In February, The Congressional Oversight Panel released a report, “Commercial Real Estate Losses and the Risk to Financial Stability.” The nearly 200-page tome painted a bleak picture of the current commercial real estate market — and the future isn’t much brighter. The report estimates that between 2010 and 2014, nearly $1.4 trillion in commercial real estate loans will reach maturation, and that almost half of these are currently underwater. The report also projects that bank losses resulting from failed commercial real estate loans could peak at as much as $300 billion before the dust finally settles. Commercial real estate woes have already caused, in large part, the recent demise of the last five banks that regulators have shuttered, according to analytics firm Trepp. Loose underwriting standards and price inflation in the ‘90s and early 2000s have made it nearly impossible to totally salvage the loans issued during that time. Put simply, property values have sunk too far, credit has become too tight and borrowers have become too strapped for cash. At this point, most efforts to rectify the situation are little more than damage control. By now, the need to get back to the basics — educated investments in quality real estate, true appraisals of property values and a realistic approach to troubled real estate assets — has become crystal clear to those in the real estate and financial industries. It’s getting there — while minimizing losses and maximizing value — that’s the tricky part. There are as many workout solutions as there are troubled real estate asset scenarios, and weighing all of the available options can be overwhelming at best and debilitating at worst. When faced with a distressed commercial property, lenders and investors must take a long, hard look at the borrower’s ability to make payments (under current or restructured loan terms); the ability to refinance; the value of the property, now and in the near and distant future; the costs involved in maintaining and managing the property, should the lender decide to foreclose and maintain indefinite possession of the building; and last, but not least, market conditions, including estimated timelines for overall economic recovery and credit market viability. With these factors come innumerable subfactors, questions and situational details that lenders and borrowers must take into account before deciding how to proceed with a troubled asset. To demonstrate this analysis process, let’s review the hypothetical case of a struggling C-class office building. Tenant occupancy had fallen to 60 percent from 90 percent in only two years, and the building’s value had plummeted to $17 million from $30 million. Until now, the borrower had been able to service his debt, but he’ll owe $20 2 From the Desk of Ken Yager: Changes in Our Future 4 News Desk 5 New Engagements 6 Expansion in a Weak Market: What Our Firm is Doing 7 A Crash Diet for the Restaurant Industry: What it Must Do to Correct Itself For Real Estate Investors, Lenders, it’s Back to the Basics By Mitch Kahn, Managing Director at MorrisAnderson, [email protected]Summer 2010 Continued on page 3 Mitch Kahn
Transcript
In February, The Congressional Oversight Panel released a report, “Commercial Real Estate Losses and the Risk to Financial Stability.” The nearly 200-page tome painted a bleak picture of the current commercial real estate market — and the future isn’t much brighter.
The report estimates that between 2010 and 2014, nearly $1.4 trillion in commercial real estate loans will reach maturation, and that almost half of these are currently underwater. The report also projects that bank losses resulting from failed commercial real estate loans could peak at as much as $300 billion before the dust finally settles. Commercial real estate woes have already caused, in large part, the recent demise of the last five banks that regulators have shuttered, according to analytics firm Trepp.
Loose underwriting standards and price inflation in the ‘90s and early 2000s have made it nearly impossible to totally salvage the loans issued during that time. Put simply, property values have sunk too far, credit has become too tight and borrowers have become too strapped for cash. At this point, most efforts to rectify the situation are little more than damage control.
By now, the need to get back to the basics — educated investments in quality real estate, true appraisals of property values and a realistic approach to troubled real estate assets — has become crystal clear
to those in the real estate and financial industries. It’s getting there — while minimizing losses and maximizing value — that’s the tricky part.
There are as many workout solutions as there are troubled real estate asset
scenarios, and weighing all of the available options can be overwhelming at best and debilitating at worst. When faced with a distressed commercial property, lenders and investors must take a long, hard look at the borrower’s ability to make payments (under current or restructured loan terms); the ability to refinance; the value of the property, now and in
the near and distant future; the costs involved in maintaining and managing the property, should the lender decide to foreclose and maintain indefinite possession of the building; and last, but not least, market conditions, including estimated timelines for overall economic recovery and credit market viability. With these factors come innumerable subfactors, questions and situational details that lenders and borrowers must take into account before deciding how to proceed with a troubled asset.
