Remember about optimism and pessimism....

If you are too optimistic, you are probably wrong. I've been there.

If you are too pessimistic, you are also probably wrong. I've been there too.

And yet I have little to dispute with the facts presented on this Fox Business video featuring dirt lawyer Stephen Meister about mezz debt, loan write downs, equity problems, extend and pretend and TARP. You can see the video at Real Property Alpha and Traffic Court. Mr. Meister thinks the tsunami is coming and points out a lot of good evidence supporting his case.

It reminds me of a borrower-lender game of chicken. The process is being delayed, just as it was in the house market, by not writing down these loans.

Saying almost every loan written between 2005 and 2008 will not be able to be refinanced is a bold prediction. And it could happen. But while I do not have the empirical evidence to back it up, I think about the two axioms above and say to myself, let's hope for just a storm surge and that lenders and borrowers can find ways to meet in the middle. Otherwise no amount of government bailout will help. And that fact alone may be enough to prevent a disaster.

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TALF and Ratings - Get Out Your Cash!

Here's the latest gloom and doom piece -- perhaps warranted, too -- this time in the Journal. The point? It is great that the government finally got on the darn bandwagon by including CMBS and commercial properties in TALF, but that's just not enough.

Now, if we are going to have all this bailout money in the first place (we will not get into the philosophical or practical arguments of how to repay all this debt) including the commercial sector is important in my opinion. But, as the story points out, only top-rated debt is eligible. And S&P is telling us that it may downgrade a boatload of properties, thus rendering them ineligible for TALF money.

A lot of people blame the ratings agencies for getting us into this mess in the first place by rating deals AAA that had no business being so. And now when they want to clean up the mess by downgrading these deals, it could create another, even larger, problem. Jeez.

The moral? Owners are going to either have to pony up equity to stay in their deals, bring in mezz lenders who could make a killing with liquidity, have a fire sale, do a deal with the special servicer, walk away or...well, you get the picture. Not a pretty one. With LTVs on loans going down and property values declining, this could be the era of the capital call.

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Thursday Tidbits - 2/19/09 Edition

I'm under the weather and also under the gun on several projects (it never fails), so just a few quick thoughts for the day.

On the gloomy side:

In case you missed it, commercial and multifamily loan originations are in the tank.

Mezz lenders are getting slaughtered, too.

What is it with Chicago and luxury Asian hotels? First the Shangri-La has its problems, and now it looks like the Mandarin Oriental may not get off the ground, foreclosure and all that. The speculators say it is a matter of time, but my thought is that people will try to buy time until October for obvious reasons.

And even the Fed is talking about CRE problems, although the hope is that the problems will not be as bad as the early 1990s.

On the less gloomy side:

Rob Bagguley of Transwestern has a great post at CPN about the encouraging signs of the market. I have to be reminded that there are good things going on and I thank Rob for doing so. Anecdotally I am seeing a slight uptick and thinking that perhaps people are seeing opportunity and possible bargains. I still really honestly think there's money out there that wants to buy notes and distressed deals. Here is an example in the retail sector.

I like my office in Chicago, but the thought of being on the 84th floor of Sears Tower sounds very cool. Executive suite operator has inked a 30,000 sf deal for 100 offices, a bunch of workstations and a videoconferencing center.

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The Battle of the Tranches

There is a very interesting story in today's WSJ that explains the incredible complexity of huge, multi-site deals, foreclosures and various investors in CMBS.

This story is about the John Hancock Tower (in Boston, not the iconic Chicago building). The tower was part of a seven site deal of a fund of Broadway Real Estate Partners two years ago. The deal's now in default, according to the story.

Back in the old days, when a deal went south, you had one lender, or maybe a syndicate of lenders with interests that were usually somewhat aligned. And you sat at a table, did conference calls or ever wrote letters back and forth working out the loan, or you proceeded to foreclosure.

Not so anymore, thanks to the complexity of CMBS. If you are a regular reader or know the business, then you are aware that CMBS has various tranches of debt, with senior tranches having the least risk (and lower return) and junior tranches having more risk but higher interest rates. The same is true in this deal, where you have multiple tranches of mezzanine debt, which was supposed to be a bridge loan pending sales or refis that went south with the credit market.

The interests of these lenders are not aligned. If a deal goes south, the senior lenders might be OK but the junior and B-piece folks are probably SOL (and I don't mean "statute of limitations" when I use that term). And that's what is going on here:

"Tranche warfare is starting," said John Zizzo, a real-estate lawyer at Cadwalader, Wickersham & Taft LLP, referring to the loan "tranches," or slices, that investors own. "It has never been tested before this current market meltdown."

The disputed $700 million of debt in the Hancock battle is mezzanine debt that was divided up among nine investors. With real-estate values declining, not all of the investors would be paid off in a liquidation.

As a result, investors who believe they would be in the money are pressing for an immediate foreclosure, according to people familiar with the matter.

Such investors include Five Mile Capital Partners, led by former real-estate financier Steven Baum, and Normandy Real Estate Partners, founded by property investor Finn Wentworth. Mr. Wentworth also is a founder of the New York Yankees' YES Network.

Investors likely to lose out in foreclosure want to give Broadway more time to repay the loan. Among those investors is a BlackRock Inc. fund run for outside investors. That fund owns the riskiest slice of the loan.

