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."

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.

Lawmakers Urge Treasury to Support The CRE Market

 

WASHINGTON - This week, Congressman Paul E. Kanjorski (D-PA), Chairman of the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, and Congressman Ken Calvert (R-CA), sent a bipartisan letter to Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke about the growing concerns that deteriorating conditions in the commercial real estate (CRE) market may threaten an economic recovery.

"The growing bubble in the commercial real estate industry has the potential to infect our economy and slow a recovery," said Chairman Kanjorski.  "In order to safeguard the businesses operating on Main Street and protect the millions of jobs depending on commercial real estate, the Treasury and the Federal Reserve now must take needed and urgent action to stave off a potentially devastating wave of commercial real estate foreclosures and bank losses." 

"I am deeply concerned about the health of our commercial real estate market and the stability of thousands of small businesses across the country," said Congressman Calvert.  "We must take the appropriate steps to ensure that our commercial real estate market does not experience a liquidity crisis that would further exacerbate our struggling economic situation." 

"A liquidity crisis in the commercial real estate market is hurting small business owners across the entire nation," said National Association of REALTORS President Vicki Cox Golder, owner of the commercial real estate company Cox & Associates in Tucson, Arizona.  "I join with all commercial property owners who applaud the efforts of Reps. Calvert and Kanjorski to resolve this problem and put small business owners back in business." 

Specifically, the letter asks regulators to take the following steps:

• Establish a clear method for measuring and evaluating the effectiveness of recent CRE loan modification guidance issued by the regulators.

• Institute metrics to more clearly differentiate performing versus non-performing loans as well as any other steps that provide lending institutions with more confidence in assessing CRE loans.

• Make clear public statements encouraging lenders to continue to make credit available for performing assets as a means of restoring confidence and long-term value in the CRE market.

The $6.7 trillion CRE sector supports 9 million American jobs.  If the conditions in the CRE market deteriorate further the negative effects will be significant and widespread, rippling not only through the CRE sector but also the broader economy.  More than $1.4 trillion in commercial mortgages will come due by 2013, and as much as 65% of those deals will have trouble getting refinanced according to recent analysis conducted by Deutsche Bank.  While the Federal Reserve and Treasury Department have acknowledged the ongoing CRE challenges, their actions have so far failed to ease growing concerns among economists and market participants. 

The text of Congressmen Kanjorski and Calvert's letter which is signed by an additional 77 Members of Congress to Secretary Geithner and Chairman Bernanke from February 1 follows: 

Dear Secretary Geithner and Chairman Bernanke:
As you know, the financial crisis continues to have a dampening effect throughout the credit markets.  The commercial real estate (CRE) market, in particular, continues to experience difficult credit accessibility conditions.  Moreover, the scarcity of credit in the $6.7 trillion CRE sector poses a dangerous threat to our financial system just as our economy has begun to show signs of recovery. 

Earlier this month real estate data provider Trepp announced that the delinquency rate for loans underlying commercial mortgage-backed securities (CMBS) ballooned 500 percent in 2009, surpassing 6 percent in December for the first time.  Additionally, the CMBS market has all but shut down over the past year making it more difficult for CRE owners to sell or refinance. 

We appreciate the acknowledgement by federal regulators of this situation in October, when the Board of Governors of the Federal Reserve System, along with the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the National Credit Union Administration, and the Office of Thrift Supervision, issued a policy statement advising financial institutions to extend and/or restructure loans backed by income-producing and/or development properties whenever possible in order to minimize losses as well as to stabilize overall asset values in the communities they serve. 

While the regulatory guidance is a relatively recent occurrence, we remain concerned by early indications that it may not yet be having the desired impact in stabilizing the CRE market. While some properties are in desperate need of modification due to the economic downturn, we are not convinced these loans are being serviced properly or in an efficient manner.  Of even more concern, anecdotal evidence suggests that regulators continue to encourage lenders to write down the value of performing loans, whose payments may well be current and, in some instance, even call the loan.  This further exacerbates the crisis by creating defaults in properties that were able to meet their debt servicing. 

