Commercial Loan Modification Solutions

Commercial Loan Modification Solutions

Modification of a commercial loan is just one of several possible outcomes a business owner should consider when facing the possibility of a commercial foreclosure.:

Term Extension - This is when the bank agrees to extend the maturity on a loan that can't be refinanced because of high LTV but has cash flow sufficient to service the debt.  This type of extension can be difficult for a lender to agree to due to its regulatory pressures.  We can often with our analysis tools convince the lender that an extension is in their best interest despite LTV's that are outside of their acceptable range .

Permanent Modification - Often a complex transaction that the bank is reluctant to do as it often reduces the value of the asset on the banks books.

Principal Reduction - These are usually only done in relation to a short sale or short refinance where the bank accepts less than the full value to settle the debt.  The bank won't reduce the principal so the property owner can make a profit.

New Equity Partner - The bank is more likely to work with a borrower that is willing to release equity in the property to a new investor that comes in with cash.

Transparency Coming to 'Extend & Pretend'

More Transparency Coming to Hidden Costs of 'Extend & Pretend' Strategies

Troubled Debt Restructurings Expected To Rise as New Accounting Rules Just Weeks Away

By Mark Heschmeyer

May 18, 2011

 

The number of loans that banks have to classify as troubled debt could increase dramatically in a few weeks as a result of new accounting rules issued last month. The new push to reclassify some loans is already hurting some lenders, and the reclassifications are expected to shine a spotlight on the commercial real estate lending practice that has come to be known as "extend and pretend."  more

Federal Reserve Weighs In on CRE

Testimony of Patrick M. Parkinson, Director, Division of Banking Supervision and Regulation

Before the Congressional Oversight Panel, Washington, D.C.

February 4, 2011

Chairman Kaufman, members of the Congressional Oversight Panel, thank you for your invitation to discuss the current state of commercial real estate (CRE) finance and its relationship to the overall stability of the financial system. Since the panel published its report, Commercial Real Estate Losses and the Risk to Financial Stability, one year ago, the rate of deterioration in market and credit conditions has leveled off, and there are some early signs of price stabilization in a number of key markets. Nonetheless, CRE delinquencies and losses are expected to remain elevated for some time.

Weakness in real estate markets, both commercial and residential, continues to be a drag on overall growth in the economy. Construction of nonresidential structures continues to lag because of weak fundamentals in the sector, including high vacancy rates and low property values, factors that are unlikely to change in the near term. Similarly, new home construction is likely to be constrained by the continuing overhang of distressed and vacant homes.

CRE-related issues also present ongoing problems for the banking industry, particularly for community and regional banking organizations. Losses associated with CRE, particularly residential construction and land development lending, were the dominant reason for the high number of bank failures since the beginning of 2008, and further CRE-related bank failures are expected over the next few years.

Credit losses for bank CRE loans typically continue well past the trough of recessions, and we expect this pattern to continue in this cycle. Working through the large volume of troubled CRE loans will take time as banks go through the difficult process of loan workouts and loan restructurings. If done prudently and effectively, including allocating appropriate levels of reserves and capital, loan restructuring can reduce the ultimate losses to the banking system. In addition, proper restructuring can reduce the damage done to businesses and the economy by limiting the forced liquidation of commercial properties that would further depress prices.

While we expect significant ongoing CRE-related problems, it appears that worst-case scenarios are becoming increasingly unlikely. CRE portfolio loan concentrations are not a significant risk factor for systemically important financial institutions. Some systemically important financial institutions have substantial exposures to commercial mortgage-backed securities (CMBS) and to derivatives securities such as CRE collateralized debt obligations. However, risks in these areas have been reduced, as significant mark downs have already been taken on these securities. In addition, conditions in the CMBS market have been improving, with spreads tightening and some new deals coming to market. However, we see losses in CRE to be an ongoing negative factor in bank portfolios that will need to be worked through over the next several years.

Current Conditions in the Commercial Real Estate Market
As housing market conditions deteriorated sharply throughout 2007, CRE markets began to experience weakness. Broad CRE market conditions remained relatively healthy until the second half of 2008, when CRE performance metrics turned down rapidly as a result of severe financial market disruptions and accelerating job losses. Vacancy rates increased sharply, rental rates plummeted, and property sales and values declined substantially. The higher vacancy rates and declines in the values of existing properties placed particularly heavy pressure on construction and development projects, which depend on market conditions at the time of completion for absorption and thus repayment.

Underlying market fundamentals of CRE remain a significant concern, but they have shown some signs of stabilizing. For instance, vacancy rates on office, industrial, and retail properties have stopped increasing, although they remained at elevated levels at the end of 2010, ranging between 13 percent and more than 16 percent, depending upon the property type and location. These levels are, on average, 5 to 6 percentage points above levels experienced in 2007. The rate of decline in rental rates has also slowed. At the beginning of 2010, office and industrial rental rates were between 10 and 12 percent lower than a year earlier, on average, but declines had slowed to between 5 and 7 percent at an annual rate at the end of the year. Sales volume of CRE properties improved each quarter during 2010, accumulating to almost $135 billion for the year as a whole. ¹ This total is double the CRE property sales volume for all of 2009.

Recent readings from CRE price indexes indicate that the rate of price declines has slowed substantially. The NCREIF Transactions Based Index fell more than 36 percent from its peak in the second quarter of 2007 to the first quarter of 2010. In contrast, the index indicated that prices as of the third quarter of 2010 were only 0.2 percent lower than they were at the beginning of the year. However, the degree of price stabilization across different types of properties and locations is uneven. In particular, demand has been rebounding for well-occupied properties in top-tier markets, while less desirable properties in less favorable markets are still struggling from a lack of demand.

Concentrations of CRE Exposure on Bank Balance Sheets
At the end of the third quarter of 2010, approximately $3.2 trillion of outstanding debt was associated with CRE, including loans for multifamily properties. Of this amount, about one-half, or $1.6 trillion, was held on the balance sheets of commercial banks and thrifts. An additional $700 billion represented collateral for CMBS, and the remaining balance of $900 billion was held by a variety of investors, including pension funds, mutual funds, and life insurance companies. Outstanding CRE debt has contracted 6 percent from its peak in 2008, while outstanding CRE loans at banks have contracted by almost 12 percent. The majority of the decrease in bank loans was associated with reductions in construction and development loan balances, which were largely the result of foreclosures and charge-offs.