Also involved in the scrum are Chicago developer John Buck, who owns the most senior portion of the debt; the RBS Greenwich Capital unit of Royal Bank of Scotland Group PLC; Lehman Brothers Holdings Inc.'s bankruptcy estate; and hedge fund Petra Capital Management LLC, run by Andy Stone, a pioneer of commercial real-estate securities.

Complicating things further, State Street Corp. inherited stakes in two tranches from Lehman Brothers, according to a person familiar with the situation. The failed investment bank had pledged the loans to State Street as collateral for a short-term "repo" loan. State Street seized the collateral after Lehman filed for bankruptcy.

Ouch. What's more? This might be just the start. If there are more foreclosures like this -- and people expect there will be -- the fighting, pain and possibly litigation will only further complicate getting properties back out into the market and into the hands of people who can turn things around. One solution is to negotiate between the tranches and settle with a buyout, giving control to one or another group. There's some very sophisticated players in that list of lenders, and I would think they will all realize their interests are better suited through compromise.

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Trmup's Lawsuit: Developer See, Developer Do

Tom Corfman's Crain's piece today predicts:

Donald Trump’s lawsuit against the menagerie of construction lenders for his riverfront tower is likely to be followed by more pre-emptive strikes by other developers.

Amid the prolonged credit crisis, such lawsuits could become common.

We've heard all the stories, so I won't bore you with lenders turning the screws on their borrowers. (Hey, the borrowers did it to them a few years ago, let's not forget.)

There were two opinions given about the lawsuit:

“We’re in an economic crisis, yes, but does that constitute force majeure?” said real estate attorney James Fox, a partner in the Chicago office of law firm Quarles & Brady LLP. “Only crazies would do that.”

The force majeure claim is “a stretch in this case, but it gave him a toehold,” said Mr. [Marv] Romanek, managing director with Northbrook-based Romanek Properties Ltd.

I wrote about this here on the 8th. The gut reaction was similar to Mr. Fox: economic problems aren't events of force majeure. But I don't know what the language is in the loan agreement. If drafted (im)properly, you might -- just might -- have a case. Look at the clauses here, for example. Others that I have looked at are too tight to beat Trump here in my opinion.

Moreover, assuming the allegations are true, would you want to have to defend banks in this climate that "no longer have the cash to fund the completion of the project" and that apparently refused to let Trump take steps to mitigate such as lowering prices? Again, I'm no Trump apologist and I think this is a negotiation tactic. While I still think he's got an uphill (mountainous, perhaps) battle to win this one, I'm no longer 100% convinced that the theory is utterly crazy or sanctionable.

The moral of the story? This is just another example of why, as a lawyer, you have to sweat the details, including the boilerplate. My favorite example of boilerplate coming back to get a party is here. (Free sub. required.)

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One last thought for the day - specialty lenders

I ave not seen many stories about non-traditional lending sources. No, I'm not talking about Guido the Killer Pimp. Specialty lenders have their legitimate place in the market, either as lenders, mezz lenders, equity participants or combinations of the above. And guess what -- they are thriving in this credit market. I know -- you're shocked at this revelation.

But like Guido, be prepared to pay for the money and the speed in which a deal can get done. Everything comes at a price, and it isn't cheap. But if it beats the alternative....

Courtesy of Deal Junkie.

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The woes of a Libor bounce

If you are in my business, you know about Libor, which is an acronym for the London interbank offered rate. For those of you not familiar with it, Libor, is a benchmark for fixing loan rates around the world. It has increasingly been used in commercial real estate over the last few years over the old standard of US Treasuries. There are Libor "contracts" of varying lengths, such as 30, 90 and 180 days that we use as a benchmark interest rate. So, in other words, if I have a loan that is "6-month Libor + 225" that means the interest rate is 2.25% above the rate for a 180 day Libor contract at a given time (and then usually subject to adjustment each six months).

Now, in addition to the loan rate floors that I wrote about the other day, we have a new wrinkle: Libor rates are spiking the last few days, due in part, it seems, to possible "growing concerns among bankers that their rivals weren't reporting their true high borrowing costs, for fear of signaling to the market they were desperate for cash." What this means? Harder to get a decent loan rate, that's what, but that's also mainly due to the floors.

Before you jump off a cliff, remember that Libor a year ago was over 5%. Now it's gone up 20 bps in two days, but still around 2.9%. So don't panic.

In commercial real estate, the rise in Libor is bound to have a chilling effect, because many developers borrow heavily using floating-rate debt linked to Libor. Until recently, declining rates had benefited borrowers, but some lenders were growing wary. Banks have started to include a floor in Libor-linked loans, said Peter Fitzgerald, chief financial officer at Radco Cos., an Atlanta developer. That means borrowers' savings would be limited if Libor continued to sink, but borrowers can be hit by the latest rise.

"If Libor were at 4% instead of under 3%, there would be a disaster that would take years to unwind," he said.

If you have a big rate hike then I'd be worried because that could make a real mess out of some deals, as increased borrowing costs screw up your pro formas and blow your returns on deals. And should the markets consider going back to the old days of Treasuries if there is real concern about the integrity of the Libor system? Maybe. (As an aside, I also see opportunity for mezzanine lenders here.)

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