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PRACTICE TIPSFOR A SUCCESSFUL

REAL ESTATE WORKOUT

Kenton HambrickAssociate General CounselFreddie Mac

Dallas Bar Association, Dallas, TexasMarch 10, 2009

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DISCLAIMER

The advice, opinions, estimates, forecasts and other views contained in this presentation are those of Kenton Hambrick, do not necessarily represent the views of Freddie Mac or its management and should not be construed as indicating Freddie Mac's business position, prospects or expected results. I have attempted to provide reliable, useful information, but cannot guarantee that the information is accurate, current or suitable for any particular purpose.

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Nationwide:Nationwide:$400 billion in commercial real estate loans will $400 billion in commercial real estate loans will mature in 2009, and the pace will increase over mature in 2009, and the pace will increase over succeeding yearssucceeding years..

The Real Estate Roundtable, December 2008The Real Estate Roundtable, December 2008

Texas:Texas:$27 billion in CRE loans are coming up for $27 billion in CRE loans are coming up for refinancing through 2011.refinancing through 2011.

Dallas Morning News, January 6, 2009Dallas Morning News, January 6, 2009

  

A WAVE OF MATURING LOANS

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Most bank lenders have withdrawn.Most bank lenders have withdrawn.

No secondary market for CRE except No secondary market for CRE except multifamily (FRE and FNMA).multifamily (FRE and FNMA).

CMBS market is shut down.CMBS market is shut down.

Cautious private equity.Cautious private equity.

Tightening credit conditions.Tightening credit conditions.

FEW REFINANCING OPTIONS

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Highest Percentage of Banks Tightening Commercial Mortgage Standards Since 1990

-30

-10

10

30

50

70

90

1990Q3 1992Q3 1994Q3 1996Q3 1998Q3 2000Q3 2002Q3 2004Q3 2006Q3 2008Q3

-30

-10

10

30

50

70

90

Source: Federal Reserve Board's Senior Loan Officer Survey, percent responding either “Tightened Considerably” or “Tightened Somewhat” (Last update: February 2, 2009)

Net Percentage of Banks Tightening Mortgage Standards During Previous Three Months

Survey question on commercial real estate loans (including construction and land development loans) : Over the past three months, how have your bank’s credit standards for approving applications for commercial real estate loans changed?

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COMMERCIAL PROPERTYVALUES ARE FALLING

““Commercial property prices may fall as much as 40 Commercial property prices may fall as much as 40 percent from peak-to-trough . . . Prices are down percent from peak-to-trough . . . Prices are down 11.5% from October 2007.” 11.5% from October 2007.” Alan Todd, Head of Alan Todd, Head of Commercial Bond Research, J.P. Morgan, December 1, 2008Commercial Bond Research, J.P. Morgan, December 1, 2008

““Commercial real estate values have declined Commercial real estate values have declined progressively this year, a trend expected to progressively this year, a trend expected to continue through 2009.” continue through 2009.” Financial Week, November 30, Financial Week, November 30, 20082008

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-10%

-5%

0%

5%

10%

15%

20%

25%

19

79

19

80

19

81

19

82

19

84

19

85

19

86

19

87

19

89

19

90

19

91

19

92

19

94

19

95

19

96

19

97

19

99

20

00

20

01

20

02

20

04

20

05

20

06

20

07

Source: Freddie Mac CMHPI (Purchase-Only Series), NCREIF Property Index

NCREIF Apartment

One- Family Homes

Appreciation (Annual Percent Change)

Apartment Values Have Begun to Decline

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COMMERCIAL REAL ESTATE DEFAULTS WILL ESCALATE IN 2009

““The volume of delinquent/defaulted loans The volume of delinquent/defaulted loans could triple in 2009.” could triple in 2009.” CoStar Group, January 14, CoStar Group, January 14, 20092009

““The delinquency rate [for loans pooled in The delinquency rate [for loans pooled in CMBS] will likely hit 3% by the end of CMBS] will likely hit 3% by the end of 2009, the highest point in more than a 2009, the highest point in more than a decade.” decade.” Richard Parkus, Head of CMBS Research, Deutsche Richard Parkus, Head of CMBS Research, Deutsche Bank, January 8, 2009.Bank, January 8, 2009.

