CRE Financial Advisors

Chasing Growth

2011-11-17T14:46:00.001-08:00

Long Term Challenges and Opportunities Inside the North Dakota Energy Boom

North Dakota and its economy have gotten a whole lot of good press in the past year. Though a sparsely populated state (it is the third least populous, with 672,591 residents according to the 2010 census) and relatively small economy in the greater scheme of things, the state has been a star economic performer in an anemic US economy hungry for stars. An oil boom has sprung up in the western part of North Dakota. The western part of the state is located over multi-state oil reservoirs known as the Bakken and Three Forks.

Almost overnight over 20,000 challenging, physical, good paying drilling-related jobs (with lots of overtime) arose in North Dakota. Over 40,000 jobs may have been added to the region in total due to the industry’s multiplier effect. Unemployed and opportunistic workers flocked to the upper Midwest. Official statistics have not caught up to tally and measure accurately the growth and many jobs in western North Dakota remain unfilled.

High oil wages have revived and re-inflated once sleepy locales. Support services and housing supply have lagged behind this huge surge in demand. Meanwhile local workers drawn into the industry have left a vacuum in the lower wage employment base of the state affecting, adversely, the economics of smaller businesses. Labor is short, there is no room at the inn. Real estate developers too have descended on the communities to try to capitalize on the boom and an address an extreme housing shortage.

Is This What 21st Century Growth Looks Like?

North Dakota oil exploration started in the early 50’s and experienced numerous booms (and busts). The biggest such expansion and sudden collapse occurred in the late 1970's and early 1980’s

New technology has energized the North Dakota oil industry once again (and this one many believe may have legs). Superior deep lateral drilling techniques and the ability to loosen up tight oil pockets in shale and recover once difficult to reach oil though the high pressure injection of specialized (and sometimes controversial) fluids means almost all wells yield and initial well production levels are high. North Dakota oil extraction is profitable at $50-60 per barrel prices even as North Dakota Sweet well head prices have been discounted for distance and transportation costs to refining locations. Rail and pipeline operators are re-configuring their systems to get Midwestern oil to market cost-effectively.

Daily production is exceeding 450,000 barrels per day. North Dakota is the fourth biggest oil producing state, rising fast and may surpass (number three) California soon.

Roughly 200 drilling rigs are operating in the state creating approximately 2000 new wells per year, a level that may soon surpass the levels established in the 1980’s boom. The North Dakota well count will soon hit 7000. Estimates of recoverable oil (depending on who you talk to) are from 4 billion barrels on the low side to all the way up to 24 billion on the high in an extraction process that might span decades. Again, depending on the point of view, anywhere from 20,000 to as many as 50,000 wells may be drilled ultimately in a field that could play out over 15 to 20 years or longer.

The immediate economic impact has been huge. Drilling wells is extremely resource and labor intensive and time sensitive. Each new well can cost up to $10 million to complete and is a costly race against the clock. But the tech advances of inventive, independent oil producers dominating the North Dakota play continue to make the process more and more efficient.

Each well needs a huge volume of supplies:

“Fresh water is needed to frac a well in order to create clean fractures which allow oil to best flow from the rock to the wellbore. Three million gallons of water and two to three million pounds of sand or proppant are needed per well."

Drilling-related truck traffic has spiked in the race to get drilling supplies in and product and waste materials out. Trucks have torn up North Dakota’s county road systems unprepared for the level of activity. Counties are racing to keep up with repairs and find sources to pay for upkeep of the overburdened road system. Road materials are in short supply. Further constraining the ability for infrastructure to catch up to demand is the region’s limited construction season. Road work and construction halt for at least half of the year. The winters on the plains are severe.

As many as 100 employees are required per drilling rig (or 20,000 in total on the 200) and temporary housing has sprung up for workers. Much of this housing has been constructed by logistics firms and paid for by oil companies. An estimated 20,000 workers are housed in “man camps” in 17 western North Dakota counties. These dense camps provide high levels of service and convenience to workers working long hours in the field. Yet the camps are straining rural infrastructure. In some cases large amounts of waste water had to be trucked to nearby cities for treatment. One resourceful logistics firm has constructed a regional waste water treatment plant to process and recycle camp waste water so that it can be reused in the "field" for fracking fluid or agriculture.

