Saturday, January 17, 2009

Single versus Multi-Asset Borrowers

One of the most irritating workouts I’ve participated in happened in Los Angeles in 1992 while I was Assistant Director of Special Assets at Home Savings (then the country’s largest S&L). Irritating, because the problem was largely self-inflicted.

We had made 17 loans secured by apartment buildings to Shashikant Jogani. At the time, Shashi was one of the largest apartment owners in Southern California. From a later court filing:

In 1979, plaintiff Shashikant Jogani (who prefers to be called Shashi on appeal) began investing in residential apartment properties in and around Los Angeles County. By 1989, he owned properties having a fair market value of $375 million and a net equity of $100 million. Because of an economic recession that started in the late 1980’s and continued into the mid-1990’s, Shashi faced defaults and foreclosures on valuable properties.

We knew some of our deals with Shashi were struggling, but we thought most of the loans would weather the storm. However, Shashi and his advisors asked for a meeting and presented an ultimatum – modifications to all his deals, or he would file bankruptcy.

At that point in the recession we were well acquainted with bankruptcy proceedings; in fact, sometimes we required borrowers to file bankruptcy to confirm our workout plan so if there was a subsequent default we wouldn’t have to go through an adversarial bankruptcy filing then. So, the threat of a bankruptcy filing ordinarily was not something that concerned us. Shashi’s case was a different, because he held almost all of his properties as an individual. A bankruptcy filing would not just involve our 17 properties, it would involve more than 50 properties and more than a dozen lenders. It would be a procedural nightmare, and there was a good chance our properties which had equity would end up supporting other lenders’ problem properties. Shashi of course knew this, and used it as leverage to negotiate with all his lenders.

We ended up agreeing to split the properties into three groups. For the most severely troubled properties Shashi stipulated to the appointment of a receiver and did not oppose our foreclosures. The marginal properties got substantial modifications (a significant reduction in interest rate for an extended period). For the properties which were performing adequately we agreed to an interest only period and allowed the excess cash flow to support Shashi’s other deals. And, we required Shashi to form separate legal entities for the properties which received modifications and transfer ownership to those entities so if the modifications didn’t work out we would not be facing the same nightmare again. As it turned out that requirement was a good idea, because Shashi subsequently defaulted on the marginal group.

Most lenders require a single asset borrowing entity to avoid these kind of entanglements. However, this ownership structure can protect owners too. The Pierce County Housing Authority recently learned this lesson; lawsuits related to mold at one of its apartment complexes put the entire Authority into bankruptcy a few months ago. From the Tacoma News Tribune:


The Pierce County Housing Authority prefers to declare bankruptcy rather than fight multiple lawsuits over a mold-ridden apartment complex in Puyallup.


The agency’s six-member board of commissioners voted Monday to take the step. If approved, bankruptcy protection would prevent 81 current and former residents from collecting damages they say they suffered from mold at Eagle’s Watch, a 193-unit complex on South Hill.


Charlie Gray, deputy director of the Housing Authority, said Wednesday that bankruptcy is the only way the agency can continue to operate and provide affordable housing for about 8,000 clients throughout the county


…[The Housing Authority] owns 1,123 apartment units in 13 complexes throughout the county, along with 134 homes.

Had Eagle’s Watch been owned by a single asset entity, it’s likely damages would have only attached to that single asset.

Isolating ownership of multifamily projects makes sense for both owners and lenders.