Previous blog posts have discussed deceptive real estate syndications.
The mother of all alleged syndication frauds is the Credit Suisse loan syndication program involving 14 U.S. resorts. A syndicated loan is a loan sold off to multiple investors. I became obliquely involved when I appraised the property of one of the resort developers as additional loan collateral. (I have no relationship with Credit Suisse or Cushman & Wakefield.)
The alleged loan fraud is described by Bankruptcy Court Judge Ralph Kirschner as follows:
“In 2005, Credit Suisse was offering a new product for sale. It was offering the owners [developers] of luxury second-home developments the opportunity to take their profits up front by mortgaging their development projects to the hilt. Credit Suisse would loan the money on a non-recourse basis, earn a substantial fee, and sell off most of the credit to loan participants. The development owners would take most of the money out as a profit dividend, leaving their developments saddled with enormous debt. Credit Suisse and the development owners would benefit, while their developments—and especially the creditors of their developments—bore all the risk of loss. This newly developed syndicated loan product enriched Credit Suisse, its employees and more than one luxury development owner, but it left the developments too thinly capitalized to survive. Numerous entities that received Credit Suisse’s syndicated loan product have failed financially, including Tamarack Resort, Promontory, Lake Las Vegas, Turtle Bay and Ginn [Sur Mer].”
What makes this alleged fraud interesting to the International Appraiser is that Credit Suisse is Switzerland’s second largest bank and allegedly created a fake Cayman Islands branch in order to get around U.S. banking laws, particularly FIRREA (Financial Institution Reform, Recovery and Enforcement Act of 1989).
Credit Suisse and Cushman & Wakefield Appraisal are currently co-defendants in three class actions lawsuits, claiming over $10 billion, over the loan defaults of all 14 resorts, as follows:
- $8 billion alleged damages. Property owners v. lender and appraisal firm. Filed January 2010.
- $2 billion alleged damages. Borrower v. lender, appraisal firm and appraiser. Filed February 2012.
- $250 million alleged damages. . Hedge fund loan investors v. appraisal firm. Filed October 2011.
The plaintiffs in the first lawsuit contend that CS saddled the resorts with debts much higher than the underlying real estate values, thereby forcing bankruptcies that impaired the value of the real estate holdings of the individual residents. Such a loan is sometimes called a “predatory loan” and the scheme sometimes called “loan to own”. As a former banker, I find such a complaint to be hard to believe. Foreclosures are rarely profitable for banks.
Credit Suisse hired the appraisal firm Cushman & Wakefield to appraise each resort according to an unorthodox methodology named “Total Net Value,” which basically ignored the time value of money in estimating the present value of each of these resort developments. Such developments were going to take years to sell out, but future revenues were not discounted for time. The “total net value” (TNV) methodology was tantamount to creating discounted cash flow models with 0% discount rates. Its sole purpose seemed to be to inflate the appraised value and thus justify a higher loan amount.
The appraisal firm performed the appraisals according the Total Net Value methodology dictated to them by the lender and attempted to cover themselves with all the necessary disclosures and Assumptions and Limiting Conditions in their reports. Others mistakenly thought that the appraisals were market value appraisals, and it appears that CS wanted to create that illusion. Cushman even mailed the appraisal reports to the Cayman Islands address, ostensibly to circumvent U.S. appraisal laws.
All 14 syndicated loans failed and property owners at four failed resorts, Yellowstone Club, Tamarack Club in Idaho, Lake Las Vegas, and Ginn Sur Mer in the Bahamas, filed the first suit against CS and the appraisal firm, claiming that CS had defrauded them with a predatory “loan to own” scheme, that appraisers had used the total net value methodology to create misleading and deceptive appraisal reports that violate FIRREA, and that the defendants, knowing this, engaged in a conspiracy to circumvent FIRREA by creating a special purpose lending entity in the Cayman Islands and having the appraisal reports delivered there. The CS Cayman branch was alleged to be a post office box.
