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

 The lack of liquidity, of course, is a huge drag on the recovery of the commercial real estate market.  Buyers of foreclosed properties, or as white knights of deals in distress, need credit as part of the investment mix.

As I've noted before (prior posting), capital market credit (in the nature of CMBS or equivalent product) is an important, and missing element in what I call the "funding gap" (i.e., the difference between CRE financing needed to refinance maturing debt in excess of financing available from traditional funding sources [banks, life companies and Freddie\Fannie]).

This week I'll be attending the June Convention of the Commercial Real Estate Finance Council.  The "hot" topic will be the "return" of multi-borrower CMBS 2.0 securitization (with a close look on the financial reform bills and the House-Senate conference committee).

For a good review of recent developments of the "return" of the CMBS loan market (sometimes referred to as CMBS 2.0), read the summary from Retail Traffic.

The good news last week is that the first large, multi-borrower CMBS was brought to the market.  It will be the second CMBS issuance this year (but first public offering), following a private CMBS securitization by Royal Bank of Scotland in the amount of $309.7million, which also was a multi-borrower deal (but mainly retail properties located in New York).

In contrast to the RBS private securitization, the JPMCC 2010-C1 is larger in amount and broader in its reach.  Here are some details:

• 36 fixed-rate commercial mortgage loans secured by 96 properties
• Twelve of the loans are secured by multiple properties
• Multi-borrower, with 13 loans (or 42.5% of the pool balance) made to a single borrower (Inland Western Retail Real Estate Trust) (so, not the "real" multi-borrower pool that we saw in CMBS 1.0 - but the market must like Inland Retail: recall the Inland Retail [single borrower] CMBS securitization last fall [briefly described by Retail Traffic)
• 76.4% of the offering were JPMorgan Chase Bank loans
• 21.6% of loans come from Ladder Capital Finance (hurrah: multi-lender, too!)
• 80.4% loan-to-value ratio
• Multi- product mix: 70.9% anchored retail, 14.1% office, 11.8% industrial, 1.8% self-storage and 1.4% manufactured housing

More details are in this presale report prepared by Fitch (pdf).

So, with these two new CMBS securitizations, what are the current projections of CMBS for 2010 to cover the funding gap, and to bring credit available for the purchase of foreclosed properties, or for use by "white knights" to buy distressed deals?

• Barclays predicts between $15-20 billion
• Trepp predicts $25-$30 billion
• My prediction (yes, I'm laughing, too): $10billion, tops

I discount the Barclays and Trepp predictions simply because:

• the start-up time at the loan production operations alone will take us into 4th quarter 2010 until we'll really see loan originaiton shops at full speed - with closing rates capable of hitting their predictions
• remember - the CMBS shops will be competing against life companies, who have not placed a significant amount of their 2010 allocations (one source reports that life companies have only placed @ $5B of their $30B allocations after the 2nd quarter of 2010)
• and the deck chairs will be realigned upon the passage of the financial reform bill - with new roles for rating agencies, new oversight regulations, etc.; all of which will take time to digest
   

Of course, while the 2010 CMBS securitizations will be a significant improvement over the $8.9B of CMBS issued in 2008 and the the $2.2B issued in 2009, the predicted amounts are way, way under the $207B issued in 2007 - at the height of the credit christmas.

But, it is a good start.

And the 2007 amount is NOT reality.

It you have any comments or questions, please post a comment below.

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At the September announcement of the REMIC announcements from the US Treasury the IRS, we posted copies of the materials relating to "significant modifications" to CMBS loans.

Last week, Lou Strawn weighed in on his perspective on the significance of these changes.

Today, the Commercial Mortgage Securities Ass'n gives us the industry's "official" perspective in a white paper.

The prediction here is that these REMIC reforms will NOT have a significant impact on the log-jam of distressed loans needing modifcation (in conjunction with a workout).

If you see it differently, or have an experience that you want to explore, please post a comment.

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Sick and beyond tired of the inflexibility of CMBS servicers in making needed modifications to CMBS loans that we all know are in the ditch?  Help might be here:

On September 15, 2009, the IRS and the Department of the Treasury issued three pieces of guidance relating to commercial mortgage loans held by a securitization vehicle (a CMBS loan).

