billion were written in the financial guaranty direct segment. AGO, in its earnings call said it has underwritten some BBB rated HELOCs, the largest of which were the two Countrywide transactions in the direct segment which comprised 90% of AGO’s direct HELOC exposure.

AGO believe the possible range of losses from its countrywide exposure is $0-$100 million, after tax. Considering that a decent proportion of thee HELOCs represent the potential for 100% losses with no recoveries due to their geographic location and high LTVs, I really believe AGO is understating their exposure to loss a tad bit.

As for the other two insurers who I have alleged to be effectively insolvent last year, let's take a glance at their CDS exposure (this excludes all municipal exposue which is on the rise for risk of loss, see Municipal Credit Risk and the Asset Securitization Crisis, part 2).

The Partial Cost of Monoline ABS Failure
	Par	Equity	Exposure Ratio
Bear Stearns	$15,673,088,703	$11,793,000,000	132.90%	BSC ABS inventory
Morgan Stanley	$22,956,101,796	$31,269,000,000	73.41%	MS ABS Inventory pdf
Lehman Brothers	$3,151,328,632	$22,490,000,000	14.01%	LEH ABS Inventory
Citigroup	$8,100,028,623	$127,113,000,000	6.37%	C ABS Inventory
Countrywide	$12,639,385,566	$15,252,230,000	82.87%	CFC ABS Inventory
Wells Fargo	$4,700,835,231	$47,738,000,000	9.85%	Wells Fargo ABS Inventory
Goldman Sachs	$18,673,869,328	$42,800,000,000	43.63%	GS ABS Inventory
WaMu	$7,658,982,498	$23,941,000,000	31.99%	WaMu ABS Inventory
Merrill Lynch	$10,224,387,634	$38,626,000,000	26.47%	ML ABS Inventory
Centex	$511,740,636	$3,197,130,000	16.01%	CTX ABS Inventory
Wachovia	$5,328,228,928	$76,872,000,000	6.93%	Wachovia ABS Inventory
Totals	$118,950,151,688	$477,918,010,000	24.89%

I believe that if Countrywide were to go bankrupt, it would probably drag a monoline of two down the tubes with it. Since these guys are so incestuous, in that they have a tight knit ring that reinsures each other in lieu of sending the risk outside of the circle - adverse selection and risk concentration is rampant - that is in my humble opinion of course. If a big monoline or two go down, they may drag a big bank or two down with them. We have already .lost Bear Stearns, just as I predicted in October and January (see Is this the Breaking of the Bear?). Looking at the equity exposure chart above, the Riskiest Bank on the Street is next in line (see Reggie Middleton on the Street's Riskiest Bank - Update).

For those that don't know, AGO, MBIA and Ambac use credit default swaps to guarantee these deals. I have posted and entire background analysis on the CDS market and believe that this may be the the next shoe to drop in this Asset Securitization Crisis (see my list of posts on the crisis here , and the CDS market here). This is a huge, unregulated market rife with cowboy style counterparty credit risk management, if any at all. The market dwarfs the markets of US stocks, mortgage securities and US treasuries by a multiple of at least 2. The Fed does not want this to come tumbling down.

As you can see, this is a huge market and Bank of America has the 3rd largest exposure in the WORLD (that's right, the WHOLE WIDE WORLD).

In addition, they have the 3rd highest concentration of subinvestment grade risk. The company in the front of this list was paid at leat $50 billion by the government to take in an insolvent bank. I really wonder what deal BAC will be able to cut, or is the CDS risk posed from a Countrywide collapse not great enough??? Exactly how many banks does the Fed plan on bailing out? If you have been following my series and blog and are willing to read everything in detail until the end of the series, you should come to the conclusion that there is going to be a lot of bailing out needed.

To make a long story short, if BAC does go forward with this Countrywide deal with no back stop and concessions from the guys with the green ink powered helicopter, I am going to rocket them to the top of my short list and will probably go to them for a HELOC to fund the short on a more reliabe basis than brokerage margin accounts! We are looking out for more information on who could be the other players to suffer the most if BAC-CFC deal doesn’t go through. I’ll keep you updated through intermittent posts as time permits.

From the WSJ :

Already burned by bad mortgages on their books, lenders now are feeling rising heat from loans they sold to investors.

Unhappy buyers of subprime mortgages, home-equity loans and other real-estate loans are trying to force banks and mortgage companies to repurchase a growing pile of troubled loans. The pressure is the result of provisions in many loan sales that require lenders to take back loans that default unusually fast or contained mistakes or fraud.

The potential liability from the growing number of disputed loans could reach billions of dollars, says Paul J. Miller Jr., an analyst with Friedman, Billings, Ramsey & Co. Some major lenders are setting aside large reserves to cover potential repurchases.

Countrywide Financial Corp., the largest mortgage lender in the U.S., said in a securities filing this month that its estimated liability for such claims climbed to $935 million as of March 31 from $365 million a year earlier. Countrywide also took a first-quarter charge of $133 million for claims that already have been paid.

The fight over mortgages that lenders thought they had largely offloaded is another reminder of the deterioration of lending standards that helped contribute to the worst housing bust in decades.

Such disputes began to emerge publicly in 2006 as large numbers of subprime mortgages began going bad shortly after origination. In recent months, these skirmishes have expanded to include home-equity loans and mortgages made to borrowers with relatively good credit, as well as subprime loans that went bad after borrowers made several payments.

Many recent loan disputes involve allegations of bogus appraisals, inflated borrower incomes and other misrepresentations made at the time the loans were originated. Some of the disputes are spilling into the courtroom, and the potential liability is likely to hang over lenders for years...

... Repurchase claims often are resolved by negotiation or through arbitration, but a growing number of disputes are ending up in court. Since the start of 2007, roughly 20 such lawsuits involving repurchase requests of $4 million or more have been filed in federal courts, according to Navigant Consulting, a management and litigation consulting firm. The figures don't include claims filed in state courts and smaller disputes involving a single loan or a handful of mortgages.

In a lawsuit filed in December in Superior Court in Los Angeles, units of PMI Group Inc. alleged that WMC Mortgage Corp. breached the "representations and warranties" it made for a pool of subprime loans that were insured by PMI in 2007. Within eight months, the delinquency rate for the pool of loans had climbed to 30%, according to the suit. The suit also alleges that detailed scrutiny of 120 loans that PMI asked WMC to repurchase found evidence of "fraud, errors [and] misrepresentations."

PMI wants WMC, which was General Electric Co.'s subprime-mortgage unit, to buy back the loans or pay damages. Both companies declined to comment on the pending suit.

Lenders may feel pressure to boost reserves for such claims because of the fear they could be sued for not properly accounting for potential repurchases, says Laurence Platt, an attorney in Washington. At least three lawsuits have been filed by investors who allege that New Century Financial Corp. and other mortgage lenders understated their repurchase reserves, according to Navigant.