Guest Post: Open Letter To The SEC Regarding Wall Street’s REIT Bait-And-Switch

Submitted by Tyler Durden, publisher of Zero Hedge

Zero Hedge regularly gets visits from the SEC and FINRA, and we can only hope they are taking some of the troubling behavior we have identified seriously. Today’s case looks like a clear regulatory violation.

A few weeks ago I noticed Merrill Lynch/Bank of America on an epic quest to underwrite equity follow on offerings for a vast majority of the lowest quality REITs including Kimco, ProLogis, Duke Realty and others. I say lowest quality, because Merrill’s own analysts had a Sell rating on these names as recently as March 31 (for Kimco) and January 6 (for ProLogis). How the global economy has really changed for the better of REITs since then is still a mystery to me. But I digress.

Yet, as much as I want to keep focusing on Merrill Lynch, it is another company that piques the interest on this occasion. The company at hand is smallish Wachovia, which, at least, in theory does not exist anymore as an entity separate from its recent acquiror, Wells Fargo.

First, I present the back cover page of the WRI prospectus through which Weingarten Realty sold 28 million shares at $14.25, where one can clearly see the prominent role of Wachovia/Wells Fargo.

Also don’t let the date on the prospectus fool you: the formal dilution press release announcement came out at 4:13 pm on April 16.

Why is this relevant: As the prospectus itself says in the Use of Proceeds section: “Affiliates of Merrill Lynch, Pierce, Fenner & Smith Incorporated, J.P. Morgan Securities Inc., Wachovia Capital Markets, LLC, BBVA Securities, Inc., and J.J.B. Hilliard, W.L. Lyons, LLC are lenders under our unsecured credit facility and will receive a share of the net proceeds from this offering used to repay borrowings under the credit facility proportionate to their respective commitments under the facility.

How much longer will banks keep offloading their REIT credit exposure to unwitting equity investors? Yes, the i’s are dotted with this terrific one sentence disclaimer, however we don’t get it. If these companies are such great and worthwhile investment prospects, why are banks rushing to offload their credit exposure, which by the way is the least risky part of the capital structure, while investors are buying equity to pay down the banks credit exposure, and taking on the first-loss risk in the balance sheet? The use of proceeds in every single REIT follow-on offering has been to pay back the banks that have underwritten it. Is it that complicated to see this for the bait-and-switch it is?

Zero Hedge tries to preserve investors what little capital they may have left. However, some just seem hell bent on throwing their money into the CRE fire pit.

But I digress… again. Back to Wachovia. As readers can recall, Zero Hedge had some heartfelt words for Merrill analyst Schmidt, who the day of the ML/BofA offering, decided to upgrade Kimco stock from a Sell to a Buy. Ok, one can structure conspiracy theories about this event, but for all intents and purposes it is not outright illegal… regardless of how many Ambien CRs said analyst has to take at night to sleep soundly. However, taking a look at the WRI offering, some much more serious questions come to mind: like does Wachovia/Wells Fargo have a compliance department and is it aware that its REIT analyst is issuing an upgrade on the stock, a day before Wachovia/Wells Fargo will issue stock in the upgraded company in order to repay Wachovia/Wells Fargo’s credit facility.

The facts: on April 15th, a day before the WRI stock offering, Wachovia/WF analyst Jeffrey Donnelly, CFA, releases an upgrade report on WRI with the following title “WRI: Upgrading To Market Perform, More Confident In Capital Plan Raising Estimates On Possibility Of Shallower Near-Term Trough.” Donnelly had downgraded the stock to a Sell a mere two months prior, on February 23, providing a 2009 FFO target of $2.25/share (his upgrade, as seen below, upward adjusts his 2009 FFO target by a whopping 7 cents to $2.32/share which in any book is worthy of an upgrade).