For hundreds of incoming workers not lucky enough to be housed in the company or private camps there are insufficient permanent housing solutions; temporary answers are found in RV and mobile home parks that have filled up as quickly as they were put into service though these alternatives may not be ideal given North Dakota’s extreme winter conditions. Some workers live in their cars.

Cities and counties are also dealing with the strains of explosive growth on medical, social and educational infrastructure. They are needing to staff up. It is hard to know where they should begin.

The effects of labor and resource scarcity are being felt in nearby and not so nearby MSA’s. Obviously Minot and Bismarck ND are in the line of fire but the cities of Fargo, Billings and Rapid City are feeling the effects of rapid growth occurring hundreds of miles away.

Housing Evolution

In the short run drilling occurs at a frenetic pace to establish productive leases and create long term units of production. Over time, as drilling activity matures and gradually winds down, drilling is replaced by the significantly less labor intensive resource extraction and maintenance.

The key for housing is to meet labor intensive short term needs and at the same time anticipate the evolution of the Bakken/Three Forks play as the extraction cycle matures. And word is that the workers want out of the man camp's constrictive spaces in the worst way. Employee retention is becoming a problem.

Staffing new construction is a chicken and egg problem as well. Imported construction labor needs housing too.

To aid cash strapped local communities North Dakota is facilitating residential development in the western part of the state by providing $100 million in impact grants that communities can use to fund extension of sewer and water services, street construction and the expansion of water treatment plants.

The residential development pipeline in western North Dakota has expanded dramatically. More than 2,300 new housing units will become available in Dickinson; the city is in the process of annexing additional land as well. In Williston more than 1,750 new housing units are in development. An additional 2000 units are planned for smaller communities in the region bringing the total potential housing units (single and multifamily) to 6000-7000 to be delivered in the next 3-5 years. This may be enough supply to house 10-15,000 people. This is a good start.

Ground Force

2011-10-20T16:29:00.000-07:00

It was three years ago when I ran into Kenneth Neatherlin in New York at the Museum of Modern Art (MoMA). It was less than a month after Lehman Brothers had filed bankruptcy and the financial crisis was reaching a noisy crescendo. Like being in the eye of the hurricane, at the center of global finance, most of us were still unaware of the eventual fallout and great extent of the economic destruction that was to follow.

I was drawn to the calm island of MoMA (hidden within the chaotic island of Manhattan) by, among other things, “Home Delivery:Fabricating the Modern Dwelling”, an exhibit that ran in 2008. The exhibit included “eighty-four architectural projects spanning 180 years” and illustrated “how the prefabricated house has been… a critical agent in the discourse of sustainability, architectural invention, and new material and formal research.”

From MoMA to Navasota

Neatherlin founded a company called Ground Force Building Systems located in Navasota TX. If you were trying to boil down what his company does in a investment or sales pitch, like one you might make to a venture capital firm, it might go like this:

“Ground Force Building Systems manufactures, off-site, residential, commercial, medical and educational structures incorporating proprietary concrete foundation systems and patented structure delivery technology that produces high quality, flexible, permanent (and reusable) building structures delivered to, and completed on-site, in shorter time frames than site-built structures thereby reducing construction waste and cost-related risks.”

Neatherlin is one of the entrepreneurs carrying the century’s long torch of prefabricators profiled in the 2008 MoMA exhibit. It is a small specialized group who has persevered in a world dominated by site-built production and a group who, at the same time, have an aversion to the lack of perceived durability and quality of traditional mobile homes.

A quixotic quest? Maybe. But in 2011 Ground Force is rolling dozens of units off its Navasota factory production line; these are completed buildings and building modules on engineered concrete foundations. This is respectable activity given the sad state of the economy and housing industry. I visited the factory in September 2011. It was the first time I had been back to Navasota since the Lehman project Neatherlin and I were working on (located in Austin TX) had halted as a result of Lehman’s bankruptcy.

A Family History of Moving the Immovable

You could say that the concept for Ground Force was born about 10 year ago after Neatherlin sold his Texas site built homebuilding operation (to an affiliate of Lehman Brothers I believe). As Neatherlin tells it, while he was a conventional home builder, he was bothered by the inefficiencies of site-built techniques and technology. He wondered if there was a way to get production out of the weather, to cut cycle times and at the same deliver foundation systems superior to those site built homes offered. The tweaking of the home building model had begun.

