http://wapo.st/avvdpU

There are some undeniable facts in this current distressed banking situation.

• Commercial real estate values have fallen.
• Many of the loans backing this real estate are ‘underwater’.
• The FDIC has stepped its enforcement of banks and their lending practices.

While the fallen commercial real estate values and underwater loans cannot be changed at this time, the FDIC practices can and should be so this country does not wind up in a situation like Japan.

The FDIC has already created zombie banks

We already have zombie banks that have been created. Banks that have so many underwater loans that they cannot sell because doing so would cause them to recognize an immediate capital loss on their balance sheets. Instead the banks continue operating with minor write downs in value, as much as they can take against earnings per quarter. In the meantime, the FDIC has seriously stepped up its auditing and enforcement of banking loan underwriting and imposed loan classification limits based on bank capital, as well as increasing the capital requirements for the banks. All of this has been done ‘after the fact’ of course.

If these actions were taken pre-crisis, before the real estate crash and before complete deregulation which allowed banks to engage in derivative trading practices that their executive officers had no real understanding of, we wouldn’t be in nearly as bad of a situation as we are now. But, let’s not go back in time and do ‘what if’ scenarios. We are in the present and we need a current solution.

Why banks can’t make loans

Here’s a very simplified explanation. A bank can only lend money up to a certain multiple of it capital on hand. For example, let’s say a bank had a 5% capital requirement (we’ll ignore loan classification limits for now) and had a capital base of equity of $100 million dollars. To find out how much money a bank can lend, you simply take $100 million divided by .05%. That gives the bank loan making capacity of $2 billion dollars. Simple, right?

If we go back a few years, the FDIC had capital requirements in place for most mid size banks (less than $5 billion in loans) of around 3-4%. As the commercial real estate values fell, the crisis began, the public howled, and the politicians got on their soapboxes and pontificated their greatness, the FDIC started getting tougher on banks. The FDIC, at the politicians behest, did this at the worst possible time.

Thank you FDIC (and the politicians)!

As a result of the fallen commercial real estate market, the FDIC began (among other actions) to increase the banks capital requirements. Many banks saw their requirements arbitrarily increased from 5% to 12% for example. This has the effect of restricting a bank from making loans. In our example above, the same bank that had $100 million in capital, now at a 12% requirement can only make $833 million in loans, a $1.167 billion dollar difference!

But what if the banks already has that $1.167 billion dollars lent out? Well, the FDIC allows them to hold on the them (with a lot of restrictions of course) if they are performing. But what if these loans go into default? What if the loans don’t meet the FDIC restrictions? Then the bank has to sell them, increase capital, or get taken over by the FDIC and have the assets sold by one of five approved loan sale advisors (don’t get me started on this subject!). Unfortunately, since the bank is already way over the amount of money they have based on a new arbitrary ‘safety limit’, they can’t make any new loans…even to the most qualified borrowers!

No loans, no business, no jobs

So, if you and some recently laid off friends want to borrow some money to start a new business, you can’t! If you’re an existing business with great credit, great prospects, great employees, etc. and you want to expand and hire people, but need to borrow money to buy some commercial space or equipment, you can’t! Or let’s say your a well running existing business, never missed a loan payment, but your balloon credit line is up for renewal, the bank cannot renew the loan!

That’s OK though, just because your business goes out of business, and you lay off your employees, and they lose their homes…at least the politicians and FDIC employees have jobs and are busy.

Why the FDIC is doing the exact wrong thing right now

With The FDIC increasing capital requirements, getting tougher on loan underwriting, imposing strict loan classification limits (real estate, non owner occupied investment property, etc), it should be viewed the same as the government increasing taxes, the FED increasing interest rates, tightening the money supply, and cutting government spending during a recession! It’s unthinkable that the government would take all those actions, since everyone knows those are the precisely wrong actions to take during an economic contraction, and yet that is EXACTLY what the FDIC is doing to banks, and therefore all of us!

The FDIC needs to let the private sector solve this problem, with some caveats and intelligent oversight and regulation. There are already many hedge type funds, and pools of money looking to buy distressed bank loan assets, but the banks cannot sell at a price the investors are willing to purchase for. The reasons are mentioned above, the banks cannot take any additional ‘capital hit‘. And, with all due respect to bankers, they are NOT real estate investors, developers, or shrewd, market savvy, value adding business people. They are bankers, and should restrict their activities to making prudent loans!

Finally, how to fix the banking crisis quickly and put the economy back on track right now!

