LSI Distressed Real Estate Seminar – Washington, D.C. – March 18, 2009
Strategies for Lenders and Borrowers For Dealing With Distressed Commercial Real Estate, Including Sales, Restructurings and Workouts
George E. Covucci George.Covucci@aporter.com 202.942.5026 Amy B. Rifkind Amy.Rifkind@aporter.com 202.942.6137 555 Twelfth Street, N.W. Washington, D.C. 20004-1206
Introduction
Presentation on Loan Sales, Workouts and Restructurings Focus of Traditional Commercial Real Estate Loans Then & Now Continuum of Lender Options, including FDIC Sales Key Topics
Dilemma of Real Estate Lenders FDIC Sales Process Lender Sales of Loans Lender Workouts Involving Property and Cooperative Borrower Borrower Strategies For Dealing with Distressed Real Estate Restructurings
2
THE FOLLOWING PROGRAM CONTAINS THE LATEST DISTRESSED REAL ESTATE NEWS. VIEWER DISCRETION ADVISED.
www.econosseur.com (as edited by Arnold & Porter LLP)
3
Dilemma Of Real Estate Lenders
Déjà vu all over again? The landscape of the late 80’s/early 90’s Tax law changes in 1981 and 1986
4
Effects of Major Tax Legislation on Commercial Real Estate
Pre-Economic Recovery Tax Act of 1981 Allowable depreciation period Allowable depreciation method Passive losses deductible? Max. ordinary income tax rate Capital gains tax rate 40 years Straight-Line Yes 70% 28% Post-Economic Recovery Tax Act of 1981 15 years 175% Declining balance Yes 50% 20% Post-Tax Reform Act of 1986 31.5 years Straight-line No 38.5% 28%
5
Failed Banks (1988-1992)
Total : 776 250
(approximately)
200
150 100 50 0
Source: FDIC Historical Statistics on Banking http://www.sba.muohio.edu/brunarkr/charters.pdf
1988
1989
1990 1991 1992
6
Today
Global recession hitting all sectors CMBS Toxic residential loans spread to commercial real estate arena and then to global market
7
How the Current Recession Compares With the Prior Real Estate Recession
16000 14000 12000 10000 8000 6000 4000 2000 0
1/2/2007
1/2/2009
DOW Now DOW Then
Close Jan1987 to Dec1992 Close Jan2007 to Feb2009
Chart showing Dow Jones Industrial Average Monthly Close Data source: MarketWatch.com
8
“Bad Bank Loans at Extreme Levels” – Jeffrey Bernstein (3/1/09) http://seekingalpha.com/article/123380-bad-bank-loans-at-extreme-levels
9
CMBS Issues: 2006-2008
Billions
228.7 202.7
250
200 150 100 50 0
75
2006
2007
2008
10
Troubled Assets Radar
Billions
$100.00 $80.00 $60.00 $40.00
$80.90
Distressed Assets Total $25.7 B
Potentially Troubled
$21.20
Troubled
$20.00
$0.00
$4.50
Lender REO
2008
“US Troubled Asset Radar Report” – 12/17/2008 Real Capital Analytics, Inc. - http://www.rcanalytics.com
11
Troubled Assets Radar in Washington, D.C.
