Tuesday, September 29, 2015

After extensions from lender (expire?), Forest City will prematurely pay off $45M loan for troubled modular tower (+$11.6M subordinate loan)

See update below that confirms that Forest City is paying off an additional $11.6 million to NYC HDC.

Redemption planned for Oct. 6
In an unusual occurrence surely prompted in part by delays and construction problems, developer Forest City Ratner next week will pay off $45 million in tax-exempt financing for the B2 modular tower rather than enjoying the fruits of the low-interest loan until 2046.

Nor does the New York City Housing Development Corporation (NYC HDC) plan to issue the additional $45 million in tax-exempt financing once planned for the tower, also known as 461 Dean Street.

That $90 million total would have gone halfway to paying for a tower initially slated to cost $183 million (including $117 million for construction).

Delays and costs overruns have added perhaps $80 million to the cost of the tower. It should open late next year, after some 3.75 years of construction, nearly twice as long as initially expected, leaving a cloud over Forest City's once-heralded plans to revolutionize construction in New York.

A loan on shaky ground

The 2012 loan is not in default, but has been on shaky ground.

Sept. 28 construction photo via Tectonic
 Last October, Forest City disclosed that the Bank of New York Mellon had suspended disbursement financing because construction had stopped for 21 days. 

It's unclear whether such disbursements resumed when construction re-started this year, after Forest City began operating the modular factory without former partner Skanska and engaged Tishman to build the tower. Construction has proceeded steadily in the past months.

But evidence points to an extended freeze, given that the forbearance agreement was steadily extended. 

In August, parent Forest City Enterprises (FCE) in its Form 10-Q warned:
we can provide no assurance that our lender will agree to extend the forbearance agreement. Depending on the outcome of our lender discussions, we may be required to repay the current outstanding balance of $45,000,000 currently secured by, amongst other things, $37,500,000 of restricted bond proceeds included in restricted cash, $10,000,000 of cash in escrow and an equity letter of credit of $9,300,000. In the meantime, we continue to fund construction costs with equity.
So, while evidence suggests the lender may have decided not to extend that agreement, forcing the bond redemption, Forest City would not confirm that. 

Forest City's statement

Forest City Ratner responded briefly to my queries:
With a relatively short period of time remaining to complete our work in the factory and field, we made the decision to use equity to continue construction and will evaluate procuring new financing at a later date.

Forgoing the unissued bonds gives the NYC HDC an opportunity to use the unused allocation for other projects to create additional affordable housing in the City. The affordable program at 461 Dean Street will remain the same.
That may indeed assist affordable housing, but surely no developer chooses to use their own equity when they can use other people's money. 

As David A. Smith, an affordable housing analyst in Boston whom I consulted, observed, "In general, never use equity when affordably-priced non-recourse debt is available." (Non-recourse means an lender seeking to be paid can only go after the collateral, not the developer's other assets.)

Forest City did not respond to follow-up questions regarding whether disbursements ever resumed or whether the lender had forced their hand.

Should 461 Dean open successfully, it could be a candidate for new financing. CEO MaryAnne Gilmartin has said, "The building, when it stands at the corner of Dean and Flatbush, will tell us whether high-rise modular has an application in the city."

Disclosure of default avoided

Even if disbursements had resumed, the future would have been grim. "The likeliest conclusion," observed Smith, when asked about the scenario in which Forest City was redeeming a bond that was being disbursed, "is simply that FCE concluded it would never be able to meet the bond takeout criteria in any practical timeframe, and it decided to eliminate the complications of having a public debt issue outstanding." 

To resolve such a debt issue in standard fashion, Smith observed, the property typically has to be finished, with its trade creditors paid, leased up to a stipulated threshold, and with a stipulated net operating income.

"Failure to achieve conversion within a certain time frame is normally also a default, even if the interim interest is being paid," he added. "When this happens, you don’t want to be paying standby fees, or having a property in default (something you may have to disclose on other regulatory filings or your financial statements), and if external capital is cheap (e.g. from China), then you are by far the best served by wiping out the proposed financing and hence eliminating the reporting and disclosure requirements."

