Detroit reaches deal to settle Book Cadillac financing lawsuit

[MSUguy]

"Detroit City Council approved Tuesday a $22 million tentative settlement stemming from the financing of the Westin Book Cadillac Detroit hotel.

The settlement would mitigate a money-losing investment made by the city and two Detroit pension funds in a hotel development that spurred downtown's revitalization following the recession.

The city and two pension funds helped finance about $42 million of the $180 million project that renovated and rehabilitated the historic hotel in 2006.

Under the tentative deal, the city and pension funds would split $22 million and settle a lawsuit alleging a secretive scheme bumped the Carpenters Pension Trust Fund ahead of other investors.
Two Detroit pension funds representing police and fire personnel and nonuniform workers have not approved the settlement.

"We are still in negotiations as to how the settlement proceeds will be distributed among us," said Tina Bassett, spokeswoman for the Detroit General Retirement System. "None of the parties involved in this settlement are going to be made whole. However, on the bright side it will give us some cash to be used in other investments and improve our liquidity."
Under the proposed settlement, the city would get at least $10 million, money that would help repay U.S. Department of Housing and Urban Development loans. The loans were part of a 17-layer financing deal in 2006."

http://www.crainsdetroit.com/article...ancing-lawsuit

[Hermod]

Rule Number One for pension funds: Invest economically rather than socially.

[Bobl]

Rule Number One for pension funds: Invest economically rather than socially.

This post is absolutely true. It is also just plain common sense.

[Hypestyles]

Rule Number One for pension funds: Invest economically rather than socially.

What does this mean, exactly?

[corktownyuppie]

What does this mean, exactly?

It means that pension funds need to be managed with the highest priority of serving the needs of the pension recipients -- rather than serving the greater good of the community around them.

Now obviously, whenever it's possible, the pension funds can and should be used in a way to benefit both. That would be the highest and best use of getting the most benefit for the dollars in the fund.

But the moment a pension fund is being used to fund projects in the hopes of creating jobs more than protecting pension recipients, you're going down a tough road. And of course, when the funds are being used to benefit the people in charge of the fund rather than the people relying on the fund, then....

I'll admit that I haven't studied with too much depth the funding structure of the Book Cadillac, other than to know that there are 20+ layers of financing, and that it took over a decade of negotiating to find a way to get the project funded. While this project by itself may have been a bad investment for lenders, you have to weigh that against the financial environment at that time. The B/C completion happen to coincide with the Great Recession in 2008, and one has to wonder how the lenders would have fared in a more normal economic climate. It's not like the Book Cadillac went into default while everything else was holding up...the carnage was unavoidable, in every suburb, city, and metro area.

Lastly, one has to consider the huge intangible benefits of the completion of this project. The Westin was one of the first successful rehab project for an old abandoned building...while it has been tough for lenders, its relative operational success paved the way for Broderick Tower, the David Whitney Building, all of Capitol Park, and now the Book Tower, the Wurlitzer, and the Metropolitan Building.

Not saying that I'm in support of the way the pension funds were used here...like I said, I haven't vetted the ridiculously complex structure of the finances. Just saying that it needs to be examined in the context of everything else taking place at that time as well as with some credit for its role in jumpstarting development downtown...all of which has some positive benefits in the city's general fund via income taxes, some incremental property taxes, and general economic environment.

[Packman41]

You have to wonder why ANY of the lenders participated in the financing of the hotel portion of the BC.

Back in October 2008 a dBusiness magazine article detailed the lender financing package was $98.5 million – please see the attachment below. Yet all of the lenders had reviewed an appraisal, dated July 2005, that forecasted two values:
· January 1, 2008, “when completed” at $78.0 million
· January 1, 2012, “when stabilized” at $96.3 million

Who in their right mind would help with the financing when they would be $2.2 million underwater seven years later? This makes no economic sense.

Some of the biggest idiots in this deal were the two pension funds involved in this lawsuit. Both committed millions without understanding the true risks with the project. Both made junior loans to guaranty senior lenders in the project would be paid first should the project have either [[1) cost overruns [[and they did) or [[2) default. Notice in the dBusiness attachment that those two pension funds were not even listed in the hotel lender stack – both are mere footnotes in deal.

Several of the senior lenders were not sure if they wanted in on the deal and required a guaranty from the borrower that they would get repaid. The borrower refused to give them a guaranty, but they did find two suckers to provide the required guarantees for him - The Detroit Police and Fire Retirement System [[PFRS) and the Carpenters Pension Trust Fund [[CPTF).