To demonstrate this analysis process, let’s review the hypothetical case of a struggling C-class office building. Tenant occupancy had fallen to 60 percent from 90 percent in only two years, and the building’s value had plummeted to $17 million from $30 million. Until now, the borrower had been able to service his debt, but he’ll owe $20
2From the Desk of Ken Yager:
Changes in Our Future
4News Desk
5New Engagements
6Expansion in a Weak Market:
What Our Firm is Doing
7A Crash Diet for the Restaurant Industry:
What it Must Do to Correct Itself
For Real Estate Investors, Lenders, it’s Back to the BasicsBy Mitch Kahn, Managing Director at MorrisAnderson, [email protected]
PDFs are available at http://www.morrisanderson.com/
newsletter/Default.asp.
Since 1980, MorrisAnderson has been working with stakeholders to steer more than 1,500 underperforming companies toward operational and financial success. With an average of 25 years of real-world line management success, executives in finance, manufacturing, distribution and logistics, marketing and information systems are working in virtually every economic sector to maximize enterprise value.
Charlotte, NC
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Denver, COMinneapolis, MN
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Other Locations
Change is not easy, especially when it involves changing your own behaviors, characteristics or outlook. It takes a fresh set of eyes and lots of energy. But those who do it on their own seem to reap something
special. After 30 years in business, and in step with the needs of the market, MorrisAnderson is taking some of its own advice. We are changing boldly.
As Dan Dooley points out in his article on page 6, we have a lot going on here at the firm. Personally, I have been asked to add Chief Marketing Officer to my responsibilities. This has lead to some new ideas. It is amazing to us how such a simple change has unleashed so much potential and produced so much opportunity for our firm and for the individual professionals who make up this team.
If you have similar responsibilities or are just curious about what we are doing, I encourage you, as a friend of the firm, to drop me a line soon. As I have discovered, there is a lot to learn and it’s good to have a fresh set of eyes with which to share opportunities.
Can Motown Go Main-stream?Ken Yager
Changes in Our FutureBy Ken Yager, Principal and CMO at [email protected]
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million when his loan reaches maturation at year’s end — an amount he’s unable to pay based on the diminished value of the building. The lender has several choices: It can extend the loan, restructure the terms (by reducing the principle or adjusting the interest rate) or foreclose on the property — in which case a whole new set of decisions must be made about the fate of the asset.
The lender first considers extending the loan. After assessing the situation, it becomes clear that the borrower’s financial situation, the rapidly decreasing value and the deterioration of the building, and the improbability of the tenant situation improving, make this a less-than-desirable option.
Not only will the payments become more and more difficult for the borrower to make, but the chances that the building’s value will go up enough to justify “kicking the can down the road,” so to speak, are slim to none. There is little incentive for the borrower to avoid ultimately defaulting in this situation, as the building will likely continue to depreciate in value.
The second option is adjusting the loan terms. First, the lender considers reducing the interest rate. While, like the loan extension, this option offers temporary relief to the borrower, it fails to remove the temptation to default, since the original, inflated principal amount remains the same as the building continues to lose value.
Reducing the principal is another option for restructuring the loan. With this solution, the borrower has less incentive to default, as the amount he will have to pay when he sells the building or settles the loan balance is substantially less, and more in line with the property’s current
value. This solution is much less desirable for the lender, however, as it results in an inevitable and immediate loss. On the other hand, if the lender determines that this loss is less than that which it would incur in the event of foreclosure, this may be a viable option.
The last option is foreclosure, which as mentioned before, brings with it an entire subset of decisions. The factors in this situation — high tenant vacancy, a borrower in poor financial health and an older property with diminishing value — make a foreclosure or short sale a workable option, depending on the route the lender takes once the property is seized. If the lender chooses to foreclose, it must then decide whether to keep the property and maintain and manage it, or sell the property.
In the event that a sale is more favorable, numerous channels exist through which to market the property and facilitate the sale, including auctions and traditional sales. While a surprisingly large amount of capital for real estate investment exists, lenders and real estate owners must be
realistic about property values. On the other hand, lenders and owners who hastily accept a first offer without doing their homework may not reap maximum value. Sellers must efficiently determine their course of action, explore their options and remain open to alternative marketing and sales channels.
