e-Newsletter                                                                                                            June, 2010

In This Issue

THANKS FOR WRITING IN

NEW PATHFINDER R3™  - HELPING BORROWERS AND LENDERS

CHARTING THE COURSE
On Earthquakes and Aftershocks

   By Mitch Siegler, Senior Managing Director

SELECTED PATHFINDER CLOSED TRANSACTIONS
 
FINDING YOUR PATH
Do You Believe in Miracles?

SNIPPETS: TRUTH IS STRANGER THAN FICTION

NOTABLES AND QUOTABLES

THANKS FOR WRITING IN

Thanks to those of you who have written in - please keep the cards and letters coming - we welcome your feedback.

NEW PATHFINDER R^3™- HELPING BORROWERS AND LENDERS

Earlier this month, Pathfinder Partners, LLC launched Pathfinder R^3™- a new rescue financing program designed to provide much-needed capital to under-capitalized owners of income-producing real estate.
Pathfinder R^3™ signifies "restructuring, repositioning and rescue financing."  The program's goal is to help real estate owners and investors - hit hard by frozen debt markets and plummeting commercial real estate (CRE) values - repurchase or restructure bank loans and reposition projects in need of capital. We launched the program because we have been receiving more and more inquiries from borrowers who are "upside down" on their properties and have been unable to refinance their loans or secure funding for tenant improvements and leasing commissions for new leases. 

Pathfinder believes that despite glimmers of hope in the economy, we are in the early innings of a multi-year commercial real estate crisis. U.S. bank lending is at an all time low, plummeting by nearly $300 billion in 2009 alone, according to a recent report by the FDIC. Fueling the problem, commercial property values are down 41.6% from just two years ago, according to Moody's/Real Commercial Property Price Indices.
Our new Pathfinder R^3™ program will enable troubled borrowers to restructure, modify or repurchase CRE loans and will provide bridge financing or equity to reposition under-capitalized projects.  Pathfinder R^3™is among the first of such offerings in the market, but we expect such programs to grow, given the large volume of loans maturing over the next few years.

In addition to providing capital, the Pathfinder team, which has participated in more than $20 billion of commercial real estate transactions and includes seasoned real estate investment analysts, attorneys and financial/restructuring experts, is poised to help restructure troubled projects and assist with complex deal structures and tax strategies.
If you would like to discuss the Pathfinder R^3™ and your income-producing real estate asset, please contact us.

CHARTING THE COURSE                       

Earthquakes and Aftershocks
By Mitch Siegler, Senior Managing Director 

On Easter Sunday, April 4th, southern California was rocked by a 7.2 magnitude earthquake. In the weeks since, the ground has continued to shake with dozens of aftershocks. Earthquakes and aftershocks - that's a pretty good metaphor for the financial crisis.

The 2007 subprime crisis, the initial earthquake, has been followed by numerous aftershocks, including Lehman Brothers, Bear Stearns, WaMu, AIG and TARP and in the past few weeks, the "Flash Crash", Greece and the $1 trillion Euro bailout program.

Southern California has stringent building codes since 7.5 or 8.0 magnitude quakes are not uncommon. In developing countries, lesser quakes cause significant casualties and structural damage and relatively minor aftershocks often bring down weakened buildings.  Shifting back to finance, the first phase of the earthquake caused poor quality loans to default while the aftershocks, a weak economy, high unemployment and a dearth of bank lending and low demand by borrowers, cause even decent quality loans to go bad. What if, in an historical context, it turns out that the 2007-2008 financial earthquake wasn't the main event?

On May 6th, Greece sneezed and world capital markets almost caught pneumonia, with the DJIA plummeting nearly 1,000 points in a few minutes time. Now, Greece is no stranger to financial defaults and debt restructurings. Greece's default in 1826 shut it out of international capital markets for 53 consecutive years. Greece also holds the honor of the record currency crash in 1944, according to Carmen Reinhart and Kenneth Rogoff in their book, This Time is Different.

