The Hospital Wards of Wall Street and LaSalle Street
April 10, 2009
"Lo! in that hour of misery; a lady with a lamp I see; pass through the glimmering gloom; and flit from room to room."
-From Henry Wadsworth Longfellow's 1857 poem "Santa Filomena" describing Florence Nightingale.
There are a lot of “ailing” and “sick” loans out there. What we all want to know is what are the banks doing with all of their troubled commercial real estate loans right now. We have been working with and speaking to various real estate lenders, in both official and unofficial capacities, every day over the past few months, and can share the following observations.
We are clearly facing the worst real estate lending environment since the early 1990s. Although the reasons behind the two crises may differ, both have caused the same basic result: many, if not most, banks find themselves holding an inordinate amount of troubled real estate loans. So what are lenders doing when faced with these circumstances?
First, most banks have stopped lending to all but their most valued long-time customers that they simply can’t afford to turn away (if any?), and have shifted the vast majority of their real estate lending staff into real estate work-out teams. There are certainly some exceptions, but that’s the general rule. Beyond that, most banks are in the preliminary stages of planning their response – just trying to figure out how to manage this onslaught of problems in the face of deteriorating balance sheets. We call this the “Triage Phase.” During triage, a few patients are dying or on the verge of death – i.e. the real bad loans – and these are sent in for immediate surgery (or burial). The rest, however – probably 90% of all of the troubled loans – are just being nursed along waiting to see if their condition improves or worsen, or when the surgeons free up from the more dire cases. As you might expect, during this phase, some lenders will take almost no action on these loans, except a phone call or two and/or the possible delivery of a default notice. On the other hand, some lenders may simply follow a standardized plan of “attack,” first sending out default notices and then filing foreclosure and guaranty actions or other remedies without really thinking about the ramifications or whether a particular situation is better served with a more customized approach. Not surprisingly, we are finding that the banks with the most internal financial issues, are the ones that tend to be the extreme cases, one way or another. This is a very dynamic time in the market. Every bank has a little different set of circumstances.
The best advise we can give to borrowers at this stage of the game is to try to continue to work hard to find your own solutions to your problems, if possible, without waiting for your lenders to respond or participate. Although lenders already, or will eventually, understand the need to participate in the solution to many of the current problems, they are not likely to take on more of a burden than they already have. Start your search for refinancing sources early, and be realistic about and plan for the possible need for additional equity infusions or the pledging of additional collateral. While you should not be shy in asking lenders for concessions, do not expect something for nothing. Particularly when lenders are in the Triage Phase, they have no time for unrealistic requests, but might make meaningful concessions in response to the right business proposal.
If you are the lender, our advice is to arm yourself with as much knowledge and information as you can about your borrower, the guarantor, the property and the related facts that have caused your loan to go into default, and to try your best to give every patient in triage as much attention as possible. Clearly, loans left unattended are much more likely to get worse, not better, in this environment. Read your loan documents. Make sure you have copies of all of the signed leases and other key property documents. Confirm that your reserves, escrows, letters of credit, and other ancillary collateral are properly in place (and fix any problems while you still have a good relationship with your borrower). Once armed with this knowledge, treat your borrower with the same degree of respect with which they are treating you. We do not believe in being merciful to a fraudulent, combative or uncooperative borrower, but, based on our experience from the 90s, we have found that the lenders that cut sensible business deals, when offered (instead of following a scorched earth policy), are the ones that most quick find the road back to profitability – you are in the business of making loans, not owning and operating or developing properties.
That brings us to the final point. We have often been asked in recent days when we might see the return of a more normalized lending environment. We believe that once all of the doctors (lenders) can get through about 75% of the patients in the triage room, they will be dismissed from their emergency room duties and return to their regular private practices of making loans. Of course, we first need to slow down the inflow of bad loans.
News you can use:
With the creation of the latest US Treasury brain-child, the “PPIF” (Public-Private Investments Funds) Program, the Obama Administration is working hard to try to clean up the banking mess. When combined with the formerly announced “TALF” (Term Asset-Backed Securities Loan Facility) Program, there should finally be direct help in cleaning up the “triage ward” described above – or at least moving the patients to a new hospital outside of the banking sector. When combined, these two programs will provide for over 90% leverage, on a non-recourse basis, to support private equity purchases of “toxic assets;” seems like a pretty good deal for PPIF investors.
Now that Wells Fargo has produced a good earnings report and bank stocks have begun to recover, will that news cause these new programs to be curtailed in any manner? Do the Banks really need these programs? Just because a few hospitals (i.e. banks) have begun to make money does not mean the patients (loans) are not still sick.