FDIC’s Crisis Approach

The FDIC recently put forth a policy reiterating strong support for workouts for distressed asset owners. How strong? The FDIC all but gives financial institutions a passing grade even if borrowers default, just so long as they tried really hard. “Financial institutions that implement prudent loan workout arrangements after performing comprehensive reviews of borrowers’ financial conditions will not be subject to criticism for engaging in these efforts, even if the restructured loans have weaknesses that result in adverse credit classifications,” is how the FDIC puts it.

The agency’s approach to distressed assets has also taken a subtle but distinct shift from several months ago. In September it closed its first distressed deal – but not in the anticipated open auction format. Rather it supported the purchase by Residential Credit Solutions of Fort Worth of a $1.3 billion loan portfolio from the Franklin Bank in Houston. It was, American Banker observed at the time, a good way for the FDIC to purge toxic assets from banks’ balance sheets.

Not that any of this should come as a surprise: the FDIC like the rest of the government and private sector is still feeling its way through this crisis. If policies don’t always mesh – like giving questionable borrowers an extension and then finding a way to sell off the assets if it comes to that – then so be it. One thing is for sure, the post mortem on these crisis policies will be interesting to follow.

The Taxman Comes

The IRS has gotten involved. Usually that phrase sends shudders down the spines of any nearby listeners, in both business and home settings. Not this time though: last week the IRS issued a guidance that will allow a CMBS loan holder to negotiate a modification for a loan that is heading for trouble – before the loan actually defaults and without onerous tax penalties.

Granted, it won’t solve the impending debt crisis – that is, the billion dollar plus tidal wave of debt that will need to be refinanced in the coming years. But like TALF, it is going to nibble away at the edges of the problem. Not all – but a good portion – of the loans that may default are still solid endeavors: the building fundamentals are strong – although probably not as good as when the loan was first underwritten. Problem is, the world has changed dramatically and even for still top performing buildings borrowers are having trouble refinancing at 60% LTVs. That is where this guidance will step in. Right now, every bit helps.

More thoughts on a Fannie/Freddie overhaul

Freddie Mac registered some impressive gains this past quarter. Too bad they were the result of mark to marketing accounting for the most part. Yet that hasn’t stopped a rally in both GSE stocks. What I am wondering about if whether the optimism is part of a larger sense that a recovery is underway – particularly in residential housing — or if the reports that the two GSEs are being primed for a major overhaul having any impact.

The CRE community seems to be of two minds about the supposed overhaul – which, frankly I am having a hard time believing is truly imminent. One school of thought is that the GSEs need it. They are hemorrhaging red ink; like a lot of lenders, they are unable to push for real momentum in their lending because of this. The other school of thought is of the it ain’t broke so don’t fix it variety. The GSEs are the only source of capital for multifamily finance right now, so any change in the charter would be a disaster for this space.

For the most part I am in the second camp, just because there is such little liquidity out there it seem foolhardy to risk one of the few reliable sources. But here’s one reason for reform that I do find appealing. If Fannie and Freddie are freed of their nonperforming assets they’ll hopefully begin buying Low Income Housing Tax Credits again. They were the major buyers in this market, which has all but dried up in the last year. Fannie and Freddie aren’t buying LIHTCs because, simply put, there are no profits against which to use the credits. It’d be nice to see that change.

Health care and Fannie & Freddie too?

Is it just me, or doesn’t it seem like this administration has a lot on its plate besides taking on Fannie and Freddie reform? At least for this year. When Congress gets back from recess there will be a huge tussle over health care. And they are going to do all this with no replacement for Lockhart?

Reforming the Rating Agencies

Remember when a 1% default CMBS default rate was a big deal? As we all now know, those are the good old days. We are heading for a $12% default rate by year’s end, if Fitch Ratings is correct in its latest analysis. The company has reported there will be $100 billion in special servicing by that point, up from the current $50 million. Retail and hotel are the most troubled asset classes.

For all that, existing CMBS has been experiencing a rally, with year to date returns more than 20% over benchmark government securities. Some of that is due to rising equity markets and a growing sense that a recovery – at least on Wall Street – is approaching. Some of it is also due to the unprecedented government programs thrown at the problem, such as TALF and the soon to be launched PPIP.

Still, though, few expect to see new issuance even come close to rivaling the halcyon days of the early 2000s – at least until certain safeguards and changes are in place. The rating agencies for one.

Last week the White House released a plan to reform credit rating agencies; its provisions include barring rating firms from consulting with companies they rate and disclosure of “pre-ratings” before a firm is picked. Some are saying it doesn’t go far enough; others protest yet another government regulatory layer – the plan also calls for a separate office to oversee the rating agencies. Like with so many of these new programs it is difficult to say whether the cure is worse than the illness, especially with financial metrics all over the board: a 12% default rate versus a 20% return year to date. Can anyone say definitively either is solely the result of misguided/insightful government intervention.

Inching to a Debt Solution

The clock is ticking on the debt refinance crisis. Not that we need a recap, but briefly the problem is this: there is anywhere from $400 billion to $700 billion of real estate debt that will need to be refinanced over the next few years. With the CMBS market out of commission, much of it will go into default.

The government is moving towards its own vision of a solution: mainly TALF, which has been expanded to include both new and legacy CMBS and PPIP, which has been announced but little else by Treasury. Also, the Obama Administration’s plan to realign the financial sector regulatory authority includes new safeguards for CMBS.

While the program has gotten off to a slow start, it’s been widely rumored there will likely be some kind of new issuance in Q3 – and certainly by Q4 with TALF as the driver.