Despite the decline in aggregate CRE loans at commercial banks, many banks still have CRE loan concentrations, as defined in the 2007 "Interagency Guidance on Concentrations in Commercial Real Estate."² Banks are considered to have a CRE concentration when loans for construction, land development, and other land exceed 100 percent of risk-based capital or total CRE is greater than 300 percent of risk-based capital.³ By this definition, almost 1,200 commercial banks, or 18 percent of all banks, had CRE concentrations at the end of the third quarter of 2010. CRE concentrations have been the dominant factor in bank failures. Of the more than 300 commercial banks and thrifts that have failed since the beginning of 2008, more than three-fourths had CRE concentrations at year-end 2007.

Notably, CRE concentrations are not a significant issue at the largest banks. Among banks with total assets of $10 billion or more, 10 percent had CRE concentrations. In contrast, one-third of all banks with assets between $1 billion and $10 billion had CRE concentrations. For banks with less than $1 billion in assets, approximately 17 percent had CRE concentrations.

Credit Quality of Commercial Real Estate in Bank Portfolios
At the end of the third quarter of 2010, almost 10 percent of CRE loans in bank portfolios were considered delinquent, a three-fold increase since the end of 2007. ⁴ Not surprisingly, loan performance problems have been most striking for construction and development loans, especially for those that finance residential development. Almost 19 percent of all construction and development loans were considered delinquent at the end of the third quarter of last year.

During 2010, delinquency rates on construction and development loans began to improve slightly, falling 1 percent in the first three quarters of 2010. Additionally, delinquency rates on loans backed by existing nonfarm, nonresidential properties leveled off in 2010. Still, even if CRE delinquency metrics continue improving, there remains a sufficiently large overhang of distressed CRE at commercial banks such that loss rates for this portfolio will likely stay high for some time and many banks with CRE concentrations will remain under stress.


Approximately one-third of all CRE loans (both bank and non-bank), totaling more than $1 trillion, are scheduled to mature over the next two years. This circumstance represents substantial refinancing risk as CRE loans typically have large balloon payments due at maturity. Banks have been dealing with maturing loans in a variety of ways, including providing extensions of performing assets, troubled debt restructurings, equity injections, collateral sales, and, in some cases, pursuing foreclosures. Since the issuance of the October 2009 supervisory guidance on prudent loan workouts, banks have significantly increased the level of restructuring of CRE loans.⁵ Economic incentives to restructure or refinance existing loans are aided by the current low interest rate environment. Some banks with properties in healthier markets are also beginning to see a pick-up in investor demand for high-quality properties with strong tenants.

Since the beginning of 2008 through the third quarter of 2010, commercial banks have incurred almost $80 billion of losses related to CRE exposure, equating to a little over 5 percent of the average exposure outstanding during this time. In past cycles, CRE credit and market fundamentals generally lagged the larger economy by a year or more. Given this historical experience and the recent improvement witnessed in the broader economy, it is estimated that banks have taken roughly 40 to 50 percent of the CRE losses that they will realize over this cycle. Using past cycles as a guide, we expect that the remaining losses will likely be incurred over the next few years.


While we can project potential losses facing banks, losses ultimately realized through this cycle will depend on the pace of improvement in the labor market, overall credit availability, and other macroeconomic and financial factors, especially unemployment rates and interest rates. Those factors are why we continue to emphasize the importance of stress testing as a critical element of managing risks associated with CRE concentrations.

Federal Reserve Supervisory Approach to Commercial Real Estate Concentrations
As noted in our previous statement to the panel on CRE conditions, the Federal Reserve led an interagency effort to develop supervisory guidance on CRE concentrations that was finalized in 2006 and published in the Federal Register in early 2007. ⁶ In that guidance, we outlined our expectations that institutions with concentrations in CRE lending need to perform ongoing assessments to identify and manage concentrations through stress testing and similar exercises to identify the impact of adverse market conditions on earnings and capital.

Since the quality of CRE loans at supervised banking organizations began to weaken, the Federal Reserve has devoted significant additional resources to assessing the quality of CRE portfolios. These efforts include monitoring the impact of changing cash flows and collateral values, as well as assessing the extent to which banks have been complying with our CRE guidance. Examiners have taken a balanced approach to ensuring that banks are recognizing losses in a timely manner, maintaining sufficient loan loss reserves, and monitoring collateral values while being mindful not to discourage healthy banks from making loans available to creditworthy borrowers.

Additionally, in an effort to encourage prudent CRE loan workouts, especially among maturing loans, the Federal Reserve led the development of interagency guidance issued in October 2009 regarding CRE loan restructurings and workouts.⁷ To better understand the effectiveness of this guidance, the agencies conducted a survey of financial institutions during their examinations. The survey was completed in the third quarter of 2010.

The survey was designed to gain an understanding of the current trends in the institution's CRE portfolios and an estimation of the volume of loan restructurings that are likely to occur within the next year. The majority of respondents described the quality of their CRE portfolios as relatively stable but expressed concern regarding borrowers' deteriorating repayment abilities and declining collateral values, which were of particular concern where maturing loans no longer met the institution's underwriting standards. Approximately two-thirds of the respondents were engaged in workout activity. Of note, respondents reported that almost three-fourths of loan modifications were performing according to their modified terms. The survey also noted that the volume of future CRE workouts was estimated to increase by approximately 60 percent during 2011. In contrast, banks have only restructured approximately 5 percent of all outstanding CRE portfolios to date.
Given the level of restructured loans to date and the estimated volume of future restructurings, the Federal Reserve will continue to review institutions' restructuring policies to ensure that modifications are pursued in a prudent manner. Moreover, examiners will also monitor banks' internal reporting systems to determine if restructured loans are performing in accordance with modified terms.

Regulated institutions continue to face significant challenges in determining the value of real estate in the current environment. For this reason, the Federal Reserve and the other federal banking agencies issued revisions to the Interagency Appraisal and Evaluation Guidelines in December 2010.⁸ The Federal Reserve expects institutions to have policies and procedures for obtaining new or updated appraisals as part of their ongoing credit reviews. An institution should have appraisals or other market information that provide appropriate analysis of the market value of the real estate collateral and reflect relevant market conditions, the property's current "asis" condition, and reasonable assumptions and conclusions.

Changes to Supervision at the Federal Reserve
To improve both the Federal Reserve's consolidated supervision and our ability to identify potential risks to the financial system, we have made substantial changes to our supervisory framework. We have augmented our traditional supervisory approach, which focuses on examinations of individual firms, with greater use of horizontal reviews, which simultaneously examine portfolios across a group of firms, to identify common sources of risks and best practices for managing those risks. To supplement information from examiners in the field, we have enhanced our quantitative surveillance program to use data analysis and formal modeling to help identify vulnerabilities at both the firm level and for the financial sector as a whole. This analysis is supported by the collection of more timely, detailed, and consistent data from regulated firms. Many of these changes draw on the 2009 Supervisory Capital Assessment Program, or SCAP.