• The final rules (see PDF entitled "TD 9463") regarding "Modifications of Commercial Mortgage Loans Held by a Real Estate Mortgage Investment Conduit (REMIC)" include changes in collateral, guarantees, credit enhancement of an obligation and changes to the recourse nature of an obligation.  These rules expand the list of exceptions that will not be considered "significant modifications" of a CMBS loan obligation held by a REMIC.
  
• The IRS also issued Revenue Procedure 2009-45 (PDF), which is a final ruling that describes the conditions under which modifications to certain mortgage loans will not cause the IRS to challenge the tax status of REMICs.  Specifically, note the factor that allows a servicer to take action more than one year prior to maturity.  Furthermore, a servicer is able to rely on information provided by the borrower unless it has knowledge to the contrary.  More importantly, while past performance of the loan is a factor in assessing risk, a "significant risk of default" (based upon a "reasonable" belief standard) can be found by the holder or servicer even if the loan is currently performing (This is great news for principals who are keeping the loan payments current from sources other than rent).
  
• In addition, the IRS and Treasury issued Notice 2009-79 (PDF) and are requesting comments on what additional guidance, if any, is needed regarding modifications of commercial mortgage loans held by investment trusts.

Additional information can be found on the CMSA's Web site (link to REMIC Reform).

Hopefully, these guidelines will allow CMBS loan servicers and borrowers greater flexibility to assess risk and allow for appropriate modifications to CMBS loans.  It is desperately needed.

We know that the public is in no mood to support a "rescue" plan for commercial real estate.  Maybe,  just maybe, "tweaking" the tax code like this will be the approach that will be taken by the government—sort of a "back door" rescue plan for commercial real estate.  However, I believe that it'll take much, much more than tweaks like this one to help commercial real estate to QUICKLY recover.

Kudos to the broad cross section of the commercial real estate industry that worked on this initiative (Mortgage Bankers Association, Commercial Mortgage Securities Association, ICSC, Real Estate Roundtable, and others).

If you have any questions or other information, please post a comment.

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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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By Guest Writer – Christopher T. Nixon, Winstead PC

CMBS Master Servicers typically lack the ability to modify a CMBS loan to preemptively address a potential loan problem. A CMBS borrower frustrated with such inability may elect to purposefully default on the loan to circumvent the restrictions placed on the Master Servicer and force the transfer of the loan to the Special Servicer. The borrower's expectation is that the Special Servicer will have the ability and agree to modify the CMBS loan to address the potential loan problem.

Risks:  If it is apparent to the Special Servicer that the borrower intentionally defaulted on the loan, the Special Servicer may elect to accelerate the debt and pursue foreclosure of the real estate collateral. The Special Servicer may determine that an aggressive foreclosure of the defaulted loan will maximize recovery for the bondholders as compared to attempting to negotiate a loan workout with an untrustworthy borrower acting in a manner detrimental to the economic interests of the REMIC Trust in which the CMBS loan is pooled.

Potential Solution:  Rather than taking the inflammatory step of defaulting on the CMBS loan to reach the Special Servicer to address a potential loan problem, a borrower should consider discussing the potential loan problem with the Master Servicer. If the Master Servicer determines that the loan problem constitutes a "reasonably foreseeable default," the Master Servicer may have the ability under the Pooling and Servicing Agreement (PSA) to transfer the loan to the Special Servicer at that time (without waiting for an actual loan default to occur) to address the loan problem. A Special Servicer may be more inclined to consider a loan modification as compared to a foreclosure if the Master Servicer and borrower present the loan problem to the Special Servicer at this stage. The effectiveness of this approach will largely depend on the quality and sophistication of the Master Servicer and Special Servicer. Given the current bad economy, Master Servicers are increasingly aware of the need to proactively discuss borrower loan problem concerns and to involve the Special Servicer early in such discussions.

Tips for the Borrower:

• Be honest about the potential loan problem when discussing it with the Master Servicer.
• Provide sufficient information to the Master Servicer for it to objectively determine that the potential loan problem constitutes a "reasonably foreseeable default."
• Do not create a potential loan problem merely to seek economic concessions from the Special Servicer. The borrower should have a sincere concern that a loan default is likely to occur if the loan problem is not promptly addressed.
   

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Guest Writer – Christopher T. Nixon, Winstead PC
(2nd in a series of 2 postings)

In my prior posting (Part 1),   I covered some of the key differences between a workout of a CMBS loan and a workout of a portfolio loan.

