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

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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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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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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(This is the last in a series covering the MBA-CREF convention.  In contrast to the first two days [link Day 1] [link Day 2] and our convention "preview" [link], this last posting focuses on the two polar extremes of the convention, and the industry.)

For Chris Nixon [link to bio] and myself, day 3 of the MBA-CREF convention (yesterday, Weds.) was filled with meetings with significant industry players from two distinct groups: special servicing and life insurance companies.

We listened for the answer to one specific question from each group, which for us (and perhaps for you) is “the” question.

• Special servicing: what tips or advice can you give a borrower in 2010?
• Life insurance company: will your loan allocations differ from your 2009 performance? (Read: will we see any “improvement” over 2009?)

Here is our summary of the answers given to us.

Special Servicing Tips

Not surprisingly, the tips were very similar to those articulated at the recent CMSA January Conference [link to 2nd day posting].    However, we heard enough “new” or different answers to craft an expanded list of tips.

True, the answers vary depending upon the particular servicer, the project, the carveout sponsor, the tenants, etc.

But putting it all together, here are the tips:

Do This:

• be nice
• send all information in; be open and transparent
• sign a pre-negotiations agreement
• keep paying cash flow
• have a reasonable, cogent plan BEFORE you contact the lender or servicer (show us that you are in a good city\market, with good tenants, good DSC, etc.) 
• show up with $ (to right size the loan) when you ask for a debt restructure
• default with dignity (i.e., have a "real" default and then be truthful)

Do NOT Do This:

• tell lender or servicer that you're "partners"
• show up with a sham balance sheet
• stiff or abuse your other lenders and the expect us to expect otherwise
• tell lender or servicer that you're a good borrower
• "fish" for information or for terms of a plan that will be acceptable
• cry
• hold lender or servicer hostage
• ask for any of the cash flow (nor a cash flow mortgage)
• fly in on a private jet
• offer a bribe
• rob Peter to pay Paul
• launch off on a religious sermon (caveat: "the special servicer knows that it is going to Hell – every day is Hell")
• ask for any return on the new equity infusion made in borrower 

(For our other postings on CMBS special servicing, use the “search” function on the right side – and search terms such as “special servicing.’)

Life Company Loan Allocations for 2010 (& comparison to 2009)

The message generally was consistent from all our life insurance company contacts:

• in 2009, roughly 30%-45% of the allocation was utilized to refinance the “best” loans\relationships in the portfolio
• in 2009, not all of the allocation was utilized . . .
• but since corporate spread have dramatically dropped in the last 6 months, mortgages are a relative good investment; so . . . 
• there is hope that the mortgage allocation will be fully funded in 2010 . . .
• however, probably the same percentage of the allocation (30%-45%) will be utilized to refinance the “best” loans\relationships in the portfolio . . .
• and, the allocation amount is not near the level seen during recent years
• the limited funds available for new loans will target the narrow bandwidth of the best projects and sponsors (high Debt Service Coverage or DSC; good Loan to Value or LTV; good balance sheet of the sponsor; good tenants; good market position; etc.)
• since large loans to single-sponsor borrowers (and not multiple loans to different sponsors) typically fit this narrow bandwidth, 2010 could be the year of the large loan for many life insurance companies

Add all of this up, and it is clear that with a muted allocation amount and the commitment to utilize a significant part of it to refinance the current portfolio, the total amount of credit available for 2010 from life companies is small (relative to demand). 

The story here reminds me of the message from the CMSA January Conference: the recent CMBS issuances are good news for Wall Street but “no” news (i.e., no help) for Main Street.

The same should be said of the Life Insurance Company mortgage loan allocations: it sounds good, but really?

So, the message from both the CMBS Conference and the MBA-CREF Convention sync very nicely. (As predicted in my earlier posting?) [link]

If the mantra during the ‘90s and ‘00s was “other people’s money” (or “commercial subprime”), the mantra for the new economy is “show me the hard equity” (or “real money for real people”).

Yes, we’re returning to real estate fundamentals.

And since a large percentage of CRE is over-leveraged (a condition that I call "subprime commercial"), we circle back to the tips on special servicing . . .

If you see it differently, or have something to add, please post a comment below.

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 One take-away for me from the second day of the convention is this: while the three different perspectives (below) point to 2010 being a better or different year than 2009, it will be far from “normal” (when compared to 1994-2004).

The Mortgage Banker: relieved

The general sense or mood of the mortgage bankers is that 2010 will be much, much, better than the train wreck of 2009 – a year of almost no new financings closed. Finally, some mortgage production. And a sense that “we made it.” And thankful for the possibility of having some meaningful work.

The Life Company Lender: guarded

On the other hand, the message from the life company lenders is that since corporate spreads are so low (when compared to the spreads of a year ago), they will be lending this year.  Their target, however, is the best borrowers and on the best property (with great DSC, LTV, etc.). And they admit that some percentage of their 2010 loan origination will be devoted to refinancing (extending) loans currently in their portfolio.

The MBA Staffer: focused on the Hill

The MBA is focused on better serving its members, as evidenced by a reorganization of its committees into various “councils” centered on its membership. But more importantly, it is focused on the US Congress and the Obama Administration.

It seems that the discussion in almost every panel returns to public policy, or financial reform.

Take a look at the MBA’s 2010 public policy priorities:

• Financial crisis responsibility fee
• Risk retention (“CMBS 2.0”)
• REMIC rule reform (“CMBS 2.0”)
• Rating agency reform (“CMBS 2.0”)
• Risk-based capital for CMBS under FAS 166 & 167 ("CMBS 2.0")
• TALF CMBS extension
• FDIC legacy loan program
• GSE restructuring (the “new” Freddie & Fannie Mae)
• FHA modernization
• FHA multi-family loan limits
• Low Income Housing Tax Credit
• Funding for rental assistance
• Life Insurance Company risk-based capital
• Covered Bonds
• Carried interest

NOT a short list!

The “real” focus on the MBA is as it should be – on the Hill. Unfortunately, the mid-term Congressional elections effectively will inhibit the passage of new legislation starting this August. So, the window for addressing these priorities is quickly closing.

The next time you hear the phrase “financial reform,” think of this long list – and the August finish line.

My Bottom Line: low expectations

No doubt, a lasting recovery for the credit market will hinge on jobs and consumer confidence.

However, just looking at the long, long, long list of public policy priorities tells me that we are a couple of years away from returning to the new “normal” – effectuating changes like this will take time. My prediction is that only a few items on this list will be realized in 2010.

Seriously, does that look like a “quick fix” list to you?

If you have any questions or comments, or your own perspective, please post a comment.

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Unlike the CMSA January Conference (where the primary focus is on addressing substantive issues) [link], the MBA-CREF convention has a primary focus on relationships: mortgage bankers meet with lenders; and lenders meet with mortgage bankers.

However, the MBA does offer some very interesting Committee and Council meetings, where substantive issues are discussed.

But make no mistake about this: the focus is on the meetings.

Any way, here are my notes from two committee and council meetings that I found particularly interesting today: the Public Policy Committee; and the Investor & Originator Council.

As a general proposition, the general "atmosphere" is much, much more optimistic than the atmosphere at the CMSA January Conference.

Maybe the credit markets have radically changed in two weeks.  (Or not.)

Public Policy Committee

• Legislative climate: bad. "Hostile environment" for lenders.  Lenders are "demonized" by the administration. No one wants to help Financial Services sector. With this background, here are MBA priorities: financial reform (big issue for CRE: risk retention provision - skin in the game; MBA try exempt multi-family & CRE); FHA role & mission (housing finance system); future of Freddie & Fannie (altho only briefly mentioned in comments to the proposed budget). Revenue raising tax issues are important to the Administration.
• Financial reform: House bill passed. Action now in the Senate. Bi-partisan working groups at work in Senate since November. Senator Dodd is not under political pressure due to his announcement that he will not run for re-election. Risk retention is focus of MBA. Calendar constrained because no hope for bills after August (due to mid-term elections). Plus other regulator reform happening, such as the "Voelker bill" (which will severely restrict the activities of banks).
• Need specifics on Administration's proposal to fund $30bill for community banks
• The MBA has a long, long list of regulatory and legislative items
• GSE: part of restructure of housing finance system; no "hard" direction from administration; the unlimited funding of Freddie & Fannie (per the Dec 10 announcement) will not continue forever
• MBA will formally oppose the fee on regulated institutions (but caveat: no one loves bankers)

Investor & Originator Council

At the beginning of this meeting, the MBA's economist (Jamie Woodwell) discussed the MBA's 4thQ data (to be released on Tuesday, 2/2); CRE loan originations up 12% on average; caution - comparing to a low level (in 2008); CRE originations still at low volume; maturity volume survey - 13% of non-bank will mature in '10 and 7% in '11 (highest product is variable rate CMBS); all to be on MBA's website.

Next, a panel of speakers gave their perspectives on the following:

• Buzz in market - things are getting better; what is your origination prediction for '10? Life Cos have almost normal funds (and spreads a good relative to corp bonds), but conservative underwriting will limit production volume; wild card is employment numbers
• Trends in last 90 days: sentiment in market is improved, w/ people wanting to invest; but challenged by worsening CRE fundamentals; tale of two cities (intense competition for best deals and no $ for bad deals); several big banks have approval to take loan applications for multi-borrower loans for CMBS pools (but same challenge - the same tale of two cities); strong investor demand for GSE bonds (a lot of capital looking for a home); need to see job growth in order for lenders to believe rents have stabilize
• Risk of double dip in '11: due to foreclosed properties hitting the market; at same time, some properties will attract investors if in good location or unique replacement cost (high quality asset); one panel member did not believe in "double dip" theory; good, performing loans are being sold at close/at par
• Will rising employment save the "kick the can" lenders? Banks need to see an accruing loan, and thus A/B note structures will be attractive; but this will take time to implement
• Rush to fix CRE is not the best strategy; lenders are taking the right approach in extending & restructuring (charge off the new B Note); average loss on foreclosure is 2x loss following smart restructure (if B motivated & doing the right thing, and a performing loan will be in place); however, this approach will affect price uncertainty; but lenders will foreclose (if B can not cure a $ default) and are motivated to sell REO
• Risk Based Capital for life insurance companies: regulators have given concessions and are working for a long-term solution
• FDIC: maybe considering keeping assets and working them out - as opposed to taking the "RTC" approach (from the late '80s)

This is a very different crowd, with a much more optimistic attitude, than the attendees at the CMSA January Conference.

If you have any comments, please post them below.

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Standard & Poors is having a half day "Leverage Credit and Recovery Conference" on February 25 in NYC.  In S&P's announcement of the conference, they summarize their 2010 outlook for leveraged credit: 

It is Standard & Poor's view that, at the outset of 2010, speculative grade corporate credits present a mixed picture. Although market prices for both bonds and loans have recovered from their record lows at the end of 2008 and beginning of 2009, we believe that credit risk remains a challenge. Borrowers face ongoing refinancing requirements and continue to concentrate at the lower end of the rating distribution at 'B' and 'CCC'. Ongoing growth in topline revenues and cash flow required for debt service remain elusive for many borrowers.
 

S&P definitely has at best a "guarded" outlook for corporate credit in 2010.

As to commercial mortgages, Chris Nixon and I are in Las Vegas for the Mortgage Bankers Association - Commercial Real Estate Finance convention. [link to conference book] 

We'll see if the MBA has the same view of the CRE Capital Markets as we heard at the CMSA January Conference.  [link to our 2nd day posting]

This I know already: our life insurance company contacts and mortgage banker contacts are sending fewer people to this event than last year, and have planned fewer, and much more "muted" parties and events.

Stay tuned over the next few days for our reports from Vegas.

If you have a particular comment, or question, for us to investigate as we attend the MBA-CREF conference, please post a comment.

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Each year, several of us write a news alert covering the "hot" legal topics for commercial real estate finance, with a focus on the prior year.  Here's the news alert we did for 2004 [download it]

Wow, reading this old piece is a slap on the face.

What a mistake on our part.

The "story" is NOT what we (lawyers) think it is.  Our thoughts might be good guesses; but they remain guesses.

As I wrote for you here at ToughTimes during the last 16 months, I've learned that you will show me the topics that interest you the most. 

Sure, you won't show me by posting in the "comment" box below.  Instead, you'll vote by reading what interests you.

So, the list below is your story for 2009.  These are the blog posts that were most highly read by followers of Tough Times in 2009.

It is a very interesting story.

TOP 10 TOPICS AT TOUGHTIMES:

(Links to the posting are furnished - but be sure to "click" on links to earlier posts in a series.)

#1 New Federal Foreclosure Law Gives Residential Tenants 90 Days to Vacate (link)

#2 Lender Liability Returns: Sample Cases and Situations (link)

#3 Lender’s Top Frequently Asked Questions (link)

#4 Key Differences Between CMBS Loans & Portfolio Loans in the Loan Default Scenario (link)

#5 Uncertain Waters: Scorecard on the CMBS Market (link)

#6 Evaluating Material Adverse Change (MAC) Clauses in the Loan Default Context (link)

#7 Steering Through CMBS Waters: A Primer for Troubled Loans (link)

#8 SARE Cases Causing Big Stir in Bankruptcy Courts (link)

#9 Ticking Sound: Review Your Title Insurance - A Quick Checklist (link)

#10 More on That Ticking Sound: Don’t Forget to Obtain or Verify Insurance Coverage (link)

If clicking these links is just too much for you, here is a PDF collecting all of these blog posts - and bundled as our "2009 Year in Review." [download]

Lesson learned: it is about YOU.

If you have a favorite posting, please tell us about it below.

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Commentators note that one great attribute of the Internet, and the communities formed within and around it, is this: when someone wanders off (or climbs on a ledge), the community does a good job of nudging each other back to the group.

Yes, I was a little disappointed (OK, even upset) at the lack of focus by the CMSA on covered bonds at the January conference (see my comment regarding the session called "Lessons From CMBS 1.0").

However, my friends at the Covered Bond Investor (link) correctly note that the Mortgage Bankers Association lists covered bonds as part of "legislation among the organization's legislative and regulatory priorities for 2010."  (posting on the MBA list)

My sense, however, is that covered bonds will NOT be a near-term reality. 

But thank you, Covered Bond Investor, for talking me off the ledge.

If you have an interest in covered bonds, visit the Covered Bond Investor.

And if you have any questions or comments for me, please post them below. 

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As noted in my lengthy postings summarizing the recent 2010 CMSA January Conference in DC [Day 1 link; Day 2 link], over 1,000 commercial real estate professionals attended the conference – roughly 2X more than expected.

Why this unexpected attendance? Answer: All of us are looking for answers amidst the continuing liquidity problems in the CRE Capital Markets. This topic was the sole focus at this conference.  (And it even shows in the number of people "visiting" TTL blog since the Tuesday [Day 1] posting: we show over 1,000 total "hits", of which over 550 are "unique", as of this blog posting.)

 I've received feedback asking for a summary covering a specified set of topics from the two (much, much longer) blogs covering days 1 and 2.  (Keep that feedback coming!)

So, here is that subset of information from the 2010 CMSA January Conference:

INVESTORS FORUM

This forum is for a broad band of CRE debt investors (such as B note holders, mezzanine lenders).