To ensure the recent CRE loan modification guidance will have a positive and stabilizing effect, and to protect the broader economy from further disruptions, we urge you to establish a clear method for measuring and evaluating its effectiveness.  Furthermore, we encourage you to institute metrics to more clearly differentiate performing versus non-performing loans as well as any other steps that provide lending institutions with more confidence in assessing CRE loans.  We also call upon you to make clear public statements encouraging lenders to continue to make credit available for performing assets as a means of restoring confidence and long-term value in the CRE market. 

In sum, we strongly believe that regulators must take continued steps to mitigate ongoing turmoil in the CRE sector before it becomes a full-fledged crisis, forestalls our economic recovery, and possibly requires additional taxpayer-funded capital injections.  Consistent with all applicable law and regulation, thank you for the consideration of our views and your attention to these matters.

### 

source http://kanjorski.house.gov/

Recent Commercial Mortgage Modification Consulting Requests

Commercial property owners are requesting help from consultants for the purpose of modifying their commercial loans at CommercialModification.com. Building owners are looking to preempt defaults as they can see that their notes are coming due or resetting and there is not enough equity to refinance.

The recent projects we have seen come through the site include two 42 unit buildings valued at over $6 mil., that have been put into default by the servicer because of missed property tax payments. Current occupancy is 95% and rent roll $62K. The owners is trying to reinstate with better terms or refinance.

An owner of a retail showroom and warehouse in northern California who put $1 million down payment a few years ago has lost nearly all his equity. He is now two months behind and making weekly payments on a loan that is close to the value of the property.

The owner of a 16 unit apartment complex in Mesa, AZ., who put $300K down 3 years ago has a loan reset in Jan 2010 when it adjusts upward. It is now only worth $400K and the loan amount is $688K. The owner of this loan faces a substantial loss if a modification is not completed before the reset date as financing is unavailable to pay off the resetting loan and the property would sell for substantially less if there were a forced liquidation. The cash flow on the property is insufficient to cover the debt load so modification is a best case scenario.

This property owner wanted to consult with firms who have a good track recorded in designing modification programs that are acceptable to the bank and servicing companies. A third party negotiator always puts you in a superior bargaining position in any type of negotiation.

The owner of 37 units in Darby PA purchased for $1,400,000 and now only worth $450,000 has a loan of $825,000 @ 13% fixed. This is another case where the debt service is a hardship because of declining rents and increasing vacancies.

Each of these unique situations present challenges for both the lender and borrower. Special Servicers, who are hired by mortgagors to deal with large commercial loans that are in default or likely to default, now have more leeway in negotiating workouts with property owners whose mortgages have been financed by selling shares to investors in the form of commercial mortgage backed securities.

Prior to a recent IRS rule change (IRS 09-45), special servicers had been opposed to any change in the status quo. The barrier removed by the Treasury department, which I applaud, allows the REMICS's to change the terms of these loans without jeopardizing their tax exempt status.

Banking on Geithner

Last week I went to went to Washington DC to participate in the CNBC Town-hall meeting with Treasury Secretary Tim Geithner. I had some tough questions for him regarding the treasury departments stance on modification of mortgages that have been packaged into commercial mortgage backed securities (CMBS). At issue are the IRS rules that prohibit modification of these commercial loans. The problem is that real estate mortgage investment conduits (REMIC) are not allowed to acquire new loans after the formation of the REMIC. A loan modification is considered a new loan if if it is adjusted beyond 1/4 of a point or more than 3 years.

The Treasury did ask the public for help in formulating guidance on the issue back in 2007 (http://www.irs.gov/pub/irs-drop/n-07-17.pdf) and Geithner was questioned by congress but the Treasury has yet to issue any guidance on the subject.

