The August 25, 2010 edition of The Wall Street Journal wrote about commercial property owners such as Macerich, Vornado, and Simon Property Group choosing to stop making mortgage payments on certain underperforming properties, even though there is sufficient overall corporate cash flow to make the required payments. Individuals have been defaulting on residential mortgages for some real reasons – i.e., no cash, and some not so real reasons – i.e., strategic. Private commercial owners have strategically defaulted to entice lenders to negotiate restructure agreements. But the phenomena of publically held companies, with ample cash flow from other sources of operation, choosing to strategically default on its loans is a relatively new undertaking.
Although the companies quoted in the article indicated that making the strategic decision to default is not taken lightly, what will be the long term ramification to these companies for making the decision to default on its loans, while having cash.
Lenders loan money to these entities because they have sufficient secondary and tertiary sources of repayment. Although the primary source of repayment may not produce ample cash flow to service the loans in question, didn’t the lenders make their credit decisions based on alternative sources of repayment, as well as the long term credibility these companies possess?
Once these companies exhibit the willingness to default, regardless of the fact that it was a difficult decision, will lenders continue to loan them money for other projects? Will their cost of debt increase? Will additional guaranties be required in the future to prevent strategic defaults from occurring next time?
I think actions like this further hurt the already damaged credit markets. Time will tell how lenders will perceive credit worthy companies that strategically default on certain properties.