Many Texas markets have expansive clay soil that wreaks havoc on conventional foundations. He dug into how a builder could eliminate the movement and cracking of slabs and started down a very long R&D road that focused on coming up with a cast concrete slab and structure that could be transported, handled and delivered without using a crane or any other type of lifting equipment. Ground Force constructs homes or commercial buildings or building modules (in a factory) and delivers nearly complete structures, in their entirety, on concrete foundations.

But the real story of this particular technological convergence starts farther back in Neatherlin’s past.

Rising to the challenge of moving the immovable runs in the Neatherlin family. His grandfather moved the first concrete structure in Houston, Texas back in the late '40s (a store, the story goes, moved with the stock left on the shelves, undisturbed). His dad perfected the hydraulics of the transportation system and moved countless large structures. His great uncle was in the business with his grandfather. Neatherlin and brother and grew up moving houses and structures with their dad and grandfather. As kids they crawled and tunneled underneath slabs and set jacks and raised foundations and loaded structures and trucked them across town or across the state.

Looking back Neatherlin says there was nothing glamorous about moving the unmovable in the Texas heat and dirt. But growing up in the building moving business and research pursued over the last decade led to the idea of marrying the moving of structures with the building of structures. Ground Force now has a broad-based utility patent on just such an integrated building system.

Puzzling Physics

The Ground Force System enables them to handle, hold and transport a completed structure or module in compression. The system’s appearance and functionality is often quite puzzling to the public.

Concrete is strongest when in compression. It cannot be attached to or rest on a surface because it will stress, twist and crack. The Ground Force transportation system consists of a compressive strut that grabs the unit at each end tightly and suspends it over the road. There is no trailer underneath the slab. There is a front end with wheels and back end with wheels. These are parts of what we think of as the normal trailer one sees traveling down the highway. The middle of the trailer is missing, however. Hydraulic cabling pulls together the front and back. The building unit itself makes up the middle of the truck’s “trailer”, like magic.

As the unit is transported down the highway and inevitably bounces the system creates greater compression with the computer-driven hydraulics that offset the transport stresses that maintains equal pressure into the floor of the slab.

The Ground Force patented carrier keeps the structural load in compression without the customary stress and also allows delivery without loading the structure on top of a trailer or needing a crane system. As a building or module moves down the highway at 60 miles an hour (or faster), bouncing does not cause cracks or fractures in the structure. In most cases the buildings arrive without a single stress crack in the drywall or the sheetrock of the building.

Equally important to the Ground Force system is the way Ground Force creates slabs.

The company casts and pours the concrete and has tweaked the composition and slab designs to create a lightweight type aggregate with twice the pressure PSI that most concrete has.

The average thickness of the floor is around three and a half to four inches at it thinnest point. The Ground Force slab incorporates cabling, steel, fibers and aggregate mixtures that translate into the strength that allows buildings to be constructed, handled and delivered on foundations that do not crack. The foundation technology is more closely related to a concrete parking garage deck (in compression) than it is to the flimsier site-built home foundation. It is similar to an engineered concrete section of a bridge overpass.

The smallest building footprint Ground Force produces is 12’x20’ and the largest as big as a 15’x60’. The sizes of a section max out as the weights and widths of transport are managed. Larger buildings are made by joining and tying together multiple sections to create commercial and institutional structures of up to 15,000 square feet.

Each module is placed on drilled piers, one at each corner. The delivery truck simply drives over building site and lowers the module in place. The drilled piers eliminate movement in the foundation.

Production occurs in the 250,000 square foot factory Ground Force occupies in Navasota. The company repurposed a shuttered mobile home plant, using, modifying and improving on an existing production line. The specially trained Ground Force production team is integral to the implementation of a Japanese-inspired continuous improvement process and just-in-time production strategies. Through this production model Ground Force continues to develop and enhance valuable “tribal knowledge” of its processes and system.