This meticulous and pragmatic analysis allows lenders and borrowers to ultimately negotiate the best possible solution for all involved. Parties involved in these situations must run through each scenario, paying meticulous attention to all contributing factors. Proper analysis requires expertise in the areas of finance, law and real estate, and an objective and realistic point of view.
In the absence of easy access to large amounts of credit and rapidly (and questionably) inflating property values, real estate investing and real estate workouts have returned to the fundamentals. While stabilization of the commercial real estate industry may still be a speck on the horizon, smart, diligent organizations can learn how to cut their losses, maximize value and rise to the surface again.
For Real Estate Investors, Lenders, it’s Back to the Basics, continued from page 1
In the absence of easy access to large amounts of credit and rapidly (and
questionably) inflating property values, real estate
investing and real estate workouts have returned to
the fundamentals.
Mitch Kahn
Mitch Kahn is experienced in real estate development and deals that involve restructurings, dispositions, lease renegotiations and acquisitions. In addition to working with MorrisAnderson, Kahn is Co-Founder and Principal of MorrisAnderson’s joint-venture partner, Frontline Real Estate Partners.
4
Dan Dooley, Chicago-based Principal of MorrisAnderson, has been appointed as Chief Executive Officer. Dooley will be responsible for guiding the firm’s strategic growth, as well as overseeing its nine offices throughout the country. For the past five years, Dooley managed the firm’s operations as Chief Operating Officer, driving MorrisAnderson’s expansion to 40 professionals and nine offices from 25 professionals and four offices.
Ken Yager, Chicago-based Principal of MorrisAnderson, has been promoted to the position of Chief Marketing Officer (CMO). In this newly created role, Yager will oversee MorrisAnderson’s national brand management, as well as expansion of the firm’s industry practice areas. Yager is also responsible for growing MorrisAnderson’s Southeastern U.S. practice.
Mike Musso has been promoted to the position of Vice President of Strategic Accounts. Based in Atlanta, Musso will lead the firm’s business development practice and further grow its relationships with the nation’s leading banks and law firms.
Mitch KahnPrincipal
Josh JosephPrincipal
Matt DarinPrincipal
New to MorrisAnderson
Kelly Stapleton has joined MorrisAnderson as a Managing Director in its New York office. Stapleton will be an integral part of the leadership team and responsible
for growing the firm’s East Coast presence. She has represented all stakeholders as a financial advisor in the areas of retail, manufacturing and logistics regarding a variety of financial and legal issues. She has also represented creditors and debtors in reorganizations, liquidations, 363 sales and fraud investigations. Stapleton previously served as U.S. Trustee for Region 3. Appointed by the U.S. Attorney General, Stapleton managed the bankruptcy system for Delaware, Pennsylvania and New Jersey and oversaw all bankruptcies filed in these states.
Purav Adiecha has joined MorrisAnderson as a consultant in its New York office. Adiecha has leveraged his wide-ranging finance experience in
several industries, including automotive, banking, telecommunications, technology, chemical, retail, media, transportation and business services. With an ideal mix of finance consulting and business strategy expertise, Adiecha is adept at assisting clients with a number of complex business challenges. In his most recent position, he was involved with relationship management and business development, research and due diligence, credit and underwriting, and sales performance.
Promotions at morrisanderson
morrisanderson enters into Joint Venture With Frontline real estate PartnersAs part of our planned expansion into the real estate industry, MorrisAnderson has formed a joint venture with Frontline Real Estate Partners. Also based in the Chicago area, the commercial real estate advisory firm specializes in providing real estate consulting and advisory services in bankruptcy and distressed situations, as well as selectively acquiring distressed real estate assets. Frontline’s leadership team has more than 25 years of real estate industry experience. Drawing from that experience, MorrisAnderson will now be able to provide referral sources and clients that have distressed real estate assets with restructuring, turnaround management, bankruptcy advisory and investment-banking services. As such, existing and prospective clients will benefit from the firm’s in-house real estate services, including management of receivership and bankruptcy transactions.
