Tough Times for Lenders : Financial Services Lawyer & Attorney : Winstead Law Firm : Finance, Banking, Bankruptcy

Guest Writer, Laura P. Sims, Winstead PC

(CAVEAT: if this blog seems familiar, it probably is because after we posted it last week, it  "mysteriously" dropped off our site - after I messed up on the posting of March 7.  And I apologize.   So, here it is again!)

This is a series of blog entries [link] in which we provide quick answers to lenders' frequently asked questions related to tenant leases (FAQ). Leases are "the" whole point of income producing property—and this series is pointed to the simple goal of helping you protect the basic value building block of your collateral—which are the leases. Of course, two things should be kept in mind. First, none of these questions can be answered in a vacuum. Questions should be considered with a thorough review of the file. And secondly, many of the questions are worth revisiting from time to time because subsequent events will impact the answers.

What are the risks involved in delaying the exercise of remedies?

A period of delay between declaration of default and exercise of remedies increases the chance that some action or omission by Landlord or its representatives will be claimed by Tenant as evidence that:

• Landlord has waived the default or
• Tenant reasonably believed (and relied on its belief) that Landlord did not intend to strictly enforce the Lease.

Either one is a bad, bad result.

So, what should you do during any time period when landlord remedies are being deferred (or not exercised)?

Here are some tips:

• avoid sending e-mail correspondence involving discussions of modification of the Lease
• avoid in-person meetings involving discussions of modification of the Lease
• don't accept partial or late cure
• don't promise to forgo exercise of remedies (in other words, don't say "we won't exercise remedies")

Ideally, if rent failure is the issue, then monthly notices of failure to timely pay and demand for payment in full can and should continue during the period of delay - in order to combat any suggestion that Landlord will not strictly enforce its rights.

One final word of warning: at some point, the Landlord will need to get off the stump and act - or waive the default.

If you have thoughts, suggestions or questions on this topic, please post a comment below.
 

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As I've noted previously [link to due diligence topics], one big difference between the current commercial real estate melt down and the last big one (in the late 80s) is the amount or level of “structure” in the deals. Like the last time, the debtor\borrower side is “structured” (with a multi-tier borrower and perhaps even a “single purpose” entity); however, unlike the last time, the creditor\lender side also is structured.

A multi-creditor structure greatly complicates decisions covering a possible workout, the remedies to be invoked, and the management, leasing and eventual sale of the collateral (after foreclosure).

Indeed, co-lender disagreements are the most difficult part of this process.  (And one lesson learned is to NOT do co-lender deals in the future; or do them only with similar lenders having similar balance sheets, ownership, investment objectives and criteria, etc.)

Part of the difficulty flows from some confusion, or misunderstanding, on the part of all of us on the technical terms and attributes of the co-lender structure. Since the typical co-lender structure either is a syndication or a participation, I've identified some of the basic terms for those two structures:

• Nature of the creditor’s interest
• Recover of taxes & funding losses; gross up for reserves
• Common law rights
• Insolvency of originator/agent
• Legal opinions
• Assignments
• Enforcement actions
• Amendment (workout) rights
• Waiver rights
• REO decisions (management, leasing & sales)

To help you better understand the difference between (i) a loan that has been syndicated (typically where each lender has its own note and all lenders share the collateral) and (ii) a loan that has been participated (where there is a single, lead lender, and the other lenders only participate without their own notes), here is list of some of the major topics of interest.

(For postings on other co-lender topics, such as A\B Note structures and lender v lender litigation, search the site using the term "co-lender.") 

 (Click on "continue reading" for a table detailing differences on these terms)

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As I noted previously [link], the mid-term elections significantly limit the time period for Congress to pass a meaningful financial reform bill. The “window” for this closes in August – five months from now – when the fall election campaigns kick into high gear.

With this short-course in mind, the CMSA and other key industry groups (listed below) are peppering Congress with this message: restoring lending for commercial real estate, and the capital markets supporting this lending, are critical elements for the nation’s recovery from this great “recession.” AND action needs to be taken now.

