Home > Financing and interest rates, Uncategorized > Refinancing in a TOPSY-TURVY MARKET

Refinancing in a TOPSY-TURVY MARKET

In 2012, roughly$400 billion worth of CRE loans are set to mature. How many are refinanceable is a whole other question.

During the worst of the commercial real estate downturn in 2009, commercial real estate loans (CRE) were generally not refinanced, but lenders offered extensions to most borrowers, trying not to upset the equilibrium of the market. Even today, it is mainly the smaller loans that are being liquidated. Still, things have changed, as regulators pressure lenders to mark-to-market the collateral for their commercial real estate loans and move them off their balance sheets.

* Meanwhile, the commercial mortgage-backed securities (CMBS) market has slowed to a crawl, and while many lenders may be abandoning their “pretend and extend” philosophy of the last couple of years, over the next five years lots of CMBS loans will be maturing and it is not clear who will finance all of this product, saysGerard Sansosti, executive managing director inHolliday Fenoglio Fowler LLP’s (HFF’s)Pittsburgh office.

In 2012,$400 billion worth of commercial real estate loans made by all lenders will mature, according toHarris Trifon,New York-based head ofCRE Debt Research forFrankfurt, Germany-basedDeutsche Bank AG. This figure appears in aSept. 12, 2011, report that Trifon authored, entitled The Road Ahead for CRE and the U.S. Banking Sector. The$400 billion compares with$375 billion in 2011. Many of these loans will not be refinanceable, so barring a modification, an extension or an equity infusion, a large number could fall into foreclosure.

Enter the life insurance companies, which have stepped up their lending – but mostly for borrowers with trophy buildings in gateway markets. And while the life companies may have originated as much as$55 billion in commercial mortgages in 2011, by some estimates, the CMBS market was forecast to end the year with about$30 billion in new issuance – which is at the low end of estimates done at the beginning of 2011. Early last year experts had pegged the CMBS market for new issuance at between$30 billion and $50 billion.

As a result, much more capital is needed to finance commercial mortgages, says Sansosti.

But there is some hope, says Sansosti. “Certainly with the disruption in the CMBS market, things have been difficult for borrowers, but there CMBS lenders still lending money at 5.5 percent to 6 percent, while life insurance companies are loaning money in the 4 percent to 5 percent range,” he says.

“The slowdown in the CMBS market is related to borrowers’ reluctance to accept the higher spreads; yet, when it comes to a borrower who needs a higher-leverage deal, their only options are a bank loan with recourse or a CMBS lender.”

When it comes to refinancing, some commercial real estate sectors are doing better than others.

“Overall it seems retail and office properties have had, on average, the lowest payoff rates, based on the data, so they have had a hard time refinancing,” saysFrank Innaurato, managing director for CMBS analytical services with theHorsham, Pennsylvania-based Structured Credit Ratings division ofChicago-basedMorningstar Inc.

So it was a surprise to many, saysDan Fasulo, managing director atNew York-basedReal Capital Analytics Inc. (RCA), when some retail properties began to get the attention of lenders in the last few months.

The interest in retail is a “global phenomenon, as people realize that the worst is over and [retail properties] have tremendous intrinsic value,” says Fasulo.

According to theMortgage Bankers Association (MBA), banks increased their lending on commercial properties, including refinancing, in third-quarter 2011 compared with third-quarter 2010 by 98 percent, and retail was among the more sought-after assets. MBA reported that origination volume of retail loans increased by 164 percent from third-quarter 2010. Only hospitality experienced a higher increase in originations, with a 406 percent change from the third quarter of 2010.

But if retail real estate has become one of the darlings of commercial real estate lenders today, that label does not apply universally to all retail developments. Only first- and second-tier retail properties are getting the attention of lenders, says Fasulo. The tertiary properties, many of which are candidates for redevelopment, will suffer, he says.

Among the largest retail properties that have been refinanced in the last few months is the 1.6-millionsquareTootPark Meadows Mall inLone Tree, Colorado. The 16-year-old property, which was renovated in 2008, was given a$360 million loan byNew York-basedMetropolitan Life Insurance Co. (MetLife) inNovember 2011, which allowed ownerGeneral Growth Properties Inc.,Chicago, to retire anotherMetLife loan, which was taken out inDecember 2007 for the same amount. The new loan has a 4.6 percent coupon, an improvement on the earlier loan that had a 6 percent coupon.

