Quote Stride Welcome to the Distressed Real Estate Summit. Thought I’d begin today’s presentation with a quote from Alan Greenspan that I think provides very relevant insight as to where we are today. [READ QUOTE] Yet the irony is this was written in 1990, and for those that lived through that era in Real Estate, what in fact was a turning in the broader economy was a good 3 to 4 years ahead of a bottoming out in commercial real estate. But are past cycles a template for today’s fact pattern, and for those that saw great wealth created back with the RTC, is that playbook applicable? I hope to answer some of those questions with my remarks this morning. My background includes working on distressed debt sales in Japan in the late 1990s and in Germany in the mid 2000s. I am a member of Ernst & Young’s Distressed Real Estate group which include many members that have spent their careers working distressed debt during the RTC days, in Asia and Europe and now back again to the States.
The first slide shows when Mr. Greenspan made that quote, on the far left, delinquencies jumped as the failure of over 700 S&L’s flooded the market with inventory and asset deflation which was followed by the ascent of delinquencies. Unemployment peaked a couple years later and the commercial market began to put in a bottom when unemployment dropped below 6% and along with loan delinquencies. Looking to the right of the chart, the unemployment rate has significantly exceeded the worst of the last cycle and levels, not seen since the (70’s?), and delinquencies are chasing the unemployment rate and will certainly surpass it by 2011.
The delinquency rate for loans underlying CMBS rose 42 points in December to 6.07%, the first time delinquencies breached 6%. Trepp LLC said that the delinquency rate which is the percentage of loans at least 30 days delinquent, rose 486 basis points in 2009 from 1.21%. Among commercial real estate sectors hotels stand at 13.87%, office at 3.42%, retail at 5.50%, industrial at 3.98% and multifamily at 9.27%. CDOs delinquencies rose to 12.3% in December from 12.1% a month earlier. If one takes into account previously delinquent loans written down or disposed of at a loss the rate would have been close to 15%. Fitch senior director Karen Trebach is calling for a continued steady increase in delinquencies likely for 2010 and projects the end the year at a 25% CDO delinquency rate. The top 100 banking companies have an average non-performing commercial real estate rate of 7.7%. JP Morgan’s 4Q20009 results included setting aside more capital for future loan losses. Managed credit-loss provisions were $8.9B up from $8.54B a year earlier. Bank of America and Wells Fargo each set aside less money for bad loans in the 4Q of 2009, even though bad loans at both banks continued to rise. BofA took permanent losses of $8.4B from bad loans, down 12% over the previous quarter, but it added another $1.4B to its $38.7B in reserves. Wells Fargo levels on nonperforming assets rose nearly 18% over the last quarter to $27.6B. Wells said commercial real estate loans are showing the worst wear.
Per the Federal Reserve Board, as of 9/2009 there was $3.4T in outstanding commercial real estate debt. Of that, banks made up 50% of the total with CMBS a distant second at roughly 21%. No other holder had more than a 10% share of the market.
As shown by this slide the current volume of total commercial real estate debt is approximately $3.4 Trillion (as reported in the CMSA Compendium of statistics). This slide illustrates the holdings by the various parties. This stat is also confirmed by the MBA who recently reported that – the level of commercial and multifamily debt held remained consistent with previous quarters at $3.48 Trillion. The break down is provided by MBA and CMSA – MBA states that the largest share of the $3.48T is held by commercial banks – being 45%. CMBS/ABS and CDO issuers are the 2 nd largest holder at 21% and Life insurance coys the third at 9%. GSE mortgage backed pools – including Fannie, Freddie and Ginnie, hold multifamily loans that support the MBS they issue and also hold whole loans – this is 10% of the total. Savings institutions and ‘other’ are including in the others category. Note the Government category above does not take into consideration any loans that the Government now owns as a result of its purchase of Bear Stearns for $29 billion – or the indirect ownership through other stimulus efforts. The maturities illustrate the ‘wave’ of commercial real estate loan issues that are on the horizon. Approx. 6%, 7%, 8.5%, 9.7%, 9.5% of the $3.48T will mature in 2009, 2010, 2011, 2012 and 2013 respectively – in aggregate approximately 40.7% will mature by 2013. (as quoted by Richard Parkus in his global securitization research publication – source being TREPP, FDIC, Intex and MBA). It should also be noted that these numbers above do not include constructions loans – which Richard Parkus has commented that banks have $600 billion of construction loans. Construction loans are currently experiencing 16.3% in default rates – clearly showing where the distress is. These statistics illustrate that something has to give and assets or loans will be traded as the banks feel the pressure to reduce NPL stats.
