Citigroup’s Distressed Muni Deal May Point Way for Takeovers
Private-equity firms and Wall Street banks, struggling for returns in troubled corporate debt, are seizing opportunities in the $28 billion market for distressed municipal bonds.
Citigroup Inc. (C), the third-biggest U.S. bank by assets, took control of St. Louis’s Renaissance Grand Hotel & Suites in December when it bought revenue bonds backed by the 1,000-room hotel after lenders foreclosed. Fundamental Advisors LP, a New York-based private-equity firm, gained control of the Memphis Redbirds’ baseball franchise and the team’s AutoZone Park after buying its tax-exempt debt.
The bonds, some of which changed hands for 53 cents on the dollar, may herald a new outlet for investors in distressed debt as credit quality deteriorates in the municipal market, where defaults in the past three years exceeded the previous eight years combined. The strategy of buying debt to gain control, common in the corporate world, is being used to take over revenue-producing municipal projects as the rebound in loan prices frustrates corporate investors.
“Assets such as highways, water-treatment plants, sports stadiums, racetracks, parking facilities or parks may be very attractive,” said Deryck Palmer, co-chairman of financial restructuring at Cadwalader, Wickersham & Taft LLP in New York. “Distressed situations provide the ideal circumstance for investors to enter municipal transactions.”
Loan to Own
Investors often target troubled corporate debt, in a strategy known as loan-to-own, to gain ownership of ailing companies in a restructuring, Palmer said. The same strategy may be applied to certain municipal assets, where ownership isn’t considered a liability, or investors may limit their influence over a municipal asset to controlling how it’s sold or refinanced, he said.
The St. Louis purchase gives Citigroup control of the trustee that oversees the hotel after the New York-based bank bought a majority stake in $98 million of revenue bonds backed by the Renaissance from Nuveen Asset Management, according to two people with knowledge of the deal who asked not to be identified because the transaction was private. The Renaissance was financed by bonds sold by the Industrial Development Authority of St. Louis in 2000.
“Our goal is to reach the best outcome for the bondholders and for St. Louis,” Citigroup spokesman Alexander Samuelson said in an e-mailed statement. “In our role as market maker, we provided liquidity for an investor by purchasing certain bonds.”
St. Louis Trip
Citigroup has sent a pair of executives to St. Louis to discuss the Renaissance with consultants, according to Steven Stogel, president of DFC Group Inc. in St. Louis, a real-estate developer who has advised the trustee. Robert Bray, general manager of the Renaissance, declined to comment through an assistant.
“My instructions from the trustee and the city are to continue to work with the ownership group and to move towards improving the operations in 2011,” Stogel said. “There will be a sale at some point, whether it’s ‘11, ‘12, ‘13 or ‘14.”
The default rate on speculative-grade corporate debt has fallen with the U.S. economic rebound, and those markets are rallying. That means investors no longer expect leveraged loans to produce the strong returns posted over the past few years, according to Debtwire’s North American Distressed Debt Market Outlook 2011. Leveraged loans, which offered the most appealing opportunities for respondents last year, are now seen as the least compelling, the survey by the New York-based news service showed.
In the municipal bond-market, rating downgrades outnumbered upgrades for an eighth-straight quarter at the end of last year, a pattern that will continue, Fitch Ratings said in a report last month. Defaults from 2008 to 2010, at $18.6 billion, exceeded the previous eight years’ combined $15.3 billion total, according to Richard Lehmann, publisher of Distressed Debt Securities Newsletter.
Declining creditworthiness of some municipal borrowers makes it possible to take control of projects by buying tax-exempt debt, Palmer said. Investors may advance stalled municipal projects by providing new funding or helping to develop them into commercially viable enterprises, he said.
Fundamental Advisors purchased tax-exempt bonds last year backed by both the Memphis Redbirds’ baseball franchise and the team’s AutoZone Park, obtaining financial control of the 14,000-seat stadium as well as the baseball team, a triple-A minor league affiliate of the St. Louis Cardinals.
