BAM - Brookfield Asset Management

[Spekulatius]

A few thoughts on recent posts, FWIW.

 

I've known BAM for 15 years and done a lot of work recently. I really like it here.

 

I like that they have three ways to win from low rates:

1) Increased value of what they own via low rate refis and lower cap rates.

2) Increased flows to alternative asset managers.

3) Entire new AUM class in the shape of insurance/pension risk transfer.

 

I like their diversity:

1) Yes, real estate might implode, but it might not, and a lot of damage is priced in already.

2) Infrastructure, renewables, private equity, and Oaktree are highly likely to continue growing for BAM.

 

I like their real estate exposure. I lean gently towards the Flatt argument that good real estate will get more valuable. I lean more strongly to the view that falling rates will lift all boats. But more controversially, I think they are more likely to be a winner than a loser if I am wrong and real estate does implode:

1) I think most of their RE equity is concentrated in relatively high quality assets.

2) I think BPY has a huge advantage in having a captive lender of last resort. They are more likely to be a buyer of distressed assets than to become distressed themselves.

3) If real estate does implode, it will happen to everyone, not just BAM. So long as they come out relatively well, they will be able to use their superb network of relationships to raise assets to buy at the bottom. In other words, a real estate implosion need not kill their real estate management business and the associated fee stream to BAM.

 

Most controversially of all, having done a lot of work and thinking I don't worry (much) about the debt. Debt always adds risk, but I like:

1) that BAM sailed through the GFC and corona crises (I doubt they would have done if central banks had allowed a depression, but they didn't and won't).

2) I like the structure, with debt at the assets, limited recourse, and no cross-collateralisation. Edper is the wrong comp in my view.

3) The duration.

 

In short I think BAM have multiple ways to win, multiples ways to turn difficult situations to their advantage, and multiple tailwinds. And I don't think much of that is priced in.

 

If you have read this far:

@Spek, would you elaborate on "BPY's crummy assets"?

@Gregmal, could you elaborate on "prices already imply $150-$300 sq/ft for things CURRENTLY going off at $600-$800 a square ft".

 

BPY’s crummy assets are retail assets and office. If not ‘crummy’, at least their marks should be way off, because they bought them at close to peak value (GGP, Forest City etc).

 

I also wonder a bit about their assets in Brazil. the currency alone is down 25%.

[petec]

Thanks Spek.

 

Do you disagree that with office and retail, BPY own good assets? Or is it more just that you think those asset classes are junk/overmarked?

 

Re Brazil, the BRL has spent 10 years going from 2 std deviations above its long term inflation adjusted average vs the USD, to 2sd below. It’s very cheap. And if it wasn’t for covid the economy would be accelerating hard. The govt is doing a lot of smart stuff (pension reform, privatisations, infrastructure auctions), inflation is under control, rates are at unheard-of lows, and my view is the next 10 years likely look pretty good. I’m very comfortable with their exposure there.

[Spekulatius]

Thanks Spek.

 

Do you disagree that with office and retail, BPY own good assets? Or is it more just that you think those asset classes are junk/overmarked?

 

Re Brazil, the BRL has spent 10 years going from 2 std deviations above its long term inflation adjusted average vs the USD, to 2sd below. It’s very cheap. And if it wasn’t for covid the economy would be accelerating hard. The govt is doing a lot of smart stuff (pension reform, privatisations, infrastructure auctions), inflation is under control, rates are at unheard-of lows, and my view is the next 10 years likely look pretty good. I’m very comfortable with their exposure there.

 

I am sort of bullish on Brazil myself, but can’t quite ignore current quotes from equities there. I don’t really know their Brazil that well, but I know some utility stocks have gotten absolutely destroyed there the last few years even pre COVID.

 

In a way, a lot of answers here regarding BAM are comforting in a sense that BPY isn’t as important than I thought.

[John Hjorth]

And here I come, as an elephant in a China boutique, quoting Cardboard, from a topic in the Berkshire Hathaway forum, for discussion here about BAM [from here]:

 

I would be really careful with Brookfield.