The meeting time was devoted to a survey of the 250+ people in the room. Here are some of the responses: 

• 45% of the voters believe that CRE values will continue to fall in 2010 with no recovery in CRE values until 2011 (this fall is in addition to the 44% fall from 2007 CRE pricing)
• with respect to the 2005-2008 CMBS pools, 37% of the voters believe that the average losses will be in the 11%-15% range (these loses will wipe out bond holder through the "AJ" class)
• 43% of the voters believe that for CMBS loans liquidated in 2010, the average loss severity will be 40%-50% (and 27% believe that the average loss severity will be 50%-60%)
• 69% of the voters believe that annual new CMBS issuances will not exceed $100B until 2013
• for new CMBS issuances in 2010: 50% of the voters believe that issuances will be single borrower transactions; and 33% of the voters believe that issuances will be multi-borrower and large loan structures (with only a few assets); and
• 58% of the voters believe that "old-school" multi-borrower, fixed rate deals will return no sooner than 2012 (or later)

REAL ESTATE FUNDAMENTALS: "THE FACTS OF LIFE"

If the focus on "CMBS 2.0" (which is the "hot" phrase used to describe the "new" CMBS model and market) is a bit too out of touch for me, this session just hammered on the current picture of the CRE market:

• unemployment at historical highs (and still rising)
• retail sales still stumbling
• consumer confidence falling
• "asking" commercial rents falling
• commercial leasing activity (absorption) falling
• CRE sales activity: stagnant
• CRE values -43% from the high in 2007
• huge amount of CRE loan maturities over the next three years, with inadequate sources of credit to pay-off those maturities
• huge shortfall in CRE equity (such that it will not fill gap between the credit available and the looming CRE maturities)
• over 75 funds have been formed to buy distressed CRE debt and properties; but little it has been deployed
• very little CRE has been "re-priced" or "re-set" by lenders or servicers foreclosing or disposing of assets
• we're still early in the CRE recover (perhaps only 25% into the process!) (One interesting comment: remember that valuation adjustment occurs early in the CRE recovery process; so we might be 75%-90% into the valuation adjustment process.)
• importantly: no one on the panel, nor else where in the room, foresees an implementation by the Government of an "RTC style" approach (where the Federal government quickly closes large numbers of banks and thrifts, and then quickly sells the loans and assets at steep discounts – resulting in a "harsh pain" but quick re-pricing of CRE
• unlike the late 80s & early 90s: this time there is no new industry (such at technology) to lead the recovery by increasing employment

BORROWER PANEL: "SURVIVOR"

This panel focused on "how" a borrower could make it through until CRE liquidity returns.

The panel has some advice for borrowers:

• show up with $ if you want to restructure your debt
• if you're in a good city, with good tenants and with DSC (get it?
• Use $ to right-size the loan), then you'll probably survive

It was interesting that while reference was made to splitting up a CMBS loan into an A Note (with good DSC & LTV) and a B Note (representing the "bad" part of the original loan), no one gave any details on the structure (such as the terms of the B Note, the proceeds waterfall between the lender [under the B Note] and the "new" equity [that injected capital needed, in part, to right-size the Note A], the rate of return on the new equity, etc.)

SURVEILLANCE & WORKOUTS: "LET'S MAKE A DEAL'

This panel didn't give any real guidance on terms of workouts, other than to list some basic rules of the game:

Do This:

• be nice
• send all information in; be open and transparent
• sign a pre-negotiations agreement
• keep paying cash flow
• have a reasonable, cogent plan BEFORE you contact the lender or servicer

Do NOT Do This:

• tell lender or servicer that you're "partners"
• tell lender or servicer that you're a good borrower
• "fish" for information or for terms of a plan that will be acceptable
• cry
• hold lender or servicer hostage
• ask for any of the cash flow (nor a cash flow mortgage)
• fly in on a private jet
• offer a bribe
• rob Peter to pay Paul
• launch off on a religious sermon (caveat: "the special servicer knows that it is going to Hell – every day is Hell")
• ask for any return on the new equity infusion made in borrower

It was an interesting day. Much like our experience in Munich – very little clapping at the end of any session (yes, it reminded me a little of the sessions at the EU conference that we attended in October 2008) [link]

In a future posting, I'll cover comments made to us by several elected and appointed Federal officials.

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

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(When we attend industry conferences, we bring you along by blogging on topics of interest to us, with our comments as a bonus. This is the second in a series of posting relating to, and from, the 2010 CMSA January Conference. [Link to Day 1] Our blogs on other conferences are found [i] under the "Market Trends" category in the archives on the right side of the page, or [ii] by a word or phrase search on the right side of the page [suggested search terms: looking glass; scorecard; pond].)

Technology Tip: darn, this American Airlines flight does NOT have GoGo Inflight Wi-Fi. I hate this. So, I'm forced to type this in Word, and then post it tomorrow morning from home. 

However, here's a tip on "how" I organize all of my passwords and PINs, including my password for GoGo:

- create a separate Contact card in Outlook for each website, frequent flyer\use membership, etc.; include the applicable website on the card

- be sure to password "protect" your phone\PDA (tip: use a password combination that you can enter with one hand, so that you can leave your other hand free)

Now, on to Day 2 . . .

Day 2 is the last day of the conference. It has a different feel than day one, in part because the crowd is significantly larger.

I've been told that when the CMSA planned this 2010 event, they anticipated @ 500 people would register for the conference. Whether is was the pain of an uneventful 2009 (read: no CRE money for no one), or simply wanting to be told that 2010 would be better (read: CRE money for someone . . . please), today it felt like every one of the registered 1,000 attendees crowded into the basement ballroom floor of the JW Marriott Hotel.

Yes, we're literally all "in this cramped CRE space together."

Today the program focused on different points of the CRE space, with appearances and comments by two members of the US House and by the Chairman of the FDIC. This posting will summarize the substantive items.

The comments by the elected and appointed officials will be included in a post later this week (or this weekend - I have to get caught up at "real" work).

Here are the highlights (with some commentary, of course) from the last session on Day 1 and several Sessions from Day 2.

LESSONS FROM CMBS 1.0: "THE WONDER YEARS"

Frankly, calling the "old" CMBS market\model "1.0" and then labeling the soon-to-come, "rejuvenated" CMBS market\model "2.0" strikes me as being very, very hopeful. From my perspective, CMBS 2.0 better be strikingly different and improved over CMBS 1.0. (Indeed, why are we so married to the CMBS model? As an Air Force brat, it strikes me as if we're focusing on making the bi-plane better.) And CMBS 2.0 better arrive quickly and with billions of Dollars. (Warning: 2.0 is no "CMBSuperman.")

Time will tell, of course.

But if the comments at this conference are correct:

• CMBS 2.0 will not arrive quickly
• 2.0 will not be the "proceeds party" that characterized CMBS 1.0, and
• 2.0 will not come close to bringing the liquidity needed to refi the huge amount of near-term loan maturities.

One panelist gave a very good description of the collateral damage to the CRE finance market caused by pushing CMBS 1.0 to the limits:

• Wall Street's intervention (or commodization) of CRE finance brought an incredible amount of liquidity to CRE
• Utilizing the CDO structure in the CRE space was a logical, yet terribly short-sighted mistake in that it effectively separated (or "de-linked" the unique credit risk inherent in CRE from the investment decision
• The liquidity party quickly spread across the CRE finance spectrum
• Wall Street underwriting, downward rate pressure, increase in proceeds and complicated credit "stack" structures quickly captured a significant share of credit extended to improved CRE, and in doing so, forced regional and community banks to change the focus of their CRE lending away from income producing CRE and into construction loans, builder lines of credit, land development loans and raw land loans.
• CMBS 1.0 was characterized by: (1) no future exposure by the loan originator and too many loan originators placed loans with other people's money (Comment: I call this the "merchant lender" mentality – 'if you lend it, someone will buy it'); (2) it did NOT adequately address the current "shut down" scenario (for example, the investment grade investor is given too little "control").
• Some of the lessons learned from CMBS 1.0, and perhaps early characteristics of CMBS 2.0:
  • the B-piece needs to be larger (for meaningful "skin in the game") or even structured out of the deal by having a mezzanine strips in place of a B-piece (the Inland Retail deal is an example of this);
  • the special servicer needs to be independent, or some other mechanism put in place to give the investment grade investor some assurance of impartiality by the special servicer, or the ability to have meaningful input on special servicer decisions;
  • limit the number of investment classes (for example, the DDR, Flagler & Inland Retail issuances in late '09 only have a handful of bond holder classes);
  • single purpose entity (SPE) changes in response to the GGP case; and
  • FINALLY, someone mentioned covered bonds [link to prior posting on covered bonds] – I find it very, very interesting that this comment was quickly brushed aside, as if the covered bond product was irrelevant. (So, if it is irrelevant, then "why" did a former President of the CMSA testify on the Hill in support of the product? Is the CMSA simply focusing on the near term revival of the CMBS market?  What about a long-term fix or better model?)

REAL ESTATE FUNDAMENTALS: "THE FACTS OF LIFE"

If the focus on 2.0 is a bit too out of touch for me, this session just hammered on the current picture of the CRE market:

• unemployment at historical highs (and still rising)
• retail sales still stumbling
• consumer confidence falling
• "asking" commercial rents falling
• commercial leasing activity (absorption) falling
• CRE sales activity: stagnant
• CRE values -43% from the high in 2007
• huge amount of CRE loan maturities over the next three years, with inadequate sources of credit to pay-off those maturities
• huge shortfall in CRE equity (such that it will not fill gap between the credit available and the looming CRE maturities)
• over 75 funds have been formed to buy distressed CRE debt and properties; but little it has been deployed
• very little CRE has been "re-priced" or "re-set" by lenders or servicers foreclosing or disposing of assets
• we're still early in the CRE recover (perhaps only 25% into the process!) (One interesting comment: remember that valuation adjustment occurs early in the CRE recovery process; so we might be 75%-90% into the valuation adjustment process.)
• importantly: no one on the panel, nor else where in the room, foresees an implementation by the Government of an "RTC style" approach (where the Federal government quickly closes large numbers of banks and thrifts, and then quickly sells the loans and assets at steep discounts – resulting in a "harsh pain" but quick re-pricing of CRE
• unlike the late 80s & early 90s: this time there is no new industry (such at technology) to lead the recovery by increasing employment

The audience was very quiet during this session.

BORROWER PANEL: "SURVIVOR"

This panel focused on "how" a borrower could make it through until CRE liquidity returns.

The panel has some advice for borrowers:

• show up with $ if you want to restructure your debt
• if you're in a good city, with good tenants and with DSC (get it?
• Use $ to right-size the loan), then you'll probably survive

It was interesting that while reference was made to splitting up a CMBS loan into an A Note (with good DSC & LTV) and a B Note (representing the "bad" part of the original loan), no one gave any details on the structure (such as the terms of the B Note, the proceeds waterfall between the lender [under the B Note] and the "new" equity [that injected capital needed, in part, to right-size the Note A], the rate of return on the new equity, etc.)

SURVEILLANCE & WORKOUTS: "LET'S MAKE A DEAL'

This panel didn't give any real guidance on terms of workouts, other than to list some basic rules of the game:

Do This:

• be nice
• send all information in; be open and transparent
• sign a pre-negotiations agreement
• keep paying cash flow
• have a reasonable, cogent plan BEFORE you contact the lender or servicer

Do NOT Do This:

• tell lender or servicer that you're "partners"
• tell lender or servicer that you're a good borrower
• "fish" for information or for terms of a plan that will be acceptable
• cry
• hold lender or servicer hostage
• ask for any of the cash flow (nor a cash flow mortgage)
• fly in on a private jet
• offer a bribe
• rob Peter to pay Paul
• launch off on a religious sermon (caveat: "the special servicer knows that it is going to Hell – every day is Hell")
• ask for any return on the new equity infusion made in borrower

It was an interesting day. Much like our experience in Munich – very little clapping at the end of any session (yes, it reminded me a little of the sessions at the EU conference that we attended in October 2008) [link]

In a future posting, I'll cover comments made to us by several elected and appointed Federal officials.

If you have any questions or comments, please post your comment below.

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(When we attend industry conferences, we bring you along by blogging on topics of interest to us, with our comments of course. This is the second in a series of posting relating to, and from, the 2010 CMSA January Conference. [Link to first posting] Our blogs on other conferences are found [i] under the "Market Trends" category in the archives on the right side of the page, or [ii] by a word or phrase search on the right side of the page [suggested search terms: looking glass; scorecard; pond].)

It has been a very interesting day. The first session started at 11a and ended at 5:30p. As you'll note below, the sessions covered a wide range of topics: from "how" investors may find loan level information to an update on financial reform from a US Senator.

Here are the highlights (with some commentary, of course).

CMSA INVESTOR REPORTING PACKAGE ("IRP") COMMITTEE

This committee works on the reporting package furnished by loan servicers to CMBS bond holders. With the onset of this horrible CRE market, the bond holders have been complaining that the loan servicers are NOT giving them sufficient loan level information in the IRP. The IRP Committee is tasked to work on establishing best standards for the IRP. Consequently, it is an important committee, but appears to be stuck between the bond holders (who demand more information in the IRP) and the loan servicers (who anticipate changes in the CMBS model, and do not want to incur the costs of implementing new IRP content).  Hopefully, in the near future, the CMSA's new "Forums" will give them much needed guidance for this important work.

With this background, here are the high lights of the IRP Committee meeting: 

• the Committee has a working draft of an "Introductory Guide to the CMSA Investor Reporting Package (CMSA IRP), which will be posted on the CMSA website in the next 3-4 weeks. This guide is intended to help bond holders locate information. (Comment: It should be helpful. However, bond holders are seeking information outside of the scope of the IRP.)
• the Committee is working on standards for disclosing indebtedness of borrower or of its owners (other than the first lien mortgage created for the benefit of the CMBS pool).
• the Committee is forming a task force to indentify information required to be part of the IRP (pursuant to the typical Pooling and Servicing Agreement) but currently is NOT part of the IRP (Comment: if you're a bond holder wanting more loan level information, then I suggest that you contact the CMSA and join this task force).

Note that the Committee appears to be on a brief hiatus, as it takes a pause pending guidance from the two member "Forums" described below.

NEW "FORUMS"

In order to facilitate better communication within the CMSA between the various business interests, the CMSA is creating "forums." The Forums are intended to educate Forum members on topics important to the Forum, and also to advocate for the particular business interest within the CMSA, the larger industry and the larger political process. (Comment: this is a very, very wise move by the CMSA. It should avoid what some call "tranche warfare," which is where the senior bond holders assert that the special servicer is NOT taking action for the benefit of ALL classes of bond holders.)

INVESTMENT GRADE BOND HOLDERS FORUM

Three examples were given of "where" the investment grade bond holder would benefit from a "forum" process that would focus on the following –

• New investor-friendly practices for newly created CMBS issuances, such as these: out of money interest accrual should not prime principal; special servicing decisions must employ market rates of return; change of control should be based on realized losses plus appraisal reduction amounts; and much better loan-level disclosure can be delivered and are needed.
• Loan resolution practices by special services, such as these: loan resolution policies and servicer reporting procedures that are in the best interest of investment grade bond holders (such as data transfers); what are special services doing, and why; and how can loan resolution practices of investment grade bond holders be implemented for legacy CMBS (Comment: one special servicer noted that his company has extended over 97% of all loan maturities. Thus, creating what he called an "extension pile-up.")
• Selling REO with financing from the REMIC Trust, such as these: special servicers and the Real Estate Roundtable are advocating this before the US Treasury, without input by the investment grade bond holder; and could this change existing pooling and servicing agreements

SERVICERS FORUM

The following was articulated as challenges facing CMBS loan servicers: 

• Change from high growth (legacy CMBS model) to shrinking portfolios (in the absence of legacy CMBS model)
• The impact of the current credit environment on special servicing operations (Comment: one servicer noted that they have extended @ 50% of loan maturity defaults if the borrower presents a viable plan.)
• Address investor demands for more information and transparency. (Comment: pooling and servicing agreement requirements need to be examined, including sharing resolution business plans with investors.)
• Future growth opportunities and challenges (Comment: one loan servicer commented that CMBS would NOT drive growth during the next 12-36 months.)
• New servicing business models (Comment: one loan servicer commented that the "new" CMBS [referred to as "CMBS 2.0"] would look like loan syndications.)
• Similarities and differences of different investors

INVESTORS FORUM

This forum is for a broad band of CRE debt investors (such as B note holders, mezzanine lenders).