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Multifamily Default Rates at Banks and Savings Institutions Are Highest Since 1996

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%1

99

3

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

Delinquent or Non-current (Percent of Average Loans Outstanding)

Note: Noncurrent loans and leases – the sum of loans and leases 90 days or more past due, and loans and leases in nonaccrual status.Source: FDIC

Noncurrent

30-89 days past due

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RISING JOB LOSSESWILL DRIVE UP CRE DEFAULTS

““U.S. commercial properties at risk of default could U.S. commercial properties at risk of default could triple if rental income from office, retail and triple if rental income from office, retail and apartment buildings drops by even 5 %, a likely apartment buildings drops by even 5 %, a likely possibility given the recession.”possibility given the recession.” Reis, Inc., reported at Reis, Inc., reported at www.bloomberg.com, December 22, 2008.www.bloomberg.com, December 22, 2008.

““Close to 5 million jobs will be lost. The Close to 5 million jobs will be lost. The unemployment rate will surge to over 9%.”unemployment rate will surge to over 9%.” Mark Zandi, Mark Zandi, www.economy.comwww.economy.com, January 6, 2009., January 6, 2009.

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0

10

20

30

40

50

60

70

80

90

100

Ju

l-99

Ja

n-0

0

Ju

l-00

Ja

n-0

1

Ju

l-01

Ja

n-0

2

Ju

l-02

Ja

n-0

3

Ju

l-03

Ja

n-0

4

Ju

l-04

Ja

n-0

5

Ju

l-05

Ja

n-0

6

Ju

l-06

Ja

n-0

7

Ju

l-07

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8

Ju

l-08

Ja

n-0

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Source: National Multi Housing Council (Last Update: January 2009)

Market Tightness Index

Market Unchanged

Market Tighter

Market Looser

Survey question for Market Tightness Index: How are apartment market conditions in the local markets that you watch? “Tight” markets are those with low vacancies and high rent increases. Conditions obviously vary greatly from place to place, but on balance, apartment market conditions in your markets today are: 1) Tighter than three months ago 2) Looser than three months ago 3) About unchanged from three months ago 4) Don’t know or not applicable.

Apartment Market Conditions Are Weaker in Most Markets

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LENDER’S OPTIONS

ForecloseForeclose

ForbearForbear

Sell NoteSell Note

Loan Extension / ModificationLoan Extension / Modification

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POSITIONING BORROWER FOR A SUCCESSFUL WORKOUT

Communicate With Servicer/Lender Early Communicate With Servicer/Lender Early And Often.And Often.

Do Not Create Problems. Do Not Create Problems. Keep Property In Good Repair.Keep Property In Good Repair. Maintain Reserves.Maintain Reserves.

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POSITIONING BORROWER (continued)

Keep Loan Current.Keep Loan Current. Be Willing To Commit New Money.Be Willing To Commit New Money. Be Willing To Change Management.Be Willing To Change Management. Have A Reasonable Business Plan.Have A Reasonable Business Plan. Cooperate With Lender.Cooperate With Lender.

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PRACTICE TIP:PREVENTATIVE CARE

   Take your borrower client’s financial pulse. Take your borrower client’s financial pulse.

Is the property cash flowing?Is the property cash flowing? Any vacancy or maintenance issues?Any vacancy or maintenance issues? How’s his relationship with Servicer?How’s his relationship with Servicer? Borrower who brings problems to the Borrower who brings problems to the

Servicer’s attention early, before default, Servicer’s attention early, before default, builds good will.builds good will.

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STEP ONE:IDENTIFY PARTICIPANTS

BorrowerBorrower LenderLender

GuarantorsGuarantors ServicerServicer

PrincipalsPrincipals Junior LenderJunior Lender

Key TenantsKey Tenants Mezz LenderMezz Lender

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PARTICIPANTS (cont’d)

Tax Exempt Tax Exempt Bond DealBond Deal

IssuerIssuer TrusteeTrustee

Credit EnhancerCredit Enhancer Tender AgentTender Agent

Interest Rate Interest Rate Hedge ProviderHedge Provider

Bond CounselBond Counsel

Bond Bond UnderwriterUnderwriter

Remarketing Remarketing AgentAgent

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PRACTICE TIP:

PRESERVE THE GUARANTY Notice guarantors on all correspondence

with borrower. Obtain guarantors’ consent to any action

that could increase guarantor’s risk or liability (e.g., modifying loan terms, partial release of principal or collateral, delaying enforcement).

