Canary Wharf, a key Brookfield office asset in distress
Canary Wharf’s financial woes debunk BAM’s non-recourse debt structure and raise questions about the real estate driven, cash-rich future
In the 2Q21 letter to shareholders, Bruce Flatt used a good deal of space telling investors how much cash they will extract from real estate acquired from BPY over the next 5-7 years. It’s good that Mr. Flatt focused on the future potential, because the current reality includes some very unpleasant and uncomfortable facts.
Canary Wharf, a marquee group of properties, ended 2020 with negative working capital, balance sheet insolvent, which necessitated BAM to violate its much vaunted non-recourse asset-level debt policy and guarantee all Canary’s liabilities.
The Canary Wharf bail-out reveals the fallacy of the non-recourse debt structure. The promise is that when things go wrong, only the particular asset is vulnerable. However, as we have seen a number of times over the last year, it is precisely when trouble arrives that the technically non-recourse debt becomes de facto recourse.
There are important questions here for Brookfield investors. At what price and cost are the purchases and guarantees effected, and how and to whom are the expenses allocated? Over the last year, private equity limited partnership capital has been be used to save a BAM-managed publicly-traded affiliate; with Canary Wharf, the balance sheet of an asset manager is being guaranteeing the liabilities of an equity accounted asset held at a supposedly independent entity.
There can be a profound disconnect between what investors think they are funding and what the capital is actually used for. All of the cash is moved at the discretion of management; the investors may never be told. This is classic conglomerate behavior wrapped in modern corporate pyramid structure.
Here’s how the dominos tumbled at Canary Wharf.
Drowning in Debt Across the Pond.
Canary Wharf (CW) is a large, mixed-use estate in London, more neighborhood than development. BPY, now BAM, owns 50%; the remaining 50% is owned by the Qatar Investment Authority (QIA), a key real estate partner for Brookfield.
CW is office-centric. Since the start of the pandemic, tenants have continued to pay, despite the fact that occupancy remains stubbornly low in the 10-15% range as of July 2021.
In 2020, BPY’s carrying value for CW declined 3.8% to $3.44B, which amounted to ~14% of LP equity. It is BPY’s largest equity accounted investment.
Despite its size and importance, BPY’s annual report only contains a short narrative passage on Canary Wharf in the Market Highlights section. The accompanying exhibit shows the blurb in its entirety.
BAM’s only relevant mention of Canary Wharf in its annual report was that it was a source of gains in the equity accounted investment segment, which is peculiar given BPY’s write-down.
The absence of operational discussion in BPY’s narrative is not unusual, but there are plenty of disclosure-worthy financial facts. Canary Wharf ended 2020 in particularly dire financial condition. However, to learn any detail, investors must put aside the 1,390 of pages of quarterly, supplemental and annual reports from BPY and BAM and turn to Canary Wharf’s 88 pages of audited financial statements.
Canary Wharf’s problem, like Brookfield’s retail segment and the LP investment segment is leverage. At the end of 2020, my calculation shows net debt/EBITDA was an eye-watering 18.8x. Distress is further evident in the disclosure that the group was in breach of covenants on one loan and may approach covenants on others.
The statement of cash flow is a transparent indicator of financial stress. In 2020, net financing costs of GBP198M were 106% of GBP187M in pre-interest cash flow from operations. As bad as this is, it gets worse. Canary Wharf is a mixed-use estate with significant development activity.
In 2020, the estate had net cash from investments of (GBP181.6M), which included development expenses of GBP 167M. On an all-in basis, Canary Wharf had an operating + investing cash deficit of (GBP192M). GPB153M of the deficit was financed with new debt.
Companies can surf the refi debt wave, but eventually the shoreline approaches. In CW’s case that was a wall of maturities in 2021.
According to the audit, CW ended 2020 with a net current liability position of (GBP 835.7M). Deloitte LLP, the firm’s auditor and auditor of many, perhaps hundreds of Brookfield entities, would not sign-off on the statements on a Going Concern basis without assurances. As a result, Deloitte declared, “Brookfield and QIA confirmed that they intend to provide financial support for the group to meet its liabilities for at least 12-months.”
In other words, BAM shareholders were on the hook for all the liabilities and non-recourse debt of this remote, legally independent, ring-fenced entity.
Were Canary Wharf an independent entity, it may have failed at some point in 2021, but it isn’t. CW was saved twice - first with guarantees by Brookfield and the QIA, then by environmentally conscious investors.
Yield starved investors came to the rescue in the form of a GBP 900M green bond offering providing the group with the means to cover maturing liabilities. It was not an easy deal to get done. A note from Fitch reveals the many hoops that had to jumped though to get the secured debt rated BBB-, one notch above junk.
Imagine that, a marquee asset of one of the world’s premier real estate managers violating debt covenants, requiring balance sheet guarantees to obtain a clean audit, and struggling to obtain a non-junk rating on its debt.
Despite all the problems, it’s not all bad news from across the pond. Canary Wharf’s science-based targets just might help reduce carbon emissions. Take comfort in that.