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| DISTRESSED REAL ESTATE UPDATE | |||
| Halloween 2009 | |||
A VERY SCARY B (NOTE) MOVIE  |
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Editor’s Note: This is part of an ongoing series of monthly newsletters on topics we hope will be of interest to our partners, clients and colleagues. The general theme of FrontView’s approach to distressed real estate will be articulated through the series, which we intend to begin with foundational topics and proceed to more sophisticated issues over time. Please visit our website for previous editions of Distressed Real Estate Update. Are you an institutional investor or private equity real estate debt fund asset manager who is wondering how you are going to face some of the scariest skeletons in your shop’s closets? For many who hold subordinated “B-note” investments in complex, distressed real estate deals, fear and avoidance are the order of the day. Carving pumpkins this weekend with the kids may seem like a good way to distract yourself from the night terrors your B-note portfolio gives you, but put the butcher knife aside long enough to read this article, and you might find that your scary movie can have a happier ending. REEL 1: IS YOUR SERVICER A GHOST? As commercial real estate distress shrouds the land like a rolling blackout after a Nor’easter, and lights are going out at master servicers everywhere, you may find your B-note investments unexpectedly in the hands of unfamiliar and even frightening special servicers. Facing down your fears when your tried-and-true master servicer has become a ghost requires recognizing the reality that both you and other players in your debt stack may be harming your collective best interests by your fear and misapprehension of the situation, whether by jumping to wrong conclusions or by being frozen into inaction. For example:
Understanding these irrational behaviors in others can help you act to avoid their worst repercussions. But to avoid acting irrationally yourself, despite your fears, is the real secret to getting out of the house of horrors alive. The starting point to acting rationally is to really understand the extent and limits of your rights as the B-note holder. Depending on the outcome of the appraisal, for instance, you may (or may not) be able to replace the initially designated special servicer, and/or exercise consent and consultation powers over the special servicer’s actions. It pays to be proactive in reviewing the PSA and co-lender agreement to understand whether or not you have the power to change horses. But in either case, you definitely don’t want to act like a headless horseman. Recognize that most special servicers are really not all that ghoulish -- they will generally respond best to their most rational, persuasive constituents, those who know their rights and how to leverage those rights into successful outcomes. For instance, you should know that your PSA and/or co-lender agreement probably gives you a very limited time period within which to respond to special servicer requests for consent -– and failure to respond timely is often deemed to be consent. Again, being proactive is the answer –- if you can anticipate consent requests before they arrive, you will be better able to respond strategically when they do arrive. Applying sufficient in-house or external expertise to the task is the only way to generate this level of proactivity, and is an investment that will pay you generous returns. Don’t hide your head under the pillow – take action! Moving beyond the documents and how they technically apply to your situation, you should also be managing the relationships that will make or break your investment, either by developing your network of special servicer contacts or by hooking up with partners or advisors who are already plugged into the best “specials”. It is essential to know who within the servicer’s organization has the mojo to really make things happen when an urgent servicing matter arises. You should also be familiar with the “play in the joints” of the servicing standard, so you can use your influence judiciously, only pressing your contacts within the special servicer to take actions that they can realistically be expected to take. And when the time comes to replace a servicer who has become a dangerously out-of-control zombie, you will want to have built strong ties with just the right substitute organization, one that has rating agency approval and that is well-suited to assume the responsibility of helping you bring your specific deal type back from the dead. REEL 2: FEELING OUT OF CONTROL? Among the most chilling terrors faced by today’s junior B-note investor is the dreaded control appraisal event. As much as you may feel the urge to run and hide when you receive the appraisal notice in the morning mail, keeping a level head and facing matters head-on is critical to avoiding a morbid outcome. Make no mistake: if you lose control party status and the attendant consent, consultation and servicer replacement rights it brings, you are in trouble – but recognize that the loss of this status and these rights is a symptom, not a cause, of that trouble. The market, or your borrower’s mismanagement, or other factors, have reduced the value of the asset in which you hold a junior debt interest, such that your interest is largely underwater – and unless you are willing and able to either post collateral to cover the shortfall, or buy out senior interest holders, it is inevitable given the logic of the modern debt waterfall with its absolute payment priority scheme that control (such as it is) of the special servicer will pass to others, those who still have skin in the game. If you have been realistic about these facts of life from the start, then you will have planned for this eventuality and can save yourself by tapping a rainy-day fund or a money partner to supply the needed rescue capital -– if not, then you will want to consult with a seasoned advisor to evaluate your tax and accounting positions as you await the near-inevitable loss of investment capital. And in any case, you should always be philosophical about the situation, by reminding yourself that the servicing standard override and other factors might have conspired to prevent you from exercising dictatorial control over the capital stack even had a control appraisal event not occurred. If, however, you consider yourself more of a fighter than a philosopher, be advised that there may yet remain some room to maneuver. If you have no right to trigger a baseball arbitration or other means of contesting the initial appraisal under the documents, then contesting matters (such as the validity of the appraisal trigger event, the correctness of the appraisal itself, or the application of the appraisal reduction formula) in court may be a worthwhile endeavor, if only for the settlement leverage it may create. Bear in mind that subtle (or gross) differences exist from one PSA/co-lender agreement to the next, and a harried special servicer may have inadvertently misread or misapplied the complex formulas and mechanisms contained in your documents to your disadvantage. Redressing that state of affairs is what the courts are there for, but the courts can work for you only if you are first an alert and zealous champion of your own rights. Other tactics to delay or avoid the “control cram down” may (depending on the circumstances) involve using your senior default cure rights to trigger a senior/servicer remedies standstill and thereby suspend the occurrence of the appraisal reduction trigger and (as mentioned above) posting “threshold event collateral” as credit support for the A-note by synthetically maintaining the B-note’s role as first loss-bearer. And bear in mind, too, that if despite your best efforts control is nevertheless lost -- but a discrete period of time has passed and it appears that asset values may have reflated -- then ordering a new appraisal may be the ticket to catapult you back into the catbird seat. Alternatively, you may (as mentioned above) par-buy the A-note –- since the A-note purchase option is a “lifetime right” of B-note holders, one that is not part of the rights package lost in the control appraisal process. (Or, if the A-note is not fully in the money, you may opt to buy the servicer’s “fair value” purchase option and exercise that instead.) ENDING CREDITS -- GIVE FEAR THE AXE Like many fearful things in life, the big scary B-note monsters in your closet may turn out on closer inspection to be only misplaced toys needing a little attention. If you have paid close attention to the previews offered above, your scary B-note movies this fall should be considerably less heart-stopping, and hopefully you will avoid being haunted by flashbacks throughout the long, cold winter to come. About FrontView Advisors FrontView Advisors is a part of FrontView Group, a real estate investment advisory firm offering our clients and capital partners relevant and "current day" experience to source, underwrite, negotiate, execute and manage existing and new real estate investments and loan portfolios in today's challenging economic climate. FrontView's principals have handled in excess of $2 billion in the workout and restructuring of complex debt and equity positions throughout the capital stack since 2007. |
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For further information please visit our website at www.frontviewgroup.com or contact any of the following:
David J. Steinberg |
Bret R. Salzer |
Christopher M. Bellapianta |
Copyright © 2009. FrontView Advisors LLC. All rights reserved. FrontView Advisors LLC is not a law firm and Distressed Real Estate Update should in no way be relied upon or construed as legal, financial or other advice and should not be relied upon to address specific factual situations without the advice of legal counsel and/or other professional advisors. |