Regarding CRE exposures specifically, we are working with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation on the collection of loan-level CRE data from a number of national and regional banks. The data collected will provide critical information on the credit quality and performance of these loan portfolios. These data will aid in the development of more forward-looking loan loss projections that will provide a useful benchmark for the broader CRE market that can be used for all institutions. They will also be used to develop more accurate stress test parameters for CRE portfolios of banks that the Federal Reserve supervises. In addition, the agencies have made adjustments to the Consolidated Reports of Condition and Income, or the Call Report, filed quarterly by banks, to obtain more detailed information with respect to their CRE restructurings.


Conclusion
Over the past year, CRE market and credit conditions have shown signs of stabilization and, in some areas, modest signs of improvement. We are also seeing signs of price stabilization in a number of CRE markets. Nevertheless, while some directional metrics are improving, the CRE market is still distressed and the strength and pace of improvements remains uneven.

We expect that banks will continue to incur substantial additional CRE losses over the next two years and that many banks with CRE concentrations will continue to be under stress. While problems in the CRE market will be an ongoing concern for a number of banking organizations and a negative factor for economic growth and lending, we do not see CRE losses as a threat to systemically important financial institutions.

Progress on working through the overhang of distressed CRE will take time and will depend on banks taking strong steps to ensure that losses are recognized in a timely manner, that loan loss reserves and capital appropriately reflect risk, that loans are modified in a safe and sound manner, and that loans continue to be made available to creditworthy borrowers. To this end, the Federal Reserve will continue to work with lenders to ensure that bank management and supervisors take a balanced approach to ensuring safety and soundness and serving the credit needs of the community.

Patrick M. Parkinson, Director, Division of Banking Supervision and Regulation

 

SBA Mortgage Relief Program to Small Businesses

Release: Congresswoman Jackie Speier Announces SBA Mortgage Relief Program to Small Businesses

02/18/11 SAN MATEO, CA- Congresswoman Jackie Speier (D-San Francisco/San Mateo) today announced that the Small Business Administration is offering a program that will help small businesses facing maturity of commercial loans or balloon payments refinance their mortgage debt.

“This is a lifeline to businesses at a time when our economy is starting to recover,” Speier said. “This program could keep business owners out of foreclosure who are making their payments on time and are doing well.”

The temporary program will permit business owners to use a version of SBA’s 504 loan program to refinance mortgage loans that would mature before December 31, 2012.  Applications will be accepted starting February 28, 2011 until September 27, 2012.

Congress authorized the SBA to approve $15 billion in loans under this program, $7.5 billion this year and $7.5 billion in 2012. SBA estimates that the program will benefit up to 20,000 businesses in the U.S., up to 5000 of them in California.

Traditional 504 loans are long-term financing tools designed to encourage economic development by offering small businesses fixed-rate financing to acquire major fixed assets for expansion and modernization. The business owner has to commit to at least 10% equity and work with a third-party lender and an SBA-approved Certified Development Company on a standard 50% /40% split. Under the temporary program, the business is not required to expand to qualify for a loan modification.
Business owners can refinance up to 90% of the current appraised property value or 100% of the outstanding mortgage, whichever is lower.

The SBA may later expand the program to businesses with balloon payments due after December 31, 2012

Find a Fact Sheet about 504 Loan Refinancing For Eligible Small Business Assets Under the Jobs Act here.

Commercial Real Estate News

A New Paradigm For Distressed Construction Assets
by Marc Metzgar, Feb. 7, 2011
In the past decade, construction lending has been a metaphoric study of the lending industry as a whole. It was a perfect storm, where experience and best practices became subordinate to production. In many ways, risk mitigation in construction lending followed the same fate as risk mitigation in residential lending. The fact that a construction loan was underwritten based [read more]

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$74.8B In Real Estate Auctions During 2010
Feb. 10, 2011
Real estate auctions accounted for $74.8 billion in sales during 2010, according to a new estimate by the Gwent Group, based in Bloomington, Ind. The figure includes live sales, government sales, estate and private "boardroom" sales, sealed bid auctions [read more]

DebtX Reports December Drop In CRE Loan Prices
Feb. 9, 2011
The aggregate value of commercial real estate (CRE) loans priced by Boston-based DebtX that collateralize commercial mortgage-backed securities (CMBS) decreased to 79.4% as of Dec. 31, 2010, from 80.3% as of Nov. 30, 2010. Loan values were 75.9% as [read more]

Blackstone Takes Majority Stake Of Hotel Del Coronado
Feb. 8, 2011
Strategic Hotels & Resorts Inc., headquartered in Chicago, has closed a definitive agreement to recapitalize the joint venture that owns the Hotel del Coronado, one of California's most famous luxury resorts. Under the terms of the transaction, a new [read more]

MBA: CRE Originations Up 36% In 2010
Feb. 8, 2011
Mortgage bankers originated $110 billion of commercial and multifamily mortgages during 2010 - an increase of 36% from 2009 - according to preliminary estimates based on the Mortgage Bankers Association's (MBA) Quarterly Survey of Commercial/Multifamily Mortgage Bankers Originations. The [read more]

MBA Ranks Top Commercial, Multifamily Mortgage Servicers
Feb. 7, 2011
The Mortgage Bankers Association (MBA) released its year-end ranking of commercial and multifamily mortgage servicers as of Dec. 31, 2010. At the top of the list is Wells Fargo, with $451.1 billion in U.S. master and primary servicing, followed [read more]

Commercial Real Estate Creeping Slowly Toward Recovery
Feb. 4, 2011
Although the commercial real estate sector is showing hints of stabilization, a full recovery is still far away, regulators and analysts say. In a hearing Friday, the Congressional Oversight Panel (COP), a federal watchdog agency, examined the impact of [read more]

Freddie's Multifamily Volume Picked Up In Second Half Of 2010
Feb. 4, 2011
Freddie Mac reports that the volume of its multifamily whole-loan and bond guarantee business totaled $15 billion last year - down from almost $17 billion in 2009. This volume includes Freddie Mac's targeted affordable-housing products, which finance apartments that [read more]

Despite New Issuances, CMBS Delinquency Rate Hits Another Record High
Feb. 2, 2011
The U.S. commercial mortgage-backed security (CMBS) rate rose again in January, with the percentage of loans 30 or more days delinquent, in foreclosure or real estate owned climbing 14 basis points (bps) to 9.34%, Trepp LLC reports. That is [read more]

