Posted on June 2, 2010 by Keith H. Mullen

Proposed Legislation To Aid Community Banks In CRE Lending, Delinquent Loans & REO Properties

Overlooked by the recent focus on health care reform, and now by the financial reform bills (see my recent blog posts, is draft legislation prepared by Representative Minnick(D-Idaho). Known as "The Community Bank and Commercial Real Estate Stabilization Act of 2010," his draft legislation has circulated on the Hill but has NOT been introduced into the legislative process.

 

His bill is based upon this premise: the "too big to fail" approach, which bailed out the largest banks and supported the CMBS market, largely ignored one very powerful economic engine.

Who is this "lost" or forgotten group?  Hints:

  • They have the highest concentration of commercial real estate loans (relative to risk based capital) among lenders
  • They extend credit to a broad range of customers (not just real estate related)
  • They are located near you - even on your Main Street
  • Every week, the FDIC seems to close 5-10 of them

The answer: Community Banks.

Hundreds have failed over the last several years; and hundreds will fail in the new future - currently, the FDIC lists 775 banks on its list of of "problem" banks (nearly 10% of all FDIC-insured banks).

I agree with Richard Suttmeier's assessment that community banks are the next key to economic recovery.

In his recent blog posting, he articulates the important role played by community banks -

  • The economy on Main Street is driven by small businesses, the housing market and local construction - none of which are "too big to fail" but when taken together . . .
  • These are the engine of job growth in the private sector
  • Without job growth on Main Street, the economy will struggle [my editing here: Suttmeier predicts a "double-dip"], and consumer spending will suffer
  • Community banks are the key to lending to small businesses
  • Thus, community banks are crucial to the economy on Main Street

Representative Minnick's bill seeks to address this oversight (or perhaps simply the relative inability of community banks to pull political levers, when compared to Wall Street and the largest banks).  Briefly, his draft legislation addresses two related goals:

  • Jump start new lending on the small-balance commercial real estate sector

Here's a quick summary of his bill (as of several weeks ago - so this could change):

  • Six-month pilot program of $3 billion, if successful, may be expanded to three years and upsized
  • Only community banks will be able to access that part of the program aimed at seriously delinquent loans and REO
  • US Treasury will guarantee bonds backed by pools of small-balance commercial real estate loans, including REO properties at community banks
  • Program administered by a Board consisting of Treasury Secretary, Fed Chairman, SEC Chairman, FDIC Chairman and four industry experts appointed by President
  • $10 million maximum loan size (or appraised value) per property
  • Conservative loan underwriting and pricing
  • Rating agency involvement to provide an independent view on underwriting and structure
  • Treasury will charge a “guarantee fee” similar to Fannie/Freddie, of between two to three percent annually
  • Any profit participation back to the originator must be earned over time

I also attach a much longer "term sheet" describing the proposed bill (there might be a more current version).

So, what do you think?

Please post your comments below.

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Posted on March 15, 2010 by Keith H. Mullen

Information & Tips On Selling Commercial REO Using CRE Auctions & Online Due Diligence Tools (a series)

For most commercial real estate lenders and loan servicers, it is important to quickly stabilize and then promptly sell property after acquiring  title to collateral.  The typical REO (definition) business plan includes the need to move the REO off the balance sheet by selling REO in an orderly manner—after coordinating loss recognition with an increase in capital reserves, with any loss sharing agreement, etc.

The sale of REO is the stuff that all of the “opportunity” or distressed investment funds target, and have been waiting for during the last 24 months.

Those funds and investors, of course, recall the quick profits realized in the late ‘80s\early ‘90s by those who purchased properties from the government (acting through the Resolution Trust Corporation or RTC), or from failing banks and savings and loan associations.

How did the RTC quickly sell the thousands of commercial real estate properties that it owned, or the mortgages on those properties?  The RTC often held auctions.

The RTC experience proved that auctions are a good way to quickly move a lot of REO off book. 

In 2009, we worked on several CRE auctions.  For 2010, we anticipate (finally) being involved in more auctions by commercial lenders—after they  take back collateral through foreclosures and deeds in lieu of foreclosure (link to prior postings on deeds in lieu).

