Activist investor Carl Icahn has a new goal — one that has long pissed off short sellers and landlords: servicing commercial mortgage-backed securities.
Icahn Funds are suing Rialto Capital Advisors, a prominent private services firm, for delaying the sale of a Nevada shopping center, allegedly stealing millions of dollars from investors, according to a complaint.
Icahn also alleges that Rialto manipulated valuations to steer service decisions away from some bondholders.
The lawsuit reflects real estate investors’ longstanding gripes on CMBS’ private butlers.
When a CMBS loan has a problem, a third party is supposed to service the debt, but there are inherent conflicts. Servers earn a fee for as long as the loan is in a private service, leading critics to suspect that some of this state is intentionally prolonged.
Icahn, with deep pockets, is seeking systemic change, but he has his own motive: he is selling CMBS debt through an index known as CMBX.6, which has reaped huge profits for him in the past (others have gotten their trades wrong). A change in the way ratings are calculated could allow Icahn to once again benefit from retail problems.
In this case, Icahn’s complaints stem from the stumbling block of the retail center in Brim, Nevada, near the California border. Five years after the property borrowed money in 2012, it was half empty and the outstanding loan principal was about $67 million. Rialto, as the custodian of the loan, appointed a receiver to oversee the property.
That’s when things went south, according to the complaint.
The property, Prizm Outlets, was revalued in April 2018 for $25.5 million — about $50 million less than the loan balance. According to the complaint, the valuation should have wiped out most junior bondholders and most second-hand bonds. Class E bondholders, including Icahn, were supposed to become the dominant class of the trust.
“Instead, because it was not in Rialto’s interest – or in the interest of other influential market participants – to adequately recognize losses … Rialto planned to refuse control of Class E certificates while operating Prizm outlets in proverbial territory,” the complaint said.
Icahn alleges that Rialto used inflated valuations to deny control of the retail complex to Series E bondholders, who would have demanded an immediate sale of the property or exchange Rialto as a private service.
An April 2019 valuation of $28.8 million assumed the position was nearly 100% occupied when half of it was vacant, according to the complaint.
In October 2019, the server ordered another valuation, which was inflated by a 10-year lease with HeadzUp, an experimental entertainment facility, the lawsuit alleges. It claims that Rialto drafted the lease agreement to create the illusion of improving conditions at Prism outlets.
In fact, Rialto had to get HeadzUp to pay the $650,000 up front and the tenant never paid rent, something that the complaint alleges Rialto hid.
Then came the epidemic. By March 2020, it was Class E bondholders. But by then, Prizm Outlets had fallen in value by millions more and millions of dollars in fees were paid.
A year later, Prizm Outlets were sold to Kohan Retail Investment Group, a well-known buyer of distressed malls, for about $400,000. Rialto incurred approximately $12.85 million in fees, advances and expenses on the property, meaning investors lost $12.4 million.
The sale prompted the bondholders to recognize a loss of $62.2 million of the entire outstanding loan principal. According to an analyst at Bank of America, this was the largest loss, both in dollar terms and in percentage terms, for a CMBS loan since the 2008 financial crisis.
Icahn funds claim that other players influence the CMBS market. He points an accusing finger at Putnam’s mutual fund and other funds that have sold multi-billion-dollar protections to the CMBX.6 index. It claims that CMBX.6 security vendors were the primary beneficiaries of Rialto’s actions on Prizm ports.
The complaint does not provide a smoking gun showing that Putnam affected the server at the Nevada Mall. However, she claims that such behavior is common in the CMBS world.
“The free and fair operation of the CMBS market is routinely eroded when servants artificially avoid recognizing obvious short-term losses, thereby exacerbating losses for CMBS investors in the long term,” said Icahn’s attorneys at Kasowitz Benson Torres. .
An outside observer, Shlomo Chubb, an advisor on distressed commercial real estate deals, said the lawsuit could have significant implications for CMBS borrowers, not just investors.
“Borrowers should thank Icahn, as this status will be transferred in many foreclosures and may lead to change in the industry,” Chubb said. “It highlights the cases that judges have dismissed over the past 10 years.”
Chubb explained that when a delinquent borrower claims that their loan servicers are playing fee-collecting games, judges dismiss them, arguing “you owe money, and who cares – pays.”
“At the same time, interest and delinquency fees are accumulating, so most borrowers either walk away or settle because the downside is too big,” he said.
Rialto did not respond to a request for comment.