 

This is spaghetti like structure with leverage at rates that would disappear at existing terms on any sign of trouble in financial markets.

 

I recall the days of Edper Brascan, big conglomerate discount, hate by market for holding things like Noranda. Now it holds office buildings, hyped up renewable infrastructure, soon 100% of Genworth or mortgage loan insurer in biggest bubble ever in Canada or overtaking Nortel, JDS Uniphase, etc.

 

When you hear can't lose stocks by fund managers you gotta to pay attention.

 

Cardboard

 

Good thing you removed him from the ignore list again! Haha.

 

Its weird but I do kind of agree with him, cant argue too much against any of that, but also own a position in the shares because I see the other side as well. People talk about reputation, and they often think "integrity" or some sort of moral compass based definition. In the financial world, reputation can take on different things. Tesla has become what it is off the reputation, otherwise known as pixy dust for the people who need to quantify everything, of Elon Musk. Flatt and BAM have this is spades and maximize its utilization which is very powerful and goes a long way. They also have become big enough to bully around lenders and smaller players which is another advantage. I like that so I put a little money on this continuing and if it does, they should have no problem operating as they have, which has been very lucrative for everyone involved.

 

No sweat, Greg! [ : - ) ].

 

I just wanted to transfer Cardboards post over here, for discussion, based on that it seems reasonable to re-discuss in this topic the BAM investment thesis, based on what has happened - so far - in 2020.

[petec]

For interest, my notes on AEL's quarter and its recent presentation on the BAM reinsurance deal which you can find here://ir.american-equity.com/static-files/b060d085-36eb-4d38-8610-40655cd9b445

 

Summary: AEL is transforming itself into a capital light originator of low cost funds by reinsuring liabilities and outsourcing asset management (often taking a stake in the manager). This process will release a ton of capital, driving buybacks. Expect BAM's % stake to grow fast as the share count shrinks.

 

○ AEL 2.0 has 4 pillars

§ Go-to-market. Core competitive advantage is raising low cost funds by selling liabilities. Want to get total cost of funds (which includes operating costs etc) below 3% by designing new products.

§ Asset sourcing. String of pearls strategy to find alternative asset managers in various sub-sectors. Will invest AUM, trading liquidity (but not risk) for yield, allowing them to offer more attractive products and sell more liabilities. Can also take stakes in managers. Low equity allocation in the insurance general account means they can easily put 1% towards these stakes (c. $500m).

§ Capital structure. Reinsurance frees up significant capital because the reinsurer can be domiciled in places with looser regulation. Will do this with Varde/agam and BAM, and will in time set up an in-house captive reinsurer and sell sidecars to third party capital providers for a fee.

§ Enhance digital.

○ Deals so far

§ Pretium Partners. $16bn AUM. Originates and services non-qualified mortgages. AEL invests $100m for a teens stake in the manager, and $1-2.25bn in AUM. 

§ Varde/Agam. Varde will set up a Bermuda reinsurer and an insurance asset manager. AEL will reinsure $5bn of liabilities, and takes a significant minority interest (they said 20% on the call) in the reinsurer and a 35% stake in the asset manager. Varde/Agam "anticipate being able to execute on a number of follow-on transactions in the life and annuity space.”

§ BAM

□ $5bn up-front reinsurance deal

® Releases $320-350m of capital, or 6-7% of required capital.

® Generates $33m of earnings/year from an insurance ceding fee and an asset liability management fee paid by BAM. These are fixed, total 90bps a year pre-tax/71bps post-tax, and last for 7 years. Discounted at 10%, the pretax profits associated with these payments total 4.4% of initial statutory cash surrender value. The alternative - retaining the liabilities - generates $35-40m of earnings, presumably for as long as the liabilities last.

® Allows them to realise gains on current portfolio - as of 2q this would be add $400m to retained asserts and could drive future earnings via book yield improvement at AEL. Wording seems odd here - don't these gains accrue to equity/capital?