The meeting time was devoted to a survery of the 250+ people in the room. Here are some of the responses: 

• 45% of the voters believe that CRE values will continue to fall in 2010 with no recovery in CRE values until 2011 (this fall is in addition to the 44% fall from 2007 CRE pricing)
• with respect to the 2005-2008 CMBS pools, 37% of the voters believe that the average losses will be in the 11%-15% range (these loses will wipe out bond holder through the "AJ" class)
• 43% of the voters believe that for CMBS loans liquidated in 2010, the average loss severity will be 40%-50% (and 27% believe that the average loss severity will be 50%-60%)
• 69% of the voters believe that annual new CMBS issuances will not exceed $100B until 2013
• for new CMBS issuances in 2010: 50% of the voters believe that issuances will be single borrower transactions; and 33% of the voters believe that issuances will be multi-borrower and large loan structures (with only a few assets); and
• 58% of the voters believe that "old-school" multi-borrower, fixed rate deals will return no sooner than 2012 (or later)

In my next posting, I'll cover the session titled "Lessons From CMBS 1.0: The Wonder Years" and then summarize some interesing comments made to us by Senator Bob Corker (R-Tenn), who is a member of the Senate Banking Committee.

If you have any questions or comments, please post your comment below.

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(When we attend industry conferences and meetings, we bring you along by blogging - offering content that we find interesting, and offering our comments [with an occasional restaurant review]. This is the first in a series covering the 2010 CMSA January Conference. Our blogs on other conferences and meetings are found [i] under the "Market Trends" category in the archives on the right side of the page, or [ii] by a word or phrase search on the right side of the page [suggested search terms: looking glass; scorecard; pond]).

TIPS ON USING WI-FI ON AN AIRPLANE

This is a new experience for me: creating a blog entry while I'm flying to an industry conference.  (Yes, I will receive much, much "grief" for this at my favorite law firm.  But then, if I can bring a little humor and laughter into their lonely, miserable lawyer lives . . . then mission accomplished.)

I promised to cover technology uses for lenders & servicers, and given our hectic schedules and work loads . . . writing this blog on an airplane just seems right on.  (Find other technology entries by [a] doing a word search using the "search" field located on the right side of the page, or [b] click on the "Technology" term in the archives section, located on the right side of the page.)

I typically travel on American Airlines (DFW=AA), and I use their GoGo Inflight wi-fi service all the time [link], which means every time that I'm on a plane with wi-fi, I use it.  I really, really like it.

Here are my tips on using wi-fi (or wifi) on an airplane:

• bring an extra battery for your notebook; or bring the proper electrical "plug" for the electrical connection (warning: the plug that works in your car is NOT the proper plug for use on the plane) (I know, that's another rant of mine: can't people use the same hardware? how about agreeing upon common or standard hardware?)
• the fee is very reasonable based upon this reason alone: by  "cleaning" out my e-mail while I'm in the air, I can quickly get to work (or to play) when the plane gets on the ground
• my notebook has a 15" screen; it is too big; I'd much rather travel using a smaller 13" screen; but if you have a large screen . . .
• sit on the aisle (or up-grade to first class) (yes, I up-graded for this 2.5 hour flight from Dallas to DC)
• save and save often; while I have never lost a wi-fi connection on GoGo, I'm just cautious enough to  . . . save and save often

2010 CMSA JANUARY CONFERENCE 

Now, focusing on the 2010 CMSA January Conference [website] -

This conference traditionally focuses on CMBS bondholder issues.  After all, in the past it was called the "Investor's Conference."  However, this year the focus has expanded due to the current CRE finance train wreck, which makes this conference very, very interesting - and drove over 1,000 people to pre-register for this conference.

So, with the crash of the CMBS market, the CMSA has re-invented itself - just as the CMBS market is . . . well . . . trying to re-invent itself?  I'll know more after this conference on all of this, and I'll post "what" I learn.

Of course, the central message or question for the Conference is the same riddle everyone is discussing, all across America (in the board rooms, office, cubes and 19th holes):

• What is the capital market solution, or replacement for the CMBS market? Will CMBS be tweaked, change or gutted? What is next? When is next? (HURRY!!)

The event is organized around meetings called "Forums" and topics of interest.  I'll be going to as many forums and sessions as possible, and I'll be posting information and my commentary.

Importantly, the Conference is in DC in recognition of the need for, or coming reality of, financial and regulatory reform.  Consequently, several events include comments from influential members of the US House (Minority Whip Eric Cantor [R-VA] and Chairman Paul Kanjorksi [D-PA,] of the House Financial Services Subcommittee),  and even a keynote address by FDIC Chairman Shelia Bair.

The topics for the breakout sessions are not surprising, and they include: Lessons from CMBS 1.0; Real Estate Fundamentals; Trader Panel; Borrower Panel; Surveillance & Workouts; Large Loan Financing; and New Sources of Capital.

Here is the CMSA's summary of the Forums:

Investment Grade Bondholders Forum: the CMSA describes this as the "Introduction of a Forum for the Investment Grade Bondholders."  (Wow. Strange that this event went from being the "Investors Conference" to now a forum.  Are you telling me that the prior conference really didn't address issues? Were they more about golf handicaps than risk\returns?) Issues to be covered include:

• Terms, Practices and Structures for new issue CMBS

• Loan Resolutions: What policies and reporting practices do investors prefer?

• Selling REO with trust level financing: What terms might make sense.

 [As an aside, I sense that the Investment Grade Bondholders want much more that simply their "own" forum. We'll see if this is enough; or if they want real change and real influence . . . . ]

Servicers Forum:

• How do you manage the increasing demands of the CRE credit issues on your servicing operations

• Where is future servicing growth going to come from, and when?

• What is the optimal business model for the future of commercial servicing?

• What do servicers want from their trade association?

Portfolio Lenders Forum

• Do you want securitization to return any time soon?

• Do you look at risk, and price risk, differently now than in the past?

• What are the biggest lessons learned from the past few years?

• What is the impact of current and proposed regulatory items on your firm?

 Investors Forum (Wow.  The CMSA has now transformed itself as the home of A\B note holders, mezzanine lenders, participants, syndicated lenders, etc.  Impressive.  But is this focus simply too broad?) As the CMSA notes: "This Forum will focus on a broad spectrum of CRE debt investor issues."

 • When will deteriorating fundamentals become a factor in bond pricing?

 • How would you change loan and bond documents knowing what you now know?

• Government involvement: too much or too little?

• What opportunities and risks exist for whole loan, B note and mezz debt investors?

 Multifamily Lenders Forum

• How will affordable housing get built going forward? Will tax credits play a meaningful role?

• What is driving asset performance today?

• Is there capital for new multifamily developments? Who is getting financing?

• Will current lenders remain active? Will other sources of capital emerge?

This promises to be a very, very interesting couple of days.  Hopefully it will be an encouraging experience (in contrast to our experience during our trip to the EU in October, 2008 [link]).

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

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(WARNING: Do not "tune this one out" simply because you're NOT at a bank.  Every lender or servicer should have this same concern . . . .)

From one of my all-time favorite movies, and an all-time favorite scene:

[about the trackers following them]
Butch Cassidy:  "I couldn't do that.  Could you do that?  Why can they do it? 
Who are those guys"?

Borrowers and guarantors are NOT the only people stopping on the next hill, and then looking over their shoulder.  Our friends at FinCriAdvisor today focus on a seldom discussed topic [link]:

"The FDIC actively is investigating dozens of former bank directors and officers at failed banks across the country, sending out more and more civil demand letters in recent months, banking lawyers report.  In many cases, FDIC investigators first are subpoenaing bank officials and workers, hoping to gather evidence to use in potential litigation."

If you were around in the late 80s\early 90s, then this action on the part of the FDIC does not surprise you.

My bottom line is that yes, I expect the Feds to do their work.  I just don't expect shocking news on regulatory wrong-doing.

So, I do NOT see much coming from this.  Why?  Because this commercial real estate wreck is very, very different than the brazen scandals and thievery of the old days.

I'm sure that books will be written about the differences—so I won't launch off on the list, except to note several glaring differences:

• This time we have complicated debt, equity, co-lender AND investment structures (this point alone gives me a headache) (Did I say "complicated?").
• Our problems are systemic —this is not a "Texas" thing, nor an "S&L Crisis."
• Does the FDIC really have money to follow through on a large number of law suits?  (Recall that the FDIC is so short on funds that it has collected in advance premiums from its members).

However, just to be careful, take a look at FinCriAdvisor's preparation guidelines, which they label as "6 Ways Directors and Officers Can Get Ready for Potential FDIC Litigation."  Here's the short version of their list:

• Understand your D&O insurance policies before the bank closes.
• Be aware that the terms of D&O insurance policies vary widely.
• Inquire about "tail coverage" for claims brought after (but based on events before) the policy's expiration.
• Get copies of bank records that can document your role at the bank before it failed.
• Think twice before giving a free-wheeling deposition to FDIC investigators after the bank closes,
• Hire new legal counsel after the bank closes.

If you want to comment with your perspective or add to the list, please do so below.

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(Part of my series on the capital markets.  Use the term "scorecard" in the search function on the lower right side of this page to find other postings in this series.)

On December 11, the US House of Representatives passed the financial reform bill.

As I've noted before, "tying" the loan originator or some other responsible party to the performance of individual loans in a securitized loan (CMBS) pool is critical to the "good" performance of the pool—which is a concept referred to as "risk retention."

The CMSA has been very focused on "who" could be the appropriate parties to have this risk of a loan going  bad. 

Below is the announcement made by the CMSA, as the financial reform bill made its way out of the House.

The risk retention provisions are an important step, BUT it only is a short-term band aid for the capital market freeze.  As a "fix" it does not address:

• the "tranche warfare" (caused, in party, by the inherent conflict of interest in special servicers affiliated with the CMBS B-piece holder) (granted, some of this is mitigated by the new approach to the "operating advisor" concept in the recent Developers Diversified Realty securitization; however, giving bondholder a degree of voting control over the special servicer is NOT nearly as effective result as the ability, in a covered bond structure, to replace the distressed loan with a performing loan; simply no comparison)
• the need for loan-level transparency and better communication between special servicers and investors
• the real "fix" for the problem is to allow the replacement of a problem loan with a performing loan (i.e., let's shift the focus from a backward look at the value of the "historical underwriting" by the B-piece buyer at pooling to a mechanism that fixes the problem as it happens—in the future)
• the fact that if a property is over-leveraged, and\or has debt service coverage problems, the problem is NOT with the capital markets—the problem is with the property  (i.e., the fact remains that commercial real estate markets will undergo market corrections; and that any "fix" should focus on softening the extreme "ends" of the ups\downs in the markets to the extent they are caused by the structures of financial products).  And this problem is the "pink elephant" in the room - and is a problem so vast that simply tweaking the CMBS model is not sufficient.  (It is the difference between a bar bell and a  tetrahedron. {Tetrahedron? I'll get to that in a minute.)

As I'll explore in future postings, I favor the use of "covered bonds" as the better long-term fix.  While this might NOT be popular to say, the CMBS model is NOT the long-term fix.

Mercy Jimenez and Spencer Punnett over at the Covered Bond Investor report "bipartisan support" for covered bonds at the hearing.  My reading of their report on the one (1) hour hearing does not convince me that pushing for covered bonds is a political reality right now.  As I gauge the political winds, the move to make the necessary Bankruptcy Code changes and changes to bank regulations (needed to protect or "circle" the bonded mortgages from issuer insolvency) is not a near-term reality.

So for the moment, we continue to band aid the CMBS model.  It is NOT the model that has enough credibility to return sufficient capital to the market in amounts that are needed for mainstream CRE, which some refer to as the middle of the "bar bell" - the trillions of CRE between the two extremes of properties in or nearing special servicing (on one end of the bar bell) and those properties having the best debt service coverage (DSC), loan to value (LTV) and tenants (on the other end of the bar bell).

As an aside, I don't see a "bar bell" in the market.  My visual picture is more of a tetrahedron, which also is some times called a triangular pyramid.  If that term sounds complicated, then you're well on your way to admitting that the current capital market for commercial real estate is no simple "bar bell" - where the cure is a "return" to the CMBS product (after, of course, tweaking it with risk retention, operating advisors and enhanced SPE provisions).

*          #--- #   **

* = the "best" commercial real estate

** = the "worst" commercial real estate 

# = the majority of the market (to the "right" of center or equilibrium with excessive leverage)

But back to covered bonds . . . .

Covered bonds are our ultimate destination for a capital markets solution that includes the middle majority of the CRE market.

Until then, we're only using a band aid.

We need to admit it, and get behind covered bonds - and pour over resources like the Covered Bond Investor.

(For more postings on my "CMBS Scorecard" series, use the term "scorecard" in a search of this blog.) 

Please post your own comments, questions or thoughts.

The CMSA Announcement

December 11, 2009—Today the U.S. House of Representatives passed sweeping regulatory reform legislation that includes language strongly supported by Commercial Mortgage Securities Association, tailoring financial reforms that would support a recovery in the commercial real estate finance market.

By a floor vote of 223-202, the House approved H.R. 4173, The Wall Street Reform and Consumer Protection Act of 2009, which encompasses large-scale reforms the Obama administration sought to prevent future financial crises and to regain stability in the overall U.S. economy.

As passed by the House, the bill includes language that would structure the ‘retention’ or ‘skin in the game’ requirement to account for the unique nature of commercial mortgage-backed securities. Specifically, the legislation grants regulators the flexibility to allow a third-party investor – or B-piece buyer – to satisfy the legislation’s new retention requirements.

Typically bonds rated below BBB are classified as “below investment grade,” otherwise known as the “B-piece.” The buyer of the B-piece takes on the highest level risk in a CMBS securitization because they are exposed to the first risk of loss. CMSA believes recognizing the role of these third-party investors who purchase the first-loss position and re-underwrite all loans during the pre-issuance period is critically important.

H.R. 4173 also includes another measure, one that would require the Federal Reserve and financial regulators to examine the combined impact of new retention requirements and new accounting standards (FAS 166 and 167) on credit availability, and to report to Congress with specific recommendations prior to any rulemaking on the retention.

“A risk retention provision that gives market and financial regulators flexibility in overseeing diverse asset types and structures is essential to support an overall recovery in commercial real estate,” said Patrick C. Sargent, President, Commercial Mortgage Securities Association. “Passage of this language by the full House today is a tremendous step toward restoring access to credit in this market,” he said.

“It is crucial that financial policymakers in Washington tailor reforms to recognize the role of sophisticated third-party investors that negotiate specifically for the riskier classes in a CMBS transaction,” Mr. Sargent added. “We encourage the Senate to support a recovery in commercial real estate by maintaining and strengthening safeguards in the CMBS market.”

The Senate has been working on financial services regulatory reform as well and they are expected to consider such legislation next year. 
 

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The CMSA has published the text of the testimony by Christopher Hoeffel, from his appearance yesterday before the US House Financial Services Committee.  As noted in my posting earlier this week (link), the Committee is investigating the use of the "covered bond" product as one tool to revive the CRE capital markets (and solve some of the problems with the CMBS model).

Here is a link to the testimony: LINK

The testimony is very instructive, and a must read.

I suggest that you research the covered bond.  We've been collecting materials for the last year.

If you have any questions, comments or help full materials on covered bonds, please post a comment.

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More on my series commenting on the CMBS loan market and the broader capital markets for commercial real estate . . . .

Previously, we've brought to your attention a type of commercial real estate debt structure that HAS worked in the EU (for hundreds of years), and it HAS been tried at least twice in the U.S.  [link to prior posting]

It is called a "covered bond." 

Click here:  Wikipedia has a good description of it .

Covered bonds offer the best hope for improving the current capital grid lock, which has the commercial real estate market on its knees.  Covered bonds will be an important piece of the credit stack for the U.S. commercial mortgage market.  It will help the commercial real estate market recover.

We've meet with a EU bank that handles this product (during our trip to the EU in 2008) and we've closely followed this important topic since the then.  So, stay tuned.  We'll write more on it.

All that you need to know right now is that covered bonds are similar to CMBS pools, with this important difference: the issuer (read: the original lender) retains some risk on the performance of the pool.  This means that the issuer services the individual loans and literally cares for the loans—yes, this is the "retained risk" phrase that you'll start to read about.  For example, when a loan in a mortgage bond pool goes "bad," the issuer can swap out the "bad" loan with a "good" loan.  (What an idea!)  Sure, there are hurdles to this concept in the U.S., including probably amending the U.S. Bankruptcy Code.  And the public probably is in no mood to do that right now.  But as the real estate "recession" extends into 2010 and beyond, the time will come . . . .

