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- With $770B of the $1.4T in commercial mortgages maturing in the next five years currently underwater, FDIC revises its rules (.pdf) to allow banks to keep loans on their books as 'performing' even when the underlying properties no longer cover the outlay.
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This news story has 44 comments:
The fact of the matter, as Sam Zell and others have observed, is that most of the owners are able to make their payments because the cash flow from the properties is sufficient to cover debt service. The decline in market value is heavily influenced by increased cap rates and more restrictive underwriting by banks. It's a catch 22, you can't borrow money because the market price has declined because banks aren't lending under the same terms as before. Under the circumstances the banks have been extending and have now received regulatory approval of their actions.
But the regulators are careful to provide a long and tedious set of examples, which abundantly clarify that pretending is not acceptable. Extending a loan when the borrower does not have the ability to repay will not excuse the banks from recognizing a loss on the situation.
For the mark to market vigilantes, the Fed is not modifying GAAP, just using common sense, if the customer makes the payments the loan is performing. That's what performance is, making the payments.
Not stated explicitly, the Fed is also trying to provide clarity so the banks don't over-react in the other direction and deny credit to those who are able to pay, thereby creating losses where none had to be. All in all, a good approach, and one that makes me more comfortable with the prospect of a successful resolution of the CRE crises.
This isn't for the banks, its for the FDIC, so they can push back the number of bank failures for a bit to replenish their own coffers.
On Oct 31 08:37 PM Karen Consumer wrote:
> The banks have already denied credit to those consumers (the prime
> and employed) able (and willing) to pay, so why would they suddenly
> change for businesses, especially those banks that are only servicing
> the debt?
>
> This isn't for the banks, its for the FDIC, so they can push back
> the number of bank failures for a bit to replenish their own coffers.
Most homeowners can't refi due to D/E ratios even though they may have healthy income...such a rule would solve that problem.
On Oct 31 08:05 PM Tom Armistead wrote:
Except that "kicking the can down the road" may have other perils too. The road maybe winding, the slope maybe steep down, and the road's surface maybe slippery due to ice and water. Look out, it could be a really skidded ride.
one of these days Tom, the lies are going to getted stopped.....and i'm sure they'll be a poster like you bemoaning the lack of lying in america...
Let Big Money go down, come down, with the rest of us for a change.
Would you lend money to over-indebted, insolvent clients?
Why are Americans insolvent? Because of the banks providing cheap money for so long.
The answer: raise interest rates. Get tough. Get disciplined. Face the pain now and give up the party mentality.
"Turn out the lights, the party is over. We know that all good things must end..."
I know accountants would rather be precisely wrong than vaguely right, but banks have a moral obligation to provide accurate information.
If a property is underwater, then the bank should write down part of the value of the loan even if the loan is performing.
On Oct 31 08:05 PM Tom Armistead wrote:
> A lot of the indignation that has been prompted by this release,
> whether sourced from the Fed or from the FDIC, is misplaced. It
> runs to more than 30 pages and critics would do well to read the
> entire document before jumping to conclusions.
>
> The fact of the matter, as Sam Zell and others have observed, is
> that most of the owners are able to make their payments because the
> cash flow from the properties is sufficient to cover debt service.
> The decline in market value is heavily influenced by increased cap
> rates and more restrictive underwriting by banks. It's a catch 22,
> you can't borrow money because the market price has declined because
> banks aren't lending under the same terms as before. Under the circumstances
> the banks have been extending and have now received regulatory approval
> of their actions.
>
> But the regulators are careful to provide a long and tedious set
> of examples, which abundantly clarify that pretending is not acceptable.
> Extending a loan when the borrower does not have the ability to repay
> will not excuse the banks from recognizing a loss on the situation.
>
>
> For the mark to market vigilantes, the Fed is not modifying GAAP,
> just using common sense, if the customer makes the payments the loan
> is performing. That's what performance is, making the payments.
>
>
> Not stated explicitly, the Fed is also trying to provide clarity
> so the banks don't over-react in the other direction and deny credit
> to those who are able to pay, thereby creating losses where none
> had to be. All in all, a good approach, and one that makes me more
> comfortable with the prospect of a successful resolution of the CRE
> crises.
