1.) JRT do a rights offering for $20/sh for shares of a brand new REIT
"JRT 2.0 Inc" with the same investment mission as the current JRT.
2.) JER assigns the management agreement for JRT to JRT2.0, thus giving the new REIT a source of cashflow from Day #1, as well as optionality from the CALPERS agreement.
3.) The new REIT will make JRT type investments, and manage the run off of Old JRT.
The core issue is that the JRT management team is top notch, but JRT as a REIT is hopelessly lost, and basicly a worn out stub.
I was referring to what happens when they fail the CDO tests. Cash from the underlying mortages is diverted from lower tranche bonds and JRT's equity in the CDO to pay down principal on the most senior bonds in an accelerated fashion. This is protection for the senior bondholders and has been triggered in JRT's case by the recent batch of rating agency downgrades. The senior bonds are paid back at par, even though they might be valued at closer to 50 cents or 60 cents on the secondary market in today's crisis environment. Unfortunately, JRT does not have the cash and/or was unable to raise any cash to be able to buy these bonds at heavy discounts in the secondary market. It is highly likely that the cash from the new offering will be used to buy back these senior bonds at 50 cents on the dollar (I don't think there is anything structurally that precludes them from being able to do this), but unfortunately, as with all of this, all of that new value creation will be captured by the new shareholders. Any highly diluted shares held by the existing shareholders will represent a long-term "hope note", so if these bond buybacks occur the existing shareholders would benefit in his/her own little way. There may have been a chance to benefit in a major way (see IStar's latest earnings announcement, they generated $300MM+ in gains from buying in bonds), but JRT leadership decided it wasn't worth trying to create this value for existing shareholders, better to entice new shareholders into buying shares by dangling this prospect in front of them. Add it to the list of how existing shareholders are getting screwed.
They are just issuing a big f-you to the existing shareholders with this plan, not much more to be said about it. I am surprised that Joe Robert is happy to go along with getting his existing share equity wiped out, but maybe his share of the management company's fees and incentive income on the new equity issued will help compensate him for that over time. Third party management is a red flag I should not have overlooked, always a conflict of interest there.
The JRT leadership will claim that they had no choice (there are hints of this in the prospectus filed), especially with the diversion of cash flow on CDO II to pay down senior tranches. But as the collateral manager for that deal they should have been managing to meet or stay close to the collateral tests so the tests wouldn't be failed. Furthermore, the rating agencies have been communicating for months about how they might revise their analysis methodology and how it might result in widespread downgrades of CMBS bonds. So this was all telegraphed to JRT and they should have been managing the portfolio to mitigate any downgrades, communicating with the rating agencies months ago and taking pre-emptive steps. These downgrades were not a surprise to anyone, but JRT was not able to mitigate them. Moreover, paying down the senior tranches is not the end of the world, all it means is the company is deleveraging until the collateral tests are once again met and cash flow gets paid to JRT after that happens. Paying off these bonds at par in the current environment sucks, but that is the structure of the deal and the bargain that AAA investors sign up for. So, for JRT to hold that out as a reason for having to issue massively diluted shares, well perhaps that would have only been a short-term phenomenon anyway. JRT's failure to manage the portfolio to be able to maintain the tests is one of many management failures here and existing shareholders are paying the price. Any buyers of the new issue should do their due diligence carefully.
Very good summary. My first thought about using most of the money to buy AAA tranches was that the ones they would buy would be THEIR OWN CDO I and CDO II AAA tranches, thereby putting themselves in a position to recapture the future interest payments that they will be forced to give up to the AAA tranches due to the OC stipulation.........good idea EXCEPT that, due to the upcoming massive stock dilution, almost all of the benefit will go to the new stock being issued.
I must say that I am very disappointed that so much needless dilution will take place. They really should just raise enough money to get JRT though this tough situation while keeping shareholder dilution to a minimum. They don't need anywhere near the amount of money that they plan to raise.
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What could JRT do? Well, we have placed our trust in the company and have made some mistakes of our own and have been punished for our mistakes by having an erosion of book value from $400MM down to $46MM, with an even bigger erosion in the market trading price. That is water under the bridge and you have to pay for your mistakes. But the company, if they have an equity underwriter in place (which they do), could go out to the market and try and raise new money at closer to the book value of $9/sh. They could make the case to new investors (and probably have a fiduciary obligation to do so) that there is SOME value in the company and that the current trading price does not reflect that value, in fact the current book value may not reflect the intrinsic value. They will tell new investors that some of the new money will be used to immediately recapture $45MM of equity value from the trust preferred buyout, some of which value should probably accrue to the new investors and not so much to the current investors (we don't have the cash to do it right now).