Although the retail rebound has happened relatively quickly, CMBS retail loans still accounted for 27.94 percent, by volume, of master servicer watchlist exposure in October 2011, according to a November 2011Morningstar monthly U.S. CMBS Delinquency report.

Retail loans had a total volume of nearly$40 billion. Only office, of all the commercial real estate sectors on the watchlist, had a bigger volume with almost$42 billion worth of loans.

Capital infusion can save the day

For some properties, the way to a lender’s heart is through an equity infusion, which improves loan-to- value (LTV) ratios. Lower property values, the result of the recession, have caused LTVs to rise higher than lenders would like. Some properties, which are otherwise creditworthy, benefit from capital infusions that lower LTVs to healthy levels.

Joseph Moinian, chief executive officer of theMoinian Group inManhattan, was the owner of just such a building, says Fasulo. “He was sitting on great properties, but had no money,” he says. To remedy the situation, inNovember 2011, Moinian brought inNew York-basedSL Green Realty Corporation, a real estate investment trust (REIT), to invest in its180 Maiden Lane,New York, property.

SL Green purchased a 49.9 percent interest in the 1.1million-square-foot180 Maiden Lane property, thus encouraging lenders to refinance, says Fasulo. SL Green provided$41 million in cash and operating partnership units valued at$31.7 million to the deal. This equity allowed the new venture to refinance$344.2 million worth of debt on the property with a five-year$280 million mortgage with theBank of China Ltd. andCanadian Imperial Bank of Commerce, according to SL Green.

“This is why people say that there are no distressed assets to buy,” says Fasulo. “These deals are getting done off the market, without a broker.”

The reason a company like SL Green would do such a deal, says Fasulo, is to keep the property out of the bank’s hands. If the lender took it over and auctioned the property, SL Green would not have gotten the same advantageous price, he says.

Moinian’s predicament is not unusual today, but not all property owners will be as fortunate as theMoinian Group was. And the degree of good fortune is partially determined not only by property type, but by location and the owner’s financial strength, as well as the type of lender.

Portfolio lenders partly fill vacuum of a weak CMBS market

Insurance companies are doing more lending today than in 2010. In the first three quarters of 201 1, according to the American Council of Life Insurers (ACLI), Washington, D.C, life insurance companies, which tend to target trophy properties, did $26.9 billion worth of commercial mortgage originations, including refinancing, the latter accounting for $4.4 billion, or 16.46 percent of the total.

By contrast, for all of 2010, ACLI reported $19.9 billion in commercial mortgages, $8.3 billion of which was for refinancing, or 41.67 percent of the total.

ACLI’s figures notwithstanding (the association’s data come from life insurance companies that responded to ACLI’s survey and represent about 75 percent of the industry by assets), Dave Henderson, senior managing director at Chicago-based PPM Finance Inc., which is part of PPM America Inc., the investment manager for Lansing, Michigan-based Jackson National Life Insurance Co., says life insurance companies were doing more refinancing in 201 1 than the year before.

Most life companies financing today are lending in the range of 200 to 300 basis points over Treasuries, a fixed rate, says Henderson. During the downturn, few life companies did large loans, but today that has changed, he adds.

Smaller life companies focus in the $1 million to $15 million range whereas large life companies are doing loans of $50 million to $300 million for the right properties, he says. “At PPM, we do loans in the $5 million to $50 million range,” says Henderson. “We don’t have a special allocation for [commercial mortgages], but if there are good opportunities, life companies like PPM have plenty of capital to finance those properties.”

According to the Mortgage Bankers Association’sQuarterly Survey of Commercial/Multifamily Mortgage Bankers Originations for third-quarter 2011, among investor types, loans for commercial bank portfolios increased by 433 percent compared with third-quarter 2010, while there was a 61 percent increase in loans from life insurance companies.

“A portfolio lender – whether a bank or life company – has flexibility with its lending,” says E.J Burke, executive vice president, group head at KeyBank Real Estate Capital, Cleveland, who also serves as MBA’s vice chairman and on its Commercial Real Estate/Multifamily Finance Board of Governors (COMBOG).

