The much anticipated FDIC guidelines for loan workouts was published today. The key word in their title is "prudent" which is the standard which banks will be held to when doing a workout.
This policy statement stresses that performing loans, including those that have been renewed or restructured on reasonable modified terms, made to creditworthy borrowers will not be subject to adverse classification solely because the value of the underlying collateral declined.
It provides guidance to examiners, and financial institutions that are working with CRE borrowers who are experiencing diminished operating cash flows, depreciated collateral values, or prolonged delays in selling or renting commercial properties. It also recognizes that during these difficult economic circumstances, continued credit availability to businesses, especially small businesses, is challenging, even where borrower performance has been acceptable. This policy statement reflects the appropriate balance of prudent credit practices and meeting legitimate credit needs.
Believe it or not, the Feds recognize that prudent loan workouts are often in the best interest of both financial institutions and borrowers, particularly during difficult economic conditions. This policy statement details risk-management practices for loan workouts that support prudent and pragmatic credit and business decisionmaking within the framework of financial accuracy, transparency, and timely loss recognition. Financial institutions that implement prudent loan workout arrangements after performing comprehensive reviews of borrowers' financial conditions will not be subject to criticism for engaging in these efforts, even if the restructured loans have weaknesses that result in adverse credit classifications.
The policy statement includes examples of CRE loan workouts. The examples, provided for illustrative purposes only, reflect examiners' analytical processes for credit classifications and assessments of institutions' accounting and reporting treatments for restructured loans. The policy statement reiterates existing guidance that examiners are expected to take a balanced approach in assessing institutions' risk-management practices for loan workout activities.
To download a copy of these guidelines, go to: http://www.fdic.gov/news/news/financial/2009/fil09061a1.pdf
Let the mayhem begin
Friday, October 30, 2009
Tuesday, October 20, 2009
Open Letter to the CMBS Industry
We are all looking for solutions: Solutions to the economic situation, solutions to the investment equation, solutions to our personal financial condition, solutions to problems we never knew we had.
The loss of jobs together with household wealth and income that has occurred over the past two years has only one precedent in our country’s history: The Great Depression.
The government reaction with regard to the commercial mortgage market has been underwhelming. With over $290 billion of commercial mortgages maturing in 2009 and 2010, the credit crunch is real and is forcing banks, special servicers and insurance companies to extend and amend….pretending that capital will return to the marketplace by the time these loans come due again – as well as the deluge of loan maturities already scheduled to occur over the next three years – which will not happen without the revitalization of the CMBS market.
It is clear that the banks and insurance companies cannot replace the capital lost when the CMBS market collapsed. Everyone in commercial real estate has a vested interest in the creation of a new and improved structure for mortgage-backed securities which uses the tremendous infrastructure that has been developed and provides appropriate safeguards in order to make CMBS attractive to investors, profitable for the participants and practical for the borrower.
Many of our industry organizations like the CMSA, the MBA, the Real Estate Roundtable and others are weighing in on these matters but the bondholders, the B-piece buyers, the servicers (primary, master and special), the rating agencies, the SEC, the IRS and the FASB are all working in a crisis mode – and buried under legacy asset issues….such that it is difficult for them to look into the future without a jaundiced eye.
We all recognize that the mechanisms put in place to prevent a meltdown did not work so we have to start with a clean slate. The following issues all need to be addressed:
Ø Creation of Generally Accepted Rating Principles including standardized underwriting standards and an industry oversight mechanism which could be modeled after the accounting profession;;
Ø A bond structure whereby loan originators and investment banks retain an interest in the bond pool to prevent aggressive and sloppy underwriting and execution;
Ø Imprudent loan structures that do not provide for future cash needs, like leasing reserves, or aggressive underwriting or sizing should result in the need for increased subordination levels over deals that do not provide these protections;
Ø REMIC rules and Pooling and Servicing Agreements need to be written to enable timely portfolio and asset management when loans become troubled.
Ø Bond pools and loan structures need to be simpler whereby conflicts of interest are eliminated;
If we are to resurrect the CMBS market, these issues and many more must be addressed. We need to start a dialogue to bring out the best and brightest ideas to establish a workable structure to revitalize the Commercial Mortgage Backed Securities market. With hundreds of billions of loans maturing in the next five years, this is one of the most critical projects we can execute to provide an exit for the legacy assets on the books today.
