FDIC Securitization and What It Would Mean for PPIP

It is looking likely the FDIC will eventually begin to securitize assets it has taken over from failed banks. There are a lot of reasons to like this plan, if you are in the industry  — it could jump start private sector activity, providing a road map or model at the same time. It could also stabilize – or rather, put concrete valuations — on distressed asset prices.

Of course if you are a taxpayer or perhaps a private sector buyer that has been waiting patiently for the prices of distressed assets to, well, reflect their distressed situation, this is not necessarily good news.  Last year the Treasury Department’s PPIP asset managers, having raised the necessary capital, set out into the market to quietly buy up such assets. With little transparency it is difficult to know where they are in the process; for all we know, they have begun accumulating securities and notes already.

One thing is clear – these two programs could wind up working at cross purposes. A FDIC distressed asset securitization would benefit from stable — and higher – distressed prices. The PPIPs, though, will not.

Getting Ready for Shoe #2

Signs are growing that commercial real estate’s precarious hold on stability may be slipping. Since the start of the year, federal regulatory authorities have shut down nine banks – a whopping five alone last Friday in New Mexico, Oregon, Washington, Florida and Missouri.

Commercial real-estate losses were responsible for a majority of the nine failures, according FDIC.

Another grim metric: GE Capital posted a small profit last week – which would have been higher had the company not been dragged down with sour commercial real estate loans.

Ever since the start of the crisis, there has been a race between the huge pile of debt coming due – debt that was underwritten against standards that will never fly in this market – and policy makers and industry representatives hastily putting together unprecedented rescue programs that might bridge the gap.

While there was plenty of argument about the stimulus package and its effectiveness, rescue measures for the commercial real estate industry – namely TALF – have been deemed a success.

Now the question is, as the number of failed banks grows – not to mention sour real estate loans – were these measures  enough to stem the rising flood that is clearly coming.

Much Ado – or Not – Over New Financial Regs

Much ado is being made about the Obama’s Administration’s proposal to overhaul the financial sector. To be sure, for the commercial real estate industry there is much to fret about – and hope for. So far, industry representatives are getting what they have lobbied for. CMSA, for instance, was delighted that the House version of the bill grants regulators the flexibility to allow a third-party investor – namely a B-piece buyer — to satisfy the legislation’s new retention requirements.  1031 exchange companies, for their part, are happy to see that that same bill has carved out regulatory oversight for their piece of the industry under this new agency.

All of this is important, but at the same time, new regulations in other quarters of Washington are quietly being redone or formed. The American Council of Life Insurers, for example, has been considering new capital guidelines for mortgages that insurers directly provide for commercial buildings, according to a recent article in the Wall Street Journal. The rules would call for establishing risk profiles of the individual mortgages rather than benchmarking insurers’ mortgages to an industry average.

Life insurance companies, never the most transparent about their investment allocations, are nevertheless showing signs of investing more in commercial real estate this year. How these rules, if implemented, will impact that remains to be seen.

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.