The owner of the property has a lot of leverage in this situation because they can pretty easily walk away from the property or force the bank to re-negotiate the terms to avoid taking the property back in this market. Then, the banks will have no choice but to take write-downs to the market price of the property.
So this "solution" will kick the can down the road, but probably not too far, since we're talking about relatively short-term financing on CRE, as opposed to the 30-year terms of residential properties.
While there is definitely a lucrative 2nd and 3rd mortgage market now, things change when you've bought a property based on a certain pro forma, and that pro forma no longer works with higher interest charges that you hadn't counted on.
One thing I can say for sure, while the banks should be quite happy with the relaxing of the rules, they are certainly not going to do you any favors when their butts are on the line.
^ What kids in europe and asia will be reading in their history books in a decade or two..
Who the hell in their right mind would want to close thousands of banks at once?
Despite the death of inflation one can easily see the popularity of gold.
If this were a TEMPORARY decline in the U.S. commercial real estate market, then such desperation measures might be justifiable over the short-term.
However, the bubble-prices of these assets are NEVER coming back unless/until hyperinflation grips the U.S. economy - in which case the real-dollar value of these assets will still be only a tiny fraction of their bubble-inflated prices.
As others have observed, this is simply another way to do even MORE "extending" and even MORE "pretending" in yet another fraud-based, U.S. asset market.
On Oct 31 08:05 PM Tom Armistead wrote:
> A lot of the indignation that has been prompted by this release,
> whether sourced from the Fed or from the FDIC, is misplaced. It
> runs to more than 30 pages and critics would do well to read the
> entire document before jumping to conclusions.
>
> The fact of the matter, as Sam Zell and others have observed, is
> that most of the owners are able to make their payments because the
> cash flow from the properties is sufficient to cover debt service.
> The decline in market value is heavily influenced by increased cap
> rates and more restrictive underwriting by banks. It's a catch 22,
> you can't borrow money because the market price has declined because
> banks aren't lending under the same terms as before. Under the circumstances
> the banks have been extending and have now received regulatory approval
> of their actions.
>
> But the regulators are careful to provide a long and tedious set
> of examples, which abundantly clarify that pretending is not acceptable.
> Extending a loan when the borrower does not have the ability to repay
> will not excuse the banks from recognizing a loss on the situation.
>
>
> For the mark to market vigilantes, the Fed is not modifying GAAP,
> just using common sense, if the customer makes the payments the loan
> is performing. That's what performance is, making the payments.
>
>
> Not stated explicitly, the Fed is also trying to provide clarity
> so the banks don't over-react in the other direction and deny credit
> to those who are able to pay, thereby creating losses where none
> had to be. All in all, a good approach, and one that makes me more
> comfortable with the prospect of a successful resolution of the CRE
> crises.
Consequently, the default rates on CRE are and will remain substantially less than on residential properties. And, a critical reason why this will occur relates back to the preceding two points:
Most CRE borrowers remain operationally cashflow positive, regardless of declines in market values of their properties. Therefore, it makes absolutely no sense for them to "walk away" from loans because their operating economics depend on cashflows, not the temporary market value of a property(ies) not for sale. If a borrower in such a situation were to abandon their assets and default on their loans, they'd lose their operating income, all their hefty downpayments, ruin their credit and have no resources with which to restart operations elsewhere to generate new cashflow. So, continuing to pay and waiting for market recovery is the sensible play.
Given that various forecasts peg the projected maximum CRE default rate to occur sometime in 2011 at around 5.4%, there's no reason that the industry, as a whole cannot weather this downturn. After all, the last major pullback, 1989-1992, saw defaults reach the same numbers, so, despite all the media hype, unless there is sone radical change in conditions, we're not looking at some CRE collapse of epic proportions, as seems too commonly believed.
Will some borrowers go bust, unable to carry their financing through the cycle? Of course. Will the entire industry melt down? Not likely.
Now, if they change the rules for mortgages that are NOT being paid on a current basis, whether or not they are underwater, then, Houston, we really do have a problem.
As long as Sheila Bair is heading the FDIC, I don't expect the latter to happen. NTL, her continuing (& absolutely correct) objections to the Obama administration's various financial initiatives may lead to her early (& unvoluntary) resignation. Then what????
