Slow Movement Along the Spectrum of Distress

'Extend and Pretend' Joins the Lexicon

Searching for Solutions

Slow Movement Along the Spectrum of Distress

Maguire sold a 19-story office property to Emmes Group, at a reported 35 percent discount, to eliminate $165 million in debt and other obligations. It was able to extend $84 million on a construction loan for its Lantana Media Entertainment campus, first until the end of September 2009 and again until mid-June, 2010, with no principal paydown. For the Quintana Campus, in which it has a 20 percent interest with partner Macquarie Office Trust, the partners entered into negotiations with the special servicer under the $106 million CMBS financing maturing in December 2011. The campus had suffered a significant reduction in cash flow in March, and a reduction to 40 percent occupancy, after the Federal Deposit Insurance Corporation (FDIC), as receiver for Washington Mutual Bank (WAMU), relinquished the majority of its Quintana lease.

In short, although it may seem as if more firms are lining up to dive into the workout business, a spectrum of distress is emerging and it is widely expected to worsen before it improves. Distress runs the gamut from maturing loans, loans in technical default, loans in actual default, loans foreclosed and CMBS debt under the control of special servicers. A few sobering statistics:

• Foresight Analytics LLC, based in Oakland, Calif., estimates that there is some $814 billion in commercial mortgages maturing in the next three years.
• According to Credit Suisse, CMBS loans coming due will grow to $42 billion in 2010 and $69 billion in 2011, up from $15 billion this year. Moody's expects the aggregate rate of delinquencies among U.S. CMBS loans to reach five to six percent by the end of this year.
• Real Capital Analytics' Troubled Assets Radar reported in July that the volume of commercial properties in distress more than doubled in 2009 versus 2008, with the value of assets in default, foreclosure or bankruptcy at over $107 billion. While hotels and retail properties are the most problematic, office distress is up 118 percent year-to-date.

'Extend and Pretend' Joins the Lexicon

"It's not very constructive, but that's most common," he said. He also noted that weaker lenders typically have not been foreclosing because "they don't want to take the hit. It's de facto forbearance." In some cases, he added, the lender doesn't extend or restructure a loan, but limps along and hopes that the borrower will raise new capital and sell the property.

Call it denial, call it hope for a quick market turnaround, but in Grey's view, "regulatory forbearance" also plays a role in the current climate. "Regulators have not been aggressive about selling bad loans or foreclosing," he said.

In what may be the understatement of the year, the Real Capital Analytics' Troubled Asset Radar report in July remarked, "Perhaps more alarming than the rapid growth in the distress totals is the very modest rate at which troubled situations are being resolved. While $60.5 billion of troubled assets have been added year-to-date, just $4.1 billion have been resolved this year. In far more situations, modifications and short-term extensions are being granted, but these can hardly be considered resolved, only delayed."

Searching for Solutions

What if your loan is distressed or poised on the brink? Mortgage bankers and workout specialists uniformly advise being open and honest with lenders about a property's condition as quickly as possible. "They're your partners," said Starr. "Anticipate problems two years out; use as little cash as possible; stay away from recourse or changes in covenants; offer cash sweeps from the property to amortize debts; and don't reduce management fees. Whatever workout you're doing now, assume it's the first of others to come."

Peter Austin, senior vice president of Welsh Capital, said that the in-house mortgage banking division of Minneapolis-based Welsh Companies LLC is doing about 50 percent of the business it did in 2008 and much of that volume is in the multi-family category. He believes that we will be well into 2010 before a meaningful turnaround; the crucial period will be the next 12 to 24 months.

"We tell clients to be more pro-active, be in constant contact with lenders, dialogue early," he said. "If you want an extension you need at least six months to figure out a Plan B." He also advised owners to "go out and visit properties: make sure they're in good shape, that there are no angry tenants and be adept at dealing with issues. Lenders are looking more at the developer than anything else. You have to tell the story."

Austin said that some solutions with commercial banks have involved changing non-recourse to recourse loans, with more leverage; or arranging for a banker to provide a line of credit that's personally guaranteed. "There is some mezzanine financing but the yields are in the mid- to high teens, so it may be better to get a personal line of credit. People have brought in partners, with fresh equity. But that's rare."

For non-performing loans, solutions are achieved on a case-by-case basis, depending on the lender. He remarked that some lenders are hesitant to foreclose and prefer to keep the borrower in place if there is hands-on ownership rather than an absentee landlord.

Austin noted that it is easiest to work with a borrower's existing lenders. "But expect a lot more scrutiny of rent roll, TIs, rollovers," he said. Moreover, even if tenants are paying what may be above-market rents, lenders will likely underwrite based on current or lower-than-market rents.

Carey Stiss, partner in the real estate practice of law firm Bilzin Sumberg Baena Price and Axelrod LLP in Miami, commented that financing solutions run the gamut, from some debt relief and back-load payments, but no waiving of interest payments. He suggested that if a loan is maturing in six months, it may be possible to "find a buyer, get what you can get and pay off the loan at a discount."

For REO properties, the lenders who have taken a hit are not looking to stay with the property and typically want all cash for it. "If an REO is overpriced, it's not selling," he said. "There's been a flight to quality and a flight to infill. Smaller deals are easier; there's no premium on large deals" (defined as over $60 million). Dennis Williams, senior director of NorthMarq Capital in San Francisco, said that the most nebulous area right now involves loans maturing in a year or two. He has heard of a few lenders contacting borrowers, asking for a 10 percent paydown in return for a three-year extension and the option to extend for three years after that. "That's smart on the lender's part," he said.

For CMBS loans coming due, six- to 12-month extensions don't help as much. "Fundamentals aren't going to be better next year," he said. "Getting a one-year extension isn't going to get you from A to Z." Conduit lenders and special servicers are "all over the map" in dealing with distressed loans, he said. "Some don't respond until the loan is 90 days delinquent. But don't start a dialogue by being 30 days behind."

The Federal government has agreed to accept CMBS as collateral under its Term Asset-Backed Securities Loan Facility (TALF), but the impact has yet to be felt in the market. But TALF will only guarantee Triple A bond buyers, at a low loan-to-value ratio, which leaves a huge gap.

That is what concerns Williams most right now. "Of the nonrecourse permanent market (life insurance companies and CMBS) of $300 billion, $250 billion of that is CMBS and no one thinks that's coming back," he said. "So there's a gap that no one is willing to fill. We need something to replace CMBS or there will be rates at eight to nine percent with 10-year terms."

For more information
Bilzin Sumberg Baena Price and Axelrod LLP:
www.bilzin.com
NorthMarq Capital:
www.northmarq.com
Real Capital Analytics:
www.rcanalytics.com
Starr Finley LLP:
www.starrfinley.com
Third Wave Partners:
www.thirdwavepartners.net
Welsh Companies:
www.welshco.com

By Ellen Rand, contributing editor, Development.