Auctions are back.

Auction companies come in all shapes and sizes. (Google search).  There even are specialists: DebtX focuses on loan sales using an on-line bidding process (The Debt Exchange).

While DebtX's online model has proven successful, and has been well-received by note buyers, I favor a blended approach: (i) real, “live” auctions in a local ballroom combined with (ii) online bidding.  And, of course, like a pure online model, any auction should utilize online due diligence tools.

This series will help you understand commercial real estate auctions; and how technology now plays a key role both in auctions (and during the on-going "life" of the asset).

In this series, I interview Bill Vaughan with CREAuction Group) (e-mail Bill at bill@creauctiongroup.com), an expert in commercial real estate auctions; and Mike Shanley with Realworkspaces) (e-mail Mike at mike.shanley@realworkspaces.com), an expert in online due diligence tools and electronic document storage.

Bill and Mike will educate and show us how CRE auctions in 2010 will be executed.  Parts of it will be very different from the RTC auctions of the late ‘80s & early ‘90s.  And that’s a good thing.

But before we get into the details of auctions and the role of technology in auctions, let’s take a quick look at two high-level pieces furnished to me by Bill Vaughan and Mike Shanley.

  • Bill Vaughan gives us this advertisement for a December 2009 auction held by CREAuction Group.  This ad points to the importance of local, “live” auctions in your REO sales strategy. [download advertisement]
  • Mike Shanley can not compete with Steve Jobs on creating a gee-wiz video of cool technology doing great things [Link to iPad announcement].  However, this picture clearly shows that using an electronic process for collecting and sharing due diligence materials results in an entirely new ecosystem—both during the auction and continuing throughout the life of the asset (i.e., the electronic file should "follow" the ownership through all stages of ownership, operations and management)

 

 

 

 

 

 

 

 

In the next posting (and series), we’ll jump into the details of auctions and how technology makes it all possible.

If you have a question, comment or war story on the topics of commercial real estate auctions and the uses of technology in it, please post a comment below.

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Posted on February 22, 2010 by Keith H. Mullen

Shared Message From The CMSA, MBA-CREF & ULI Meetings: Rough Times Ahead for Commercial Real Estate

Significant industry organizations and participants all agree that commercial real estate is heading into a very, very rough time period - and it will be lengthy.

In the past month I have blogged from the Commercial Mortgage Securities Association (CMSA) January Conference [link includes links to prior entries] and the Mortgage Bankers Association’s Commercial Real Estate Finance (MBA-CREF) Convention [link includes link to prior entry].

  • My blog entries from the CMSA conference summarize the meeting content and the market perspectives of the capital market lenders (and the speakers selected by the CMSA).
  • My blog entries from the MBA-CREF convention do the same, but with a focus on life insurance companies and their mortgage bankers.

While the perspectives from these major commercial mortgage lending organizations are interesting, they are one-sided: they focus on the credit side of commercial real estate.

it is interesting to contrast and compare them to a summary of the 2009 annual meeting of the Urban Land Institute [link to ULI home page].  The meeting was this past November in San Francisco.

In contrast to the CMSA and the MBA, the ULI has an owner, developer and user focus on commercial real estate - what I call the equity side of commercial real estate.

When we combine the credit-side perspective (from the CMSA & MBA-CREF meeting) with the equity-side perspective (from the ULI meeting), we get a much more complete picture.

The ULI summary (below) is part of an e-mail received by a friend, who forwarded it to me.

  • Was the general tone, tenor or perspective of the ULI meeting different from the CMSA conference or the MBA-CREF convention?

The short answer: Yes and no.

  • “Yes” in the sense that the ULI attendees and speakers agree on the major challenges in the commercial real estate market.
  • “No” in the sense that the ULI meeting (based upon this summary) had a much, much tougher view on the future of the commercial real estate market.

Why the difference in their views?