A recent Google search found more than 3,000,000 references to "Greek contagion", twice as many as for "Greek Ouzo" and 15 times more than "Greek goddess". Perhaps investors' priorities are out of whack but that doesn't stop pundits from worrying about who could be next. While the U.K. and the good ol' US of A make some lists, Ireland, Portugal and Spain are the odds-on favorites for spots the outbreak might show up next.

Of course, Spain is no stranger to sovereign debt defaults and restructurings, with seven in the 19th century and six more in the preceding four centuries. The country has actually had a pretty clean record since 1900, unless you count the 30 months from October, 1936 to April, 1939, when the government suspended payments on its international debts and went into arrears on its domestic debts.

Understandably, government finance ministers are focused on containing the damage and had been having about as much success with containment as BP with the Gulf of Mexico oil spill. While the European Union and European Central Bank cobbled together a $1 trillion bailout, ordinary Greeks (who never much liked paying taxes to their notoriously corrupt government) clashed with riot police to protest multi-year austerity programs which will simply never be enough - no way, no how. Makes you wonder if Greece isn't playing the role of Lehman Brothers and Portugal and Spain might not be Bear Stearns and AIG?

Closer to home, a potpourri of government stimulus programs have worked wonders for housing demand. The Fed has provided direct and indirect subsidies to the banks (a near-zero Federal Funds rate, guaranteeing profitable spreads) and, through FHA (which accounts for more than 90% of recent mortgage issuances) to the mortgage market. The Fed's purchases of mortgage-backed securities (estimated at more than 80% of the buy-side of the market) gave a further boost to the mortgage market until that program ended on March 31st. The Fed has also kept mortgage rates at historically low levels and the first-time homebuyer tax credits (which were extended last November and finally expired in April) also propped up demand.

Meanwhile, supply has been restrained by virtue of various programs courtesy of the bank regulators (read "lack of pressure" on the banks), which enabled them to amend and extend (read "extend and pretend") both residential and commercial mortgage loans. HAMP and Hope for Homeowners have effectively frozen the foreclosure process for millions of homeowners who defaulted on their mortgages, significantly reducing the supply of homes. An estimated six million home mortgages are now 60+ days delinquent with fewer than 500,000 modifications completed. Despite considerable fanfare and countless news reports, that's a lackluster 10% success rate. Whoopdeedoo. 

All of this combines to create a housing market that has the appearance of having stabilized, with robust sales volumes and prices which have stopped declining or, in some locales, are increasing once again. This stabilization, created by restricted supply and artificially stimulated demand, is an illusion, which is only sustainable as long as the underlying Rube Goldberg-style public policies are continued.

While we've long ago stopped trying to guess what the government will do next, we suspect that the sugar high brought about by the various and sundry homebuyer stimulus programs are closer to the end than to the beginning. And, pressure on the banks clearly seems to be mounting - as evidenced by the five-fold increase in bank failures so far this year as compared with the same period in 2008 and the fact that the FDIC's "Problem Bank List" grew to 775 at the end of the first quarter, up from 702 at year-end.  More rumblings ahead.

Mitch Siegler is Senior Managing Director of Pathfinder Partners, LLC.  Prior to co-founding Pathfinder in 2006, Mitch founded and served as CEO of several companies and was a partner with a boutique investment banking and venture capital firm.  He can be reached at msiegler@pathfinderpartnersllc.com.

FINDING YOUR PATH
Do You Believe in Miracles?
By Lorne Polger, Senior Managing Director

SNIPPETS: TRUTH IS STRANGER THAN FICTION
A Collection of Comical, Outlandish, Bizarre and Frightening True Stories

A compendium of notable news articles relating to commercial lending and real estate which we've edited and commented upon.  

