When credit markets seized up and the full wrath of the Great Recession began taking its toll, Costa Mesa,Calif.-based Donahue Schriber found itself in the same position as many other developers. It had too much debt and, as property values crashed, it was quickly treading water.
“We had debt levels of 65 percent and when you have a 30 percent devaluation in properties, all the red lights go on,” recalls Chairman and CEO Patrick S. Donahue, “We had to change our organization and look at our company from top to bottom to address this crisis.”
The 42-year-old firm that today owns or operates 81 shopping centers representing more than 12 million square feet of retail space in the Western United States had seen its share of tough days before. It has weathered several real estate cycles. Moreover, it survived the sudden and shocking death of one of the firm’s founders, Patrick’s brother Dan, who passed away in 2002.
Nevertheless, the 2008 crisis presented new challenges. The company’s delinquencies quickly mounted. It was forced to go to its major funding partners and ask for infusions of cash in the form of preferred stock. And it began a process of deleveraging the company.
The firm also reduced its head count by about 15 percent and adjusted the roles of those who remained. For example, seeing that development would be a dormant business, the company moved its head of development into asset management. All remaining members of the development team moved over to leasing.
It took the firm’s head of asset management and had her focus exclusively on four primary properties “where we needed her transaction and merchandising ability to help those properties through the recession,” Donahue says. And it took her top assistant, who had been responsible for 40 properties, and had her focus exclusively on the company’s top asset.
These moves paid off as it was able to stabilize and increase lost occupancy at its remaining properties.
More significantly, less than three years after Lehman Brothers failed and triggered the credit crunch, Donahue Schriber cleared a major hurdle in late July by completing the final piece of a $1.2 billion balance sheet recapitalization.
The recapitalization occurred through several transactions. The final piece was a $365 million loan with a bank syndicate led by Bank of America and which also included Wells Fargo Bank, U.S. Bank, PNC Bank, Union Bank and City National Bank.
The loan refinances a portfolio of 31 of Donahue Schriber’s assets, encompassing grocery- anchored and power centers across, Arizona, Oregon and Nevada. The new financing has a term of 5 years with a built-in option for a 2-year extension, a lower interest rate and eliminates many restrictive covenants. With assistance from Chatham Financial, Donahue Scrhiber also locked in a LIBOR swap of $255 million as a hedge against potential rising interest rates. The transaction results in an annual interest savings in excess of $6 million.
“We’re very pleased to be continuing what has been a long and valuable relationship with Donahue Schriber,” stated Allen Staff Jr., Bank of America market president and region executive, at the time the recapitalization was announced. “They are a solid company with a very bright future.”
In addition, the company’s major investors, the New York State Teachers’ Retirement System (NYSTRS) and the JPMorgan Chase Bank Strategic Property Fund, converted their $188 million of preferred stock and accrued dividends into shares of common stock. They have also committed to provide the company with $100 million of additional common capital for future growth opportunities.
Included in the recapitalization total is the $248.5 million 10-property refinance with Allstate Life Insurance Co. that closed May 31, 2011.
Donahue called the recapitalization “one of the most important events in the company’s 42-year history.”
More importantly, it positions the firm to move from defense to offense, just as the retail real estate sector seems to be finding some solid footing. The firm will now be in a position to grow.
Donahue and the company’s President and COO Lawrence P. Casey spoke with Retail Traffic Editor-in-Chief about the recapitalization and about what lies ahead for the firm.
An edited transcript follows:
Retail Traffic: Walk us through the company’s history and how it got to where it is today.
Donahue: One of the major points to make is that we came up in the industry as a developer in the regional mall business. As the business evolved and matured, the company has had to do the same thing. My late brother Dan and (Chairman Emeritus) Tom Schriber, they were old-school developers. The game was to find an opportunity, to find a money partner and to execute the plan. That worked effectively through the 70s and 80s.
In the early 90s, as the business changed and many companies went public, we didn’t have the structure to do that. Dan and Tom ended up selling part of the company to Cambridge Shopping Centers. Right after that, the recession of 1990-91 hit.
Frankly, that ultimately set the stage to our reaction to the recession of 2008. When you’re in a crisis, the most valuable weapon you have is your experience. It’s that very experience you need during a crisis to be effective.
When the recession of 1990-91 hit, we hunkered down, went into the asset management business and the third-party business of managing other people’s malls with our major asset remaining the Glendale Galleria.
As Tom and Dan reached their mid-50s, they had to take some risk out of the equation. It was Tom’s idea that we needed to align ourselves with capital. We’ve really been a company that’s anticipated where we thought the industry was going and morphed our structure. In 1997, we had four development properties and a couple of small assets. We raised $100 million of growth capital and, in effect, sold the company to NYSTRS and a large family foundation and basically, at that point, we became more institutional than entrepreneurial.
We now had capital, but we couldn’t compete in the regional mall business. That had matured. But we did see an opportunity in the non-regional mall space. We thought what we did in the mall business would translate into the neighborhood center business.
So we bought Diversified Shopping Centers in 1998 and that set the platform for the company. In 2002, JP Morgan Strategic Fund replaced the family foundation as our other key investor. So at that point we had two large pension funds as our major shareholders. That transformed the operation, because we had to become more institutional.
And, then Dan unexpectedly passes away on Dec. 31, 2002. That forced a change in the course for the company. We might be a different company had he still been sitting here. But that situation was thrust upon us. Tom and I had to go and decide how to manage the company without its visionary.
Tom was always more the financial person. Dan was the merchant of the company. This forced us to take another look at who we were and got us to focus on the business of the neighborhood shopping center.
