Era of Less (Reprise: Part 2)
November 23, 2010
In a prior posting, I covered Chapter 1 entitled Entering the Era of Less. This week I will summarize Chapter 2 of the report which is entitled Real Estate Capital Flows.
My comments follow each of the bullets.
Chapter 2 – Real Estate Capital Flows
- “In 2011, the “huge spin game” of extend and pretend also finally starts to run its course.” – In the years following the meltdown, lenders were deferring losses to build up capital, trying to keep the regulators off their backs.
- “… lenders will drop the hammer on troubled borrowers (the have nots), and rationally leveraged owners (the haves) will be able to obtain precious refinancing when their loans reach maturity.” – Owners who that are “in between” the haves and the have nots may be able to get an extension and continue to kick the can down the road … as long as they can cover debt service.
- “CMBS loan delinquencies rise to record levels” (see chart) – lenders (special servicers) have already begun the process of taking more writedowns on discounted payoffs so they can raise cash to put out another fire.
- “Loan-to-value (LTV) ratios are not as important. “Who really knows what the value of some of these assets is?” – We are in a “deleveraging” era. The new buzzword is “financial structure right-sizing”.
- “The brightening outlook for major market financial institutions and their better-capitalized clients does not necessarily extend to hobbled banks based in commodity markets. These regional and local banks, which serve less well-heeled investors, developers, and businesses, must continue to kick the can down the road surviving on low-interest-rate life support” – Evidence of this is the amount of FDIC takeovers. Through November 19th, the FDIC closed a total of 149 institutions this year. Many predicted that between 150 to 200 would fail in 2010. The FDIC Deposit Insurance Fund has now been drained by $2.4 billion in the fourth quarter to date, which brings the deficit to an estimated $20.0 billion.
- “Some local and regional banks face more daunting challenges; outsized distressed debt portfolios deteriorate further without a vibrant employment outlook and improving demand for housing and commercial space. They cannot sustain restructuring or marking loans to market – values have declined too much – and they have little or no capital to refinance or make new loans” – This is a situation being played out throughout the country but especially here in Florida. ANY type of loan is hard to come by. Most banks are too afraid to approve anything unless the borrowers are rock solid or if a government guarantee is in place (USDA, SBA).
- “ … CMBS markets have begun to resuscitate. The only way to head off a repeat of the recent debacle is to require issuers to retain a percentage of each securitization and force underwriting discipline. Rating agencies can’t do the job. They were overwhelmed by the sheer volume of assets in offerings and have conflicts because sponsors pay their fees”. This has been a common theme throughout the aftermath of the real estate fallout. The other major complaint involves the special servicers since those companies ring up more and more asset management fees the longer it takes to resolve a problem loan.
- “For years Emerging Trends … have predicted a mountain of lawsuits between tranche holders over failed CMBS investments. Only a limited number of lawsuits have been filed despite significant losses.” The lawsuits have failed to develop since the resulting brain damage of litigation is not worth the just liquidating at market prices. Another issue is that many asset managers have never been through a previous meltdown and are paralyzed by the sheer volume of the problems they face.
- “Filling the recapitalization gap looks ready-made for mezzanine debt investors, who can claim less-risky positions in the capital stack or angle for loan-to-loan deals.” This is where the best opportunity lies in my opinion but ONLY for those mezz lenders who retain asset managers that have experience in running assets and are not just financial engineers looking for a quick buck.
Posted by Scott R. Lodde