Tuesday, 24 August 2010

First Allied Corporation watch no. 2: more defaults as predicted

This is the second in an occasional series keeping an eye on the Glazer family's US property business, First Allied Corporation. As with previous posts on this subject, if you don't see the relevance of any of this to the fortunes of Manchester United or the Tampa Bay Buccaneers I suggest you stop reading now!

Information on First Allied comes from monthly and quarterly reports by the company to the trustees of the Commercial Mortgage Backed Securities ("CMBS") which contain the relevant mortgages, and from the company's own website which shows vacant space. My original work on First Allied, used by the BBC Panorama team, was based on information available in the May CMBS filings. We have now had three months of additional data (the August filings are in) and as I predicted originally, First Allied continues to deteriorate with no signs of a pick-up in performance.

In May I identified 34 shopping centres (out of a total of 64) which I thought were at serious risk of going bust in the next twelve months (to add to the four that had already gone that way). Three months on and the mortgages of five of these centres have become "delinquent", that is to say the centres have started to miss mortgage payments. Whilst occupancy rates at some of First Allied's centres have risen, at others occupancy has fallen further and overall the vacancy rate has increased slightly over the three months (from 10.5% to 11.1%).
The delinquent centres are:

So these five centres, originally valued at over $38m with over $7m of equity, have become delinquent in the last four months. For all but Ulster Terrace, the issue is clearly very poor occupancy (readers may recall University Plaza in Houston as it was featured on BBC Panorama). Ulster Terrace is interesting because First Allied's website shows it as fully let (it was only 79% let in July), yet it has still failed to make a mortgage payment. The explanation is that Ulster Terrace is one of the 31 centres coming off interest only deals in 2010, in this case the interest only period ended in April. On my calculations, Ulster Terrace will still be unable to meet the new higher payments, which will now include repayment of the capital, even when fully let. I expect many other centres to run into similar problems in the next few months.

Returning to the original list of 34 "at risk" centres, 15 have seen material changes in occupancy (more than 5%) since May, occupancy has fallen by more than 5% at 8 centres and risen by more than 5% at 7 centres. The changes in occupancy and the level of their debt service coverage ratios ("DSCR") at current occupancy can be seen in the chart below:

Four centres are probably out of the woods for now, with DSCR back above 1x (the same goes for another, Murphy Crossing in Texas, where occupancy has risen 3% since May). Whilst these five centres are no longer at risk of default, five new centres (Golf Glen Mart Plaza, Heritage Plaza, Preston Lloyd, River Plaza and Allen Central Market) which had previously been covering their mortgages, have now joined the "at risk" list after seeing falls in occupancy.

First Allied's problems are not just a product of a weak US economy struggling to come out of recession, they are in large part due to aggressive financing structures put in place before the credit bubble burst. For 15 shopping centres, the terms of the mortgages on them make insolvency virtually inevitable.

I believe the state of First Allied Corporation explains much about the Glazer family's ownership of Manchester United and the Tampa Bay Buccaneers. If centres with negative cash flow are ignored, the portfolio generates around $9m of pre-tax cash per annum but these cash flows are before any of First Allied's central costs and before tax. The whole business is generating virtually no cash flow at all (and that is before we take into account centres being given short-term support by the parent company). So for a Bucs fan wondering why there hasn't been any investment by the owners after a 3-13 season or for a United fan wondering how the Glazer family is going to repay "their" PIKs, the state of First Allied provides some uncomfortable answers....