I implore our industry organizations and government regulators to start an open dialogue with all industry professionals – through blogs, conferences, meetings and any other way for us to get the great CMBS financial engine running again.
Please let me know your thoughts
The loss of jobs together with household wealth and income that has occurred over the past two years has only one precedent in our country’s history: The Great Depression.
The government reaction with regard to the commercial mortgage market has been underwhelming. With over $290 billion of commercial mortgages maturing in 2009 and 2010, the credit crunch is real and is forcing banks, special servicers and insurance companies to extend and amend….pretending that capital will return to the marketplace by the time these loans come due again – as well as the deluge of loan maturities already scheduled to occur over the next three years – which will not happen without the revitalization of the CMBS market.
It is clear that the banks and insurance companies cannot replace the capital lost when the CMBS market collapsed. Everyone in commercial real estate has a vested interest in the creation of a new and improved structure for mortgage-backed securities which uses the tremendous infrastructure that has been developed and provides appropriate safeguards in order to make CMBS attractive to investors, profitable for the participants and practical for the borrower.
Many of our industry organizations like the CMSA, the MBA, the Real Estate Roundtable and others are weighing in on these matters but the bondholders, the B-piece buyers, the servicers (primary, master and special), the rating agencies, the SEC, the IRS and the FASB are all working in a crisis mode – and buried under legacy asset issues….such that it is difficult for them to look into the future without a jaundiced eye.
We all recognize that the mechanisms put in place to prevent a meltdown did not work so we have to start with a clean slate. The following issues all need to be addressed:
Ø Creation of Generally Accepted Rating Principles including standardized underwriting standards and an industry oversight mechanism which could be modeled after the accounting profession;;
Ø A bond structure whereby loan originators and investment banks retain an interest in the bond pool to prevent aggressive and sloppy underwriting and execution;
Ø Imprudent loan structures that do not provide for future cash needs, like leasing reserves, or aggressive underwriting or sizing should result in the need for increased subordination levels over deals that do not provide these protections;
Ø REMIC rules and Pooling and Servicing Agreements need to be written to enable timely portfolio and asset management when loans become troubled.
Ø Bond pools and loan structures need to be simpler whereby conflicts of interest are eliminated;
If we are to resurrect the CMBS market, these issues and many more must be addressed. We need to start a dialogue to bring out the best and brightest ideas to establish a workable structure to revitalize the Commercial Mortgage Backed Securities market. With hundreds of billions of loans maturing in the next five years, this is one of the most critical projects we can execute to provide an exit for the legacy assets on the books today.
I implore our industry organizations and government regulators to start an open dialogue with all industry professionals – through blogs, conferences, meetings and any other way for us to get the great CMBS financial engine running again.
Please let me know your thoughts
Monday, October 12, 2009
Bad boys parts I, 2 and 3....
The "Bad Boy" carveouts hang over the heads of real estate investors who sunk their life savings into buying properties and using a conduit loan to finance it...If the ownership enity files BK, then the loan becomes recourse to the guarantor which is typically the principal in the investment. So, you either turn over the keys and walk away, or risk the family farm if you try to save your investment through the courts and fail....that is the choice...Well, GGP proves that you cannot tell a book by its cover and each circumstance needs to be evaluated on the facts and circumstances of the specific transaction....Investors have significant equity investments in properties that are suffering cyclical stress....all you have to look at is the increase in value realized from 1991 to 1996 and beyond to know that the current values are just that - current - which means that they are not reflective of tomorrow's value....We know that without liquidity, property values are going to continue to decline - and where that liquidity comes from is yet to be seen - but we all just know that we have to be close to the bottom, we just have to be....The following article raises the issue of the "bad boy" carveouts.... do they work or don't they, it depends....
Mon 12 Oct, 2009, Commercial real estate's bad boys: Agnes T. Crane, a Reuters columnist. The views expressed are her own -
NEW YORK (Reuters) – The bad boys are back, but whatcha gonna do when they come for you? That’s a song investors in commercial real estate shouldn’t have in their heads thanks to “bad boy” provisions built into loan agreements that aim to protect their interests.