Dan, frankly, never liked that segment very much. He liked the regional malls and urban renewal projects. But by this point we saw neighborhood centers as the bread-and-butter and future of the company. We sold Glendale in late 2002, right before Dan died. We were out of the mall business and really had to make something of the neighborhood center business.
We started developing and buying. This was all through self funding. We would sell properties and that provided capital for our next opportunities. And we were taking on some more debt.
All of a sudden, 2008 hits like a ton of bricks. By this time, Tom had stepped aside, Larry had become our president and it was up to Larry, myself and the management team to navigate our way through the situation… If there’s something I’m most proud of, it’s that we did that. And now we have set our company on a course where its best days are ahead of us.
Retail Traffic: How difficult was it to work through the credit crisis?
Casey: The fourth quarter of 2008 was when the explosions began to cause some casualties. We were facing—as was everyone—busting a covenant with our major lenders. So our major investors had to step in at the end of 2008 in order to keep us in compliance with the provisions set forth in the debt.
In 2009 things continued to decline and those investors had to step in again. But by the end of 2009 and the beginning of 2010 we were able to begin to restructure our debt with the help of those investors. So we began to delever the company.
This led us to today, where the $365 million loan that aggravated our leverage has been restructured on very favorable terms. All of those covenants that were driving us crazy have now disappeared.
Retail Traffic: And now the investors have agreed to convert to common shares, correct?
Casey: When they stepped in, they stepped in with preferred shares. That’s how they delevered us. And those preferred shares had a high coupon and by converting them to common shares, that coupon disappears. So it is a very favorable situation for the company.
Retail Traffic: Are there other things that you did to put the company on surer footing?
Donahue: In late 2010 we were saying to ourselves, “Wait a minute, we are an operating company.” So how do we look at our entire capital structure, not just the Bank of America loan, and go and create a structure that will enable us to do the things we want to do and that our shareholders want to do?
That was a watershed moment.
The real story here is going through the storm, stabilizing the patient and then saying, “OK, how do we get this company to maximize its opportunities going forward with our existing structure?”
You cannot minimize the value, as a business operation, of the structure with our shareholders. It’s different from that old entrepreneurial model. We’re employees. This is a different game than having a limited partnership. However, this is a much more effective business model in this stage of the business cycle of retail real estate.
We don’t think it will revert back. You have to have capital. You have to have someone that will weather the next recession, or weather entitlements taking longer than you thought. You have to have patient capital betting on the business you’ve invested in.
And NYSTRS and JP Morgan deserve a lot of credit. They have been with us for a long time and they said, “You go to work, and we’ll watch your backside.” They weren’t happy about writing checks. But they wrote them. They showed us the confidence to let us do what we had to do. Without them, there is no recapitalization.
Now, the company is in a situation where I don’t remember it being on better footing in terms of staff, policies and procedures and having the right people in the right places and having $100 million of growth capital and a portfolio of 80 of the best shopping centers on West Coast.
Retail Traffic: So what is your growth strategy going forward?
Donahue: The strategy is no different from what it was when Dan and Tom formed the REIT in 1997. That is, we want to be the premier operator of neighborhood and community centers in the Western United States. That’s the goal. We’re not going to change the strategy. We’ll be judged in how we accomplish that.
We will continue to operate our 80 centers in an effort to maximize the value. We’re doing that now with remodeling. And we’ll continue to try and assess and capitalize on the existing portfolio. That’s the mothership that generates over $160 million in revenues.
We also will continue to be a developer. We have developments that were put on a shelf. We did entitle them during the recession. And we do have one major project—750,000 square feet going on in Rocklin, Calif. that will begin construction in late 2012 for late 13 or early 14 opening. And we have other properties that we’ll continue to try to create value.
The public companies are tough competition. But the smaller companies that we used to compete against, they frankly are working out their own issues. There is not a capital source for many of them right now. We think that’s a two or three year advantage that we can capitalize upon.
Retail Traffic: Do you have plans to tweak or grow the portfolio?
Donahue: We will continue to acquire shopping centers—particularly those we can add value to. We will also alter our geographic footprint slightly. We would like to expand into the Pacific Northwest and have looked at properties in Seattle and Oregon. In three years, we will hope to have 10 percent of [our] portfolio there.
We will also begin to take down some of our exposure in Arizona in the next few years. Frankly, that’s not because it’s not a good place to be, but we cannot be a force there the way we are in California. There are a lot of good developers there.
Overall, in three years we will probably be at 100 shopping centers. But we don’t have that written on the wall. What we do have written down is that we are 95 percent occupied and we want to get to 97 percent occupied. We do have rents that have been flat, so let’s keep pushing how we can create more value.
We learned in the last recession that occupancy should be the primary goal, not rent or rent growth… In retail, if you have a vacant anchor it really costs you a lot of money to bring it back.
Our goal was to make sure if a retailer was going to do ain a market, we wanted that deal to be with us. You need to meet the market on rental rates.
And remember, we doubled our leasing staff overnight by taking development types and putting them in leasing. I think that’s a point that’s important to make.
Retail Traffic: What kind of corporate culture defines Donahue Scrhiber?
Donahue: There’s no question that the corporate culture for the company was started by Dan and Tom and that is to work hard and play hard. We want to make sure you have fun. Work can be drudgery. Or it can be fun. We like fun a lot better than drudgery.
What Larry and I were challenged with when we took over leadership was that many people felt we might lose that company culture. But we embraced what Dan and Tom had started and tried to enhance it.
I get emails from everybody in the company on any subject. I had email today, for example, asking to put the Women’s World Cup game on our office TV. I said sure.
Casey: I think everyone is respectful of each other. We won’t tolerate people who are not respectful both up and down the chain.
Donahue: One last way to look at it is that our average tenure with the company is 11 years. That’s a pretty healthy number. I think it says we’re doing something right.