® Taken together this represents "a solid double digit percentage" of transferred liabilities as economic value to AEL.

□ $5bn of follow-on reinsurance

® Terms not disclosed, but not necessarily the same.

® Allows AEL to fund growth without committing capital.

○ Maths

§ AEL 2.0 should generate an ROE ex-AOCI of 11-14% in the next few years and 15%+ long term. It should be able to return $250-300m of capital to shareholders per year starting in 2021, and growing. I think this is just from earnings.

§ The BAM and Varde/Agam reinsurance deals liberate $1bn of capital - $700m up front and (I think) another $300m with the second phase of the BAM reinsurance deal, which they imply should happen within 12 months.

Current market cap is $2.3bn. Assume BAM's stake rises fast as AEL buys back shares at $24!

 

Edit: Speculating, but AEL's cost of paying liabilities is about 160bps. Might mean BAM's total cost of funding for the $10bn of reinsurance AUM is 160bps for annuities + 90bps of fees for 7 years, and then 160bps thereafter on whatever liabilities remain.

[fisch777]

Cutting through all the complexity, double counting, plan value bullsh*t, etc, this business generated 2.6B of CAFDR (closest proxy I can get to for actual free cash flow) in TTM ending 6/30.  That includes $300M+ for earnings on cash, which is arguably aggressive.  At $32, you are at 19.6x.  Is that cheap? 

[petec]

Cutting through all the complexity, double counting, plan value bullsh*t, etc, this business generated 2.6B of CAFDR (closest proxy I can get to for actual free cash flow) in TTM ending 6/30.  That includes $300M+ for earnings on cash, which is arguably aggressive.  At $32, you are at 19.6x.  Is that cheap?

 

Which business? And what’s at $32?

[rkbabang]

Cutting through all the complexity, double counting, plan value bullsh*t, etc, this business generated 2.6B of CAFDR (closest proxy I can get to for actual free cash flow) in TTM ending 6/30.  That includes $300M+ for earnings on cash, which is arguably aggressive.  At $32, you are at 19.6x.  Is that cheap?

 

Which business? And what’s at $32?

 

BAM is at $32.  This is the BAM topic after all.

https://www.google.com/finance/quote/BAM:NYSE

 

[petec]

Cutting through all the complexity, double counting, plan value bullsh*t, etc, this business generated 2.6B of CAFDR (closest proxy I can get to for actual free cash flow) in TTM ending 6/30.  That includes $300M+ for earnings on cash, which is arguably aggressive.  At $32, you are at 19.6x.  Is that cheap?

 

Which business? And what’s at $32?

 

BAM is at $32.  This is the BAM topic after all.

https://www.google.com/finance/quote/BAM:NYSE

 

Ha. Fair, although the most recent post on it was about AEL and I wondered if the post was a reply to that.

 

As to whether BAM is cheap, we will find out.

[thepupil]

another day, another big cash out refi for BPY. 2.75% interest only $800+/foot

 

Brookfield’s stable well leased extremely financeable office is the port in the real estate storm....for now.

 

https://commercialobserver.com/2020/11/banking-consortium-provides-1-3b-cmbs-refi-on-manhattans-grace-building/

 

 

[OnTheShouldersOfGiants]

"It retires $900 million in existing commercial mortgage-backed securities (CMBS) debt that had been provided by Deutsche Bank in 2014."

 

Does anyone know how to find out details on the previous debt, in particular the interest rate.

[thepupil]

google the building+bank+cmbs etc.

 

https://www.prnewswire.com/news-releases/morningstar-credit-ratings-assigns-preliminary-ratings-for-grace-2014-grce-mortgage-trust-commercial-mortgage-pass-through-certificates-grace-2014-grce-259404651.html

 

https://newsroom.morningstar.com/newsroom/news-archive/press-release-details/2014/Morningstar-Credit-Ratings-Assigns-Preliminary-Ratings-for-GRACE-2014-GRCE-Mortgage-Trust-Commercial-Mortgage-Pass-Through-Certificates-GRACE-2014-GRCE/default.aspx

 

the last mortgage was $900mm 7 year interest only at 3.6%.