As you can see in the attachment, PFRS promised to repay the $15 million loan made by Independence Bank should the borrower fail to pay them. IB was stiffed and the PFRS had to pay them the $15. At least the PFRS was smart enough to get a junior lien on the property.

The CPTF was not that smart – they never took a lien position at all. So when there were cost overruns, they started paying out millions to the senior lenders. And with NO lien position they had no way of ever getting their $17.2 million back. So they approached the senior lender, iStar, bought their note at a discount and took over as the new first mortgagee – iStar was now out of the deal.

Question: How stupid can you be? These two pension funds received very modest fees for their guaranties and in return assumed 100% of the downside risk. That is near criminal stupidity on their part.

[Bham1982]

The B-C renovation made no financial sense. It was, and is, an economic turkey, with low room rates and lethargic residential demand. It's a pretty good metaphor for the wildly exaggerated "downtown boom" meme. If a hotel as grand as this can't get a respectable room rate, and condos can be had for a song, there's still a demand issue.

That doesn't mean it shouldn't have been renovated, though. There's certainly a non-economic argument for restoring this grande dame of hotels. And I'm happy this beautiful structure is in its current shape.

[dtowncitylover]

The B-C renovation made no financial sense. It was, and is, an economic turkey, with low room rates and lethargic residential demand. It's a pretty good metaphor for the wildly exaggerated "downtown boom" meme. If a hotel as grand as this can't get a respectable room rate, and condos can be had for a song, there's still a demand issue.

That doesn't mean it shouldn't have been renovated, though. There's certainly a non-economic argument for restoring this grande dame of hotels. And I'm happy this beautiful structure is in its current shape.

Lol $200-500 per night isn't respectable and low?!?!?!

[Bham1982]

Lol $200-500 per night isn't respectable and low?!?!?!

Those aren't the room rates. They frequently offer $99 room rates.

Big city grande dame hotels should be getting $500+ a night. It's a spectacular property, the best in Michigan [[even better than the Townsend).

The B-C fills during special events, and has minimal demand at other times. It's been losing money since opening.

[dtowncitylover]

Those aren't the room rates. They frequently offer $99 room rates.

Big city grande dame hotels should be getting $500+ a night. It's a spectacular property, the best in Michigan [[even better than the Townsend).

The B-C fills during special events, and has minimal demand at other times. It's been losing money since opening.

So the $500+ rates for next weekend and the $200+ for a random weekend in August were all just an imagination. Got it.

[drjeff]

So the $500+ rates for next weekend and the $200+ for a random weekend in August were all just an imagination. Got it.

Cheapest room available for tonight is $439. I'm not aware of any large events happening on a random Wednesday night and there are no sporting events in town.

[rjlj]

Where are your numbers to back your statements?

The B-C renovation made no financial sense. It was, and is, an economic turkey, with low room rates and lethargic residential demand. It's a pretty good metaphor for the wildly exaggerated "downtown boom" meme. If a hotel as grand as this can't get a respectable room rate, and condos can be had for a song, there's still a demand issue.

That doesn't mean it shouldn't have been renovated, though. There's certainly a non-economic argument for restoring this grande dame of hotels. And I'm happy this beautiful structure is in its current shape.

[Bham1982]

Where are your numbers to back your statements?

Read the thread post before getting ultra-defensive. This entire thread is about the B-C losing money.

And ask anyone who has an interest in downtown real estate [[lead brokers, property owners, anyone with hospitality business downtown). The Westin contract has been a money-loser since Year 1, and they basically gave up on selling the condos. They rent out the unsold units.

I know it doesn't jibe with the "there's a real estate frenzy downtown and no availability, but nothing is being built because property owners are dummies" meme. Property owners are generally a better judge of market conditions than starry-eyed 23 year old downtown boosters who just arrived from exurbia. If they can make money adding new housing, they'll do so.

[jt1]

Read the thread post before getting ultra-defensive. This entire thread is about the B-C losing money.

And ask anyone who has an interest in downtown real estate [[lead brokers, property owners, anyone with hospitality business downtown). The Westin contract has been a money-loser since Year 1, and they basically gave up on selling the condos. They rent out the unsold units.

