With more than $1.6 billion in second-quarter losses and plans to sell off its most viable business operations, Capmark Financial Group Inc. provides a painful example of the turmoil plaguing many large lenders to the commercial real estate industry.
In its second-quarter report published earlier this month, the Horsham, Pa.-based commercial real estate finance company disclosed an agreement to sell its mortgage banking origination and servicing businesses to Berkadia III, a partnership owned by Warren Buffett’s Berkshire Hathaway Inc., and Leucadia National Corp., for $450 million. Later that week, rating agencies lowered Capmark’s credit ratings to reflect the company’s likelihood of defaulting on its cumbersome debt.
“This has been long coming,” says Edward Mermelstein, managing partner at Manhattan-based law firm Edward A. Mermelstein & Associates. “Anyone who has a good overview of the market has been expecting Capmark, as well as other companies of the same size, to either head into bankruptcy or somehow be repositioned or acquired.”
Selling Capmark’s mortgage-origination and loan-servicing units will enable those businesses to retain their value while the remaining banking and investment business units are wound down, sold piecemeal or stabilized, according to analyst Jeff Zaun, associate director at Standard & Poor’s. The rating agency left Capmark’s commercial mortgage servicer rankings unchanged when it lowered Capmark’s long-term credit rating to CC from B-minus on Sept. 4.
“In our view, the originate-to-distribute model is still viable,” Zaun says. “Large funds are going to want real estate exposure and they are not going to want their own origination shops.”
What happens to the rest of the company? Most likely, Capmark will either file for bankruptcy protection or will hammer out agreements with its lenders outside of bankruptcy court. Even if the company comes to an agreement with lenders, however, those lenders won’t be getting their full return under original terms, so the company is expected to default on its debts to some degree in either scenario. That likelihood is reflected in recent downgrades by Standard & Poor’s and by both Moody’s Investors Service and Fitch Ratings.
Although Capmark has made progress this year toward restructuring, deteriorating commercial real estate fundamentals and a spike in loan delinquency rates have overshadowed improvements in the company’s structure. In its second-quarter report, Capmark explains that growing numbers of its borrowers have been unable to obtain replacement financing to satisfy their matured loans, resulting in a growing number of defaults. Commercial real estate fundamentals, too, are eating away at property values and accelerating the rate of default.
Capmark isn’t alone in its struggles to deal with crippling defaults. Just this month, on Sept. 11, government regulators closed down Chicago-based condominium construction lender Corus Bank. Earlier this year, parent company Corus Bankshares reported that it had roughly $2 billion in non-performing loans.
According to a Fitch report published Aug. 18, the agency assigns a negative credit outlook to nearly half of the 20 largest U.S. lenders it rates, and a major concern contributing to those negative outlooks is the potential of further deterioration in loan portfolios with a specific emphasis on commercial real estate.
As lenders seek liquidity through distressed sales, and as bankruptcies mount, private buyers are circling to snatch up deals. Attorney Mermelstein has clients that are already poring over some of Corus’ properties in Miami and other markets where condominium development burned hottest.
Mermelstein offers a simple system for investors who want to determine which lenders are most likely to join the ranks of distressed sellers or be forced into bankruptcy liquidations. The writing is on the wall – or on the fence, to be exact.
“Lenders that are highly exposed in Miami, New York and other areas of the country that have had a tremendous amount of new construction in the last couple of years are the lenders that are most exposed,” he says. “You can drive from unfinished project to unfinished project, and looking at the names of the lenders on the gates, you basically know who’s in jeopardy of going under.”