 

[OnTheShouldersOfGiants]

Thanks pupil, I really appreciate it

[petec]

So the owners have extracted $350m for an additional cost of $1.975m pa, or 0.56%, and extended the term by 3 years. Sounds like an asset class in crisis ;)

[petec]

Interesting comments on the Kennedy Wilson call.

 

One point is that they see suburban, low-rise, business-park office properties where tenants have their own front doors as the winner of covid - not the CBD high rise. BAM might disagree.

 

Second, on work from home: We are not overly concerned...good example of MSFT announcement Oct 9th...all workers can opt to work remotely...hybrid model...but on the same day the VP of Global Real Estate spoke at an event in Puget Sound where he said MSFT will need more space due to social distancing and significant growth in cloud computing investment.

[petec]

Note: I have edited this post because I misremembered some stats.

 

Useful comments on BPY call about handing back the keys on some retail assets.

 

- this may apply to a relatively high number of assets, worth about 2-2.5bn in GAV but almost no NAV.

- total retail debt is 21bn so in effect 10% of retail debt could just disappear.

- lenders don’t want the assets so the other possibility is to renegotiate, buy back debt at a discount, inject new capital ranking higher than some of the debt, or otherwise create value. This can only add to NAV.

 

Thinking back to the investor day claim that 10bn of retail equity (out of a total of 13bn) was at 25 high quality assets conservatively levered at 36%, we could extrapolate that:

- the other 3bn of equity carries the rest of the retail debt, or about 15bn

- the worst case outcome here is the keys get handed back on all of the bad assets, wiping out 3bn of equity and 15bn of debt, which would absolutely transform BPY’s leverage metrics.

- the best case is some renegotiation which creates additional NAV.

 

Conclusion:

- BPY is not nearly as levered as it looks, but has some nice options. It might be best to think of the debt on the bad assets as an equity option.

- You need to be very careful with debt/ebitda and ev/ebitda metrics.

- Non-recourse funding is smart but there is another level here. By putting the debt at the bad assets they derisk the entity while creating option value in the form of possible renegotiations. If they had funded the crap by levering the cream, they'd be in all sorts of trouble.

[tiddman]

BPY’s crummy assets are retail assets and office. If not ‘crummy’, at least their marks should be way off, because they bought them at close to peak value (GGP, Forest City etc).

 

At the time of the deal, Brookfield was widely considered to have executed a take under of GGP, to the point that shareholders filed a lawsuit over the valuation.

 

https://wwd.com/business-news/retail/ggp-shareholders-file-lawsuit-to-block-brookfield-merger-1202647265/

 

This article shows that the price was agreed upon right at a 5 year low point of the Regional Mall Index:

 

https://www.fool.com/investing/2019/09/08/has-brookfield-acquisition-ggp-reit-worked-out.aspx

 

Other analysts agreed:

 

“I understand the market frustration because it’s completely a low-ball bid, but at the same time the alternative is less appealing,” Goldfarb said.

 

"GGP’s stock fell because the offer is not a great price, said Scott Crowe, chief investment strategist at CenterSquare Investment Management in Philadelphia."

 

"As of last week, GGP’s shares were trading more than a quarter below the company’s relative value, which measures an asset against similar ones, Thomson Reuters data shows."

 

https://www.reuters.com/article/us-usa-property-malls-valuation/brookfields-bid-for-ggp-seen-undercutting-true-mall-values-idUSKBN1H32YL

 

This was all pre-pandemic of course and valuations have undoubtedly come down since then, but I don't think it's accurate to say that they either overpaid or paid peak value.

[tiddman]

In terms of the quality of the assets, there are some very premium assets within the portfolio of GGP. They own malls in affluent areas like Tysons Galleria or Oakbrook Center that generate sales per square foot over $1000. GGP had 120+ properties though and surely not are all premium. But to call these "crummy" assets is an overstatement. Retail is hated currently and we're in the middle of a global pandemic, but owning a premium mall in a high growth area with average household incomes of $150-200k is a great asset, especially when you consider the development potential. This is the retail equivalent of a trophy office tower.