Note that new investor Greenland Holdings owns 70% of Atlantic Yards/Pacific Park going forward, excluding B2 and the Barclays Center. The clearance of the loan removes one obstacle to new investment, though the legal issues likely need to be settled first.

NYC HDC 2014 audit
NYC HDC statement

NYC HDC spokeswoman Christina Sanchez told me that the loan was not in default, as Forest City Ratner was able to extend the forbearance agreement with the Bank of New York Mellon.

"However, the borrower has decided to pay off the HDC mortgage loan and HDC will redeem the bonds on October 6th," she wrote. "The HDC Regulatory Agreement that is recorded against the property enforcing the affordability of the units will remain."

"It is not common for HDC loans to be paid off during construction," she added, in response to my query, "and we are unaware of any plans for additional HDC financing."

One scenario in which loans are paid off early might be when interest rates plunge, so a borrower could refinance at a lower interest rate.

Fees for the loan, via NYC HDC
That is not the case here. Indeed, the interest rate was .02% to .12%, according to a 2014 NYC HDC audit (see screenshot above), though there were much larger annual fees associated with the issuance (see graphic at left).
Why now--harvesting losses?

Beyond potential pressure from the lender, it's possible that FCE wants to harvest as many losses as possible before the end of the calendar year, when its financial structure changes.

As I noted in January when the firm announced its plan to become an REIT, CEO David LaRue in August 2014 told investment analysts that, while the company was still a C Corporation, "We still have substantial NOLs [net operating losses] that allow us as a C Corp to continue to be very tax-efficient... As we go through repositioning, and go through non-core asset sales, it gives us some additional flexibility."

A tangled tale, and another loan to be paid off

The NYC HDC financing of 461 Dean Street contemplated two bond issuances to fund the entire mortgage loan. The first tranche was issued with the closing of the loan in December of 2012, while the second was supposed to come in 2013. It did not, perhaps because the modular factory was behind schedule.

Even earlier this year, that loan seemed to be contemplated. According to minutes from the 4/20/15 board meeting, NYC HDC executive Catherine Townsend said "that a second tranche of bonds for 461 Dean Street, which was authorized by the Members in December 2012, was not expected to be issued until construction resumes."

Construction did resume. However, Sanchez told me, "Since the borrower has decided to pay off the construction loan, HDC will not be issuing the second tranche of bonds and will redeem the bonds on the first tranche."

Also, according to a November 2012 memo (excerpt at right) from NYC HDC President Marc Jahr, this building was to receive an additional loan from the agency of $11.6 million, with a 1% interest rate. 

Update: "HDC provided a $11.6M subordinate loan at the loan closing for B2 in December of 2012," Sanchez confirmed. "Forest City Ratner is not in default on this subordinate loan. However, they will pay off the subordinate loan in conjunction with the first mortgage loan on October 6."

A rising price tag

The price tag for 461 Dean Street has skyrocketed. Last November, FCE said that, while it had designated $155 million for B2, related to land, building and capitalized interest, total project costs could reach $215 million to $265 million. 

That said, it does hope to recover some of those cost increases after litigation with former partner Skanska, which was hired to build the tower and lead the operation of the modular factory.

As noted last February, Forest City in 2014 recorded an impairment charge of $146,300,000--a loss of value--regarding the building in 2014. This past August, it stated:
As of June 30, 2015, we have $74,182,000 capitalized on the Consolidated Balance Sheet related to B2 BKLYN. Based on the most current information available, total project costs are estimated to be $162,100,000, after giving effect to an impairment charge recorded in 2014. 
Does that mean that building's overall cost to Forest City could exceed $300 million, with the impairment added to the the project costs? Unclear.

Impairment charges can be murky. "There’s a huge body of financial reporting requirements around when you take an impairment, when you reverse it, and so on," Smith commented. "They are a mixture of science, art, and necromancy."

The redemption notice

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