Is iStar Sprouting A Portfolio Full of Contingent Liabilities?

iStar, the embattled Mortgage REIT, has been taking it on the chin recently. Last quarter, they set aside $217 million for bad loans, and a $45 million charge for mark to market losses. The REIT's high profile developer defaults in Miami, the epicenter of the bubble, are already well-known. However, its new get tough policy with deadbeat borrowers may be starting to produce unintended "collateral" damage.

Magnolia Green Development LLC, the borrower under an $85 million construction loan, is alleging that iStar is improperly attempting to recall $24 million of the loan. The developers have filed a $250 million lawsuit, plus damages estimated to exceed $100 million, against iStar for allegedly illegally threatening to sieze control of the project. Magnolia Green is seeking a jury trial (which is unusual) and a declaratory judgment that they are not, in fact, in default.

The developers allege iStar is attempting to "lay claim to the project's extraordinary projected profits...as a quick fix for its sagging balance sheet." It said that iStar's stock price had dropped dramatically to about $7 a share when the suit was filed, down from $47 in January 2007, when iStar made the loan.

The suit alleges that iStar's "attempt to seize control and ownership of the Magnolia [Green] project have been motivated and influenced by defendant's precarious and embattled financial and legal condition, including multiple legal actions pending against it."

Curiously, iStar apparently evidently never declared the loan to be in default. According to the suit, iStar declared that the loan was "out of balance". In letters to the developer dated July 17th and August 4th, iStar demanded that Magnolia Green deposit $24.3 million into the loan account and an additional $1.2 million into the interest reserve by August 21st. Magnolia Green refused, and instead filed suit on August 18th.

The disputed project is one of the largest in the country, a development of nearly 3,500 homes on 1,898 acres in Virginia with a large commercial and office component. Many of the homes, which range in price from $300,000 to $1 million, are already built or nearly completed, and homeowners are already living in some. The development also includes the Westham Golf Club, an 18-hole Nicklaus Design golf course. The work on the golf course is about 70 percent complete, the developers said.

Lifestyle Homes, the operating entity behind Magnolia Green Development, is no stranger to the legal system. After purchasing the huge tract of land in 2003 for $39 million, they successfully took the seller to court seeking monetary damages and specific performance under the purchase contract when the land was delivered without the required easements.

This dispute with Magnolia Green is but one high profile result of iStar's new survival strategy, as it battles former clients in an effort to "aggressively take back the keys" on doubftul projects. In the last earnings call, iStar descibed a "higher beta" around loan loss recoveries than had been anticipated.

Unfortunately, as more of the REIT's projects go into default, the potential for "contingent" liabilities like the potential $350 million claim from Magnolia Green dispute will increase also. The disclosures in iStar's footnotes in this regard should be required reading for all iStar shareholders. Not only is management increasingly distracted by these workouts, but additional unforeseen balance sheet liability could also be lurking in the wings. [Update: On Sept. 27, Magnolia voluntarily withdrew the lawsuit. Neither iStar nor the developer would comment, but the lawsuit clearly provoked a settlement, likely involving a loan modification].

In other iStar news, the REIT has apparently found a buyer for the land it foreclosed on in relation to the failed $2.2 billion, three tower Brickell CitiCenter, which was to include the tallest building in Miami (not to mention 2400 condominiums) before the market there collapsed.

It's unlikely that the buyer will proceed with the approved plans for condominiums, given the state of the Miami housing market. Tory Jacobs, president of the Brickell Homeowners Association, said he doesn't know anything about the pending land sale, but he has an idea what he'd like there.

"It's prime area, but obviously there's overbuilding in residential," he said. "I think we could use some sort of a retail complex that wasn't fancy — maybe a Target or something."

Disclosures: None at the time of this writing

SFI Taking 2009 to the Bank

Where did THAT banana come from?

IStar announced earnings today, along with an estimated 50% cut in the dividend. The cut was signaled pretty clearly in a pre-announcement on July 18th.