  • The equity side of commercial real estate (the ULI) lives on the development of commercial estate.  In contrast, the credit side of commercial real estate (the CMSA and the MBA) lives on stabilized, income producing properties.  While they both agree that development of new commercial real estate will be slow (or even non-existent) over the next 3-5 years, the fundamental focus of each side takes them onto two different paths from this common perspective: the credit side still has opportunity in financing the existing stock of commercial real estate; in contrast, the developer is forced to the side line with no work (other than perhaps finding opportunity in asset management. work).
  • I know that this is not a popular idea, but I'll say it anyway: just like the residential sector, commercial real estate operated under the mantra of "other people's money" for the last 15 years.  The result was what I call "subprime commercial."  Now we're in the de-leveraging portion of the cycle.  Consequently, the equity side of commercial real estate goes on a severe diet (read: no development and a focus on asset management); and the credit side focuses on "real people with real money" and tends its distressed portfolio.

Here is the ULI meeting summary (emphasis added by me), which includes wonderful detail on specific CRE niches and challenges.  Click on the "continue reading" link below . . . .

It is very, very interesting.

If you have any comments, questions or observations, please add them below.

 

 "This week I attended the Urban Land fall conference. ULI is the top real estate industry group in the world. All the most senior people in the industry. 

  1. Not one expert was willing to predict what things will look like in 3 years other than they think it will be better 
  2. One top economist said if you are a developer find another career for the next 3 years-there is nothing to do and it may be 5 years 
  3. Recovery will be slow. Unemployment will not drop back to more normal levels until 2014. First they will bring back people on 4 day weeks to 5 days, then they will increase hours form the average 33 hours now, then part timers will become more full time, then they will start to hire.   
  4. Real estate values are down generally 40% and there is a huge need for value reset to occur 
  5. Nobody knows what debt will look like when it returns other than it will be far more conservative. Nobody knows what securitization will be when it does return.
  6. The rating agencies will operate differently. There is a discussion among some of us that there needs to be an agency probably of Treasury that collects fees of some sort from issuers each time there is an issuance of debt to be rated and that agency will then hire a rating agency to be a analyst firm to determine the quality of the issue. There will definitely not be a continuation of investment bankers hiring the raters and paying them directly. There needs to be a rule that the I bankers cannot talk to the raters. There was far to much threats of withholding fees, and other inducements to the raters before making ratings about as accurate as appraisals which were also paid for by I bankers who needed high appraisals to justify the over leveraging.   
    7. Housing in some bad markets is still bad and the first time buyer credit is making it a somewhat phony market. Phoenix has 45,000 housing lots so there is a literal lifetime supply of lots. Land prices in Phoenix, S CA and other markets are 50% of the cost of the infrastructure installed on finished lots. The land has zero or negative value. In most areas it will be at least 5 years before any of this land will get built out in any quantity. There are still 2-3 million too many houses in the US. 
    8. This time is really very different than any recession in the past
    9.  The US is no longer the world economic leader and will not lead the world out of this mess.
    10.   Real estate will once again be an investment and not the trading vehicle it became which is what led to this crisis. 
    11. We will go back to financing real estate with long term debt, and not the short term floating rate debt used to all a quick flip.   
    12. The Internet completely changed unemployment trends. Instead of just pumping up the US economy and bringing back production jobs, the Internet has caused the entire world to be competitors for many jobs in the US. It ranges from call centers to research, financial analysis, medical research, and on and on. This may be one of the most historic changes in history and one everyone needs to be aware of. It likely means wages in the US will be reduced below where they might have been were it not for this competition. As several economists put it, the young in China and India and other Asian countries are hungry to get ahead and enjoy the good life, while US kids feel entitled and poorly educated. Those of us who built businesses were very hungry. Today there are still some like us, but many are too comfortable and unwilling to really sacrifice to make it like we were. The Asians want to learn. Our young people think they already know it- whatever it happens to be. 
    13. The 3rd Q GDP number is inflated by clunkers home buyer subsidy etc. Growth next year will be more like 1%-2% in the first part of the year. 
    14 Inflation will return in 3-4 years 
    15. US corporations are sitting on record cash balances way beyond any they ever had. They will be doing more acquisitions. 
    16. The best market in the US is Washington DC. For obvious reasons 
    17. Investors fled real estate completely fled real estate in the early 90's. This time they see the long tern opportunity to create wealth and will be back as soon as the opportunity to buy appears
    18 There is an enormous amount of cash on the sidelines 
    19. The Fed is intentionally holding rates at zero to try to force investors to invest in longer term riskier assets instead of collecting nothing on money market or CD's. 
    20 The banks are still weak. 
    21  All values are still dropping and we have only gotten to 80% of the drop so far. Office and retail are only 80% there, industrial is only 60% and will be hurt by further inventory liquidation and lower levels carried going forward.  Rents are only 75% of the way to the bottom. 
    22. In the 90's it was easier to fix the problem because the damage was much more confined to a small number of large new buildings which were revalued and then rerented. Now the damage is widespread and covers a lot of older buildings so it will take a lot longer to solve. Quality really matter now.   The best buildings will return, a lot of others will struggle.
    23. Office vacancy will hit 18.6% nationally, retail 23%, and multifamily 8%. 
    24. The unwind of the massive Fed stimulus is critical to how it goes.   Everyone thinks Bernanke is great but nobody ever did this before -it is truly uncharted waters. Then there is the politics and what will the rest of the world do.
    25. As you will read below there will not be the massive foreclosure and asset disposal we all expected. The lenders are going to hold on. When assets do come to market prices will be higher than they should be due to very few deals being chased by massive dollars. There is already evidence of this in the multifamily market. 
    26. Mobile phones, and other devices are now becoming all sorts of tools and multiple use devices. Social networking is growing faster than anything anyone can imagine. The growth rates are beyond comprehension. This is where everything in the world is going from ordering food or reserving a car on Zip Car, to reading the news or anything. If you are over 30 you can't grasp what is happening and how fast. The growth in usage is by tens of millions in months, and it is worldwide. You can't get your mind around this. There has never been anything in modern times that even is remotely like this. The growth rate makes the growth in TV usage look like it was glacial. This is the biggest transformation of how the world functions in maybe hundreds of years. You need to learn all about this or get run over.   

