Promenade caught in credit squeeze

LOVELAND – The initiation of foreclosure proceedings on the Promenade Shops at Centerra is illustrative of a growing trend in the commercial real estate world that has financial regulators scrambling to ease pressure on lenders.

On Nov. 3, the Promenade Shops became the largest property to enter into the foreclosure process in Larimer County when KeyBank, as the agent for a group of lenders, filed a notice of election and demand for sale for the remaining $112.86 million balance of a $116 million loan made in October 2004.

The dubious distinction of largest-in-foreclosure was previously held by Integrated Capital LLC, the California-based owner of three Marriott-branded properties in Fort Collins, which received a NED from lenders for late payments on a $32 million loan balance in August.

In the case of The Promenade Shops, no payments were late, but Centerra Lifestyle Center LLC – a partnership between McWhinney and Memphis, Tenn.-based Poag & McEwen – could not pay off or refinance the loan when it came due.

Executives at both firms cite timing, the regulatory landscape and the complexity of the consortium behind the construction loan as the main reasons for the lenders’ actions. Both are also adamant that the center is doing good business.

“The property is doing well, which is the frustrating thing,” Josh Poag, president of Poag & McEwen, said. “I’m hopeful that we’ll be able to figure something out.”

Doug Hill, chief operating officer at McWhinney, said that the center is 90 percent leased. Poag pointed out that a recent survey by the Urban Land Institute of mall developers found most were down 20 percent to 30 percent last quarter. Centerra was down only about 4.4 percent.

“Unfortunately, in this situation the timing of the maturity of the construction loan couldn’t have been worse,” Hill said.

When Poag & McEwen, as managing partner, started working on finding permanent financing in the summer of 2008, the economy had definitely slowed, but it came to a screeching halt in September following the collapse of Lehman Bros.

Permanent financing dried up

Poag explained it is typical for projects to kick off with short-term construction financing then transition to long-term financing. He said that permanent financing previously came through one of two sources – the commercial mortgage backed securities market or from large insurance companies. Today, there is virtually no market for CMBS and insurance companies are being very selective, seeking low-leverage, low-risk deals.

According to ratings firm Realpoint Research, the CMBS market had a delinquent balance of $31.73 billion in September, up from $28.16 billion in August and an increase of 583 percent from September 2008. The report also pointed out that retail loans were the greatest contributor to overall CMBS delinquency, accounting for 30 percent. The retail sector has had the highest default rate since May when it surpassed multifamily.

Poag & McEwen was able to get an extension on the loan through the start of 2009. Since January, the ownership group had been working with the lenders “without duress,” Poag said. Adding to the issue of timing is the fact that the borrowers are working not with one lender, but a consortium of seven.

“It’s a very complex situation,” Hill said. “It’s like herding cats.”

Poag echoed the issue of complexity: “You definitely have many opinions around the table.”

While KeyBank is the lead in negotiations, it must gather a consensus among a group of banks with varying issues:

n Bank of Scotland;

n Cosmopolitan Bank and Trust, which was purchased by Park National Bank and subsequently closed by bank regulators and merged into U.S. Bank;

n JPMorgan Chase Bank;

n First Tennessee Bank;

n National City Bank, which was purchased by PNC Financial Service Group in late 2008 after struggling for more than a year to clean up a messy mortgage portfolio; and

n LaSalle Bank, which was acquired by Bank of America in 2008.

Aside from their individual issues, all banks are subject to an industry-wide regulatory crackdown on commercial real estate concentrations in anticipation of continued weakness for the sector. Regulators are also requiring bulked-up capital cushions, which has put a squeeze on already vulnerable portfolios.

“They’re well-intentioned regulations but not well-thought-out. It’s just nonsensical,” Hill said, adding that the regulatory pressures on commercial real estate will be a self-fulfilling prophecy. “When that’s your business, it’s a tough message to hear.”

New guidance for CRE workouts

Recognizing that the system has become counterproductive, Federal Financial Institutions Examination Council issued new guidance on commercial real estate workouts on Oct. 30. Council members include the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corp., the National Credit Union Administration, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and a State Liaison Committee.

The guidance is meant to provide some assurance that “prudent” loan workout arrangements will not draw the ire of examiners. The regulators provided scenarios involving different types of loans to clarify.

One scenario involved a shopping mall property with a much smaller loan than the one for the Promenade Shops, $10 million versus $116 million, and in much worse condition, with occupancy at 55 percent as opposed to 90 percent. Potential solutions included a short-term extension to allow for the lease-up rate to increase, a write-off of the debt for the amount the property value had declined and debt restructuring on an interest-only basis.

Poag said he is unaware if the guidance, which was released just days before the lenders filed their NED, would have had any impact on their ability to restructure the loan. Likewise, he declined to discuss the details of the negotiation process or the reasons that the lenders would not reach an agreement. He was also unaware of what a current appraisal of the Promenade Shops would reveal but believed one was now under way.

“There’s some lack of clarity,” Hill said of why a deal could not be struck.

Foreclosure clock ticking

Right now, the owners are analyzing what needs to be done next. The fact that the foreclosure process has started, setting the clock ticking, doesn’t give them any more leverage, Hill said. Poag added that none of the prospects for financing to date have been attractive.

“We explored a lot of options, and we’ve kissed a lot of frogs,” he said.

The partners have until March before the property will be formally foreclosed on and go to auction. Because the loan in question is a non-recourse loan, none of their other properties are involved in the foreclosure. Even so, the state of the financial market will continue to take its toll.

“We’re in the business of creating great places for people,” Hill said. “The lack of credit impacts our company’s ability to continue to function.”

At the same time, he is confident in McWhinney’s ability to power through the downturn. Hill explained that the company’s other properties are not impacted by the down market, in part because it was aggressive about securing long-term financing.

“We tend to be long-term holders and manage our finances very conservatively,” he said.

Already this year, the company has refinanced or received new loans totaling $100 million, many with Wells Fargo.

Hill said that while McWhinney is facing some hurdles now, it is also seeing opportunities to pick up properties in Northern Colorado and beyond. He said that some of the possible deals are far into the negotiation stage, but declined to say if and when the company might close on anything.

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