Yet, at least two high-profile cases have quashed the idea that investors in commercial real estate debt can rest easy that the collateral backing non-recourse loans won’t get tied up in messy legal proceedings. When financing finally returns to the beaten-down sector, lenders should demand more concrete concessions from borrowers — like more equity and higher interest rates — rather than rely on personal pledges by borrowers to stay out of court.
Like many assumptions cherished during the credit boom — home prices never fall, credit default swaps can cushion the financial system against shocks and securitization helps minimize risk — personal guarantees in the commercial real estate market could turn out to be just as flimsy.
“Bad boy” provisions are intended to protect lenders from the antics of an irresponsible borrower by making someone — usually a principal — personally responsible for the loan. Most loans funded by bond investors and insurance companies are non-recourse, meaning the borrower can walk away without putting his other assets at risk. The guarantees helped lenders sleep better at night since they’re handing over millions, if not billions, of dollars to fund a project, purchase or development.
The types of behavior deemed bad are many, including failing to properly maintain the property, fraud and environmental liability, and of course, bankruptcy.
Lenders hate bankruptcy. They would rather an underwater borrower turn over the keys and foreclose on a property then force creditors into a protracted battle in court. After the savings and loan crisis, lenders started to demand a no-bankruptcy pledge from borrowers in exchange for the non-recourse loan that often carried with it cheaper financing.
The bankruptcy provision, however, doesn’t look so iron-clad anymore.
Take David Lichtenstein and his attempt to dodge a $100 million personal liability he agreed to when buying Extended Stay. Lichtenstein filed for bankruptcy in June, just two years after he bought the hotel chain from Blackstone Group (BX.N: Quote, Profile, Research) for $2 billion. By striking a deal with some of his creditors, Lichtenstein hopes to wiggle out of his bad boy clause.
The bad boy provisions are just one piece of a larger issue of “bankruptcy remote” — that collateral backing the loans and by extension bonds can be sealed off from bankruptcy proceedings.
The bankruptcy of General Growth Properties, one of the nation’s largest REITs, though upended the whole concept of bankruptcy remote — namely that collateral backing commercial real estate loans would be safe from bankruptcy proceedings if it is tucked away in special purpose entity.
There are likely to be other cases as the commercial real estate sector, unlike other areas of the economy, is extremely weak. Not all borrowers will be successful in shirking their personal pledges, and lawyers note that courts have been sticklers in ruling in favor of lenders when it comes to other bad boy guarantees.
But, it could — and should — have a lasting impact on lending terms.
Mon 12 Oct, 2009, Commercial real estate's bad boys: Agnes T. Crane, a Reuters columnist. The views expressed are her own -
NEW YORK (Reuters) – The bad boys are back, but whatcha gonna do when they come for you? That’s a song investors in commercial real estate shouldn’t have in their heads thanks to “bad boy” provisions built into loan agreements that aim to protect their interests.
Yet, at least two high-profile cases have quashed the idea that investors in commercial real estate debt can rest easy that the collateral backing non-recourse loans won’t get tied up in messy legal proceedings. When financing finally returns to the beaten-down sector, lenders should demand more concrete concessions from borrowers — like more equity and higher interest rates — rather than rely on personal pledges by borrowers to stay out of court.
Like many assumptions cherished during the credit boom — home prices never fall, credit default swaps can cushion the financial system against shocks and securitization helps minimize risk — personal guarantees in the commercial real estate market could turn out to be just as flimsy.
“Bad boy” provisions are intended to protect lenders from the antics of an irresponsible borrower by making someone — usually a principal — personally responsible for the loan. Most loans funded by bond investors and insurance companies are non-recourse, meaning the borrower can walk away without putting his other assets at risk. The guarantees helped lenders sleep better at night since they’re handing over millions, if not billions, of dollars to fund a project, purchase or development.
The types of behavior deemed bad are many, including failing to properly maintain the property, fraud and environmental liability, and of course, bankruptcy.