Fannie Mae Delivers New Multifamily MBS Product
Feb. 2, 2011
Fannie Mae has introduced Guaranteed Multifamily Structures (Fannie Mae GeMS), an expanded multifamily mortgage-backed securities (MBS) execution that will include DUS Megas, DUS REMICs and syndicated DUS Megas. Syndicated Mega deals will be managed by broker-dealers and offered in [read more]

Morgan Stanley And B Of A To Issue CMBS
Feb. 2, 2011
A second commercial mortgage-backed securities (CMBS) deal has hit the market this week, The Wall Street Journal reports. The $1.55 billion issuance is being put forth by Morgan Stanley and Bank of America. Earlier this week, the WSJ reported [read more]

Survey Finds CRE Markets Mending Slowly
Feb. 2, 2011
The Real Estate Roundtable, fresh off its 2011 State of the Industry Meeting last week, says its 1st Quarter 2011 Real Estate Roundtable Sentiment Index shows the most positive results since the survey of senior commercial real estate (CRE) [read more]

Deutsche Bank, UBS To Offer $2.2B CMBS
Feb. 1, 2011
Deutsche Bank and UBS are planning to issue the year's first commercial mortgage-backed security (CMBS) offering, a $2.2 billion bond offering. The Wall Street Journal reports that the bond consists of seven tranches, including three that are AAA-rated. The [read more]

Fed: More Demand, Less Funds For CRE Loans
Feb. 1, 2011
Approximately 10% of U.S. banks have reported an increased demand for commercial real estate (CRE) loans, the strongest reading since early 2006, according to the Federal Reserve Board's January 2011 Senior Loan Officer Opinion Survey on Bank Lending Practices. [read more]

Investor Consortium Acquires FDIC Structured Transaction
Jan. 28, 2011
A consortium of investors organized by Colony Capital LLC, including Colony Financial Inc., a real estate finance company focused on acquiring, originating and managing commercial mortgage loans, has participated in the acquisition of a structured transaction with the Federal [read more]

Cantor Fitzgerald Plans $1B CMBS Offer
Jan. 27, 2011
New York-based bond broker Cantor Fitzgerald LP is planning a $1 billion securities offering tied to commercial property loans. According to a Bloomberg report, the offering is the first for the company, which began its real estate finance [read more]

Commercial Modification News

What Is Loan Audit Commercial? | ROCKY POINT REAL ESTATE 1 A loan audit commercial may be applied to any forms of loan modification, including industrial loan mods, warehouse loan modifications and a lot more. ... www.rockypointrealestate1.com/what-is-loan-audit-commercial/

The Benefits Of Hiring A Commercial Mortgage Broker A good commercial mortgage broker has the option to shop hundreds of lenders ... Shocking Facts Nobody Dares to Tell About Obama's Loan Modification Plan! ... ezinearticles.com/?The-Benefits-Of-Hiring-A...Broker...

Taking Commercial Loan Modification To Avoid Property Foreclosure ... Commercial loan modification may help commercial property owners avoid foreclosure. With the real estate crisis affecting real estate owners, ... arizona-first-time-homebuyer.com/?p=6

Commercial Loan Solutions Files Complaints Against Lenders Tags, : commercial loan modification, commercial mortgage modification. Last Updated, : Jan 25, 2011. Shortcut, : http://prlog.org/11248429 ... www.prlog.org/11248429-commercial-loan-solutions-files-co...

Maximizing Profits In Distressed Commercial Real Estate

In 2008, Commercial Equity Solutions (CES) began to negotiate with lenders at the request of their clients who own commercial real estate. Their commercial property (or real estate portfolio) was under attack.
 

With the economic fallout most investment real estate began to experience higher and higher vacancy rates.  The owners were forced to lower leasing rates to retain quality tenants or had lost the less credit worthy tenants altogether. The Commercial Real Estate (CRE) investors were no longer able to sustain the debt service and asked CES to contact their bank to find a solution to their dilemma.

After hundreds of client interviews, property reviews and confidential bank negotiations, CES has utilized the applied theory of consultation and negotiation in commercial real estate workouts to observe a significant void in the current market: knowing where and how to acquire commercial real estate at its maximum profit delta.

This discovery has expanded the focus of our commercial real estate consulting practice from strictly a property owner as client to an acquisition investor as client perspective.  

By helping property owners achieve a significantly discounted loan payoff opportunity, they are assisting the banks in removing non-performing debt from their books.  This creates an opportunity for an investment client and allows the property owner to reset the basis of their property, setting the table for investors to acquire, or become part of, stable cash flowing real estate throughout the United States.

Of course this all happens prior to foreclosure, before these real estate opportunities are known to the general public.

Most CRE investors understand that once a property has been foreclosed upon, the bank is not going to be as amiable in selling at the best possible price. Additionally, the previous owner may have been the best financial steward that property has seen, but due to outside forces, not their management skills, the property lost its sustainability.

Now as a bank owned property, it will lose further value as tenants flee to a more secure or better priced property. Acquiring or becoming an equity partner prior to these negative consequences is where CES has answered investor’s liquidity and risk concerns.

The maximization of cash flow, sustainability, risk reduction, and profitability (not to mention the altruistic aspects of assisting a neighborhood or an entire community to take a step back towards stabilization and security), is the sweet spot most investors are looking for.

CES has now taken the next step by releasing an investor driven and directed marketing approach to acquire the specific property type, the location, and risk level investors are looking for. This program allows investors to initiate their chosen market and demographics and have the first look at properties that meet these criteria.

This program provides targeted properties negotiated through the CES system that will maximize investor profits in distressed commercial real estate.  Contact a member of our team today to find out how you can leverage our experience and contacts to expand your commercial real estate portfolio.

Larry Larsen
Director of Client Services
Commercial Equity Solutions, LLC
888-807-2786

The Proper Care and Feeding of Bankers

When engaging a banker for the purpose of a commercial mortgage workout, your success will be in direct proportion to your understanding of what motivates your banker.  Understanding who your lender is and what their motivations are is essential to negotiating a workout.

The different types of lenders that you could encounter include, large national banks, community and regional banks, CMBS special servicers and structured sale buyers that originate when the FDIC takes over a bank.

A large national bank who may be trading on the stock market at less than book value  because of unrealized CRE losses may be more apt to recognize a loss in exchange for a quick resolution as they are trying to clean up their balance sheet.  The small community bank may be in a position that they can't afford to realize a loss and might be more apt to "pretend and extend".  In this case, it may be likely that three months from now you may be dealing with a completely different set of circumstances as the smaller banks get gobbled up or closed by the FDIC.

