While UDF management claims to have “identified the housing bubble and avoided lending in frothy markets,” in reality, there are numerous instances that highlight the fact that UDF was lending on real estate in tertiary markets leading up to, and at the onset of, the financial crisis in late 2007, at a time when the housing market was particularly and notably “frothy.” Following a number of these instances in which loans were issued just prior to the onset of the great financial crisis, UDF used capital from subsequent funds (such as UDF IV) to provide liquidity to prior funds (such as UDF III), perpetuating a scheme in which new investor capital appears to have been used to repay existing investors or other stakeholders.
In early 2016, UDF’s access to new capital was largely shut-off following the termination of the UDF V offering, through which UDF management was attempting to raise an incremental $1 billion in new capital. Not surprisingly, soon thereafter, the cracks in UDF’s facade began to show. Shortly after the termination of the UDF V offering, UDF IV acknowledged certain events of default had occurred and both UDF III and UDF IV suspended distributions to investors. Without a related fund to which to turn for new capital, UDF management has been trying to dissipate collateral in order to generate sufficient liquidity to repay its creditors and avoid bankruptcy, an effort that has been pursued in the background and which has remained largely undisclosed.
Prior to this new reality, it was much easier for UDF to kick the can down the proverbial road, often relying on new capital from subsequent funds to provide liquidity to prior funds. The stark contrast between how UDF operated when hundreds of millions of retail dollars steadily funneled into successive funds and how UDF is now forced to operate without any meaningful access to new capital, is telling. Understanding UDF’s historical practices highlights just how critical access to new capital was and why, without it, issues that long existed are now becoming visible.
One example which underscores UDF’s problematic past (and present) involves Northpointe Crossing, a residential real estate development in Anna, Texas (far-North Texas). In the lead-up to the great financial crisis, UDF III issued a second lien loan in December 2007 to the developer, which happened to be a wholly-owned subsidiary of UDF I. Years after the crisis, UDF I was still struggling to repay its senior lender, entering into multiple short-term modification and extension agreements (during 2011 and 2012). Despite these challenging circumstances, UDF III increased the commitment on its second lien loan by 150% in 2011 and has, in aggregate, amended and extended the loan four times. In May 2013, UDF IV purchased a “participation interest” in UDF III’s second lien loan and subsequently the balance owed to UDF III was virtually all repaid. However, as of UDF IV’s last public filing (September 2015), it was still owed a significant balance despite the fact that virtually all of the initial collateral has since been dissipated, indicating that the collateral was woefully insufficient to repay and support the loan. As a consequence, UDF IV capital allowed UDF III to fully recover its investment related to Northpointe Crossing, transferring considerable risk and any losses from UDF III to UDF IV.
Despite this example and other evidence that would suggest otherwise, UDF management claims to have “identified the housing bubble and avoided lending in frothy markets.”
Hayman’s latest presentation outlines how UDF’s disclosures regarding this situation are opaque at best and, in aggregate, misleading. The relevant omissions in disclosures, and the current 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 funds (such as UDF IV) to provide liquidity to prior funds (such as UDF III), the 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.