It is unfathomable how Mr. Donnelly would not be restricted by his compliance department, by his research supervisor and by his capital markets desk from publishing a material, stock moving report 24 hours ahead of a follow on offering in which his bank is a key underwriter. The first rule for any sell-side analyst is do not publish research reports that could get you in hot water with the regulators. Wachovia squarely broke that rule. The only logical (and legal) explanation is if the WRI offering was put together so haphazardly and hurriedly, that the bank really had no idea it would be an underwriter until the day of the offering and thus did not even give Donnelly the change to get restricted. Of course, this possibility only spells doom for any investors who got caught in the manic rush to catch the last minute window of capital markets access as underwriters were scrambling to allocate share blocks to their respective syndication desks, knowing full well the window would close within hours (not days) and the stocks would come tumbling down. However, both possibilities reside strongly in the ethical twilight zone, with the first one likely being so in the legal zone as well. It is, again, shocking, that Wells Fargo’s compliance team did not catch this report before it came out, as its publication will inevitably cause serious headaches for all parties involved, especially if WRI stock proceeds to crash over the next several days and the class action lawsuits start trickling in.

Adding insult to injury, WRI management itself came out on April 17th and stated that it now expects its 2009 FFO (see above) to be in the $1.83-$2.06/share range, after giving effect to the offering (yes it is diluted, and yes it is a about 20% lower than Donnelly’s $2.35/share target, serving as the basis for his upgrade report).


And of course it doesn’t end there.

JP Morgan and Wachovia announce yesterday they are doing a follow on offering for Regency Centers Corporation, another small REIT. What is the use of proceeds? Yup, you guessed it: “We intend to use approximately $205 million of these net proceeds to repay outstanding indebtedness under our line of credit. Our line of credit matures in February 2011 and currently has a variable interest rate equal to LIBOR plus 40 basis points, which as of April 17, 2009 was 0.96%.”

Zero Hedge wonders yet again, just which banks benefit from new investors parting with their money so that banks can minimize their secured credit exposure to yet another REIT. Come to think of it, it is about time FINRA and the SEC did too.

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  1. Moopheus

    How does this rank in the order of things to be mad about? It’s already getting to be kind of a long list and I’m getting tired. So the bank’s own analysts basically puffed up the REIT so investors would give the REIT money to pay off the loans the REIT owed the bank? Is that it? Maybe what we need is a blog that documents when bankers behave legally and honorably. It won’t need nearly so much effort to maintain.

  2. Stephen

    I have not done the research, but the Goldman Sachs upgrade of Simon Property corresponded very closely with an equity offering. And I have been struggling to understand how SPG could possibly be a “Conviction Buy”

    Today there was a Foreclosure Filing on a Non-Performing Simon Mall near where I live. The other Simon property in my area is also delinquent and the mortgage was recently sold at a loss to a local investor who I believe is planning to foreclose. Anyone remotely involved with CRE financing knows what a mess is brewing here…

    Maybe Goldman is actually smart enough not to be as blatant as Wachovia was, but I have a hard time buying anything these analysts say. They seem to show their conflicts of interest constantly. Why the markets give them any credence is beyond me.

    Full Disclosure – I am short Simon.

  3. Daniel

    Seriously… Who actually buys into these secondaries?

    Weingarten priced 28 million shares at 14.25/share. That’s $399 million… Where does that kind of money come from??

  4. Marlowe

    Tyler, I very sincerely appreciate and respect what you’re doing. To have an insider slugging for us is like fresh air to the suffocating.

    Hope you’re well defended with VMS tunneling and proxies and whatnot.

    I salute you, sir.

  5. Doc Holiday

    I think I'm gobsmacked, or am I just drooling (again)? Where is my drool cup when I need it most?

    See, taste and feel: A gob has to do with the mouth. It can mean ''a mass,'' as in ''gobs of money,'' from the Old French gobe, ''mouthful.'' The Gaelic gob is ''mouth, beak.'' One sense of the verb gobble, from the same French root, is ''to eat fast and greedily.'' And when a politician says a mouthful with some degree of articulation, he is said to have the gift of gab.

    Why is a sailor called a gob, which has the dialect sense of ''to spit''? Because in British nautical slang of the 19th century, coast guardsmen used to tell yarns, chew tobacco and spit out the juice. The common denominator of all this gobbledygook is the mouth.


  6. SameAsItEverWas

    “Seriously… Who actually buys into these secondaries?

    Weingarten priced 28 million shares at 14.25/share. That’s $399 million… Where does that kind of money come from??”

