Written by Stan Ross, Chairman of the Board, USC Lusk Center for Real Estate
The financial markets have been anticipating major defaults in the commercial mortgage sector for some time now. We are all aware that there is close to $300 million of CMBS -- commercial mortgage backed securities -- coming due by the end of 2009 and almost a similar amount in 2010. But that market has been illiquid - the holders of these bonds are not able to sell their shares that have fallen in value and the real estate backed by these bonds can't find anyone to refinance their properties to pay off the bondholders.
The question is, will the investor (lenders) let these bonds go into default or are we going to see some other strategies and options surface? My own view is that we've already seen a few new structures work. A number of the big REITs have gone out and raised new equity capital and that equity capital is being used to pay off or replace some of this CMBS debt. More importantly, we've had a real hurdle for some time with tax issues relating to any restructuring done with the servicers of these mortgage-backed bonds.
We now have a new proposal that came from the Treasury which would allow discussions on negotiations for modifications including lowering the interest rate or extensions on troubled loans without having to worry about the tax results. You could do that whether the debt is delinquent, in default or whether or not they are at their maturity dates. With that kind of a release from a tax trigger, I think we are going to see many more modifications.
In addition, I've been observing that a number of the institutions that are holders of these bonds are able to enter into a structured transaction where they sell a portfolio of the assets purchased with these securities, and then provide the financing for that sale in return for getting back an equity component from the buyer. I've seen this on some real estate transactions. Just recently, Barclays PLC sold off a $12.3 billion portfolio of securities backed by subprime mortgages in the U.S. and provided the new owners with a loan to finance the deal.
I don't see a pending disaster here so while I think we'll have delinquencies, some defaults and some covenant defaults, I think we're going to work our way out of this. For the long term, I'm hoping that the government's Public Private Investment Program (PPIP) will also help to reduce problems in the CMBS sector.
While all this activity is going on, the commercial developers are taking a lot of steps in order to survive and they are doing it a lot earlier. They are doing whatever it takes to protect their company and their asset base.
Primarily, they are taking a hard look at their entire asset base: looking at their strategies and business plans, evaluating their assets on a more realistic basis, doing sensitivity analysis, looking at the options in financing, but most important, being current, transparent and increasing the communication with their lenders so that hopefully they are not caught in any last minute surprises. I think all these steps will be very positive and help if a loan modification is needed.
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