Citicorp Lines Up Investors For Big Troubled Properties
Citicorp is arranging to sell hundreds of millions of dollars of prime commercial real estate in transactions structured to give the bank a share of the profits in these projects when markets improve.
Bank officials said last week that one deal is close to an agreement with investors and 10 others are in preliminary talks.
Speculation about which projects Citicorp may sell is centered around two office towers in midtown Manhattan - where it is the lead lender - and a foreclosed apartment building on the West Coast, which Citicorp owns.
Citicorp is borrowing an approach that a handful of other banks have used on a much smaller scale.
By adapting it to the industry's largest portfolio of real estate loans, however, the giant money-center bank is all but certain to accelerate the trend, experts predict.
A Lesson from Texas
"Citicorp was very aggressive," said Stephen E. Roulac, managing partner in the Roulac Group, San Francisco. "Their position in the financial community is not what it once was. But there's no question, when a major institution starts doing something, it has an influence."
The technique is modeled on participating mortgages used to restructure loans in Texas a few years ago and in the national real estate recession of the '70s.
In this case, Citicorp plans to write down each loan to the point where cash flow covers debt payments.
In exchange, it will retain the right to a portion of future profits, if any, from the sale of the building.
Suited to Top-Notch Properties
The strategy assumes a recovery of real estate values in five to seven years, when the newly issued mortgages come due. It is best suited to top-notch properties - the biggest, newest downtown office buildings that are coming on the market at the worst possible time.
Mr. Roulac said the technique is "not going to help a whole lot" with loans that are too far under water.
But he said the strategy could help banks improve their recovery on projects that are just shy of being able to make debt payments in today's soft market.
"If they pull the plug and do a fire sale, they're going to get less," Mr. Roulac said, describing the banks' thinking. "If they extend, they have the potential to get 100% or more" of their original loan.
Although, at first, the participating mortgage strategy may apply only to a small portion of Citicorp's $15 billion portfolio of loans, the ripples may well look like waves in communities where Citicorp financed the biggest new downtown projects.
Out with the Developers
More than half the deals that are contemplated would displace original developers.
Eric D. Hovde, executive vice president of Hovde Financial Inc., Washington, said the strategy marks a more aggressive attitude for banks that are trying to squeeze the most juice from their lemons.
"You don't go in with the mind-set that you are only going to get back to the original loan amount," Mr. Hovde said. He is an adviser to Society for Savings, a Hartford thrift with a similar program.
Focus on Possible Investors
Citicorp officials declined to name the new investors or the projects, but said they have identified about $3 billion as available for real estate investment by "vulture" funds, investment boutiques, and pension funds - among other sources.
According to some sources, the Zell Merrill Lynch Opportunity Fund, controlled by Chicago investor Sam Zell, is among the firms negotiating to buy Citicorp-controlled properties.
Similarly, sources say an investment fund controlled by Trammell Crow Co., Dallas, also talked to Citicorp about some of its properties, but is not thought to be close to a deal.
Most of the projects are brand-new office towers in which the credit exceeds $50 million, said John D. Hirschfeld, a vice president of Citicorp Securities Markets who has been pitching the deals to investors.
Available Assets Identified
Some are properties with loans in excess of $100 million, he said.
"We have done a broad-scale review of the Citi portfolio," Mr. Hirschfeld said. "There are scores of assets in the portfolio that are likely to lend themselves to this."
Citicorp was the leader of the industry's ill-fated venture into commercial real estate lending in the 1980s.
It now hopes to atone by pioneering the use of a refinancing structure sometimes known as "sandwich equity."
The "sandwich equity" moniker derives from the sandwiching of new equity between the first loan and the claim on future sales proceeds.
Another term that has been introduced to describe the strategy is "nonjudicial cramdown," derived from the likelihood that the bank has to swallow a loss by writing down the original loan; later, it hopes, the market will recover enough to produce a profit.
Blueprint for New Lending
Once demand for new construction returns, a successful program that uses sandwich equity to restructure loans could provide a blueprint for new construction finance, predicted Robert Laughlin, division executive of real estate for Citicorp.
Under a simple structure, the loan amount is reduced, the investor takes an ownership interest with a preferred rate of return, and the bank takes a subordinated participation in future proceeds.
This combination "seems to have struck a chord" with some investors approached by Mr. Hirschfeld.
"They're saying: |Where the hell have you been?'" when presented with attractive proposals for the first time in years, he said.
Higher Risk, Higher Return
The structure would generate the internal rate of return that these investors insist on - in the high teens or more - in exchange for taking on the market risk.
Mr. Hirschfeld said there could be any number of variations on the same scheme that would accomplish the same objectives.
For instance, if the original developer were to remain in the project, he might put in equity in the form of subordinated debt. Or an investor might work in tandem with a developer and take a participating second mortgage.
Cash Flow in the Picture
The new cash - amounting to 20% to 30% of total capitalization - would be used to complete tenant improvements, market the property, and, possibly to service a portion of the first mortgage in the early months. The equity investor would enjoy first claim on cash flows beyond the payments on the first mortgage.
Most important, he said, the bank would be able to keep a portion of the credit in performing status on its books, rather than writing off the whole loan.
One of the properties being marketed by Citicorp under this new program is said to be an apartment building in San Francisco known as the Fillmore, which the big money-center bank acquired from Integrated Resources.
S&L Aspect of Participations
The technique has also proved helpful in placing assets of troubled thrifts back in the market. Early this year, a similar deal took place with Heller Financial, a Chicago-based subsidiary of Fuji Bank.
Heller provided an $800,000 participating junior loan as equity-gap financing, in the sale of a condominium property by a liquidation unit of Franklin Federal Bankcorp, Austin, Tex.
The investment is not for the fainthearted, short-term player, Mr. Hirschfeld noted. A significant part of the high yield on the investment relies on eventual sale of the property once the loan matures.
And there is still some debate as to whether certain markets will come back quickly enough.
With rents still declining in New York City, it will be another year before before his clients are ready to invest, said one investment manager, speaking on condition of anonymity.
Real estate investors identified two New York office-tower projects in Times Square - one developed by Solomon Equities and the other by Ian Bruce Eichner - as likely candidates for such a restructuring.
One local developer estimated that cash flow from the Eichner project, in which all office space remains vacant, would support only about half the construction cost. That scenario means the bank would have to take too big a hit to reduce the mortgage sufficiently.
But market rumors say Bertelesmann Music Group, the parent of RCA, may be poised to sign a lease on 250,000 to 500,000 square feet of the space, improving the prospects of an investment in that project.
In at least half the deals, Mr. Hirschfeld said, the original developer would be asked to hand over the key: New investors are expected to insist on control of the project.
While some developers may try to block sales of this type, Citicorp officials said most will be motivated by hopes of once again doing business with the bank. "The survivors will go along," Mr. Laughlin said.
Mr. Eichner declined to comment. Warren Shad, chief financial officer of Solomon, did not return phone calls.
Mr. Hirschfeld acknowledged that Citicorp's portfolio includes some big Manhattan office properties. But he emphasized the fact that properties subject to restructurings are "ubiquitous" around the nation.