I know it doesn't jibe with the "there's a real estate frenzy downtown and no availability, but nothing is being built because property owners are dummies" meme. Property owners are generally a better judge of market conditions than starry-eyed 23 year old downtown boosters who just arrived from exurbia. If they can make money adding new housing, they'll do so.

So no actual data as usual? 'asking anyone' is really proof or quantitative data. Of course, whenever asked to prove your statements you respond with additional anecdotal statements and no data.

[corktownyuppie]

Property owners are generally a better judge of market conditions than starry-eyed 23 year old downtown boosters who just arrived from exurbia. If they can make money adding new housing, they'll do so.

For what it's worth, a friend of mine at a $6-Billion, home building company based out-of-state just contacted me last week because they are starting due diligence work for possible development in the city and wanted to get my opinions on site selection and renter/investor demand.

I'm almost 40, so I try to keep my starry-eyes to a minimum.

They haven't plunked down any money to build anything yet, but they are definitely starting to take a hard look at the numbers. For a company known for building suburban developments with homes in the $300-500k range, that in itself is progress.

[Eber Brock Ward]

For what it's worth, a friend of mine at a $6-Billion, home building company based out-of-state just contacted me last week because they are starting due diligence work for possible development in the city and wanted to get my opinions on site selection and renter/investor demand.

I'm almost 40, so I try to keep my starry-eyes to a minimum.

They haven't plunked down any money to build anything yet, but they are definitely starting to take a hard look at the numbers. For a company known for building suburban developments with homes in the $300-500k range, that in itself is progress.

Toll brothers? Their CEO or prez was prominent in death of the suburbs talking about focusing on such development going forwsrd

[corktownyuppie]

The Westin contract has been a money-loser since Year 1, and they basically gave up on selling the condos. They rent out the unsold units.

I can't speak to the Westin contract, but I will mention the condos because I was under contract to live there. They didn't "give up" on selling the condos. As they were approaching the closing date on all of the sales, National City -- the bank which had committed to doing all of the mortgages -- was on the verge of bankruptcy. They eventually sold to PNC Bank, who was unwilling to honor the lending commitments made by National City.

Now one could argue that it's because when they re-appraised the collateral, the appraisal value fell below the sales prices -- prices which buyers had already agreed to pay and a bank had committed to lend, btw.

Is that because the B/C was a bad investment? Plausibly. But the reality is that this dynamic was taking place all over Michigan and all over the country. I saw a condo in Livonia go from $180,000 to appraising under $90,000 in 12 months.

So they didn't "give up" on selling the units in that it was a "bad investment". That's sort of implying that there were tons of developments holding stable value while these dropped. That's not what was happening...prices dropped everywhere and universally. And so they stopped trying to sell them at their original list prices because banks wouldn't lend on those prices coinciding with the real estate crash.

How often do you see a development go bad because the bank pulls out last minute?

In any case, I don't know how many unsold units are left, but recent sales prices in 48226 imply that they should be able to liquidate any unsold inventory if they haven't already.

[Bham1982]

So they didn't "give up" on selling the units in that it was a "bad investment". That's sort of implying that there were tons of developments holding stable value while these dropped. That's not what was happening...prices dropped everywhere and universally. And so they stopped trying to sell them at their original list prices because banks wouldn't lend on those prices coinciding with the real estate crash.

Fair enough. I did not mean to imply that the B-C had some unique conditions that made it a bad investment. Most of metro Detroit was a pretty bad investment, for a pretty long time. However, it's pretty clear that the original pro formas just didn't work out.

Michigan's economic crash is pretty old news at this point. The U.S. recovered all jobs lost in the recession a couple of years ago, and real estate prices are at historic highs. Michigan's real estate markets have been pretty strong for a good five years at this point. Some real estate jokers in Birmingham think they can sell condo units for $2-$3 million. That's a lot of dough for condos with no outdoor space in Metro Detroit.

I don't think it's unreasonable to think that if there are still unsold units, then there isn't a sufficient demand for this product at the desired price points, at least not yet.

[Packman41]

Where are your numbers to back your statements?

Did you read my earlier post? It is #3 above.

The appraised value was between $78.0 million and $96.3 million, yet they borrowed $98.5 million. This did not include ANY real equity from the borrower.

“Neither the city nor the two pension funds have received payments in return on their investments in the Book Cadillac development.” Quote from today’s Free Press.

What else defines a bad real estate investment deal for you?

