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Life at the Margin

Toll borrows a page from Lennar's Rialto to play in the FDIC broken-deal game.

Recovery's sluglike pace and feeble pulse have begun to separate pure-play home builders from some of their peers who plan to dash for nearer-term gain in residential real estate finance, even as new-home sales stay stuck in neutral.

After Lennar dusted off its Rialto Capital Advisors unit this past February to avail of opportunity in the big-time, pennies-on-the-dollar broken land deal game, Toll Brothers in July created an asset acquisition and management unit designed to profit from distressed real estate. By August, Toll's new Gibraltar Capital and Assets Management group had teamed up with Oaktree Capital Management and Milestone Merchant Partners to buy the $1.7 billion AmTrust portfolio of distressed land and loans from the Federal Deposit Insurance Corporation.

Toll's initiative sends two strong signals as home building company management and stakeholders try to gain sight of what the market's short- and midterm outlook might be. One is that tangible contrasts in business model and strategy may play an increasingly important role among public home building companies trying to reach the finish line to recovery. The other is that, by ramping up noncore cash-generation initiatives, certain companies may be evidencing a conviction that new-home sales' recovery may remain anemic longer than the next six to 12 months. Hence, the need to hedge a company's operational bets if it has the wherewithal.

As the U.S. economy's employment picture continues to grip consumer sentiment, access to capital, and mortgage credit in a stubbornly tight hold, home builders' respective runways to viable volumes of production and cash flow remain clouded. While public companies deftly improved their balance sheets, retermed their debt schedules, and stockpiled all the cash they could during the past 36 months, many of their models will begin to show strain in the next year or so if home building's pace fails to strengthen.

The AmTrust portfolio, which the FDIC took in receivership in December 2009, includes roughly 200 loans, most of them nonperforming, with an unpaid balance of about $1.32 billion. A significant majority of the loans were made for real estate acquisition, development, and construction.

The portfolio also includes 80 real estate properties, land, lots, condominiums, and single-family and multifamily communities in 17 states at various stages of completion, and a book value of $382 million. The average loan/asset size in the pool is $6.1 million.

The FDIC has retained a 60 percent equity interest in the limited liability company it created to hold the assets—Amtrust CADC. It also will provide about $303 million in nonrecourse financing at 0 percent interest, and a nonrecourse advance credit facility of about $40 million for additional working capital needs, with an interest rate of Libor plus 300 basis points.

Oaktree contributed about 79 percent of the capital, and Toll contributed about 20 percent. Milestone contributed 1 percent. Milestone and Gibraltar will conduct day-to-day management and workout oversight.

Dealing with distressed assets runs in Toll's DNA. Gibraltar unit leader, Roger Brush, a 17-year Toll veteran, focused on distressed real estate assets with the Resolution Trust Corp. during the early 1990s. Also key to Gibraltar management is Michael LaPat, a senior manager in the company's finance group. LaPat has more than 10 years with Toll, working on mergers and acquisitions, due diligence, valuations, and the structuring and financing of complex ventures.

The Toll real estate capital investment play mimics Lennar's—which also had experience with distressed assets in the last big downturn—in the business of working with the FDIC on repossessed loan and real estate portfolios for multiple gains.

This past February, Lennar announced that it had formed a public–private partnership with the FDIC to buy and manage $3.05 billion in distressed real estate loans through its Rialto subsidiary, formed two years earlier.

Other well-capitalized builders, with the cash, in-house real estate know-how, and patience it takes to deal with a mixed bag of distressed assets, could follow. M.D.C. Holdings CEO Larry Mizel didn't rule out the possibility that his company might get into the business during its most recent earnings call with analysts.

“I think that we have always had an open mind,” he replied. —Teresa Burney