 

Forest City also had good properties.  Rouse on the other hand was widely known as having primarily B malls and I have never quite understood why Brookfield bought them. They were spun off from GGP before Brookfield took them over and they do not seem to fit their profile.

 

But one thing I find interesting is that many malls are not contiguous properties. Back when many malls were built, the department stores like Macy's and JCP were considered anchors and the malls were built around them, the idea being that the department stores would drive traffic to the malls. The department store properties were owned separately, either by the retailers themselves or on long-term ground leases. Sometimes the ownership off the rest of the mall is also fragmented, for example Forest City owned just a portion of the Short Pump mall in Richmond.

 

There is value in having a contiguous property and I wonder if part of Brookfield's strategy is to buy up the different owners of these parcels and combine them. This may explain their interest in Rouse and JCP for example and they have bought some individual locations from Macy's.

 

They made some comments at their investor day which I found really interesting about the concentration of value in their properties.

 

We have $13.5 billion invested in that business. But in recent years, we have either invested in or developed 15 office and mixed-use complexes. These include Brookfield places that are across the globe, Canary Wharf, Manhattan West, Bay Adelaide Center, Potsdamer Platts, amongst others. These are located in top markets: New York, Toronto, London, Berlin, Perth. These properties are 94% occupied with credit quality tenants and have an average 10-year lease life.

 

And alone, these properties comprise $21 billion in asset value, which is about 70% of the total of our entire office business.

 

...

 

Similarly, in retail, where we have 122 properties and $13 billion invested. If you look at only our top 25 properties in that portfolio as measured by sales performance. These include Ala Moana, Oak Brook Center, Tysons Galleria and the Fashion Show, amongst others.

 

All of which regularly achieve sales per square foot in excess of $1,000. It's not surprising they are 97% occupied and consistently outperform in terms of occupancy and leasing spreads and NOI growth. Alone, these properties account for $15 billion of total asset value or about 45% of the total of our entire retail portfolio.

 

https://bam.brookfield.com/~/media/Files/B/BrookField-BAM-IR-V2/ir-day/2020/brookfield-2020-investor-day-transcript.pdf

 

In BPY's Q3 call they were asked a lot of questions about properties getting under water, whether or not they would consider "letting the lender take the keys" i.e. just give them back, and they actually seemed rather cavalier about it, Kingston said that they had no problem doing that and were considering it in many cases.

 

This sounds a little surprising until you look at the overall strategy.  I think that they buy operations like GGP or Forest City not for the breadth of the portfolio but just for the best properties.  They can develop and improve them, especially if they can combine them with other adjacent parcels, and create enough value that way to justify the whole deal.

[tiddman]

- You need to be very careful with debt/ebitda and ev/ebitda metrics.

 

I agree with you but I wonder if you care to elaborate on this comment?

[tiddman]

Cutting through all the complexity, double counting, plan value bullsh*t, etc, this business generated 2.6B of CAFDR (closest proxy I can get to for actual free cash flow) in TTM ending 6/30.

 

For this $2.6B figure are you simply omitting disposition gains and carried interest?

[petec]

- You need to be very careful with debt/ebitda and ev/ebitda metrics.

 

I agree with you but I wonder if you care to elaborate on this comment?

 

Well, the retail portfolio seems to split into two: very roughly, there is $15bn of GAV in high quality assets levered at under 40%, and $18bn of GAV in lesser assets levered at over 80%.

 

It seems fair to assume that the debt/ebitda ratio is higher in the more levered pool of assets.

 

If that's right, then the debt/ebitda ratio for the whole company would be transformed if they simply hand back the keys on the lower quality assets. 

 

There would also probably be an impact on ev/ebitda, but that's a bit harder to prove.

 

Perhaps it would be more accurate if I had said you need to be careful with consolidated debt/ and ev/ebitda metrics, because the leverage level is so different for different assets.