    Here is the real stunner. A senior person at Treasury said to a small group of us that it is now official Treasury policy to extend and pretend on real estate loans. In other words, the policy statement from last week says, if you can make an analysis that says even if the current value is less than the loan, if you can do a spreadsheet that shows if you extend for 3-5 years, and if the economy gets better, and if the loan can be amortized down to where the loan is no longer more than the value, then the lender does not have to take an impairment -write down. Loans are to be modified by rate reductions, deferral of reserves, deferral of amortization or what ever.  [Link to the Federal Financial Institutions Examination Council (FFIEC) issued a policy statement that was adopted by the OCC, the Fed, the FDIC and the Office of Thrift Supervision as Guidance on Prudent Commercial Real Estate Loan Workouts (FFIEC's Guidance under the OCC Bulletin 2009-32)] [Link to our summary of the FFIEC policy statement]  Just NOT principal reduction. This is just like they are doing in housing. 
      
    Giant make believe. The free market seeking an equilibrium price is no longer economic policy. In short, the working of the free market is suspended. She went on to say it was administration policy that they will create new employment and by doing so they will boost the economy, and so then real estate values will return to old levels. There were 50 of the most senior and smartest real estate people in the room. They ripped her to pieces. It looked like one of the town hall meetings of August, except everyone there was a very senior, polished professional. At one point everyone was calling out or moaning at her. It was clear to all she had been given a few talking points and she was told to stick to them no matter how foolish she looked. The group told her in no uncertain terms this is terrible public policy. They said for jobs to be created you need to lower rents so the cost of occupancy was at a level to encourage more hiring. If the loan is kept at old levels and building values not reduced, then landlords can't reduce rents to where they need to be to make taking space by tenants economically viable. Retailers costs remain higher than they should be making it harder to lower prices to induce sales. So there is a massive make believe going on. When I pressed the issue of political interference she said -what do you want us to do, bankrupt all the banks. 
      
    That is the choice. 
        
