Recourse is returning in commercial (read this)
I asked my brother, a commercial specialist, what he thought of my blog. Said he thought it was too detailed, thinking there was too much macro information, didn't think it'd resonate with my residential clients. Hmmm, good point. But I think the macro is really affecting what's happening locally, the big issues trickle down to the day to day activities of selling a house, or a shopping center (coming in a few months). This article is about commercial lending, I think it's important that even a first-time homebuyer understands that today's credit crunch is felt all over. It's from yet another WSJ article published 6-18-08 from Lingling Wei titled: Developers Dread Return of Recourse.
After a decade of easy lending, the dreaded personal guarantee is making a comeback in the real-estate industry, bringing back the kind of tough terms that borrowers hoped not to see again: Recourse loans -- once a staple of commercial lending -- had largely fallen by the wayside during the past decade as banks found ways to minimize their risk. Now, with the securities market for commercial loans still anemic, recourse loans are popping up again. Those who can't wait out the credit crisis may have little choice but take a deep breath and sign a recourse loan.
Take, for example, Judah Hertz, chief executive of Hertz Investment Group in Santa Monica, Calif. About 3½ years ago, Mr. Hertz took out a $50 million mortgage from LaSalle Bank to buy an office building in New Orleans. That loan required no personal guarantee. As the loan is due next month, he is left with little choice but to accept a new $50 million loan from Wells Fargo that requires him to personally guarantee 25% of that amount.
During the recent sales frenzy for commercial properties, nonrecourse loans were the norm. Typically, this meant that the developers put up as collateral only the buildings they were purchasing. If they couldn't pay off the loans, they simply handed the building's keys to the lender and walked away. The borrowers' other holdings -- including personal assets such as homes and boats -- remained intact. The investment banks that originated many of these loans felt comfortable with the arrangement because they typically packaged those loans into commercial-mortgage-backed securities, or CMBS, and sold them as bonds, reducing their own risk if the borrowers couldn't pay. Now, with a 90% drop in CMBS sales, banks have all but stopped originating loans aimed at the bond markets. Instead, they're returning to the traditional model of holding on to -- as opposed to selling -- the loans. Even for banks, recourse lending can cause headaches. Borrowers are more likely to fight the banks if they face losing much of their net worth over one bad gamble. Plus, the banks make less money; the interest rates they can charge on recourse loans are about 1% lower than on nonrecourse loans.
Banks that have already suffered losses related to residential mortgages are increasingly viewing recourse loans as a necessary layer of protection. When prices were rising, the bank could take control of a building and sell it to pay off the loan. Now, with falling valuations, the building could be worth less than the debt on it. In that scenario, banks want a way to make up the difference.
After a decade of easy lending, the dreaded personal guarantee is making a comeback in the real-estate industry, bringing back the kind of tough terms that borrowers hoped not to see again: Recourse loans -- once a staple of commercial lending -- had largely fallen by the wayside during the past decade as banks found ways to minimize their risk. Now, with the securities market for commercial loans still anemic, recourse loans are popping up again. Those who can't wait out the credit crisis may have little choice but take a deep breath and sign a recourse loan.
Take, for example, Judah Hertz, chief executive of Hertz Investment Group in Santa Monica, Calif. About 3½ years ago, Mr. Hertz took out a $50 million mortgage from LaSalle Bank to buy an office building in New Orleans. That loan required no personal guarantee. As the loan is due next month, he is left with little choice but to accept a new $50 million loan from Wells Fargo that requires him to personally guarantee 25% of that amount.
During the recent sales frenzy for commercial properties, nonrecourse loans were the norm. Typically, this meant that the developers put up as collateral only the buildings they were purchasing. If they couldn't pay off the loans, they simply handed the building's keys to the lender and walked away. The borrowers' other holdings -- including personal assets such as homes and boats -- remained intact. The investment banks that originated many of these loans felt comfortable with the arrangement because they typically packaged those loans into commercial-mortgage-backed securities, or CMBS, and sold them as bonds, reducing their own risk if the borrowers couldn't pay. Now, with a 90% drop in CMBS sales, banks have all but stopped originating loans aimed at the bond markets. Instead, they're returning to the traditional model of holding on to -- as opposed to selling -- the loans. Even for banks, recourse lending can cause headaches. Borrowers are more likely to fight the banks if they face losing much of their net worth over one bad gamble. Plus, the banks make less money; the interest rates they can charge on recourse loans are about 1% lower than on nonrecourse loans.
Banks that have already suffered losses related to residential mortgages are increasingly viewing recourse loans as a necessary layer of protection. When prices were rising, the bank could take control of a building and sell it to pay off the loan. Now, with falling valuations, the building could be worth less than the debt on it. In that scenario, banks want a way to make up the difference.
posted by Mike Bell at
3:03 PM
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