[Hypestyles]

When people speak of "layers in financing", what does that mean, to laypersons..? How many entities were involved in lending the money to get this project going? Banks? how many investment companies or individuals?

[Eber Brock Ward]

When people speak of "layers in financing", what does that mean, to laypersons..? How many entities were involved in lending the money to get this project going? Banks? how many investment companies or individuals?

I'll try to make it really clear, but the concept can be complicated.

Large capital projects typically have multiple sources of debt funding. These sources can either be in parity with each other, which means they're paid out equally, or layered, which means some have senior rights to revenue compared to others. Let me give you two examples:

1. First example, two lenders in parity with each other: Hypestyles really wants to buy a car but doesn't have the money, so he asks Bham and CY to borrow $10,000. They're good friends and each loan him $5,000 without interest and agree that Hypestyles will pay $100 per month to both of them for 50 months, so a total of $200/mo, and they all agree that if Hypestyles falls short one month, they'll split it equally. So say Hypestyles gets his hours cut and only has $150 one month... because CY and Bham are in parity with each other, they'd each get $75.

2. Second example, layered financing: Now Hypestyles wants to buy a house. He spots a beauty in Rosedale Park that needs a little work, and he can get for $100,000. He only has $10,000 for a down payment, though, so he needs to finance $90,000. Talmer will give him a loan, but only for $80,000, so he has to get a second mortgage for an additional $10,000 from Flagstar. As part of this deal, Talmer gets first dibs on mortgage payments [[senior lien) or if, god forbid, Hypestyles can't pay, the proceeds from a foreclosure sale. Because of this increased security, they charge a lower rate of interest. Flagstar has second dibs [[junior lien) so they have decreased security and, as a result, get priced in at a higher rate of interest.

Basically, when everyone's not equal/in parity, the more toward the front of the line you are, the lower interest you get, because your loan is better secured. These different spots in line are the "layers" of a deal. This "front of the line/lower risk/lower rate" vs "farther back/higher risk/higher rate" concept provides the foundation for deals like the Book Cadillac, and it's a pretty big deal that the Carpenter's Pension Fund allegedly got to skip forward in the line because [[1) they'd almost certainly been getting paid a higher interest rate all along for agreeing to be back in the line and [[2) if the Book Caddy defaulted and were sold in foreclosure, they could get paid and there might not be anything left for folks farther back in line than them.

[Packman41]

When people speak of "layers in financing", what does that mean, to laypersons..? How many entities were involved in lending the money to get this project going? Banks? how many investment companies or individuals?

Yes this is complex financing and it did NOT take ten years to negotiate. It was done in months and the rush to get it done at any cost contributed to the problem. Remember this was done in the Kwame era and he was trying to show a good face to counter his other problems.

As you can count in the chart in my earlier post there were 10 lenders or layers of financing in just the hotel side of the deal.

Each layer means how the loan is repaid – both interest and principal. So the loan payments were supposed to be paid out in this order:
1. First mortgagee: iStar – later CPTF pension fund
2. Second mortgagee: City of Detroit [[HUD Loan)
3. Third mortgagee: Detroit General Retirement System
4. Fourth mortgagee: DEGC Development Loan
5. Fifth mortgagee: DEGC Remediation Loan
6. Sixth mortgagee: First Independence Bank – later the Police & Fire pension fund.
7. I think you see how it goes for the remainder of the lenders in the stack.

Today’s newspaper states that none of the junior lenders [[second and below) have received any money in the last 8 years. IMHO I suspect the CPTF has received only meager loan payments.

All the major banks [[Detroit and elsewhere) ran from the deal – because they knew better. To be polite, the former First Independence Bank was out of their league, but at least they had the good sense to ask for a FULL loan guaranty to be paid to them BEFORE any of the 5 lenders ahead of them. This was the purpose of the Police & Fire “investment”. That pension fund paid off First Independence and took over their position. So the only lender that got out of the deal whole is First Independence.

The original loan was to be paid off in June 2012. But the lenders have gone the “extend and pretend” route hoping some day in the future they will get their money back. It will be a sad day for them. The principal amount is somewhere near $100 today and forgone interest would add say, another $75 million.

[SDCC]

Yes this is complex financing and it did NOT take ten years to negotiate. It was done in months and the rush to get it done at any cost contributed to the problem. Remember this was done in the Kwame era and he was trying to show a good face to counter his other problems.