The Frontline Team
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Transportation
• Acted as financial advisor for the lender of a $300-million oceanic oil and gas barge and tug boat company
• Acted as financial advisor for a $60-million trucking and logistics services company
• Acted as financial advisor for the lessor group of a $250-million Mississippi River barge and tanker operator
• Acted as assignee for the wind-down of Sitton Trucking, a $35-million Arkansas trucker
Consumer Products
• Acted as Chief Risk Officer (CRO)/Interim CEO for a $50-million scented candle manufacturer
• Acted as financial advisor for an $80-million outdoor spa and above-ground pool manufacturer and retailer
• Acted as financial advisor in the wind-down of a $40-million file folder manufacturer
• Acted as financial advisor for a $180-million fitness equipment manufacturer
Business Services
• Acted as financial advisor for a $55-million utility outsourcing service business
• Acted as financial advisor for the lender of a $45-million temporary staffing company
• Acted as CRO for a small IT outsourcing service business
Other Industries
• Acted as financial advisor and real estate advisor for a shopping center owner with a $12-million loan value
• Acted as financial advisor for a $65-million pre-fabricated construction materials manufacturer
• Conducted buyer due diligence for a $30-million automotive injection molder being sold in a Chapter 11
• Provided litigation support for an $85-million dairy cooperative that faced significant product recall litigation
• Acted as financial advisor for the unsecured creditors’ committee for Mount Vernon Monetary Corp. DIP (N.Y.), which provides ATM/check-cashing and armored-car services
• Acted as CRO for a $60-million gaming equipment manufacturer
• Acted as federal receiver and investment banker for three pharmaceutical and industrial chemical test laboratory businesses
• Acted as financial advisor for the lender of a $25-million furniture and furniture components manufacturer in a Chapter 11
New
Confirmed Plans of Reorganization
• Dave Bagley acted as CRO for restaurant chain Fundamental Provisions LLC (La.)
• Larry Hennessy acted as CRO for ethanol production and distribution company Wyoming Ethanol/Renova Energy (Wyo.)
• MorrisAnderson acted as financial advisor to the unsecured creditors’ committee for metals foundry Neenah Holding (Del.), a 100-cent case
• MorrisAnderson acted as financial advisor to the unsecured creditors’ committee for automotive parts manufacturer Accuride Corp. (Del.), a 100-cent case
Going Concern Sales
• Assisted in the 363 sale of the cosmetics business for Specialty Packaging DIP (Del.) (We previously assisted in the sale of the company’s injection molding business.)
• Assisted in the 363 sale of building materials distributor Ridgewood Corp. DIP (N.J.)
• Assisted in the Article-9 sale of automotive components manufacturer Whitehall Industries (Mich.)
• Assisted in the 363 sale of restaurant chain Santa Fe Cattle Co. DIP (Tenn.)
• Assisted in the 363 sale of two operating cemeteries for Burr Oak Cemetery DIP (Ill.)
• Assisted in the equity sale of automotive component manufacturer DriveSol (China)
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Everyone in the insolvency community is a little surprised at how slow the industry has been this year, despite the fact that the U.S. economy is still struggling through a deep recession.
The big financial advisory firms are laying off employees and desperately looking for work, launching short-term marketing efforts aimed at middle-market firms. Big-company Chapter 11s are nearly non-existent and the cases that do file are mostly fast pre-packs with shortened life cycles.
Surprisingly, perhaps, MorrisAnderson is still doing just fine. First-half volume matched 2009 levels, and in the second half, we continue to keep pace with last year.
We have consciously chosen to continue our firm’s long-term expansion plans despite the unexpected market slowdown. Since we started our expansion a few years ago, we have had no interest in growth for growth’s sake. We are only interested in measured and thoughtful growth that preserves the importance of our culture and provides professional opportunities for our growing group of consultants, now at 43.
So let me tell you what we have done over the last six to nine months. We:
• Created an exclusive distressed real estate joint venture with Frontline Real Estate Partners.
• Under Principal Domenic Aversa, established a substantial presence in New York City, where we have grown to six consultants from two.
• Opened offices in Charlotte and Minneapolis, with experienced operators who live in these markets.