• Temporarily relax capital requirements for banks.
• Put in place regulations that require periodic progress towards better capital positions.
• Allow bankers to be bankers, let the C’s of lending come back somewhat.
• Let performing loans be renewed!

Temporarily relax capital requirements for banks

By temporarily relaxing the capital requirements for banks to near zero, banks will be able to sell their non performing or distressed loans at market clearing prices to investors. Since these loans are ‘dead’ on the books right now anyway; the loans produce no income, the underlying properties have to be foreclosed upon (which is expensive and time consuming), and then the OREO (Other Real Estate Owned) still has to be sold most likely at a loss, it is better for the banks to get what cash they can from the distressed loan sale and redeploy that money into an income producing loan to a qualified borrower. Right now the banks can borrow money from the FED to lend at nearly .25% and lend at 7% or better! That is a HUGE interest rate spread that will allow the banks to EARN their way back to a sound capital position quickly!

Put in place capital progress requirements for banks

Since having capital requirements for banks is a sound idea, relaxing the requirements to near zero can only be for a temporary time. The FDIC should work with each bank management to put in place attainable and reasonable time and capital benchmarks to get the newly cash rich banks back to very safe capital levels. For example, 1, 2, 3, and 5 year benchmarks seem reasonable.

Allow bankers to be bankers!

I got my first loan on my own when I was 13 years old for an ATV purchase from my local community bank. The lending officer knew my parents, knew my teachers and where I went to school, and knew that I worked bagging groceries and mowing lawns and doing whatever I needed to do to make money to repay the loan. In other words, it was a loan based on Character (one of the C’s that used to define bank loan making decisions). Bankers these days have been restricted and regulated down to customer service clerks where they have no decision making authority left. The bankers have no discretion. There are good, prudent bankers out there that make excellent loan decisions. We need to let them make loans, make the banks hold their loans, and stop them from trying to make profits packaging loans and trading derivatives.

Let Performing loans be renewed

If a business is making their existing loan payments, and their business future prospects look reasonably sound, then allow the banks to ‘roll’ the loan when it comes due. Many business lines of credit and/or loan have balloons or short maturity dates of a year or two. These performing loans used to be nearly automatically renewed (with new fees generated to the banks each time, of course), however, with higher capital requirements, these loans couldn’t be renewed by the banks. I can’t tell you how many personal stories we have heard from sound businesses that went bankrupt because their multimillion dollar loan was suddenly not renewed! These companies had never missed a payment, had customers, employees, and the personal guarantees from the business owners. The FDIC, at the behest of knee jerk reactions from the politicians, have destroyed more small and mid size businesses, their employees, and consequently caused more job losses and home foreclosures than most people realize.

Summary

This entire banking crisis is based on flawed, knee jerk, policies from the FDIC that run exactly counter to sound macroeconomic policy. While the above is a simplified version (in the interest of brevity) of the problem and solutions, it is nonetheless doable and would overnight fix most of the banking crisis, create jobs, stabilize if not propel the real estate market, and benefit the economy and government with increased tax revenue from the increased economic activity.

Stuart Dobson
Commercial Note Brokers

Robert Kiyosaki wrote a very interesting article today about the looming sub-prime/derivative disaster waiting to blow up in our faces.  That may sound a bit drastic but a $700 Trillion dollar disaster (according to Kiyosaki) is waiting to happen.  Through my blogs, I’ve hinted to the fact that we’re facing a financial bomb but nothing as big as a $700 Trillion.  This is somewhat disturbing when you think about it. 

There’s a property here in Colorado that was originally sold for $540,000.  In a perfect situation, and based on the bank’s estimate of it’s worth, this property would have netted around $580K on the note.  Today, the remaining balance on this note is above $470K and, unfortunately, this property has underperformed.  Now, the bank has decided to go for a short sale, netting only $346,470 based on their best estimate.  Given the remaining principle, that’s a real discount of about 26%.  On a non-performing property, if a bank can get anything above 60-70% on the note, that might be an acceptable deal.  But it has taken an astounding nine months to get to this point and, to-date, the deal is still ongoing.  What if they let it fall into an REO situation?  That discount would grow further after considering attorney fees, holding costs, property taxes, and the countless hours of manpower they would continue to throw at it. Either way, we’re looking at a deal where the bank is losing thousands by righting these assets off at crazy discounts.