But today, where is the current stress. Per Real Capital Analytics, the US market of current distress (troubled loans, restructured/modified loans or lender REO) is $178B across 8,529 properties resulting in an average loan balance of approximately $21M. The Las Vegas market has the largest amount by volume of distress in the west with $18B, while Las Angeles has the greatest by # of properties at 837 representing $14B. Other key distressed markets include Phoenix and San Francisco at $8B and $7B respectively.
Let’s look at the property market. There is a presumption that the disciple of the capital markets would act as a governor on speculative over development. So, you would conclude comparing the unregulated S&L’s of the 90’s with vast financial transparency of CMBS, that the peak vacancy rates should be much more moderate this go around, yet each market shows variation, on balance, the estimated peak vacancy rates will be comparable with LA, NY and the location of our conference, Dallas, maybe faring a little better, with Chicago a little worse.
But what are the market clearing prices for these loans? Well, per Real Capital Analytics, the recovery rates decreased in the 4Q of 2009 to a weighted average rate of 52%. For all of 2009, the mean recovery rate was 63% with acquisition/refinance related loans recovering 67% and development/redevelopment loans seeing a recovery rate of only 56%.
By property type we see that recovery rates in the 4Q 2009 were the greatest in the industrial sector, followed by retail, office, multifamily, hospitality and finally development. For all property types, except industrial, the recovery rates were lower in the 4Q of 2009 versus the first three quarters of the year. On a dollar basis, industrial saw a recovery rate of almost 80 cents on the dollar in the 4Q while retail saw a rate of 70 cents on the dollar and office and multifamily where almost identical at approximately 57 cents on the dollar. Hospitality recovered just over 50 cents on the dollar, while development projects where around 45 cents on the dollar.
Here in LA, to date, recovery rates have been the highest of many of the metro areas at just over 70 cents on the dollar. The San Francisco area also achieved relatively high recovery rates of just over 65 cents, while Phoenix was under 60 cents on the dollar.
As one would expect, the agencies that were the most conservative in their underwriting during the boom years are recovering the highest amounts with the Insurance companies leading the way. For both acquisition/refinance and development/redevelopment loans international, national, regional and local banks are comparable all recovering more than 60 cents on the dollar. CMBS which only originated acquisition or refinance deals is struggling to achieve 60 cents on the dollar.
Now lets turn our attention to the magnitude of the problem.
Ernst & Young’s Transaction Real Estate group Distressed Debt - Commercial Real Estate California & Southwest market update
Distressed debt – a market update The current state?
“ From recent data,” he said, “one can infer the beginnings of a modest firming in economic activity.” He added, “While we cannot be certain we are as yet out of the recessionary woods, such evidence warrants at least guarded optimism.”
