East Bay Loans Lead List of Monitored Debt

By Sharon Simonson

More than $187 million in unpaid loans collateralized by Oakland area real estate have been added to a “watchlist” compiled by Morningstar Credit Ratings LLC.

The assessment puts the East Bay among the top metropolitan areas nationwide for commercial real estate debt newly identified as potentially wobbly. All of the loans evaluated by Morningstar back debt instruments known as commercial mortgage-backed securities.

Inflating the East Bay numbers is a $92.9 million loan balance collateralized by Fremont’s Pacific Commons Shopping Center, an 865,000 square-foot retail development with multiple anchor tenants including Lowe’s Cos. Inc., Costco Wholesale Corp. and Kohl’s Corp. The borrower is TPG Fund VI, an $18.9 billion global buyout fund launched in 2008. Its investors include the California Public Employees’ Retirement System, according to Morningstar.

The loan appears on the Morningstar list because the debt-service coverage ratio has fallen to 1.05, meaning the property was just barely producing enough income to pay its annual debt-service costs. That compares to debt-service coverage of 1.40 when the loan was underwritten. The debt-service coverage ratio is calculated after normal property operating expenses are deducted. Occupancy and cash flow at the center also were down. Nonetheless, Morningstar concludes that with occupancy still above 90 percent—93 percent to be exact—default risk remains low.

Other East Bay properties where debt-service coverage, imminent loan maturity, lease rollover or other factors are raising concerns include the 64-unit Hillcrest View Apartments in Antioch with a $5.9 million outstanding loan balance and the 433,900 square-foot East Bay Bridge Shopping Center in Emeryville, where there is a loan balance of more than $63.7 million.

The nearly 70,000 square-foot Granada Shopping Center in Livermore has seen its debt-service coverage drop to 1.06 from 1.39 when the loan was underwritten, earning it a place on the list. The property is collateral for an outstanding loan balance of $6.9 million. Also under watch is an outstanding loan of $8.8 million against a 257,000 square-foot San Leandro industrial property on Farallon Drive where the largest tenant, North Face Inc., occupies more than half of the property and its lease expires this summer.

Properties appear on the watchlist for a variety of reasons including low occupancy, loan-maturity risk, near-term lease rollover and struggling anchor tenants, Frank Innaurato, Morningstar managing director for CMBS Analytical Services, said in an email message.

The Morningstar watchlist incorporates debt that loan-servicing companies have identified for special attention based on standardized industry practices and definitions, Innaurato said. Morningstar analysts augment the narrative about each property by scrutinizing for additional risk at the loan, property and borrower levels.

On a national basis, Morningstar added 524 loans to its watchlist, which was released in mid-April. Those loans are collateralized by 690 properties nationwide with a principal unpaid balance of $6.98 billion. Eighty-two of the 690 properties nationwide are in California; 22 of the 82 are in the Bay Area.

Despite the somewhat ominous subtext of being placed on a “watchlist,” by and large Morningstar concludes that with most Bay Area properties repayment risk is not great. Loan payments typically remain current, and the value of the underlying collateral is often sufficient to repay the loan were the borrower actually to default.

For instance, Almaden Financial Plaza at 1, 55 and 99 Almaden Blvd. in downtown San Jose appears on the list based on the maturity early next month of a junior mezzanine loan with a balance of $37.7 million. The more than 407,000 square-foot office complex was less than 70 percent occupied at the end of 2011, but its debt-service ratio is more than 14-to-1, and the loan has not been delinquent in the last year. “We consider this loan a low default risk,” Morningstar said, noting that even if borrowers were to stop paying, the collateral is likely valuable enough to repay the outstanding debt.

Morningstar draws the same conclusions about the 58-room Holiday Inn Express Hotel & Suites—Mountain View at 93 El Camino Real. When the loan was underwritten, the property’s debt-service coverage was 1.60. By 2009, it had fallen to 0.54, but by the end of last year, had recovered to just more than 1-to-1. Default risk is “very low,” Morningstar says, and with a loan balance of $2.28 million, the collateral value is great enough to repay the debt were the borrower to default.

The largest concentration of newly “watchlisted” loans, which are backed by properties in 188 metropolitan regions nationwide, is in Washington, D.C., according to Morningstar. Those loans have an unpaid principal balance of $1.21 billion. New York City has the second-highest number of newly tagged loans with not quite $600 million in unpaid principal, followed by Dallas-Fort Worth. In Los Angeles, Morningstar identified loans totaling $201 million, placing L.A. eighth on the top-10 list; the Oakland metropolitan area ranked ninth.