It’s time for banks to realize that the faster, less risky, and more profitable way to release these troubled assets from their financial statements is to sell the note.  A note broker can get higher offers, in a much more efficient manner, and from an increasingly large pool of buyers.  These investors are as hungry to buy at a discount as the banks are to rid themselves of underperformers.

This brings us to my next point – the dollar amount of your offer (you, being the buyer). Forget the low-balling. If a bank has a commercial note they’re willing to sell at a 15-20% discount, don’t offer 30 cents on the dollar – they won’t even return your phone call. Banks view these offers as dead ends. They’re not looking for negotiation battles; instead, they want these notes off their books quickly and quietly, and they recognize the number of investors in the market. Making foolishly low offers is, therefore, almost as bad as making no offers at all.

Banking industry – watch out!

Banks that have loans to businesses in the Gulf States – especially in the Panhandle region better start preparing for some unfortunate problems.  Once the tourism starts to decline the domino effect will take place… businesses will most likely have a hard time making their monthly payments and thus will put banks in a dangerous position.  A lot of banks already have been shut down from the FDIC in Florida and more are to come.  If banks were smart, they would have already started selling their performing commercial notes at a slight discount to avoid these notes switching over to non-performing status if this scenario actually happens.  I’m not trying to be a pessimist but this oil spill has not been contained and the oil is actually en route to the Florida beaches through certain currents.  Florida’s economy is 60% tourism and the Panhandle plays a HUGE role.  This resource that Americans covet and rely on so much has ruined, and will continue to ruin both wildlife and economies.

Some special asset managers are smarter than that.  Let me explain…special asset managers realize that they, or their team, cannot possibly duplicate our experience with Search Engine Optimization (SEO), Social Media and Email marketing.  Furthermore, they don’t have our manpower, database of buyers and brokers, or singularity of focus to be able to concentrate solely on non performing note marketing.  So, they are smart to engage our services for the marketing, and use their time to make the final decisions, negotiate with the note buyers that we bring them, execute deeds in lieu when necessary, and generally make the assets more marketable.

Our role will not only be to assist the banks and special asset managers with their notes through this current banking crisis, but also help the banks to dispose of all their troubled assets, even including the REO, C & I loans, etc. in the future.

Landlords who have tenants in the retail space should be worried and should work with each tenant individually to make sure they are happy in their current lease and should tend to their every need.  For example, landlords should look at each tenant evaluate their business to see what the landlord can do – in anything – to help with the growth of said company.  With the availability of commercial space in many markets, tenants are always looking to get a better deal somewhere else.  Landlords need to repay their commercial notes each month and most cannot afford to lose any tenants.  With that being said, should landlords give their tenants some flexibility in their monthly payments if the landlord knows the business may be struggling?  Should they not?  If the landlord believes in the business model of their tenants and the tenants are struggling, should the landlord reduce their monthly payments for a year or two until the business gets back on track?  Would the tenant look favorably on their landlord?  Most likely.  The last thing an investor wants to do is have their property foreclosed upon by the bank because there are no more tenants to pay the monthly mortgage.  Banks are worried and landlords are worried.  Both will continue to worry for years to come.   If landlords can’t pay their mortgages, banks will have an abundant number of commercial notes for sale that investors will jump all over.  However, with the market growing with commercial note buyers, banks are starting to get close to fare market value for their commercial notes they are desperately trying to sell.

According to this report, the apartment sector grew though.  This can be expected as the foreclosure rate remains high and people can no longer afford to own so they must now rent.  I expect more articles like this in the future.  I don’t see a recovery until late 2011 or possibly 2012.  Investors seeking commercial notes for sale will have no shortage as banks will have to get rid of their inventory if their concentration levels are not approved by the FDIC.  Scary times out there.  Hopefully, I’m wrong and the recovery happens sooner rather than later.

Uplifting articles and news stories will continue to run.  However, you must be wary of them.  The public likes to think that the market is on a rebound.  They want to read and hear about how the market is on the rebound and that the economy is heading north – especially the commercial real estate market. Well, maybe some pockets around the country are on the rebound.   But you can’t read an article about the market in New York and expect it to have anything to do with Kansas City.  Savvy investors know this and know the market is still on the way down.  These investors are cashing in on this market – buying discounted commercial notes and REO properties all across the country.   The market may be going up in certain areas but I still don’t believe we’ve seen the worse yet of the commercial real estate market.  Banks with commercial loans will most likely be fretting the FDIC for many years to come.  If you’re trying to purchase commercial bank notes, you can and you will most likely get a good deal.