Podcast Notes – Bank Failures, and the Opportunities They Present

July 13, 2010

Recently, heard a podcast from an interview presented on the Commercial Real Estate Distressed Assets Association (CREDAA).  JW Najarian, one of the founders of CREDAA interviewed Peter O’Kane, a partner with Roanoke Financial Group.  Roanoke specializes in the acquisition, servicing, and disposition of loans and loan pools from banks, FDIC controlled institutions, and other lending intermediaries.  The group was formed one year ago to capitalize on the opportunity to acquire loans at discounted prices due to the changing economic environment. 

CREDAA was founded in January of 2010 and is the brainchild of Scott Miller and Warren Samek, both National Commercial Account Executives with Fidelity National Title in Seattle, WA and JW Najarian, formally a commercial lender with Pathfinder Commercial Mortgage and the Founder of The Commercial Real Estate Professional Investor Group out of Los Angeles.

CREDAA is dedicated to, discovering solutions to the troubled assets market to help and guide in supporting, enlightening, educating and engaging its member base and the industry on the current state of Commercial Real Estate, Distressed, toxic, unstable, troubled Assets or Non-performing Notes.  The organization uses technology, seminars, lectures, symposiums, webinars, teleseminars, and other media to deliver high quality and pertinent industry news, views, content, analytics and analysis and education.

During the interview, Peter discusses the RTC of the 90’s, Loss Share Agreements, the FDIC and how they handle failing banks and acquiring banks. Peter also discusses how his firm capitalizes on the opportunities to help investors find out where the opportunities exist.

In addition to JW Najarian, both Warren Samek and Scott Miller were on hand to ask questions and provide relevant comment.

The following are my notes from this enlightening discussion with some additional background and insight that I provided to clarify a number of issues covered during the interview.

During the last real estate meltdown, the Resolution Trust Corporation (RTC) was formed to help liquidate real estate and financial assets which it inherited from insolvent thrift institutions.  Between 1989 and mid-1995, the RTC closed or otherwise resolved 747 thrifts with total assets of $394 billion.

The Resolution Trust Corporation pioneered the use of so-called “equity partnerships”.  While a number of different structures were used, all of the equity partnerships involved a private sector partner acquiring a partial interest in a pool of assets, controlling the management and sale of the assets in the pool, and making distributions to the RTC reflective of the RTC’s retained interest.

Prior to introducing the equity partnership program, the RTC had engaged in “bulk sales” of asset portfolios. The pricing on certain types of assets often proved to be disappointing because the purchasers discounted heavily for “unknowns” regarding the assets, and to reflect uncertainty at the time regarding the real estate market.

By retaining an interest in asset portfolios, the RTC was able to participate in the extremely strong returns being realized by portfolio investors. Additionally, the equity partnerships enabled the RTC to benefit by the management and liquidation efforts of their private sector partners, and the structure helped assure an alignment of incentives superior to that which typically exists in a principal/contractor relationship.

During my tenure at Liberty Real Estate Group, Inc. (division of Liberty Mutual Insurance Company), we purchased a portfolio of loans and assets from the RTC during the early 1990’s.

RTC vs Now

In the previous savings and loan crisis, the average failed banking institution had total assets of $205 million. In 2009, the average collapsed institution had total assets of $1.2 billion.

RTC took assets in and auctioned them off at a discount in bulk sales of asset portfolios.  As noted above, they also pioneered the use of “equity partnerships” or sharing arrangements.

In the current situation acquiring banks want deposits NOT loans.  The loss sharing arrangements being utilized are often necessary to entice the acquiring banks to take the loans through guarantees (usually up to 80%) if loss is realized at the time of sale.

Prior to closing a bank, the FDIC polls acquiring banks that might have interest in purchasing the branches of the failed institution. The often negotiate “best” bank to acquire failed bank deposits and assets.  They strive to have no interruption of services to the existing clients of failed bank.  This process is NOT open to everyone and is relatively “hush hush”.

If the FDIC cannot find an acquiring bank to take the impaired loan portfolio of a failed institution, they will conduct sealed bid auctions three to six months later. 

This is the business that Roanoke Financial bids on.

