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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 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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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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