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

An article by Chad Eric Watt with the Dallas Business Journal gives a "real life" example of the nature of the "disputes" between lenders, when a loan goes into the ditch and the credit stack has multiple lenders.  In his discussion of a Texas court decision involving Orix Finance and NexBank, Chad addresses the bigger picture - and the relevance of this case to everyone in commercial real estate finance.

As I've noted in the past (list of prior blog entries), often the most challenging part of distressed investments is dealing with the different lenders.

So, if you're about to close a financing involving multiple lenders, or if your portfolio includes debt involving multiple lenders, here are some general comments for you to consider:

• the lenders need to be few in number
• the lenders needs to have common or shared goals, balance sheets and profiles
• the terms of the co-lender agreement are very, very important (but even the "best" document crumbles when one co-lender has different goals, balance sheet and profile - which is when a lender's behavior can "side step" contractual terms and be driven by forces and decision makers unrelated to the deal)

Kudos to Chad for focusing on this elephant in the room.

If you see it differently, or have a similar story to tell, please post a comment below.

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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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This is the second of a two-part series (PART ONE) covering initial due diligence topics for workouts involving co-lender structures, with a focus solely on the participated or syndicated co-lender structure. The series is not a comprehensive listing of possible issues on this topic, but merely a basis template to assist you as you review the co-lender and other relevant loan documents.

Typical Servicing issues:

• how are on all decisions made within the co-lender group on these subjects?
  • waivers and consents
  • default\enforcement (special servicing issues)
  • after enforcement (expenses to protect\preserve, to sell, to complete; title of the property [name of servicer; tenant in common; nominee entity jointly owned]
  • advances, expenses and losses
  • excess recovery
  • is there a buy\sell provision if co-lenders are not able to resolve disagreement?
• what decisions may servicer make without input from co-lenders
• duties of servicer: what must it do (reporting, inspections, etc.)?
• standard of care of servicer
• what if servicer has an equity position?
• rights of co-lenders to examine and copy
• notification rights (when must servicer notify a co-lender)
• fees (primary servicing; special servicing; asset management and disposition)
• future property inspections and reporting (review reports only; or more active role, such as accompany servicer during on-site inspections)

Does the loan seller or originator have any liability?

• contractual duties and warranties
• fiduciary duties

Transfers

• buy\sell for disagreements
• transfers to affiliates
• transfers to third parties (right of first offer?)
• is sub participations\syndication prohibited?

Sharing of payments: on sums paid by the borrower, are payments applied -

• proportionately to all co-lender?
• non-proportionately to co-lenders?

If you have any comments, suggestions or additions to the foregoing, please post a comment.

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1st in a series of 2 postings

Much of the focus in the media on troubled real estate debt focuses on sophisticated debt structures, or on investors holding bonds in pools of loans. This focus, however, misses an important, intermediate player between these two ends of the barbell: the real estate lender.

In several real estate workouts that I’m handling now, the most difficult discussions are not with the borrower or its lawyer. Instead, the difficulty is within the mortgage lender group itself. Indeed, one distinctive in the current workout environment from the late 80’s is the large number of real estate loans involving multiple lenders holding a portion of the same mortgage loan or lien position.

Now, I’m not describing the situation where one lender has the mortgage lien, a second lender has a lien on the ownership interests in the borrower, and perhaps a third lender has an unsecured loan with the entity owning an interest in the entity owning the borrower.

Instead, I’m describing a single mortgage loan or facility that has been syndicated or participated among multiple real estate lenders. While the multiple or “co-lender” mortgage structure is not new to life insurance company lenders (nor to balance sheet lenders), in the last 15+ years the co-lender mortgage structure became widely used by the broader creditor market; and banks, Wall Street (the investment banks) and mortgage funds joined life companies in “structuring” the first-lien position.

This posting is Part One of a two-part series covering initial due diligence topics for workouts involving co-lender structures, with a focus solely on the participated or syndicated co-lender structure. The series is not a comprehensive listing of possible issues on this topic, but merely a basic template for your use as you read the co-lender agreements and related loan documents.

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