On Nov 01 10:36 AM Tack wrote:
> Typical CRE lending differs from residential lending in two important
> ways: 1) CRE usually requires high downpayments, unlike the fantasy
> 100-125% no-docs nonsense that passed for recent residential lending,
> and 2) CRE loans are backed both by the borrower's finances and by
> an anticipated stream of income, whereas, typical residential loans
> are supported by a buyer's income alone.
>
> Consequently, the default rates on CRE are and will remain substantially
> less than on residential properties. And, a critical reason why this
> will occur relates back to the preceding two points:
>
> Most CRE borrowers remain operationally cashflow positive, regardless
> of declines in market values of their properties. Therefore, it makes
> absolutely no sense for them to "walk away" from loans because their
> operating economics depend on cashflows, not the temporary market
> value of a property(ies) not for sale. If a borrower in such a situation
> were to abandon their assets and default on their loans, they'd lose
> their operating income, all their hefty downpayments, ruin their
> credit and have no resources with which to restart operations elsewhere
> to generate new cashflow. So, continuing to pay and waiting for market
> recovery is the sensible play.
>
> Given that various forecasts peg the projected maximum CRE default
> rate to occur sometime in 2011 at around 5.4%, there's no reason
> that the industry, as a whole cannot weather this downturn. After
> all, the last major pullback, 1989-1992, saw defaults reach the same
> numbers, so, despite all the media hype, unless there is sone radical
> change in conditions, we're not looking at some CRE collapse of epic
> proportions, as seems too commonly believed.
>
> Will some borrowers go bust, unable to carry their financing through
> the cycle? Of course. Will the entire industry melt down? Not likely.
On Oct 31 08:05 PM Tom Armistead wrote:
> A lot of the indignation that has been prompted by this release,
> whether sourced from the Fed or from the FDIC, is misplaced. It
> runs to more than 30 pages and critics would do well to read the
> entire document before jumping to conclusions.
>
> The fact of the matter, as Sam Zell and others have observed, is
> that most of the owners are able to make their payments because the
> cash flow from the properties is sufficient to cover debt service.
> The decline in market value is heavily influenced by increased cap
> rates and more restrictive underwriting by banks. It's a catch 22,
> you can't borrow money because the market price has declined because
> banks aren't lending under the same terms as before. Under the circumstances
> the banks have been extending and have now received regulatory approval
> of their actions.
>
> But the regulators are careful to provide a long and tedious set
> of examples, which abundantly clarify that pretending is not acceptable.
> Extending a loan when the borrower does not have the ability to repay
> will not excuse the banks from recognizing a loss on the situation.
>
>
> For the mark to market vigilantes, the Fed is not modifying GAAP,
> just using common sense, if the customer makes the payments the loan
> is performing. That's what performance is, making the payments.
>
>
> Not stated explicitly, the Fed is also trying to provide clarity
> so the banks don't over-react in the other direction and deny credit
> to those who are able to pay, thereby creating losses where none
> had to be. All in all, a good approach, and one that makes me more
> comfortable with the prospect of a successful resolution of the CRE
> crises.
This is what we would have liked to have for home mortgages. They seem to be living and learning.
So, they are trying to keep honest people honest.
No matter the rule, you cannot keep dishonest people honest. But you still need guidelines and rules.
I thought the main reason this was on everyone's radar screen was precisely that CRE investors were not cash flow positive, and needed to straighten their finances out in bankruptcy. See Capmark from last week:
www.bloomberg.com/apps...
To say that most of them are cash flow positive would mean that the economy is humming along, business as usual.
I'm sorry, but I just don't see any of that as being true.
On Nov 01 10:36 AM Tack wrote:
be subject to much more stringent regulation...so commercial real
estate delinquency rates will have a greater impact on lenders to chargeoff loan faster.....monitor delinquency rates...
On Nov 01 10:30 AM Jeff Nielson wrote:
> I see there are still a number of bankster 'apologists' alive-and-well
> at Seeking Alpha.
>
> If this were a TEMPORARY decline in the U.S. commercial real estate
> market, then such desperation measures might be justifiable over
> the short-term.
>
> However, the bubble-prices of these assets are NEVER coming back
> unless/until hyperinflation grips the U.S. economy - in which case
> the real-dollar value of these assets will still be only a tiny fraction
> of their bubble-inflated prices.