If the loan is with a CMBS special servicer, you must take into consideration that the special servicer usually gets 1% of what they collect and all of the default interest.  They also hold the first loss position tranche of the securitized note.  The special servicer will allow the broader investor pool to take the property through foreclosure rather than forfeit the default interest and other fees that are called for in the serviceing agreements.

A structured sale buyer is a bank that acquired a portfolio of loans from the FDIC when they took over a bank.  These lenders often paid pennies on the dollar to take over what are considered toxic assets.  These lenders are looking to maximize their investment and may be interested in acquiring the property itself through foreclosure.

Which ever of these lenders owns your note, it is important that you communicate with them.  Bankers hate surprises.  They all fall somewhere on the banking food chain and have to answer to someone.  Understanding who they have to answer to and what their motivations are will help you to formulate a workout plan that meets their goals.  Only the lender can approve a workout.

You must have patience with your lender.  There are three distinct stages the lender goes through when there is a problem on a loan.  the first stage is denial.  "Just keep sending your payments, no problem".  Then comes anger.  "I'll sue!"  Next is acceptance.  Your lender understands that the problem is real and needs to be addressed.  This is where you get a workout.  Each of these stages must be dealt with.  You can't skip ahead and these can't be accomplished in the first few meetings.


Bankers like documentation.  When you see things are getting bad, talk to the lender and give him supporting documentation.  Let him know what you are up against so that he isn't surprised if you miss a balloon or interest payment.

By Ted Schmidt, Director of Marketing
Commercial Equity Solutions, LLC

Recent Successes Negotiating with Lenders

Some of our more recent and more sophisticated clients have had success negotiating effectively with their lenders.  This scenario is more likely to happen where there is not a personal guarantee or where the borrower is not financially collectible to the lender for deficiencies.  These clients have been able to convince the lender that it is in everyone's best interest to agree on a discounted payoff "DPO".  This allows the lender to remove the note off their books and make the necessary regulatory adjustments. 


Once this number is agreed to, the borrower then must perform within a limited time period to either refinance or pay off the lender to consummate the deal.  It also allows the borrower to reset the basis on a new loan that will cash flow.  We are assisting these new clients, performing on the negotiated DPO's.


The process of obtaining new financing, especially where the commercial lending market is already very limited, and where most borrowers are not able to come up with the normal 30 - 40% down payment can be extremely challenging.  We have been able to attract lenders and investors that understand this difficult situation and are willing to lend or invest in this environment.  It is important that any commercial borrower that is working through this situation understands the importance of seeking professional assistance in this process.  The DPO may create a taxable event and consultation with a qualified CPA is not a bad idea.  Failing to take advantage on the negotiated DPO can be very expensive to both the lender and the borrower.


We also have clients that have already lost their property to foreclosure and would like to make an offer to the lender to purchase the property back from the lender REO department.  These clients also require financing or an investor partner to accomplish this purchase.  Seeking the assistance of a professional that understands the challenges associated with this process can save time and money.



We find that working through these ever changing markets conditions is a challenge to all of us.  Particularly in commercial real estate, no two properties are the same, and each transaction must stand up to the merits of the deal.  Understanding the moving parts and the motivation of each affected party is key to achieving success for each workout.



For additional information or comment please contact the author:

Chuck Matheny  602.697.7904

chuck@commercialequitysolutions.com

Strategic Defaults in Commercial Real Estate

By, Dr. Ted C. Jones, Economist Stewart Title

Latest NCREIF Data Show an Improvement in Commercial Real Estate Values in Q2

With an estimated $1.4 trillion of commercial real estate debt set to refinance by the end of 2014, more than half of that is underwater according to a Wall Street Journal article.
Good news, however, is an improvement in the just released Q2 2010 MIT Real Estate Group’s analysis of The National Council of Real Estate Investment Fiduciaries (NCREIF) data.  NCREIF is a not-for-profit trade association that provides data and analysis to the pension fund industry.  They track returns and prices and have more than $234 billion of value in 6,066 income producing properties.  Since these properties are held by pensions funds or retirement accounts, there no tax implications whatsoever.

Rather than using comparable sales, MIT produces what is similar to S&P’s Case-Shiller House Prices Indices, but for commercial real estate.  Rather than examining comparable sales and imputing that to other property values, these indices are based on a sale of a previously acquired property.

The table below shows the typical property value change since the time of acquisition.  The good news is that for the first time since 2007, property values did not track down further in value.  Bad news is that essentially, if a property was acquired since 2004 (but not in the last two or three quarters) it likely is worth the same or significantly less, depending on the date of acquisition.  In the table below, for example, an industrial property acquired in Q3 2007 is now worth almost 44 percent less than the purchase price.  Depending on the property type, acquisitions at the market peak in 2007 are now worth from 27.7 percent to 43.6 percent less than the purchase price.

You need to note that MIT states “results for the 1st, 2nd, and 3rd quarters of any year are considered preliminary and subject to revision until the calendar year is completed with the 4th quarter results.”

Maybe the light at the end of this tunnel is not yet another train.  And these days good news in real estate has been tough to find. 

Commercial Equity Solutions, LLC assists real estate owners in all aspects of their commercial real estate and have successfully assisted and counseled borrows to work with their lenders to modify their commercial loans and mitigate personal and corporate liability.



Commercial Property Owners Choose to Default- WSJ article
 For more info on these price data see MIT Real Estate Group’s analysis of NCREIF data.

Recent Commercial Modification Success Stories

Thrift Store Gets A 2 Year Extension

In February of this year a retail store owner in Glendale, AZ approached us and asked if we would be able to help save their store.  The store provides jobs for battered woman and the profits go to support battered woman's shelters.  They were just 2 weeks from the sale date when they engaged Commercial Equity Solutions, LLC to help.

They had become delinquent on their taxes and could not keep up on the payments.  Previously, the property owner had attempted to negotiate an extension and got nowhere until they retained Commercial Equity Solutions, LLC.

By demonstrating to the lender that the stores income had stabilized over the last few quarters, the lender agreed to a 2 year extension with interest only payments.

110,000 Square Foot Retail Center Gets Principal Reduction.

This multi-tenant retail property in Minnesota has had a high turnover rate because of constant retail lease renegotiation.  The property owners were unable to keep current on the taxes and soon became delinquent on the debt service.

The lender (a CMBS Trust) turned the account over to a special servicer and began foreclosure proceedings on the $9.4 million note.  Commercial Equity Solutions, LLC was successful in negotiations with the servicer and they agreed to a pay off of $5.5 million.