Whatever the case, if they successfully issued shares at closer to today's book value, then they would not be selling the company for nothing, they would not be hitting the "re-do" button with a new company, and they would not kick the current shareholders who have stayed with them all along in the teeth. There is no crying in baseball, so perhaps they don't care much about the current shareholders and that will have proven to be another mistake made by the current shareholders. Hopefully Joe Robert, who probably has $10MM or more invested in the company, would not be too pleased about having his share of the book value wiped out, even with the chance to put some of his wealth into a new company by buying some of the new shares.
The company could be moving forward with a plan to try and issue new equity at a reasonable price (not today's trading price) to be able to buy in the trust preferreds, to buy in some of the CDO debt at big discounts (a strategy that has a sizable tax advantage under the Obama plan), and to buy high grade CMBS with big yields in today's market, all of which most current shareholders would applaud. That may be what they are communicating, though perhaps announcing the number as high as $150MM is not prudent (they only need $15MM for the trust preferreds), you would only want to issue even marginally dilutive equity on an as needed basis. I guess we will see what they really mean in short order.
[Hey, guess what? I just saw this morning's announcement of an offering of $150MM in new shares for about 150MM new shares, or $1.00/sh.. Massively dilutive and basically giving away the existing book value for nothing. We have our answer ladies and gentlemen, this says everything about the Board and management of JRT. I know that some observors will respond that the book value is phony and that it is really $0 or negative anyway. Well, perhaps the CFO and other execs should not certify that the book value was $46MM at 12/31/08 when they issue the 10K]
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The company has $46MM of book value ($9.21/sh.) and that hasn't gone to $0 in two months, especially since JRT has taken out a lot of the repo risk and is less likely to be forced to sell assets at steep losses. As discussed above, that $46MM might be understated if the realized losses on CMBS turn out to be far lower than anticipated as JRT works out loans and the economy recovers. On top of that, JRT is indicating that it may have the opportunity to buy in some trust preffered at approx. 25% of par, which would boost book equity from $46MM to close to $90MM or $18/sh.. Unfortunately, as we all can see, the market is not giving much credit for any of this and the stock is trading at $0.75/sh. Maybe the market is right, but maybe this is in fact a good value play for anyone buying shares at these low levels. Maybe the management team, the Board, the independent directors on the Board, and Joe Robert (~8%-9% stake in that book value), will be fighting hard to bridge that gap in value for the shareholders. I would say (and I hope the NYSE and others would too) that the Board has a fiduciary obligation to try and recapture that value for shareholders.
Which brings us to the surprise announcement of a potential $150MM equity offering. I'm not sure exactly what the Board and management are thinking on this one, but if they issue equity at these low stock price levels, they will be destroying equity value for existing shareholders and handing that equity value to new shareholders. The math is pretty straightforward, selling equity at, call it, a $1.00/sh. that has a book value of $9/sh. and maybe an intrinsic value well above $9/sh. is not in the best interest of current shareholders, who the Board is supposed to represent. If they issued the full $150MM at these prices, the Board and management are essentially saying that the old JRT has no value and they want a "re-do" with a new set of shareholders to be able to go out and take advantage of very high yields for high grade CMBS in the current market. I would not agree that the old JRT has no value, in fact the company's accountants are indicating that it has a book value of $46MM, which might be able to grow to $90MM with the trust preferred buyout, and is probably materially higher as the loss assumptions on the CMBS prove to be conservative over time. As with other commentators on this board, I ask myself how JRT might be able to go out and basically do an IPO/fresh equity raise of $150MM in this kind of negative market for mortgage assets, with the kind of track record they just delivered with JRT over the past few years (not good), and entice new equity to give them another chance? Seems crazy right? But, it would not be too crazy if the new investors saw the virtue of: (1) taking over JRT's in-place workout machine for free, just when the U.S. is on the verge of the biggest distressed asset buying opportunity ever known to man (2) were able to acquire the $9/sh. of book equity that would immediately become $18/sh. with the trust preferred buyout for only $0.75/sh-$1.00/sh. (quite a bargain) and (3) acquired the right to any recapture of the book writedowns from the CMBS portfolio in the coming years. Many investment banks have been decimated in the past year, but just about any ibank team could sell that package of goods to new investors to raise $150MM, even in this environment. And that's what would happen if the Board and management issue new equity at these low price levels.
