Borrowers Find What Citigroup Says Isn't What It Does (Update1)

[Joanne98]

By Bob Ivry

March 14 (Bloomberg) -- Real estate developer John Wimmer paid Citigroup Global Markets Realty Corp. almost $1 million last year to lock in a 5.6 percent mortgage rate on the refinancing of six commercial properties.

At the November closings, Citigroup, citing plummeting demand for mortgage bonds, boosted the rate to 7.123 percent.

``I was very upset,'' Wimmer said in a phone interview from his office in Hales Corners, Wisconsin. ``We had many proposals to lock the rate with other financial institutions and we picked Citigroup because of their reputation and strength.''

Wimmer sued. So did a developer in Kentucky after Prudential Mortgage Capital Co. invoked the ``material adverse change'' clause in their loan agreement to raise his rate.

Banks have used the clause after calamities such as the terrorist attacks of Sept. 11, 2001, to free themselves from lending obligations. With the spreads between commercial mortgage- backed securities and 10-year U.S. Treasuries at their widest in at least 12 years, banks are applying the concept to avoid lending at money-losing rates, scuttling deals, leaving borrowers at risk and casting doubt on contracts that have already been negotiated.

``We are in an extremely uncertain time and no one should feel sanguine about any agreements that are on the table,'' said Scott A. Singer, executive vice president of Singer & Bassuk Organization in New York, which arranges real estate financing. ``Lenders with the best intentions find the game changing on them. This is a time to put your head down and execute business as quickly and efficiently as you can.''

Sept. 11 Attacks

Commercial mortgage lenders had not used the material adverse change clause, or MAC, to back out of commitments since the Sept. 11 attacks, and the case law on its invocation in mortgage lending has not been established, said Douglas Buck, a real estate attorney at Foley & Lardner LLP in Madison, Wisconsin.

``No one has developed a standard,'' Buck said. ``To borrowers, material adverse change has to be a total catastrophic event, like 1929 or 9/11, but I don't think that's what it is in the eyes of the lender. If there's a 60- or 70-basis point jump in the market, that's not a material adverse change. It's a bad business decision.''

A basis point is one-hundredth of one percentage point. An increase of 65 basis points on a 5.6 percent interest rate would bump it to 6.25 percent, for example.

Legal Reason

Changes in the financial situation of the borrower, such as an anchor tenant moving out of a mall, can be considered a material adverse change and provide a lender with a legal reason to back out of a deal, said Dennis Greenwald, head of the real estate department at the law firm Greenwald, Pauly, Foster & Miller in Santa Monica, California.

``The notion that the lender can come back after making a rate agreement and say there's a lot of foreclosures or our cost of lending has changed, that would never fly,'' Greenwald said.

The re-emergence of the MAC clause comes as 10-year fixed conduit spreads for commercial mortgage-backed securities -- one measure of the cost of commercial real estate lending -- more than tripled to 291 basis points since November, according to data compiled by New York-based Morgan Stanley, the second-biggest U.S. securities firm by market value.

After two hedge funds run by New York-based Bear Stearns Cos. collapsed last July, resulting in $1.9 billion of writedowns in the fiscal fourth quarter, demand for mortgage-backed securities dried up, sending a chill through the credit markets.

No Market

The thaw still hasn't come, said William Fryer, partner and head of the real estate capital markets practice group at the King & Spalding law firm in Atlanta.

``The market is largely shut down,'' Fryer said.

CBRE Realty Finance Inc., an indirect unit of CB Richard Ellis Group Inc., the world's largest commercial real estate broker, took a charge of $19.2 million in the fourth quarter for loans made to New York City developer Harry Macklowe. It hired Goldman Sachs Group Inc. to carry out a strategic review.

Moody's Investors Service, the New York-based bond-rating company, expects commercial real estate values to decline by as much as 20 percent over the next few years, erasing the gains of the last two years.

Buyout firms have used the MAC clause to walk away from planned acquisitions. Last year, Kohlberg Kravis Roberts & Co. LP and Goldman Sachs Group Inc. abandoned their $8 billion purchase of Harman International Industries, and JC Flowers & Co. dropped its buyout of student loan maker Sallie Mae.

Buyers who cited adverse market changes also abandoned takeovers of Accredited Home Lenders Holding Co., HD Supply Inc. and Genesco Inc.

Voided Loans

Citigroup Global Markets Inc., Deutsche Bank Securities Inc. and Goldman Sachs Credit Partners Inc. used what they characterized as a material adverse change in the credit markets to void $2 billion in loans to help St. Louis-based chemical manufacturer Solutia Inc. emerge from bankruptcy.

The case was settled last month, with the issue of what constitutes fair invocation of the MAC clause left undecided.

``The MAC clauses I've seen are remarkably vague,'' said George Triantis, the Eli Goldston professor of law at Harvard University in Cambridge, Massachusetts. ``What's probably going to happen in the near future is they will get more specific and detailed.''

The case involving Prudential Mortgage Capital, a unit of Newark, New Jersey-based Prudential Financial Inc., the second- largest U.S. life insurer, was similar to Wimmer's case against Citigroup.

Retail Developments

Robert Langley of Lexington, Kentucky-based Langley Properties paid Prudential Mortgage $1.14 million in June to lock interest rates of 6.3 percent and 6.36 percent for a pair of mortgages totaling $57.1 million on two retail developments in Alabama and Mississippi, according to court documents.

On Aug. 20, Prudential asked Langley to pay another $636,000 toward the rate lock deposit on the Mississippi mortgage. The next day, Prudential raised the rate to 6.9 percent and Langley canceled the deal, the documents said.

Prudential requested another $2.6 million from Langley in November for the rate lock deposit on the Alabama property, according to the court documents. When Langley refused, Prudential terminated the agreement, the documents said.

Prudential blamed the disruption in the financial markets that began in July for increasing Langley's payment, according to the documents.

Langley sued.

``I was forced to look elsewhere for permanent financing at an interest rate anticipated to be higher than the rate that was locked by Prudential,'' Langley said in an e-mail message.

`Smacks of Fraud'

Senior U.S. District Judge Joseph M. Hood of the Eastern District of Kentucky, central division, ruled in Langley's favor in December. For Prudential to claim the interest rate was not locked ``smacks of fraud,'' Hood wrote in his decision.

Prudential was granted a stay, with an appeal expected in June, said Langley's attorney, P. Douglas Barr of Stoll Kennon Ogden PLLC in Lexington, Kentucky.

Prudential spokeswoman Lisa Iurato said the company declined to comment.

Wimmer, a fifth-generation Wisconsin builder-developer whose partner is his older brother Mark, said Citigroup informed him of the interest rate increase on the Tuesday before Thanksgiving, and he and his brother were frantic to get a replacement loan.

``We had a 90-day window to refinance without penalty,'' Wimmer said.

Wimmer said a mortgage broker got them new loans at about 5.83 percent.

Citigroup spokeswoman Danielle Romero-Apsilos defended the bank's actions.

``We believe this complaint is without merit and that we have acted in good faith and in accordance with the terms and conditions of the parties' contracts,'' Romero-Apsilos said in a statement.

Wimmer disagrees.

``I guess the rate lock agreement protected me against a drop in the interest rates,'' he said.

http://www.bloomberg.com/apps/news?pid=20601109&sid=aIGRziUnaXjE&refer=exclusive

[truedelphi]

1. Sorry I did not get to this until the recommend period expired n/t

[Earth Bound Misfit]

2. "no one should feel sanguine about any agreements"

De-regulation, what a concept.