Photo Credit: Randy Pollack
Last November, Key Bank informed Novi, Mich.–based Crosswinds Communities that it was in default on an $18.3 million note with an $11.5 million balance. Crosswinds’ CEO, Bernie Glieberman, had personally guaranteed that note, and to get out from under this obligation, he found an investor willing to purchase the note’s collateral—115 lots and 19 completed or partially completed homes—at a price Key agreed to in May.
Banks now expect this kind of initiative from builders that are struggling to service construction debt and revolving credit. National lenders have been taking hard lines with builders about paying down loans or have abruptly shut off financing, sometimes even when loans aren’t in default. More than one-third of 344 builders that the NAHB polled in May said their lenders had ordered new appraisals on their single-family construction loans. That same month, nearly two-fifths of builders polled by the housing research firm Zelman & Associates said their lenders were “not willing” to work out underperforming loans. Zelman predicts that lenders could charge off between 10 percent and 26 percent of their loans to builders over the next five years, compared to only 0.7 percent in 2007.
The loss of financing and credit is impacting builders in different ways. Having curtailed construction to less than one-fifth of the homes it started four years ago, one Southern California–based builder wasn’t disrupted too badly when Key Bank last December stopped financing its $23 million note, of which $15 million was a revolver. Key declined the builder’s offer to buy back the balance on that note at 50 cents on the dollar, even after the loan became one of 83 (including Crosswinds’), with balances totaling $932.1 million, that Key Bank repackaged and put up for bid. Numerous lenders, including IndyMac Bank, PFF, and Wachovia, have likewise marketed bundles of loans to investors, with mixed success.
On the other hand, Kalian Homes of Red Bank, N.J., had two projects started in Mississippi that never got to the model phase because one lender cut off financing after woeful buyer demand prevented Kalian from servicing its debt. (Kalian Homes exited Mississippi this summer, having closed only 35 homes there in 2008 versus more than 650 annual closings during boom years.) “It made no sense,” laments Patrick Kalian, the builder’s president, about his bank’s decision. The infrastructure had been installed and many of the homes partly completed. “A building halfway finished is worth zero. I know one community could have sold at least half of the houses, at a discount I admit, but the banks would have gotten some cash” instead of taking back land and houses.
Banks’ stances on workouts vary widely, and Kalian acknowledges that the majority of his lenders have been open to discussions. The good news for builders around the country is that many banks are still trying to help them survive. “Even when assets are underwater, there’s a solution,” says Steve Huntley, a partner with Huntley, Mullaney, Spargo & Sullivan, a Roseville, Calif.–based workout advisor whose builder clientele has included Reynen & Bardis, which owes lenders nearly $1 billion. But solutions often depend on improvements in the economy’s health or the infatuation of private equity with the housing sector. Neither of these solutions is an immediate certainty.
Clogged Cash Flow
Andrew Hede manages a group within Alvarez & Marsal, a New York–based consultant that advises builders on how to avoid bankruptcy. He says banks want to see a “viable plan” that reflects a borrower’s willingness to make tough decisions that don’t place the onus of a workout entirely on the lender’s shoulders. “They need to come prepared for problem solving [with] openness and honesty,” says Jill Janka, Bank of America’s Home Builder Division executive. Huntley adds that a workout plan’s credibility is only as good as its “detailed financial and cash-flow models.”
The immediate concern for a company with debt issues must be cash, say experts: How much does it have; where can it get more? “It will be difficult to get approved a proposal that makes a bank’s [loan] position worse off than it is today,” says R. Bird Anderson, senior vice president for Wachovia’s home builder banking group. When any of City View’s 37 projects has encountered financial problems, lenders typically have asked the Santa Monica, Calif.–based company to ante up more capital in exchange for, say, lowering their minimum release prices on homes sold, says president Sean Burton. Some loan restructurings require builders to remit to lenders up to 95 percent of the proceeds from the sale of homes or land. The aforementioned Southern California–based builder is completing, for a fee, homes on 41 lots it returned to one of its banks. “We owe them more than what the homes will sell for, so we don’t know how this is going to play out,” says the builder’s owner, who requested anonymity.
When cash dries up, more builders are being forced to dip into their personal stashes to keep their businesses on life support. Anderson says he’s seen small builders sell residences and large builders sell apartment buildings to raise cash. Kalian has been covering “99 percent” of his company’s expenses out of his own pocket. Other builders have successfully negotiated forbearance agreements with lenders, which allow them to postpone paying or servicing debt and to temporarily stop projects, or even close their companies, until buyer demand returns.
What Cost Survival?
Forbearance is a tough sell for banks, which have their own problems and don’t have the luxury of time. That’s one reason cash-strapped builders file bankruptcy, to keep operating while fending off creditors. Bankruptcy may be an unpleasant course of last resort, but it became a means to an end for Gilbert, Ariz.–based Trend Homes, whose one-time owner, Reed Porter, took his company into Chapter 11 as a prelude to selling Trend, for $86.5 million, to the investment firm Najafi Cos. Chapter 11’s protection allowed Trend to auction itself through what’s known as a 363 sale, so Najafi’s purchase would be unencumbered by liens that would be settled through the bankruptcy court. The bankruptcy filing lifted a freeze on assets that Trend’s senior lender, Franklin Bank, had imposed. Najafi now capitalizes Trend’s operations through a credit facility from Franklin, and the builder is taking home orders again.
Private equity is riding to the rescue of troubled builders more frequently. The two most publicized and riskier examples to date are last year’s $525 million joint-venture between Morgan Stanley and Lennar, where the builder sold 11,000 home sites; and Standard Pacific’s $530 million deal with the investment group MatlinPatterson Global Advisors, through which the builder reduced its debt by $128.5 million. Oaktree Capital Management, a Los Angeles–based investment management firm that had liquidated most of its housing-related investments, is hunting for deals again, too. “The time might be right to consider ownership of a builder,” says Mark Oei, a managing director with Oaktree.
But Oei remains wary of a housing industry that might not bottom out for another year or two. “I think [investors] are still waiting for more broken glass” before they rush in, observes C. Stephen Cordes, managing director with New York–based ING Clarion, which invests in multifamily projects. Cordes foresees opportunities to pick up distressed real estate and get it re-entitled for higher-density communities.
Private equity is trying to get in cheaply. “There’s a significant gap between the bid and ask prices, which is why so few deals have gone down,” Huntley says. One investor offered Kalian $1 million for land that he insists is worth $7 million. But if abysmal market conditions persist, banks will surely be pressuring precarious builders to take whatever offer comes their way to pay back at least some of their indebtedness.
Step by Step
Tips to consider before approaching a lender about working out debt:
Be proactive. Banks want to know when they are going to be paid and how much. It’s up to builders to come up with solutions that don’t make the banks worse off.
Be realistic. Banks want builders to present them with a believable plan supported by detailed financial data. The credibility of such a plan could hinge on how convinced the banks are that the builder will be around long enough to execute it.
Cash is king. Generating cash flow should be your main objective, and a loan modification could include handing the bulk of any proceeds from home sales over to your lender. Even when banks allow builders to forgo interest payments on debt for a while, they want evidence that the builder is willing to tap other cash sources, including unencumbered personal assets.
Find new financial partners. Banks often want builders in workout situations to drum up buyers for land and finished lots that collateralize their debt or investors to fund new construction. Private equity money is out there, but it’s not cheap, and might require the builder to give up operational control or ownership.
Think long term. Business conditions might not recover for years, so builders might need to mothball certain projects, or even their entire operations, for a while. But they’ll need to convince lenders that providing financing and waiting are in their best interests.