 . . . maybe sooner than later.

A recent announcement from the CMSA (Commercial Mortgage Securities Association Web site) got me going today on this topic - tomorrow the U.S. House Financial Services Committee will hold a hearing entitled "Covered Bonds: Prospects for a U.S. Market Going Forward."  Here is the CMSA announcement:

"CMSA Executive Committee Member and immediate past president Christopher Hoeffel will testify before the full House Financial Services Committee on Tuesday, December 15 at 10:00 a.m. ET. The hearing, “Covered Bonds: Prospects for a U.S. Market Going Forward,” will provide a forum to discuss how such a market could be structured in light of current changes and the recovery efforts occurring within the financial markets.  For its part, CMSA supports efforts by policymakers to facilitate a U.S. commercial covered bond market in order to provide an additional source of liquidity through new and diverse funding sources, and the association continues to advocate for the inclusion of commercial mortgages in a covered bond market.  Mr. Hoeffel’s remarks and the hearing itself can be watched live through the House Financial Services Committee’s video sever shortly before the 10:00 a.m. ET start-time December 15."

IF Congress and IF the American public can stomach including covered bonds as part of the financial reforms, then the commercial real estate market will finally have some capital relief.

There is hope.

If you have thoughts, comments, questions or resources covering covered bonds, please post a comment.

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On October 30, 2009, the Federal Financial Institutions Examination Council (FFIEC) issued a policy statement that was adopted by the OCC, the Fed, the FDIC and the Office of Thrift Supervision as Guidance on Prudent Commercial Real Estate Loan Workouts (FFIEC's Guidance under the OCC Bulletin 2009-32).  The policy replaced the Interagency Policy Statement on the Review and Classification of Commercial Real Estate Loans that banks have been operating under since November 1995.  (For a copy of the policy statement, see our earlier posting [link].)

OVERALL TONE
The overall tone of the Guidance is to provide prudent but pragmatic guidance on risk assessment, allowing financial institutions in the present environment to actively engage in CRE workouts without undue fear of reclassification by examiners.  For example, the Guidance states:

"Financial institutions that implement prudent loan workout arrangements after performing a comprehensive review of a borrower's financial condition will not be subject to criticism for engaging in these efforts, even if the restructured loans have weaknesses that result in adverse credit classification."

While there are a few hard and fast prohibitions in the OCC bulletin, as a general matter its cornerstone is flexibility and pragmatism in working out distressed commercial real estate credits. Institutions are encouraged to consider both the asset and Borrower/Sponsor capacity for repayment of the credit.

The Guidance establishes protocols encouraging institutions to apply prospective, "forward thinking" to the cash flow analysis of distressed real estate projects.  Additionally, it discourages "second guessing" by examiners on such items as assumed cap rates, lease renewal assumptions, lease-up periods and other forward looking market conditions. The Guidance also reinforces, and in some cases clarifies regulatory and GAAP reporting requirements.

KEY POINTS

The Guidance includes the following key points:
 

• Renewed or restructured loans to borrowers who have the ability to repay their debts according to reasonable modified terms will not be subject to adverse classification solely because the value of the underlying collateral has declined below the loan balance.
   
• In general, renewals of maturing loans to responsible borrowers who, because of the present financial crisis, cannot locate a source of refinancing, should not suffer adverse classification.
   
• Separating a single loan into an "A/B" note structure (with impairment and/or non-accrual hitting the B note only) receives a regulatory "stamp of approval" under appropriate circumstances illustrated in the Guidance.
   
• Troubled debt restructuring (TDR) contains a two-prong test in which both prongs must be met: (a) the borrower is experiencing financial difficulties (examples of what this means are provided in attachment one of the Guidance) AND (b) the lender grants a concession that it would not ordinarily grant except for the status of the real estate and/or economic conditions.
   
• "Fair value" vs. "Market value" - Fair value is still required under impairment situations (pursuant to FASB 114) and for properties deemed to be TDR. "Market value" (i.e. predictable future values) can be considered if consistent with the facts and circumstances of the workout.

• Clarifies Allowances for Loan and Lease Losses (ALLL) calculations utilizing fair value; existing guidance remains in place.
   
• The concepts of "market interest rate" become of paramount importance in: (i) classifying or reclassifying the credit, (ii) going on or off of accrual basis, and (iii) booking losses (examples of what is considered and not considered "market rate" are illustrated in Attachment One to the Guidance).  Market interest rate calculations should:
  
  - Take a forward-looking view at the cash flows, rent rolls and property type analysis
  
   - Be influenced by the credit quality of both the borrower and the real estate
  
   - Be adjusted (positively or negatively) by the existence of quality loan guaranties utilizing current financial information
  
   
• "Interest only" concessions for periods beyond one year in order to allow the property's cash flow to service the debt will be frowned upon, and likely not deemed "market."
   
• Generally "second guessing" by examiners is discouraged and will be viewed as inappropriate in the analysis of certain specified forward-looking circumstances.
   
• Overall, the Guidance encourages bank institutions to be proactive and forward thinking in applying their analytics at the property level.

In summary, the Guidance stresses the need to examine each commercial real estate loan on its own merits; examining borrower, sponsor and guarantor credit and payment capacity, as well as the current and projected quality and durability of asset level cash flows.  The examples contained in Attachment One to the Guidance demonstrate that this process will inevitably involve subjective judgments.  Although there is a definite change of tone, the regulatory construct remains fundamentally unchanged.

It will be interesting to see how banking institutions and their examiners react to the October 30th announcement.  Given the general and subjective nature of the subject matter, and that guidance is provided largely through examples, implementation may well prove to be uneven among banking institutions.

As we move into the next phase and begin to work with the Guidance, we encourage you to share your comments and experiences.

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By now you should be well aware of this "bad" fact stemming from failure or lock-down of the CMBS loan market:

• Between now and the end of 2012, more than $600 billion CRE loans will mature in EXCESS of the average 3-year historical gross originations from all non-commercial CRE lenders.  In other words, in the absence of a CMBS loan origination market, +$600 billion of CRE loans will mature with no historical source for pay-off (See PDF).

In other words, if the loan is within the tight bandwidth of the best underwriting standards (for example, high debt-service coverage and low loan-to-value), then the loan probably will find a refinancing source.  If it is not, then there simply isn't credit available to repay the loan.  Thus, the lender\servicer has two choices: extend the loan or foreclose.

This gives you a good perspective of the "why" behind the "extend and pretend" approach adopted by banks and CMBS servicers.

So, for all those loans that are not in the tight bandwidth, where are we on the all-important topic of jump starting or replacing the CMBS market?  (Show us the money)

Here's a quick scorecard that indentifies a few recent milestones:

• New CMBS Issuances!!  Yes, two new issuance of CMBS hit the market last week.  It has been nearly two years since the last sale of new CMBS issuance.  While it is an important first step, the DDR Depositor LLC Trust 2009 Commercial Mortgage Pass Through Certificates (series 2009 DDR1) signals little hope for the typical CRE investor: this CMBS pool is a single sponsor structure, with low loan-to-value (@ 62%), great debt-service coverage (@ 1.4x), and a significant percentage of investment-grade tenants (@23% of total square footage and @15% of base rent).  And the same can be said of the second issuance, which was the Bank of America Large Loan Trust 2009-FDG.  The BoA deal was a single, seven-year, fixed-rate non-recourse loan to entities of Fortress Funds.  Neither issuances, however, involved a pool of small loans from a wide variety of borrowers.  While something is better than nothing, these two issuances do not signal immediate help to the typical owner (Link to CMSA summary).  Bottom line: great news for Wall Street; no help for Main Street.

• Basic Changes to the CMBS Model - Risk Retention. The Hill seems to be listening to the CRE industry.  In September, the CMSA issued a white paper (PDF) giving input on the 2009 Financial Regulatory Reform proposals currently being studied by Congress—but from the perspective of the commercial mortgage market.  Last week, the House Financial Services Committee passed an amendment to the reform bill that (i) places the risk retention requirement at 5% and (ii) recognizes third-party investors (who purchase the first-loss position and re-underwrite all loans during pooling) as proper holders of the risk retention piece.  This is a important victory for the CRE industry.

• Rating Agencies in the Spotlight. Part of the reform includes changes in the role and function of the rating agencies.  My perspective is that we really haven't heard much from the most important player in the mix: the investor. (The party who literally "buys" the CRE investment, whether in the form of a CMBS bond or a limited partnership interest.) For a hint of the investor's perspective, read this white paper (PDF) from the Council of Institutional Investors (website).  It strongly argues for more accountability on the part of the rating agencies.  At the very least, this points to the fact that the "re-examination" of the CMBS recipe is wide ranging.  And with topics such as rating agency liability on the table, I doubt that there will be a quick fix.  And, as noted above, the "table" is located on the Hill,  which is not a friendly banquet hall for commercial real estate . . . .

• More Extend and Pretend. What does a "no quick fix" mean?  Navigating the CMBS ship through the political process will NOT be a quick trip.  Consequently, for loans that are nearing maturity, or are in distress, the rescue plan will involve the current lender for the next 12 months.  At the loan level, it will take creativity and a thorough understanding of the market and the lender\servicer constraints (such as the new guidelines for banks or the PSA limitations for CMBS servicers), in order to keep the loan out of foreclosure.

 Please post your thoughts or comments on other key markers that you've seen.

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The “co-tenancy” clause is a lease provision where Tenant A has the ability to take certain actions (such as reduce rent or even terminate the Lease A) if Tenant B does something, such as ceases operations or even terminates Lease B (Tenants such as Tenant A and Tenant B are called “anchor tenants” or “lead tenants”).  

Right now, it has the ability to both maim AND kill a retail center.

What is a Co-Tenancy Clause?
The clause is a lease concession granted by the landlord\borrower in order to attract the all-important anchor tenant to the center (Tenant B) after a “lead” anchor tenant (Tenant A) has already leased space in the center. Since the clause assists in creating the all-important tenant mix, it is viewed as a “good” clause. Rent is good! It’s great when consumers are spending money in the center; which of course, builds value in the center, allowing the landlord\borrower to finance the center. Everybody is happy.

The co-tenancy clause is important in bringing about all of this happiness.

So, the clause is overlooked or even applauded at loan origination when the rent roll and the tenant mix is the focus.

Co-Tenancy Clauses Can Sever a Limb
Of course, that perspective changes when consumers stop spending money. When tenants are no longer happy. When rent is slow-paid (or simply not paid). When tenants are looking at the lease as a major drain on their income statement.

In this economy, Tenant B now might do that “something” (such as ceases operations, or terminates Lease B), with the result that Tenant A will have the ability to invoke its right (under the co-tenancy clause) to reduce rent, to terminate Lease A, etc.
The result will be like losing the arms or legs to the retail center.

So, here are some suggestions:

• Add this clause to your short list of “most dangerous” lease clauses and be sure to flag it during your lease reviews
• As you modify leases, DELETE it from the lease

But wait, there is a new, innovative use of the co-tenancy clause, where it spreads like the flu and then threatens to kill the entire retail center.

Co-Tenancy Clauses Can Kill
Be aware of this new, even innovative, use of the co-tenancy clause:

• Tenant B is in distress and is considering ceasing operations or terminating the lease
• Tenant A learns of this, and starts to consider whether it will invoke its rights under the co-tenancy clause
• Tenants C through G (the other, “small” retailers in the center) learn of this. They meet and for the first time, realize that not only is their economic success tied to Tenant B and Tenant A, but that they should take this collective step with each other . . .
• All tenants, as a collective whole, (Tenants B, A and C through G) approach the landlord\borrower for new rental and lease concessions FOR ALL OF THEM.

This type of collective bargaining is taking place.  It could spread to a retail loan in your portfolio.

It is flu season for landlords. And for lenders and loan servicers. It could kill.

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This past Friday (October 31, 2009), the Federal Financial Institutions Examination Council (website) released a major policy statement giving guidance, and articulating general principals, for the distressed commercial real estate debt market.

The report is a "must" read: PDF.  (Footnote #1 to the report lists the Federal & State Regulators - visit the FFIEC website for the complete list.)

The introductory paragraphs and the Article I "Purpose" statement contain some very, very interesting (even bold) statements:

• " . . . financial institutions and borrowers may find it mutually beneficial to work constructively together"
• "The regulators have found that prudent CRE loan workouts are often in the best interest of the financial institution and the borrower."
• "Financial institutions that implement prudent loan workout arrangements after performing comprehensive reviews of borrowers’ financial conditions will not be subject to criticism for engaging in these efforts even if the restructured loans have weaknesses that result in adverse credit classifications."
• " In addition, renewed or restructured loans to borrowers who have the ability to repay their debts according to reasonable modified terms will not be subject to adverse classification solely because the value of the underlying collateral has declined to an amount that is less than the loan balance (emphasis added)."

This is a must read for everyone involved in CRE.

This is very different from the regulatory guillotine used in the late 80s & early 90s.

And the policy statement should have major implications - and undoubtedly will influence regulatory bodies such as the NAIC (which loosely governs commercial mortgage investments by life insurance companies) (website) and other "unregulated" financial institutions.

Please post your comments.

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Every downturn and recovery offer opportunities for investors to adapt and respond to changing economic conditions.  Today's climate requires investors to look for commercial real estate opportunities in new and challenging ways.  Investing in distressed assets presents investors with one opportunity for growth as market conditions improve.  Winstead PC and Cohen Financial hosted a webinar covering topics important to implementing an investment strategy in this difficult market.

Did you miss the webcast?
Don't worry, one reason that you follow this blog is to gather information on your own terms, and on your own schedule. 

• Click here to watch the webcast
  
• Click here for a copy of the presentation materials

After you watch this webcast or read the materials, please post comments or questions.
 

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For the next couple of days, I'll be attending the annual meeting of the American College of Mortgage Attorneys (ACMA).  Members of ACMA are a select group of in-house and outside counsel, who are recognized as leaders in commercial real estate finance.

OK, I know:  You're rolling your eyes as your internal big screen pans a view of a room full of (ego laden?) lawyers, sitting in your basic seminar setup, listening to speakers (most by now are far enough up the tech curve to use PowerPoint), and discussing . . . .

Here's where you should wake up to the relevance of it all:  What are the topics that the legal thought-leaders are focusing on?  What has their attention?

I'll admit that some (most?) events like this are grueling for me, but simply because I can't sit still for a stretch of 8 hours.  The content, however, keeps my attention.  And because I think that it might interest you, below is a summary of several of the topics.

A reminder for you:  If you want more information on distressed debt & investments, go to the "Client Resources" tab on our blog homepage.  It contains instructions on how you can access our extranet site, where we have posted 60+ papers, articles and presentations for you to read, download, etc.  It is free.  It is available 24/7.

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Periodically, we alert you of opportunities to participate in online webinars on various topics—from the "comfort" of your own computer.  No travel.  No hassle.

On Wednesday, October 7, Cohen Financial and Winstead PC are hosting a webinar on investing in distressed assets.

Every downturn and recovery offer opportunities for investors to adapt and respond to changing economic conditions.  Today's climate requires investors to look for commercial real estate opportunities in new and challenging ways.

Investing in distressed assets presents investors with one opportunity for growth as market conditions improve.  The professionals at Cohen Financial and Winstead PC will present you with the knowledge needed to evaluate this investment strategy.

During this webinar you will learn:

• How to find distressed commercial real estate assets
• What is involved in the valuation and financing of these assets
• How to buy debt
• How to buy commercial real estate
• The tax issues involve

Investing in Distressed Assets – Webinar

Wednesday, October 7, 2009
11:30am PT/12:30pm MT
1:30pm CT/2:30pm ET
Click here to register (link)

This webinar should interest players from every point or perspective, whether sellers, buyers, special servicers\asset managers, REO\asset managers, or intermediaries.

If you have questions in advance, please post a comment.

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Earlier this month, the Corporate Executive Board announced (Bloomberg story) that it will collaborate with Legal OnRamp in an initiative to bring new resources to law department members of the General Counsel Roundtable (which is a program of the Corporate Executive Board).  The goal of the initiative is to enable in-house counsel to network and share knowledge with one another through the use of Web-based collaboration tools.