Here are three examples (with a few comments by me) of action taken over a recent Thursday through Monday:

1. Thursday, Feb. 25 Letter: The organizations include those listed in a letter [download\link] sent on Thursday (Feb. 25) to Committee Chairman Chris Dodd and Ranking Member Richard Selby of the Senate Banking Committee. It is an impressive list:

American Hotel & Lodging Association

American Land Title Association

American Resort Development Association

Associated General Contractors of America

Building Owners and Managers Association International

CCIM Institute

Commercial Mortgage Securities Association

Institute of Real Estate Management

International Council of Shopping Centers

NAIOP, Commercial Real Estate Development Association

National Apartment Association

National Association of REALTORS®

National Association of Real Estate Investment Managers
National Multi Housing Council

Briefly, this letter argues that the “risk retention” requirements (also known as “skin in the game”) for CMBS 2.0 issuances need to allow a third party (known as the “B-piece” buyer) to hold that risk. 

Comment: one lesson learned from CMBS 1.0 that this third party will undergo greater financial scrutiny and underwriting by the initial investors, AND by potential buyers in the secondary trading market. And, I believe, investors will look for ways both to monitor the “skin in the game” party and to receiver better loan level information if\when a workout or default arises under a specific loan. Underwrite this third party? Sure. Better information from this third party? Bet on it.

2. Joint Panel Hearing on Friday, Feb. 26: The House Financial Services Committee (chaired by Barney Frank, D-Mass) and the House Small Business Committee (chaired by Nydia Velazquez, D-NY) held a hearing to discuss commercial real estate and issues facing small businesses.

Questions:

• How many people attended this hearing? (Hopefully more people than the handful who attended the Dec. 15 hearing on covered bonds.) [link to my two postings on that meeting]
•  What kind of media coverage did the Feb. 26 hearing generate? Was it “lost” in the health care debate and other issues?

3. Monday, March 1 position paper: The CMSA issued a paper titled “A Framework for a Sustainable Commercial Real Estate Recovery” [download\link]. This is a must read. The paper gives a succinct description of the current state of the CRE market, a listing of “unique” features of the CMBS product and market, and a framework for CRE recovery.

A few comments:

• There is no mention of CDOs [link] – thankfully.
• The paper states that one unique feature of CMBS is “most CBMS loans have 5- to10- year terms with 20- to 30-year amortization schedules.” Question: no mention of all of the interest only (“IO”) loans? What percentage of the loans currently in special servicing loans are IO loans? When people discuss implementing “standard underwriting” standards, are they really talking about banning IO loans?
• The paper states that the structure of CMBS allows investors the ability to gather detailed, loan level information; and that the information available to investors is “tremendous.” While this is the message in the front entry hall, the pillow talk in the bedroom between investors and special servicers is all about the need for MORE loan level information.  Greater loan level transparency is a late night topic certain to bubble up in the CMSA's new Investor Forum.
• The paper points to a recent European ruling that requires credit agencies to implement new ratings for certain US securitized products. Putting aside the merits of the argument, it is alarming that the investment community appears at odds with industry organizations on this basic issue – or at least the EU sees it differently. Can this get any more complicated? (Remember: the window slams shut in August.)
• Finally, I’m pleased to read that covered bonds remain on the list. Covered bonds [link] are a favorite topic of mine - as the best, long-term capital market product for commercial real estate.

If you have any questions or comments, or some observations of your own, please post a comment.

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Guest Writer, Laura P. Sims, Winstead PC

This is a special series of blog entries in which we provide quick answers to lenders' frequently asked questions related to tenant leases (FAQ).  Leases are "the" whole point of income producing property—and this series is pointed to the simple goal of helping you protect the basic value building block of your collateral—which are the leases. Of course, two things should be kept in mind. First, none of these questions can be answered in a vacuum. Questions should be considered with a thorough review of the file. And secondly, many of the questions are worth revisiting from time to time because subsequent events will impact the answers.

What kinds of default will support termination of the Lease or repossession of the premises?

Most Texas courts (and courts in other states as well) are reluctant to enforce a Landlord's right to terminate a lease or repossess a Tenant's premises in the absence of a specifically negotiated or egregious non-monetary default, if the Tenant is otherwise in compliance with the lease.

By contrast, even a relatively small monetary delinquency will be enforced per the plain language of the lease.

Accordingly, where the lease provides Landlord the right to cure non-monetary defaults and obtain reimbursement of such costs from Tenant as additional rent, it may be expedient for Landlord to exercise such right to cure, so that if and when Tenant fails to reimburse such costs, Landlord can proceed on a claim of monetary default.

However, at least in Texas, non-monetary defaults such as abandonment, voluntary bankruptcy, failure to pay utilities to third parties, and allowing the attachment of liens have provided a basis for exercise of Landlord's more aggressive remedies.

Furthermore, if the lease sets forth termination or repossession as the specific remedy for a given non-monetary failure (such that Landlord is not relying on "catch-all" non-monetary default language), a court is more likely to enforce the parties' negotiated remedy.

