Lawmakers Look at Commercial Real Estate

This has some interesting ramifiacation for our General Growth Properties…

WASHINGTON (Dow Jones)–U.S. lawmakers rang alarm bells about the troubled commercial real estate industry, which has been walloped by the credit crunch and an implosion of property values.

“The commercial real estate time bomb is ticking,” Joint Economic Committee Chairman Carolyn Maloney, D-N.Y., said in opening remarks to a hearing before her panel Thursday.

U.S. Sen. Sam Brownback of Kansas, the panel’s top Republican, said he was distressed about the situation the industry is facing.

Banks have yanked back on lending to developers of shopping malls, apartment complexes, hotels and office parks. Meanwhile, the securitization market – a key source of funding for the commercial real estate industry – has been in a deep freeze since last year.

The situation is fueling concerns that property developers won’t be able to refinance roughly $400 billion in commercial real estate debt coming due this year.

General Growth Properties Inc. (GGWPQ), one of the largest U.S. shopping mall owners, filed for bankruptcy protection along with 158 of its properties in April, citing lack of financing.

A wave of defaults of commercial real estate loans would deal a blow to the already weakened economy and banking sector. The U.S. commercial real estate market is roughly $6.7 trillion in size and is underpinned by about $3.5 trillion of debt.

A panel of witnesses painted a dire picture for lawmakers. Property values have plunged 35%-45% in many markets as transactions have slowed to a crawl, Deutsche Bank Securities Inc. (DB) mortgage analyst Richard Parkus told lawmakers.

The market won’t begin to recover until 2012, or even later, he said. “We believe the bottom is several years away,” he added.

Plunging property values are further hampering developers’ ability to refinance their debt or loan extensions, the industry said.

The Federal Reserve has taken steps to get lending flowing to the industry. On June 16, it announced it would accept as collateral new issuance of commercial mortgage-backed securities as part of its emergency program to thaw the securitization market. As early as next week, the Fed is expected to extend that to existing, or “legacy,” CMBS already held by investors.

The industry welcomes these moves, but worries that the Fed program is set to expire at the end of this year.

The program aims to spark investor appetite for a range of asset-backed securities, now including CMBS. To the extent that CMBS investors are able to buy and sell the securities again, spreads will tighten, the Fed and the industry argue. That will allow financial institutions that make loans backing the CMBS to free up their balance sheets and make new loans to the industry or refinance existing debt.

U.S. Rep. Kevin Brady, R-Texas, criticized banking regulators for leaning too hard on banks to reduce their commercial real estate exposure.

In testimony before the panel, the associate director of the Fed’s Division of Banking Supervision and Regulation, Jon D. Greenlee, said the central bank was trying to strike the right balance between ensuring credit flows to the sector while maintaining the safety and soundness of the banking system.

“It is important that supervisors remain balanced and not place unreasonable or artificial constraints on lenders that could hamper credit availability,” he said.

What does it all possibly mean? Anything that shakes the CMBS logjam loose is a good thing. Acknowledgement by both industry analysts and Congress that the market has been shuttered and that there is zero financing available in this arena also helps General Growth’s cause in Court.

It also means it behooves Congress/Banks/Fed to take some sort of action to stop a foreclosure cascade throughout the industry. The last thing Congress can afford is a housing type fiasco on commercial real estate. What to do?

Fortunately, unlike housing much of the commercial real estate (REIT’s) are somewhat healthy. They are paying their bills and paying the interest on their loans. What they cannot do, is make multi-million dollar repayments of loans that come due that under ordinary conditions, they would have simply rolled over into a new loan. Because of this, unless something is done, you will have more otherwise healthy REIT’s filing Chapter 11, just like General Growth.

Because they are other wise healthy, there is a solution already available to both Congress/Banks/Fed that has both legal precedent AND avoids the moral hazard question that plagues all homeowner bailout plans.

What is it? Cramdown(for more details on this click here)….

A cramdown works for because it keeps all stakeholders (debt and equity) whole, compensates debt-holders additionally for the debt extension AND avoids moral hazard.

In a cramdown current debt maturities are extended, giving the company more time to make principle payments or refinance the debt (roll over) when debt markets improve. During this time frame they continue to make interest payments as they have been doing in the past. Because debtholder must accept a longer time period before their debt is repaid, they are then granted a higher interest rate on that existing debt. Win/Win.

What about the moral hazard? Cramdowns are not available for companies who cannot make their interest payments and are not currently “liquid”. Those “sick” institutions would then be forced to file Chapter 11 and the courts would deal with their assets/liabilities accordingly. Again fortunately for Congress/Banks/Fed this is not even close to the majority of the institutions that will be forced to file should debt extensions not be granted. In all reality, this solution is perfect because it will allow the functional operations to survive and weed out the weak, just as it should be.

A simple debt maturity extension program from Congress/Banks/Fed would stave off the $400 billion in defaults that are sure to happen should nothing be done.

The icing on the cake for the Congress/Banks/Fed is that is also reduces the need for banks to begin the massive CRE mortgage write-downs that will be necessary should REIT’s begin to be forced to file bankruptcy if nothing is done. Those write-downs will make what is happening in housing look like a picnic and probably break the backs of several dozens of additional institutions, some VERY large.

The cramdown scenario is one that truly enables all parties to comes out clean in the long run.

Disclosure (“none” means no position):Long GGWPQ