Hot Potato
Oct 1, 2008 12:00 PM, By Elaine Misonzhnik
But developing a viable debt vehicle takes time, notes Weissburg, and it will take some work to convince those investors who have been burned by CMBS that the new bonds are much safer. “People have been creative in the past, and certainly times like these almost breed creativity,” he says. “But the market will have to calm down and the Fed will have to stabilize things,” before Wall Street will get a chance to prove that its new debt instruments work.
Apocalypse now
In the worst-case scenario, the financial markets will continue to deteriorate. If that happens and no new source of capital emerges, the consequences will differ for holders of traditional and CMBS loans. In the case of a default on a traditional loan, the issuer still has the power to help the borrower, by granting extensions, redesigning loan terms and simply waiting out the credit freeze, according to Mason. That's already been happening in secondary and tertiary markets, where owners of retail properties are having a harder time collecting their rents, says Gary E. Mozer, principal and managing director with George Smith Partners, a Los Angeles-based real estate investment banking firm. They will also have the option to do a “deed in lieu of bankruptcy,” where they will technically assume ownership of the property, but will have an extra 24 months to decide how to proceed further. In the meantime, the borrower can continue managing the asset.
In general, lenders will try to avoid foreclosure as long as possible because they don't want to be forced to sell their assets at a discount. “There is an old saying that a rolling loan gathers no loss,” Mozer says.
CMBS lenders, however, will face a much more daunting task in dealing with defaulting borrowers. There are significant tax penalties to changing the terms of a CMBS loan, says Weissburg, and instead of having just one party — the issuer — make the determination on whether to reengineer the terms, every agency with a stake in the conduit will have to grant its agreement. What's more, a traditional lender can afford to lower the monthly mortgage payment, the best the CMBS lender can usually do is grant an extension. “In a classic workout, the lender owns the loan and says, ‘I need to do a, b and c,’” Mozer notes. “The special servicer in a CMBS loan doesn't have money to advance, so that's an impediment.”
If the servicer doesn't manage to extend the loan, the issuer might find itself in a tough position. Since CMBS loans cover a host of properties and are owned by a number of bond investors, foreclosing on an asset that's defaulted might prove as difficult as reworking the loan. Even if the issuer takes back the property, the investors are not qualified to manage it. The most viable option in such a case is to sell the loan.
There is no doubt, however, that with the financial markets in the shape they are in and with up to 100 investment funds waiting to pounce on distressed loans, there will be some fire sales in 2009, says Mason. He estimates the discounts might reach up to 50 percent and will peak around the middle of next year. However, Mason doesn't think we will see a replay of the early 1990s, when billions of dollars' worth of loans were dumped on the market. “It's a carryover of what happened in 1992, when the sold loans ended up being worth more than they were sold for,” Mason says. “I don't see the banks just dumping it all out there. I know there are maybe 30 banks that the Fed is looking at [that are experiencing problems], but they are still holding on.”
Whether his prognosis is too optimistic depends on how many more bankruptcies in the financial sector we will see between now and the end of the year.
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