Balloon Mortgage Refinance for Commercial Real Estate

If you work in the commercial banking or financial industry, you already know what a toxic asset is and you may even know why the government had to step in and subsidize the banks and AIG. I did not and most people do not understand this as well as people in the financial industry.

Here is a simple example of a commercial balloon mortgage in trouble

The Office Project Economy was Good Mortgaged Backed Securities Goverment Stepping In Toxic Assets Hindsight is 20/20 The Balloon comes Due Solution 1 Solution 2 Solution 3 Solution 4

The Office Project (December 1999)

I will use a friends example and his commercial balloon mortgage to shed some light on this topic.

In 1999 my buddy "Bruce" took out a 20 million dollar balloon mortgage on a project that he had been working on for 5 years with a developer in the Redwood City, California. It was the tail-end of the dot-com bubble and Bank of America was more then happy to read in the executive summary that a 5 year lease was signed by a major sofware game developer.

BOA underwriters had been reviewing the project for 6 months and we had finished Review Checklist, Site Plan Checklist, and agreed on all the Fee Schedules.

Economy was good (July 2004)

The bank is happy and the borrower has a booming business. So the banks are making thousands more prime and sub-prime mortgages to borrowers. The mortgage inventory was growing very fast and the regulators were looking the other way.

Banks started to loan to these sub-prime borrowers and often they made adjustable-rate mortgage loans to these borrowers. These loans often started out at very low, affordable interest rates. These low interest rates were fixed for a certain number of years but then they adjusted to a higher interest rate. Just like the conventional mortgages, they were packaged into mortgage-backed securities and sold to investors. Because the credit risk was higher for these subprime loans, the possible return on the mortgage-backed securities was even higher and investors were clamoring for them.

Mortgaged Backed Securities (1997 - 2009)

BOA started putting loans together, thousands of them, and selling them to other banks. Banks like Citicorp and other very large banks. The larger banks packaged the mortgage loans together into what they call a mortgage-backed security.

A mortgage-backed security, actually a pool of mortgage loans, pays out the cash flows that homeowners pay, to investors. In other words, the loan payments from homeowners are passed through to investors each month. Fannie Mae and Freddie Mac are two of the organizations that repackaged these mortgage loans and pass through income to investors each month. These packages of mortgages, through Fannie Mae and Freddie Mac, have backing by the full faith and credit of the United States government.

Goverment Stepping In (Jan 2009)

The Federal Reserve said Tuesday that it will begin purchasing up to $500 billion in mortgage-backed securities early next month in an effort to bolster the long-suffering housing market.

The Fed first announced that it would purchase the securities, which consist of pools of mortgages that are bundled together and sold to investors, in late November but did not say when they would begin. The central bank will buy securities guaranteed by the government-controlled home loan giants Fannie Mae, Freddie Mac and Ginnie Mae, a federal agency.

Toxic Assets Hindsight is 20/20 (April 2009)

BOA realized some of the mortgages in the Mortgage-backed-Security were alot more risky than others. Alot of them were very bad investments. But it was too late.

The Balloon comes Due (December 2009)

Bruce is preparing for the worst because he is worried that he may not be able to get another Balloon mortgage and the bank may foreclose on him if he cant pay the entire balance on Dec 14 2009. Normally, he would just find another bank to take then note and he would keep making the monthly payments.

But with the tightening of the commercial lending market, he knows it will be very difficult to roll over the mortgage.

Solution 1 for a Commercial Balloon Mortgage

1. The most logical solution is to renegotiate with BofA for an extension. That would be possible if BofA were the investor and not just the servicer of Bruce’s loan. As a servicer of loans the fiduciary requirements are very restrictive on what the servicer is permitted to modify. Since the bonds backing Bruce’s mortgage may be owned by more than one investor and may have different levels of risk (traunces) they may not agree on any modification that will lessen their respective positions. However, it is always best to start with renegotiating with the existing lender first.

Solution 2 for a Commercial Balloon Mortgage

2. Re-financing the existing mortgage with a third party lender is the second alternative. The current credit freeze makes the normal sources of refinancing either completely out of the market or very selective. Since the mortgage backed securities market has imploded that very large source of capital has disappeared a traditional source of capital. The commercial bank have become over leveraged in real estate loans and want to decrease their exposure. This take a viable source and limits it use to well run and conservative bankers who are not going to stretch loan amounts to make a deal. Low loan to value and high debt service coverage ratios are going to be us for awhile.

Solution 3 for a Commercial Balloon Mortgage

3. If Bruce’s property has held its value and there is adequate cash flows then the opportunities for a refinance are greatly enhanced. The new era of 65% loan to value and debt service coverage north of 1.3X are here. The other interesting dilemma is the loan per square foot is much more in focus now. All of these underwriting tools were always used but now they are being tightened down as the pendulum swings the other way from risk. If Bruce’s loan is 65% or less of value then there will most likely be lender willing to refinance his loan. If his value has decreased and he is above 65% then it is likely Bruce will need to put more equity into his deal. Our solution is to find the equity and the debt to restructure the loan.

Solution 4 for a Commercial Balloon Mortgage

4. The mezzanine lenders have now gone away just as the mortgage backed securities have disappeared so this logical source of capital no longer exists. The more traditional investors know good deals and also want lower risk. They too have been hurt by over leveraged deals. It is our opportunity to bring this capital to Bruce’s deal whether it is short term or a longer term solution.