Greenspan quote February 21, 1990, The New York Times
Distressed debt – a market update Today’s delinquency rates
CMBS delinquencies top 6% in December 2009, the first time delinquencies breached 6%. 6 January 2010 SNL
US CRE loan CDO delinquencies rose to 12.3% in December 2009. Accounting for previously delinquent loans written down or disposed of at a loss the rate would have been close to 15%. 19 January 2010 SNL
Top 100 Banking Companies in CRE loan holdings have an average non-performing loan rate of 7.7%. 15 January 2010 CMA
Distressed debt – a market update Who is holding the bag? Total Secured Commercial Real Estate Debt = $3.4T
Distressed debt – a market update Approx. 41% of total CRE debt matures in the next 3 years…. Source: CMSA, Deutsche Bank research, MBA Maturities by Major Holder (billions) Year CMBS Ins. Co. Bank/ Thrift Total 2009 19 17 168 $204 2010 38 20 188 247 2011 62 23 211 296 2012 75 26 236 338 2013 42 25 265 331 Total 236 111 1,068 $1,415
Distressed debt – a market update Where is the stress? Source: Real Capital Analytics All US Markets LA Metro Las Vegas Phoenix San Diego San Francisco Metro
Distressed debt – a market update Key statistics in certain metro areas Source: TWR office trends reports Note 1: Difference is between CBRE peak forecast vacancy and peak vacancy in the last cycle. Note in most regions this peak has been forecasted by CBRE in 2010/11. Metro area Peak vacancy (’90s) 2009 YTD TWR Forecast peak Difference (Note 1) (favorable) Los Angeles office 22% 16% 19% (300 bp) Las Vegas 25% 22% 22% (300 bp) Phoenix 27% 27% 27% 0 bp San Diego 25% 21% 22% (300 bp) San Francisco 18% 14% 14% (400 bp) Total national office 19% 17% 20% 100 bp
Distressed debt – a market update Notable Transactions
Colony Capital bid wins $1B FDIC portfolio of which 70% were delinquent. Price was 44% of UPB. 8 January 2010 FDIC
Starwood Capital Group et al acquires a $4.5B portfolio of performing and non-performing construction loans and REO. Price was 60% of UPB. 6 October 2009 FDIC
OneWest acquires First Federal’s assets from the FDIC at a 6.6% premium or $401 million. 28 December 2009 WSJ
Winthrop acquires interests in 4 loans with an outstanding balance of $34.8 million secured by class A office building in NYC, LA metro, Beverly Hills Hilton Hotel and a retail condo in NYC. Price was 45% of UPB. 4 January 2010 SNL
CIM Group and Harry Macklowe team up to try to control of the old Drake Hotel in NY. Blackstone Group is making a grab for Highland Hospitality. Both are trying to gain control through debt acquisitions.
CB Richard Ellis Investors bought 12 defaulted mortgages on San Francisco apartment properties owned by the Lembi family. 15 January 2010 CMA
Distressed debt – a market update Notable Offerings
CBRE is taking bids on a $40.4 million mostly distressed commercial mortgages originated by Wachovia and Synovus Financial. 15 January 2010 CMA
CWCapital via Mission Capital Advisors is offering a $135.8 million portfolio encompassing 8 loans on a mix of property types in 7 states 15 January 2010 CMA
Carlton is marketing $307 million CMBS loans in one of the largest sales by a nongovernmental agency. 6 January 2010 WSJ
An international bank is marketing $273 million portfolio which includes a 100 unit multifamily loan located in California.
FDIC has roughly $30 billion in real estate debt that was previously held by failed banks. 6 January 2010 WSJ
Distressed debt – a market update Recovery Rates on Defaulted Mortgages Source: Real Capital Analytics
Distressed debt – a market update Recovery Rates on Defaulted Mortgages by Property Type Source: Real Capital Analytics
Distressed debt – a market update Recovery Rates on Defaulted Mortgages by Location Source: Real Capital Analytics
Distressed debt – a market update Recovery Rates on Defaulted Mortgages by Lender Type Source: Real Capital Analytics
Distressed debt – a market update Summary of Trends
While there have been signals of hope from the broader economy, not so for commercial real estate
Financial institutions continue to impose tightened restrictions and standards on lending with the levels of permissible leverage still low
Rising default rates and declining property values are impacting the commercial real estate market. The wave of borrowers handing back the keys appears to have started.
Distressed loan market is becoming active, but not compared to the magnitude of the problem. Banks are holding back so the FDIC is still the only major game in town.
We are seeing increasing activity by PE firms looking at failed bank opportunities. Only two have closed so far (IndyMac and Bank United), but more are sure to come. To be sure, the former IndyMac, now OneWest paid a 6.6% premium for failed bank First Federal.
Distressed debt – a market update Survey of distressed debt players What is your activity level related to NPL portfolios compared to 6 months ago? 95% of the respondents were more or at the same level of activity as 6 months ago.
Distressed debt – a market update Survey of distressed debt players How would you describe the current state of the US NPL market?
Distressed debt – a market update Survey of distressed debt players What NPL loan type best meets your investment criteria? Land Commercial (office, retail, industrial, multi-family, A&D) Hospitality CMBS RMBS
Distressed debt – a market update Survey of distressed debt players When do you anticipate market conditions will be favorable enough for you to enter the market?