• For instance, where Landlord and Tenant have negotiated an obligation for Tenant to open for business by a certain, critical date, with a clearly stated and unique right of termination for failure to perform by such date, the declaration of default and exercise of such termination right should be enforced.
• Conversely, even where a lease requires Tenant to take occupancy or open for business by a date certain, if no specific remedy is stated for that failure, it is unlikely that a Texas court would allow Landlord to terminate the Tenant's lease for such failure, particularly if Tenant occupies the premises or opens for business within a short period following the originally required date.

As a general rule for evaluating the strength of non-monetary defaults as a basis for termination or repossession consider:

1. Whether the breach affects the negotiated bargain between the parties
2. Whether the harm to Landlord is commensurate with the loss a termination or repossession would cause the Tenant
3. And further consider obtaining the opinion of an experienced litigator or real estate attorney before making a final decision about pursuit of remedies

If you have thoughts, suggestions or questions on this topic, please post a comment below.
 

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Have you checked your boilerplate lately? There is no longer anything standard about the "standard" language in financial services contracts. Whether you are drafting or litigating origination documents, workouts or settlement agreements, you won’t want to miss this seminar (on Thursday, February 25, in our Dallas office)! Otherwise, you could be litigating in an unfriendly forum, fighting over representations made before the loan documents were signed, or find yourself without adequate remedies when the other side defaults. Learn how to minimize your risks and strengthen your position by effective negotiation and drafting.

The seminar brochure [download] is attached.  And here's a short version of the agenda and session topics:

• 11:30 - 12:15: registration and lunch
• arbitration clauses
• forum selection clauses; venue and choice of law provisions
• indemnity clauses
• remedy provisions
• jury waiver provisions
• merger clauses
• panel discussion: The View From 10,000 Feet (I'm "on" this panel.)
• 4:30 - 5:30p: reception

We know that these topics are "hot" ones - we're dealing with them as we handle distressed investments.

Our seminar speakers include a former Texas Supreme Court Judge, litigators currently handling CRE finance litigation, and workout lawyers.

Who should attend?  This seminar is for any professional who regularly negotiates, drafts or litigates financial services contracts, including in-house counsel, transactional lawyers, special assets and workout professionals and litigators. If you deal with contracts on the front end or after the fighting starts, this program is for you.

I know that this blog announcement is late; but since space is limited (and we're paying for the food at lunch and then drinks at the closing reception), we first offered this one to clients.

However, we have a limited number of "extra" spaces.  And you're invited.

If you'd like to attend, please send (ASAP) an e-mail with your contact information to:

• mlee@winstead.com

Directions to our offices, and parking instructions, are on the brochure.

If you're in Fort Worth\Dallas tomorrow, please consider coming.

I'll enjoy the opportunity to meet you.

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Yesterday, the Commercial Mortgage Securities Association (CMSA) submitted a comment letter [download] to the FDIC concerning the FDIC's 'Safe Harbor' rule [down load the FDIC's Advanced Notice of Proposed Rulemaking] covering the securitization of commercial real estate loans. 

Of course, the CMSA is not the only industry organization to comment on the FDIC's proposed rule.  For example, Housing Wire [link] describes comments to the proposed rule raised by the American Securitization Forum, the Mortgage Bankers Association and the Securities Industry and Financial Markets Association.

The FDIC's proposed rule is designed to isolate, from the failure of a bank, the underlying assets of securities held by the bank.  The treatment by the FDIC of assets transferred by a bank in connection with a securitization, and the subsequent failure of the bank, is an underlying building block for securitization - simply because investors will NOT buy CMBS bonds if the underlying loans may be stripped from the CMBS pool, if the bank that originated the loan goes into FDIC conservatorship or receivership.

Under the proposed new rule, the safe harbor would be amended to include numerous preconditions regarding a transaction’s capital structure, disclosure, documentation, origination and compensation.

I really don't have anything to "add" to the pointed comments made by these organizations .  If you want the "detail" on their perspectives, I've furnished you the links (above).  (They contain some very, very interesting points.)

My focus is on the following statement in the CMSA' e-mail announcing its comment letter:

"[The] CMSA suggests that the FDIC work in concert with Congress, the Obama Administration and the other agencies that are developing securitization reforms to ensure that FDIC's safe-harbor efforts do not lead to a regulatory framework of conflicting or overlapping requirements that may impede the restoration of functioning credit markets."

