Deutsche Bank: Financial Dealings in Vegas for Make Benefit Glorious Bonuses of Bank Managers

Deutsche Bank Lost in Vegas as Defaults Make Lenders Decorators
By Jonathan Keehner and Bradley Keoun

June 23 (Bloomberg) -- Workers building the $3.5 billion Cosmopolitan Resort & Casino on the Las Vegas strip are getting used to their financiers from Deutsche Bank AG. Lately, the weekly visitors from 60 Wall Street have been critiquing plans that called for a black-and-white decor.

``They are considering changing the color palettes and finishes,'' said Travis Burton, a vice president for lead contractor Perini Corp., who outfits the bankers with safety vests and hard hats before touring the site.

Since January, when New York developer Ian Bruce Eichner defaulted on a $760 million loan, Frankfurt-based Deutsche Bank has been cutting Perini a monthly check for $70 million to continue construction, now in full swing with 2,800 workers on site and a dozen cranes towering overhead.

Deutsche Bank, which declined to comment about the Cosmopolitan, is one of a dozen investment banks that rode a five-year boom in commercial real estate by financing developers and landlords while profiting by packaging loans into securities. Then credit markets seized up in 2007, sticking banks and brokerage firms with commercial mortgages and bonds. The amount for large U.S. banks alone: $169 billion, according to Fitch Ratings Ltd. The resolution may take more than providing advice on drapes as the economy falters and mall vacancies increase.

``Wall Street banks have a lot of exposure to commercial real estate, and it's definitely a concern,'' said Ryan Lentell, an industry analyst at Chicago-based Morningstar Inc. ``They really pushed through lending and principal investing. The exposure has a lot to do with their problems.''

Tropicana Squeezed

Not far down the strip is the Tropicana Resort & Casino, whose parent filed for bankruptcy protection in May. Tropicana Entertainment LLC defaulted in April on a $1.3 billion syndicated credit line arranged by Zurich-based Credit Suisse Group to help finance the purchase of the casino in 2006, according to bankruptcy papers. Credit Suisse spokesman Duncan King declined to comment.

The economic slump that began in the U.S. housing market has spread to commercial real estate, Wachovia Corp. senior economist Mark Vitner wrote in a June 4 note. Retail vacancies in the first quarter were up 8 percent from a year earlier, he said. And he predicts average prices for U.S. commercial real estate may drop by 15 percent to 20 percent as demand for office and industrial space declines.

Commercial-mortgage delinquencies, at 0.56 percent, are below the 2.5 percent mark reached in October 2003, after the dot-com bubble burst and the U.S. economy fell into a recession following the 2001 terrorist attacks, according to Lisa Pendergast, a managing director of real estate finance research at RBS Greenwich Capital in Greenwich, Connecticut. They are even further from the 7.5 percent peak reached in the early 1990s.

Deutsche Bank's Holdings

That perspective may offer little comfort to shareholders of banks exposed to the market. The four biggest New York-based securities firms -- Goldman Sachs Group Inc., Morgan Stanley, Merrill Lynch & Co. and Lehman Brothers Holdings Inc. -- accounted for $84 billion of the commercial mortgages and bonds tallied by Fitch at the end of last year. They've written down their holdings by at least $7 billion since the start of 2007.

Deutsche Bank had 15.5 billion euros ($24.2 billion) of commercial real estate loans and securities at the end of March, about half in North America, company reports show. The bank has written down the investments by 728 million euros since the beginning of 2007.

Earlier this year, it took control of seven New York office towers after developer Harry Macklowe defaulted on about $7 billion in loans Deutsche Bank helped arrange to enable him to buy the buildings from New York-based leveraged-buyout firm Blackstone Group LP last year. Deutsche Bank is selling the properties.

Market Muscle

Credit Suisse said it reduced its commercial mortgage holdings by about 25 percent in the first quarter to 19.3 billion Swiss francs ($18.7 billion), through sales and writedowns.

Wall Street firms used commercial mortgage-backed securities, known as CMBS, to muscle into a market previously dominated by regional and commercial banks that often held the loans to maturity.