With the loan basis on the property reset to its market value, this shopping center will once again cash flow sufficiently to service the new debt.

Recent Commercial Modification News

To Fix Sour Property Deals, Lenders 'Extend and Pretend' Wall Street Journal - Carrick Mollenkamp - Lingling Wei But the practice is creating uncertainties about the health of both the commercial-property market and some banks. The concern is that rampant modification ...

Fitch Takes Various Actions on Bear Stearns Commercial Mortgage Trading Markets (press release) - 1 day ago ... modified and the borrower is performing under the terms of the modification. ... Similar to Fitch's prospective analysis of recent vintage commercial ... Fitch Downgrades GMAC Commercial Mortgage Securities 2001-C1 ...? - Earthtimes Fitch Takes Various Actions on Nomura Asset Securities Corp. 1998-D6? - Benzinga all 99 news articles »

Fitch
Affirms Protective Life Insurance Co.'s CMBS Servicer Ratings
MarketWatch (press release) - Jun 15, 2010
The servicer ratings are based on the methodology
described in Fitch's reports 'US Commercial Mortgage Servicer Rating
Criteria' dated June 19, 2009, ...
The
role of mortgage servicers? - Financial Times
The
role of mortgage servicers? - Financial Times
Fitch
Affirms Halliburton's IDR at 'A-'; Outlook Stable? -
Bradenton Herald
all
29 news articles »

BERNANKE ON COMMERCIAL REAL ESTATE

BERNANKE ON COMMERCIAL REAL ESTATE
"We are concerned about it, it clearly is a very weak point in the economy. For many banks, including small and medium-sized banks, it is a problem. We have done a number of things. The Federal Reserve, working with the Treasury, has developed programs to try to restart the commercial mortgage-backed securities markets. Beyond that we have issued guidance to banks on commercial real estate and we're trying to work with them to restructure commercial real estate loans and to find ways to manage in terms of loans, so we're doing the best we can with banks and with the markets. There seems to be, I would say, a few glimmers of hope in this area, some stabilization of prices in some markets, for example, but it does remain a serious concern and we're watching it very carefully."

Commercial Loan Workouts and Modifications

By Chuck Matheny

Commercial Equity Solutions, LLC


Many commercial borrowers now find themselves in the same condition today that a significant majority of homeowners are in. These commercial borrowers have negative equity or in other words their loan is greater than the value of their property. What is worse is that often the income from the property is not sufficient to pay the monthly debt service and taxes due on the property. This poses a problem when it comes to the end of the term of the loan and a refinance or extension is necessary. It also causes a more immediate problem of how will the commercial borrower pay the monthly loan and tax obligations.


This situation has evolved in most cases for two reasons; 1) the economy has caused many business’s to downsize or disappear thus causing increased vacancies and 2) due to the soft market many tenants have requested rent reductions from their landlord to help keep them in business and landlords have voluntarily granted them as it is most often in their best interest.


This situation leaves many commercial property owners in the tenuous situation of having to”feed the property” or support the monthly loan obligations while the property cannot sustain itself. At some point many owners have to determine if it is worth trying to hang on to their properties. The question that is often asked is do I want to keep spending good money after bad in this particular investment.


The lenders on the flip side are having no choice but to send out default notices if the payments due are past 30 days. If the lender feels that deficiencies are not curable and that the property is not being managed properly many will initiate some kind of foreclosure action and attempt to take the property back or at the very least appoint a receiver.


The good news in this scenario is that commercial lenders are realizing that it is often in their best interest not to aggressively pursue a foreclosure action. Often a better action is to modify on a temporary basis the terms of the note. Sometimes this can be done with the shortfall being forgiven by the lender. Some lenders are under such heavy regulatory pressure that the best solution is simply to move the note off their books through a short sale or short refinance. This can often be done where the lender will realize more than would come from a foreclosure. One key component in determining the best course of action for both lender and borrower is an accurate measure of the current value of the property. This is not an easy task where many of the comparables typically used in a valuation or appraisal are a balance between foreclosure sales and legitimate investor income or capitalization rate based sales. This value becomes a moving target. This is also one reason why appraisal firms are so busy. Values are changing monthly and have a wide range of variance.


If a short refinance is pursued as a course of action since the traditional commercial finance markets are so tight the best alternative is often private financing. This adds a whole new dimension of complexity to the process. Borrowers may even have to give up future equity to accomplish this short refinance with a private lender.


The other significant question that bears weight in the decision of what to do is the level of personal guarantees associated with the particular property. In many commercial properties, ownership involves multiple partners and this further complicates the situation. If some of the partners are not able to make necessary cash calls you can imagine the stress that is created.


Many borrowers would be well advised to get professional help in trying to make these difficult decisions, as there is usually significant equity at risk. Find someone that you feel will take the time to get familiar with the details of your commercial property. Also take the time to find someone that will understand the different values that your property will have in this distressed market. Finally, find a professional that will not be too pushy or adversarial with your lender as they are not obligated to do what the borrower desires to accomplish. Remember we are working for the most part in uncharted waters for both borrower and lender and no one knows how long these distressed market conditions will continue.

Commercial Loan Modification Article in National Mortgage Professional Magazine

Please read the following article I wrote for National Mortgage Professional Magazine.
"Commercial Loan Modification"

Record CMBS Delinquencies Reported by Realpoint

Realpoint released their  Monthly Delinquency Report.  Here are some highlights and charts from their 15 page report.



In January 2010, the delinquent unpaid balance for CMBS increased by another $4.3 billion, up to $45.94 billion from $41.64 billion a month prior. The overall delinquent unpaid balance is up 326% from one-year ago (when only $10.79 billion of delinquent unpaid balance was reported for January 2009), and is now over 20 times the low point of $2.21 billion in March 2007. The distressed 90+-day, Foreclosure and REO categories grew in aggregate for the 25th straight month – up by $7.42 billion (28%) from the previous month and over $27.95 billion (508%) in the past year (up from only $5.51 billion in January 2009). This included a substantial jump in 90+-day delinquency in January 2010.

CMBS Delinquency Amounts

CMBS Delinquency Percentages

 

All deals seasoned at least a year have a total unpaid balance of $789.07 billion, with $45.94 billion delinquent – a 5.82% rate (up from only 3.15% six months prior).