"Scarcity Premium" Leading to Cap Rate Compression

Last year, capitalization (cap) rates on large office property sales jumped from the mid-6's to the mid-8's. This year, cap rates have reversed course, falling back just as rapidly to the mid-7's. The same dynamic is at work on large multifamily transactions, with stories of dozens of bids and the "winner" taking home the prize at a sub-5 cap rate commonplace. Normally, this would imply that property values are heading north. But, talk with commercial real estate pros and you're unlikely to hear a lot of happy talk.

Cap rates, like dividend yields for stocks, are calculated by dividing a property's income by the selling price. When cap rates increase, it generally means property values are decreasing. Last year, pundits agreed that the rapid rise in cap rates reflected an equally rapid fall in property values. Few translate this year's decreasing cap rates to rising property values.

Real estate investment trusts, among the largest buyers of commercial properties, raised tens of billions in fresh capital in 2009 and are itching to put it to work. And, with REIT stock prices up about 140% year over year, these buyers may feel they're spending Monopoly® money. Fred B. Córdova III, senior vice president for Colliers Asset Resolution's western regional team, says there is two to three times more capital in the market than there is product, which has pushed values up by 20% in just three months.

Meanwhile, the banks, which now control the majority of the commercial real estate properties being sold, have been limiting the number of properties they're taking to market.  According to Córdova, the current supply/demand imbalance has created a "scarcity premium" that has "pushed cap rates down by as much as 200 basis points in just three months."

Red Flags for Housing

There are signs that the key spring home selling season may not be all it was cracked up to be. According to Barron's, building permits declined nearly 11% in April. Mortgage applications were down 27% in the week ended May 14, the lowest level since 1997. That's while rates for 30-year mortgages fell, to 4.8%. We knew the first-time homebuyer stimulus program, which expired April 30, would pull forward demand - now, it's becoming apparent just how much. While homebuilder's aren't yet singing the blues, the 30% decline in the price of lumber during the past month might be another red flag.

U.S. Home Prices: Signs of a Double Dip in Housing?

The S&P/Case-Shiller 20-City Composite Index rose 0.6% year-over-year on a seasonally adjusted basis in February, 2010, the first year-over-year gain since December, 2006. However, on a monthly basis, home prices in the 20 metro areas fell 0.1% between January and February, 2010, after eight consecutive months of monthly gains. On a seasonally unadjusted basis, the 20-city composite index fell for the fifth consecutive month, down 0.8%, following a 0.4% decline in January, 2010. Only one of the 20 cities showed a monthly gain in prices in February, 2010, compared to a peak of eighteen cities in July, 2009, when the first-time homebuyer tax credit was in full effect. Some analysts assert that the recent stabilization will pave the way to a gradual recovery in home prices in 2010. Others argue the stabilization is temporary and that further downward correction of home prices is likely once government support to the housing sector is withdrawn, beginning with the phasing out of MBS purchases by Q1, 2010 and the expiration of the homebuyer tax credit in April, 2010. The marginal success of mortgage modification programs and the expiration of foreclosure moratoria also pose the risk of a wave of distressed homes entering the market and pressuring home prices in 2010.

Banks Still Tight With Credit, per Fed Survey

Most U.S. banks maintained tight restrictions on most types of business and consumer loans over the past three months, making it difficult for borrowers to obtain credit, according to a Federal Reserve survey of senior loan officers from 56 domestic and 23 foreign banks released in early May. The Fed reported that the volume of outstanding commercial and industrial loans at commercial banks had declined 19% over the past year. And, 70% of banks said their standards for business credit card accounts for small businesses were stricter than usual, with 27% saying their standards were unchanged.

Large companies are able to tap capital markets or fund operations from retained earnings. Smaller businesses can't do that as easily, which could limit their ability to expand or to hire workers.

Loans for commercial real estate also remained hard to find. About 14% of banks said they had further tightened standards for commercial real estate, while only 1% had loosened standards. Extensions, though, are a different story; 47% of banks said they were more likely to grant extensions for CRE loans over the past six months.

