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8/2/2016 Pearson Collections https://collections.pearsoned.com/student/#print/0ac602b6­5431­1984­8154­3a8ed34802a9/0/6 1/17 KEL697 Revised October 16, 2012 ©2012 by the Kellogg School of Management at Northwestern University. This case was developed with support from the June 2009 graduates of the Executive MBA Program (EMP-73). This case was prepared by Professor Craig Furfine and Sam Schey ’13. Cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. To order copies or request permission to reproduce materials, call 800-545-7685 (or 617-783-7600 outside the United States or Canada) or e-mail [email protected] No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of the Kellogg School of Management. CRAIG FURFINE Working at Workouts: Commercial Real Estate Debt in Distress Sam Schey, asset manager at Drive Property Solutions, came into his office on Monday, May 10, 2010. He had just returned from a weeklong tour of distressed retail properties in the southeastern United States. Touring commercial properties at various stages of distress was the most fascinating part of Schey’s career. His specialty was “special servicing”—the resolution of defaulting commercial real estate loans—a niche industry that had recently become big business in the wake of the severe downturn in commercial real estate. On his voicemail Schey heard a message from Jonathan Stewart, a lawyer representing Michael Burton, the current owner of Northwinds Community Crossing, one of the distressed properties Schey was overseeing. After deciphering the lawyer-speak, Schey believed that Stewart was offering a financial settlement. With an interest in resolving as many of the distressed properties as possible at the greatest value to Drive and its outside investor partners, Schey anticipated some long days ahead preparing for a protracted negotiation to resolve the problems with Northwinds. Distressed Debt During the commercial property boom of 2005–2006, owners of commercial property borrowed huge amounts of money directly from commercial banks and indirectly from sophisticated investors through the sale of commercial mortgage-backed securities—a trend that would soon reverse itself ( Exhibit 1 ). As the economy began to weaken in the latter half of 2007, commercial property owners were faced with rising vacancies and lower rents ( Exhibit 2 ). In an increasing number of cases, property owners were left in the unenviable position of not being able to meet loan obligations. Delinquent loans—those in obvious financial distress—rose dramatically ( Exhibit 3 ). Traditionally, lenders negotiated bilaterally with a borrower in distress and tried to work out the loan in a way that was mutually beneficial to both borrower and lender. Although the approaches varied from borrower to borrower, workouts typically involved some sort of payment made by the borrower in exchange for some concession on existing loan terms made by the lender. Failing such a workout, lenders had the right to take ownership of the property through the legal process of foreclosure. While within their legal rights, this put bankers in the position of property owners—a less than desirable position in which they had no particular expertise. For the exclusive use of R. Jaruse This document is authorized for use only by Rob Jaruse in Strategic Financial Decision Making taught by Alexa Zahares, NORTHEASTERN UNIV from 01/1970 to 01/2017.
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8/2/2016 Pearson Collections https://collections.pearsoned.com/student/#print/0ac602b6­5431­1984­8154­3a8ed34802a9/0/6 2/17 WORKING AT WORKOUTS KEL697 2 KELLOGG SCHOOL OF MANAGEMENT Although this approach to managing nonperforming mortgage loans worked well for lenders under normal circumstances, the financial crisis of 2008 and the subsequent dramatic decline in the value of both residential and commercial property led to an unprecedented increase in loan delinquencies. At the extreme, banks burdened with excessive exposure to real estate often failed. As a result, many of the bad real estate loans came to be owned by the Federal Deposit Insurance Company (FDIC), an independent agency of the U.S. government in charge of finding acquirers for the assets and liabilities of failed banks. By May 2010, the FDIC had closed or facilitated the acquisition of 245 banks since the onset of the financial crisis. 1 As a result, the FDIC had amassed a portfolio of more than $7 billion of largely nonperforming mortgage loans, much of which was secured by commercial real estate properties. The influx of loans was overwhelming and, more often than not, the receivers put in place by the FDIC simply monitored payments while the government agency assembled portfolios of loans to market to bidders for their large note auctions. These auctions were marketed to a dozen or so approved bidders, who would be equity partners in joint-venture relationships with the FDIC for the liquidation of these pools of assets. These investors would assume the risk of nonpayment on the loan in exchange for purchasing the distressed notes at a discount. For example, a bidder might be willing to pay $650,000 for a loan (mortgage note) that carried a face value (promised repayment) of $2 million. Drive Property Solutions Once investors purchased these distressed notes, their interest was to maximize their financial recovery. Because distressed commercial property was a unique asset, investors often looked to special servicers to try to maximize their recoveries from the nonperforming loans. Drive Property Solutions was a special servicing firm employing seventeen people in downtown Chicago. The company’s primary function was to resolve distressed debt in the commercial real estate space. Drive’s proficiency in resolving nonperforming commercial real estate debt stemmed from its knowledge and expertise in legal remedies (e.g., foreclosure, receiverships); property management should it ultimately own the distressed property; and the working out of distressed loans. Schey was relatively new at Drive. He had previously worked at a “too big to fail” commercial bank where he monitored regulatory policies and seemed to answer to federal auditors at every turn. Looking for greater career growth, Schey pursued his MBA at the Kellogg School of Management, focusing on finance and real estate. He would not have predicted his career would turn to restructuring nonperforming debt and foreclosing on delinquent commercial borrowers, but this was the bottom of a deep recession, and Schey felt privileged to have been recruited from a big bank to a thriving new entity such as Drive. As special servicer, Drive was currently managing a pool of 1,000 notes secured by commercial real estate across the country. With the recent boom in distressed commercial properties, however, Drive began investing in the debt as a principal, often in partnerships with private equity firms that supplied most of the capital in exchange for Drive’s expertise in dealing with the debt. As such, Drive was one of the few approved bidders for assets auctioned by the FDIC. 1 Federal Deposit Insurance Corporation, “FDIC: Failed Bank List,” http://fdic.gov/bank/individual/failed/banklist.html. For the exclusive use of R. Jaruse This document is authorized for use only by Rob Jaruse in Strategic Financial Decision Making taught by Alexa Zahares, NORTHEASTERN UNIV from 01/1970 to 01/2017.
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