Business Mortgage: Borrowers Frustrated When Lenders Stop Walgreens Financing
Walgreens recently announced that it will gradually decrease organic growth in new stores from a planned 5% to 2.5-3% starting next year through 2011. But Walgreens is a big chain, and even considering the slowdown, there should be between 30 and 50 new Walgreens outlets popping up on street corners across the country every quarter for several years to come.
The Walgreens model calls for most new stores to be built by developers, owned by investors, and simply leased to Walgreens. But with the credit crunch continuing to plague borrowers, the question is where will the capital come from to build all those stores?
Lately, many Walgreens loans originated from a rather obscure lending platform known as “tenant credit lease” or CTL financing. CTL loans are underwritten in a very different way compared to traditional commercial real estate mortgage loans. In CTL financing, the property lease, not the physical property itself, is considered the primary collateral backing the loan. Each agreement is written based on the structure of the lease and the financial strength of the tenant signing it, rather than the underlying value of the building and the credit of the borrower.
To finance CTL loans, commercial mortgage banking companies would issue private placement mortgage bonds and sell them to fixed income investors. The bond buyers that provided the liquidity for CTL funding were often pension funds, endowments, trusts, and insurance companies, all with insatiable appetites for safe, dependent income.
Despite the economic downturn, Walgreens has maintained its very healthy credit rating (A1/A+) and the chain tends to sign 25-year renewable ironclad leases. These factors made Walgreens bonds among the most desirable securities in the private placement debt market. With Walgreens opening several hundred stores per quarter, there was never a shortage of Walgreens paper. Investors bought everything that was offered to them as fast as the mortgage bankers could issue it.
Unfortunately, the incredible success of Walgreens’ CTL funding has now led to a near-universal shutdown of the program. Without warning, bond buyers have stopped buying Walgreens paper. Recent portfolio reviews by the investment policy committee and portfolio managers revealed the fact that many portfolios were heavily overweight in the coveted document. Many Walgreens bond buyers are highly regulated and must, by law and policy, maintain strict diversification standards. In simple terms, they own too much Walgreens debt and cannot take on more without running afoul of their stated investment policies.
Starting two months ago, one CTL mortgage banker after another stopped accepting mortgage applications for commercial buildings that housed Walgreens pharmacies. As of now, it is extremely rare to find a lender that is still willing to originate a Walgreens CTL deal; they know that there will be no forthcoming financing.
The loss of CTL financing for developers with Walgreens leases and commercial real estate investors with pending purchase contracts comes at a particularly inconvenient time; The entire banking system continues to deal with a severe credit crunch.
If the credit environment were working properly, the loss of one form of financing would be offset by increasing other types or developing a temporary replacement financing vehicle. The collapse of the public market for commercial mortgage-backed securities (CMBS) coupled with the banks’ refusal to lend, means that the lost CTL cash flow cannot be easily replaced.
Many real estate buyers and commercial developers chose Walgreens stores because they thought their tenant’s good name and excellent credit would make it easier to obtain mortgage and construction loans. They expected a smooth closing and then cashing that very reliable Walgreens rent check month after month. Now even the best-rated Walgreens finds itself caught in the credit crunch, not because they are hard to finance, but because they are easy to finance.
CTL financing is a long-term, high-leverage loan. Rates are fixed for the life of the loan and the terms match the lease. For Walgreens loans, that meant store owners could borrow nearly 100% of a property’s value and secure 25-year loans at today’s historic low interest levels. With no CTL loans available, there are virtually no long-term, high-LTV fixed-rate mortgages for Walgreens buildings. Not many banks are still actively lending against retail real estate and none with high LTVs. Those who lend money usually offer fixed terms of 3, 5, 7 or, less frequently, 10 years. Short-term loans will initially carry a lower interest rate, but will force borrowers to seek refinancing years from now, when rates will almost certainly be much higher than they are today.
Some CTL lenders anticipate that their Walgreens financing programs will be frozen for 6-9 months. Other, more optimistic bankers tell clients that Walgreens CTL Loans will be back online in just 3 months. In either case, property developers and real estate investors with pending deals are frustrated by the lack of reliable financing.
The bond buyers who financed the past few years of Walgreens’ growth will not return until their portfolios grow significantly or a large portion of their current Walgreens debt is retired. None of those things are likely to happen quickly. Mortgage banking firms are desperately trying to recruit new investors who have room for the Walgreens role in their funds.
Walgreens loans, it seems, are victims of their own success. One hundred Walgreens a month were opening in population centers across the country. An innovative lending platform called CTL made it possible. Now CTL lenders have had their fill of the A+/A1-rated Walgreens bonus, and need to take some time to digest what they’ve already consumed.
Pharmacy chain, CVS cannot boast as high a credit rating as Walgreens, however CTL money for CVS loans is readily available even when lenders decline Walgreens loans. We are living in strange times.