    What does this tell you? 
            A. The problem is going to take much longer to solve than it should, 
            B. The banks are still very weak, so lending will not return anytime soon, 
            C. A massive refi problem is getting deferred to 2013-2015. 
            D. The administration is playing politics with the economy to a degree that is dangerous. There has to be a massive value reset for real estate. We are deferring the inevitable    .   
        
    I think I captured a lot of what was said in various panels and conversations. We have a long way to go and the government is making it harder to fix the problem."
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Posted on June 30, 2009 by Louis F. Strawn

Rating Agency Surveillance of Existing RMBS and CMBS Mortgage Securities: Legitimate "Surveillance," or Changing the Rules of the Game?

National rating agencies, and Standard & Poor's (S&P) in particular, are developing new analytics to be applied to CMBS and RMBS pools originated in the years 2005, 2006 and 2007.  As a preliminary matter, it looks like the new criteria will, when applied to the Triple-A tranches, result in downgrades of a substantial percentage of Triple-A CMBS for the three years of issuances reviewed.  While the details of the analytical changes have not been made public, investors holding RMBS and CMBS, as well as those with a stake in seeing that the securitization industry be revived in some form (such as the CMSA) are naturally inquiring to S&P about the specifics involved in the analytical changes.

It will be interesting to see if S&P is merely changing the stress assumptions for further declines in the market, or if in fact they are adding new criteria from lessons learned along the way in the financial crisis.  Since not all Triple-A CMBS pools have anywhere near the same kind of risk characteristics, perhaps a reexamination of Triple-A CMBS, in order to make meaningful quality risk distinctions between pools, would be a good thing for the market.  However, S&P's decision is likely to add more unwelcome investor confusion to the mix.

As most of you know, the Federal Reserve created the Term Asset-Backed Securities Loan Facility (TALF) to help borrowers and lenders as market participants meet the capital credit needs across a wide range of asset classes, including asset-backed securities (ABS), collateralized by auto, student, equipment, credit card, and small business administration loans.  More recently, commercial mortgage loans including CMBS were added as an asset class eligible for TALF.

On Tuesday, June 16, TALF offered borrowers the opportunity to participate in one of the first CMBS offerings in a long, long time.  The rate available for a loan with an average life of two years was 3.2710% and for five-year, fixed rate loans the rate was 4.130%.  Surprisingly, (or perhaps not surprisingly) even in the present capital starved environment, no loan requests were submitted for CMBS/TALF borrowing execution.  There could be a number of reasons for this, including continued investors current aversion to risk, particularly in this asset class, a continued belief in future weakening of real estate fundamentals, as well as uncertainty about the precise nature of the TALF execution.  At any rate, the last thing mortgage capital markets need is greater uncertainty caused by rating agencies mentioning (but not fully explaining) significant future downgrades of Triple-A CMBS.

This takes us full circle; back to an examination of the fundamental, underlying assumption that criteria can be developed which will adequately assess risk for securitized pools backed by commercial real estate.  Commercial real estate investments as an asset class, poses very unique risks and rewards, and arguably are not susceptible to precise bond ratings.

The problem is that rating agencies have taken on the task of providing "on going surveillance" for these asset classes.  As S&P collects more information about pool performances, their rating assumptions and general market conditions, they are likely facing a growing need to rerate CMBS pools.

Overall, National Recognized Statistical Rating Organizations risk much by stepping out and being active in the present regulatory/political environment.  If they do nothing, they will clearly draw significant criticism.  As the need to regulate rating agencies draws increased scrutiny and the possibility of creating federal oversight of these agencies increases, the rating agency should be very circumspect in changing rating methodology midstream and the effect such actions will have on an already dormant market.  And it's very difficult to see what type of analytics, when applied to CMBS pools, will shed light on what's happening in the market, given the dearth of reliable activity and data.

Perhaps a better approach would be to simply issue surveillance reports that show specifically what analytics have been employed to arrive at the more generalized conclusion that investors can not rely on the present accuracy of the original rating.

CMBS investors as well as rating agency professionals are invited to comment.
 

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