MortgageOrb checked in with John Busillo, a partner at Cadwalader, Wickersham & Taft LLP, whose practice concentrates on commercial real estate with a special emphasis on financing and workouts of distressed real estate. He stresses the importance of examining original loan documents and presents his predictions for the commercial mortgage market's general fortunes this year.
Q: With commercial mortgages involving complex financing structures now defaulting and controversies emerging over foreclosure procedures and timetables (such as the recent case of Boston's Hancock Tower), how can both financiers and the legal community properly navigate these cases?
John Busillo: The first step is to perform a careful review of the relevant documents. The major documents with respect to securitized mortgage loans are the securitization pooling and servicing agreement, any co-lender or intercreditor agreements among the various mortgage and mezzanine loan lenders, and the loan documents.
Although these documents can be complex and highly structured, they do shed light on the procedures and remedies available to the various lending parties. Guidance on these complex documents and structures can be obtained from the law firms and other third-party professionals who were involved in the origination and securitization of these loans and who understand the structures and documentation and the interplay among the various levels of debt.
In addition, although these loan structures are relatively new, the basics of workouts, foreclosures and bankruptcies are not. For professionals that have seen more than one downturn, this downturn is a return to some of those basics. Firms with extensive experience in both the securitization of commercial mortgage loans as well as the workout and foreclosure of such loans will be in demand in these areas as the downturn progresses.
Q: Ultimately, how do you expect most of these complicated foreclosure cases to go? Are the investors in the riskier tranches likely to be wiped out? Will we see a lot of loan extensions (as Fitch has recently predicted)?
Busillo: As a law partner of mine said recently, tranche warfare is commencing. Each level of the loan stack will make a determination as to which options to pursue – to go the foreclosure or workout route, to permit an extension or other modification, or to cure a default of senior loans (or purchase those loans), on the basis of a variety of factors. Key factors include the lender's view of whether it is in the money or not (based on the current value of the mortgaged property) and whether it has sufficient funds to exercise cure rights or purchase options.
Another consideration for the lender or servicer is whether it has an appetite for foreclosure, with the possibility that it will hold the mortgaged property or mezzanine interest for some time (given the current lack of financing due to the credit crunch) or, instead, has a desire to control the senior levels of the loan stack through cure of senior loan defaults and purchase of the senior loans. Each loan and property will have its own story.
I expect loan extensions to continue to be prevalent in the short term, given the continuing credit crunch and inability to refinance and the likelihood that many foreclosing lenders will be unable to find buyers with the financing necessary to acquire the properties from the lenders. Also, some servicers and lenders may not be equipped to asset-manage these properties. Properties with relatively stable cashflow and strong sponsorship will continue to be candidates for extensions.
Q: Do you expect to see any beginnings of recovery in commercial real estate lending by the end of 2009? Should we consider this a lost year and just look to 2010?
Busillo: I expect 2009 to see a continuing increase in workouts, foreclosures and bankruptcies in the commercial real estate finance world, given the combination of severe recessionary pressures on property values and the continuing credit crunch. Whether any type of recovery occurs in commercial real estate lending by the end of 2009 will depend in part on whether a bottom in the market is perceived and whether seller and buyer pricing expectations have become more aligned (with credit loosening).
I would not venture a prediction in this environment, although it seems apparent that we are still in the early stages of the credit crunch/recession fallout in the commercial real estate world.
Q: What are a commercial mortgage borrower's best bets for finding capital these days? Are life companies and banks tapped out? Is hard money the way to go?
Busillo: There is some lending occurring in the commercial real estate area. However, this activity appears limited mostly to portfolio lenders' refinancing strong sponsors with relatively stable cash-flowing properties, and with underwriting standards that are very conservative – clearly requiring a much higher equity component than previously.
Insurance companies and some banks – mostly regional banks and some foreign banks unaffected by the subprime mortgage crisis – are still potential sources of funding. But there is still a great deal of general caution.
In addition, a number of distressed debt funds and other debt/equity funds may be able and willing to originate new loans and provide equity, but as of the end of 2008, there was still not agreement in the market on appropriate spreads. Extension of the Troubled Assets Relief Program or the Term Asset-Backed Securities Loan Facility to cover the purchase of toxic commercial mortgage bonds could help free up funding sources from banks, investment banks and other lenders in the securitization area.
Q: Among the major commercial property types, which do you see suffering the most this year? Retail has been in the news, but what others might fare especially poorly? Which will be comparatively stronger?
Busillo: Clearly, recessionary pressures on consumers will result in pain for retail tenants and shopping center properties. Hotel properties, which depend on discretionary consumer and business spending, will also feel the fallout.
Multifamily and student housing may be able to hold their own in this environment, given the need and the ability to tap into certain government-backed programs, and infrastructure projects should do well, given the emphasis by the new administration on stimulus spending for such projects.