So what?  What does that have to do with dealing with distressed debt?

It is important because we've (finally) reached the tipping point (ok, the starting point) where, over the next few years, all of the talk of "how technology will change our business" will be transformed into "technology sure has improved the process and the results of how we manage risk in our commercial investment portfolio."

You're probably thinking "whoa, that's a huge A to Z leap" and "what are you talking about?"

Understanding "how" disruptive technologies will change (for the better) my relationships with clients and the commercial finance industry is a passion of mine.  I've worked on MISMO committees  (Winstead is a member), written about eMortgage [PDF], created a legal database used in the sale of an equipment lease portfolio, dabbled in databases for commercial mortgage loan originations, and launched a Web-based tool used for monitoring workouts (on a national basis) for an apartment lender.  I get the value proposition in technology as the tool for collaboration and separate deliverables.

However, I also understand that the commercial side of the financial services industry, and certainly most lawyers do NOT really understand the value proposition.

This announcement has spurred me to blog about it.

It is a huge subject.  And "huge" can be difficult.  Transforming high level, broad generalizations into practical pieces can be daunting (Or at least a sure path to joining the Don Quixote brotherhood).  But the topic must be addressed.  I'll write about both ends of the space.

This first piece will be a broad overview.  In future postings, I'll be more practical.

Clearly, technology promises to dramatically change how we work with distressed investments.  And all of us can point to tangible examples of this within the 4 walls of our offices when we look back to the downturn of the late 80s.  The mag cards are gone.  Spreadsheets are now everywhere.  Databases now abound.  We have e-mail.  We have PCs.  We're all "connected" (Perhaps with too much data and not with the "right" type of connectivity).

However, the next 10 years promise to bring even more dramatic changes--and it will be technology driven.

The changes will seem most dramatic in the following:

• Our interaction with each other as we handle distressed investments (new, different knowledge collaboration tools; [a form of social networking])
• New deliverables between lenders\servicers and vendors--even outside counsel (new format: paper to electronic)

We've already seen how disruptive technologies bring huge changes to newspapers, medicine, banking, etc.

We're about to experience similar changes in our handling of commercial investments, including distressed debt.  We'll see the changes between all points of the vendor compass in the financial services industry.  We'll even see it in the interaction with outside counsel.

From the legal perspective, various thought leaders have been harping on this for some time, including sharp thinkers such as:

• Richard Susskind, author of the book The End of Lawyers?
• Mark Chandler, GC of Cisco and one of the founders of Legal OnRamp
• And in my hometown of Dallas, Tom Mighell, co-author of a book published by the ABA on Legal Collaboration

In future postings, I'll comment on their work, and the work of others on changes coming to us through disruptive technology.

The "new" economy has changed.  For those of us handling distressed commercial investments, disruptive technologies will form a basis for new relationships with richer, new business processes.  The commercial finance service industry will be different, with new dialog and relationships.  And technology will be the reason "why"-- and the back bone of it all.

Finally.
More to come . . .

If this topic is of interest to you, or if you have your own perspective, please post a comment.

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Last Thursday, the Joint Economic Committee of our U.S. Congress heard testimony calling for the "return" of the CMBS market as a means to promote the recovery of the U.S. commercial real estate finance markets.  Attached (PDF) is the testimony of Richard Parkus (who, of course, expressed his personal view and NOT those of his employer).  (His employer only paid him to do the research; the analysis is just a hobby!)

I agree with him: we do need the commercial real estate finance markets to "return" or at least improve.  OK, even to simply turn on.

We've heard or read most of his testimony before from other sources - including the large percentage of total losses in CMBS (he says between 9-12%, or about $65-$90 billion), with the highest looses in 2005-2007 commercial mortgage loans placed in CMBS pools.

Interesting, but "old" news by now.  Maybe even dull since many of those CMBS loans merely are being extended.

More startling to me is that he actually articulated exactly what I've been expecting: it's all about commercial real estate exposure at the regional and local banks.

Parkus reminded the committee that banks own @ 50% of all commercial real estate.  (Note: the Mortgage Bankers Ass'n has great information on all of this.)

So, what about the banks?

On the topic of construction loans

• "Moreover, exposure to construction loans rises rapidly as one moves from large money center banks to smaller regional and local banks - the four largest US banks have an average exposure of less than 2% of total assets, while the 31-100 largest banks have an average exposure of about 12%" (Wow).
• "In my view, losses on construction loans are likely to be in excess of 25%, possibly well in excess, which will imply losses of at least $140 billion.  This, of course, will be disproportionately borne by regional and local banks" (Wow, again).

On the topic of core commercial real estate loans

• "The four largest banks have an average exposure of 3-4% to commercial real estate loans, while smaller regional banks have an exposure of 15-20%" (I'm catching a trend here).
• " . . . loss rates on core commercial real estate loans in bank portfolios . . . will imply losses of at least $120-$150 billion on banks' core commercial real estate portfolios" (Oh, no).

Parkus' main point is that the CMBS market must be revived (OK, that's his employer speaking).

More perceptive to me is his articulation of the extremely dire, even horrible, condition of the real estate portfolios of regional and local banks.  He gets it.

The tough times might not even have arrived - the residential sub prime thing could just be the first course.

If you're experienced in workouts, many a meal could be coming your way from your regional or local bank.

Please post your thoughts or comments.

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We all recall the Treasury Department's announcement back in April regarding the creation of the Legacy Loan and Legacy Securities Programs under the general rubric of the "Public-Private Investment Programs" (PPIP).

The Treasury's message had two very specific announcements with a set of frequently asked questions regarding efforts to "discover a market" by implementing these two programs designed to purchase either toxic whole loan assets or securities (in the form of RMBS and CMBS).

So far at least, activity under these two programs has been underwhelming.

The original programs indicated that the Federal Deposit Insurance Corporation (FDIC), as primary bank regulator, would expect to receive business plans from regulated banks which would articulate a plan to dispose of the "toxic assets" through the PPIFs.

Within a very short number of weeks after the announcement of the Legacy Loan and Legacy Securities Programs, the Board of Governors at the Federal Reserve issued the results of the so-called "stress test" (the supervisory capital assessment program; overview of results, issued May 7, 2009). Nineteen bank-holding companies were examined under a stress set of criteria and were given until year-end 2010 to transform their capital base so that "tier 1 common capital" would meet or exceed 4% of assets, on a risk adjusted capital adequacy level as described in the report.

The results went on to disclose that even the very large bank-holding companies had started to manage to these "risk adjusted" goals and were able to make significant headway in getting to the guidelines of adjusted capital between the end of the year 2008 and first-quarter results for 2009. 
In effect by mid-May, the overall market reaction to the stress test publication was that the banks were not going to be required to "fire sale" toxic assets, but "had time" to let markets recover.

Many have wondered if that is not a substantial reason for the lack of sellers being willing to take significant discounts on their toxic assets in the PPIF programs.  After all, their targets need to only be met by year-end 2010 and the banks are well on their way to meeting them.

Does anyone out there think that the Legacy Loan and Legacy Securities Programs will begin to see some transactional action in the next six months?  Please share your comments.
 

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We've now had a few weeks to review and react to the release by the Board of Governors of the Federal Reserve Systems stress test. See The Supervisory Capital Assessment Program: Overview of Results, dated May 7, 2009.

The Fed goes out of its way to state what the stress test IS, and what it is NOT. Specifically, it is NOT a prediction about the future downward movement in the economy, but simply a measurement device that the Fed will use to determine how much of a buffer certain selected large US bank-holding companies (BHCs) would need under a significantly negative set of economic assumptions about the future. The idea is to ensure that even under a relatively dark set of assumptions, major American banks will have the capital to survive.

To that end, a detailed paper on the Supervisory Capital Assessment Program ("SCAP") was released on April 24. The "SCAP buffer" requires that the BHC's attain by the end of 2010, Tier 1 capital of at least 6% of assets and Tier 1 common capital at least equal to 4% of total assets. Of the 19 BHC's in the study, 9 of them already have capital sufficient to meet this requirement. Of the remaining 11 that must add Tier 1 capital, the vast majority of the 185 billion will be added to Tier 1 common capital to attain the 4% requirement.

The Fed makes a point of noting that these hurdles are not designed to be an ongoing regulatory requirement imposed by either the Federal Reserve System or the FDIC. The most important point is that the Fed is acting decisively and quickly in an effort to have major banking institutions design, within the next 30 days, programs to reach the results called for in the stress test mentioned above by December 31, 2010.

Interestingly, the Treasury has not only put in place requirements for shedding certain assets (home mortgages, second tier commercial mortgages and both commercial and residential mortgage back securities (RMBS and CMBS)). Further, the Treasury through offering to the TARP program (principally TALF loans and the Legacy Loan Program and Legacy Securities Program) is not only setting out the requirements but is also providing the tools, for accomplishing the tasks placed before BHCs over the next 2 years.

In effect, we have a road map for the way out. The FDIC, the Fed and the Treasury have acted decisively and in close coordination in an effort to get capital flowing at what may turn out to be surprisingly increased levels toward the end of this year.

Will it work? Stay tuned.
 

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More in our "Watch For Change" series . . .

While NOT directly relevant to workouts, the Council of Institutional Investors recently issued a white paper (PDF) pushing Congress for stronger oversight and accountability of credit rating agencies.

Briefly, the paper calls for

• "Enhance oversight by creating a new Credit Rating Agency Oversight Board or supplementing the authority of the Securities and Exchange Commission (SEC) to substantively regulate rating agency practices - including disclosure, conflicts of interest and rating methodologies - and reduce reliance on ratings."
• "Remove rating agencies' exemption from liability under the Securities Act of 1933 and make Nationally Recognized Statistical Rating Organizations subject to private rights of action under the anti-fraud provisions of the securities laws."

Just another example of the broad scope of the movement to "correct" current market problems and of the possibility of "new" regulatory bodies and roles.

Please post your questions or comments below.

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More on our "Watch For Change (at the state house)" series (prior postings on new business tax; new foreclosure fee) . . . .

I suspect that many state and local authorities soon will be requiring lenders to register a loan BEFORE the loan is foreclosed.

Yes, another foreclosure trip wire.

Recently, a representative of MERS (the electronic note registry used extensively with residential mortgage note and to a lesser extent with commercial mortgage notes securitized in CMBS pools) told me that MERS is being used in new ways - most notably, several cities (such as Chula Vista, CA) are using the registry to "track down" and identify owners, servicers and managers of foreclosed single family houses.

He also tells me that several states (VA & CA, for example) have pending legislation requiring all foreclosed property to be registered in a database for use by governmental authorities (data points for the registry include ownership, servicer, property manager, etc.).  (I'm tracking down information on this.)

• Why? Thousands of homes have been foreclosed, and sit vacant and unattended.  And the public wants them to be kept secure, yards mowed, pools serviced, etc.  No one wants a meth lab, or a party house, as your newest next door neighbor.
• Why not?  Public officials want votes, so they're looking for ways to "please" the public without spending public funds.

However, since most commercial mortgage notes are NOT registered with MERS, it will NOT be a data-ready tool for use in tracking down commercial lenders after foreclosure (one caveat: some CMBS notes have been registered in MERS).

. . . yet. I predict that this will catch on in state legislatures across the nation - making registration a requirement before foreclosure.

If you can give us some information on this, or if you have any questions or comments, please post a contact.

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Yesterday (Thursday) was the second, and my last, day of the conference.  As I did with the first day of the conference, I summarize some of the sessions.  So, here's the executive summary:

From a session on bankruptcy issues:

• as reported by the Commercial Mortgage Securities Ass'n in its press release, the bankruptcy court in the General Growth Property bankruptcy issued a good ruling on Wednesday.  The ruling recognized the integrity of the special purpose vehicle (or single purpose entity; also called "SPE") utilized by GGP in the ownership of each mall in its portfolio. (Recall that many GPP malls are owned by a SPE subsidiary of GGP.)
• for detail on the importance of the SPE structure to the commercial mortgage lending industry, and for an understanding of the structure itself, take a look at the brief filed by the CMSA in the case.
• briefly, the debtor-in-possession financing recognized the validity of the SPE structure: it did NOT place a lien on each mall (which are owned by separate SPEs) and the first-lien holders of each SPE-owned mall were given a first-priority lien on the cash collateral from their mall collateral
• next step of interest in the case: the hearing on the bad faith filing issues.  Was it proper for the solvent SPE to be included in the bankruptcy of the parent GGP?

From a session on the challenges in complex transaction structures:

• one of the first tasks in handling a distressed loan is identifying the parties and their issues.  For example: (1) who\what are the creditor & borrower issues? (2) who\what are the co-lender issues? (3) and if there is a separate servicer, what are the terms of the servicing agreement? The answers: find the documents.  Read the documents.
• the many, varied structures of the credit stack present challenges simply in understanding the relationships between all of these parties.  Here is a short list of common structures: 1st lien & mezzanine debt (with one or more mezz debt positions; and each mezz debt could have all of the following structures); A note and B note (and the A note might be securitized); A1, A2 and A3 note (and the A1 note might be securitized); "true" participations of any of these notes (if not securitized); etc. Some of these credit stack structures will give you a head ache.  And often the borrower has NO knowledge of them - although a sophisticated borrower might recognize some of the clues pointing to a complicated credit stack.
• for credit stacks that include securitized debt, the rating agency faces multiple challenges: (1) post-closing surveillance (in that it often does not have access to loan documents covering discrete loans in the credit stack); (2) issuing confirmation letters ("no down-grade letters") can be problematic for the same reason; (3) intercreditor agreements and loan documents might not comply with rating agency requirements
• special servicers in securitized loan pools are being changed by the controlling class holders and the B note holders.  This can result in two different special servicers: one appointed by the controlling class holders for the entire pool; and a second by the B note holder as to the notes that it has first-risk loss.  Another complication, of course, is that the special servicer must be approved by the applicable rating agency.  And to further complicate it all, often the intercreditor agreement(s) have a higher rating standard than the standard required by the rating agency monitoring the pool.
• some of the credit stacks are so complicated, that it is difficult for the servicer to determine "who" should receive notice of a change in servicing (or "who" should receive any other notice).  One answer is to follow the money: if the master servicer is the paying agent for the pool, the servicer's treasury group has contact information.
• against this complicated back drop, borrower's often communicate to the incorrect lender! And have difficulty in indentifying "who is who" among this confusing group of players.
• in a prior posting, we commented on the question of whether a borrower should intentionally default a loan that has been put in a securitized pool.  The panel noted these dire consequences for a borrower in special servicing: (1) default interest will accrue; (2) late fees will accrue; and (3) workout land is NOT "borrower friendly" - and if borrower does not obtain its desired result, there is no "free pass" back to the safety of master servicing.
• for loans with "springing" lock box features: borrowers are refusing to do the paper work to create lock boxes.  This results in a covenant default under the loan, which triggers a transfer of the loan to special servicing.  Also, on several loans, local banks (who have long-standing relationships to the principal behind the borrower) have closed dormant, "springing" lock box deposit account - which is a real problem when the lockbox "comes to life" and the master servicer attempts to implement the lockbox structure.

From a session on loan surveillance:

• each point of the mortgage compass is requiring more and better information: bond holders, rating agencies, federal and state regulators, investment committees, etc.
• loans are being reviewed more often (even monthly)
• all of this is a major difference from the late '80s & early '90s
• what are some of the warning signs of a loan going "bad"? (1) exhausting a debt service reserve (recall: this type of reserve was used when a project was not stabilized); (2) exhausting a contingency line item (in a construction loan); (3) change in ownership of any portion of the credit stack (this is often difficult to monitor); (4) low utilization\occupancy of space by tenants; and (5) ___________
• surveillance needs to have a "forward" looking component, such as: (1) future lease rollover; (2) local market information and trends (new construction of competing projects; tenants looking for space; etc.); (3) sponsor level debt information (amount; maturities; etc.); (4) free rent and rental rate trends in the market; and (5) _________
• use "free" resources available on-line
• one problem for servicers: each lender seems to have their own, unique reporting form
• one lesson in this "new" economy: real estate really is unique.  Thus, people need to understand and evaluate each tenant, project, market and principal.
• one panelist briefly mentioned the all-important "mortgage experience adjustment factor" - which is a risk-based capital concept governing insurance companies who hold commercial mortgage debt.  Some time in the near future we'll blog on that mind-boggling concept - and the draconian effect that it has upon insurance companies and their mortgage portfolios.  It is horrible.

