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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Some people point to this as a positive point on the credit crisis trend line:

• Life company commitment to commercial mortgage lending remains strong
• Generally, life companies generally have NOT decreased their commercial mortgage origination allocations for 2010 (when compared to 2009)

Question: is it correct to say that, at least for commercial mortgage credit from the life insurance companies, the credit crisis has softened a little bit?  More money now is available?

I say “not really.”

It is a “now you see it, now you don’t” experience.

While I do not have hard, empirical data to support this statement, the typical life insurance company mortgage seems to be using 20%-30% of the 2010 mortgage loan allocation to renew, extend and modify loans currently in the portfolio.  Unlike in the past, however, insurance companies are reaching "deeper" into their portfolio as they examine loans that might leave their portfolio at maturity.  Instead of looking at loans maturing in the next 6 months, they are looking closely at loans maturing in the next 12 to 24 months.  And then they use a significant portion of the 2010 mortgage loan allocation to refinance the best of those loans.

This means there is less money available for "new" borrowers currently seeking mortgage funds from life insurance company lenders.  (Now you see it; now you don't.)

Why this "longer" look at the current mortgage loan portfolio?

• Life companies remain very sensitive, as they should be, about the effective of the “mortgage experience adjustment factorr” to their balance sheet. Thus, they remain very cautious lenders when it comes to commercial mortgage lending.  They are my poster children for my "real money for real people" mantra (meaning, they continue to apply conservative underwriting standards, using the best loan-to-value and debt service coverage tests, etc.).  So, they are motivated to retain the best mortgage loans on their portfolio; and will refinance them now (and not wait for them to mature in the next 12-24 months.
• Rating agencies are now focusing on, and up-dating, the capital adequacy tests used by them in evaluating real estate investment risk for insurance companies.  For example, in April, Standard and Poors updated its asset stress capital factor analysis.   The criteria are replacing S&P’s existing methodology for evaluating the capital adequacy of insurers related to their holdings of CMBS, directly originated commercial real estate loans and RMBS.

This plays out like this:

• Assume life company X has $1.5B in mortgage lending allocation for 2010; maybe as an increased amount over the 2009 allocation
• As it monitors it’s mortgage portfolio, it not only identifies loans at risk of not being able to find new sources of financing (to pay off the mortgage), but it also now has identified loans that are the “best”: great debt service coverage; great sponsorship; great tenant mix; great location; etc. In other words, it knows the relationships and projects that the life company does NOT want to lose at loan maturity.
• The life company renews, extends and modifies the terms of these best loans right now – even though the loan will not mature until 2011 or 2012
• Faced with a certain increase in interest rates over the next few years, this "best" borrower jumps at the opportunity to renew and extend at the current “low” interest rates
• These are loans that are NOT competing with borrowers needing funds in the next 6 to 9 months
• The result: a portion of the 2010 mortgage loan allocation is deployed
• Less mortgage money available in the market for near term or immediate loan maturities
• Then, add in improved rating agency evaluation standards and a better understanding of the risk position of insurance companies in commercial mortgages, the result is that real estate allocations now are under even more scrutiny (as real estate "competes" with other investment classes for the investment $ at insurance companies)

So, don’t get too “excited” as you hear or read that the credit crisis has “softened” due to life company “commitment” to commercial real estate mortgages.

More is NOT more in this instance.

More really is less.

Life insurance companies remain true to their conservative, careful nature.

Question: are you seeing this, too?

Please post you comment or question below.

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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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