My read of the situation remains unchanged:

• unlike at the creation of the CMBS model in the early '90s, the financial crisis and the role of CMBS 2.0 in it is a political process - which means a large number of parties have a voice in the process
• the changes needed to restart the CMBS model (referred to as "CMBS 2.0") are not easy
• mid-term elections mean that Congress will NOT address this critical component of the credit crisis once the heavy campaigning begins (in August) . . .
• . . . which leads to the conclusion that in 2010, we will NOT see a return to a meaningful CMBS market.  In other words, no CMBS 2.0 for the small commercial real estate borrower.  Sure, single sponsor deals with the best DSC, LTV and other uber-credit criteria will be launched (good for Wall Street).  But a multiple borrower pool of small loans (help for Main Street)?  I say not in 2010.

I hope that I'm wrong.

If you view it differently, please comment below.

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Significant industry organizations and participants all agree that commercial real estate is heading into a very, very rough time period - and it will be lengthy.

In the past month I have blogged from the Commercial Mortgage Securities Association (CMSA) January Conference [link includes links to prior entries] and the Mortgage Bankers Association’s Commercial Real Estate Finance (MBA-CREF) Convention [link includes link to prior entry].

• My blog entries from the CMSA conference summarize the meeting content and the market perspectives of the capital market lenders (and the speakers selected by the CMSA).
• My blog entries from the MBA-CREF convention do the same, but with a focus on life insurance companies and their mortgage bankers.

While the perspectives from these major commercial mortgage lending organizations are interesting, they are one-sided: they focus on the credit side of commercial real estate.

it is interesting to contrast and compare them to a summary of the 2009 annual meeting of the Urban Land Institute [link to ULI home page].  The meeting was this past November in San Francisco.

In contrast to the CMSA and the MBA, the ULI has an owner, developer and user focus on commercial real estate - what I call the equity side of commercial real estate.

When we combine the credit-side perspective (from the CMSA & MBA-CREF meeting) with the equity-side perspective (from the ULI meeting), we get a much more complete picture.

The ULI summary (below) is part of an e-mail received by a friend, who forwarded it to me.

• Was the general tone, tenor or perspective of the ULI meeting different from the CMSA conference or the MBA-CREF convention?

The short answer: Yes and no.

• “Yes” in the sense that the ULI attendees and speakers agree on the major challenges in the commercial real estate market.
• “No” in the sense that the ULI meeting (based upon this summary) had a much, much tougher view on the future of the commercial real estate market.

Why the difference in their views?

• The equity side of commercial real estate (the ULI) lives on the development of commercial estate.  In contrast, the credit side of commercial real estate (the CMSA and the MBA) lives on stabilized, income producing properties.  While they both agree that development of new commercial real estate will be slow (or even non-existent) over the next 3-5 years, the fundamental focus of each side takes them onto two different paths from this common perspective: the credit side still has opportunity in financing the existing stock of commercial real estate; in contrast, the developer is forced to the side line with no work (other than perhaps finding opportunity in asset management. work).
• I know that this is not a popular idea, but I'll say it anyway: just like the residential sector, commercial real estate operated under the mantra of "other people's money" for the last 15 years.  The result was what I call "subprime commercial."  Now we're in the de-leveraging portion of the cycle.  Consequently, the equity side of commercial real estate goes on a severe diet (read: no development and a focus on asset management); and the credit side focuses on "real people with real money" and tends its distressed portfolio.

Here is the ULI meeting summary (emphasis added by me), which includes wonderful detail on specific CRE niches and challenges.  Click on the "continue reading" link below . . . .

It is very, very interesting.

If you have any comments, questions or observations, please add them below.

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Guest Writer, Laura P. Sims, Winstead PC

This is a special series of blog entries in which we provide quick answers to lenders' frequently asked questions related to tenant leases (FAQ).  Leases are "the" whole point of income producing property—and this series is pointed to the simple goal of helping you protect the basic value building block of your collateral—which are the leases.  Of course, two things should be kept in mind. First, none of these questions can be answered in a vacuum.  Questions should be considered with a thorough review of the file.  And secondly, many of the questions are worth revisiting from time to time because subsequent events will impact the answers.

FAQ - Is Landlord required to give notice of all defaults at the same time?

No.

Where multiple defaults exist, some discretion may be used in listing the individual failures, with clear emphasis on monetary defaults and material non-monetary defaults.