Lenders hate bankruptcy. They would rather an underwater borrower turn over the keys and foreclose on a property then force creditors into a protracted battle in court. After the savings and loan crisis, lenders started to demand a no-bankruptcy pledge from borrowers in exchange for the non-recourse loan that often carried with it cheaper financing.
The bankruptcy provision, however, doesn’t look so iron-clad anymore.
Take David Lichtenstein and his attempt to dodge a $100 million personal liability he agreed to when buying Extended Stay. Lichtenstein filed for bankruptcy in June, just two years after he bought the hotel chain from Blackstone Group (BX.N: Quote, Profile, Research) for $2 billion. By striking a deal with some of his creditors, Lichtenstein hopes to wiggle out of his bad boy clause.
The bad boy provisions are just one piece of a larger issue of “bankruptcy remote” — that collateral backing the loans and by extension bonds can be sealed off from bankruptcy proceedings.
The bankruptcy of General Growth Properties, one of the nation’s largest REITs, though upended the whole concept of bankruptcy remote — namely that collateral backing commercial real estate loans would be safe from bankruptcy proceedings if it is tucked away in special purpose entity.
There are likely to be other cases as the commercial real estate sector, unlike other areas of the economy, is extremely weak. Not all borrowers will be successful in shirking their personal pledges, and lawyers note that courts have been sticklers in ruling in favor of lenders when it comes to other bad boy guarantees.
But, it could — and should — have a lasting impact on lending terms.
Thursday, October 1, 2009
Real Estate Impact Huge Under Accounting Changes
I first heard about the proposed changes in accounting for leases last spring when the ICSC picked up on the issue from the on-going discussions between FASB who is sets the accounting standards and the International Accounting Standards Board to create a uniform accounting standard around the world. CB Richard Ellis has published a report on the potential impact of the change in accounting. Globe St. published a special report summarizing this study which is below. The full report can be accessed at: http://www.cbre.com/NR/rdonlyres/8D7AEFC0-1154-472A-8521-6323B02AE3A6/777874/FAStalkingCBRE082009.pdf
By Bob Howard GlobeSt.com EXCLUSIVE Last updated: October 1, 2009 10:05am
LOS ANGELES-New accounting standards requiring property to be marked to market and proposed changes in lease accounting rules could have an immense impact on the balance sheets, income statements and overall financial outlook of US corporations, many of whom are unprepared for the changes, according to a new report from CB Richard Ellis.
The white paper by CBRE, titled "FAS Talking--Unpacking Real Estate's Impact on Financial Statements," says that the estimated balance sheet impact of the proposed lease accounting changes alone could be well in excess of $1 trillion for US companies. The report says that the combined effects of mark-to-market and the lease accounting changes hold the potential to negatively impact earnings, capital requirements, debt covenant ratios, credit ratings and other measurements of corporate financial health.
Todd P. Anderson, CBRE senior managing director of global corporate services who co-authored the report along with CFO Michael M. Omiya of Boeing Realty Corp., explains to GlobeSt.com that the changes in accounting standards are "a continuation of the effort to have greater financial transparency, in particular in the financial statements for publicly traded corporations."
The white paper analyzes the potential impacts of both the mark-to-market requirement and the proposed lease accounting changes--which could go into effect as early as 2011 or 2012--and discusses courses that corporations can purse in order to mitigate the effects of the changes. The mark-to-market requirement, known as FAS 157, went into effect for financial assets as of Nov. 15, 2007 and for non-financial assets including real estate as of Nov. 15, 2008.
Anderson explains that one of the problems corporations face in marking down the real estate they own is that when a property is marked down, the write-down not only reduces the asset's value on the balance sheet, it generates a pre-tax loss on the income statement. The issue is further complicated by the difficulty of valuing real estate in a market in which few if any comparable sales are available because so few properties are trading. One of the steps that corporations can take to prepare for the impact of mark-to-market, Anderson says, is to review its properties before the end of the year to determine which ones have the potential to create write-downs.
"In the absence of comparable sales, you have to figure out how to establish a value for your property," Anderson says, and the time for a corporation to do that is before the end of the year when it is busy with so many tax and accounting duties that it will be hard-pressed to complete the tasks on time. "The corporate real estate department, if it understands what's going on in the mark-to-market arena, can come in early and start to take a look at its properties and basically create an argument for why it is valuing properties the way it is," he says.
