The Relevance of Messrs. Houlihan, Lokey, Howard & Zukin

As indicated by the date of this post, I have been awake for many an hour over this past weekend, reading deep into shadowy paperwork such that would make lawyers cringe. My subject of interest: none less than one Gramercy Capital Corporate. Let me start by saying, there is a story here, in all of this; one that could very well be made into a book, when all is said and done.

The stock price tanked twenty percent on Friday, and at first, I was quite baffled as to why. There was seemingly no news to be found, and so I guessed that some larger institutional holder must be unwinding. However, I am rarely satisfied with hypotheses that have no basis, and so, I continued to look out.

Houlihan Lokey is an investment bank that began, during the late eighties, to specialize in handling companies with distressed situations, by advising them in bankruptcy proceedings or bankruptcy alternatives. Their financial restructuring group is one of the best in the country, if not the world, having advised the bankruptcies of Lehman Brothers, Enron, WorldCom and Conseco. I believe they had a hand with GM as well.

As it stands, GKK has roughly just under $6.8 billion in assets. They have an associated, rough estimate of $6.2 billion in liabilities. That puts the shareholder value at just over $550 million. Assuming all favored ownership contracts are converted to standard ownership titles and you can see that the shares are, even now, worth more than $10. That’s after all the shit their CDO portfolio has been taking, with so many of the products being at present written to $0.

Even with Bank of American deserting a large portion of Gramercy’s rental space, continued losses from their loan portfolios, and a looming threat of interest rate hikes, all indicative of continued negative cash flow, the amount of long term damage that can seemingly be done is, at less than $3 a share on today’s exchanges, presumably minimal, you would think?

So what’s the problem? In as few words as possible: Goldman Mortgage Loan. Actually, it’s two mortgage loans, from Goldman Sachs, Citigroup, and a couple other sources, valued at $241.3 million and $553.5 million. These loans, which represent barely less than 12% of all assets, and not even 13% of all Gramercy’s liabilities, set to expire by March 2011, have the ability of completely sinking the company.

How is this possible, you might ask? I know I did. The answer has to due with the nature of mortgage backed securities and, specifically, how these two loans were financed. You see, these loans are not, apparently, backed by any specific property. Rather, they are backed by what I ascertain to be a pool of every property the company owns. Hence, any one of their creditors, however minimal, at the event of default, has the ability to force foreclosure of their entire operation.

Which brings us to the apogee of this little story. You see, Gramercy typically finances itself using a system of CDOs and CMBSs. However, as we’ve all seen, markets for these types of debt financing are, at present, taboo. Thus, GKK has been left to resort to standard debt and equity offering. If you’ve seen their share price lately, or their short term debt maturity levels, then you know this isn’t particularly helpful. But, by itself, it isn’t completely material. Ideally, the company just needs to unwind heavily, leaving behind the five hundred and fifty million of shareholder value in the process.

Unfortunately for Gramercy Capital Corporate shareholders, Goldman Sachs and Citigroup have detected weakness.

They seem to be refusing to restructure the debt, and are demanding repayment by maturity, which means a fire sale of assets would be the only way to repay in time. The haircut that a real estate based company would take in this market is more like a decapitation. And default ends in exactly the same way. So, they are effectively using next to zero exposure as sufficient leverage to force the company into bankruptcy, where, I gather, they will attempt to seize a disproportionate amount of the company’s assets while wiping out as many of the shareholders as possible.

I am not looking forward to the coming months, where this stock is concerned. Although my exposure to GKK was only a couple percent of my portfolio, it is a couple percent I don’t want to lose. I will be taking steps, at the first opportune moment, to let go of half of my shares. I’m going to keep the other half, in a fit of denial that the bankruptcy option will be exercised or at least the hope that the subsequent trial will be light on affliction to shareholders. If the company should weather the storm, and go to fair value, then I will break even. If things turn south, at worse I’ll lose a conservative estimate of 75% my original investment (I’ve already lost half). I suppose that’s indefinably better than getting completely wiped out.

However, Houlihan Lokey being forced onto Gramercy by the banks is an ominous sign. While my head tells me that restructuring this company should be a viable option, my heart tells me that we are now long past such simple reason. The men of Goldman and Citigroup are armed, their spears sharpened, and they are looking for blood. Houlihan Lokey is a warning shot. If I were you, I’d stay the hell out of the way.

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