Defaulted Student Housing Project in Chicago Picks Up Steam

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Flowers bloom in front of the Fullerton Ave. entrance during the summer on DePaul University's Lincoln Park Campus. (DePaul University/Jon Cecero)

CHICAGO — After struggling for years with high vacancy levels, a student housing facility privately developed for DePaul University in Chicago is marking its second year of near full occupancy by chipping away at some overdue debt service with the resulting boost in revenues.

The Fullerton Village Project's improved prospects and its progress in making up some of its defaulted debt service payments prompted an upgrade from Moody's Investors Service Friday.

Moody's upgraded the A series of student housing bonds to Caa2 from Ca.

The bonds still remain in default status and in junk bond territory. The upgrade only impacts the $53 million senior lien A series, but it's a sign the credit has stabilized and may have reversed course, one market participant following the bonds said.

The bonds were sold in 2004 through the Illinois Finance Authority on behalf of the project's owner, MJH Education Assistance Illinois IV LLC. A subordinate B series for $15 million remains rated C, representing analysts' expected recovery rate of 35%. Moody's did not rate the $13 million C series of junior subordinate bonds, held by the developer.

Trustee U.S Bank NA has made all interest payments on the A bonds and marked a milestone this spring by making some defaulted principal payments. Additional principal payments were made earlier this month, according to trustee filings and information discussed during a trustee-hosted investor teleconference last week. No payments have been made on the defaulted debt service for the B series.

"The upgrade is based on improved financial performance of the project that has been sufficient to make interest payments and payments on some of the past-due principal," Moody's wrote in its report. "The project's vulnerable market position and competitive operating environment offset its strengthening performance."

When the bonds were issued in 2004, the A series carried a Baa2 rating and the B series carried Moody's lowest investment-grade rating of Baa3. The proceeds financed construction of the six-story, 275,000-square-foot student residence that includes parking and a retail complex. It's located one block from DePaul's main campus on Chicago's north side in the Lincoln Park neighborhood.

The bonds are primarily secured by rental income generated by the facility from residents and the retail space. Bondholders hold a mortgage lien.

Moody's cited significant demand for student housing on the campus, favorable enrollment trends at the school, and good projected debt service coverage of 1.5 times for the senior debt and 1.2 time for the subordinated series, when it issued its original low investment grade ratings.

A challenge for the credit at the time was the absence of an occupancy guarantee or long-term financial commitment from DePaul. The school had entered previous deals with MJH using other structures such as a sale-leaseback that kept the debt off DePaul's balance sheet, but the Fullerton project lacked similar occupancy support and guarantees.

Moody's said the current ratings reflect the bond program's expected recovery estimates, uneven affiliation with DePaul University which Moody's rates A2 with a stable outlook, and fluctuating financial performance. The project's improved performance was reflected in a 1.28 times coverage ratio of scheduled debt service from revenues in fiscal 2013.

"The stable outlook is based on the project's lease-up for fall 2014 which is projected to generate adequate revenue to cover operating expenses and interest payments," Moody's wrote.

Challenges remain the project's weak market position with its operational performance heavily dependent on DePaul University's enrollment and waitlist for housing, competition from university-owned housing, and off-campus options.

After struggling to fill its rooms, the project began defaulting in 2008. Moody's said in a 2012 report that part of the facility's problems stemmed from its unconventional design with loft-style apartments with concrete floors and high ceilings which created noisy living quarters. Occupancy fell to 52% in 2007.

Fullerton Village contrasted with the sector's general stability, according to a 2012 Moody's report which said privatized student housing project bonds had generally demonstrated stable performance as debt service and occupancy rates remained solid for most Moody's-rated financings.

The overall credit quality of the sector had been resilient to the downturn in the real estate market and the mixed credit trends in the higher education sector, with the majority of projects reporting healthy financial performance.

Fullerton Village's turnaround is due to a number of factors, sources said. The project's managers moved more aggressively to attract non-DePaul students through master lease negotiations with other schools, and DePaul has improved its efforts to promote the facility.

With rents at other private housing facilities and college facilities on the rise, the Fullerton Village's current prices have become more competitive and the facility's managers reported on the investor call it is now nearly full with 566 residents.

Bondholders could have sought to accelerate repayment of the bonds after the defaults or foreclosed on the facility, but instead have showed patience in giving the property a chance to avoid such penalties.

The trustee provides frequent cash flow updates and investor calls.

"The operators want the bondholders to be patient and bondholders have showed restraint" with good communications with the project's managers, said one market participant that follows the project's status.

With the increased revenue from higher occupancy, the project made its first principal payments on the senior tranche this spring. Those and other recent payments bring to $3.2 million the amount of principal payments made on sinking fund redemptions due in 2010, 2011 and 2012. They will reduce debt service by approximately $160,000 in interest annually.

The trustee reported in a notice Sept. 3 nearly $5.9 million in principal payments due between 2010 and 2014 were unpaid on the A series. The trustee reported in the notice its intention to distribute payments on Sept. 8th totaling $2.2 million in overdue principal payments on the A bonds, bringing the amount still owed down to $3.7 million.

Another $4.5 million remains owed on interest payments due on the B bonds between 2008 and 2014, plus $1.8 million of principal.

"The trustee will monitor funds in the future to review the feasibility of making up other past-due payments, although no assurances can be given they will be made," the Sept. 3 notice said.

Under the indenture, interest installments on the A bonds are paid first from project revenues in the order due, then principal in the order of maturity, then interest on the B bonds in order due, and then principal on the B bonds in order of their maturity.  Default interest on the unpaid balance of any past-due installments of interest accrues until the past-due interest installment has been paid.

The project is current on all interest owed on the A bonds and its managers hope to get caught up on back principal payments on the A bonds by 2018, after which it would then start to make back principal payments owed on the B tranche, officials said during the investor call. The operators also will consider rate hikes.

The A bonds mature through 2035 with the term bond in that final year paying a 5.3% rate at the time of issuance and the B bonds final term bond in 2035 paid a 5.6% rate. Citi and the former Lehman Brothers underwrote the bonds.

The A series have traded recently at 70 cents on the dollar and the B series in the single digits, according to trade data. Nuveen is a major holder of the A bonds and Goldman Sachs a major holder of the B bonds. A Nov. 6 investor conference call was set to discuss potential rate hikes and cash flow ahead of a Dec. 1 debt service payment.

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