At life companies, when a loan is coming due and the company likes the property and the market, it will just rewrite the loan and extend it for a long time, he says. The same is true for banks, says Burke. “Although it depends on individual circumstances, with a bank, if a borrower has a strong relationship with the banker, it will also extend the loan,” he says.

“Banks are very important for refinancing commercial mortgages today,” says Innaurato, especially for smallerbalance loans. “But they are pushing low-leveraged assets, because many banks don’t have much room on their balance sheets to take on loans of high risk,” he says.

It depends on the property type, but generally for commercial properties, banks and most life companies want to see loan-to-value ratios of 65 percent to 70 percent, says Burke, and for the multifamily sector, it is closer to 75 percent.

“In Key’s portfolio in 2008 and 2009, we asked many borrowers to re-margin their loans [bring in more equity), but that happens far less today,” he says.

CMBS tending has its limits

The CMBS market slowed down at the end of 201 1, and was forecast to come in at only $20 billion to $35 billion in fixedrate conduit issuance in 2012, according to a Nov. 18, 201 1, report entitled 2012 Issuance Projection (with Refinancing Prospects) Color, put out by CMBS Strategy and Analysis, a department at Citi Investment Research and Analysis, a division of Citigroup Global Markets Inc., New York.

The report also forecasts that in 2012, issuance of all kinds of CMBS, as well as multifamily issuance from Fannie Mae and Freddie Mac – not all of which is CMBS – will range from $60 billion to $102.5 billion.

“This forecast [for both categories] takes into consideration the tighter underwriting metrics in the conduit market and the weaker profile of loans scheduled to mature in the coming year [2012],” according to the November Citi report, which noted that “a large component of the issuance projection is based on refinancing likelihood.”

Unlike other kinds of commercial real estate loans, with a conduit loan a borrower may be able to get a shortterm extension but can virtually never get a long-term extension for this kind of loan, says Burke. “CMBS lenders typically don’t have [the long-term] relationships with their borrowers” the way banks do, he says. A CMBS trust is not a vehicle designed to extend loans indefinitely.

Still, according to a Dec. 2, 2011, report, CMBS Weekly: Modification Complexity Continues to Reign; Sectors Show Delinquency Trends, also put out by Citi’s CMBS Strategy and Analysis department, “Modifications will remain a key workout method for troubled loans amid an increasingly challenging lending environment.”

“Although [lenders] are still granting modifications today, a borrower has to give a concession, such as a 10 percent repayment,” says Jeffrey Berenbaum, director of CMBS Strategy and Analysis, the department at Citi Investment Research and Analysis at Citigroup Global Markets.

According to the aforementioned Nov. 18 2022 Issuance Projection (with Refinancing Prospects) Color report put out by Citi’s CMBS Strategy and Analysis department, of the fixed-rate CMBS private-label deals (not government-sponsored enterprise [GSE] deals such as those from Fannie Mae and Freddie Mac), only about 43 percent of 2012 maturing loans, or $18.8 billion out of a volume of $43.4 billion, is “likely” or “very likely” to be refinanceable, says Berenbaum.

Refinanceability, according to the report, is based on three measures: marked-to-market loan-to-value ratios; debt yield; and debt service coverage ratios.

According to Morningstar’s monthly U.S. CMBS Delinquency report for November 2011, which includes all kinds of CMBS loans, including GSE portfolios, in the 12 months beginning Nov. 1, 2011, approximately $79 billion worth of CMBS loans will come up for refinancing.

Of those, says Innaurato, it would appear that approximately 60 percent of the scheduled maturity balance has debt service coverage ratios that suggest they could be successfully refinanced.

“This [judgment] is based on the most recent DSCR cut-off of 1.26 as reflected in the most recent cash-flow performance for the underlying assets. This is not the least-acceptable DSCR, but simply a standard level of acceptable performance for an amortizing commercial loan,” he says.

“But it is worth noting,” says Innaurato, “that some of the DSCRs are based primarily on interest-only debt service requirements, and thus performance on an amortizing basis would be even lower and lead to further issues with potential refinancing.”

CMBS loans totaling $39.2 billion (49.7 percent of the scheduled maturity balance in the 12 months beginning Nov. 1, 2011) are making interest-only payments, according to Morningstar.