>
> As others have observed, this is simply another way to do even MORE
> "extending" and even MORE "pretending" in yet another fraud-based,
> U.S. asset market.
(75% LTV) and the property is now worth 6 million...55% decline in value...they must have bought higher than the market highs....
On Nov 01 08:45 AM battman wrote:
> I think the banks will now ask for an equity injection from the borrower
> to try and make things more "on side". A $ 10 million loan for a
> property now worth $ 6 million, would probably need a $ 4 million
> injection of fresh capital. This could prove problematic and create
> an even more lucrative mortgage market for 2nd and 3rd "high risk"
> mortgages (or simply the dreaded default they're trying to avoid).
> Would the "performing" mortgage be offside now with a new 2nd mortgage
> at a 3% or 6% higher rate and all its associated fees?
> While there is definitely a lucrative 2nd and 3rd mortgage market
> now, things change when you've bought a property based on a certain
> pro forma, and that pro forma no longer works with higher interest
> charges that you hadn't counted on.
> One thing I can say for sure, while the banks should be quite happy
> with the relaxing of the rules, they are certainly not going to do
> you any favors when their butts are on the line.
I took your scenario a step farther and applied some rough numbers to it. I don't necessarily agree with your assumption of 75% ltv - I think it was typically higher than that, which magnifies the problem even further, but I used what you have started.
I did this quickly with a sheet of paper, so I took liberies in the rounding. If a $10MM loan was used to purchase an asset for $13.3MM, and assuming a 7% CAP rate the Net Operating Income (NOI) would have been $930K and the debt service would have been 720K at a 6% rate, resulting in net cash flow of $210K. I assume that NOI is made up of just over $1MM income and 100K of non-recoverable costs (10% of income).
Now lets assume that the rent drops 17%, which is what we have been seeing in the office sector. That would be 860K in income and the non-recoverables would not change very much. In fact they might increase due to increased marketing, a shouldering of the utilities cost that may have been paid by the former tenant, etc. NOI is now $760K and the income now barely covers the debt service (it probably doesn't at the end of the day by the time we clean up my rounding and throw in other non-recoverables that I ignored for the sake of simplicity). The CAP rate may now be 9-11%, which we are clearly seeing throughout the industry. If we take the better end of that at 9% our value based on income is now $8.4 MM. It is easy to see why an owner with non-recourse debt would consider walking away.
Now going back to my original statement we realize that an entire industry fell into this trap. We are not talking about a few that paid above market. Over the next few years as these loans roll over this will play out over and over and....
On Nov 01 12:32 PM bbro wrote:
> A 10 million loan implies the property was worth 13.3 million
> (75% LTV) and the property is now worth 6 million...55% decline in
> value...they must have bought higher than the market highs....<br/>
His take: most borrowers will be able to make their payments because the cash flow on the important (institutional) property is sufficent for that purpose.
As far as whether the banks will extend loans as they expire, Zell says they're in the business of lending money and CRE is too big to walk away from.
Jamie Dimon, who has walked through shit and come out smelling like a rose on this whole thing was asked about CRE on the last conference call. He replied to the effect that the area is attracting capital. REITs have raised 19 billion this year at last count, backing up Dimon's point of aview.
Please be aware that much CRE lending is done by Regional and Local Banks, it is their bread and butter and they are not in the position of the Investment banks to think they can make it up trading derivatives.
So I will rely on the opinions of Zell and Dimon, they are credible.
On Nov 01 10:30 AM Jeff Nielson wrote:
> I see there are still a number of bankster 'apologists' alive-and-well
> at Seeking Alpha.
>
> If this were a TEMPORARY decline in the U.S. commercial real estate
> market, then such desperation measures might be justifiable over
> the short-term.
>
> However, the bubble-prices of these assets are NEVER coming back
> unless/until hyperinflation grips the U.S. economy - in which case
> the real-dollar value of these assets will still be only a tiny fraction
> of their bubble-inflated prices.
>
> As others have observed, this is simply another way to do even MORE
> "extending" and even MORE "pretending" in yet another fraud-based,
> U.S. asset market.
Why does this document even exist? It seems to be a rehash of rules
that any prudent lender should be following anyway.
Why is the government doing this? These lenders should be paying a
third party to monitor their portfolio and publish ratings. Just as
they do with accounting firms.