A default and demand letter that identifies

• defaults of a . . .
• nature and materiality that would support termination of the lease, or the exercise of rights of repossession if not cured, should suffice . . .
• so long as suitable language (which has been either developed or reviewed by counsel) is also included in the letter to reserve any and all Landlord rights with respect to other defaults, known or unknown, and to disclaim any intent to waive any such defaults.

The third bullet point is very, very important.

If you have thoughts, suggestions or questions on this topic, please post a comment below.

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On Thursday, Feb. 11, the Congressional Oversight Panel issued its report (dated Feb. 10) addressing "commercial real estate losses and the risk of financial stability."  The report highlights the possibility of commercial mortgage failures over the next four years, with the potential to cause banks to lose as much as $300 billion.  (Now that is big - but are you really surprised?)

The Panel is responsible for overseeing Treasury's TARP program and reporting to Congress with the results.

The report is long (189 pages) (download it here).  And it is scholarly,

I have not thoroughly digested the entire report; however, I offer up these highlights and observations (both from the report and from other sources):

•  The New York Times begins its summary of the report this way: "A huge wave of mortgage failures on commercial real estate could hit next year, causing banks to lose as much as $300 billion, imperiling lending for small businesses and hindering the economic recovery, a Congressional panel is warning."   (Right.  We know this. In fact, I'd put the number much, much higher given all of the "maturity defaults" on the 3-4 year horizon.)
• If you want to read the "best" or most relevant portion of the report, read Section One, Part G.  It focuses on regulatory, accounting and workout issues.
• The report asks policy makers, bankers and servicers to honestly evaluate "the components of the crisis and to try to moderate them" (p. 103).  It then notes that while non-viable banks (due to the poor quality of their commercial real estate loans) should not be allowed to operate, it does not mean that banks "that engaged in relatively prudent lending, but were undercut by the depth of the recession," should be closed (p. 103).
• The Panel notes that "not all banks should be treated the same way" and that there are "reasons not to force all potential losses to be recognized immediately' (p. 102).
• The executive summary of the report (p. 3) concludes with this charge: "The Panel believes that Treasury and bank supervisors must address forthrightly and transparently the threats facing the commercial real estate markets. The coming trouble in commercial real estate could pose painful problems for the communities, small businesses, and American families already struggling to make ends meet in today's exceptionally difficult
  economy."  (Right.  But it'll take more than a 189 page report to pull this topic to the top portion of the political agenda.)
• Against this backdrop, the New York Times highlights the political in-fighting between the Panel and Treasury: "The panel’s chairwoman, Elizabeth Warren, has been pressing the Treasury to compel thousands of banks to undergo stress tests like the ones that the Federal Reserve required of 19 of the country’s biggest financial institutions early last year. The Treasury secretary, Timothy F. Geithner, has called that idea impractical."
• And of course, Treasury and the FDIC have been squabbling on various financial reform issues.  And did you note that even the U.S. Comptroller of the Currency has weighed in, warning that some of the proposed rules will hamper a healthy secruitization market [link]?

So, where does my quick read take me?

• "Extend and pretend" will continue in order to avoid loss recognition for the (relatively) better banks.
• This report is a must read - just like the October 31 regulatory announcement [link to prudent peace pipe blog posting].
• Of course, will these broad philosophical approaches be implemented at the bank examiner level? (At the recent CMSA January conference [link], FDIC Chairman Sheila Bair answered "YES" - the examiners are being instructed to implement the Oct. 31 announcement.
• The FDIC will continue to take down 4-8 banks every Friday.  (Nibble, nibble, nibble - but for good reason: could the consumer really stomach a CRE debacle?.)
• The commercial mortgage problem is attempting to claw up on the political agenda pecking order (fighting health care, Federal deficit, taxes, etc.)
• Regardless of the relative order of importance or priority, it appears that the problem now is a political problem - and  . . .
• A complicated problem thus becomes all the more challenging given all of the industry and political players clamoring to be part of the solution (or the TV sound bite).  Some of these players are promoting a different cause entirely.  So, the podium is crowded with clashing perspectives: Congress (which has many voices); in-fighting within the Administration (FDIC v. Treasury v. Comptroller v. ______ [your pick]); industry groups such as the Real Estate Roundtable, the MBA and the CMSA; and a host of others promoting other (worthy) causes and agendas. 

I do not have an answer for the pointed "where is" all of this going.

Only an observation: this is democracy at work.

It is noisy.

It is messy.

And we know that, when compared to other forms of governance, it works.

But there is no promise that it will be painless.

Painless was the "old economy."

If you have any comments or musings of your own, please post them below.

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