• Started organizing our consultants and expertise around nine industry groups in which our company has deep experience.
• Launched a creditor-side practice (lender groups and creditor committees) to diversify from our historical business operations, which have been 90 percent debtor-side work.
The majority of the companies we service have traditionally had annual sales of $15 million on the low side and $500 million on the high side. Because MorrisAnderson has apparently done such a strong job marketing our brand, many of our referral sources have been given the false impression that we only work with big companies — not true. The following is a statistical snapshot of the most recent 20 projects we have booked, in terms of revenue size. Please note that 75 percent of our recent project mix is with companies with annual revenue of between $15 million and $100 million.
We continue to realize the importance of having solid industry experience from the perspective of our referral sources and clients. One of MorrisAnderson’s advantages is that we have a wealth of industry experience among the members of our consulting team. Our
firm has more than 30 years of experience in a variety of industries and we have 43 consultants who have an average of 25-plus years’ experience — with no one on staff having less than 10 years of experience. Of our most recent 20 projects, 65 percent have been in one of the nine industries in which MorrisAnderson has deep experience, with 50 percent being concentrated in the top three: consumer products, transportation or business services. Here are the nine industries in which MorrisAnderson has significant experience:
The following statistics illustrate venue, client representation and primary services for the most recent 20 projects:
In conclusion, MorrisAnderson continues to expand — even in a down market. We have added people, expanded our geographic presence and services, and most importantly, brought on great consultants over the last few years. We remain committed to our strategy of expansion, regardless of the overall insolvency market conditions.
Expansion in a Weak MarketBy Dan Dooley, Principal and CEO at MorrisAnderson, [email protected]
Dan Dooley
AnnuAl Revenue
PRoject count
PeRcent of Business
$100 million
or greater3 15%
$40 million to
$100 million8 40%
$15 million to
$40 million7 35%
Less than $15
million2 10%
Total 20 100%
• Automotive
• Metals
• Plastics
• Construction products
• Real estate
• Consumer products
• Business services
• Restaurants
• Transportation
venue client
RePResentAtion
PRimARy seRvice
Out-of-court:
70%
Company:
70%
Financial
advisory: 50%
Bankruptcy:
20%Lender(s):
25%
Interim
management:
10%
Receivership/
ABC: 10%UCC: 5%
Investment
banking: 10%
Litigation/M&A:
10%
100% 100% 100%
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In the 1990s and early 2000s, the restaurant industry gorged itself — opening locations with abandon, enjoying years of excess in which consumers’ restaurant spending grew to all-time
highs, and ultimately oversaturating the market. Now, it’s paying the price.
From 1990 to 2009, the number of restaurants and bars skyrocketed more than 49 percent, according to the National Restaurant Association, far outpacing the 22.6 percent growth in U.S. population. Experts now say this restaurant growth was extreme, even by economic boom-time standards. As the housing and credit markets crumbled, ushering in the worst financial crisis since the Great Depression, a bloated restaurant industry felt the pain. No one was immune — from mom-and-pop diners in middle-America to high-traffic locations of chains such as Applebee’s and Outback Steakhouse.
After nearly three years of dismal numbers — restaurant sales were down 1.2 percent and 2.9 percent in 2008 and 2009, respectively — optimism is slowly creeping back into the industry’s collective consciousness. Still, the National Restaurant Association predicts that 2010 sales will remain flat when inflation is factored in, and the light at the end of the tunnel may still seem a long way away for many restaurant owners and chains.
Even if the worst days are behind us, many industry analysts say that it could be years — if ever — before restaurant-goers return to their free-spending ways. In the meantime, stretched restaurant businesses continue to struggle.
The effect of this downturn is visible across the industry. Even well-managed companies run by good operators are having issues. After a long downhill period, the recent flattening in sales has almost become a cause for celebration — a sign of the bottom and that things may start to settle. For companies that may have been down 10 percent to 15 percent from the year before, however, having flat sales this year still makes for a precarious financial situation.
At MorrisAnderson, we have seen some commonalities in clients’ situations over the last 12 to 18 months: working capital constraints, inability to service debt effectively and problems with managing metrics instead of service levels.