This is my last posting on the conference.  It met my expectations.  Everyone agreed: it was the "best" servicing conference in years - undoubtedly because this is the worse real estate market in years.

Today it is back to the office, and the nitty-gritty of workout world.

Please post your comments, suggestions or questions below.

P.S.: back to the restaurant review thing - although there are "cooler" places to go in New Orleans, if you stay at the Hilton Riverside (the conference hotel), then you're immediately adjacent to the Riverwalk Marketplace mall.  The Crazy Lobster (504.569.3380) is a free-standing bar and restaurant on the Riverwalk.  It is a good place to catch a breeze and a change of pace.  Like many places in NO, it has live entertainment in the evenings.  We escaped the conference for several lunches at the Crazy Lobster.  It is a short (100 yards?) walk from the Hilton.  (And yes, it is a GPP mall - and probably owned by an SPE.) (See discussion above on GPP and SPEs.)

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The first day of the 2009 MBA's Commercial/Multifamily Servicing and Technology conference has ended.

It has been a long day, filled with attending panel presentations and meetings with people over meals, in the halls and at receptions.  It started at a 7:30 breakfast and ended @ 10p (when I refused to join a group that headed toward B___n Street).

Attendance this year seems down by @ 40%-50% from prior years.  Indeed, several companies told me that they would not be attending this year.  And many companies seem to have sent only 1 or 2 people this year; instead of the usual 4 or 5.

It is late, and if I don't get this down-load out soon, tomorrow will hit with more panel presentations and meetings - and I'll "lose" these data points.  They are in the order collected by me during the day - and so they are NOT ordered by relative importance.  Here is the down-load  (remember, this is a blog and not a thesis or brief; and it is very late).

(One other preliminary and important thought: if your boss requires that you prepare a memo on the conference, consider this permission to cut'n paste as you wish . .  . . )

From the opening general session:

• during the next 2-3 years, the commercial mortgage finance industry will focus on servicing & asset management, which will be the new front line for the industry
• unemployment remains a key leading indicator of the performance of real estate as an asset class (and since unemployment is expected to increase, it will take several years for the asset class to recover)
• while defaults presently are @ 3%, some predict that the default rate will increase to 6%; consequently, special servicing will become busier, and the need for greater transparency will be increased (in order to support better decision making) (Note the Fitch report described below.)
• one speaker articulated five areas of focus for the industry: (1) greater transparency (with "real time" property performance data); (2) the need for high quality and detailed physical asset condition inspections; (3) greater focus on customized business plans for each asset, which points to the need for more expertise by special servicing; (4) the increase in defaults will strain human resources at companies (and require greater recruiting, more training and better integration); and (5) companies must be better at understanding macro trends and changes

From a session on developments in Washington, DC:

• expect more changes and experimentation by policy makers
• accounting issues include: (1) FASB 140 (true sale changes); (2) FIN 46(r) (balance sheet consolidation with the "primary beneficiary" of securitization vehicles); and (3) FASB 157 (fair value); all due to "FASB's perceived suspicion" of real estate structures
• REMIC reform will take a back seat to other issues at Treasury
• Single Purpose Vehicle (or single purpose entities) and separateness covenants: the General Growth Properties bankruptcy will be an initial stress test of this "bankruptcy remote" structure; although one panelist labeled the GPP structure as "SPE light with bad cash management."  Another panelist called the GPP case simply "bad facts, which should not be followed by other situations."  (This last point puzzles me: a clever borrower might view the GPP case not as "bad facts" but as a "helpful road map.")
• One panelist expects to see a new securitization in 3rd or 4th Q of 2009.  Wow.  Given all of the accounting and structure "issues" detailed during the day, anticipated increase in the default rate, etc. - a securitization in 2009 would be . . . well  . . . wow.
• Federal limits on executive compensation are a huge problem for investors; and are chilling the market by impeding companies from participating in Federal programs
• Terrorism insurance needs to be addressed . . . but the Executive Branch needs to cut programs - not increase the funding of them.
• Welcome to the "Age of Regulation"

From a panel session on dealing with troubled securitized loans:

• even life companies are starting to see their mortgage portfolios in distress (so they are focusing in-ward on their portfolios; and not outward to refinance CMBS loans)
• the demand for new commercial mortgages exceeds the supply
• long term, fixed rate interest mortgages are limited in amount
• property values are difficult to establish
• debt service coverage & loan-to-value criteria are very conservative (and thus underwriting is tough)
• CMBS structures do not offer refinancing (with only a limited ability to extend)

From a panel session on today's servicing challenges:

• servicers are surprised that subordinate lenders do not understand their rights (relative to the rights of the first-lien secured lender)
• communication among the lenders in the credit stack can be "challenging" (Wow; that was an understatement.  I've seen some deals where the disparate balance sheets and agendas of the lenders present the biggest hurdle to resolving a distressed project.  The project and the borrower can almost be an afterthought)
• valuation is a huge problem: every party at every point of the debt stack and the equity stack needs a good\reliable value in order to make decisions.  No value=No decisions=No peace
• as reported by Fitch Ratings in an April 29, 2009 special report, CMBS special servicing volume increased by more than 5.0X in the 15 months ending March 31, 2009 (from $4.6B at 12/31/07 to $23.7B at 3/31/09).  And these figures do not address distressed bank debt, nor distressed life insurance company debt.  More wow.

Taken together, I come away from the day with much the same impression as I did on that day three session at the EU conference last fall: no one is clapping.

Time to go to bed.

If you have your own comments, or follow up questions, please post a comment below.

P.S.:  Returning to the eating theme from my posting on Tuesday, and before I get some sleep -  here's another good restaurant in New Orleans: Herbsaint Bar and Restaurant.  This is the second restaurant recommended to me by a New Orleans native.  I now understand.  It is very, very good.  Not as fancy as Nola; much more stylish than Jacques-Imo's. And not in the French Quarter. Together, all three restaurants will pull me back to New Orleans.

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Over the last 8 months, we've blogged in October from the EU, where we attended a real estate convention and visited with several clients (link to last day), and then in February from the MBA-CREF convention in San Diego (link to last day),

This week, we're attending the MBA's Servicing & Technology Conference in New Orleans.  This will be my 9th or 10th time at this conference.  In the past, the focus at each conference has been the nuts'n bolts of master servicing (i.e., servicing performing loans after loan origination) and the growing use of technology as the servicing backbone.  Bread and butter stuff, with a growing awareness that technology could make significant improvements to the production and servicing model.

Each year at this conference, the special servicing "naysayers" (i.e., those handling the servicing of distressed loans) darkly predicted that the loan production party was about to end - that the workouts surely were about to start.  Surely.  Sometime.  Simply a matter of time . . . .

Well, it has ended, and the conference this week has a heavy focus on distressed debt.  Broadly stated, here is a quick, high-level summary of the topics to be covered at the conference:

• Loan workouts and restructures
• Default management and delinquencies
• Risk mitigation
• Insurance issues
• Bankruptcy & receivership
• Accounting & tax issues (including REMIC issues & implications)
• Servicing issues in a changing environment
• Transparency issues
• Issues in foreclosure

As it turns out, this conference completes a trifecta for us - this is the last of  three meetings which, when taken together, would be fertile material for Shakespeare:

• Act One: The Global Hurricane Hits (our EU experience)
• Act Two: Loan Production in the Big Ditch (our MBA-CREF experience)
• Act Three: Special Servicers to the Rescue (this week in New Orleans)

Stay tuned.  I'll be posting from the conference.  And I suspect that we'll be collecting materials for many more postings after this week.

P.S.: OK, so I snuck into town several days before the conference - simply to eat and sleep.  Top restaurants so far - on two extremes:

• Jacques-Imo's: full of locals for a funky, affordable creole & cajun food (eat with the locals); 30 minute ride on the St. Charles Street car from downtown (more fun)
• Nola: great food but expensive (relative to Jacques-Imos); white table cloth

If you have any questions or comments for us to investigate while we're at the conference, please post a comment.

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Earlier this month, I was interviewed by financial journalist Nathan Stovall on the state of banks and loans in Texas.  Stovall's article in SNL Financial's Banks & Thrifts section focuses on the Texas economy and how banks are preparing with regard to commercial real estate loans. My comments can be found in the article pasted below (half way through the article). SNL Financial is a global company that collects, standardizes and disseminates all relevant corporate, financial, market and M&A data — plus news and analysis — for the banking, financial services, insurance, real estate, energy and media/communications industries.

Will Texas remain the Lone Star?
April 16, 2009 5:47 PM ET
By Nathan Stovall

With the Texas economy beginning to soften, first-quarter bank earnings will clearly show that the Lone Star State is not immune to the downturn, but it should still outperform the rest of the country.

The Texas economy has proved to be a positive outlier, and lenders' credit quality in the state has outperformed banks in the rest of the U.S. The Texas economy's GDP expanded by 4.2% in 2008, more than double the pace of the U.S. economy. The state comptroller's office estimates that GDP in the state will increase 1.8% throughout fiscal 2009, well above the expectation for the U.S. economy, an 0.9% contraction.

Sterne Agee & Leach Inc. analyst Brett Rabatin has questioned whether GDP projections for the Texas economy could be too optimistic, highlighting the fact that a March commentary from the Federal Reserve Bank of Dallas indicated a "more pronounced drop-off in recent weeks" amid waning consumer demand, a declining real estate market and tumultuous financial markets. Rabatin noted in an April 13 report that Texas is beginning to feel the impact of falling energy prices, which equated to roughly 10% of the state's GDP in 2007. The analyst further said that the index of Texas Leading Indicators, a metric produced by the Federal Reserve Bank of Dallas combining eight measures that can anticipate changes in the Texas business cycle by over a three- to nine-month period, experienced a more meaningful year-over-year decline in January than in any other point during the previous two recessions. It fell by 15%.

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Following up on my earlier posting covering impossibility performance as a possible defense to performance\pay-off of a loan at loan maturity -

As everyone knows, yesterday the #2 owner of malls in the U.S. (General Growth Properties) filed for bankruptcy.  Here's link to a blog on seekingalpha.com that contains copies of GPP's 8-K and the voluntary filing, and some interesting commentary about the situation.

From my perspective, the GPP filing simply might be the logical and ultimate outcome of an impossibility of performance "defense" or perspective - with the important twist that GPP is simply too big to assert the defense in each of the states where it does business.  In other words, the combination of (i) an "impossible market" and (ii) a huge, multi-jurisdiction business footprint simply forced it to file BK.

Here are portions of the blog posting that lead me to this perspective:

• This is not a typical Chapter 11 as the reason for reorganization is not due to a company that cannot pay bills, credit markets have cause extenuating circumstances.  Because of that, the "usual outcome" some assume must be discounted and other options receive more weight.
• There is legal precedent in 11 for equity remaining whole
• [The COO on CNBC states]:
  
  * Rent are stable
  * NOI up
  * Not negotiating leases
  * Occupancy strong

Please post your thoughts, comments or perspective.

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I've commented before on the need to closely monitor "changes" in your state legislature.  I've highlighted pending legislation in South Dakota on commercial loans by life insurance company; and pending legislation in Wisconsin lifting the limit of the state's wage lien law. 

This trend will continue as the economic "crisis" continues.  It probably is bred by several factors:

• states searching for more money (who doesn't need more money now?);
• politicians becoming more populist (who doesn't want to keep their job?); and
• _____________ (you can fill in the blank).

Even Texas seems to be joining this movement, which is somewhat shocking, because generally, on many topics, Texas embraces "caveat emptor" - everyone should take care of them self.  ("This is a big state and everyone needs to be a big boy.")

Recall that in an earlier posting, I mentioned the Texas Attorney General's proposal to give Texas residential consumers a mandatory 45 day cure period on mortgage defaults.

Well, the Texas legislature now joins the movement. Earlier this month, legislation was introduced in both the Texas House (where it is in committee) and in the Texas Senate to impose fees on lenders as they post mortgages for foreclosure.

These fees will be used to fund civil legal services for indigents in Texas - if the legislation becomes law.

The importance of my comment is NOT to predict whether this legislation will become law, nor to debate the need for civil legal services for the poor.  The importance is that these pieces of legislation clearly substantiate the validity of my "factors" listed above: state politicians are looking for money and for votes.

But why is it important for all of us to monitor these trends?

• these laws will increase the cost of doing business; and
• these laws will be "trip wires" for us as we deal with distressed debt (in that they will cause delay, and will be a possible source of much pain if we forget them)

No doubt, dealing with distressed debt will just keep being more and more difficult.

Please post a comment if you are seeing similar trends in your state.

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Last week the G20 met in London during the most severe global recession in G20 history. A serious time to face issues needing serious answers. But it's difficult to take the G20 seriously. Sad, because they make up over two-thirds of the global population and 90% of its economic power.

Besides a vague "commitment" from the rest of the world to "stimulate their economies" by spending 1.1 trillion dollars over the next year, nothing but a bunch of generalities about "better cooperation among nations and sharing of information" has come out of the meeting.

Over the last year or so, numerous U.S. Treasury announcements (mostly coming from Secretary Paulson) lamented the inadequacy of "nation-based" tools to deal with a "global" crisis. Bank regulators and financial ministers from around the world generally agree that they fundamentally lack jurisdictional tools to deal with the global financial crisis. What is needed is a structural and fundamental change in the relationship between G20 member nations and its governing body so that concerted and concrete agreements can be reached with binding consequences on member nations. Additionally for the current crisis, the G20 created a very specific agenda with subcommittees designed to deal with such issues as:

• developing standard convention reporting on credit default swaps and derivative trading, with a goal toward some form of reliable "central clearinghouse data" for nations to share;
• the development of "floor and cap" limitations for a 2-year period on the fluctuation of currency exchange rates;
• the development of a process to articulate specifically what regulatory areas could be addressed for establishing capital-to-loan ratios for large international banks and other financial institutions.

If the G20 wants to be taken seriously, it has to come up with a set of relatively specific recommendations to begin the process of regulating global economic issues in a way that will lend stability to global markets in an effort to avoid the type of "rolling financial crises" we have seen reverberate throughout the world.

If you have any comments, or helpful links, please post a comment.

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Is it possible to "discover" a market? We've all had a little more than a week now to digest the recent Treasury announcements regarding the creation of two public-private investment programs which, through Washington, DC wizardry, will magically convert heretofore "toxic" assets into "legacy" assets.

Briefly, here's what the two programs look like:

The Legacy Loan Program ("LLP") will purchase residential mortgage loan pools and other troubled eligible assets from participating banks through the provision of FDIC debt guarantees and Treasury equity co-investment with private investors. A wide array of private investors are expected to participate. The program will particularly encourage the participation of individuals, mutual funds, pension plans, insurance companies and other long term investors. The program is intended to boost private demand for distressed assets that are currently held by banks and facilitate market priced sales of troubled assets. The FDIC will provide oversight of the formation, funding and operation of a number of public-private investment funds ("PPIF"), that will purchase assets from banks. U.S. banking institutions of all sizes (including state banks) will be eligible to sell assets under the Legacy Loan Program. To start the process, the banks will identify for the FDIC "troubled assets" setting on the balance sheets; typically pools of mortgage loans they wish to sell. Assets eligible for purchase will be determined by the participating bank organizations, including the primary bank regulators, the FDIC and the Treasury. The FDIC will guarantee the debt issued by the PPIF to the banks to purchase these assets. These loans will not exceed a 6:1 debt to equity ratio. After the banks and FDIC have identified the loan pools and established financing terms, the eligible pool of loans, with committed financing, will be auctioned by the FDIC to qualified bidders. Private investors will bid on a 50% equity basis, with the Treasury contributing the remainder of equity.