 Geography

• The top three states ranked by delinquency exposure have remained consistent since January 2009, as California, Florida, and Texas collectively accounted for 30% of delinquency through January 2010.
• The 10 largest states by delinquent unpaid balance reflect 57% of CMBS delinquency, while the 10 largest states by overall CMBS exposure reflect 52% of the CMBS universe.
• The state of California remains a major concern at near 13% of CMBS delinquency. By MSA, however, such delinquency is concentrated in the Los Angeles, Riverside-San Bernardino, and Orange County MSAs highlighted below.
• While by state delinquency exposure Florida ranks second, no Florida MSA is found in the Top 10 MSA’s ranked by delinquency exposure (highest being Miami, which ranked 14th in our data).
• Notably, over 10% of total CMBS exposure in the states of Florida, Arizona, Nevada and Michigan are delinquent, with the Phoenix, AZ and Las Vegas, NV MSAs accounting for the top 2 by delinquency exposure at (14% and 14.5% of the MSAs, respectively).
• Credit also appears to be deteriorating further in the Riverside-San Bernardino, CA MSA, as over 11% of the total MSA exposure was reported delinquent through January 2010.
• Texas delinquency is highly concentrated within the Dallas-Fort Worth and Houston MSAs.
• Only one MSA topped 4% of CMBS delinquency in January 2010, consistent with the prior month.
• The 10 largest MSAs by delinquent unpaid balance reflect 30% of CMBS delinquency, while the 10 largest MSAs by overall CMBS exposure reflect 34% of the CMBS universe.

Video: How Will The CRE Bubble Be Resolved?

Watch this interesting discussion on the commercial real estate crisis. Tom Flexner, head of real estate at Citigroup, and Richard LeFrak, president of the LeFrak Organization, talk to CNBC.

Billions in opportunistic private money remain on the sidelines as the large rift between buyers and sellers highlights the state of commercial lending.

Congressional Oversite Panel Issues Gloomy CRE Report

The Congressional Oversight Panel issued its 190 page report on CRE .  Find the executive summary below.  The complete report is available at http://cop.senate.gov/documents/cop-021110-report.pdf



Executive Summary

Over the next few years, a wave of commercial real estate loan failures could threaten America’s already-weakened financial system. The Congressional Oversight Panel is deeply concerned that commercial loan losses could jeopardize the stability of many banks, particularly the nation’s mid-size and smaller banks, and that as the damage spreads beyond individual banks that it will contribute to prolonged weakness throughout the economy.

Between 2010 and 2014, about $1.4 trillion in commercial real estate loans will reach the end of their terms. Nearly half are at present “underwater” – that is, the borrower owes more than the underlying property is currently worth. Commercial property values have fallen more than 40 percent since the beginning of 2007. Increased vacancy rates, which now range from eight percent for multifamily housing to 18 percent for office buildings, and falling rents, which have declined 40 percent for office space and 33 percent for retail space, have exerted a powerful downward pressure on the value of commercial properties.

The largest commercial real estate loan losses are projected for 2011 and beyond; losses at banks alone could range as high as $200-$300 billion. The stress tests conducted last year for 19 major financial institutions examined their capital reserves only through the end of 2010.

Even more significantly, small and mid-sized banks were never subjected to any exercise comparable to the stress tests, despite the fact that small and mid-sized banks are proportionately even more exposed than their larger counterparts to commercial real estate loan losses.

A significant wave of commercial mortgage defaults would trigger economic damage that could touch the lives of nearly every American. Empty office complexes, hotels, and retail stores could lead directly to lost jobs. Foreclosures on apartment complexes could push families out of their residences, even if they had never missed a rent payment. Banks that suffer, or are afraid of suffering, commercial mortgage losses could grow even more reluctant to lend, which could in turn further reduce access to credit for more businesses and families and accelerate a negative economic cycle.

It is difficult to predict either the number of foreclosures to come or who will be most immediately affected. In the worst case scenario, hundreds more community and mid-sized banks could face insolvency. Because these banks play a critical role in financing the small businesses that could help the American economy create new jobs, their widespread failure could disrupt local communities, undermine the economic recovery, and extend an already painful recession.

Present Condition of Commercial Real Estate

The commercial real estate market is currently experiencing considerable difficulty for two distinct reasons. First, the current economic downturn has resulted in a dramatic deterioration of commercial real estate fundamentals. Increasing vacancy rates and falling rental prices present problems for all commercial real estate loans. Decreased cash flows will affect the ability of borrowers to make required loan payments. Falling commercial property values result in higher LTV ratios, making it harder for borrowers to refinance under current terms regardless of the soundness of the original financing, the quality of the property, and whether the loan is performing.

Second, the development of the commercial real estate bubble, as discussed above, resulted in the origination of a significant amount of commercial real estate loans based on dramatically weakened underwriting standards. These loans were based on overly aggressive rental or cash flow projections (or projections that were only sustainable under bubble conditions), had higher levels of allowable leverage, and were not soundly underwritten. Loans of this sort (somewhat analogous to “Alt-A” residential loans) will encounter far greater difficulty as projections fail to materialize on already excessively leveraged commercial properties.

Economic Conditions and Deteriorating Market Fundamentals

The health of the commercial real estate market depends on the health of the overall economy. Consequently, the market fundamentals will likely stay weak for the foreseeable future. This means that even soundly financed projects will encounter difficulties. Those projects that were not soundly underwritten will likely encounter far greater difficulty as aggressive rental growth or cash flow projections fail to materialize, property values drop, and LTV ratios rise on already excessively leveraged properties. New and partially constructed properties are experiencing the biggest problems with vacancy and cash flow issues (leading to a higher number of loan defaults and higher loss severity rates than other commercial property loans).

For the last several quarters, average vacancy rates have been rising and average rental prices have been falling for all major commercial property types.

Current average vacancy rates and rental prices have been buffered by the long-term leases held by many commercial properties (e.g., office and industrial). The combination of negative net absorption rates and additional space that will become available from projects started during the boom years will cause vacancy rates to remain high, and will continue putting downward pressure on rental prices for all major commercial property types. Taken together, this falling demand and already excessive supply of commercial property will cause many projects to be viable no longer, as properties lose, or are unable to obtain, tenants and as cash flows (actual or projected) fall.

In addition to deteriorating market fundamentals, the price of commercial property has plummeted. As seen in the following chart, commercial property values have fallen over 40 percent since the beginning of 2007.

For financial institutions, the ultimate impact of the commercial real estate whole loan problem will fall disproportionately on smaller regional and community banks that have higher concentrations of, and exposure to, such loans than larger national or money center banks. The impact of commercial real estate problems on the various holders of CMBS and other participants in the CMBS markets is more difficult to predict. The experience of the last two years, however, indicates that both risks can be serious threats to the institutions and borrowers involved.

Although banks with over $10 billion in assets hold over half of commercial banks’ total commercial real estate whole loans, the mid-size and smaller banks face the greatest exposure.