Scary Math

We're indebted to Gluskin Sheff + Associate's David Rosenberg for these gems:  

     ·  1 in 10 American homeowners missed a mortgage payment in the first quarter.
     ·  1 in 6 Americans are either unemployed or underemployed. 
     ·  4 in 10 unemployed Americans have been out of work for six + months.
     ·  1 in 4 Americans with a mortgage have negative equity in their homes.  
     ·  1 in 10 Americans believe their income will rise in the next six months. 
     ·  1 in 5 Americans see business conditions improving in the next six months. 
     ·  1 in 50 Americans plan to buy a home in the next six months. 
     ·  1 in 8 Americans believe current government policy is helping the economy.
     ·  1 in 10 American small businesses have a job opening.  
     ·  1 in 10 American's credit card usage is being written off.
     ·  5 unemployed workers are competing for every job opening.

CMBS Delinquency Rate Hits 8%; Rate of Increase Declines Slightly

The delinquency rate for commercial real estate loans in commercial mortgage-backed securities (CMBS) continued to increase in April although the rate of increase slowed from the March pace, according to TreppNews.

In April, the market was surprised when delinquencies jumped 89 basis points   (bps). While about 40 bps of that increase was due to the delinquency on the   massive Stuyvesant Town loan, the remaining 49 bps net increase was more   than twice the February increase. This chart, showing the rate of 30-day+   delinquencies since April, 2009, isn't pretty. And, it's not just Trepp: Fitch   Ratings expects more than 11% of  about $536 billion of CMBS loans to be   60+ days past due by year's end.  The late-payment rate now is about 7%.

Deflation? Wal-Mart Reduces Prices on 10,000 Items, Plans More

Wal-Mart Stores Inc., the world's largest retailer, reduced prices on more than 10,000 items in April after sales at U.S. stores dropped in the first quarter. The company plans to cut more prices in the coming months, Linda Blakley, a spokeswoman said.

Wal-Mart is cutting the price of a 100-ounce (3-liter) bottle of Procter & Gamble Co.'s Tide laundry detergent to $10.94 from $13.97 this month. Twelve rolls of Bounty paper towels are selling for $12.50, down from $15.77, according to a newspaper ad.

The company is focusing on price reductions lasting more than a month for food and other consumables said Bill Simon, chief operating officer of U.S. stores.

Nine-year old Seattle high-rise too flawed to fix

Hundreds of residents and business owners who live and work in a modern, 25-story Seattle apartment building were told to move out as soon as possible because of major structural flaws in the building. The building owner said it is too expensive to fix all of the problems at the 272-unit, $32 million project finished in 2001 so it plans to demolish the building. (This sad story is not without irony - the building owner is a Seattle-based venture, Carpenter's Tower, formed by pension funds and the local carpenters union.)

Defects include corroding and rusting cables, defective reinforcements in the building's exterior concrete and structural problems, the company said. Load-bearing cable ends have corroded because they weren't painted properly and builders also used the wrong type of grout, which allowed water to seep in, according to Carpenter's Tower.

Tax Credit Less Effective This Time Around

Time for Housing to Clear

Nearly a year after the recession likely ended, and despite huge government support, the housing market still looks sick. Despite a plethora of mortgage modification programs being foisted on the banks, as of March 31, borrowers on 10.06% of residential mortgages had missed at least one payment, up from 9.47% on December 31, according to the Mortgage Bankers Association.

The high jobless rate is, of course, a major factor. But, the longer default rates remain high, the more investors should be concerned about a negative feedback loop, where high foreclosures force prices down, leading to more mortgage defaults. [Editor's note: It is what it is. The housing market should be allowed to clear. The impact may be painful but the result is inevitable.]

