FREEP: Book Cadillac Not Paying Loans from the Pension Funds

Recognizing I may be called a heretic, I caught this in the Detroit Free Press today:
http://www.freep.com/article/2013090...unds-Kevyn-Orr

I always wondered how the financing was going to work out for this place. When it was conceived it was called one of the most complex mortgage transactions with something like 22 levels of financing. Now we see that the two Detroit pension funds are not being paid by the developer.

The Detroit General Retirement System [[GRS) has never received a debt service payment for the $9.0 million investment they made in the hotel. They have already marked their principal investment to zero and probably will never collect any of the interest due them over the past six or seven years. If they thought they would earn 8.0% on that money, then they also lost another $5.04 million. IIRC the GRS sits in a third mortgage position, so the first and second mortgage lenders have to be repaid all of their money BEFORE any funds can flow to the GRS.

The Detroit Police & Fire Retirement System [[P&F) did not lend any money directly to the hotel. Rather, they were a co-signer, guarantor, for a $15.0 million loan made by First Independence Bank. When FI Bank could not get a personal guaranty from the developer, someone approached the P&F to guaranty the loan instead of the lender. So, when FI Bank did not receive its debt service payments, then the P&F has to make the payments. Assuming an 8.0% interest rate on the FI Bank loan, that means P&F has to pay about $1.2 million each year to FI Bank. Additionally, if FI Bank does not receive its $15.0 million principal, then the P&F must repay that too. BTW, I think FI Bank sits in the sixth mortgage position.

Is this a great county, or what???

What's next? Detroit's financials are a _luster_uck at this point. Then the CEO of the company that got the loan to rehab the Book Cadillac, poo-poo's not making the payments like it's not a big deal. Does _hit like this happen anywhere else?

Good observations. That well-written article deserves some more quoting.

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John Ferchill, chairman and CEO of Cleveland-based Ferchill Group, did not deny the firm is not repaying the General Retirement System’s $9-million loan. But he said the hotel is performing well and is not at risk of foreclosure.

“We’re not in default, so I don’t know what the problem is,” he said.

Ferchill said the company is abiding by its loan documents, but he declined to explain why the General Retirement System isn’t getting paid if the firm is complying with its loan agreements.

“I don’t want to explain that,” Ferchill said. “Those documents are so complicated, it’s unbelievable.”

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What's unbelievable? Not wanting to explain it? Go ahead try us. We're all ears.

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Ferchill told pension officials last year that the hotel was able to make payments on the top-priority loan of $50 million to the Michigan carpenters pension trust, although it had not been paying the General Retirement System and other debts connected to the project.

The carpenters trust bought the debt from the original lender on the $50-million loan, iStar Financial. Officials with the Carpenter Pension Trust Fund-Detroit and Vicinity could not be reached for comment.

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Meanwhile the Carpenters are doing just fine and the GRS is asked to zip it. If Mr. Orr starts turning over rocks as to why one gets paid and another doesn't who knows what worms will get exposed.

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The Ferchill Group had asked the General Retirement System not to declare a default on the loan because it would create a public relations nightmare...

The pension investments are part of a complex package of loans to finance the historic Book Cadillac’s redevelopment. The deals can be traced to a troublesome period for the pension funds, when former Mayor Kwame Kilpatrick and his allies held influence and spearheaded several failed investments.

A federal indictment made public in February 2012 charged former Detroit pension trustee Jeffrey Beasley, who also served as city treasurer under Kilpatrick, with taking bribes and kickbacks in a scheme that cost the two pension funds $84 million in losses. Some of the losses were tied to real estate deals, but the Book Cadillac project is not mentioned in the indictment.

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All's well that ends well? The hotel being a financial success could put this all to rest.

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Ferchill and two business associates candidly described the hotel’s financial situation during an appearance before the Police and Fire Retirement System in March 2012, one week before the pension fund would begin making interest payments on an unpaid loan it backed to help launch the redevelopment.

Ferchill and his representatives told the board the hotel opened at the height of the recession. But they insisted business had picked up. The occupancy rate had climbed to more than 65% at the end of 2011, well above the market average of 52%.

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So show me the money.

