Last month, a consortium of private equity firms: Starwood Capital Group, TPG Capital, Perry Capital and WLR LeFrak announced it had sold Laketown Wharf, a residential complex in Panama City, Florida. It was the last significant asset to be sold from a portfolio acquired in a watershed transaction for US real private real estate that happened in 2009.
Laketown was part of a $4.5 billion distressed real estate loan portfolio previously owned by Chicago's Corus Bank which collapsed during the global financial crisis. Before the crisis, the bank had built a large construction lending business to mainly condominium developers in big cities in the US such as New York, Miami and Las Vegas.
The Corus Bank transaction was significant when originally struck six years ago, but it has become even more noteworthy today because it turned out to be the largest structured transaction sale by the Federal Deposit Insurance Corporation (FDIC) during the crisis.
The back story to Corus Bank as well as the subsequent property sale and how the Starwood/TPG-led consortium made a profit from the portfolio contains several intriguing aspects. In 2009, Corus was the 90th bank failure that year alone. It had already been earmarked on a watch-list as a bank likely to fail and when it did, it came as little surprise. But what made it unusual and interesting was that Corus Bank had largely an internet-based deposit base. It operated very few actual bank branches in Chicago – only 11. Its deposits were deployed into, among other things, condominium loans, and that proved to be a very good business for many years. Indeed, at the peak of the condominium market in 2006, Corus reached close to $10 billion in assets, primarily in condo construction loans.
It was regarded as one of the largest and one of the most successful condominium construction lenders in the country. The bank generally underwrote high quality borrowers and good quality buildings in major gateway cities in the US requiring real equity, including mezzanine financing – junior to the bank in some instances. Then came the crisis, which paralyzed the US condominium market. Accordingly, one of the sectors hit hardest by the crisis in 2008 was condominium development. Inevitably, sales stalled and borrowers suffered liquidity issues. As this scenario unfolded, Corus Bank found itself in serious difficulty.
At the turn of 2009, rumors circulated that Corus was on a watch list and might fail. Private equity firms circled anticipating another BankUnited or IndyMac asset grab. For some groups, Corus was doubly interesting because not only might an opportunity be presented to recapitalize the bank but there was also potential to take over $4.5 billion of real estate loans.
TPG's Kelvin Davis, senior partner, recalled: “If Corus failed, no one was quite sure whether the FDIC was going to seek a recapitalization of the bank itself, or whether it would become a breakup of assets, in which case it would become an NPL/REO trade.”
While private equity firms were looking, so too were many real estate private equity funds, one being Barry Sternlicht's Starwood Capital, a firm known for its ability to act in contrarian fashion and find value in times of economic turmoil. Sternlicht, Starwood's chairman and chief executive officer, looked around for possible capital partners and found the answer in TPG based on relationships that he had with Davis and David Bonderman, TPG's co-founder, dating back to the early nineties. Sternlicht knew TPG had raised a $19.8 billion fund in 2008, called TPG Partners VI, which could provide the necessary equity alongside his Starwood.
And so in spring 2009, TPG and Starwood joined forces, shortly followed by Perry Capital and LeFrak, important given US banking regulations imposed limitations on any one investor from owning more than a certain percentage of US banks.
Promptly after closing the bank on September 11, 2009, the FDIC sold off Corus' banks branches to a local Chicago bank, MB Financial Bank, clearly indicating that as opposed to a financial services recapitalization, this would be a break-up. That meant a big real estate deal.
Shortly after being appointed receiver to Corus, the FDIC – via its adviser Barclays Capital – ran a rapid auction process for the $4.5 billion of face value loans and REO assets. Close to the time, the Wall Street Journal reported bidders included a joint venture between New York's Related Companies and Lubert-Adler Partners, a team of Miami developer Crescent Heights with Lone Star Funds and an investor group led by Tom Barrack's Colony Capital and iStar Financial.
The Starwood/TPG-led consortium bid the highest and in the aftermath of being selected by the FDIC to work out the gigantic portfolio, media reports then surfaced suggesting the consortium had perhaps paid too much.
Very favorable outcome
Yet the outcome suggests those views might have been premature. On the contrary, in a statement made upon the disposal of the last remaining significant asset last month there was a strong suggestion the deal has in fact made opportunistic-like returns. Marcos Alvarado, managing director at Starwood Capital Group, said: “We believe that this collaboration has produced a very favorable outcome for our investors, partners and the FDIC.”
The process leading up to the Starwood/TPG-led consortium winning the bid took various twists and turns. Some of the private equity bidders fell away when it became clear that Corus was not another 'whole bank' financial institution play, but TPG and Starwood had already been getting busy. The acquisition teams had spent six months analyzing every asset and market to get comfortable with the associated risk. The firms had also organized teams to underwrite as many of the 101 loans and REO properties as possible before key announcements were made as to what would happen to them. It helped that the assets were clustered in cities that could be divided between different underwriting teams. The main clusters were in New York, Las Vegas, Miami, Atlanta, and Los Angeles.
In talking to local real estate brokers, even in 2008 as depressed as the property market was, it became evident that condos in these huge cities seemed to be trading. The market intelligence that the consortium had gained gave it confidence to essentially make a call that the US housing market was near its nadir. “We weren't sure when the recovery was going to happen but we were reasonably confident we were close to the bottom of the US housing market,” said Davis, “and that if given enough time, we would see appreciating markets during our ownership.”