The Memphis Redbirds Baseball Foundation, which spent $80 million building the stadium before defaulting in 2009, has operated under forbearance agreements with creditors since missing payments on its $72 million tax-exempt bond issue, according to John Pontius, treasurer of the Memphis Redbirds Baseball Foundation.
The Redbirds’ relationship with its original bondholders, a group of asset managers and regional banks, became “adversarial” after the team failed on its business plan and operations suffered as it struggled to service debt, Pontius said.
“We owed so much to the bondholders that we didn’t have enough money to run the team properly,” said Pontius, who has served as volunteer treasurer of the foundation since 2005. “We had a database of potential customers who we weren’t calling and repairs we weren’t making. Our new bondholders see this as a partnership and are making reasonable judgments concerning the working capital needs of the business.”
Pontius said the Redbirds have renewed calling efforts since Fundamental Advisors purchased the debt and that sales are poised to increase this season.
“There are certainly opportunities in distressed projects financed with municipal debt for investors who understand this nuanced, opaque market,” said Laurence Gottlieb, chief executive officer of Fundamental Advisors, who said the deals are often difficult to make happen.
“The municipal bond market is in many ways more intricate than the corporate one and there are substantially fewer deal-oriented investors,” Gottlieb said.
Issuance of revenue bonds, which are backed by specific projects such as a toll road, bridge or hotel, peaked in 2007 at $317 billion, more than double the amount in 2000, according to data compiled by Bloomberg. They make up 80 percent of its distressed securities, or $22.3 billion, Bloomberg data show.
Investment firms including Goldman Sachs Group Inc. (GS) have discussed raising funds with investors that would target assets backed by distressed revenue bonds, according to people familiar with the talks. Among the potential targets are infrastructure assets such as toll roads and power plants, the people said.
A fund managed by New York-based Goldman Sachs holds revenue bonds backed by Branson Airport, a privately owned $155 million facility that opened in May 2009 in the Ozark Mountain region near Branson, Missouri. The city has more than 50 performance theaters billed as the “Live Music Show Capital of the World.” The airport’s construction, financed with about $114 million of municipal debt, required displacing more than 11 million cubic yards of dirt in the largest earth-moving project in Missouri, according to its website.
Now Branson Airport LLC, which is led by former Greenwich Capital Markets executive Stephen Peet, is in talks with the Goldman Sachs fund and other bondholders over restructuring the debt, according to a person familiar with the project. The airport, which has dipped into reserve funds to pay bondholders, lost $9.8 million for the first three quarters of 2010, according to its filings.
If an agreement can’t be reached on adjusting debt terms and infusing more equity in the project, creditors could seek control of the airport, which includes a 58,000-square-foot terminal, the person said.
Jeff Bourk, executive director of the airport, and Peet didn’t return calls and e-mails seeking comment. Goldman Sachs spokeswoman Andrea Raphael declined to comment.
Salomon Smith Barney, as Citigroup’s investment bank was known then, underwrote the revenue bonds in 2000 for the St. Louis convention center hotel project, as the city made a push to increase its draw as a conference destination.
The Renaissance, which features panoramic views of the city from its Crystal Ballroom and has 54,750 square-feet of meeting space, violated its bond covenants in 2004 after the convention center generated half the bookings originally anticipated, according to bond filings.
Nuveen sold about $55 million of the debt for 53 cents on the dollar in December, Bloomberg data show. When Nuveen’s municipal high-yield fund reported its stake in the St. Louis revenue bonds in April 2007, it valued them at 99 cents on the dollar.
The Chicago-based asset manager sold the debt to Citigroup to pursue more attractive opportunities with the proceeds, according to John Miller, chief investment officer of Nuveen Asset Management.
With its controlling stake in the revenue bonds, Citigroup may now direct the hotel’s trustee, UMB Bank N.A., to sell the hotel, which was foreclosed on after failing to make full interest payments on the debt in 2008, the people familiar with the matter said. Hotel deals may increase as much as 25 percent this year, as a rebound in U.S. business and leisure travel attracts investors, according to Jones Lang LaSalle (JLL) Hotels, which has advised Renaissance bondholders.
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