2. Morgan Stanley defaulted on a $2 billion loan after buyingCrescent Real Estate Equities Co., handing over 17 millionsquare feet of office buildings to Barclay’s Capital.3. Tishman-Blackrock ceded control of the Stuyvesant Townand Peter Cooper Village housing complex in Manhattan afterdefaulting on $4.4 billion of debt used to finance the $5.4billion purchase.While there may not be many more “give-backs” of the size andscope of those mentioned above, the fact that this type of default isoccurring with more frequency should be monitored closely in themonths ahead.
MORE ON THOSE “LOAN EXTENSION” STRATEGIES
You have undoubtedly heard extensive discussion (both here andelsewhere) about the “strategy” by banks to extend the maturity oncommercial loans that cannot be refinanced in the current market.In truth “extend and pretend” is not so much a strategy as a LACKof options in a desperate attempt to prevent more default andrepossession expense.Banks, particularly smaller to midsize regional banks are currentlyfacing several unpleasant choices: (1) take write-downs on loansthat are underwater and be forced to raise more capital in thismarket, (2) sell off loans to pare exposure and realize a loss thathas the same implication to capital, or (3) kick the can down theroad, extend the maturity and hope and pray that property valuesincrease and the economy turns around.With so much pressure building in the pipeline to refinance overthe next 3-4 years, some would argue that banks have no choicebut option 3. Many in the industry believe the banks have the tacitapproval of the regulators to pursue option 3, who late last yearprovided guidance on the prudent workout of commercial loans. If not that, the banks and their borrowers certainly have a mutuallybeneficial reason to further the “extend and pretend” strategy.Borrowers allowed to remain in business have at least the hope of working through the economic malaise, and banks are notburdened with additional commercial real estate of which theymust dispose.The potential downside to this strategy (“extend and pretend”) isthe economy continues to muddle along, unemployment remainshigh, confidence ebbs further and property valuations continue todeteriorate. In this scenario, loss severities are even greater thanthey would have been, the market correction is prolonged and evenmore banks fail.Make no mistake, the vast majority of the 143 banks that have beenclosed in 2010 had very heavy CRE exposure and the majority of the 829 banks listed on the FDIC’s troubled list undoubtedly haveabove average CRE concentration as well.Approximately $24 billion in nonresidential loans were restructuredthrough Q1 2010, the result of which is a lack of transparency intothe true health of bank balance sheets as well as the ultimatevaluations in CRE property.
ISSUES ON THE HORIZON
There has been enough moderation in certain indicators of late tolead many to believe that stabilization may be taking hold in theCRE markets. However we urge caution in assessing the overallhealth of the sector, especially when many of the “improvements”are not reversals of trends but merely a slowing in the percentagedecline of the trend.The retail sector may be one of the more misleading areas withincommercial real estate. While corporate profitability has increasedover the last couple of quarters, it has done so largely due to thereduction of 1 million retail jobs since December 2007 and thereduction of the inventory-to-sales ratio (a measure of how manymonths’ of inventory is available given the current pace of sales) toa scant 1.38 months.Bloomberg compiled an interesting chart that tracked the number of retail stores relative to the level of Real GDP. As you can see inChart 4 there has existed a very strong correlation, however the redcircled area shows that retailers have been slow to reduce storesduring the current recession. As the level of GDP decreased (rightto left on the X axis, the number of stores should have moved down(top to bottom on the Y axis), that clearly has not happened.
2010 2011 2012 2013 2014 2015 2016 2017