Commercial Mortgage Lenders in the Banking Sector
Oftentimes when a bank was failing, the FDIC looked for a compatible bank and sold to the acquiring bank most of the assets, and kept the toxic assets for FDIC to handle on their own. In 2009 the FDIC revived a technique that had been used a bit in 1991. When certain banks fail, the acquiring bank is required to purchase all the assets of the failed bank, and the FDIC is to reimburse the acquiring bank for approximately 80% of the losses associated with the acquired assets. Currently approximately 160 banks have this loss-share agreement in place with the FDIC. It sounded like a great plan, but the problem has become that the acquiring bank is unable to get the FDIC to confirm for specific transactions whether it will reimburse for the losses on those particular assets. So the acquiring bank does not transact and the banking system and asset resolution for these assets gets stuck. Stated differently, when a purchaser offers the acquiring bank a market price to purchase a troubled commercial real estate loan that the bank desires to dispose of, the bank is at times unwilling to transact despite this third party standing ready to purchase the asset that the bank being desirous of selling the asset. For certain transaction types all banks with these FDIC loss share agreements are unwilling to transact, representing billions of dollars in troubled loans getting trapped in the banking system.
One hurdle is that the people at FDIC are regulators by background, not used to approving an investment or sale. It would be like asking an umpire at a baseball game to stand in as pitcher. Yes the umpire knows what a pitcher does, but he is not a pitcher, he is an umpire. Furthermore, many commercial mortgage lender banks in 2008 through 2010 that have been deluged with troubled loans have set up or beefed up departments, sometimes with in-house resources and sometimes by outsourcing, to manage and resolve their troubled loan portfolio. For complex troubled loans sometimes this has resulted in confusion as well as at times competing motivations that tend to prolong commercial loan workouts, and sometimes the workouts have or are alleged to have additional layers of complexity that are raise by the parties’ legal counsels. At times these influences are making it very difficult for a third party, or existing participant to the transaction, to purchase an asset from a bank at a market price despite the bank wanting to sell. This type of foregone transaction activity is what this economy desperately needs right now.
We don’t have to look too far back in history for examples of similar problems that beset the banking industry. In the early 1990s the Savings and Loans collapsed. In that financial debacle many real estate loans were made with relaxed underwriting and credit standards, and many S&Ls failed based on those mortgage originations. At that time the FDIC setup the Resolution Trust Company to dispose of those troubled assets. Some financial players today believe that a similar type loan sale push by FDIC might be on the horizon. This latest real estate cycle, roughly from 1995 through 2007, beset the banks with problems related to mortgage securitization and credit default swaps for which they had provided financing to Wall Street and ended up for the most part with defaulted loans, and also from the uptick in speculative commercial construction loans, land loans, and bridge loan for properties that were not stabilized. Some banks were avid lenders in these financial products between 2003 and 2007 and all of those troubled loans, which are currently estimated at $350 billion, have to be resolved. Adding to the complexity are balance sheet maneuvers that some banks perform at quarter end to ‘dress their earnings’ as reported by the Wall Street Journal last week and it becomes murky to understand the financial position of some of these banking institutions.
I have spoken to a number of financial participants, both in the banking and surrounding the banking industry, who agree that it may be possible to better standardize financial reporting so as to avoid some of these problems. Right now there are different income reporting methods for accounting, tax, cash, and accrual ; in addition to varying balance sheet treatment of items including capitalization of assets, commercial loan writedowns, and chargeoffs. With the banks having a number of choices to make regarding presentation and reporting methods, it becomes harder to assess the creditworthiness of strength of the bank and its assets. There is a consensus among some financial market observers that a concerted push to liquefy troubled asset positions, whether through sale of restructuring, as well as more standardized corporate reporting would be a step in solving some of the current financial crisis.
Michael Schwartz graduated from Columbia Business School in 1995 with honors recognition in finance and real estate finance and has been a commercial mortgage broker, representing borrowers, since that time. His firm, Financial Compound based in Santa Monica, CA, is a leading commercial real estate finance broker that has remained an innovator in structuring and identifying capital markets opportunities.