I just wanted everyone to know, everytime I refer to a person or a stock as a CRIM I am refering to the following. I am in the mortgage business you know. Crim to me means a bad deal.
How Criimi Mae Ended Up Bankrupt
By Alex Berenson
Senior Writer
10/7/98 3:02 PM ET
Long Term Capital Management was too big to fail. Criimi Mae (CMM:NYSE) wasn't.
Investors in Criimi, a little-known real estate investment trust based in Rockville, Md., learned that lesson the hard way Monday when the company abruptly filed for Chapter 11 bankruptcy. To say the move was a surprise would be an understatement: Only a few weeks ago, Criimi's top executives were buying more shares in the company.
The details of Criimi's business, which centers on mortgages that finance hotels, office buildings and apartments, are complicated and difficult to understand.
But behind the jargon of CMBS, IO strips and FHLMC funding notes is a simple explanation for Criimi Mae's sudden collapse. The company apparently failed to understand that in a crisis of confidence the much-bigger investment banks with which it had done business for years wouldn't necessarily have its best interests at heart.
Criimi is just one of several so-called mortgage REITs that are part investment bank, part real-estate company. Fears that the company's peers could be vulnerable to the same crunch have caused investors to flee the industry at almost any price. In the last week, IndyMac (NDE:NYSE), Criimi's biggest competitor, has lost almost $1 billion in market capitalization as its stock has plunged to 9 1/4 from 20.
Criimi and the other mortgage REITs own bonds backed by mortgages on commercial real estate, or commercial mortgage-backed securities. Because these bonds are risky, they pay interest rates significantly higher than the rates paid by safer bonds like U.S. Treasuries. But by carefully picking and choosing the bonds it owns, and by retaining the rights to service -- or collect payments -- the mortgages that underlie them, Criimi can minimize the risk of defaults and keep the excess return for itself.
Criimi ran its business well, according to several sources, including a person who is short the company's stock. (Short-sellers sell stock they don't own, hoping to buy it back later for a lower price. So shorts rarely have reason to compliment the companies they've targeted.) The company has had no losses due to defaults this year, according to spokesman James Pastore. And although a spate of building has left some sectors of the commercial real estate market marginally weaker than they were earlier this year, the U.S. market remains extremely strong, with office rents in many cities at all-time highs.
"The fundamentals are very strong," Pastore insists. Even the bears agree, although they worry that a weakening U.S. economy will combine with new supply to cause problems in the next few years.
Yet the fact that cash is still flowing from the mortgages underlying its bonds didn't save Criimi. The company had used leverage aggressively, building a portfolio of close to $3 billion in bonds supported by only about $500 million in capital. To finance the bonds, Criimi depended on more than $2 billion in loans provided mainly by investment banks like Merrill Lynch (MER:NYSE).
The company depended on close relationships with its lenders because it was so highly leveraged, because its assets consisted mainly of complex, hard-to-value loans and because many of the loans it obtained were extremely short term. But Criimi had reason to be confident. Its lenders were largely the same investment banks from which it bought its bonds. In fact, Criimi essentially functioned as a partner for the banks, receiving loans in return for buying the riskiest mortgage-backed bonds.
According to Pastore, Criimi had input on which mortgages would be included in various commercial mortgage-backed securities offerings.
But that partnership had been unraveling for weeks before the bankruptcy. Since the Long Term Credit debacle, which forced Wall Street's biggest investment banks to put up $3.65 billion in capital and left them potentially on the hook for billions more, banks have been steadily tightening their loan requirements, forcing borrowers to put up more and more capital as collateral. That contraction of credit has frightened buyers away from the risky debt that makes up most of Criimi's portfolio. In fact, there are now essentially no bidders for many of Criimi's bonds, according to the short. But Pastore notes that many of Criimi's bonds have always been illiquid. As long as real-estate developers keep making mortgage payments and the interest on the bonds keeps flowing, Criimi can continue to pay off its loans.
But without a liquid market, the bonds are impossible to value objectively. Their worth as collateral is what Merrill and the other companies that have lent Criimi money decide. And in the last few days, the banks told Criimi its bonds are worth less and less -- and demanding more and more collateral, in cash, to make up the difference.
Referring to investment banks, an industry source says, "We've been put at the mercy of the dealers, after the dealers have been all our best friends, and we've worked with them. If these guys want to give us a margin call, we don't have any choice. And, in this environment, it's very difficult to turn around and say we're going to take our business elsewhere."
So by last week, Criimi found itself in a very bad place financially. Its bonds were all but unmarketable, even as its lenders demanded that it continue to add to its collateral cushion. Somehow, the fact that the assets underlying the bonds -- the mortgages -- continued to perform just fine didn't matter.
In other words, the same investment banks that had previously worked with Criimi, had previously sold it bonds -- and lent it money to buy those bonds -- were now forcing it to put up money because they decided that the bonds were worth less than they'd previously been.
Then, on Friday, the company reached the breaking point. An investment bank -- Criimi won't disclose which one, but doesn't deny a Dow Jones story that it was Merrill Lynch -- made another collateral call. Criimi "disputed" the valuations the bank had used in the call, but the bank wouldn't back down. So Criimi "decided that it was not right to sacrifice that big a chunk of its liquidity (to one lender). Bankruptcy was the best way to protect the assets and the shareholders and even the other lenders," Pastore says.
A Merrill spokesman declined to comment.
But the crisis is by no means confined to Criimi. Any highly leveraged REIT is vulnerable to the same collateral calls that felled the company, the short argues. He's short Chastain Capital (CHAS:Nasdaq) and Clarion Commercial Holdings (CLR:NYSE) and says Laser Mortgage (LMM:NYSE), another small trust, is also extremely vulnerable. Chastain and Clarion did not return calls seeking comment, while Laser declined to comment.
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