IStar set aside $217 million noncash for bad loans, which thankfully was much less that the high end of the $275 range they estimated on July 18th (and that, in addition to a new $50 million stock repurchase program with whose money? they announced, is probably why the stock is up today), and recorded a $45 million charge for mark-to-market impairments, which was also less than the $50 million forecast two weeks ago. Thus, the silver lining, if there is one, is that there may be a floor on their new dividend estimate of .30 to .40 cents a share. Nevertheless, there was a lot of equivocation on the exact amount of the dividend going forward.

However, the bigger problem is that none of the "many moving pieces" have been moving in the right direction. IStar frequently boasts about its ability and infrastructure to work out impaired assets (what else would they say, given that they are busy taking Fremont dirt back by the truck load?), but obviously their recoveries have not been living up to their original portfolio assumptions.

The "higher beta around asset recovery" (a euphemism for having guessed wrong on the first place) relates to two things that may get even worse in the current environment. The first is the length of time it's been taking to effect the workouts. It is simply taking them much longer than they thought wait,.. weren't they the experts?? to stabilize and sell the assets. Given that the era of indiscriminate capital - which had been bailing out a lot of borrowers and owners - is now over, this is not likely to get much better.

The second issue is related to the first and that is their reliance on "recourse" provisions is turning out to be not so reliable. Recourse allows a lender like IStar to go after other assets of the borrower in an event of default. In this environment, however, any unencumbered assets that may be available to satisfy those provisions are quickly becoming the object of a massive lender scrum, with Istar just one among the hungry crowd. Consequently, they have not been providing the safety net that was originally you mean they were wrong?? thought.

To be fair, this is now all history and most of the reason why the stock went into the toilet back on July 18th. What about the prospects going forward? IStar says they have "scrubbed" their portolio (of what, pesky fleas or the dogs that carry them?) well into to 2009 and that they are now more confident of their estimates - yet again - even after having stressed their loan book with a hypothetical 50% reduction in the amount of scheduled 2009 repayments. They also say they will not need to raise any new debt or equity capital through 2009.

Nevertheless, this is now a show-me REIT. IStar has a lot more "dead money" in it's portfolio than they previously forecast, and they are now very, very close to breaching their bond covenants. If any additional fleas do turn up in the Fremont deal, and in this environment you should assume the worst, IStar will need to pay a visit to the rating agency wood shed.

Significantly, in the conference call, Sugarman several times referred to the need for the ratings agencies to be "fair" in their future evaluations of IStar. In this environment, that is not something I would want to depend upon if I were a shareholder.

Disclosure: None at the time of this writing

IStar Dividend Appears to be in Jeopardy

Is IStar the Canary in the Coal Mine, or is this Just Fremont Coming Home to Roost?

IStar saw the need to issue interim estimated earnings estimates for the second quarter today, and it wasn't encouraging. As a result of loan losses and impairments uncovered during the Company's quarterly risk review process, IStar said it now expects net income per share to be in the range of $0.05 - $0.15, and that it will book an adjusted earnings loss of between $1.45 and $1.55 per share when its second quarter results are announced at the end of the month. There was no update on guidance for the full year. In the first quarter, IStar reported adjusted earnings of .87/share, which was down from .93/share for the first quarter of 2007.

The tone of the conference call was business-like, but Sugarman only amplified concerns with respect to the health of the Company's operating environment, saying he was "shocked" and "stunned" that the general credit environment had deteriorated so rapidly as a result of the rumors swirling around Fannie and Freddie.

Fortunately, the Company now has plenty of cash and liquidity, but Sugarman said that if Fannie and Freddie continue to deteriorate, "all options would be on the table" with respect to raising new capital. However, with the encumbrance of their net lease portfolio recently, and the issuance of $750 million of unsecured debt, additional secured financings would imperil IStar's investment grade debt rating - if it isn't imperiled already.