The CBRE white paper points out that, "If a corporation has the financial wherewithal to carry the property until normalized market conditions return, the argument exists that the company should be able to avoid a distressed sale scenario in which the asset would be valued at a fire sale price."
Regarding the proposed changes in lease accounting, Anderson explains that the new rules would reclassify "operating" leases as "capital" leases, which in turn would require the operating leases to be reflected on corporate balance sheets instead of held off the balance sheet as they are now. Anderson comments on what a far-reaching change this could be: "Many companies can have as much liability for operating leases as they do for all of their other liabilities on their balance sheet, but operating leases today are not on the balance sheet," he says.
Under current practices, the only item that companies record on their income statements regarding operating leases is one year's worth of rent expense. "If you have a 10-year operating lease on a building, you will show nothing on your balance sheet and only one year of rent on your income statement," Anderson points out. He says that the argument in favor of reclassifying these as capital leases--which are reflected on balance sheets--is that operating leases are like bank loans, which are reflected on balance sheets. The argument is that an operating lease, like a loan, is an obligation of the corporation, not just for one year but for the entire duration of the lease. "The regulatory bodies are starting to say that such an obligation is too much of a financial component of a company to not be represented on the financial statements," Anderson observes.
Under the proposed accounting changes, corporations would compute the present value of all of their future lease payments and record them as both assets and liabilities on their balance sheets. "Just doing those two things alone could throw off debt covenants and various financial ratios that could have significant implications for a company's credit rating and other impacts," Anderson says.
The proposed changes would also affect how leases are treated on income statements, producing both depreciation and interest expenses, which would be greatest during the first half of the lease. The upshot is that corporations would take hits on their balance sheets in terms of performance ratios such as return on assets and debt covenant ratios, and they would also take hits on their income statements for the first half of the lease term.
The proposed changes in lease accounting have myriad implications for how companies structure and manage their real estate, Anderson points out. Not every company has the same proportion of owned versus leased properties, so the lease accounting changes would have very little effect on a company that owned the majority of its properties. A competitor that leased the majority of its properties, on the other hand, would suffer significant hits to its financial statements. One answer for such a company would be to execute shorter-term leases, which would show up as lesser obligations on the balance sheet, but the solution isn't always that simple: Not all real estate is suitable for short-term leases because the user may require long-term control of the property, Anderson points out. For properties that a corporation might need for 10 years or longer, it might be more practical to buy rather than lease because of the depreciation advantages of ownership.
Although the new lease accounting rules would not go into effect until 2011 or 2012, corporations should be looking at their real estate now to prepare for the potential impacts of the rules changes, Anderson advises. "Most companies are only beginning to understand these changes," he says.
Anderson notes that the accounting changes address only the user side of leases. "One of the big unknowns is what will this do to the landlord/investor side of the market," he says. Accounting standards boards have yet to tackle that question, so the answer "is truly an unknown right now," Anderson says.
By Bob Howard GlobeSt.com EXCLUSIVE Last updated: October 1, 2009 10:05am
LOS ANGELES-New accounting standards requiring property to be marked to market and proposed changes in lease accounting rules could have an immense impact on the balance sheets, income statements and overall financial outlook of US corporations, many of whom are unprepared for the changes, according to a new report from CB Richard Ellis.
The white paper by CBRE, titled "FAS Talking--Unpacking Real Estate's Impact on Financial Statements," says that the estimated balance sheet impact of the proposed lease accounting changes alone could be well in excess of $1 trillion for US companies. The report says that the combined effects of mark-to-market and the lease accounting changes hold the potential to negatively impact earnings, capital requirements, debt covenant ratios, credit ratings and other measurements of corporate financial health.
Todd P. Anderson, CBRE senior managing director of global corporate services who co-authored the report along with CFO Michael M. Omiya of Boeing Realty Corp., explains to GlobeSt.com that the changes in accounting standards are "a continuation of the effort to have greater financial transparency, in particular in the financial statements for publicly traded corporations."
