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

(This is my last blog covering the CREF-C June Convention)

Below is a very random collection of information (and comments) as “take aways” from my attendance at this convention earlier this week. You'll note that I really don't jump into the CMBS 2.0 panels, nor into the special servicing panels. Why? Most of the content from those panels is not really new - or simply not that interesting to me. And there were a couple of panels that were so, so detailed - I simply can't drag you through it here.

So, on to random but hopefully interesting –

• Forums: the CREF-C is organized around interest groups that it calls “forums” [list]. Yes, the list is, in substance, remarkably similar to the MBA’s council structure. No real surprise in this look-a-like approach: as least with respect to commercial real estate, they are pulled by the same magnetic source.
• Portfolio Lender Forum (and focus): this list addresses topics of concern to life insurance company lenders, and has some real mind-benders and heart burn in it.  Generally, the life company mortgage lenders are being very cautious - and one reason is all of the uncertainty surrounding these issues -
  • NAIC Capital Adequacy Issues: this is the MEAF concept, the all-important risk-based capital requirement. As noted by the WSJ last week [subscription required], the MEAF subcommittee of the ACLI has recommended (for yet another year) some temporary relief in the MEAF requirements for 2010.  The WSJ reports that the action will reduce (for 2010) from 4% to 2.6% a proposed increase in risk-based capital for life insurers whose portfolios contain commercial mortgages. The original proposal would have cost the life insurance industry an addition 53% in capital; under the revision, capital would be roughly 12% higher than it was in 2009. However, a permanent solution is needed (a suggested approach is expected by this committee in August).
  • Rating Agency Experience & Stress Test Methodology: the complaint here is that the rating agencies simply do NOT utilize appropriate stress test on life company mortgage loan portfolios. For example, why do they use CMBS stress tests, designed for IO (interest only) loans, in the review of life company mortgage loans that amortize? And concern was raised at the perceived lack of experienced staff on the part of the rating agencies, which goes to their ability to thoroughly evaluate life company mortgage loans.
  • Government Sponsorship of Community Banks: this is a topic that I have addressed in several blogs [latest blog, which refers to other blog entries]. The bottom line here for the life company mortgage lenders: any government program supporting community banks will put life companies at a competitive disadvantage, and be a barrier to a “level playing” field.
  • Fair Market Value Accounting (new FASB rules): concern was expressed that this concept is not accurate in that unlike other investment products, such as bonds (which are a “trade today” approach), mortgage loans are a product designed using a “hold to maturity” approach. The general belief was that this change, which is being driven by the accounting world, will be implemented by 2013. My take away: this could be an additional reason to DECREASE mortgage loan allocations. Yes, less money available to the CRE industry. Not a good thought.
• Distressed Debt Sales – When?? Of course, this is THE question for many, many and many "opportunity" funds formed in the last 3 years, who have raised capital in hopes of great values (read: discounts) in the sale of distressed commercial mortgages from life companies and banks. The general consensus at the CREF-C convention: this is the second year for banks to stash cash as capital reserves, which should meant that 2011 will be the year when the banks will be able to (finally) sell “bad” mortgage loans at some sort of discount. What about life companies? Nothing was said – which I take to mean that life companies generally still are selling notes quietly, and selectively right now; but the volume is NOT large.
• Financial Reform: This should NOT surprise you, given that the CREF-C is pulled by the same magnetic force (commercial real estate finance) as the MBA – my summary of the MBA-CREF [link] was repeated; almost word for word. So, I’ll repeat it: [link]
• Better Attitude: yes, the JPMCC 2010-C1 deal had everyone in a hopeful mood [link] – but most people were still guarded given the experience of the tough times over the past several years. But hopeful. But expecting that the “lessons learned” from the Christmas Credit of 2004-07to be quickly forgotten and somewhat repeated – after all, this market is built on competition and repetition.

I hope this is of interest. If you have any questions or comments, please post them below.
 

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Recently, I've addressed the importance of community banks in the economic recovery, and in furnishing credit for commercial real estate.  My focus is on the draft legislation prepared by Representative Minnick (D-Idaho) extending federal aid to community banks (prior blog and refrence to an earlier blog), which will allow community banks to make small commercial real estate loans on favorable terms.

During a panel presentation during the second day of the June Convention 2010 of the Commercial Real Estate Finance Council, the comment was made that Representative Minnick's bill will be introduced in the House some time this week, perhaps as an amendment to other legislation.  The comment was made that the legislation might include commercial real estate lending.