The current distribution of commercial real estate loans may be particularly problematic for the small business community because smaller regional and community banks with substantial commercial real estate exposure account for almost half of small business loans. For example, smaller banks with the highest exposure – commercial real estate loans in excess of three times Tier 1 capital – provide around 40 percent of all small business loans.

Foresight Analytics, a California-based firm specializing in real estate market research and analysis, calculates banks’ exposure to commercial real estate to be even higher than that estimated by the Federal Reserve. Drawing on bank regulatory filings, including call reports and thrift financial reports, Foresight estimates that the total commercial real estate loan exposure of commercial banks is $1.9 trillion compared to the $1.5 trillion Federal Reserve estimate. The 20 largest banks, those with assets greater than $100 billion, hold $600.5 billion in commercial real estate loans.

Figure 17: Commercial Real Estate Loans by Type (Banks and Thrifts as of Q3 2009)

 

 

As seen in the Foresight Analytics data above, the mid-size and smaller institutions have the largest percentage of “CRE Concentration” banks compared to total banks within their respective asset class. This percentage is especially high in banks with $1 billion to $10 billion in assets. The table above emphasizes the heightened commercial real estate exposure compared to total capital in banks with $100 million to $10 billion in assets. Equally troubling, at least six of the nineteen stress-tested bank-holding companies have whole loan exposures in excess of 100 percent of Tier 1 risk-based capital.

Risks

In the years preceding the current crisis, a series of trends pushed smaller and community banks toward greater concentration of their lending activities in commercial real estate. Simultaneously, higher quality commercial real estate projects tended to secure their financing in the CMBS market. As a result, if and when a crisis in commercial real estate develops, smaller and community banks will have greater exposure to lower quality investments, making them uniquely vulnerable.

As loan delinquency rates rise, many commercial real estate loans are expected to default prior to maturity. For loans that reach maturity, borrowers may face difficulty refinancing either because credit markets are too tight or because the loans do not qualify under new, stricter underwriting standards. If the borrowers cannot refinance, financial institutions may face the unenviable task of determining how best to recover their investments or minimize their losses: restructuring or extending the term of existing loans or foreclosure or liquidation.

On the other hand, borrowers may decide to walk away from projects or properties if they are unwilling to accept terms that are unfavorable or fear the properties will not generate sufficient cash flows or operating income either to service new debt or to generate a future profit.

Delinquent Loans

Although many analysts and Treasury officials believe that the commercial real estate problem is one that the economy can manage through, and analysts believe that the current condition of commercial real estate, in isolation, does not pose a systemic risk to the banking system, rising delinquency rates foreshadow continuing deterioration in the commercial real estate market. For the last several quarters, delinquency rates have been rising significantly.



The extent of ultimate commercial real estate losses is yet to be determined; however, large loan losses and the failure of some small and regional banks appear to some experienced analysts to be inevitable. New 30-day delinquency rates across commercial property types continue to rise, suggesting that commercial real estate loan performance will continue to deteriorate. However, there is some indication that the rate of growth, or pace of deterioration, is slowing. Unsurprisingly, the increase in delinquency rates has translated into rapidly rising default rates.



The increasing number of delinquent, defaulted, and non-performing commercial real estate loans also reflects increasing levels of loan risks. Loan risks for borrowers and lenders fall into two categories: credit risk and term risk. Credit risk can lead to loan defaults prior to maturity; such defaults generally occur when a loan has negative equity and cash flows from the property are insufficient to service the debt, as measured by the debt service coverage ratio (DSCR).

If the DSCR falls below one, and stays below one for a sufficiently long period of time, the borrower may decide to default rather than continue to invest time, money, or energy in the property. The borrower will have little incentive to keep a property that is without equity and is not generating enough income to service the debt, especially if he does not expect the cash flow situation to improve because of increasing vacancy rates and falling rental prices.

Broader Social and Economic Consequences

Commercial real estate problems exacerbate rising unemployment rates and declining consumer spending. Approximately nine million jobs are generated or supported by commercial real estate including jobs in construction, architecture, interior design, engineering, building maintenance and security, landscaping, cleaning services, management, leasing, investment and mortgage lending, and accounting and legal services.

Projects that are being stalled or canceled and properties with vacancy issues are leading to layoffs. Lower commercial property values and rising defaults are causing erosion in retirement savings, as institutional investors, such as pension plans, suffer further losses. Decreasing values also reduce the amount of tax revenue and fees to state and local governments, which in turn impacts the amount of funding for public services such as education and law enforcement. Finally, problems in the commercial real estate market can further reduce confidence in the financial system and the economy as a whole. To make matters worse, the credit contraction that has resulted from the overexposure of financial institutions to commercial real estate loans, particularly for smaller regional and community banks, will result in a “negative feedback loop” that suppresses economic recovery and the return of capital to the commercial real estate market. The fewer loans that are available for businesses, particularly small businesses, will hamper employment growth, which could contribute to higher vacancy rates and further problems in the commercial real estate market.

Conclusion

There is a commercial real estate crisis on the horizon, and there are no easy solutions to the risks commercial real estate may pose to the financial system and the public. An extended severe recession and continuing high levels of unemployment can drive up the LTVs, and add to the difficulties of refinancing for even solidly underwritten properties. But delaying write-downs in advance of a hoped-for recovery in mid- and longer-term property valuations also runs the risk of postponing recognition of the costs that must ultimately be absorbed by the financial system to eliminate the commercial real estate overhang.

Any approach to the problem raises issues previously identified by the Panel: the creation of moral hazard, subsidization of financial institutions, and providing a floor under otherwise seriously undercapitalized institutions.

There appears to be a consensus, strongly supported by current data, that commercial real estate markets will suffer substantial difficulties for a number of years. Those difficulties can weigh heavily on depository institutions, particularly mid-size and community banks that hold a greater amount of commercial real estate mortgages relative to total size than larger institutions, and have – especially in the case of community banks – far less margin for error. But some aspects of the structure of the commercial real estate markets, including the heavy reliance on CMBS (themselves backed in some cases by CDS) and the fact that at least one of the nation’s largest financial institutions holds a substantial portfolio of problem loans, mean that the potential for a larger impact is also present.

There is no way to predict with assurance whether an economic recovery of sufficient strength will occur to reduce these risks before the large-scale need for commercial mortgage refinancing that is expected to begin in 2011-2013.

The Panel is concerned that until Treasury and bank supervisors take coordinated action to address forthrightly and transparently the state of the commercial real estate markets – and the potential impact that a breakdown in those markets could have on local communities, small businesses, and individuals – the financial crisis will not end.