As you can count in the chart in my earlier post there were 10 lenders or layers of financing in just the hotel side of the deal.

Each layer means how the loan is repaid – both interest and principal. So the loan payments were supposed to be paid out in this order:
1. First mortgagee: iStar – later CPTF pension fund
2. Second mortgagee: City of Detroit [[HUD Loan)
3. Third mortgagee: Detroit General Retirement System
4. Fourth mortgagee: DEGC Development Loan
5. Fifth mortgagee: DEGC Remediation Loan
6. Sixth mortgagee: First Independence Bank – later the Police & Fire pension fund.
7. I think you see how it goes for the remainder of the lenders in the stack.

Today’s newspaper states that none of the junior lenders [[second and below) have received any money in the last 8 years. IMHO I suspect the CPTF has received only meager loan payments.

All the major banks [[Detroit and elsewhere) ran from the deal – because they knew better. To be polite, the former First Independence Bank was out of their league, but at least they had the good sense to ask for a FULL loan guaranty to be paid to them BEFORE any of the 5 lenders ahead of them. This was the purpose of the Police & Fire “investment”. That pension fund paid off First Independence and took over their position. So the only lender that got out of the deal whole is First Independence.

The original loan was to be paid off in June 2012. But the lenders have gone the “extend and pretend” route hoping some day in the future they will get their money back. It will be a sad day for them. The principal amount is somewhere near $100 today and forgone interest would add say, another $75 million.

Are these loans secured? And if yes, what was [[is) the security?

[Packman41]

Are these loans secured? And if yes, what was [[is) the security?

Yes, all the loans are secured now. And that is the EXACT reason for this lawsuit among the lenders – not the Book Cadillac or Ferchill. Originally, two lenders were not in a secured position.

The Police & Fire pension fund only got into the 6^th lien position when they paid off the First Independence Bank. The CPTF pension fund NEVER even had any lien position when they got into the deal. Only after buying out the iStar loan at a discount did they leap-frog over all the other lenders and landed in FIRST lien position.

By leaping into first position the other lenders took exception to that and started the lawsuit.

The security for the loans is only the value of the real estate – there are NO personal guaranties from the borrower, Ferchill. And even if there were, IMHO, he could not come up with the cash.

So the question comes down to what the B/C is worth?

IMHO the property cannot be worth the outstanding loan amount.

I say this based on the fact that none of the lenders in the stack have forced a sale or refinance of the property. Because at that point the existing lenders get paid off in order of lien position. Thus, they “extend and pretend” that sometime, out in the future, the value of property will be worth more than their loans and growing unpaid, accumulating interest.

BTW, after this lawsuit the CPTF pension fund still remains in 1st lien position. They have first dibs on any sale or refinance proceeds on $44 million plus all accumulated unpaid interest. Then the next next lender in the stack gets paid their unpaid principal & interest -- and so on down the stack.

[SDCC]

Yes, all the loans are secured now. And that is the EXACT reason for this lawsuit among the lenders – not the Book Cadillac or Ferchill. Originally, two lenders were not in a secured position.

The Police & Fire pension fund only got into the 6^th lien position when they paid off the First Independence Bank. The CPTF pension fund NEVER even had any lien position when they got into the deal. Only after buying out the iStar loan at a discount did they leap-frog over all the other lenders and landed in FIRST lien position.

By leaping into first position the other lenders took exception to that and started the lawsuit.

The security for the loans is only the value of the real estate – there are NO personal guaranties from the borrower, Ferchill. And even if there were, IMHO, he could not come up with the cash.

So the question comes down to what the B/C is worth?

IMHO the property cannot be worth the outstanding loan amount.

I say this based on the fact that none of the lenders in the stack have forced a sale or refinance of the property. Because at that point the existing lenders get paid off in order of lien position. Thus, they “extend and pretend” that sometime, out in the future, the value of property will be worth more than their loans and growing unpaid, accumulating interest.

BTW, after this lawsuit the CPTF pension fund still remains in 1st lien position. They have first dibs on any sale or refinance proceeds on $44 million plus all accumulated unpaid interest. Then the next next lender in the stack gets paid their unpaid principal & interest -- and so on down the stack.

Excellent reply, and thank you.
I certainly agree that the guesstimated value of the building is not worth the value of the loans. It is highly speculative, and quasi risky financial position for these borrowers to be in. What decade are investors expecting to see capital flowing out of the building, and back in their accounts?