Significantly, the Company said it had alerted the ratings agencies to the revised guidance yesterday, but the agencies hadn't yet had time to "process" the information. However, management thinks that their leverage ratio would still remain "flattish" despite the asset write downs, so perhaps IStar can hang on to its rating for the time being. Nevertheless, the margin for error in this regard has disappeared; everything has to go right from here on out.

IStar's policy is to pay out 100% of taxable income in the form of dividends, but when asked about the ability to maintain the dividend, CEO Sugarman was circumspect. I would expect nothing more even in the best of circumstances, but it's obvious that taxable earnings are heading in the wrong direction, which suggests that that the dividend will soon follow suit.

The adjusted losses stemmed from loan loss provisions of approximately $275 million, including $215 million of asset specific provisions. In addition, the Company expects to record approximately $50 million of mark-to-market impairments and approximately $50 million in write-offs of goodwill and certain intangibles. The Company said about two thirds of the losses were in the Fremont portfolio, and that all of the asset specific losses were "expected".

I have heard this sentiment expressed from management before with respect to the Fremont deal, usually going something along the lines of "the assets are perfoming in-line with our original underwriting". Translated, that means that the deals they thought would be underwater when they priced the acquisition are in fact face down in the lake, and the deals they thought would be ok are actually doing ok.

But sometimes it helps to be a simpleton when wading through all this Park Avenue puffery, so the obvious simple question is this: if these losses were expected, then why the unexpected loss?

Disclosure: None

Powered By GE, SFI Sinks Three Pointer on Fremont Debt

SFI To Use Net Proceeds of $960 Million Financing to Repay Existing Debt

Costar reported today that GE Real Estate's New York regional office completed a $960million interest-only first mortgage financing with iStar Financial Inc., secured by 34 single-tenant office, R&D and industrial properties in 12 states.

According to Costar, this financing for iStar represents the largest debt deal of 2008 for GE Real Estate. It is also the largest loan originated by the company in the past several years. Funding of approximately $810 million occurred at the initial closing of the financing. The balance of the funds is expected to be provided before the end of the second quarter of 2008, subject to the finalization of additional loan documentation. The three-year financing is pre-payable in 20 months.

The Boston and New York offices of HFF (Holliday Fenoglio Fowler LP) arranged the loan on behalf of iStar and which closed in less than 45 days.

"While sizeable, this is a relatively conservative transaction, well-margined and secured by a geographically-diverse portfolio of single-tenant properties. Almost half the tenants are rated investment grade," said Alec Burger, president of GE Real Estate's North America Lending division. "We've known the management of iStar for several years and are confident they will use this financing to build a strong platform for the future. We see this as the first of many deals together."

HFF directors Janet Krolman and Greg LaBine and executive managing director John Fowler (New York) worked exclusively on behalf to secure the adjustable-rate, interest only, cross-collateralized and cross-defaulted loan.

"Historically, iStar would have obtained financing on an unsecured basis by utilizing the company's BBB, investment grade credit rating. However, the current market conditions are such that it was more efficient and cost effective to finance a subset of their existing single tenant portfolio on a secured basis," said Krolman.

"There were a number of ways to accomplish this including putting together a club deal to finance the portfolio, splitting the portfolio into smaller sub-portfolios or financing the whole portfolio with one source," LaBine added. "iStar concluded that a one-stop-shop alternative with GE was the best fit for their needs, as it was a simpler, cost-effective alternative that was accomplished in a very short time frame," Fowler said.

The portfolio of properties totals nearly 12 million square feet and is currently 99.6% occupied with an average lease term of 9.2 years. Nearly half of the approximately 21.9 million-square-foot portfolio is leased to tenants that are rated investment grade.

Costar reported that iStar will use the net proceeds of the three-year floating rate, cross-collateralized and cross-defaulted loan to retire existing debt, which presumably means the $1.3 billion Fremont acquisition loan due June 30.

With this new deal, SFI takes a significant step forward in the serpentine process of swallowing Fremont's commercial loan business. It's just one more fascinating story playing out in the REITwrecks world.