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Asked on Thursday about the conversation, [George] Orzech — now chairman of the pension board — said Ferchill’s rosy picture of the hotel’s business operations didn’t sit well because the firm wasn’t repaying some of its debts.

“How can you say everything’s great?” Orzech said. “OK, how come you aren’t paying? What are you doing with the money?”

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I had always thought the money in the pension fund should not be used for anything but for the retirees who work for the city of Detroit

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Originally Posted by stasu1213

I had always thought the money in the pension fund should not be used for anything but for the retirees who work for the city of Detroit

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The problem with leaving it sitting in an account is that inflation eats away at it's value. They have to invest in *something* to keep up [[or increase) it's value.

The problem is you get pension fund managers who like investing in things for political reasons, or something their friend is doing, or something similar.

I always thought pension funds should get into the commercial paper business. Low interest, short-term, *very* low risk loans to big companies like GE and Walmart. Banks make a killing in this area. Undercut them by a few fractions of a percent and start raking it in.

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Originally Posted by JBMcB

I always thought pension funds should get into the commercial paper business. Low interest, short-term, *very* low risk loans to big companies like GE and Walmart. Banks make a killing in this area. Undercut them by a few fractions of a percent and start raking it in.

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Commercial paper rates are too low to make reasonable pension investments. See http://www.federalreserve.gov/releases/cp/

However, I can't see any good argument for pension funds guaranteeing loans for third parties--pension plans aren't insurers and there is no reason to think the have the ability to assess the risks properly. I would be OK with restricting pension funds to buying publicly traded securities. It might [[might) reduce their returns a bit, but it would make them a lot more transparent and less subject to misuse.

Clearly political pressure was brought on to the pension managers to invest in certain projects. Yet another way of spending someone else's money. Not unlike, oh I don't know, GM & Chrysler pushing employees into buying their stock as an investment, only to have the stock be rendered worthless when all non-losing assets were transferred to a new company. Considerations beyond the financial prospects for a business cloud one's judgment.

Maybe having the state take over the pension funds and run them as a part of the state pension system might put the piggy bank beyond reach of the "friends and family" in Detroit.

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Originally Posted by Hermod

Maybe having the state take over the pension funds and run them as a part of the state pension system might put the piggy bank beyond reach of the "friends and family" in Detroit.

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Sure, but the rules [[and the oversight) that the people are working under are at least as much a problem as the people. Helping to finance the Book Cadillac wasn't an ignoble idea, or, at least as far as we know, a corrupt one. It was just a dubious way to invest, and one which was unquestionably influenced by non-economic factors.

While it is true that moving municipal pension funds to state management would reduce the influence of municipal politics, it would be mistake to think the state pension funds are without problems, and that is because they often don't have appropriate rules or oversight either. I don't think that moving to centralized state pension fund management would be a bad idea, but I'd like to see some reforms at that level as well.

maybe individuals should be responsible for their own "pension funds" and be allowed to invest personally/individually as they see fit....

crazy idea.... free market.....

This example is merely the tip of the iceberg. The reporting is primarily accurate, except that:

1. The Carpenters actually had a loan behind the two pension funds. Buying the first mortgage was an attempt to save face.

2. Everyone involved knew exactly what the rules were about cash flow distribution. If the money wasn't there to pay for operating expenses and the lenders, those further down the capital stack were not going to get paid anything. The pension funds had a very low chance of ever being repaid, right from the beginning.

3. If they look, the Detroit pension funds had a long history of investing only in Detroit-based deals [[either Detroit property or Detroit operators). Some of this was crooked, some merely stupid.

"Socially Responsible Investing" is the bane of pension funds. The Detroit employees would have been better off if their money had been invested in something truly EEEEEEEEEEEVULLLLLLLLLL like Walmart.

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Originally Posted by Goose

maybe individuals should be responsible for their own "pension funds" and be allowed to invest personally/individually as they see fit....

crazy idea.... free market.....

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Not crazy, but it turns out that it hasn't worked very well for retirement savings.

