Scavenger investors are circling like buzzards over property investors as they embark on negotiations with creditors on maturing loans. In a deleveraging world, the potential for maturity defaults represents the greatest hope for these opportunity investors and the greatest fear of borrowers and lenders.
The real source of distressed mortgages may not be financially strapped borrowers, but existing mortgage holders who find themselves in distress. These note holders include myriad real estate investment trusts, hedge funds and private equity investors that took on the role of lender during the recent market peak. They now hold a range of mortgages that are hard to dispose of, and which they had intended to sell or securitize before the CMBS market tanked in the late summer of 2007.
Fitch Ratings has already reported an uptick in maturity defaults among the pools of loans that make up the mortgage-backed securities it rates. In October 2007, non-performing mature loans made up 16% of new delinquencies and 4% of Fitch's overall index. One year later, as of October 2008, 42% of new delinquencies and 15% of the overall index are comprised of non-performing mature loans.
So when Manny Weintraub, founder of the money management firm Integre Advisors, recently told his clients that the key to finding viable investment opportunities today is to search for firms or borrowers with the ability to pay off their maturing debts, his point was well taken. And while it may even seem elementary to seasoned commercial real estate investors, his unwillingness to be caught holding equity in companies and real estate operations at risk of experiencing maturity default is at the center of what currently grips the real estate industry.
“What I've been trying to avoid for my clients are those companies that can't pay off their debts by the time the debts mature,” says Weintraub. The Las Vegas Sands, which has $10 billion in debt just had to do a dilutive equity raising, and General Growth Properties may declare bankruptcy, given the company has been unable to roll over $27 billion in debt.
In another stark case of a potential maturity default, Cap Cana, S.A., a 30,000-acre vacation home project under development in the Dominican Republic, recently announced that talks with lenders of a $100 million bridge loan broke down. The loan was arranged by Morgan Stanley and Deutsche Bank two years ago, and according to the company, efforts by Cap Cana's principal shareholders to renegotiate, and a request to extend the terms of the recently matured loan, were not sufficient to satisfy the creditors.
The dissatisfied creditors in this case included hedge funds to which banks had syndicated the loan. Many hedge funds are struggling with investors demanding return of their investment funds, forced liquidations, and deleveraging.
These developments suggest that many of the broken-down efforts to negotiate extensions of maturing loans are occurring not as a result of borrowers' inability to perform, but due to the creditors themselves being in distress.
“The company's principal shareholders offered ‘significant injections’ of capital to forestall a default under the bridge loan,” says Dr. Ricardo Hazoury, president of Cap Cana. “It proposed alternatives to the lenders that Cap Cana considered sensible given prevailing market conditions.”
Whatever borrowers such as Cap Cana principals consider significant injections or sensible solutions, it's clear that maturity defaults are rising and will test the staying power of many lenders.
Lenders that cannot keep deals performing by extending loan maturities will face the difficult and often expensive prospect of rising defaults. But for those who can stay with the loans, work with the borrowers and actively manage the real estate assets in question, they will be the survivors that leave scavenger investors wondering what could have been.
W. Joseph Caton is managing director of Oxford, Conn.-based Hartford One Group, a real estate finance consultant.