    I think this needs to be looked into by the regulators. This has got to be Other People’s Money. No way individual investors are buying into these crap secondaries.

    Is there payola involved? Do the funds that buy into these secondaries get some kind of kickback? Are the banks who are using this money to pay off their debts actually in control of the funds that are buying into these secondaries?

    This whole thing just smells way too fishy. I can’t see anyone buying into a secondary with their own money, so OPM has to be involved and the people in charge of that OPM need to be investigated.

  7. Richard Kline

    We are going to see much, much more of this kind of behavior in the next 18-24 months, but for all that rake that muck, Tyler buddy. The public has to see and smell to understand just what our system has become. To me, there _is_ an explanation for this: all parties involved are busted, broke, BK full stop if they can't scam there way into faux profits by the fistful in the near future. Seriously, we should have nationalized these 'zombiewriters,' but haven't because of governmental _connivance_. But the boys have to scrape up some bucks from somewhere before Congress is forced by the public to revisit the issue. It's a race against time, see; if they can't spin profits out of Other Peoples' Money mighty damn quick, they _are_ going to be taken over anyway, so they have everything to lose by playing by a semblance of the rules. And since the government has already thrown out the rule book to save their loathsome spotty behinds, they don't expect to be hearing from the SEC or anyone else in the immediate future. So having looted the Treasury, they have a green light to loot secondary parties as long as there is a pretension to following the regs. That's how I see it.

    What we have here is Savings & Loan-itis gone China Syndrome, every incentive to loot, corporate death for compliance, and officialdom hissing frantically at them to speed it all up. Our financial system has become one ginormous Enron. And just as then, it's the public who are the dupes while the participants rig the 'markets' they claim should be free.

  8. REIT Wrecks

    Zero – congrats on addressing the lowest common denominator. Lou Dobbs meets html. Way to go!

  9. skippy

    When did the American Government/Financial Sector become the East Indies Trading Company Pty, Ltd.

    They want everyone to smoke their stuff, but don’t use it, and why, is it bad for humans?

    Ohh I see, with their monies they will look after us poor common folk, with out their wealth they can not tend to their flock of un-washed chattel and breed us to greater efficacy, too increase their wealth even more, how sad.

    skippy…we are truly doomed, our masters wealth is in jeopardy, how will they sustain us.

  10. Ginger Yellow

    I don’t know jack about equity, but on the ABS side, I used to regularly see positive research on individual entities and on sectors while a bond is being marketed by the research house’s syndicate team. All a coincidence, I’m sure.

  11. DiverCity

    Those of us who read Naked Capitalism, Calculated Risk, Zero Hedge and other financial blogs already know, as Mr. Kline said above, that our financial system is one ginormous ponzi scheme and that the regular folks are getting scammed. The question is, what are you going to do about it? Will you actually participate in rallies against the two-headed one-party monster? Will you vote to banish your Congressman? Will you take your money out of and refuse to do business with the money center banks? I thought not.

  12. Elizabeth

    I was on a conference call yesterday that Cohen and Steers had.

    Their story was that they pushed these offerings as a way to shore up the capital structures of the reits. Part of the reason these stocks have been hit even worse than the underlying markets is that they had way too much debt. Paying off debt with equity raises dilutes existing shareholders and lowers future earnings per share but those earnings will at least have some kind of multiple associated with them because the REIT might actually be a going concern.

    All of these REITs made huge tactical errors by having so much debt.

    In general, though, the REIT structure is very problematic – they have to pay out all cashflow so they are always dependent on capital markets rather than internally generated money. This has been Third Avenue’s mantra for a long time.

    And yes, the conflict of interest on almost every level is so rife that America is hurt almost as much by its capitalistic structures as it is helped.

    You need investment banks and they will be sharks, but if the investment side was more separate, this would be less of a problem.

  13. Shanky

    Dude – the SEC is a joke – a total farce – and i hope they read that here and now. They won’t do a darn thing. It is brothers in arms in DC land. While they beleive they are doing the best for the country, they are really protecting corpopate interests and their jobs and their money. It’s all a sham. I appreciate your efforts but much like the case with the Madoff whistleblower Markopolos nothing will get done. Nothing. It is so sad to see our country getting bastardized.

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