Bringing fore closure

As hard times drag on, developers catch heat from lenders worried about losing money in a weak real-estate market.
By Frank Maley

On a weekend night, EpiCentre lives up to its name. Men, women, girls and boys stroll among its stores and restaurants, sometimes venturing inside or stopping to chat with friends. Occasionally, laughter erupts in the well-lit courtyard beneath the dark sky and all 60 stories of the nearby Bank of America Corporate Center.

But beyond the bright lights and bonhomie, a less cheerful saga plays out. Despite the crowds it draws and role it plays as an entertainment hub in the heart of downtown Charlotte, EpiCentre has generated plenty of ill will among the people who created it. Since it opened in late 2008, they’ve traded accusations — subcontractors claiming they hadn’t been paid and the developer and general contractor pointing fingers at each other. Last summer, the project’s lender got into the act. Regions Bank, a subsidiary of Birmingham, Ala.-based Regions Financial Corp., started foreclosure proceedings, saying developer Afshin Ghazi’s Pacific Avenue LLC and Pacific Avenue II LLC had missed payments on a $90 million loan. To block foreclosure, both companies declared bankruptcy. After several months of stalemate, Regions agreed to sell the loan to a third party.

It’s not an isolated incident. With the financial and construction industries wobbly from three years of recession and an agonizingly slow recovery, developers are feeling heat from lenders worried about losing a bundle in the weak real-estate market. That anxiety is manifested in escalating foreclosures of all kinds of properties — statewide, they were up 18.4% in October, compared with the year before. Perhaps hardest hit have been loans for acquisition, development and construction, says Ray Grace, N.C. deputy commissioner of banks. The big problem: Demand for space has plummeted. When developers can’t find buyers or tenants, they have trouble paying back loans. “The banks will work with them for a reasonable period of time, but sooner or later they have to succumb to pressures on their balance sheets, and that’s when they do the foreclosures.”

Indeed, Ghazi says a bank’s willingness to give struggling developers leeway corresponds with its own financial condition. “If a bank is on an FDIC watch list or they’re a bank that’s heavily invested in real estate, we’re seeing a whole lot more pressure from them to do certain things — as opposed to a couple of Canadian banks that we’ve worked with that have not experienced much of a hit from the economy. They’ve been more business as usual, extensions are acceptable, etcetera.”

That has led to confrontation in cases where more than one bank makes a loan. In July, Regions sued San Francisco-based Wells Fargo & Co. to recover its portion of $70 million owed on a loan to the developer of a 19-story office tower adjoining the new NASCAR Hall of Fame in downtown Charlotte. The two banks teamed up to make the loan, and Wells Fargo is the administrator.

One big difference between the banks is their financial condition. Wells Fargo netted more than $12 billion in 2009 and has turned a profit in every quarter this year. Regions is struggling to overcome two straight years and three straight quarters of losses. Wells Fargo has the financial cushion to play nice guy — and also the motivation, says Tony Plath, associate professor of finance at UNC Charlotte. It bought Charlotte-based Wachovia Corp. at the end of 2008 and has been slowly integrating it, with plans to convert all Wachovia branches to Wells Fargo within a year. “It’s an emotionally difficult transition for Wells and Wachovia,” Plath says, “so they are trying to make nice in the Charlotte community, and they’re also not trying, in the headquarters location of a big part of their bank, to perturb their relationship between the bank and the community. Regions doesn’t have that particular focus, and I don’t blame them. It may offend the uptown crowd, but there’s nothing wrong with what they’re doing. They’re making good decisions about loss mitigation, and they need to make those decisions.”

But they’re still hard decisions, and foreclosure isn’t an especially palatable option because the value of the collateral has in many, if not most, cases shrunk since the loans were made, Grace says. Liquidating property often leaves an unpaid balance that banks have to charge off. “You just have a lot of this stuff on their books, and the developments are not moving. Vacancy rates are going up, and so cash flows are down, and therefore the ability of borrowers to repay loans is diminished, and the ability of the real estate to support the amount of debt outstanding is diminished. It’s sort of a painful spiral.”

“I’m not sure banks are any more aggressively trying to foreclose now than they were six months ago or 12 months ago,” says Harry Davis, a finance professor at Appalachian State University and economist for the North Carolina Bankers Association. “What’s different is we’re further along in the process. The number of people whose payments are way in arrears is going up, so therefore there are obviously more foreclosures.”

No part of the state has escaped the pain. In Wilmington, John Evans put his River 2 Sea LLC into bankruptcy to avoid foreclosure on property he owns on the Cape Fear River six blocks from downtown. He had planned to sell it to developer Ron Pickett, who wants to build an 11-story condo tower with stores on the ground floor. They were set to close on the transaction within 90 days, but the lender, Atlanta-based SunTrust Banks Inc., started foreclosure proceedings.

Part of the problem was that recession has made banks reluctant to lend money, Pickett says. He thought he had financing lined up several months earlier, but the lender backed out at the last minute. “I think SunTrust got frustrated because we had an aborted closing earlier in the year. I had to start all over again. It took a few months to get another deal put together.” Considering that it had taken two years to get financing, he’s not blaming the bank. “I’m not sitting here today telling you SunTrust did something I wouldn’t have done. They were very cooperative for a long time.”

Ultimately, what’s afflicting developers is a weak economy with high unemployment. If people don’t have jobs or their income is shrinking, they don’t have as much to spend on homes or the goods and services that keep businesses growing and needing more space. After 15 months in double digits, the jobless rate in North Carolina finally fell below 10% in July, but it was still above 9% this fall. The recession, experts say, ended in June 2009. But not everyone agrees. “If we’re in 9-plus percent unemployment and we’re not rapidly coming out of that, it’s still a recession to me,” Grace says. “I live in the real world. I have neighbors who seemingly had very stable careers, and a number of them unfortunately have been hit by this recession and lost their jobs. And in a couple cases, they have been out of work for 2½ years now. I’m not sure how you cope with that.”

Few expect foreclosures to drop until at least the second half of next year, and it will take longer than that before commercial construction comes back. “I’m not optimistic at all about any new construction or development, other than just specific anchor-driven projects,” Ghazi says. “I’d say the days of speculative development and construction are over for the next two or three years.”

Plath predicts that when it does come back, it will happen quickly because the Southeast’s population is still growing. In the meantime, more developers and contractors will succumb. “There’s going to be no work, and you’re going to wake up one day in 2014 and have a two-year queue again. And we’re not going to be able to get the work done because we’ve lost so many contractors.”