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Webster Financial Corporation. Commercial Real Estate “The End of Extend and Pretend” March 2012. How Did We Get Here?. Déjà Vu All Over Again Too much capital – debt and equity Aggressive deal terms – free options Overpriced values. Industry Dynamics. 1990s. 2008+.
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Webster Financial Corporation Commercial Real Estate “The End of Extend and Pretend” March 2012
How Did We Get Here? Déjà Vu All Over Again • Too much capital – debt and equity • Aggressive deal terms – free options • Overpriced values
Industry Dynamics 1990s 2008+ • Tax code change (1986) • Overbuilding • Aggressive underwriting (S&Ls) • Recession – unemployment peaks at 8.2% • Office overbuilt • Cap rate paradigm shift • Too much capital / leverage • Aggressive underwriting (CMBS) • Severe recession – unemployment at 9+% • Consumer impact on retail supply
Regulator’s / Lender’s Approach 1990s 2008+ • Hands were tied • Aggressive Regulatory environment; came in with biased mindset from experiences in Texas • Regulators dictating values; performing / non-performing • More adversarial with Borrowers • More flexibility • Regulators applying lessons learned from 1990s; will not dictate values • Tightening underwriting standards • Increasing pricing; risk premium back in • Refinancing maturing loans; no alternative source of capital • More collegial with Borrowers
Portfolio Realities • Falling market values • Stressed cash flows with near term lease rollovers and declining rents • Increasing covenant defaults • Near term maturities • Increasing payment defaults, sponsor liquidity issues • Negative risk rating migration and capital issues
Portfolio Strategies • Early identification and resolution of the problems • Timely risk rating changes and aggressive action is critical to avoid regulatory scrutiny • Favorable regulatory guidance, work with sponsors wherever possible • Negotiate permanent solutions, do not “kick the can”
Loan Decision Tree Loan Work with Sponsor Don’t Work with Sponsor Note Sale to 3rd Party Foreclosure A / B Structure Renewal / Mod / Extension Bankruptcy REO • Retain B note or equity kicker for future upside • Put A note back as performing loan • Retain loan • Higher LTV • Control economics • Increased income from higher rate Discounted Payoff • Removal of substandard / non-accrual loans • Fix / lock in charges
Renewal / Modification LTV @ Maturity Problem Solution: • $500,000 pay down • Term: 3 year extension • Cash flow sweep to fund T/I escrow reserve • $125,000 interest reserve (add’l collateral) • LTV: 85% • DSCR: 1.20X • TDR Status • Loan: $10 million • Maturity: 11/01/11 • Occupancy: 85% • LTV: 90% • DSCR: 1.10X
A/B Note Structure Problem Solution: “A” Note - $7.5 million • LTV approx 100% • DSCR – 1.10X • Cash flow sweep • Performing status • TDR Status “B” Note - $2.5 million • $2.5 million charge off (not forgiven) • Accruing at 1% rate • Loan: $10 million • Occupancy: 70% • LTV: above 130% • DSCR: Below 1.0X
Conundrum Are TDRs a true measure of a bank’s future defaults? • TDR problems and implications: - Classification inconsistency across the industry - Went from simple accounting classification to 1.) a metric used by Wall Street to access future defaults and 2.) incremental FDIC requirements given classified status • Due to capital and valuation implications with TDR labels, workout structures may change to include: - Larger charge offs on A/B structures - No perceived concessions – need for “market” transaction
Scorecard • Regulatory / lender approach definitely a plus • Banks able to resolve liquidity issues • Banks raised or shored up their capital positions • Minimized charge offs and costs • Pressure today for banks to clean up their balance sheets • Myth vs. reality – are TDRs the next shoe to drop?