Mortgage on Circuit City HQ a ‘loan of concern”

It was a loan the lender didn’t want, sold in a public offering that wasn’t very public.

Now the tenant, Circuit City Stores Inc., is bankrupt, and the bonds that its western Henrico County headquarters helped to finance have been downgraded.

The mortgage on Circuit City’s now-empty headquarters — arranged by a now-defunct firm that sold the loan to itself and then sold bonds partly based on the loan to investors — is now a “loan of concern,“ a downgrade that echoes the credit market meltdown of 2008 that sparked the deepest recession since the Great Depression.

The complicated financial dealings involved in commercial mortgage-backed securities — CMBS — generated big fees for Wall Street players and helped create a financial market that was massively unstable. But no one cared at the time.

“In boom markets, the average investor was willing to take a blind eye to the favorable deal structure for underwriters,“ said Ken Daniels, a finance professor at Virginia Commonwealth University.

The Fitch Ratings agency said last month that the $31.3 million mortgage on the Circuit City headquarters is one of the biggest “loans of concern” in the $1.95 billion pool backing an obscure set of CMBS issued by a shell entity called Bear Stearns Commercial Mortgage Securities Trust 2005-Top 20. It downgraded the trust’s securities — a type called CMBS bonds — by one to three steps, depending on which gets first claim on income from mortgages in the pool.

The mortgage on Circuit City’s headquarters was the biggest single problem loan in the pool — although a package of mortgages on four Park ‘N Fly parking garages in Georgia, Ohio and Texas that Fitch also described as being of concern totaled $47.9 million, a Times-Dispatch analysis of hundreds of pages of Bear Stearns filings with the Securities and Exchange Commission showed.

While the Circuit City loan is still current — the monthly payment is $133,028, according to the trust’s SEC filings — the building has been vacant since April. Fitch said its market value analysis suggests potential losses for investors as a result of the loan. The property is assessed at $54.8 million, still above the $53 million that Illinois-based Inland Real Estate Corp. paid for the property in 2005, county court and tax records show. Circuit City had sold the property to a Texas firm in 1997 for $48.9 million.

Inland was generating $3.6 million a year in net operating income from the building, or more than twice the debt service on the mortgage, at the time the mortgage was added into the pool backing the securities, the SEC records show.

The mortgage got into the pool because the lender, Bear Stearns Commercial Mortgage Inc., sold it to the Bear Stearns trust about five months after lending the money in 2005.

Another unit of Bear Stearns & Co. arranged the sale of the $1.95 billion in bonds, along with Morgan Stanley Inc., which owned a commercial mortgage firm that, like the Bear Stearns unit, also made hundreds of millions of dollars of loans that ended up in the pool that backed the Bear Stearns trust’s bonds.

The trust apparently made money on the deal, receiving $3.5 million more in cash than the book value of the entire pool of mortgages, SEC filings show.

The origination and discount fees the Bear Stearns mortgage company made when it arranged the mortgage were not disclosed. Neither were the fees or commissions Bear Stearns & Co.‘s bond sales team made on the deal.

“We’ll decline comment,“ said Joseph Evangelisti, head of global media relations for JP Morgan Chase, the giant bank that took over Bear Stearns early in the financial meltdown.

Wells Fargo & Co., which also originated many of the mortgages in the pool, along with a real estate investment trust that bought more than 50 percent of the bonds, collected $74,000 a month in fees for collecting mortgage payments and sending off checks to investors.

Daniels believes that it was around 2005, when the old separation between mortgage-lender and bond-seller blurred as firms sought to earn fees from both sides of the loan-to-securities buyers chain, that the market for CMBS bonds became unstable.

In 1998, less than 2 percent of real estate-based bonds had the same firms arranging mortgages, putting them into a pool and selling bonds based on that pool. By 2005, nearly a third of the deals did. At the same time, the average size of deals ballooned from about $45 million to nearly $440 million, while the total sold to investors rose from $266 billion to $1.37 trillion, Daniels said.

A lot of the bonds simply stayed on the books of financial firms as they swapped each others’ paper.

Within four months of selling the bonds that included the Circuit City mortgage, for instance, the Bear Stearns trust won SEC permission to stop filing financial reports because fewer than 300 investors owned the paper.

Now, it still theoretically is possible to buy a block of the bonds that still have a triple-A rating, because they have first claim on mortgage payments from the pool. But no one is quoting prices for any of the other blocks of bonds the trust issued.

It was when trading dried up in such bonds, whether for CMBS or other kinds of asset-backed securities, that Washington stepped in with hundreds of billions of dollars to shore up the banks’ financial capital.

“It was a market that was not sustainable in the long run,“ Daniel said.

David Ress is a staff writer for the Richmond Times-Dispatch.