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

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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Recently Laura Sims and I (ok, 99% Laura and 1% me) co-presented a seminar on distressed commercial leases with an in-house counsel at a very, very large life insurance company (and pension advisor).  This question came up during the presentation:

• do you have any tips on e-mail and oral communication with the tenant, as the lender (now owner) discusses with the tenant the request for rent and other lease concessions?

My answer was, well, as you deal with distressed leases, use the same approach taken when you dealt with the borrower before you acquired title to the property.

In other words, there is no reason to abandon careful communication once you take off your special asset or workout hat and replace it with the landlord\owner hat (or the REO hat).

To find our entries on e-mail and oral communication, use the "search" function and the search term "oral communication."

If after reading those suggestions, you have suggestions, comments or questions, please add a comment below.

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With more banks and CMBS loan servicers taking title to CRE (via foreclosure and deed in lieu of foreclosure), the amount of REO (or real estate owned) has grown - and will continue to grow and grow as CRE defaults escalate. Most REO sellers have regulatory or contractual limitations on the time periods that they can continue to hold or own the properties – meaning they are motivated to sell the property.

This is no “ordinary” purchase and sale agreement (or a contract of sale) because the seller (as the former lender) did NOT develop or operate the project, nor own it on a “for profit” basis. Instead, the seller acquired it under circumstances where it was under performing and perhaps not well maintained. Consequently, the seller of REO has a very different agenda, approach and attitude toward the terms and provisions of the sales contract.

This different perspective is reflected in the following provisions of the REO sales contract:

• Sales Price: The seller wants to maximize its price, but with the recognition that it does not have sufficient knowledge about, nor experience in operating, the property. A key factor here also is that the “basis” of the seller’s investment in the property is the loan balance at the time the seller took title. Thus, if the loan balance is less than the market value of the property, the seller might consider selling at a sales price below market value.  In other words, the seller wants to recover its debt investment, and typically is not looking to make a profit.
• Regulatory and Contractual Limitations: The seller’s approach to the sales price will be governed by the overlay of applicable contractual limitation and any regulatory restrictions. So, “yes” the buyer can get a “deal” in buying REO; but the basis for the deal will depend upon seller’s unique regulatory circumstances and contractual obligations.
• Quick to Close: Most REO sellers will require the buyer to quickly go “firm” on the contract, and then to quickly close. Consequently, some sellers furnish the form sales contract to bidders on a “take the form unchanged, or don’t bother to bid” basis, and even tell all bidders that the bidder with fewest comments to the form will be given “preferential” consideration when the seller evaluates all of the purchase offers. Also, some REO sellers make due diligence materials (title, survey, environmental reports, rent rolls, etc.) available to prospective buyers in advance of signing a sales contract.
• Limited Buyer Remedies: The sales contract will limit the type of remedies for Seller’s default under the contract. The buyer remedies will not include damages (since its business plan is not that of an investor in real estate) and will be limited to these two remedies; buyer may terminate the contract or sue for specific performance. The seller will NOT be liable for any damages.
• AS-IS: Seller will minimize the amount of responsibilities on its part in the sales agreement. For example, the sale will be “AS IS, WITH ALL FAULTS” with respect to the property condition. And it can only turn over the operating information in its possession; thus, historical operating information might not be available.
• Confidentiality: the seller should insist upon confidentiality, both at the pre-contract stage, during the due diligence period and after the closing of the contract. Thus, confidentiality will survive the closing.
• Qualifying the Buyer: Many REO sellers require that the prospective buyer furnish information, or access to information, in support of the buyer’s ability to actually close the purchase.   For example, the prospective buyer must authorize credit and background check, and also furnish current financial information.
• Expenses: Simply because many REO sellers to NOT have a ready source of funds, the sales contract will require the buyer to pay all closing costs. Thus, the sales price will take this into account.

If you have additional items to add to this list, please comment below.

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As I've noted previously [link to due diligence topics], one big difference between the current commercial real estate melt down and the last big one (in the late 80s) is the amount or level of “structure” in the deals. Like the last time, the debtor\borrower side is “structured” (with a multi-tier borrower and perhaps even a “single purpose” entity); however, unlike the last time, the creditor\lender side also is structured.

A multi-creditor structure greatly complicates decisions covering a possible workout, the remedies to be invoked, and the management, leasing and eventual sale of the collateral (after foreclosure).

Indeed, co-lender disagreements are the most difficult part of this process.  (And one lesson learned is to NOT do co-lender deals in the future; or do them only with similar lenders having similar balance sheets, ownership, investment objectives and criteria, etc.)

Part of the difficulty flows from some confusion, or misunderstanding, on the part of all of us on the technical terms and attributes of the co-lender structure. Since the typical co-lender structure either is a syndication or a participation, I've identified some of the basic terms for those two structures:

• Nature of the creditor’s interest
• Recover of taxes & funding losses; gross up for reserves
• Common law rights
• Insolvency of originator/agent
• Legal opinions
• Assignments
• Enforcement actions
• Amendment (workout) rights
• Waiver rights
• REO decisions (management, leasing & sales)

To help you better understand the difference between (i) a loan that has been syndicated (typically where each lender has its own note and all lenders share the collateral) and (ii) a loan that has been participated (where there is a single, lead lender, and the other lenders only participate without their own notes), here is list of some of the major topics of interest.

