The peculiar nature of the relationship between lender (UDF) and borrower (Centurion American) is central to the core debt-versus-equity question: what was the intent of the parties? In an effort to evaluate various factors which inform on this issue, Hayman has scrutinized the public record, identifying and detailing a material number of irregular loan-level red flags, as well as broad patterns across the loans, and will continue to do so. Collectively, the irregularities and red flags lead to legitimate questions as to whether the parties intended for various transactions to be debt in name only and whether debtor entities were or are, in reality, straw borrowers.
Throughout the 10-month period since its auditor resigned, UDF’s external management team has not hosted a single conference call to answer questions from public shareholders or the media, which is typical of transparent, public companies that are subject to scrutiny. While UDF struggled to repay certain creditors, the repayment of creditors itself is just the starting point, given UDF’s latest stated financial position with over $684 million of purported assets (book value) and only $171 million of debt. One of the reasons why UDF struggled for so long to repay certain creditors is that a significant portion of UDF’s loans do not actually generate any cash income. This reality is partly due to the fact that a material percentage of loans are second lien, subordinate “loans,” but more concerning is the fact that numerous development sites funded by UDF remained undeveloped for years. One such example, among many, is Alpha Ranch.
In 2012, UDF IV issued multiple subordinate loans to affiliates of Centurion American, theoretically to acquire and develop Alpha Ranch into a residential neighborhood. Despite a punitive interest rate of 13% on each loan, there has been no evidence of any apparent development activity – horizontal (roads, utilities, sewer) or vertical (homes, amenities) – in over four years. Further, based on a public-records request and discussions with local officials, Hayman has been informed that an official plat for Alpha Ranch, a precursor to development, has not even been accepted by the relevant local jurisdiction. During the period since UDF issued these loans, the senior lender related to one of the loans sent a default letter and threatened to accelerate the debt and to proceed with a foreclosure sale. Despite this, the outstanding balance on these subordinate loans has more than doubled since the end of 2012. Given the lack of development activity and the ballooning debt, there are legitimate questions regarding the “borrower’s” ability to repay debts and whether the intent to create a debtor-creditor relationship comports with economic reality.
Setting aside the relevant debt-versus-equity questions, the existence of numerous 13% interest subordinate development loans which are not supported by any development activity or discernible lot-sale income helps shed light on just why UDF struggled for so long to generate enough liquidity to repay relatively small debts. The nature of such circumstances also highlights a core flaw in UDF’s model as a REIT that pursues land development activities, directly or indirectly, and why it historically had to rely on Ponzi-like distributions practices, sourcing funds from new investors and stakeholders in order to maintain distribution levels to existing investors or pre-existing funds.
In addition to the precarious nature of UDF’s loans, the general financial status of UDF’s primary borrower, which accounts for over two-thirds of all loans (collectively affiliates of Centurion American), also likely contributed to UDF’s inability to timely pay its debt. As evidenced by the public record, various Centurion affiliates have had financial issues, ranging from, but not limited to, default letters, foreclosure sale notices, delinquent tax lawsuits and numerous tax lien contracts needed to finance property taxes. Since UDF last filed financial statements with the SEC, over $250 million in “loans” owed by affiliates of Centurion American (excluding any “debts” owed to other UDF affiliates which are significant) have come due. The fact that UDF acknowledged certain events of default on a small, $35 million loan suggests that Centurion American was unable to repay an even smaller percentage of what it owed as loans matured and came due. Despite these issues, UDF has not disclosed the financial problems of its largest borrower nor is there any public evidence in county deed records that would suggest UDF has taken action typical of a third-party lender when distressed borrowers fail to timely pay debts.
Why is a residential land developer in North Texas struggling to timely pay a considerable number of relatively small debts, exclusive of the over $600 million owed to UDF affiliates collectively, given the economic environment?
Hayman’s latest presentation outlines another case study highlighting numerous recurring red flags regarding UDF loans and the nature of the financial relationship between UDF and its largest borrower. Misleading disclosures and the current financial circumstances lead to questions regarding the intent of the parties in structuring investments and the substantive nature of UDF loans. When considered with other irregular patterns and red flags (documented at length by Hayman through various case studies), there is a reasonable basis to question whether a number of UDF loans are appropriately characterized as debt. If it is determined that any, if not a material number, of UDF’s loans are equity investments rather than debt, then there could be significant tax consequences (including potential REIT qualification consequences) and financial disclosure consequences. Equally as relevant, had UDF management not used capital from subsequent investors or subsequent funds to help fund shareholder distributions, the financial issues which are present and evident today would likely have surfaced far sooner.
The information in this presentation is relevant to investors, regulators, and tax authorities, as well as former and current auditors, and is being made public for any and all interested stakeholders to review. While the list of red flags already identified to date is confounding, additional red flags will be highlighted in the days, weeks and months to come.