See linked diagrams:
Legacy Loan Program
Legacy Securities Program

The Legacy Securities Program ("LSP") creates PPIF's designed to purchase the over-hang of Residential Backed Mortgage Securities ("RMBS"), Commercial Mortgage Backed Securities ("CMBS") and other non-real estate asset backed securities, all originally rated AAA without credit support. The Treasury intends to make this program available under the previously announced TALF Program or through pre-qualified PPIF accounts run by five pre-approved "Fund Managers" who are experienced fund managers and meet specified criteria. The equity for these funds will be 50% from private investors and 50% from Treasury. Additionally, the Federal Reserve will provide supporting loans (on terms yet to be determined) equal to 50% of the fund's total equity. The Treasury will consider requests for senior debt for PPIF's in an amount up to 100% of the fund's total equity. Additionally, it is possible that these funds will be independently funded by TALF senior debt.

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In several earlier postings, I've warned of changes at the court house, and at state legislatures and state regulatory\administrative agencies.

Today, the Mortgage Bankers Assn circulated an e-mail relating to current legislation in South Dakota for a new business tax "on interest and servicing income of life companies for loans made on commercial properties, similarly to what it charged for banks."

The announcement explained that in response to the legislation, the American Council of Life Insurers argued "that life companies are lending to meet the actuarial needs of policy holders and that their income is already taxed under a different regime (gross policy receipts tax) and taxing the commercial real estate lending activity of life companies would constitute double taxation for life companies."

The announcement goes on to state that "South Dakota is doing this primarily to raise revenue and to allay banking industry arguments that life companies have a competitive advantage by not having to pay business taxes on net income.  The South Dakota legislature is anticipated to take action on this legislation on Tuesday, March 3. Despite frenzied lobbying efforts last week, unfortunately, we are not optimistic that this legislation can be stopped because it has been strongly supported by the Governor. If this is of concern to your organization, we would urge your government affairs team to weigh-in on this issue with their contacts in the South Dakota’s legislature and Governor’s office." 

This one is worth watching: what state will NOT be looking for new ways to raise money?

• anything like this in your state house?

A friend of mine several years ago told me that "change is our friend."

I think we'll all agree that in the foreseeable future, "change will be expensive."

Please post a comment or identify any other trends of interest to commercial lenders.

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In a prior posting, I mentioned the need to watch for local legislative and regulatory\administrative trends or changes.  But don't forget to watch for changes at the court house, too.

We've been watching, waiting and even researching this one: an assertion that Borrower would pay at maturity of the commercial mortgage loan, except that the credit crisis makes it "impossible" for the Borrower to find another loan to pay-off the matured debt!  This is NOT a "new" legal theory.

In the "old" economy, such as argument was, well, perceived as silly in the context of commercial mortgage finance.  What fool will argue impossibility when money is plentiful?  And, today there still is money available - it just costs an arm and a leg (from equity sources and from debt sources).

However, in the "new" economy (or whatever you want to call it), the argument becomes more interesting. 

It's just begging for the right jurisdiction, the right facts, the right judge, etc.  Maybe a jurisdiction where charging an arm or a leg will no longer be tolerated.  Maybe a jurisdiction with an implied covenant of good faith and fair dealing, and a "new" judiciary willing to extend the concept in a crisis . . . .

This "impossible" assertion has bubbled up on two recent cases: (i) a recent posing at The Dirt Lawyer's Blog describes a case in Chicago involving a "dead" acquisition of an office building located at 180 North LaSalle in Chicago, and in passing refers to a case that we've been watching, (ii) the Trump Tower case, also in Chicago, but involving mortgage finance issues.

Succinctly stated:

• I can't buy this office building (180 North LaSalle), because I can't find reasonable funds
• I can't pay off the loan on this building (the Trump Tower), although I can continue to make the monthly payments, because I can't find reasonable funds

Strangely, Chicago seems to be ground zero.  (What 's going on in Chicago?  Recall the River East case in late 2006, which involved a Federal trial court ruling that a yield maintenance clause was an unenforceable penalty under Illinois law.  Of course, the Seventh Circuit Court of Appeals reversed the trial court in 2007.)

I can think of several other jurisdictions where this argument might find a home - if not in Chicago.

From my perspective, this is exactly the type of innovative lawyering that we'll experience in these tough times.

You need to get ready for change from the legislatures, the administrative\regulatory agencies, and the courts.

• are you seeing the "impossibility" argument in any cases where you operate?
• are you hearing borrowers starting to beat the drum on this one?

Please post your comments and observations.

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The Wisconsin Bankers Association reports on a Wisconsin bill that could foretell things to come, if the "new" economy continues to slide:  laws that protect the wage claims of workers at the expense of existing liens held by others.

Briefly, this Wisconsin statute recognizes the rights of employees (subject to certain exceptions excluded by the statute) to enforce a wage claim lien as a "super priority" lien even against pre-existing liens.  Currently, there is a $3,000 per employee cap amount. However, legislation has been introduced in Wisconsin to remove the cap.

Why should you care (unless you're hibernating in the frozen tundra of Wisconsin)?

• It points to the importance of knowing the local law. When you exercise remedies, your first move should be to hire qualified, experienced local legal counsel who know the bumps in the local road – and who stay current on the most recent changes and trends.
• Expect pro-borrower changes to the law. Look for it. The prediction here is that we're going to see more and more of these types of pro-borrower laws in the near future – most certainly as the public becomes frustrated with the economy, the role lenders played in the financial melt down, the public "investment" in banks, _________ (you can fill in the blank). So, be on alert for changes to the default and foreclosure process.

Indeed, even in the State of Texas, a bastion of caveat emptor and "free" markets, we're seeing pro-borrower changes.  Last fall, the Texas Attorney General proposed consumer-friendly changes to residential foreclosure laws – including requiring lenders to give longer cure periods, to contact the consumer by phone or in person (as a condition to starting the foreclosure process), and a time period to vacate the residence after foreclosure.

This is just one way that this real estate down turn will be different.  Change is coming.

This will be a different tough time.

Please give us your comments, questions, predictions or incite to changes in your state.
 

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The MBA Commercial/Multifamily NewsLink is a wonderful tool if you're wanting to keep current on trends, news and data.  Consider subscribing to this daily resource.

Today's issue contains a summary of the convention.

It is worth reading.

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(This is part of a series of postings from the 2009 MBA-CREF convention in San Diego.) (Trends; Arriving;  Day One; Day Two; Day Three)

My time at the convention has been a series of "firsts" for me:

• "live" blogging on Day Two during the Opening Session talk by Paul Begala of CNN and Tucker Carlson of MSNBC (thereby cementing, and forever embracing, my "inner geekness")
• after experiencing the credit crisis first hand in the EU last fall (Before; Day 1, Day 2, Day 3, Day 4 & Last Day), I completed the high-level credit crisis perspective by immersing myself in it here at the MBA-CREF conference - after years of drinking from the "frothy" side of the real estate finance cycle
• finally, this is the second blog entry for today - the last day of the convention.  I've never done two of these in one day.  (. . . need to find a hobby.)

But don't think that I've saved the "best" for last; because there is a "positive" side to the new economy.  There is opportunity in chaos and change.

However, I am continually approached by people concerned about the inability of CMBS borrowers to locate financing to refinance their CMBS loan.  Notwithstanding efforts by the CMSA and the MBA to educate the industry on this product (such as their brochure explaining CMBS debt), much confusion and misinformation exists about CMBS loans.

So, this last entry will focus on a session here at the convention that addressed the myths of CMBS servicing . . . . "click on" to read on . . . .

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(This is part of a series of postings from the 2009 MBA-CREF convention in San Diego.) (Trends; Arriving;  Day One; Day Two; Day Three)

It is no surprise that the convention is markedly different from previous years.  Everything has changed (unfortunately that's almost NOT a terrible understatement): lenders have a new focus (and those with "real" investment allocations to lend are few in number), servicers are under scrutiny in the face of looming defaults, and mortgage bankers are seeking ways to serve (read "save") their best borrowers.

Kudos to the MBA for directly addressing these changes and challenges.  The sessions were informative.  The discussions were frank.  Too bad attendance at the convention is down.

Here are some of the topics, observations and comments:

• Servicing is servicing.  While servicing CMBS clearly has unique twists and challenges (such as the servicing standard of care, "tension" among the investor classes, etc.), portfolio lenders and CMBS servicers share many common hurdles in dealing with troubled loans.  (My next post will address some frequently asked questions about dealing with troubled CMBS loans.)
• The erosion of credit and value is a critical challenge.  Yesterday's debt service coverage and loan to value definitely is not today's story.
• The stack of first lien mortgage, mezzanine debt and even holding company leverage, which I affectionately call the "Other People's Money" mantra of the "old" economy, is yesterday's story and today's headache.  In prior conventions, sessions focused on these "tools" of the finance market.  This convention didn't even mention it - for good reasons: we're now dealing with the hangover.
• It is difficult to identify the correct asset disposition strategy when relative values are difficult to determine - values seem to change weekly.  In all sectors (products) and markets, appraisal valuations are problematic.
• Life companies are placing greater emphasis on debt service coverage, with less reliance on loan to value measures.
• The ability of borrowers to pay off a loan at maturity (the inability to pay is called a "maturity default") is under question due to the fear that community and regional banks are tapped out in their ability to place mortgage debt on their balance sheets.  And since these loans are limited term floaters, with equity pay-downs and guaranty agreements, they are only a temporary "fix" to the larger credit problem.  In other words, the boomerang remains in the air.
• Generally, the strategy of CMBS servicers and portfolio lenders is this: extend (if possible), wait and increase surveillance.  However, an extension has a price: new underwriting of the market, the project and the sponsor, with an extension fee, new reserves, lock box structures, amortization, etc.  An extension needs to make sense.
• Regulatory reform is coming.  For the life company, this means possible changes to risk-based capital (and the dreaded "mortgage experience factor") and possible "opt in" Federal licensor.  For the CMBS servicers, this means possible REMIC reform (again) addressing seller financing, control over the special servicer, etc.
• The need for greater information flow.  For the life company, this plays out in rating agencies asking for loan level information - like the information available in CMBS pools.  This second guess is totally new for life companies.  (For years, I periodically ask my life company clients: do you want outside counsel to prepare a loan and property summary like the ones we prepare when we close a CMBS loan? The prediction here is that the time has come for this change.)  For CMBS servicers, investors are asking for even more loan level information.  They've learned that they can not simply "trust" the certificate rating - they need to understand the current status of each loan in the pool (beyond the data contained in the current investor reporting package).
• Note sales are problematic.  On the CMBS side, they have slowed, with a wide gap between the bid and the ask price.  It was noted that there exists a correlation between AAA CMBS spreads and the volume of note sales.  Thus CMBS prices need to stabilize in order for loan sales to increase.  On the portfolio lender side, the risk-based capital rules literally rob the portfolio of the ability to craft loan restructures that place the lender in a position to increase its yield (and profit from a rebound in the market).
• Life company underwriting is now a return to the basics: 1.50x minimum debt service coverage; maximum 55% maximum loan to value (slightly higher for multifamily); shorter term; avoid hotels; beware of retail and "transitional" projects (which is a problem for banks seeking takeouts for construction loans); closely examine employment base of local market; scrutinize debt maturities of the principal; consider the use of lock box and SPE structures; less reliance on appraisals (due to valuation challenges) and more reliance on debt service coverage; etc.

This convention has been "rich" - not in the sense of money being thrown at deals (as in prior years); but rich in information, determination and the resolve to navigate these challenges.

The unspoken mantra seems to be: we can do tough times.

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(This is a little out of order, in that in our Monday blog we covered in "real time" the Opening Session and today [Tuesday] we cover the Sunday committee meetings.  But then this is a blog, which is a bit different any way.  So, here is our summary of the Sunday committee meetings.)

Although separate servicing and origination meetings were on the agenda, last minute plans combined the groups into one meeting; perhaps because the silence would have been deafening, had the originations group held their own meeting.
 

The meeting was candid and sobering without being alarmist, covering a wide range of topics, including:
 

• CMBS servicers generally believe that annual delinquency estimates for 2009 have increased from 7.5B (estimate in Nov. 2008) to 15B currently and that real estate values will decrease further from 2008 by an additional 10% to 15%.

• The life industry is having a hard time articulating 2009 allocations for "new" originations because they are generally limited by ratios of in-force mortgages to total assets, and they are very unsure how their mortgage and bond portfolios will pay-off, refinance or be extended, either internally or through 3rd parties, all having significant effects on funds available later in the annual cycle (3rd and 4th Q)

• Risk-based Capital Allocation requirements are hurting servicing outcomes for the life companies

• Discussion of maturity default risk and it's timing (late 09, but significantly more in 2010 and 2011)

• Modifications (through the use of extensions) instead of foreclosure in a capital frozen environment seems to be the way to go

• Emphasis on "capturing the cash", i.e. cash management as the cornerstone of workouts

• Special servicer concerns over liability under the PSA or as fiduciary for actions taken or directed by the B piece buyer as the controlling class

• Much gripping about mark-to-market and the need for clarifying guidance from the SEC.
   

The sun came out today,
but like the fickle markets,
didn't stay.

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Yesterday (Sunday) at the 2009 MBA-CREF convention was like every Sunday in past conventions, where the "hard core" attendees participated in committee meetings addressing industry issues, while the "hard core" loan originators played golf. 

The late afternoon and evening was full of the usual receptions.  However, since there are no longer any investment banks, the parties were muted and without live music (past conventions featured The Eagles and The Steve Miller Band -  usually at parties hosted by the investment banks).

But, this is the "new" economy and it controlled the day on Sunday:

• the industry issues were evident to everyone at the meetings, which were the most frank, direct and pointed discussions in my years of attending the Sunday meetings (we'll post on those issues in a separate entry)
• it was even a sunny day for the golfers

Right now, I'm sitting in the huge meeting room for the opening session.  Last year it was a standing room only session.  Today, there are extra seats.

This is the first time that I've done a "live" blog.  So, here we go, with the opening session of the 2009 MBA-CREF convention. 

Both John Courson, President of the MBA, and David Kittle, Chairman of the MBA (and EVP of Stonegate Mortgage Corporation), both gave opening remarks.  Courson's remarks focused on the MBA's role in the real estate finance industry, and the liquidity crisis (using by analogy the King Kong movie).  KIttle focused on the opportunities in the crisis, including MBA's proposals being pushed on the Hill, in the regulatory agencies and with the new administration.  In particular, Kittle mentioned the recent white paper issued by the MBA on the liquidity crisis (specifically the secondary mortgage market and the role of the government-sponsored enterprises).

Now for Tucker Carlson of MSNBC and Paul Begala of CNN . . . .

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The last posting articulated some of the issues that we hope, or expect, will be addressed at the convention.

We arrived in San Diego, California yesterday (Friday) to visit a life insurance company client.  My initial impression is that several of my "remote" perspectives appear to be right on:

• It was raining. It was cold.

Yes, cold and raining in sunny and pleasant San Diego.  I can't ever remember it raining at an MBA-CREF convention in San Diego.

Even checking into the main convention hotel was a different experience.  In prior years, when this event was held in sunny San Diego, the two "main" hotels sold out months in advance, and then the 4 or 5 "secondary" hotels filled up.  (During my first time at this convention [10 years ago], I registered two months in advance, resulting in, to be gentle, "fourth" or "fifth" tier hotels -- as in 4 bolts on the inside of my hotel room.)

On Friday, however, when we checked in at the main convention hotel, extra rooms were available.  Today (Saturday) is the day before the first day of the conventions.

• It is still raining.  Even the weather is tough.

Tomorrow the convention starts.  We'll see if even the typical "upbeat" commercial mortgage lending community can put a positive spin on the "new" economy.

I hope that at least the weather gets better.  We need some sun.

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In October 2008, Brenda Brown, Keith Mullen and Lou Strawn authored a series of posts while attending a real estate conference in Munich, and then from London as we returned to the United States.  The series chronicled the European perspective as the economic crisis first rattled around the world (Day 1, Day 2, Day 3, Day 4 & Last Day).   A "big picture" view of the crisis can be helpful in dealing with a troubled loan.

Before we attended the conference in Munich, we anticipated some of the topics that we thought would be of interest to Europeans, as the EU anticipated changes in U.S. politics, and as they watched alarming events in the U.S. economy (Pre-EU Trip ).