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STEP TWO:PRENEGOTIATION AGREEMENT

Allows open discussion.Allows open discussion. Contents privileged, not discoverable or Contents privileged, not discoverable or

admissible.admissible. Not an agreement to modify.Not an agreement to modify. No modification until subsequent No modification until subsequent

agreement signed by all. agreement signed by all.

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PRENEGOTIATION AGREEMENT (cont’d)

No waiver of rights, remedies or No waiver of rights, remedies or obligations. obligations.

Lender reserves right to pursue all Lender reserves right to pursue all remedies at any time. remedies at any time.

Any party may terminate Any party may terminate negotiations at any time.negotiations at any time.

Include guarantors any other Include guarantors any other interested parties. interested parties.

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PRACTICE TIP:

KEEP YOUR POWDER DRY

Borrower - Avoid negotiating the prenegotiation agreement. Don’t squander goodwill over a routine matter.

Lender – Don’t include provisions that invite negotiation.

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STEP THREE: REVIEW LOAN DOCUMENTS AND CLOSING FILE Assemble complete set of loan documents. Review rights of each party. Look for special terms (e.g., modified

notice and cure, restrictions on lender’s rights).

Participation agreements, intercreditor agreements or other loan-related agreements may require notice and/or opportunity to cure.

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PRACTICE TIP:

BORROWER SHOULD HAVE A PLAN Before approaching lender, borrower’s

counsel should work with client to develop a reasonable business plan with a plausible exit strategy. Approach the workout as if it were a new loan.

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STEP FOUR: UPDATE DUE DILIGENCE

Title and Litigation Searches

Update title report Confirm perfection of security interests. Does borrower still own the property? Junior lienors? Mechanics liens?

Review title policy and notice any claims.

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DUE DILIGENCE (cont’d)

UCC Search Has the UCC filing lapsed? Equipment - PMSI or leases?

Litigation search on borrower and guarantors.

Judgment liensBankruptcy filings

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DUE DILIGENCE (cont’d)

Property Due DiligenceProperty Due Diligence AppraisalAppraisal Environmental concernsEnvironmental concerns

O&M Plan (lead paint, asbestos, storage O&M Plan (lead paint, asbestos, storage tanks)tanks)

Mold Remediation PlanMold Remediation Plan

Phase I Assessment Phase I Assessment

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DUE DILIGENCE (cont’d)

Update Financial Information

Property Operating Statements Detailed Income and Expenses

Identify Reserves

No odd accounting (cash not accrual)

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DUE DILIGENCE (cont’d)

Financial statements for Borrower, Financial statements for Borrower, Principals and Guarantors.Principals and Guarantors. Identify liquid and unencumbered Identify liquid and unencumbered

assets.assets. Trust assets / community propertyTrust assets / community property Signs of larger problemsSigns of larger problems

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STEP FIVE: ANALYZE SOURCES OF RECOVERY

Full recourse or guaranteed exceptions to non-Full recourse or guaranteed exceptions to non-

recourse?recourse?

Exceptions breached?Exceptions breached?

FraudFraud

WasteWaste

Conversion of insuranceConversion of insurance

Bankruptcy triggerBankruptcy trigger

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SOURCES OF RECOVERY (cont’d)

If personal liability of borrower or If personal liability of borrower or guarantor, are assets available? guarantor, are assets available?

Do the principals have the resources Do the principals have the resources and commitment to contribute to a and commitment to contribute to a workout?workout?

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STEP SIX:PURSUE WORKOUT AND FORECLOSURE SIMULTANEOUSLY

Identify and document defaults. Identify and document defaults. PaymentPayment Non-monetaryNon-monetary

Send demand letter to borrower and Send demand letter to borrower and guarantor.guarantor.

Copy other interested parties (Copy other interested parties (e.ge.g., ., servicer, subordinate lenders, others servicer, subordinate lenders, others in title). in title).

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PURSUE FORECLOSURE (cont’d)

Send non-waiver letter if partial Send non-waiver letter if partial payments received.payments received.

Consider time frame for foreclosure Consider time frame for foreclosure (judicial vs. non-judicial)(judicial vs. non-judicial)

Consider special state laws (Consider special state laws (e.ge.g., ., single action rule, election of single action rule, election of remedies.)remedies.)