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JRT has book value of $46MM at 12/31/08, or $9.29/sh. At it's high point book value was close to $400MM (in 2006), so there have obviously been some losses and writeoffs along the way. Some of those writeoffs were not necessarily credit related, but had to do with how the assets were financed. Those losses have been realized and that equity is gone forever. Though not credit related, the management team funded some of these loans on repo lines as late as Q1 and Q2 2007, AFTER many of the subprime lenders had melted down and during a time when maybe they should have been a little more cautious about putting out new capital (especially at lending rates of 5%-6%). But they made the loans, sold them at a loss within about 12 months or lost them back to the repo lender at a loss, and wiped out some equity. Not credit related, but maybe not too smart on the capital allocation during a time when many in the industry saw big storm clouds coming.
So, some of the losses have been realized, but much of the other erosion in equity value results from writedowns on CMBS based on JRT's evaluation of future cash flows from the underlying loans. I would argue that this equity erosion is somewhat credit related since JRT underwrote the original portfolio of mortgages and made assumptions about cash flows, defaults, future losses, etc.. That was their area of expertise gained during the last R.E. crisis, and they priced the assets based on their underwriting of the mortgages. They are now expecting higher potential credit losses in these mortgages and have taken book writedowns on the assets. Though there are undoubtedly credit crises related issues in some of the writedown (e.g. maturity defaults), there are also some credit issues that simply have to do with underwriting mistakes and of course not foreseeing the type of economic meltdown we are in now and how that would impact some of the underlying loans. Very few of us were able to forecast how bad the economy has become, but someone has to take responsibility for the deteriorating credit in the portfolio and there were some credit misses in there. The potential positive about these writedowns is that, thus far, JRT has had very little in realized losses, only $3.4MM vs. $37.2MM underwritten. I think this has to do with one of the reasons many of us made investments in JRT to begin with, they have deep experience in working out trouble loans. They are showing that they can minimize losses when loans turn bad. Part of it may also be related to being conservative on valuations, so ultimately the losses come out lower than anticipated (that is a good way to underwrite). So, the big unrealized writedown taken in Q4, which helped bring the book equity down to $46MM, may end up being hidden value down the road as JRT applies its workout skills and maybe benefits from being conservative on the valuations in Q4. If the realized losses continue to be below what they are anticipating, then some of the book value loss will be recaptured. These are the types of situations that value investors look for, book value materially understated with potential to recoup value later on.
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Think of this deal, as being like when a private company goes public via a reverse merger with a publicly listed shell company.
JRT is the empty shell, it's listed on the NYSE, reports to the SEC, has analyst coverage, quality BoD etc.
Think of it this way. CalPERS gave JER $400M to manage, of which JRT owns 50% of the manager of the JER/CalPERS JV.
People who are investing in the equity offering are doing so, because they know the management team, and the great opportunities in investment grade CMBS.
They are not investing for anything related to Old-JRT. All that's left of old-JRT is CDO I, and maybe some crumbs of unencumbered assets. CDO I will probably implode sometime soon.
The benefit to investing in the $150M offering is that unlike a LP fund structure, the public company shares are liquid, and you have more oversight.
Joe Robert is *exactly* the man for these times.
Yes it sucks that Old JRT collapsed. But don't forget that Joe Reobert himself own's 9.8% of the company.
Not at all. If you look at JRT's credit performance. It is *outstanding*, the company was done in by financing issues, not credit issues.
Looking at the company 1 year ago (before the really serious drama started) you had a very nice book that was balanced between CMBS, loans, and those amazing schools with the 14% cap rate.
This is not RAS, AFN or SFI etc.
The underlying credit performance has been excellent. Now that certainly confused some people like Jizzy, who greatly over estimated the companies earnings power. .
Having lost all those loans to GS, plus losing 70% of earning assets contained in CDO II, the company has no earnings power what so ever.
So for shareholders of Old JRT, it is much better to own 4% of new JRT, than to own 100% of old JRT.
The buy back of the trups is a nice touch, and will get the company off to a good start.
I won't be at all surprised if RAS reports further impairment on their trups portfolio.
The go forwards company will have fresh cash to invest in CMBS etc, and will have the optionality from the promote on the CALPERS fund. That promote could be huge.
Depending on whats in the S-11, I may very well look forwards to investing in New JRT.
I'd like to thank current shareholders (especially Jizzy, Adec, and nwlean) for keeping the all shares I sold back in Jan 2008 safe and in good condition.
I may never get those same shares back, but the crisp new certificates could be very interesting.