Seems my post just a couple of days ago about how DVC adds to the room mix at WDW was timely indeed. At least in the sense that I mentioned in some detail how Disney treats DVC units in counts of occupancy and per room guest spending.
Here is what I had to say:
‘So while in general DVC units would be treated somewhat differently since they are ‘ownership’ shares, that apparently mostly applies to revenue recognition for when the contracts are sold (and again when they are re-sold on the secondary market as part of a package of mortgages much like what got the rest of the real estate into a mess in the first place). Tom Staggs has mentioned a few times over the last couple of years that Disney has had some delayed revenue recognition because they’ve been having to hold onto those contracts longer than normal. Disney collects transaction costs and presumably some upfront money when a contract is sold, but can’t recognize the rest of it until it has a fair price, which is whatever a bond holder will pay for it in the secondary market.’
I say timely because Jason Garcia of the Orlando Sentinel just wrote an interesting piece (and a pretty good one I might add) on just the thing we were noting above about Disney’s issues over the last year or better with having to hold onto DVC contracts longer than normal.
So lets talk just a bit about how this all works, in general terms anyhow. Disney, under the Disney Vacation Club subsidiary, offers to sell you and I an ownership interest in one of their properties. For $98 a point (after discounts), Disney offers to sell you a contract good for 160 points for 50 years. That means the cost is about $15,680. Disney offers you a 10 year mortgage with a 10% down payment at a prevailing interest rate, you sign the paperwork and out the door you go. The proud owner of a deeded share of a nice resort complex in Florida at your favorite place to vacation! You pay the yearly maintenance dues to help pay the operating expenses of your nice place, make your monthly mortgage payment, and enjoy your DVC membership for years to come.
Inside the DVC however, all is not so peaceful! Disney probably takes part of your upfront payment for general sales and administrative expense (after all, someone has to pay all those people in the parks and in the DVC center selling you the property, and usually that’s born by the acquirer at the point of sale). So they record money in at $15,680 times all the other contracts for the quarter, subtract expenses and then have the underlying mortgage and 10 years of interest payments to look forward too. At 10%+, it’s decent money, as long as you pay on time.
The problem is of course that all of the mortgages weigh down Disney’s balance sheet overtime as they accumulate, and Disney would rather have your money now instead of over the next 10 years where depreciation will eat into the return (at 2% growth for inflation, it won’t take long for that 10% to not be worth much in future years). So Disney takes large bundles of these mortgages, wraps them together and sells them to an ‘investor’ like a discounted bond. The investor pays money now for a stream of payments in the future and Disney gets a lump sum payment in year 1 or 2 for the WHOLE contract. Just like Fannie and Freddie do for most of yours and my conventional home mortgages.
That upfront payment is of course risk rated and that affects how much (or little in this case) the investor is willing to pay for the bundle of contracts. The investor bakes in an estimated default rate in what he’s willing to offer so as to try and make sure he stays in the black over the life of the contract, since he now owns it and can loose money. Here that investor was Citi Corp, who you and I as taxpayers now own a large chunk of.
In this case Citi also asked Disney, according to the Sentinel article, as part of the agreement to backstop, or provide the equivalent of insurance, to Citi in the event that more than an expected number of contracts started to default. That would be like that other insurance company that you and I ALSO now own a large part of did for many in the conventional mortgage market, AIG.
In turn, Disney got the right to take back and exchange any deals that were going bad so that they could keep the points inside the system and maintain the overall experience while protecting your ownership interest as well.
You’ve been enjoying your DVC membership for a couple of years and suddenly something happens and your unable to keep up your payments. This isn’t a primary residence, so you don’t qualify for any government assistance to reset or refinance your mortgage. You can try to sell it through an after market reseller, but chances are you will probably have to offer it for less than you owe on it to attract a buyer unless you’ve made substantial principal payments in the last couple of years. You make a tough decision and let the mortgage lapse into default and heading for foreclosure.
Disney has to buy back your contract and swap it and if they can’t then that insurance kicks in and Disney pays Citi a flat rate to essentially payoff your contract. This happens at a higher than projected rate and Citi comes back during a normal contract renegotiation and tells Disney it can no longer honor the terms of the original agreement because its suffering losses far in excess of what it had estimated it would (i.e. they are either not making as much money or they are actually loosing money).
Disney balks at the amount of ‘insurance’ Citi now wants and talks break down. In the meantime Disney keeps selling contracts, but its lost its ability to go for the ‘easy money’ by packaging and selling them and instead now has to service the loans and generate cash from the interest payments. DVC cashflow slows and the Parks and Resorts folks take a cash hit because they are now lugging around all those mortgages they’d have otherwise not had.
So it’s an interesting peak into how the market works.
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