Besides the FDIC, Roanoke has several other sources of loan sales.  Some solvent banks are now trading sub-performing loans to “clean up” balance sheets.  This is also true for the special servicers of CMBS loans.

According to its own estimates, the FDIC will sustain losses exceeding $36 billion to cover the 140 bank failures in 2009. That price tag will eclipse the total dollar amount of the losses the FDIC incurred during the six years spanning 1987 through 1992, when 1,049 banks collapsed during the savings and loan (S&L) crisis, costing the FDIC $29.6 billion.  From 2000 to October of 2007 only 27 banks were closed down by the FDIC.  Since the recession started, the FDIC has closed down 237 banks.   As of the first quarter in 2010, 775 financial institutions with $431 billion in assets were on the FDIC’s “Problem List.” 

As far as the FDIC and the banking industry, everything being done now is being done with the hope that the economy will miraculously turn around before judgement day appears. Almost nothing is being done to deal with the long term; everything is being done to save the present in regard to banking and the U.S. economy. 

FDIC is currently out of money and is getting the banks to prepay three years of fees into the fund, in hopes of not having to admit the need to tap into the credit line offered by the Treasury Department.

Sheila Colleen Bair, the Chairman of the FDIC is hoping these tactics work.  Expected losses from bank failures from 2009 through 2013 are now $100 billion.   It originally was estimated at $70 billion.

Therefore, the need for the FDIC to extend out losses on asset sales (extend and pretend). They need to recover the maximum possible on these failed loans over the next 2 to 3 year period and slowly absorb the expected losses.

This is a different strategy than RTC which took hit on many loans and moved on.  The FDIC is “pushing ball down the road”.  Things will get resolved over time by extending “reset” date on existing property.

Many believe this is akin to what happened in Japan during 1990’s.  Peter O’Kane is big believer in taking hit and moving on.

That being said, the FDIC has some “duality” in their approach.  They encourage some banks to get rid of certain type of assets and loans while forcing others to “extend and pretend”.

The big banks that can’t be taken over are starting to dump some of their own troubled assets through the auction process.

There are multiple buyers in market now but “price discovery” is big problem.

Roanoke bids on many pools.  They don’t win every time… if they do they feel they are paying too much.

The company targets a 20% plus return on loans.

Many LARGE buyers are losing out on portfolios (multifamily, hospitality) and there appears to be a bidding frenzy going on for top tier assets and loans.

Large companies have a lot of money to put out.  Some fund managers need to get it back if not put out.

Roanoke is competing with people all over the country for smaller portfolio of loans.

So, will there be a tsunami of bad loans and property in the near future? 

It won’t happen since FDIC is extending out the recovery.  Since they cannot currently cover losses, this process could extend out another 5-10 years.

Peter O’Kane and others, are afraid the U.S. will experience a “lost decade” just like Japan did in the 1990s.

No one can pick up any momentum since there are no current or relevant valuations.

The good news is there is a lot of capital.  However, many cannot see a clear path so they do nothing and there doesn’t appear to be clear vision by the Federal government. 

VERY cloudy out there.

“A crisis is a terrible thing to waste”

Roanoke starting operating about a year ago.  They describe themselves as a boutique loan acquisition and servicing firm.  An opportunistic firm looking to make above average returns due to the banking crisis.  They look for smaller portfolios … the ones the large firms often ignore.

To them it’s not about finding perfect apartment building in perfect location.  It’s not about finding the perfect asset at a perfect price. 

They would rather buy at 30 cents on a dollar in a third tier city.  Their philosophy is that if you buy an asset at a great price then it is hard to go wrong.  Any kind of asset at the “right” price.

“There is no bad asset there is just a bad price”

Their downside … get our money back.

The firm caters to high net worth investor and smaller investment firms.

When they buy loans they are not looking to foreclose.  Their preference is to work out arrangement with borrower.

Property types – multifamily is still trading at fairly high prices.

They use an intelligent approach to finding good assets.

In closing, everyone believes we are not going back to the way things were.  There is truly a shift going on.  Debt game is changing.  Commercial real estate market will be different in the next ten years.

Most firms are going back to Business 101.  Concentrate on how the property is doing right now.  Don’t buy hoping that cap rates will fall in the future.

 Posted by Scott R. Lodde

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