The FDIC finally announced what the structure was to be for the property transaction. Contrary to most people's expectations, the FDIC offered 50 percent financing at a zero interest rate for the first five years. The FDIC would finance incremental draws of capital that new owners would need in order to fund hundreds of millions of dollars-worth of construction of uncompleted condo projects. The FDIC also decided to retain a 60 percent interest in the portfolio along with certain approval rights. Determined to learn lessons from the 1990s savings and loan crisis, the FDIC decided that if it appointed the right partners, it could share in any upside.
With Barclays Capital's Michael Dryden (now at Credit Suisse) running the sales process, things were moving fast, but the Starwood Capital/TPG-led consortium was feeling bullish because of the enormous work it had already completed and because of what it had discovered about the assets and the markets it was in. Indeed, the consortium had formed the opinion that this was an unusually high quality portfolio of assets. “I remember thinking this is as high a quality portfolio as we are ever going to see this cycle,” said Davis.
In between the first and second bids, a fairly unusual step in the process began. The shortlisted consortia were called in to be interviewed by the FDIC at the New York office of Lehman Brothers bank in Times Square that was occupied after 2008 by Barclays Capital.
Michael Muscolino, partner at TPG's Special Situations Partners, said, “Our teams carried in umpteen ringbinder folders containing asset-by-asset business plans demonstrating the work the consortium had done.”
It was quite a show that the Starwood/TPG-led consortium laid on. Sternlicht was flanked by Alvarado, managing director of acquisitions and Daniel Yih, chief operating officer. Davis and Muscolino plus representatives from Perry Capital and LeFrak were also in attendance and they proceeded to explain their credentials and also the plan for how they would manage such a large portfolio and deal with challenges. This seemed appropriate – after all, they were not just bidding to buy a portfolio, but would become stewards of taxpayer capital through FDIC's retained ownership.
Ultimately, the consortium put forward the highest bid in the final round and when it was notified of that, the group was obligated to close on the $4.5 billion portfolio within about 10 days of acceptance of the bid. This of course was a huge step to take. As the successor to Corus Bank, the new consortium would have the legal obligation under the existing loan agreements to continue funding borrowers.
As the many ringbinders implied, managing this portfolio was to be a herculean effort. Starwood and TPG decided the best thing to do was create a new asset management company. The existing Corus team came with the deal and transferred to the new asset management company rebranded as ST Residential. The asset management team was augmented by the consortium's handpicked people.
Members of the consortium freely admit there was elation when they won the auction. One major advantage it had was the favorable financing where the FDIC provided both 50 percent of the capitalization of the portfolio at zero cost, with the first amortization payment not for five years. In fact, the principal was paid off in just two years alone from the cash flow generated by the assets.
In a way, the financing meant this was a largely unlevered investment for the last three or four years and the structure also setup a financing facility allowing construction of incomplete projects or the funding of loans that were performing. Were it not for the FDIC this financing would have been very hard to replicate in the private sector in 2009. In many cases there were hundreds if not thousands of condominium units to be completed.
There was a little surprise for the consortium. It reckoned that of the 80 loans in the portfolio, about half would perform to maturity and half would default, with foreclosure being a possibility. As the US economy began recovering in 2010, buildings had sponsors that were willing to put in time and money to support the assets and the condominium market in the US began a recovery as liquidity returned to the markets. What resulted was not a dramatic spike in the number of loans that performed, but the assets the consortium eventually controlled were patiently sold over time and the investor group benefited from the recovery in condominium values.
Overall things went according to plan. The new asset manager ST Residential took an 'owner-developer' approach wherever it could with assets – some real value-add decisions were being taken. For example, in Las Vegas the consortium started converting condominium buildings to multi-family rentals. The assets started leasing up quicker than they had expected and at higher rents. It bulk-sold many multi-family rental units to investors as it began to monetize the portfolio, capitalizing on the tremendous strength of the US apartment market. At the same time the asset management company sold condos that had in many cases been repositioned and completed. In Vegas it was all about switching from condo to multi-family rentals, whereas in places like Miami it was more about selling condos once completed or improved.
This dual strategy ended up maximizing value for a large part of the portfolio and by the time it came around to the last significant asset – Laketown Wharf, the 1,000 unit complex in Panama City, Florida, the returns had been made. Laketown Wharf would have been a difficult asset to sell as it was an unusual one – part hotel, part condo – and in dire need of improvements. But the consortium took its time and transformed how it looked. The sale last month netted a solid return, as has the entire portfolio.
Sternlicht said, “As a result of the ST Residential team's discipline, creativity and tenacity, we can now look back with tremendous pride on what has proven to be an extraordinary investment for us and the US government.”
The consortium is proud of its achievement, and views the Corus transaction as a beacon amid the gloom of the global financial crisis. At the time, it was accused of overpaying, but the financing offered by the FDIC and adviser Barclays Capital was key because it gave the consortium time to add value. Hard work and a bit of good fortune helped too as some markets sprang back quicker than expected. For the consortium, it was a case of making its own luck.