The immediate response to that is probably, 'Look at the stock rating
agencies and how they failed'. And my response to that is, if they
don't do their job they should be liable for fraud charges and go to
prison. The firm goes under because it wasn't responsible. The
investors are responsible for their decisions and not a government
regulator. That is what got us in this mess in the first place.
This is all because of the faulty design of our financial system. We
control the dependent variable (interest rates) and let the
independent variable which should be closely controlled (money supply)
float freely. And we let the people controlling the money supply
(financial institutions) be the same people that are profiting by
money supply. What a disastrous control system design! It's why we
have blow ups in the economy every 5 years or so. Of course, there is
probaly no one at the Fed or in Congress who even understands control
theory and systems theory. :-)
So, my non emotional response after reading the document, is that I
agree with those who say this is yet another way to kick the can down
the road, hoping that the inflation currently being engineered by the
central banks will kick in in time to 'rescue' these financial
institutions. Never mind what it does to ordinary people, they don't
count, these large financial institutions must be coddled at all
costs.
This is another consequence of the way our financial system is
designed is that during periods of inflation, financial institutions
get money first when it is created out of thin air, so they use it
while it still has the old non inflated value. The rest of us pay for
that, it is like a tax on every member of society going directly to
the financial institutions. Can you tell that the financial system
was designed by the financial institutions? ;-)
The moral hazard this creates is that it rewards imprudent risk takers
at the expense of prudent investory. If these assets were liquidated
at current market rates, those who purchased them would be those who
were prudent enough to keep their assets through the meltdown. Our
current policy leaves those assets with the institutions who caused
the meltdown through their imprudent policies. Future disaster.
On Nov 01 12:32 PM bbro wrote:
> A 10 million loan implies the property was worth 13.3 million
> (75% LTV) and the property is now worth 6 million...55% decline in
> value...they must have bought higher than the market highs....<br/>
the entire point of MINE is, these reg's come out of the woodwork, not due to the intelligence of the gov't hacks, but by phone call pressure from BANKS!!! get it????? this is why people are irate, or.....emotional....
They will take another government hand up and turn it into a temporary profit centre until the s**t hits the fan again.
Will we ever learn? Who knows.
Just because CRE is built on the tradition of refinancing these amounts when they come due every three years or so does not mean we should all just shrug when they REIT is unable to refinance at the end of the term. Using the "but it's not my fault it's the credit market" defense is weak. It doesn't work for the consumer so why should it work for the REIT?
I know why it DOES work -- because the banks can't afford to have all this worthless property on their hands and don't want to deal with the writedowns. Just as they are dragging their feet on home foreclosures for the same reason. But knowing why it happens and accepting that everything is okay in CRE land are two different things.
I have read a lot about how GGP has their lenders over a barrel because they are basically forced to extend these massive loans (and these FDIC rules are just clariying that the banks will not be penalized for making these extensions), but I can't express how angry that makes me. Borrowing money is supposed to be about using capital to make an investment and paying back the money from the profits. It's not supposed to be about a whole bunch of glib investors who snark that "the banks can't touch us or they'd lose their shorts." Am I wrong in thinking this is not how the process is supposed to work?
its fucking SICILIY!!!!!!!!!
Be upset because it's not fair, but don't be so naive as to cut your ears, nose, lips and eyes off just to spite your face.
Along these lines, There is nothing wrong with doing what we need to avoid systemic collapse.
But you'd better believe there is hell to pay once the gun has been taken from the 8 yr old and there are measures put into place to punish him so that he learns the error of his ways and to ensure that he never gets hold of another gun....
And along these lines we need to (but won't) punish those who put all of our lives in danger and do what we need to do to ensure this won't happen again.
The advice of "listen to the eight year old, he has a gun" is only half the story. The missing piece of the puzzle is how this is going to be dealt with when we are out of the woods.
On Nov 02 02:06 PM battman wrote:
> It's not Sicily, it's common sense. The entire world, never mind
> just the US, can not afford for the system to cave in on itself.
>
> Be upset because it's not fair, but don't be so naive as to cut your
> ears, nose, lips and eyes off just to spite your face.
On Nov 02 09:28 PM rick flair wrote:
> This is the quintessential reason why america will fail, because
> no one has the nuts left to do the hard stuff.