Restaurants rely on free working capital. Depending upon the restaurant concept, 60 percent to 70 percent of a restaurant’s costs are food and beverage, and labor costs, which are typically paid on 14- to 21-day terms. Add to that the 7 percent to 10 percent sales tax funds restaurants collect daily, but only pay once a month, and many restaurants end up with negative working capital. When revenue declines and locations close, working capital becomes scarce. The reason? Close-down costs: Locations with $500,000 in annual revenue, for example, may cost as much as $100,000 to shutter, because of the overhang of accrued liabilities. It’s tough to eliminate costs or reduce losses when closing locations drains valuable resources.
When it comes to debt problems, the restaurant industry’s situation is no different than the other public boom and bust stories of this recession. As we mentioned before, restaurant companies expanded rapidly in the ‘90s and early 2000s, thanks to easy access to money, optimistic forecasts and multiple development projects. Because restaurants’ cost structures are highly variable, however, their ability to meet the demands of fixed debt payments when revenue declines is severely limited. One client, for example,
had a group of restaurants that supported $40 million worth of debt with $8 million worth of cash flow, and another group trying to support $30 million worth of debt with $500,000 worth of cash flow. The second group had seen double-digit sales declines for three consecutive years. Ideally, we would focus on operational improvements, but some situations call for financial restructuring.
Ultimately, problems involving working capital and debt often result in an increased focus on financial metrics — much to the detriment of service. When people go to restaurants, they expect friendly, competent service and overall value — something special for the extra money they spend to dine outside their homes. Yet in hard times, many restaurants have focused so much on metrics and finances that it actually inhibits their search for increased customer traffic and revenue.
In one example, allotting 20 percent of costs to labor was considered ideal — as determined by speed-of-service requirements. When the restaurant experimented in adding more staff during busier times of the week and implementing a two-week training course to increase speed of service, the location saw a top-line increase of 10 percent in only three weeks. Although these efforts required a labor-cost percentage increase of 4 percent, initially, the restaurant was able to bring labor-cost percentages back to original levels fairly quickly, while still maintaining speed of service and customer satisfaction.
The restaurant industry is considered a barometer of the general economy, and may eventually indicate that the economy is improving. Although we are beginning to see signs of recovery, there will continue to be a weaning-out period, during which many restaurants will struggle. To survive and thrive, restaurants must take proactive steps to manage working capital and debt — while still maintaining a focus on quality service and value.
A Crash Diet for the Restaurant IndustryDavid Bagley, Managing Director at MorrisAnderson, [email protected]
David Bagley
55 W. Monroe, Suite 2500Chicago, IL 60603
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MorrisAnderson Makes the List of Top Crisis Management FirmsAs Dan Dooley and Ken Yager mention in their articles on pages 2 and 6 of this newsletter, MorrisAnderson is focused on leveraging its established position within the insolvency industry. The firm is among the top 10 crisis management firms by volume in the country, according to The Deal LLC, a diversified media and information company. MorrisAnderson hopes to continue to grow and progress, to help clients maximize enterprise value as much as possible.
Top Crisis Management Firms, By Volume in Bankruptcy Cases ($B)*
cRisis mAnAgement fiRms no. of cAsesAvg. Assets PeR
cAse ($B)totAl
liABilities ($B)totAls
Assets ($B)
1 FTI Consulting Inc. 118 9.2 1,124.4 1,085.2
2 Huron Consulting Group Inc. 32 23.2 711.1 743.9
3 Alvarez & Marsal LLC 45 16.5 703.6 742.3
4 Goldin Associates LLC 7 102.4 682.0 717.0
5 AlixPartners LLC 29 6.2 283.8 180.7
6 Capstone Advisory Group LLC 42 3.5 148.0 146.4
7 Loughlin Meghji + Co. 8 2.9 24.2 23.0
8 CCV Restructuring LLC 2 10.4 19.4 20.7
9 MorrisAnderson 23 0.8 20.0 19.4
10 Carl Marks Advisory Group LLC 4 1.0 2.8 3.9
*Includes all debtor, creditor and other assignments within active bankruptcy cases. All assignments active as of March 31, 2010. Source: The Deal, LLC