Slowly, though, there are other, more independent signs of life in the private sector of some kind of CMBS revitalization: The so-called re-REMICs that hit the market last month. Such issuers as Morgan Stanley, Bank of America and Credit Suisse essentially resecuritized CMBS loans after realigning the risk profile to be more favorable to investors. It’s not as good as having new orginations – basically the re-REMICs are just nibbling away at existing inventory. But then again, any activity in the securitization market these days is a good thing. Whether the combined efforts of the government and private sector will be enough to beat the clock on the first wave of expected debt defaults, remains to be seen.

Straight Answers Please on Toxic Debt

The government – first under Bush and now under Obama – is developing a serious creditability problem with the business community with its zips and zaps as it tries to solve this crisis. Leaving aside the very big issue of lax enforcement and certain agencies that did not pick up on wrongdoing and rouge asset managers ( I am looking at you SEC) I have been sympathetic with both administrations as they have grappled with this crisis: after all, they are dealing with an incredibly complex and interlocked economic meltdown, unable to consult the history books to map our way out. But shifting back and forth –and then back again – on strategies is not helping. FDIC is sending off signals that it is no longer going to package up and sell off toxic debt (tinyurl.com/p3gclf). Is PPIP next? A straight answer would be nice.

K-Certificates and the capital markets

Freddie Mac has been talking about an exit strategy for the multifamily mortgages its purchases for a while: rolling out the K-Certificates (http://www.globest.com/news/1418_1418/washington/178869-1.html) could not have come at a better time. You know the drill why: lending is at a standstill unless you are a stellar sponsor and project and so on. There are a lot of reasons for this state, starting with the fact that the capital markets are frozen solid.
For sure, Freddie Mac’s new debt plan is going to free up liquidity in the multifamily market – which has fared better than other asset classes thanks to the GSEs. The bigger question is whether these securitizations – which come with a Freddie Mac guarantee – will spur more movement in the capital markets. It’s tempting to think they will; there has been talk of bringing new CMBS issues to market (http://www.globest.com/news/1415_1415/insider/178811-1.html). I’m betting that while the K-Certificates won’t alone pry open the markets, they will at the very least provide a model for what real estate securities should look like in their next incarnation. One of the problems with the CMBS was that originators did not retain any of the risk. Securities with some form of guarantee could be the answer.

Life insurers and TARP

Will life insurance companies be the next shoe to drop – that is, flounder, fail or otherwise need a 23rd hour bailout? Technically the answer is no, since most of the largest ones are now eligible for TARP funding and will presumably use the funds to bolster balance sheets. The question is, will all of the life insurance companies found eligible to take the funds – now and down the road – actually do so. Ameriprise and Prudential, among the first wave of companies approved by Treasury last week (http://www.globest.com/news/1411_1411/washington/178704-1.html) , are declining the funds; Ameriprise on the grounds that its capital is more than adequate. To a certain extent life insurance companies have less wiggle room in declining or accepting TARP funds because of different regulations regarding their capital adequacy. Still, though, watching banks struggle under the restrictions that come with TARP funds – not to mention the number of banks that are repaying or trying to repay TARP – has no doubt made an impression on life insurers. There is also a perceived ‘taint’ of taking on TARP funds by shareholders and analysts. How much the industry is in need of TARP funds is debatable – but it should be noted that they also gorged on MBS and CMBS securities.

Like or not the biggest factor that appears to keep these companies from participating in TARP are the restrictions on compensation. Treasury should keep this in mind as it refines its plan for PPIP – the program it’s working on to buy up toxic or legacy debt. If banks and (maybe) life insurance companies are turning away needed funds because the money comes with strings attached, how will it convince investors to participate who don’t necessarily need the government to invest in a bargain basement security.

Five-Year Terms Coming for TALF

If the latest rumors — not to mention a recent flurry of news reports -– are any guide, the Federal Reserve Bank is going to allow longer loan terms under the TALF, or Term Asset-Backed Securities Loan Facility program. Specifically, it will permit five-year loans in the program; currently it is limited to three year-terms.

There is anecdotal reason to believe the rumors are true: the Federal Reserve has been receptive to the arguments by the commercial real estate community that 1) a crisis is looming with upcoming CBMS debt that will require refinancing and 2) there is no other place for this debt to be refinanced other than the government – at least not right now.

Problem has been, the government has moved at a glacier pace to respond to these issues. When TALF was first unveiled last year, it didn’t include commercial real estate backed loans at all; it was aimed primarily at the consumer markets. Later real estate was brought back into the fold; but at terms that were not a practical solution to the industry woes.

So here we are now: hopefully on the cusp of another step forward no matter how delayed. However there are a number of other measures that need to be taken – some of which are more amorphous than merely allowing five-year loan terms. Chief among these is a greater sense of certainty about the role of the government and what it expects from participants. The flap over the AIG bonuses – no matter how justified the outrage – has had a chilling affect on the industry. The reasons are both self-serving – no self-respecting, profit-seeking banker is going to rush to embrace a program that limits his or her pay – as well as practical. If the government can backpedal on contracts when public fury is whipped up, how will it react when TALF or PPIP (the Public Private Investment Partnership program for toxic debt) becomes a target for public ire?

Some of these doubts may be hindering TALF’s progress already — although that is a difficult call to make with any certainty. For sure TALF has not gotten off to a rousing start: in the first round only $4.7 billion in loans was requested; that number dropped to $1.7 billion in the second round.

It may be that the borrowers are waiting to see how the program unfolds; or to get a better sense of where the economy is heading. But those numbers do not bode well for commercial real estate – even if a five-year loan term is part of the mix.