Several comments:

• Life insurance companies view this legislation as unfairly and inappropriately favoring small banks, at the expense of life insurance mortgage lenders, in making small commercial mortgage loans
• if this legislation becomes law, no doubt the message is that any recovery from the credit crisis remains fragile
• if this legislation becomes law, the follow up question is "will this be a slippery slope leading to government sponsorship of larger commercial real state loans?"

So, let's keep a watch for this legislation.

If you have information or comments on this topic, please post a comment below.

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The importance of community banks to small businesses, and consequently to the broader U.S. economy, has been largely ignored in our focus on "too big to fail" (relating to the largest banks) and now on "sovereign credit risk" (relating to the credit rating of Greece, Spain and Hungary).

Aid to community banks just might be coming onto the national stage (see my earlier posting on this topic).

Jeannine Aversa of the Associated Press reports that in a June 3rd speech in Detroit, Federal Reserve Chairman Ben Bernanke recognized this latest hurdle as being fundamental for economic recovery: getting loans to small businesses.

Aversa reports that Bernanke noted the following in his speech:

• 2nd quarter 2008 (financial crisis at full throttle): lending was almost $700B
• 1st quarter 2010 (as economy improved): lending fell to $660B
• Bernanke and the Fed are focusing on ways to ease the credit crisis for small businesses, and will present their findings at a conference later this summer

Of course, as the architect of the country's monetary policy, Bernanke has no direct control over fiscal policy, which is controlled by Congress and the White House.   (Difference between monetary policy and fiscal policy.)

However, Bernanke is very influential.  His focus on lending to small businesses could (and I predict, it will) rally support in Congress for Federal aid to community banks - such as  "The Community Bank and Commercial Real Estate Stabilization Act of 2010" described in my earlier posting.

This is worth watching.

If you have any comments or additional information, please post a comment below.

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Overlooked by the recent focus on health care reform, and now by the financial reform bills (see my recent blog posts, is draft legislation prepared by Representative Minnick(D-Idaho). Known as "The Community Bank and Commercial Real Estate Stabilization Act of 2010," his draft legislation has circulated on the Hill but has NOT been introduced into the legislative process.

His bill is based upon this premise: the "too big to fail" approach, which bailed out the largest banks and supported the CMBS market, largely ignored one very powerful economic engine.

Who is this "lost" or forgotten group?  Hints:

• They have the highest concentration of commercial real estate loans (relative to risk based capital) among lenders
• They extend credit to a broad range of customers (not just real estate related)
• They are located near you - even on your Main Street
• Every week, the FDIC seems to close 5-10 of them

The answer: Community Banks.

Hundreds have failed over the last several years; and hundreds will fail in the new future - currently, the FDIC lists 775 banks on its list of of "problem" banks (nearly 10% of all FDIC-insured banks).

I agree with Richard Suttmeier's assessment that community banks are the next key to economic recovery.

In his recent blog posting, he articulates the important role played by community banks -

• The economy on Main Street is driven by small businesses, the housing market and local construction - none of which are "too big to fail" but when taken together . . .
• These are the engine of job growth in the private sector
• Without job growth on Main Street, the economy will struggle [my editing here: Suttmeier predicts a "double-dip"], and consumer spending will suffer
• Community banks are the key to lending to small businesses
• Thus, community banks are crucial to the economy on Main Street

Representative Minnick's bill seeks to address this oversight (or perhaps simply the relative inability of community banks to pull political levers, when compared to Wall Street and the largest banks).  Briefly, his draft legislation addresses two related goals:

• Jump start new lending on the small-balance commercial real estate sector

Here's a quick summary of his bill (as of several weeks ago - so this could change):

• Six-month pilot program of $3 billion, if successful, may be expanded to three years and upsized
• Only community banks will be able to access that part of the program aimed at seriously delinquent loans and REO
• US Treasury will guarantee bonds backed by pools of small-balance commercial real estate loans, including REO properties at community banks
• Program administered by a Board consisting of Treasury Secretary, Fed Chairman, SEC Chairman, FDIC Chairman and four industry experts appointed by President
• $10 million maximum loan size (or appraised value) per property
• Conservative loan underwriting and pricing
• Rating agency involvement to provide an independent view on underwriting and structure
• Treasury will charge a “guarantee fee” similar to Fannie/Freddie, of between two to three percent annually
• Any profit participation back to the originator must be earned over time

I also attach a much longer "term sheet" describing the proposed bill (there might be a more current version).

So, what do you think?

Please post your comments 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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