Tom Lindmark's  Instablog

Tom Lindmark
Send Message
About a year ago, a company asked me to write a daily blog for them. I told them that I’d never read a blog and had absolutely no idea how to write one but sure, if you want to pay me for it, I’ll give it a shot. It was either my good or bad fortune to start at the beginning of the credit... More
My blog:
But Then What
  • Plan C And The CRE Conundrum 3 comments
    Jul 11, 2009 5:11 PM

     The Washington Post has a good article on the Treasury Department's new task force charged with closing

    the barn door now that the horses are long gone. It's called Plan C and their job is to figure out where the next disaster might be lurking in the financial system.

    That's how the Post describes their job. I, on the other hand would suggest that we pretty much know where the problems lie, it's simply an issue of figuring out how to cope with them. The list includes all the usual suspects, consumer loans, credit cards and of course the elephant in the room, commercial real estate.

    The article does a good job highlighting the looming disaster that is CRE:

    The officials in charge of Plan C -- named to allude to a last line of defense -- face a particular challenge in addressing the breakdown of commercial real estate lending.

    Banks and other firms that provided such loans in the past have sharply curtailed lending.

    That has left many developers and construction companies out in the cold. Over the next few years, these groups face a tidal wave of commercial real estate debt -- some estimates peg the total at more than $3 trillion -- that they will need to refinance. These loans were issued during this decade's construction boom with the mistaken expectation that they would be refinanced on the same generous terms after a few years.

    The credit crisis changed all of that. Now few developers can find anyone to refinance their debt, endangering healthy and distressed properties.

    General Growth Properties, which owns the Tysons Galleria mall in Northern Virginia, one of the most profitable shopping centers in the nation, filed for bankruptcy this spring after it could not roll over its loans. The John Hancock Tower in Boston, one of the city's most famous landmarks, was auctioned off after its owner defaulted on its debt.

    "There's going to be a lot of these stories where people relied very heavily on this high-leverage cheap availability of debt," said Kevin Smith of Blackwell Advisors, a financial consultancy.

    Kim Diamond, a managing director at Standard & Poor's, said the trend is expected to accelerate over the next few years, further depressing prices on some of the nation's most valuable properties.

    "It's not a degree to which people are willing to lend," she said. "The question is whether a loan can be made at all."

    The problem affects not just the recipients of the loans but also the institutions that lend, many of them small community banks and regional firms.

    Thousands of these institutions wrote billions of dollars in mortgages on strip malls, doctors offices and drive-through restaurants. These commercial loans required a lot of scrutiny and a leap of faith, and, for much of the decade, the smaller banks that leapt were rewarded with outsize profits.

    In doing so, many took on bigger and bigger risks. By the beginning of the recession in December 2007, the median midsize bank held commercial real estate loans worth 3.55 times its capital cushion -- its reserve against unexpected losses -- according to the Federal Deposit Insurance Corp.

    Borrower defaults increasingly are draining capital from many of those banks, forcing some to close. Financial analysts said losses on commercial real estate loans are now the single largest cause of bank failures.

    A lot of that is probably of no surprise to you if you read this blog or those of others who are following the slow motion destruction of CRE. But one thing in the piece I excerpted really hit me between the eyes. Look at it outside of the article:

    In doing so, many took on bigger and bigger risks. By the beginning of the recession in December 2007, the median midsize bank held commercial real estate loans worth 3.55 times its capital cushion -- its reserve against unexpected losses -- according to the Federal Deposit Insurance Corp.

    The first thing I asked myself when I read this was where have the regulators been. No matter what the asset or how exotic it might be, the one thing that will kill a bank quicker than anything else is an over concentration of loans in one asset class. How could they have allowed the banks to build up such a dangerous concentration of loans? We talking about small to medium-sized banks here, not the behemoths. They're not that difficult to examine, there isn't that much complexity.

    In reality, the exposure to commercial real estate is probably understated. It's not at all uncommon that the security backstopping what might appear to be commercial loans to small businesses and entrepreneurs is in fact some form of real estate. Sometimes a personal residence, but often raw land, the physical plant for the business or other commercial real estate that the borrower might have picked up for investment and pledged to secure the loan.

    By allowing this concentration to develop the regulators have left themselves with very little room to solve the problem. Given the deterioration in the value of commercial real estate any event that forces the banks to value the property at current prices would surely exhaust their loan loss reserves and begin eating into capital. Smaller banks don't have the earnings capacity of larger banks, particularly in this economy, so growing out of their problems is not nearly so viable a recapitalization alternative.

    Private equity might recapitalize some of the more attractive banks but that will cover a small fraction. It seems unlikely that a PPIP or anything of that nature will work because the writedowns will fracture the banks' balance sheets. There's just too much exposure.

    The Plan C boys have their work cut out for them trying to untie this Gordian Knot. My guess is that they have to use a lot of taxpayer dollars to work out the problem.

Back To Tom Lindmark's Instablog HomePage »

Instablogs are blogs which are instantly set up and networked within the Seeking Alpha community. Instablog posts are not selected, edited or screened by Seeking Alpha editors, in contrast to contributors' articles.

Comments (3)
Track new comments
  • Mark54
    , contributor
    Comments (164) | Send Message
     
    The FDIC did issue "guidance" early last year that they did not want to see a bank have > 300% tier 1 capital invested in CRE. A day late and dollar short. Put simply... there just isn't enough balance sheet out there to handle the refinance tsunami on the horizon. We need securitization.
    11 Jul 2009, 10:52 PM Reply Like
  • Tom Lindmark
    , contributor
    Comments (271) | Send Message
     
    Author’s reply » I agree but who's going to eat the losses. You need refinance capacity but the credits that are being refinanced have underlying asset values 30% to 50% under what they're carried for now. Someone has to take the hit or pony up the equity to make refinancing feasible.

     

    On Jul 11 10:52 PM Mark54 wrote:

     

    > The FDIC did issue "guidance" early last year that they did not want
    > to see a bank have > 300% tier 1 capital invested in CRE. A day
    > late and dollar short. Put simply... there just isn't enough balance
    > sheet out there to handle the refinance tsunami on the horizon.
    > We need securitization.
    12 Jul 2009, 12:05 AM Reply Like
  • Senior Carl
    , contributor
    Comment (1) | Send Message
     
    The plan C folks may find that the best path is to create a replacement for the conduit market that imploded. The fed would initially be the only player in all likelihood, but as it worked to loan to CRE and build / securitize transparent instruments (all containing exactly the same class / size of loan) out of those loans, the other market players should join in. A market is the only way we will get out of this mess in one piece.
    13 Jul 2009, 10:54 AM Reply Like
Full index of posts »
Latest Followers

StockTalks

More »

Latest Comments


Instablogs are Seeking Alpha's free blogging platform customized for finance, with instant set up and exposure to millions of readers interested in the financial markets. Publish your own instablog in minutes.