Early next week, we'll focus on the "big picture" in the U.S., as the three of us (and other Winstead lawyers) attend the Mortgage Bankers Association's Annual Commercial Real Estate Convention.  The focus of the convention is commercial real estate finance in the U.S. It is a huge "meet and greet" for lenders and mortgage brokers - where lenders explain their loan production in the prior year and present their projected production in the coming year, and ask mortgage bankers to help them achieve these goals.

Just as we did prior to our EU trip, we have listed what we think will be some of the "hot" topics at the MBA-CREF convention:

• Some anticipate that the turnout will be 40% below the attendance at last year's convention. What does this say about the anticipated volume of commercial real estate loans in 2009? Are people NOT attending the convention because they anticipate a significant decrease in loan production in 2009? Or is all or part of the drop-off simply because the investment banks, and the CMBS loan production shops (and product) have disappeared?
• As to CMBS, what about the looming "maturity defaults"covered by our earlier post? What will replace this large component of the financial market? What will happen when there are limited sources of commercial mortgage finance?  What does a severly constricted loan production line look like?
• Will the life companies increase their investment allocations to allow for an increase in mortgage loan production? What about the rumor that several life companies remain "out" of the market, and that other life companies have a defacto "no new loan" policy, based upon extremely cautious underwriting criteria? What will this look like in the market?
• Another rumor is that interested investors actively are contemplating starting new loan production platforms (partly in response to the void created by the death of the CMBS loan origination market). Is this for real?
• Some believe that we're about to enter the "age of regulation." How will this play out in 2009? For example, the risk-based capital rules severely limit the ability of insurance companies to restructure troubled loans. Will these rules be revised? Also, will Federal regulation of insurance companies be implemented; and how will that play out in mortgage investments?  Turning to banks, one rumor is that bank regulators effectively have put a freeze on new commercial mortgage lending. Will the regulators change their tune, so that banks, who hold a majority of commercial mortgages in the U.S., start to lend again?
• In 2009, will we (finally) experience a significant up-tick in defaulted commercial mortgage loans? Will they be bank loans, CMBS loans or life insurance company loans? And is the industry prepared?

These are incredibly troubled times in commercial real estate finance. This should be an incredibly interesting convention.  We will be reporting on what we hear and discover at the convention next week.

Please post your comments and questions.
 

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Many of our postings deal with the practical and granular subjects (and perspectives) of problem loans. Periodically, however, we'll leave the action on the ground and comment upon topics far overhead. This posting touches upon one of the culprits or causes of this extremely tough economy.

We all know about credit default swaps (CDS); those shadow-lurking liabilities contained in securities offerings in which a “counterparty” agrees to “repurchase” the securities upon the happening of a “credit event.” This is the much ballyhooed “sword of Damocles” that in the event of a true worldwide credit meltdown would create a $60 trillion potential liability. Because the CDS has been unregulated and unreported, the liability number has been hotly debated. Many say that the $60 trillion number - more than the capital of the insurance and banking industries combined - is a “gross” number and does not take into account the value of the underlying assets, and that the “net” number is substantially less (yes, FAS 157 “mark to market” concepts are at work here).

Credit default swap agreements have been used since the late 1990s as a method of providing credit to a static pool of securitized assets. But it wasn’t until the Commodities Futures Modernization Act of 2000 (the “Act”) that Congress acted to create a category of derivatives called “Security Based Swaps,” which became largely an unregulated and unreported activity (the Act pre-empted state regulation for most, but not all, CDS as being outside the “business of insurance”).

With that as a background, last week The Congressional Committee on Oversight, after establishing widely held sentiments on both sides of the aisle that CDS should be regulated, moved to the question of just who should be doing the regulating. Should it be the FDIC, since its regulated banks were up to their eyeballs in these liabilities? Or should it be the SEC, because of the securities aspects of these transactions? Or should it be the Commodities Futures Trading Commission? Yes, and even the State insurance commissioners have gotten into the act. The New York State Insurance Department has done a flip-flop on this; back in 2000 it was the New York Department’s view that CDS not held by beneficiaries who also had an owner interest in the underlying securities were not an “insurance product” and that sellers of such swap agreements were not “engaging in the business of insurance.” More recently we’ve come to find out that the New York State Insurance Department believes that it has the power, and presumably should, regulate CDS in which the beneficial holder of the interest of the swap has a direct securitization interest in the pool (estimated to be about 10% of the CDS universe) and that therefore the credit provider is engaging in “Financial Guaranty Insurance,” regulated under New York State law.

Many have speculated that the purpose of the New York insurance commissioners pronouncements aren’t to bring this incredibly large morass of problems under New York State regulation, but simply to get the federal government to act.

My two cents worth is that this problem is way, way bigger than even the great State of New York can handle, involving issues of national and international consequence. So does that mean the feds can do it? Not necessarily, but they need to try.
 

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Day Five Report from Keith Mullen and Lou Strawn in Europe

Our trip to the EU nears to the end as we touch down in London for a brief day and a half stay.

The cultural change between the two cities is a bit of a shock (or to phrase it as an American, it is "stunning"). And, of course, the difference plays out on page one in banner headlines of the London newspapers:

• The Guardian: Lost in Iceland - L1 billion from councils, charities and police
• The Daily Mail: Cold War!  As Iceland refuses to honour L20bn British investments in its failed banks, furious PM goes on the attack and freezes THEIR assets
• The Times: "World must follow my example," says Brown

While the British are reserved in their personal communication (when compared to us), and dry in their humor, these headlines clearly show that the economic crisis is at the top of their day - for the entire day.

Tomorrow morning we return to the U.S., and on Monday to the granular expression of the new economy: the work on individual, troubled credits. We do so with a new appreciation of the global reach of the economic crisis.

We definitively are not in it alone.

If you have any observations or comments, or any questions that you'd like to ask about our EU trip, please "post" a comment.
 

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Day Four Report from Contributing Writer Brenda Brown (with Keith Mullen and Lou Strawn) in Europe

On this fourth day of our trip, I awoke to yet more news of the ever-evolving, now global ‘credit crisis’ during our stay in Munich, where we are attending a real estate conference. It's great to be back in Munich (where I studied during college) to experience the Bavarian culture again, and to readjust my ear to the unique Bavarian accent. I'm amazed at how quickly my ability to even "think" in German (auf Deutsch denken) returns to me. While Keith Mullen and Lou Strawn listen to CNBC Europe and read the English papers, I focus on the German media.

German news highlighted the general instability and frozen financial markets now spreading across Europe, the 40% loss of value of the Royal Bank of Scotland, Iceland’s nationalization of banks, possible bankruptcy of its banking system, and the current, virtual standstill in commercial real estate finance.

Uncertainty in the financial markets seems a greater concern than illiquidity. However, one has to wonder, and ask the age-old question, “which came first?”

The daily changing financial crisis has caused a general perception that real estate investment capital will remain, in large part, on the sidelines during 2009, waiting not only for the “bottom” in valuations, but also for a sense that conditions are stable.

Predictions indicate that over the next year future loans will involve significantly lower risk, and therefore will be ‘safer’ for lenders (due, in part, to better income coverage and value ratios). The headline of a front page article in the Immobilien Zeitung (the German real estate trade newspaper) sums up the apparent turn to avoidance of risk: Investment Markets - 2009 will be ‘the Year of Safety’.

German TV this morning also surprised me when I heard the newscasters telling people not to take their money out of the banks.

The three of us are amazed at how the Germans share the same concerns as we do. At a cocktail party last night, conversing with the locals, it was clear that the 40-something generation is concerned, but generally believes it will work out. By contrast, our parents' generation seems to have a grave concern that we'll see a crisis that may take decades to recover.

If you have any observations or comments, or any questions that you'd like us to ask during our EU trip, please "post" a comment.
 

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Day Three Report from Keith Mullen and Lou Strawn in Europe

On this third day, Keith Mullen, Brenda Brown and I attended the opening session of a European-based real estate conference.

The opening meeting was a Q&A session with a panel composed of the head of a major German bank, the head of the Morgan Stanley European Real Estate Fund and the former chairman of the Euro Hype Fund. The room was standing room only, and the subject was (you guessed it) "Subprime, Credit Crunch Nonperforming Loans . . . The Year After (Strategies for dealing with the crisis)."

What is clear is that the Europeans are as concerned about their banking industry as their U.S. counterparts. The panel stated that this crisis has migrated from a "credit crisis" to a fundamental "trust crisis," and that trust will not be restored by more or stronger regulation, or enforcement, but by the investment behavior of the banking institutions themselves. Upon reflection, it is an interesting and alarming thought.

On a brighter note, the panel emphatically stated that there was no real danger of EU depositors losing funds as of last Friday (October 3rd), when it became clear that members in the EU would commit (and had committed) bailout capital similar to the U.S. Germany committed 520 billion euros; Ireland committed 400 billion euros; and Holland a similar amount. (This amount is in excess of the U.S. bailout.) However, these members did not take the buy "toxic debt instruments" like the U.S., but instead, they elected to directly back bank deposits.

The panel also discussed the volatility suffered by EU banks due to the swings in "mark to market" rule interpretations -- it was almost as if the panel was describing the U.S. banks. And, of course, the panel at length focused on the need for transparency, and the "German mortgage bond," which we know as the"covered bond."

No one clapped at the end of the session.  Everyone simply left the room.

If you have any observations or comments, or any questions that you'd like us to ask during our EU trip, please "post" a comment.
 

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Day Two report from Keith Mullen and Lou Strawn in Europe

The second day of our trip (and the first full day) is sunny, without a cloud in the Munich sky. To acclimate ourselves to the time change and for a quick immersion into German culture, we take a long walk through the Englischer Garten, which is the "central park" of this manicured Bavarian city. We're seeking a late brunch and perhaps some beer.

The park is alive in the celebration of Oktoberfest. If life on the U.S. side of the pond has inhibited or sheltered you from this event, think of it as a mixture of the Texas state fair (which is the largest in the U.S. except Oktoberfest is much, much, much bigger) and pregame at The Grove when LSU is in Oxford, Mississippi playing Ole Miss (except substitute beer for whisky, but much, much more beer). Now throw in a wonderful mix of old and young wearing traditional Bavarian clothes. It is a colorful and engaging picture.

While the beer mugs at the Chinesischer Turm and the Seehaus are many and full, the credit crisis is a dark cloud.

Here are several examples:

• At the concierge's desk at our hotel, free copies of the October 2 issue of Time magazine are available. The feature story is "The New Hard Times" and the cover shows a soup line from the '30s. Both Lou Strawn and I are military "brats" who lived in then West Germany in the '60s, when our U.S. military fathers were part of the U.S. occupation after WWII. The hard times story strikes a deep chord.
• At the Seehaus beer garden, we join several hundred people enjoying the sun and rich German beer. The couple sitting next to us reads the Munich paper. Like The Times in London, the credit crisis is fully covered. But in Munich, the failure of the German Hypo Real Estate fund grabs head lines.
• Back at the hotel, the news shows focus on one thing: the economic crisis, the bank bailouts, the Hypo Real Estate failure, etc.

Sunny skies. Oktoberfest. World-wide economic crisis. Both sides of the pond focused on troubled times.

This was NOT on the itinerary when we started planning this trip six months ago.

If you have any observations or comments, or any questions that you'd like us to ask during our EU trip, please "post" a comment.
 

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Day One Report from Keith Mullen and Lou Strawn in Europe

London's Heathrow Airport certainly is a remarkable place. The entire world seems to be here in a controlled chaos that the Brits handle with great charm and even wit.

After an exhausting 8-hour flight, we homestead several chairs and grab the Saturday (October 4) edition of The Times.  It doesn't take us long to discover Britain's interest in the financial crisis. The crisis appears in a text box on page one with a lengthy story and a smaller story on page three. In addition, the business section of The Times contains several stories covering subjects related to the crisis, and Martin Walker's column which focuses solely on the U.S. bailout legislation.

We have six hours before our plane departs for Munich.  Reading these stories energizes us and helps us fend off the desire to nap.

Here is what we're reading:

• Like their U.S. brethren, the Brits see the crisis to be at the end of the beginning with no one really knowing how long this will last and when (or even if) the bailout will succeed.
• The Brits view the financial crisis as long and deep with extensive damage to world economies in terms of job loses and GDP.
• Martin Walker acknowledges that initially he, like other Brits, placed fault at the feet of the U.S. financial system, but he now states that this misconception has evaporated by recognizing the EU role in it: the near collapse of Italy's Unicredit, government packages for Greek and Ireland banks, and bailouts in Belgium, Holland, Germany and Iceland
• There is widespread acknowledgment of the "R" word (recession), and EU leaders are all over it. (Calling for a summit to respond to a banking crisis described as unlike any other since the '30s)

We've only been across the pond for a few hours. Our initial observation is that we are in tough times, both in the U.S. and in the EU.

From this perspective, the pond looks like a puddle.

If you have any observations or comments, or any questions that you'd like us to ask during our EU trip, please "post" a comment.

 

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Keith Mullen and Lou Strawn head to Europe
Next week, we will be in Munich, Germany and then London, England visiting clients, and meeting with investors, lenders, title companies, investment bankers, mortgage bankers and fund advisors -- almost the entire spectrum of the "players" in the international real estate space.

We think that we know what some of the hot topics will be:

• What replaces the CMBS financed product? (covered bonds?)
• How "deep" is the stress in the U.S. commercial real estate markets?
• The U.S. economy in the next couple of years
• The much-discussed federal legislation and the "new" role of the U.S. government in the economy
• The demise of the U.S. investment banks (what's next?)
• "Where" are the opportunities for investors (debt and equity)?
• U.S. finance laws
• Transparency: tell us more about . . . .
• The U.S. Presidential election and the possible changes with the "change"

To keep you informed, we'll be blogging on a frequent basis during our stay in Europe.  If you have a favorite topic, or simply a question that you'd like us to ask during our trip, please "post" a comment for us.

(And yes, it is Oktoberfest in Munich.  Merely a coincidence. . . . )
 

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Below is a graph showing the refinancing challenge facing the securities industry for the years 2008 through 2012. Note that while $8 billion of unamortized 5-year CMBS loans will reach maturity by the end of 2009, that number grows to nearly $20 billion in 2010 when you add loans with partial interest-only payments. That amount may well exceed the entire securitization originations in 2008. This makes for a pretty gloomy prediction regarding maturity defaults in 2010 and beyond. It also, of course, does not include maturing loans that will need to be refinanced outside of the securitization world.

What does this say about our future? Unless there is a thaw in the credit markets, we're all going to become very good at workouts.
 

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In an attempt to breathe life into the credit markets, the last few months have been full of activity designed to encourage the development of a market for "covered bonds" ala the European model. "Covered bonds" are merely borrowings by financial institutions (especially banks) that ultimately are supported as bank obligations, but are first repaid from a pool of specifically identified mortgage loans and their cash flows.

In Europe, the covered bond market has taken off over the last four or five years and is now at $1.7 trillion. The Fed and the Treasury, in attempts to stimulate the credit markets in the United States, have encouraged the development of a covered bond market with the FDIC proposing certain types of accounting and tax treatment to overcome the banking industry's concern about reserves, etc. At first blush, I thought, "Oh no, here we go, our government is getting involved trying to attempt to create a market after neglecting the abuses in the credit market for a number of years."

 However, on closer examination, it would appear that the covered bond concept would address a number of specific abuses that closed down the credit markets in the first place. First, the issuers of the bonds that are "covered," continue to own the underlying pool of mortgages (it is not a sale or securitization of those mortgages, but the pool of mortgages is pledged as security for the repayment of otherwise full bank obligations). In the covered bond structure, the banks still have "skin in the game" and own the mortgages. They are largely able to manage the assets because in fact the bank continues to own them and suffers the consequences of any eroding underlying value in the mortgage pool. Further, having a discreet pool of assets to back the bonds that have been issued, gives the covered bond investors some comfort regarding the overall eroding general credit of banking institutions.

While we should all be wary of our government going too far in "greasing the skids" for these types of investments, they do seem to be addressing the abuses of synthetic and derivative securitizations.

But do you think investors will bite?
 

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