For instance, see http://theweek.com/article/index/226...s-of-americans

And simply on a mathematical basis, collective pensions are better. For an explanation, see http://blogs.hbr.org/fox/2013/08/why...risks-are.html

This makes for good reading and highlights the dangers of supporting local projects with pension funds. But from a financial viewpoint, the losses here are statistical noise. The invested assets of the funds likely gain or lose more each day with the ups and downs of the markets than was lost in total with these deals. Doesn't make it right but makes the point that what garners inches of newsprint doesn't equal what's of importance when talking pension fund finances.

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Originally Posted by Novine

This makes for good reading and highlights the dangers of supporting local projects with pension funds. ...snip...

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Don't put all your eggs in one basket. Investing in anything local is a big mistake for a city. Better guideline would be to NEVER invest in anything local -- even if its traded publicly on the NYSE.

Let's say Detroit invested in GM. Gee -- GM sank at same time as Detroit. Hmm.

And as someone else said -- stop the social responsibility thing. This is someone's pension you're playing cute with. Let the market punish the socially irresponsible. Don't try to use pension money to make a point. Just make money.

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Originally Posted by Hermod

"Socially Responsible Investing" is the bane of pension funds. The Detroit employees would have been better off if their money had been invested in something truly EEEEEEEEEEEVULLLLLLLLLL like Walmart.

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When I lived in NY, the city and/or state politicos were constantly making political decisions about investing pension funds. Politically correct causes received boatloads of money, and politically incorrect [[companies not paying a "living wage", funds invested in tobacco or oil, etc) were always targets to be avoided. Pure idiocy. Hope the "feel good" vibe will be accepted at the store when they lack actual money.

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Originally Posted by Novine

This makes for good reading and highlights the dangers of supporting local projects with pension funds. But from a financial viewpoint, the losses here are statistical noise. <...snip...>

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Noise??? Is that how you want to characterize and diminish this? Noise? Try telling that to the retirees when they get their haircut. “Don’t worry, because collectively, what was cut from your benefits was just the ‘noise.’”

A $24.0 million loss here and other losses due to incompetency and pretty soon you are talking about some real money here. These losses are NOT because of the market being up or down, but because of stupidity and possibly criminality – they should have never been made in the first place.

This $9.0 loan and co-signing for a third-party $15.0 loan are more examples of the lack of fiduciary responsibility on the part of the pension fund boards. Maybe you missed the series of articles the two Detroit papers have been running for the past number of years citing the bone-headed moves the board has routinely pulled time and time again. An abbreviated listing of articles can be found here:
http://www.freep.com/article/9999999...heme=PENSION09

Of particular interest is the article from December 2010 titled “Risky bets cost Detroit pension funds $480 million.” That is not too far away from the amount the pension funds claim they are underfunded.

And then there are the FBI & SEC investigations and the series of indictments and convictions. Or is that more “noise” ?

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Originally Posted by Novine

This makes for good reading and highlights the dangers of supporting local projects with pension funds. But from a financial viewpoint, the losses here are statistical noise. The invested assets of the funds likely gain or lose more each day with the ups and downs of the markets than was lost in total with these deals. Doesn't make it right but makes the point that what garners inches of newsprint doesn't equal what's of importance when talking pension fund finances.

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If you are talking about this specific instance, then it isn't a significant issue, but we know these aren't the only investments that were made on the basis of things other than funding retiree's pensions. We don't know the significance in aggregate.

The odd thing about the article is that it refers to a meeting in March 2012 and the increasing hotel occupancy rates in 2011. Aren't occupancy rates even better now, and aren't condo sales ticking up as well? I'd be more interested in a more current appraisal of the Book's finances.

Hmmm… Now isn’t this an interesting development?

Detroit pension funds sue investor [another lender] over payments in Book Cadillac Hotel development

http://www.freep.com/article/2013102...dillac-lawsuit

“To be clear, this is a civil dispute among the lenders regarding the priority and repayment of their respective liens and loans,” Don Wagner, special counsel to pension funds…”

“The lawsuit … centers around a complicated financial deal that arranged all the lenders who backed the $180 million development in an order of repayment.

“The suit alleges the Carpenter Pension Trust Fund … carried out a secretive scheme that put the carpenters’ fund at the head of the line for repayment. The secret deal deprived the project of more than $16.7 million that should have went toward repaying the loans…”

Seems that the two pension funds are miffed that one of the other lenders bought out the original first mortgagee, before they thought of the idea and did it themselves.