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Time is bondholders' enemy on defaulted housing bonds in Chicago

The clock is ticking for holders of $84.4 million of defaulted affordable housing bonds issued for three Chicago-based portfolios.

Time is the enemy of bondholders' recovery potential, according to the bond trustee, because other debts continue to pile up that could eventually interfere with the trustee's efforts to reach a solution.

“We are coming into a critical period” with decisions that need to be made on how to proceed, trustee UMB Bank NA representative Michael Slade told bondholders on one of the three calls held in September for investors in the Ernst, Icarus and Shoreline portfolios.

The bonds were sold between 2016 and 2018 through the Illinois Finance Authority on behalf of Ohio-based Better Housing Foundation, but the affordable housing portfolios stumbled out of the gate with reports of code violations, dwindling occupancy, and the loss of Chicago Housing Authority voucher payments.

Court-appointed receivers in the coming months can petition the court to foreclose on the properties in an effort to recoup their expenditures, which hold senior lien status. Purchasers of the housing stock’s delinquent property tax payments could also eventually move to take title.

Overdue water bills and other liens filed by a former manager have also added up.

Those debts could complicate the trustee’s efforts to raise the capital needed to fund repairs necessary to clear housing code violations and raise occupancy levels now at just 10% to 15%.

“Time is not our friend,” William Smith, a partner at McDermott, Will & Emery McDermott which is representing UMB, said in one bondholder call during the week of Sept. 15. UMB at the request of a majority of bondholders in each of the three portfolios took over from the original trustee Wilmington Trust NA earlier this year.

A decision on how to proceed is likely needed by the end of the year to prevent factors that could by early 2020 complicate a fix that would involve a restructuring or property sales.

While BHF is actively marketing some properties for sale, the trustee at the direction of a bondholders is exploring a potential restructuring for some of the portfolios or a sale of the properties through a housing court or bankruptcy proceeding and is cautiously optimistic about the potential outcome.

A workout that forces a sale of the facilities could occur through a foreclosure/receivership process in housing court with the city and receivers’ cooperation. The court can order a sale of the facilities at the direction of the receiver.

The trustee could also pursue an insolvency process with BHF’s support, but a stalking horse bidder would be needed to create a competitive bidding process and sale of properties with the bankruptcy court’s blessing. That is the more common track and would allow for various liens to be cleared.

Both involve the cooperation of BHF and to some extent that of the court-appointed housing receivers and the city.

Any deal that leaves the bonds in place would have to hold not-for-profit status given the tax-exempt status of the bonds. Because BHF is a not-for-profit it must be a willing participant. The trustee can’t force an involuntary bankruptcy proceeding to restructure the bonds.

Amid turnover in BHF leadership, efforts to address poor conditions that had led to code violations, dwindling occupancy, and the loss of Chicago Housing Authority voucher payments have faltered, and BHF lacks the funds for repairs.

Most of the housing stock is now under control of receivers sought by Chicago and approved in city housing court. “This is a good thing for holders at least in the short run,” Slade told bondholders.

The receivers are now managing, securing, insuring and spending some funds to correct code violations that have rendered most of the apartments uninhabitable. The receiver’s fees and expenses represent a senior lien of future project revenues.

BHF defaulted on the June 1 debt service payment.

On one call, holders asked for the odds that they would get “all” or “some” of their investment back.

Smith told them “it's difficult at this point” to say, because the trustee is waiting on an assessment of the property value and cost of repairs but noted that the properties are desirable once repaired and the city wants them back in service and could lead to a “good recovery.”

Senior holders must be whole for subordinate holders to recoup their investment. Recent trading varies on the bonds ranging from 20 cents on the dollar to 30 cents on the dollar.

Property condition reports and appraisals have been ordered and the bonds’ underwriter, Stifel, is covering that cost.

During several of the calls, investors voiced their frustration about the swift fall the bonds took from investment grade ratings to default in June and some raised the specter of potential fraud in estimates of the project’s fiscal prospects. Some also questioned whether the underwriter should be pursued for additional costs.

The bonds for the Shoreline, Icarus, and Ernst portfolios were with ratings between the triple-B and single-A categories depending on their senior or junior lien status. All are now junk-rated, including BHF’s suburban Windy City and Blue Station suburban portfolios, which remain current on payments.

One holder on a call said he purchased bonds in January and April of 2018 that were then rated at the A-minus level. “I've never seen anything in my life go so bad so quickly,” the investor said.

“It almost sounds fraudulent,” said one holder.

Smith told bondholders on one call that such claims don’t typically run through the trustee and are handled on a separate track led by original buyers. While the trustee could down the line help facilitate efforts to pursue such claims, the bondholder steering committee it’s working with is currently focused on the next steps on a sale or restructuring. "These are not claims that the trustee is able to bring,” Smith said on one call.

Communications between the trustee and BHF — which has undergone a series of leadership changes — remain frosty, said sources. BHF had sought to use the city’s receivership petitions over the summer to persuade bondholders to support funding for the repairs that are needed to cure housing code violations.

“BHF believes it is imperative for all stakeholders to engage in negotiations in order to immediately address the underlying issues and direct the trustee to release a portion of the funds it currently holds so that such issues can be addressed and the receiverships avoided,” read a BHF filing earlier this year.

Previous loan agreement defaults were triggered, and the ongoing and new default triggers remedies that allow for bondholders to demand immediate repayment of the bonds or foreclose on the property.

After the June default, S&P Global Ratings cut the ratings to D from CCC-minus on Shoreline’s 2016 bonds, Icarus’ 2017 bonds, and Ernst’s 2018 bonds.

Problems had been brewing for some time as detailed in an August 2018 Chicago Tribune report that highlighted the poor condition of the foundation's buildings and reported that that little was accomplished by the bond transactions other than generating millions of dollars in fees paid to people associated with the foundation and its real estate and debt transactions.

Despite new leadership at the foundation, efforts to solve poor conditions have faltered and all parties agree that a cash infusion is needed. Current managers blame their predecessors. Several lawsuits related to the projects are pending.

“The portfolios are all in financial distress,” BHF wrote in a voluntary disclosure posted April 22 on the Municipal Securities Rulemaking Board’s EMMA website. “Because of the condition of the facilities, the financial performance of the portfolios has been strained. As a result, none of the portfolios will be able to make the debt service payments due on the bonds on June 1, 2019.”

Debt service reserves were tapped to cover the Dec. 1 payment and were insufficient to cover the June payment.

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