Amazing New Apps

Neatherlin believes the system has potential to revolutionize the building industry. First and foremost he maintains that the building system is true ‘flex’ space. His buildings look site-built but the design and engineering of the structure or module means that they can be moved again easily, if needed. Modular design allows the building to be added to or subtracted from or, as in the case of a hybrid structures, combined with site built structure(s). There is residual value to the flexible structures and modules.

Because the foundation system resembles a bridge the structures are natural for coastal and wetland installations where flooding is an issue. Ground Force’s finished products are engineered to be positioned on elevated stilts well above the flood line.

Earthquake prone California is also a potential market for the system. Units placed on engineered drilled piers can incorporate seismic shock absorbing caps that neutralize the effects of the West Coast’s destructive ground movement.

Neatherlin is sure that architects, engineers and designers, once familiar with the system, will create new construction applications that he and his team have not even thought of.

Signed, Sealed and Delivered

Neatherlin does not believe there are any competitors that can do exactly what Ground Force does. It is the company’s holistic approach of handling and delivering structures that distinguishes the firm.

Many sites cannot be accessed by a crane or it is too expensive to deploy a crane to set a 1,500 square foot house that is located in the middle of nowhere.

With these advantages and numerous construction applications Neatherlin hopes to take his unique family of building and transportation technologies on the road.

Ground Force plans to market its technology and processes to modular manufacturers in other parts of the country. Ground Force’s experience at repurposing an idled mobile home plant may also be useful in revitalizing unused industrial capacity located across the US.

The company has perfected the equipment, perfected every system in the factory to be able to handle and deliver the extremely flexible structural applications.

Where To From Here?

Memorialized in the MoMA Home Delivery exhibit was the story of architects, inventors and entrepreneurs that do not let the gloom of the present get the best of them but instead, in the darkest times, derive solutions to problems that may eventually dispel the malaise.

It has been over three years since the economic and financial meltdown has crushed housing markets. We have had plenty of time to look back across the devastation wrought, particularly to the damage done by the housing and finance industries to themselves. A moribund housing sector is generating new home sales at an annual rate of roughly 300,000 per year, down from the 2006 peak of one million homes. Nothing seems to indicate that housing market conditions will improve soon.

Three years after the meltdown Neatherlin pushes ahead with his decade long adventure, ever the optimistic entrepreneur taking on a challenge that few see and even fewer could solve.

How big is his technology? How disruptive? What will be the impact on conventional construction methods?

It remains to be seen.

But what can be seen is that despite the harsh and hostile economic environments in which we operate there are those that keep grinding away, producing one new type of house, one flexible commercial structure, one technological breakthrough, one software application at a time in an attempt to get industries back to working again and to work even smarter this time.

The housing and housing finance industries are a long way from finding new formulas to revive themselves. Eventually they will be restored, slowly and steadily gaining ground.

A Jerry Maguire Moment

2011-10-18T10:27:00.000-07:00

Pimco bond gurus (El-Erian and Gross) have a lot of good ideas about the direction of US economic policy might take as outlined in five points in the New York Times’ Caucus blog:

“The first is housing, staggered by fallen prices, foreclosures and “underwater” mortgages that exceed the value of the homes they financed.

One critical step, Mr. El-Erian said, is for government to ease refinancing rules for homeowners who remain current on their payments but do not meet borrowing criteria. (Mr. Gross observed that these lower-interest-rate refinancings would cost Pimco money on its mortgage investments.)

The second is the labor market, which has steered too many workers toward the housing, retail and leisure sectors, which will not fully recover anytime soon. To create new and better jobs, the government needs a renewed focus on improving math, science and engineering education, as well as job retraining programs to make workers more competitive.

While waiting for education investments to pay off, however, Mr. Gross says the government should finance immediate job creation to shore up the third structural weakness: America’s fraying infrastructure. Updating roads, bridges and airports would provide an engine for reducing unemployment faster.

“You’ve got to create a demand for labor,” Mr. Gross said. “The private sector is not going to do it.” Even if the government must do it directly, he said, “Putting a shovel in the hands of somebody can be productive.”

The fourth weakness lies in lending. Banks, still smarting from the loan losses that resulted from the financial crisis, want to lend to big companies that don’t need money, but not to small businesses that do.

“Credit pipes are clogged,” Mr. El-Erian said. One way to unclog them is a program of public-private partnerships, like the Infrastructure Bank that the Obama administration has proposed.

