Last week, REIT Realty Finance Corp. said it was terminating its CEO, Kenneth Witkin, adding that it had no plans to replace him with a full-time CEO. It was the latest in a series of dramatic – and humiliating – turns for the company, which went public with great fanfare just three years ago.
The rapid deterioration of the commercial real estate markets has crippled Hartford-based Realty Finance Corp. In the past year, the firm has been dumped by its corporate management partner, the international brokerage CB Richard Ellis, and seen its once-soaring stock de-listed from the New York Stock Exchange.
Anemic cash flows have left the company on the brink of dissolution. Its would-be saviors, the blank-check company Stoneleigh Partners Acquisition Corp., is battling with liquidity issues of its own. Realty Finance Corp. had previously warned investors that if it weren’t able to merge with Stoneleigh, it might be forced into “winding down the affairs of the company.” This is a firm that has not been treated kindly by the post-crash economy.
Plenty Of Shaky Investments
But in many ways, Realty Finance Corp. is not just another carcass on the side of the highway. It’s also an embodiment of the excesses of the modern financial era.
Realty Finance’s lending capacity came from $1.6 billion in collateralized debt obligation (CDO) bonding. It then took that borrowed money and sank it into a portfolio of shaky investments. If there was a bad bet that investment companies could have made over the past four years, Realty Finance made it.
Sec filings show that it got burned on massive condominium conversion projects that were trying to take off just as the market for them was going into freefall. It larded up on high-yield, high-risk commercial mortgage-backed securities (CMBS), only to see those bonds’ values evaporate. It lent aggressively to office buildings in marginal markets, and to office buildings with tenancy problems. It took on bad derivatives. It hopped into bed with infamously failed New York developer Harry Macklowe – twice.
And Realty Finance lost its entire $26.6 million investment on a 1.2 million square foot portfolio of office and industrial properties along Route 495, Route 3 and Route 128. It had acquired those properties in a joint venture with Everest Partners LLC, and quickly became embroiled in an ownership dispute with Everest.
It seems the firm did everything it could have done to inflate the bubble that has now crashed upon it.
Prior to 2009, Realty Finance operated as CBRE Realty Finance. It licensed the CBRE name, and received management advice from the two CBRE execs who sat on its board. In 2006, a year after its founding, the firm raised $133 million in an initial public offering. A year after that, the company was suffering big losses on two Maryland condo projects. It booked its first quarterly loss, a $4.6 million hit, in the second quarter of 2007. The company’s board blamed the losses on dislocations wrought by subprime mortgages, replaced its CEO, and vowed to refocus on its core business – providing first mortgages, mezzanine loans, B-notes and bridge loans to commercial borrowers. It said it was temporarily suspending new lending while it reexamined risk on its $1.3 billion loan portfolio.
Witkin, who took over as CEO in August 2007, vowed to bring a focus on risk management. Lending never resumed.
The company’s second-quarter 2007 earnings release pointedly took issue with investors who had sent its stock price into freefall, saying Wall Street was undervaluing its assets – primarily composed of commercial loans and CMBS bonds – by $205 million.
“Considering the strong fundamentals of the commercial real estate market,” the release said, “management believes the company is substantially undervalued in the public markets.”
The opposite was true. After posting a $1.6 million profit and a $4.6 million loss in the first two quarters, the company ended 2007 $70.8 million in the red. Realty Finance’s commercial holdings, not its residential ventures, did the most damage to its punch-drunk balance sheet.
Macklowe’s Woes
Early commercial losses were driven, in part, by the firm’s $82.8 million exposure to Macklowe. Realty Finance helped Macklowe acquire a peak-market office empire with a $40 million mezzanine loan. It also had a $42.8 million B-note on a Manhattan parcel of land Macklowe hoped to develop. In both cases, Realty Finance’s loans stood behind senior lenders. And in both cases, Realty Finance was slow to recognize and write down losses on loans that, because of rapidly falling land values and a moribund transaction environment, would eventually be completely wiped out.
Realty Finance also bought more than $317 million in CMBS bonds. The vast majority were rated below investment-grade. Those CMBS holdings began a rapid decline in the middle of 2007. By the end of 2008, mushrooming commercial defaults had forced Realty Finance to write down its $317 million in CMBS to a mere $54.6 million. In the first quarter of 2009 – the final quarter Realty Finance would file with the SEC – the CMBS bonds were written down another $10.6 million, for an aggregate loss of more than $273 million.
Throughout 2008, funds from operations fell, while commercial loan delinquencies mounted. Many were term delinquencies: Realty Finance lent out lots of money on short timeframes, and its lenders were unable to refinance when those three-year mortgages came due. Delinquencies from office buildings mounted quickly. Often, office mortgages were underwritten with aggressive rent growth assumptions; when rent growth failed to materialize, borrowers found themselves with negative cash flow. Several office buildings in Realty Finance’s portfolio also had tenancy troubles.
Even though Witkin’s firm was slow to fully recognize losses on its bad loans, in 2008, loan loss provisions eclipsed total revenues. Net investment income for the year came in at half its 2007 levels, and continued falling. Realty Finance lost $157 million for the year, was dumped by CBRE, and de-listed from the NYSE.
Bad loans and massive loan-loss reserves thinned Realty Finance’s margins, and by this past April, the firm had violated collateralization clauses on both its CDO bonds. Those defaults mean Realty Finance’s bondholders, not the firm itself, now collect revenues on loans that haven’t defaulted yet. Net investment income has hit an all-time low, and the company warned it was operating with “minimal incoming cash flows from its primary business.” Debt-to-book-equity ratios ballooned to 8.1.
In May, Realty Finance announced it had found a rescuer in the form of South Norwalk, Conn.-based blank check company Stoneleigh Partners Acquisition Corp. Stoneleigh was to salvage Realty Finance for $25 million in cash. However, soon after that announcement, Stoneleigh received a violation notice from NYSE AMEX because it hadn’t held an annual shareholder meeting in 2008. Stoneleigh did have a meeting – at which Stoneleigh’s shareholders extended the firm’s liquidation deadline, and also withdrew $206 million from the company’s trust. That move left Stoneleigh under the $20 million liquidity threshold it needs for the Realty Finance takeover.
At press time, Stoneleigh hadn’t raised the extra cash it needs to complete the deal.