Millions
3700M
4000
3500
3000 2500 2000 1500 1000 500 0 Distressed Assets
*Real Estate Forum February/March 2009
Value # Properties 337M 145
17
Potentially Troubled
12
Commercial Real Estate World Turned Upside Down
Millions
2007 Acquisition
120 100 80 100 80
60
40 20 0
Assume: $5M NOI 5% cap rate 80% loan
Property Value Debt
Equity: $20M
13
Commercial Real Estate World Turned Upside Down
Millions
2009 Value
120 100 80 80 64.3
60
40 20 0
Assume: NOI declines by 10% to $4.5M Cap rates increase by 200 basis points to 7%
Property Value Debt
Deficiency: $15.7M
14
Government Intervention
Then
– – Federal Deposit Insurance Company (“FDIC”)
• Receiver for 776 Savings & Loans
Financial Institutions Reform Recovery & Enforcement Act of 1989 (“FIRREA”)
• • • Created Resolution Trust Corporation (“RTC”) Approximately $400B sold Teamed with Wall Street in developing CMBS industry
15
Failed Banks (1988-1992)
Total : 776 250
(approximately)
200
150 100 50 0
Source: FDIC Historical Statistics on Banking http://www.sba.muohio.edu/brunarkr/charters.pdf
1988
1989
1990 1991 1992
16
Government Intervention
Now
– – – – FDIC & Banks TARP Possible RTC2 Impediments
17
Failed Banks (2007- Present)
25 20 15 10 5 0 2007 2008 2009 YTD
(as of March 9, 2009)
Source: FDIC Failed Bank List http://www.fdic.gov/bank/individual/failed/banklist.html
Total: 45
(approximately)
18
Failed Banks – First Months of 2009
Total: 16
10 8 January February
6
4 2 0 Bank Failures for 2009
Source: FDIC Failed Bank List http://www.fdic.gov/bank/individual/failed/banklist.html
19
Total Number of Banks (2008)
7,085
8,000 6,000 4,000 2,000 0 Commercial Banks
FDIC: Historical Statistics on Banking – “Number of Branches, Institutions and Total Offices of FDIC-Insured Commercial Banks” http://www2.fdic.gov/hsob/hsobRpt.asp
Total: 7,085
20
Less Regulatory Pressure To Classify Failing Real Estate Loans Resulting in Reactive Lenders and Borrowers
No exit strategy such as RTC Funds with liquidity on sidelines No clear valuation methodology for problem assets Failures of banks may stabilize markets
21
The Washington Post – March 7, 2009
22
FDIC Sales Process
100% Ownership
– Smaller loan portfolios.
Individual Sales
– CBRE, as listing agent, opened website last week
80/20 Joint Ventures
– Larger loan portfolios – Management fees – Process run through Keefe, Bruyette & Woods
23
Lender Sale Options
Lender objectives Loans to real estate
– Sale of individual note vs. bundling notes into loan portfolio sale – “As Is” sales
Motivations of buyers Limitation on information Loan sale process
24
Lender Sale Options (cont’d.)
Options and values increase with cooperative borrower
– Access to Information – Other arrangements with borrower – Workout Options
• Note sale • Deed-in-lieu – Relative ease and speed v. junior financing issues • Friendly foreclosure – Involvement of court v. extinguishing subordinate liens • Pre-packaged plan in Chapter 11
25
Borrower Strategies For Dealing With Distressed Real Estate
Borrower objectives Unilateral remedies
– Internal restructuring – Outside investors – Acquisition of note (at discount)
Pitfalls and issues
– – – – – Limitations in loan documents Sources of funding Appropriate returns Property valuations Income tax pitfalls
26
Role of real estate consultant
Can Borrower/Lender Cooperation Create a Win-Win Situation for Restructuring
Lender perspective
– – – – – – – – – Relationships Options Time horizon Litigation and other risks Preference issues Default options Potential remedies Project documents Property condition
27
Lender due diligence
Can Borrower/Lender Cooperation Create a Win-Win Situation (cont’d.)
Process for restructuring
– Pre-workout letter – Standstill agreement – Forbearance agreement
Loan modification agreement
– – – – – – Extension of term Reset interest rate Restructure note Guarantees Additional collateral Subordinated debt
28
www.econosseur.com
29
Conclusion
One size does not fit all situations Borrower and lender must realistically assess legal and business issues Potential workout or restructuring will be measured against worst case scenario – bankruptcy/lender liability or suit and recovery under guaranty Value to lender can increase with cooperative borrower, but Borrower will negotiate concessions Outside factors (regulatory, accounting or tax consequences) can result in irrational conduct by borrower and/or lender
30
Conclusion (cont’d.)
May we survive this global recession and not as quickly forget, as we have in the past, lessons learned regarding:
– – – – Careful underwriting and due diligence Benefits of the transparency of financial products Better oversight by ratings agencies Limits on leverage
31