Market Commentary
Some Comments on Distressed Loans
by Robert Mathes
The fate of soon-to-be real estate loan maturity defaults has the capacity to shift the landscape of the overall economy and commercial real estate. As a distressed asset specialist, my job is to facilitate the least painful result for troubled properties.
The drama of a distressed property/loan and determining if the financial relationship between a borrower and lender can be repaired before a separation makes sense — tends to involve three main players:
1) The bank, which provided the loan,
2) The borrower, which has taken out the loan to acquire or refinance the property, and
3) A workout specialist whose role is to quickly stabilize, add value and resolve the situation.
Lenders should begin a dialogue with the Borrower prior to a maturity in order to improve the odds of a successful outcome before the actual default and all parties become distressed.
Success in resolving the situation requires a focus on problem-solving and keeping a diverse array of stakeholders happy. Any property upgrade before selling means figuring out priority issues and getting everyone on board.
My goal as a Workout Specialist is to lay out a plan of action after a review of the current situation. I explain to both lenders and owners what they may get for the asset “as is” under both distressed and orderly sale scenarios. Both Borrower and Lender must decide how each wish to proceed. That is when the real negotiation begins.
Post-default most Lenders typically want to sell either the note or the property as quickly as possible, recover as much of the loan basis as they can and move on as Banks are not set up to hold or manage property long-term.
Situations where market shifts or downturns push borrowers to abandon their investments are not novel. What is new, and challenging, today is the drop in demand across all property types due to the impact of remote and hybrid work, particularly in downtown office districts.
The workout process does not always need to be contentious, especially when the borrower happens to have a large portfolio and sees value in moving on and finding a resolution as quickly as possible.
Investors looking to buy assets on the cheap will likely face extensive competition as there is significant capital on the sidelines.
Additional price discovery complications arise because Banks are highly regulated institutions and as such their decisions may factor in not only the market value of the underlying asset but also the regulatory impact of one or more distressed note sales on their financial condition.
One of the more challenging aspects of the distressed property space is how much may be coming. It is early in the process with so many properties potentially at risk of default due to lack of demand and recent increases in interest rates. There is likely going to be high demand for specialists such as myself as many Banks no longer have workout groups and existing loan officers have conflicted motivations.
Concerns about insolvency
by Keith Botvinivk
Concerns about insolvency due to the erosion of bank capital buffers from declining CRE values has gotten the attention of the regulatory community (see below). It appears to be driving greater scrutiny on CRE portfolios requiring more granular disclosures in bank accounting and reporting. Under the guise of promoting transparency for analysts and investors, it does not bode well for community and the regional banks already under pressure to keep up capital ratios as NIM has compressed and deposits become scarcer. Time is running out on “wait and see” as values continue to erode in many markets. The anticipation of dropping rates may not come to fruition fast or substantial enough to rescue maturing credits and especially those one-year extensions that require updated appraisal leading to mark to market valuations. Appraisers will continue to struggle with the scarcity of comps in a choppy investment sales market and lack of consistency in cap rates to determine value. Regardless, borrowers are going to face refinance challenges in today’s interest rate environment where credit has adapted to tighter underwriting standards. As income stagnates or recedes, expenses rise and interest rates remain elevated, there’s greater propensity for default or at the least fall deeper into non-compliance with loan covenants. Consider the impact on a balance sheet of over a 70% loss of value on a multi-million-dollar loan. It is the case with Blackstone’s Manhattan 1740 Broadway office tower where appraised value dropped $430 MM (see below) and the note is for sale. Most bankers will never be confronted with this kind of loss, but portfolio managers should be mindful and prepared to see how their book may be perceived in this context by the examiners.
FDIC Financial Institution Letter Advisory: Managing Commercial Real Estate Concentrations in a Challenging Economic Environment 12/19/23
Managing Commercial Real Estate Concentrations in a Challenging Economic Environment
A Defaulted Loan On Blackstone's 1740 Broadway For Sale
SEC Wants Some Banks to Disclose More on Commercial Real-Estate Exposure
Monetary Tightening, Commercial Real Estate Distress, and US Bank Fragility
https://qz.com/commercial-real-estate-woes-are-a-bankruptcy-alarm-for-1851109651