How Could My Big, Beautiful Loan Go So Bad, So Quickly?

"It's surprising that you'd have a New York City multifamily [default] happening so quickly," said Manus Clancy, senior managing director at Trepp Research.

Surprising, that is, unless the mortgage payment is more than double the monthly net income. Impossible you say? Not really, this was the beginning of 2007, and almost anything was possible. "Our job is to create loans for securitization," said an official from Wachovia Corp. (WB) a few years earlier. "We're trying to manufacture the product that the investor base wants." And so they did.

On the surface, this deal looked pretty good. The pro-forma loan to value was 66.18%, and pro-forma debt coverage was a very safe looking 1.73%. It was a "value-add" deal, and the borrower planned to pump almost $30 million into improvements and then raise the rents. Pretty simple.

That led to the $225 million first mortgage, topped off with a $25 million mezzanine loan from Deutsche Bank (DB). The first mortgage also became one of the top 15 loans by value (about 3.4% of the initial mortgage pool balance) in a nearly $6 billion CMBS deal issued in March of 2007.

Consequently, one would think that this loan would have received a lot of attention from the underwriters, bond traders and CMBS portfolio managers looking at the securitization. Presumably, these sophisticates could evaluate the loan economics more closely, particulary the rather precarious day-one debt coverage ratio of .39x, which meant that the loan had absolutely no hope of being paid through existing cash flow ('let's see now, the guy's income is less than half the amount of his monthly mortgage nut....')

But this was 2007 and the property, known as Riverton Apartments, is no ordinary place. It is a massive 12 building, 1,232 unit complex sitting on 7.6 acres of prime East River (Manhattan) waterfront property. I wouldn't know, but I guess that and the "air rights" were what justified the $250 million of debt, even though the propery was purchased just 12 months earlier for $135 million. The new loan allowed the borrower to walk away with about $40 million in cash. (Thanks, the keys are in the mail!)

At closing, over 90% of the units (1,143 to be exact) were regulated, rent-controlled apartments. The premise of the loan was that these units would be converted to fair market, such that by 2011, more than half of them would be deregulated and rented at full market.

Unfortunately, this is also New York City, and the only thing more coveted than a long weekend in the Hamptons (or perhaps a phat Congressional seat) is a rent-controlled apartment. Consequently, the conversion did not go as planned, and that .39% day-one debt coverage ate up whatever was left in just eighteen months.

Comments

[hrant:]

A great example of what has happened to so many projects. I believe that some of this was intentional by the participants . what bothers me is that no one is going to jail (after so many have been hurt (robbed) by these people.

2008 Aug 17 12:35 PM

[Jimmy Lathrop:]

Remember the video game "Flight Simulator?" It was pretty advanced for its time when it came out - you learned how to take off, use a stick, yaw, roll, all sorts of aerial maneuvers. A lot of fun.

That being said, its a long jump from fooling around on a video game to taking over the controls of a 737 in midair with no pilot.

"Airplane!" is a funny movie. "The Super" is a funny movie.

Banks lending money for a project where almost all of the units are rent regulated is hilarious! Imagine making a movie where a bank officer says "Hey, how are you going to deregulate all of the apartments? If it is so easy, then why can't anyone deregulate apartments at will in NYC?" and then the real estate guru waves dismissively and says "My cousin is a great landlord/tenant attorney, he says it will be a snap!" Then you can fast forward through the rest of the movie, past the housing court judges laughing, the cousin looking crestfallen and the guru tearing his hair out, to the end where Dan Ackroyd and Eddie Murphy are on a beach drinking cocktails. Wait, that's "Trading Places" but you get the idea.

2008 Aug 18 12:07 AM

[notsosmart:]

when scamming becomes legal its a new ballgame. as a young man if anyone charged 20% interest they would go to jail.as they say-"you can look it up".we will not have enough jails for all these crooks now in business.you see how fast the banks are making good on those phony securities.but they wont pay taxes for years to come so me\r. average sucker will pay more or have more service cuts.poor goldilocks must wear old clothes for a while.

2008 Aug 18 02:23 PM