[tiddman]

I generally agree and given their different lines of business there's an apples vs. oranges problem.

 

The premium and stabilized (i.e. completed development) office towers are generally conservatively financed at around 60-65 LTV. These are the easiest to see because the financing terms of each asset is often disclosed.

 

The retail assets run the gamut from premium to mediocre. They say that 20% of their retail properties represent 45% of the portfolio value. On the low end of that scale there are undoubtedly properties with 80-100% or higher financing i.e. under water. They have been taking impairments and say that current carrying values reflect fair value so if they had to give them back they would lose debt but would not lose any equity.  While that makes sense today, I certainly don't think they acquired these properties with the expectation that they'd give them back unless they feel they got such a great price on the overall deal that they could just flush the bottom 25% of the assets.

 

Then there is also the "LP Investments" which are deconsolidated and held in a separate entity. These I guess are "trading sardines" i.e. the "fix and sell" portfolio. The leverage here isn't clear to me because they account for them differently i.e. equity accounting.

 

Aside from all that there are minority interests in many of their properties. "Interests of others" represents about 35-38% of the equity and NOI in their properties, however I believe they are obligated to report the full amount of debt on those properties. If this is the case then debt/NOI or debt/FFO would be overstated because it includes 100% of the debt but 65% of the income.

[petec]

I generally agree and given their different lines of business there's an apples vs. oranges problem.

 

The premium and stabilized (i.e. completed development) office towers are generally conservatively financed at around 60-65 LTV. These are the easiest to see because the financing terms of each asset is often disclosed.

 

The retail assets run the gamut from premium to mediocre. They say that 20% of their retail properties represent 45% of the portfolio value. On the low end of that scale there are undoubtedly properties with 80-100% or higher financing i.e. under water. They have been taking impairments and say that current carrying values reflect fair value so if they had to give them back they would lose debt but would not lose any equity.  While that makes sense today, I certainly don't think they acquired these properties with the expectation that they'd give them back unless they feel they got such a great price on the overall deal that they could just flush the bottom 25% of the assets.

 

Then there is also the "LP Investments" which are deconsolidated and held in a separate entity. These I guess are "trading sardines" i.e. the "fix and sell" portfolio. The leverage here isn't clear to me because they account for them differently i.e. equity accounting.

 

Aside from all that there are minority interests in many of their properties. "Interests of others" represents about 35-38% of the equity and NOI in their properties, however I believe they are obligated to report the full amount of debt on those properties. If this is the case then debt/NOI or debt/FFO would be overstated because it includes 100% of the debt but 65% of the income.

 

Re: handing back keys: agreed, this makes sense now but doesn't mean they got a good deal. What I do think was smart was putting leverage against the lesser assets. It sounds counterintuitive but it means you have less equity at risk and a better chance of renegotiating against lenders who really don't want those assets. If they levered those assets post-acquisition, dividended the cash, and are then able to renegotiate the debt, they may actually do very well on them in the end.

 

[tiddman]

I have been wondering how this works exactly though. Say there is a mall owned and operated by Brookfield that is under water.  They get behind on the loans, go to special servicing, and potentially give back the asset. Brookfield's debt is wiped out and the servicer owns the asset.  But then what?

 

The servicer probably can't operate the mall, they are a loan servicer, not a mall operator. If it sits there vacant it will lose even more value. They will want to sell it as fast as they can, and one of the buyers could be Brookfield. So Brookfield is inherently still in the mix even if they give up on the mall. I think this is especially true with CMBS where there is no one party involves but it is securitized.

 

And then what happens if Brookfield gives back the mall but then owns a department store location in that mall like JC Penney? Do they now go from being the owner of the mall to a tenant?

 

Kingston has alluded to this on the past two calls and has said that they can "negotiate" or "work out" the asset. They will take a loss of some kind but might still be involved with it.

[petec]

I think those complications are exactly why they’ve got a good chance of renegotiating some of that debt. Having taken write downs already they may now have little to lose and lots to gain.