On the fifth problem, the government’s questionable long-term solvency, the Pimco executives say Republicans and Democrats are both right. Spending on Medicare, Medicaidand Social Security entitlements must be curbed, and taxes must go up — on the affluent and perhaps the middle class, too.

Given the scale of the problem, Mr. Gross says the tax increases proposed in the “grand bargain” that Mr. Obama and Speaker John A. Boehner sought earlier this summer were too small. Instead of $1 in tax hikes for every $3 in spending cuts, he wondered, “How about one-to-one?””

Like a Jerry Maguire I came up with a list of ideas (on the same topics):

The underlying assumption is that the US 'base' has been hit harder by the Super Recession than anyone would like to admit. The US consumer base must be helped by a mix of measures and steps. These steps are the key to the economic recovery.

Big banks received a multi-trillion dollar flood of (necessary) capital to save the financial system; Main Street has yet to see tangible benefits from the flood of capital into the system.

1. US Infrastructure
Strategically important infrastructure is, among other things, food, housing, health, education, energy, transportation and communication systems that supports the healing and long term health of the damaged US household (addressing the hierarchy of needs).

The best way to reverse the decline is to start the bottom of the pyramid, preferably at the household level. Get the US consumer back on his/her feet. The household, the consumer IS the US demand driver.

The mantra is 'nurture the household, nurture the nation'. This is where successful corporate and government strategies should be the same.

Big, hasty and haphazard top-down macro investments, like a flood, are much of the time wasteful and often times become corrupted with corporate cronyism. Like floodwaters the investment runs off quickly and money goes to waste. Big banks got a multi-trillion dollar infusion. Main street has yet to receive a corresponding dividend.

'Trickle down' does not trickle unless there is ground-up demand. Methodical steps must be taken first to water the grass and re-grow the base.

As Pimco suggested above, perhaps rewriting home mortgages on a massive scale that passes along lower interest rates to the US consumer (requiring loan writedowns by big banks mentioned in item 3 below) could encourage consumer cash to flow into the economy and allow the base to begin to contribute to a recovery.

2. Government Solvency
Government spending and administration requires more discipline and feasibility analysis. What spending provides a measurable marginal return? What spending adds both quantitative and qualitative (and sometimes intangible) value? The current moment of political stalemate and partisan paralysis provides an opportunity to reflect on how effectively and how much money is being spent by the government. US spending requires financial discipline. Spending or 'investment' needs to be thoughtful, methodical, transparent and accountable not politicized, hasty, wasteful, reactive or haphazard. That is, it needs to be smart.

3. Bank Lending
Bond vigilantes may or may not want to hear this (depending on their book) but we need to cleanse the banking system of consumer and commercial bad debt once and for all. The hit must be taken and resulting (even large) bank and institutional failures dealt with. When the markets clear they will recover balance and, at a reduced and more manageable basis, be positioned for long term, organic growth.

Without catharsis markets will continue to founder on the fear of bad (euro-like) debt that lies hidden on balance sheets (in markets that continue to be driven by uncertainty, a lack of transparency and incomplete information).

Darkness and uncertainty may be profit centers for high frequency traders but are not desirable for a US system that needs to be righted.

Going forward we need to make a clear distinction between safe, consumer-centric banks and excessively speculative institutions. Then informed consumers can choose where to put their money.

The Consumer Financial Protection Bureau’s efforts and FDIC’s ‘Living Will’ mechanism (if public) will provide necessary, digestible transparency about the practices, balance sheet and riskiness of our financial institutions.

4. Labor Market
We need to line up the labor market and educational infrastructure to jointly and directly address near and long term strategically important demand-side sectors (more than just the much needed repairs to roads and bridges). Education must be informed by labor market data and is about training the workforce to get and to stay ahead of the ever increasing rate of change in the labor market. We long ago left the 20th century Henry Ford economy for a Steve Jobs economic model (we have yet to fully comprehend) in the 21st.

‘Near and long term demand sectors’ might be, for example, the development of ‘smarter’ food, housing, health, education, energy, transportation and communication systems. The tech sector already has incredible and unstoppable momentum towards such disruptive efficiency and systemic change. Disruptive change continues to seep into public sector's systems.