Unfortunately, the CNBC Town-hall meeting was too short for me to get to ask the Secretary the questions I had prepared and instead the meeting dealt with broader issues. The meeting can be seen below.

Gov Has No Plan for Coming $1 Trillion CMBS defaults

Earlier this week, Fed Chairman Ben Bernake appearing on Capitol Hill said that commercial mortgages packaged into CMBS "ought to" be modified the same way residential mortgage backed securities are now.

The total arrears on all CMBS reached $817 billion in June. This represents a 4.5% delinquency rate. This has increased from a 2% rate last year and is expected to reach $1 Trillion by the end of the year.

On Friday, Treasury Secretary Timothy Geithner, appeared before the House Financial Services Committee.

Rep. Carolyn Maloney, who described the commercial mortgage situation as a "ticking time-bomb" questioned Geithner about commercial loan modifications. She asked what administrative guidance the Treasury will issue as they did with residential modifications. He said "we have not made a judgment as to whether that is necessary, appropriate or possible and he would be willing to discuss it in more detail".

Rep. Maloney went on to ask what the problem is with giving modifications on CMBS the same as residential mortgage backed securities. He said "it is an enormously complicated set of issues and we will talk to you and your staff about it later".

We will have to wait and see what will happen in the coming months as the fuse burns down. It is obvious by Giethners testimony that our leadership in Washington has no plan to deal with this issue. Giethner does not even know if it is necessary?

Commercial Mortgage Modification Consulting

Commercial Mortgage Modification Consulting, by Ted Schmidt

Commercial property owners are increasingly under distress in today's economy. Over the next few years billions of dollars in commercial mortgages that were made in the bubble years of 2004-2007 will need to be rolled over with new financing. The problem is that many of these loans were made with loose underwriting standards to feed the demand for CMBS's. Now that values have declined 30-50% or more in some hard hit areas, refinancing is out of the question. Right now the water is receding and curious onlookers are rushing to the water's edge as the tsunami approaches.

Property owners are left with few choices and loan servicers are left with even fewer. Commercial securitization and servicing agreements prohibit loan modifications without unanimous consent of the actual securities owners. This is almost impossible since they are spread all over the world. Furthermore, senior tranche holders will never agree to modification since they stand to lose money to the benefit of the riskier junior tranches.

The only way to modify these loans is by judicial cramdown in bankruptcy or by other action of law. At some point the government will get involved to make provisions for commercial loans to be modified. The first few bailouts did not address the commercial real estate problem. There is likely to be a shift in political will towards forcing commercial modifications.

As for loans that are not securitized, there is an opportunity to negotiate and come to a resolution that works for all parties.

Consulting Opportunities

These business owners will want to prevent or delay a foreclosure to preserve the cash flow that they are receiving. In some cases these are high income individuals who have lost their primary source of income and are living off the cash flow from their building. Other cases are small businesses that have suffered a downturn in business and have fallen behind. The opportunity exists in helping these people save their property and preserve their income.

Commercial mortgage modifications a challenge

In spite of increased traffic and interest in our commercial mortgage modification portal (see International Business Times) actual loan workouts have been scarce. Says Dempsey Mork of Whiehall Montegue and Associates, "the servicers of commercial mortgages which have been securitized (CMBS) are subject to strict servicing agreements and do not have the authority to modify the loans in many cases, as they do in the residential market." Whitehall consults owners of commercial property that hope to get their loans modified. He goes on to say that these loan servicers tend to be the same people that would underwrite the loan to begin with and are typically very knowledgable about the projects and their challenges.

A consultant can propose a modification plan that makes sense for all parties. Portfolio lenders are more likely to accept an offer since they actually are the owners of the notes. More often a forbearance agreement is negotiated which delays a foreclosure and gives the owner time to raise cash to bring the note current, file bankruptcy or sell the property.

As the commercial refinancing crisis looms, modifications of existing loans will be difficult and under current market conditions refinancing is almost impossible.

Ted Schmidt
President
Leadsnet, Inc