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PRACTICE TIP:

CONSIDER TAX CONSEQUENCES

Depreciation recapture may be triggered by foreclosure or a write down of principal.

Negative tax basis creates taxable gain on sale. Gain = (Unpaid Debt) – (Depreciated Value of

Property) Modification of a securitized loan may expose the

REMIC or other securitization vehicle to severe tax penalties.

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PRACTICE TIP:

CONSIDER BUSINESS CONSEQUENCES Demand, acceleration or foreclosure may make a

workout harder to achieve. Impair borrower’s effort to refinance Trigger defaults in other lending agreements Affect credit facilities for borrower affiliates Scare commercial tenants Senior housing / hotels

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STEP SEVEN:DOCUMENTING THE WORKOUT MATURITY EXTENSIONMATURITY EXTENSION

Continue regular payments Continue regular payments Breathing space to refinance Breathing space to refinance

FORBEARANCE – “WAIT AND SEE”FORBEARANCE – “WAIT AND SEE” Default, but Lender stands stillDefault, but Lender stands still Short termShort term Plausible borrower exit strategy Plausible borrower exit strategy

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DOCUMENTING THE WORKOUT (cont’d) TRANSFER AND ASSUMPTIONTRANSFER AND ASSUMPTION

White knight in the wingsWhite knight in the wings

LOAN MODIFICATIONLOAN MODIFICATION Rate reduction Rate reduction // I/O conversion I/O conversion Accrue and defer interestAccrue and defer interest Principal paydownPrincipal paydown Reamortization Reamortization // Term extension Term extension

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DOCUMENTING THE WORKOUT (cont’d)

TYPICAL LENDER CONDITIONSTYPICAL LENDER CONDITIONS Additional guarantyAdditional guaranty

Increase base guarantyIncrease base guaranty Additional guarantorsAdditional guarantors

New MoneyNew Money Debt service escrow / letter of creditDebt service escrow / letter of credit Repair and/or replacement reservesRepair and/or replacement reserves Repair escrow / Schedule of repairs / budgetRepair escrow / Schedule of repairs / budget

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DOCUMENTING THE WORKOUT Lender conditions (cont’d)

New management New management Additional collateralAdditional collateral

Cross-collateralization / cross-defaultCross-collateralization / cross-defaultWARNING: Preference issueWARNING: Preference issue

OtherOther Cash flow participationCash flow participation Equity participation on saleEquity participation on sale Hope noteHope note Lock boxLock box

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PRACTICE TIP:

BANKRUPTCY STAY WAIVER

Waiver of the automatic stay in workout documents. Waiver of the automatic stay in workout documents. may be enforced if a) debtor is sophisticated with may be enforced if a) debtor is sophisticated with competent counsel; b) debtor receives competent counsel; b) debtor receives consideration (consideration (e.ge.g., forbearance from foreclosure); ., forbearance from foreclosure); c) other parties are not affected; d) debtor has no c) other parties are not affected; d) debtor has no feasible plan. feasible plan. SeeSee In Re Bryan Road, LLCIn Re Bryan Road, LLC, 382 , 382

B.R. 844 (Bankr. S.D. Fla.B.R. 844 (Bankr. S.D. Fla. 2008).2008).

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CONCLUSION The recession is likely to continue for the near The recession is likely to continue for the near

future. Turnaround will take time.future. Turnaround will take time. If credit markets remain tight, there will be many If credit markets remain tight, there will be many

more CRE maturity defaults.more CRE maturity defaults. If economic fundamentals such as employment If economic fundamentals such as employment

and property values continue to deteriorate, and property values continue to deteriorate, payment defaults will accelerate in all areas of payment defaults will accelerate in all areas of commercial real estate. commercial real estate.

With careful preparation and a methodical With careful preparation and a methodical approach, lawyers can help both lenders and approach, lawyers can help both lenders and borrowers achieve a successful workout. borrowers achieve a successful workout.

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Kenton HambrickAssociate General Counsel – Litigation and

Distressed Real EstateFreddie Mac, Mail Stop 2028200 Jones Branch DriveMcLean, Virginia 22102Telephone: (703) 903-2473Email: kenton_hambrick@freddiemac.com