In its motion to dismiss, the appraisal firm claimed that the plaintiffs were aware that the appraisal reports properly disclosed that they were not based on market value. They also pointed out that there was no connection between the plaintiffs and the appraisers and thus no basis for privity (fiduciary responsibility). The motion to dismiss, interestingly enough, also states that the appraisals’ non-compliance with U.S. banking laws was irrelevant to any of the loans because the lender was from the Cayman Islands. How convenient.
The Yellowstone Club example illustrates the magnitude of appraised value inflation as a result of the TNV methodology. Yellowstone Club is a private vacation home community in Montana that includes such notable residents as Bill Gates and Dan Quayle. Prior to CS’s involvement, the same appraisal firm had appraised Yellowstone Club for $420 million. CS instructed the appraisers to revalue Yellowstone Club several months later using “total net value” methodology, and the appraised value shot up to $1,165,000,000, supporting a $375 million loan decision by Credit Suisse. The loan later went into default and foreclosure.
On July 17th, 2009, the foreclosed Yellowstone Club was sold for $115 million to Cross Harbor Capital Partners. The loan loss was therefore about $260 million.
Lessons to be learned
From the standpoint of international investors, there should be the fundamental realization that appraisal or valuation reports ordered by a syndication sponsor are not “independent valuation reports”, as they are often labeled. Allowing syndication sponsors to buy and pay for valuation reports is just placing foxes in charge of the hen house.
The U.S. certainly has laws against appraiser misconduct, but enforcement is rare, and was certainly not enough to prevent the greatest global financial crisis since the 1930s, which was due in large part to massive mortgage fraud enabled by appraisal fraud. What’s worse is that most other countries do not even have laws as strict as the U.S., which implemented tougher laws after the Savings and Loan Crisis of the 1980s.
Some appraisers may think that certain liberties can be taken in an appraisal report as long as they are disclosed in the report. Appraisers may agree among themselves on what these types of disclosures are, but those outside the appraisal profession may not understand disclosures when they see them. This particular case may test the limits of how far this possibly undue reliance on disclaimers can go.
The appraisal reports for CS were previously published on the Internet and contained standard disclosures, disclaimers and Assumptions and Limiting Conditions. The “intended use” was for loan underwriting and the “intended user” was CS. An appraiser reading these reports could reasonably infer that the appraised values were not labeled as or intended to represent market values. The first plaintiffs in this case would not normally be considered to have a claim based on privity [duty of care to the plaintiff], either. Nevertheless, the appraisal firm is still facing an $8 billion lawsuit after an unsuccessful motion to dismiss.
The current judge on the case has raised the question of whether the plaintiffs properly understood the reports or had such capability. This raises the questions of whether disclosures and Assumptions and Limiting Conditions are enough to prevent the public from being misled. Appraisers should consider that any number printed as “appraised value” is likely to be interpreted by others as an expression of market value. There are many persons, particularly investors, who may rely on an “appraised value” without reading the report and finding the disclosures. Some properties or projects are even marketed with representations of appraised value without ever allowing the public to see the supporting appraisal reports, as was the case with Credit Suisse.
Large firms, in this case an international brokerage and appraisal firm, have deep pockets that can serve as a target for lawsuits. It would be in such a firm’s best interest to avoid all situations allowing accusations of impropriety. In this case, the reason for the using Total Net Value methodology instead of market value was not explained, making it seem that TNV’s sole purpose was to inflate the appraised value. This may make the appraisers seem complicit in the alleged loan fraud by CS, which the appraisals enabled. It is questionable if the appraisers expected to be part of a syndicated loan fraud scheme, though, as the only benefit to them were the fees earned for the reports. Nevertheless, whistleblower Michael Miller at C&W has come forward with allegations and incriminating e-mail messages (such as “not in jail yet and continuing to write these appraisals”) indicating that his colleagues knew they were creating misleading reports.
Congratulations to Cushman are in order for their award of a large "Financial Advisory Valuation Services" contract by the FDIC. Who says that excellence does not go unrewarded?
Here is a suggestion for investors: Order your own appraisal or at least hire an appraiser to review the “independent valuation.” American Property Research provides such a service.
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