Here are some more:

• Flexibility.  Due to REMIC rules and the restrictions and limitations set forth in the PSA, a Special Servicer is not able, or has less flexibility than a portfolio lender, to substitute collateral, take additional collateral, capitalize past due interest, bifurcate the debt, take an equity or contingent interest position, operate an REO property, or lend additional money as a loan default solution.
• No CMBS Loan Dragnet Clause.  The borrower has no other source of repayment for a Special Servicer to consider in the workout of a CMBS loan, which may not be the case in a portfolio loan workout scenario.
• SPE Provisions.  A CMBS loan borrower is bound by bankruptcy-remote SPE provisions in its organizational documents.

a.) Bankruptcy Remote.  There are structural impediments to the borrower's ability to file bankruptcy. Even if the borrower files bankruptcy, the CMBS lender is likely the only secured creditor.
b.) Single Purpose.  The borrower has no ability to substitute or add collateral to address a CMBS loan default.

• Carve-out Guaranty.  While many portfolio loans are recourse loans, CMBS loans are typically non-recourse. With respect to a CMBS loan, the borrower and the principals of the borrower may face recourse liability for certain bad acts described in the loan documents.
• Cash Management.  Many CMBS loans have a lockbox cash management component, which facilitates the control of cash collateral. Portfolio loans typically do not have any such component.
• Regular Borrower Financial Reporting.  While portfolio loans typically do not have rigid borrower financial reporting requirements, regular borrower financial reporting requirements of a CMBS loan keeps the Servicer apprised of the financial status of the real estate collateral. The information in such financial reports may be critical to a Special Servicer in making an informed decision about how to address a loan default.
• Property Management Control.  CMBS loans typically assign to the lender the right to replace the property manager with a lender-approved property manager. Portfolio loans typically do not have any such assignment provision.

The differences between the two types of loans are significant. And this list is not all-inclusive. So, be careful – and as self servicing as this sounds, use legal counsel who is experienced in handling CMBS loan workouts.

If you have any questions or  suggestions, please post a comment.
.
 

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Guest Writer – Christopher T. Nixon, Winstead PC
(1st in a series of 2 postings)

In the commercial loan default scenario, CMBS Special Servicers are not able to provide to borrowers many of the accommodations that may be provided to borrowers by portfolio lenders. CMBS Special Servicers are subject to many more restrictions and limitations than to which portfolio lenders are subject in a loan default situation.

Understanding the key differences between CMBS loan workouts and portfolio loan workouts will facilitate a borrower's efforts in attempting to address a CMBS loan default with a Special Servicer. Some of the key differences between CMBS loan workouts and portfolio loan workouts are as follows:

• Standards. A portfolio lender applies its own individualized standards in addressing a loan default; and a third-party servicer will administer the loan in accordance with the servicing standard articulated in its servicing agreement with the lender. A CMBS Special Servicer must administer the loans in accordance with the Servicing Standard set forth in the applicable Pooling and Servicing Agreement (the "PSA") and comply with REMIC rules to protect the federal income tax-free status of the REMIC Trust in which the CMBS loan is pooled.
• Continuity of Relationship. A portfolio loan has continuity in the origination, servicing, and workout of the loan. The portfolio lender has an ongoing relationship with the borrower and retains tight control over any third-party loan servicer. On the other hand, a CMBS loan involves the fragmenting of the obligations, responsibilities, and liabilities for the loan between multiple parties involved.
• Workout Goals. A portfolio lender attempts to preserve the value of the asset and, in some instances, its relationship with the borrower. A CMBS Special Servicer attempts to preserve the integrity of the Trust, while maximizing recovery for the bondholders.
• Preemptive Abilities. A portfolio lender may make additional loan advances or enter into preemptive loan modifications to address a potential loan default. A Master Servicer typically lacks the ability to preemptively address a potential loan default.
• Due Diligence Review. A CMBS Special Servicer's review of due diligence may be more challenging than that of a portfolio lender because the Special Servicer is often not familiar with the loan before the transfer of the loan from the Master Servicer to the Special Servicer (i.e., the "Servicing Transfer Event").

My next posting will list several other differences.  If you have any questions or suggestions, please post a comment.
 

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