(For postings on other co-lender topics, such as A\B Note structures and lender v lender litigation, search the site using the term "co-lender.") 

 (Click on "continue reading" for a table detailing differences on these terms)

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Every downturn and recovery offer opportunities for investors to adapt and respond to changing economic conditions.  Today's climate requires investors to look for commercial real estate opportunities in new and challenging ways.  Investing in distressed assets presents investors with one opportunity for growth as market conditions improve.  Winstead PC and Cohen Financial hosted a webinar covering topics important to implementing an investment strategy in this difficult market.

Did you miss the webcast?
Don't worry, one reason that you follow this blog is to gather information on your own terms, and on your own schedule. 

• Click here to watch the webcast
  
• Click here for a copy of the presentation materials

After you watch this webcast or read the materials, please post comments or questions.
 

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Periodically, we alert you of opportunities to participate in online webinars on various topics—from the "comfort" of your own computer.  No travel.  No hassle.

On Wednesday, October 7, Cohen Financial and Winstead PC are hosting a webinar on investing in distressed assets.

Every downturn and recovery offer opportunities for investors to adapt and respond to changing economic conditions.  Today's climate requires investors to look for commercial real estate opportunities in new and challenging ways.

Investing in distressed assets presents investors with one opportunity for growth as market conditions improve.  The professionals at Cohen Financial and Winstead PC will present you with the knowledge needed to evaluate this investment strategy.

During this webinar you will learn:

• How to find distressed commercial real estate assets
• What is involved in the valuation and financing of these assets
• How to buy debt
• How to buy commercial real estate
• The tax issues involve

Investing in Distressed Assets – Webinar

Wednesday, October 7, 2009
11:30am PT/12:30pm MT
1:30pm CT/2:30pm ET
Click here to register (link)

This webinar should interest players from every point or perspective, whether sellers, buyers, special servicers\asset managers, REO\asset managers, or intermediaries.

If you have questions in advance, please post a comment.

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Here's another topic from our "ticking sound" series covering insurance issues and environmental issues:

The subject of insurance for foreclosed properties doesn't seem to come up very often, most likely because there are so many other more pressing problems to worry about. But failing to ensure that the property has adequate insurance – not just "trendy" coverage like environmental impairment insurance but also "old fashioned" property, liability and flood insurance – is absolutely vital to avoid problems that arise all too often.

A lender, servicer or foreclosure purchaser's analysis of insurance on foreclosed property should start with the working presumption that the borrower's insurance will not protect the lender, servicer or foreclosure purchaser after the property is transferred. This may no be so, particularly if care has been taken on the front end to ensure that the lender is included as a named insured on applicable policies, but it still is possible (if not quite likely) that the borrower quietly cancelled the policies to pick up any premium refunds that might be available. Even if the borrower did not resort to such a tactic, the transfer of title from borrower to lender may deprive the borrower of an insurable interest in the property, without which the policy may be void. Some policies also include exclusions or other provisions limiting or precluding coverage for abandoned property, and when the borrower walks away, these provisions may be triggered. The result can be a nasty surprise when a claim occurs later.

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Insurance issues often are overlooked in the context of a workout or a foreclosure.  (Recall our other posting(s) covering title insurance.)  So, here's another topic from our "ticking sound" series covering insurance issues . . . .

Many real estate and construction contracts now include detailed alternative dispute resolution ["ADR"] clauses stipulating that the parties will attempt to resolve their differences short of litigation by submission of the dispute to mediation, arbitration or both. The impetus for such clauses is the parties' perception that these ADR procedures will lower litigation costs and speed resolution of disputes. The hasty invocation of ADR clauses may result in loss of available liability insurance proceeds through the insurer's invocation of two significant but overlooked requirements in virtually every insurance policy; (1) the provisions in virtually every policy stating that the insurer will "pay on behalf of the insured only those sums that the insured is legally obligated to pay as damages and that the insurer has no obligation to reimburse the insured for voluntary settlements it makes without the insurer's consent; and (2) the clause requiring the insured to give prompt notice to the insurer of all claims and demands.

The first pair of provisions – that portion of the basic insuring agreement obligating the insurer to pay sums its insured is "legally obligated to pay as damages" and the policy condition stating that the insurer has no obligation to reimburse the insured for settlements made without the insurers provision – implement the overarching principle in a standard liability policy that the insurer is allowed to control the defense and determine when to settle within policy limits. See, e.g., Judwin Properties, Inc. v. U.S. Fire Ins. Co., 973 F.2d 432, 435 (5th Cir 1992). The two provisions also express and even more basic idea, as succinctly stated by the Nebraska Supreme Court in City of Scottsbluff v. Employers Mut. Ins. Co., 265 Neb. 707, 658 N.W.2d 704, 710 (2003): "The parties to the insurance contract at the time the contract was made could not have reasonably intended it to cover the voluntary agreements of the insured to pay for damage it was not otherwise legally obligated to pay." In other words, the otherwise commendable instinct to "make things right" may have the unintended consequence of costing the Good Samaritan its insurance coverage.

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