The white paper analyzes the potential impacts of both the mark-to-market requirement and the proposed lease accounting changes--which could go into effect as early as 2011 or 2012--and discusses courses that corporations can purse in order to mitigate the effects of the changes. The mark-to-market requirement, known as FAS 157, went into effect for financial assets as of Nov. 15, 2007 and for non-financial assets including real estate as of Nov. 15, 2008.
Anderson explains that one of the problems corporations face in marking down the real estate they own is that when a property is marked down, the write-down not only reduces the asset's value on the balance sheet, it generates a pre-tax loss on the income statement. The issue is further complicated by the difficulty of valuing real estate in a market in which few if any comparable sales are available because so few properties are trading. One of the steps that corporations can take to prepare for the impact of mark-to-market, Anderson says, is to review its properties before the end of the year to determine which ones have the potential to create write-downs.
"In the absence of comparable sales, you have to figure out how to establish a value for your property," Anderson says, and the time for a corporation to do that is before the end of the year when it is busy with so many tax and accounting duties that it will be hard-pressed to complete the tasks on time. "The corporate real estate department, if it understands what's going on in the mark-to-market arena, can come in early and start to take a look at its properties and basically create an argument for why it is valuing properties the way it is," he says.
The CBRE white paper points out that, "If a corporation has the financial wherewithal to carry the property until normalized market conditions return, the argument exists that the company should be able to avoid a distressed sale scenario in which the asset would be valued at a fire sale price."
Regarding the proposed changes in lease accounting, Anderson explains that the new rules would reclassify "operating" leases as "capital" leases, which in turn would require the operating leases to be reflected on corporate balance sheets instead of held off the balance sheet as they are now. Anderson comments on what a far-reaching change this could be: "Many companies can have as much liability for operating leases as they do for all of their other liabilities on their balance sheet, but operating leases today are not on the balance sheet," he says.
Under current practices, the only item that companies record on their income statements regarding operating leases is one year's worth of rent expense. "If you have a 10-year operating lease on a building, you will show nothing on your balance sheet and only one year of rent on your income statement," Anderson points out. He says that the argument in favor of reclassifying these as capital leases--which are reflected on balance sheets--is that operating leases are like bank loans, which are reflected on balance sheets. The argument is that an operating lease, like a loan, is an obligation of the corporation, not just for one year but for the entire duration of the lease. "The regulatory bodies are starting to say that such an obligation is too much of a financial component of a company to not be represented on the financial statements," Anderson observes.
Under the proposed accounting changes, corporations would compute the present value of all of their future lease payments and record them as both assets and liabilities on their balance sheets. "Just doing those two things alone could throw off debt covenants and various financial ratios that could have significant implications for a company's credit rating and other impacts," Anderson says.
The proposed changes would also affect how leases are treated on income statements, producing both depreciation and interest expenses, which would be greatest during the first half of the lease. The upshot is that corporations would take hits on their balance sheets in terms of performance ratios such as return on assets and debt covenant ratios, and they would also take hits on their income statements for the first half of the lease term.
The proposed changes in lease accounting have myriad implications for how companies structure and manage their real estate, Anderson points out. Not every company has the same proportion of owned versus leased properties, so the lease accounting changes would have very little effect on a company that owned the majority of its properties. A competitor that leased the majority of its properties, on the other hand, would suffer significant hits to its financial statements. One answer for such a company would be to execute shorter-term leases, which would show up as lesser obligations on the balance sheet, but the solution isn't always that simple: Not all real estate is suitable for short-term leases because the user may require long-term control of the property, Anderson points out. For properties that a corporation might need for 10 years or longer, it might be more practical to buy rather than lease because of the depreciation advantages of ownership.
Although the new lease accounting rules would not go into effect until 2011 or 2012, corporations should be looking at their real estate now to prepare for the potential impacts of the rules changes, Anderson advises. "Most companies are only beginning to understand these changes," he says.
Anderson notes that the accounting changes address only the user side of leases. "One of the big unknowns is what will this do to the landlord/investor side of the market," he says. Accounting standards boards have yet to tackle that question, so the answer "is truly an unknown right now," Anderson says.
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