Many of these loans were most likely originated in 2007, at the peak of the market, says Innaurato. As leverage for nearly all of these loans has gone up, a majority of them cannot be refinanced if they don’t increase their cash flow, he says.

For those loans that are not refinanceable, they will of course be resolved in other ways, such as by modification, extension and, for some unlucky borrowers, foreclosure and liquidation.

In fact, over the 12 months ending Oct. 31, 2011, says Innaurato, monthly liquidations were the highest ever in the history of the CMBS market. At the same time, delinquency exposure is at its highest levels as well, because in spite of liquidations, more loans are being turned over to special servicers all the time, says Innaurato.

As of the end of October 2011, according to Morningstar’s delinquency report, out of a total of $734.17 billion in CMBS loans, 8.35 percent, or $61.27 billion, were delinquent.

Of the $79 billion of loans maturing in the 12 months ending Nov. 1, 2012, 7.3 percent, ($5.8 billion) is already reported as delinquent; 14.7 percent ($11.6 billion) is in special servicing; and 13.8 percent ($10.88 billion) has DSCR levels below 1.0 (break-even) and so does not generate sufficient cash flow to cover existing debt service.

For all of 2010, $7.83 billion in loan workouts and liquidations were reported across 1,181 loans at an average loss severity of 50.9 percent, according to Morningstar. As of the end of October 2011, $10.49 billion in loan workouts and liquidations were reported across 1,193 loans at an average loss severity of 47.2 percent. In March 2011 alone, there were $1.49 billion in loan workouts and liquidations among 148 loans recorded by Morningstar with an overall average loss severity of 42.7 percent – the highest monthly liquidation amount tracked by Morningstar.

Among the various kinds of liquidations, discounted loan payoffs are less common than extensions, modifications and foreclosures for smaller loans, which are often sold by special servicers through note sales or as a portfolio, says Innaurato. But there are exceptions, as in cases when it is less expensive for the trust to accept a discounted payoff than pursue the debt through workouts or other resolutions.

In September 2011, the $100 million mortgage on a 18,000-acre property in Punta Gorda, Florida, was purchased at a discount that resulted in a $51.8 million loss to the CMBS trust it was a part of. The loan was bought by Syd Kitson, chairman and chief executive officer of Palm Beach Gardens, Florida-based Kitson & Partners. His company already owned the property and had taken out the original loan in 2007. The discounted loan sale was considered an unexpected blow to investors as the loss erased two classes of the underlying CMBS transaction and wiped out half of the value of a third class, says Innaurato.

“This loan appears to be another clear example of the aggressive underwriting practices that were prevalent at the peak of the market,” says Innaurato. “The loss of $51.8 million on the $100 million loan reflects a 51.8 percent [loss] severity,” he says.

“For comparison’s sake, year-to-date 2011 [as of the end of October 2011], retail loss severities averaged 51.1 percent [across 384 liquidated properties through the end of October 2011],” he says. The overall year-to-date 201 1 loss severity average was 47 percent, says Innaurato.

Although there have been a lot of liquidations of CMBS loans recently, it is not always in the best interest of the trust to foreclose on a property, says Innaurato, so many lenders try to work with existing borrowers and modify a loan.

“Simply foreclosing and taking every property as an REO [real estate-owned]” has its own costs, he says. “Why spend a lot of money to foreclose on a $2 million loan and then sell the note?,” asks Innaurato. “If [the lender] can just sell the note, that is better than hiring legal counsel and filing for foreclosure,” he says. “This is especially true if the loan is in a tertiary market with a small balance.”

Lenders, special servicers and borrowers will have to be creative and flexible to resolve the issues associated with more loan maturities coming up in the next couple of years, says Innaurato. Lenders will be looking more at the long term, especially the overall creditworthiness and quality of the borrower, and borrowers may have to commit additional money upfront in case of default, he says. All of this will be important, “because special servicers and other lenders won’t want to take over every property whose loan is maturing,” says Innaurato.

Only firstand second-tier retail properties are getting the attention of lenders, says Fasulo.

Lenders, special servicers and borrowers will have to be creative and flexible to resolve the issues associated with more loan maturities coming up in the next couple of years, says Innaurato.

Hortense Leon is a freelance writer based in Miami. She can be reached at hortense@bellsouth.net.

Reprint from InsuranceNewsNet.com     By Leon, Hortense   Proquest LLC

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