Now the market has collapsed. After climbing to $233 billion last year, up more than sixfold from 1997, the volume of new CMBS issuance in the U.S. may fall to $35 billion this year, according to New York-based Moody's Investors Service. That means Wall Street banks will lose a revenue stream, while also having to write down the value of their holdings.

`Holding the Bag'

``They didn't have a good exit strategy,'' said David Hendler, an analyst at CreditSights Inc. in New York. ``They felt there would be a market for the product they were producing, or they'd always come up with the next newfangled structured-finance instrument. Now they're stuck holding the bag.''

Lehman ranked among the biggest CMBS underwriters last year, managing or co-managing $48.2 billion of new securities, triple the amount in 2004, according to Commercial Mortgage Alert in Hoboken, New Jersey. Lehman now has $40 billion of CMBS, loans and other real estate investments on its balance sheet, more than twice the firm's stock-market capitalization.

Lehman also financed 23 residential developments, most of them in southern California, and a luxury high-rise built by Irvine, California-based developer SunCal Cos. Last October it teamed with Tishman Speyer Properties LP to buy Denver-based Archstone-Smith Trust, the biggest U.S. apartment real estate investment trust, for $13.6 billion.

Lehman's Losses

Lehman posted a second-quarter net loss of $2.8 billion, the first in its 14-year history as a public company, partly because of $900 million of losses on commercial mortgages and real estate investments. The firm marked its SunCal investments -- mostly senior debt -- to around 75 cents on the dollar and recorded a $350 million writedown on its Archstone stake, Lehman Chief Financial Officer Ian Lowitt told investors on a June 16 conference call.

Morgan Stanley reported $100 million of writedowns on commercial mortgage bonds for the second quarter, while Goldman Sachs didn't disclose any. Merrill Chief Executive Officer John Thain said during a June 11 conference call that commercial real estate investments rank among the firm's most troubling assets.

``The banks were drawn in by their ability to take a bunch of projects and mush them together into structured securities,'' said Lawrence White, an economics professor at New York University's Stern School of Business. ``They may not have really understood the risk or known exactly what they were getting into.''

Financing LBOs

With issuance of CMBS estimated to be down 85 percent this year, banks aren't finding buyers for their debt and landlords are having a tougher time finding financiers to replace loans coming due. That's what happened to Macklowe, who has been forced to sell New York's General Motors Building and three other office towers to pay off delinquent loans.

Banks also relied on mortgage securities to finance LBOs, including Hilton Hotels Corp. of Beverly Hills, California, and Las Vegas-based Harrah's Entertainment Inc. More than half of the $34.2 billion in CMBS offerings scheduled for sale in the first quarter were related to five LBOs, according to a January research note from Credit Suisse, Switzerland's second-largest bank. Four of those deals had not gone to market as of June, according to Credit Suisse.

U.S. commercial real estate sales increased to $436 billion in 2007 from $76 billion in 2001, according to property-research firm Real Capital Analytics Inc. in New York.

Wall Street Touch

``The Wall Street banks probably touched more than half of those deals last year through principal investing or lending,'' said Robert White, Real Capital's president. ``It's definitely the highest amount of exposure since we began tracking the data in 2001 and likely unprecedented.''

The boom in CMBS led banks to make riskier loans, like construction finance, said David Spring, an analyst at Fitch Ratings in Chicago.

Large banks had about $250 billion in U.S. construction and land-development loans by the end of 2007, roughly double the amount of 2004, Spring said. During that period, the delinquency rate for construction loans rose to 3 percent from about 0.6 percent, where it had been until the end of 2006, according to a report he wrote May 13.

``The performance of large bank commercial real estate portfolios will depend on factors specific to each bank,'' Spring said, including property types, geography, quality of underwriting, and risk management.

It will also depend on getting projects finished. Deutsche Bank's Cosmopolitan casino is about 40 percent complete, according to Burton, who says the bankers ``understand the importance of keeping the project moving.''

That would mean Deutsche Bank anteing up the $1.1 billion in construction costs that Burton says he needs to complete the casino or finding another buyer before the roulette wheels start spinning.

To contact the reporters on this story: Jonathan Keehner in New York at jkeehner@bloomberg.net; Bradley Keoun in New York at bkeoun@bloomberg.net.