Mortgage Defaults May Be Driving Consumer Spending

Lender Processing Services, in its latest "Mortgage Monitor Report" says: "The nation's foreclosure inventories reached record highs. February's foreclosure rate of 3.31% represented a 51% year-over-year increase. The percentage of new problem loans also remains at a five-year high. The total number of non-current first-lien mortgages and REO properties is now more than 7.9 million loans. Furthermore, the percentage of new problem loans is also at its highest level in five years. More than 1.1 million loans that were current on January 1 were already at least 30 days delinquent or in foreclosure by February 28."  That's 7.9 million Americans not paying their mortgages. That probably means many of these people are paying other bills (credit cards, car loans, etc.) ahead of their home loans.

We read a piece by Paul Jackson, publisher of Housingwire.com, who wrote of an applicant for the government's Home Affordable Modification Program (HAMP). The couple had an $1,880 monthly mortgage payment (on which they had defaulted), but their bank statement showed payments to a tanning salon, nail spa, liquor stores, DirecTV bill with premium charges, and $1,700 in retail purchases from The Gap, Old Navy, Home Depot and Sears, among others. 

According to Jackson, "Even if you assume that just half of the current 7.4 million currently delinquent mortgages fit this sort of 'spending profile' (that is, they're spending their mortgage payment) and you assume a $1,000 median monthly mortgage payment for most U.S. homeowners, you get a $3.7 billion monthly jump in consumer spending. Mark Zandi from Moody's Economy.com thinks the impact could be double. According to Zandi, "With some six million homeowners not making mortgage payments (some loans in trial mod programs and paying something but still in delinquency or default status), this is probably freeing up $8 billion in cash each month. Assuming this cash is spent (not too bad an assumption), it amounts to nearly 1% of consumer spending."

A recent CBS News 60 Minutes piece on homeowners makes clear that the old rules and mores simply don't apply to many borrowers. "Strategic defaults" are the new zeitgeist. And, it now takes over a year, often nearly two years, to go from the first missed mortgage payment to eviction. That's plenty of time to go shopping.

[Editor's note: If this story sounds familiar, it's because we speculated months back that the large number of homeowners who hadn't paid their mortgages in months or years might also be contributing to the recent uptick in consumer spending.]

The Condo Conundrum

If a condominium owner is behind on his mortgage, he generally isn't paying his condo association dues either. And, strangely enough, that could be helping to keep the already record-high rate of U.S. condo foreclosures from worsening.

Condominium pre-foreclosure actions - issuance of Notice of Default and other legal machinations that must be completed before a property can be seized - rose 37% in 2009 from 2008, according to research firm RealtyTrac. But, completed condo foreclosures fell 9%.

In part, this is the result of an over-burdened court system, government pressure on lenders to work with borrowers and the willingness of those lenders to allow short sales. But, lenders' reluctance to pay past due condo association fees also is a factor.

These fees, which can range from $100 to more than $1,000 per month - depending on property location, original sales price and common area amenities - pay for the upkeep of buildings and grounds and for reserves for long-term capital expenditures, like roof repairs. If one owner doesn't pay, his neighbors must cough up more. In the hardest-hit markets (Florida, California, Nevada and Arizona) - some condo owners are two or three years in arrears on association fees.

When a bank forecloses, it often has to pay those fees, plus any that accrue until it resells the unit. Fourteen states, including Florida, now have "super lien" laws requiring that a lender pay at least part of the owed dues when it seizes a property. For lenders, the easiest way to delay (or avoid) paying association dues is to postpone the foreclosure until a buyer is ready to pick up the tab (which means further price discounts). In hard hit areas, that can take a very long time.

Says Andrew Fortin, a vice president of the Community Association Institute, a national organization that represents 30,000 single-family-home and condo associations: "A lot of banks just aren't foreclosing, but leaving people to live in their property two years without making payments to their associations or on their mortgages." The problem is compounded by the fact that Fannie Mae and the Federal Housing Administration, which have recently been purchasing more than 90% of residential mortgages, won't buy loans made in communities with 15% of units 30 days behind in association dues.)

NOTABLES AND QUOTABLES