It will take a national strategy, extensive project analyses and extreme patience to tame, turn and reverse the job destruction trends technology and efficiency bring and that we are so fearful of. Success requires iconoclastic thinking. Success requires a 10-50 year plan.

5. Housing
Last, housing values must adjust to long term, sustainable income levels (that will result in greater affordability as assets and loans get written down to under-writable levels). Post catharsis, let housing establish policy-neutral market equilibrium. Don’t prop up the housing (or any) industry artificially.

Encourage and support demand-driven innovation in housing. Housing follows and supports employment, demography and evolving communities.

For example:

Housing that meets the requirements of a more ‘mobile America’.
Housing that meets the requirements of an aging boomer America.
Housing that meets the requirements of a connected America.

Abandoning (soviet-style) supply-driven, credit-fueled, bubble-dependent and exploitative housing (and other) industrial growth models for grassroots, consumer-friendly, thrift-promoting household initiatives is disruptive to the system at first but will create more stable, sustainable, and organic consumer-led growth in the long run.

FDIC Announces Winning Bidders for its Small Investor Program Maiden Sale

2011-08-04T12:45:00.000-07:00

FDIC Structured Sales Summary

Since May of 2008, the FDIC has turned to a “partnership model to sell large numbers of distressed assets (primarily non-performing single family and commercial real estate loans and related real property) held by recently failed financial institutions.”

As of August 2011, the FDIC has closed over 27 structured sale transactions transferring over 39,800 assets and $24.2 billion in unpaid principal balance.

The FDIC has stayed on as a partner in these transactions with the stated goal of capturing upside and appreciation as the loans are worked through and the economy and asset values recover.

The good news is that FDIC structured sales are generating a certain level of public price discovery in the distressed debt markets. The marked down balances provide room potentially for new investors to restructure the loans or liquidate the assets. The ‘reset’ debt levels and/or adjusted real estate asset values may, in the long run lead to healthier, more sustainable and competitive markets.

The First 2011 Structured Sale

In the late spring Commercial Real Estate Direct reported that the FDIC was planning to market $1.5 billion of assets under their structured sales program. No new FDIC sales have been announced this year. The last structured sale from 2010 (RADC/CADC 2010-2 Venture, LLC) closed in January 2011.

In particular, among the assets to be offered, were loans fresh from the January 28 closure of FirsTier Bank. The FDIC sale “involves $300 million of ADC loans on commercial properties in Colorado. They were on the books of FirsTier Bank, a $781.5 million-asset bank in Louisville, Colo.”

Commercial Real Estate Direct also indicated that at the time the FDIC planned to create “two pools, with balances of $160 million and $140 million, and expects to take offers on July 12. Its goal is to make the assets as attractive as possible for small investors...." and is to be known as the FDIC Small Investor Program (“SIP”).

The FDIC Announces Winning Bidders for its Small Investor Program Maiden Sale

On August 4, 2011 the sales of first SIP pools closed. The FirsTier commercial real estate and commercial acquisition, development and construction loans (“CRE/CADC” assets) were sold to Acorn Loan Portfolio Private Owner IV, LLC ("Acorn"). The residential acquisition, development and construction loans (RADC assets) were purchased by HRC SVC Pool II Acquisition LLC (“HRC”).

Acorn is based in Los Angeles, CA and is owned by Calista Corporation, a minority-owned business. As described in their website, “Calista is one of 12 Alaska based Regional corporations established to benefit Alaska Natives who have ties to Lower Yukon and the Lower Kuskokwim River”. Also in the ownership are FACP Mortgage Investments, LLC and entities controlled by Oaktree Capital Group Holdings of Los Angeles. Oaktree specializes in alternative investments. As of June 30, 2011 Oaktree Capital's managed assets totaled $79.5 billion of which $28.2 billion were distressed debt assets.

The FDIC press release indicated that “Acorn paid a total of approximately $25.6 million (net of working capital) in cash for its initial 25 percent equity stake in the LLC holding the CRE/CADC assets; its bid valued the CRE/CADC assets at approximately 65 percent of the aggregate unpaid principal balance (UPB) of such assets. The CRE/CADC assets are comprised of 116 loans with an aggregate UPB of approximately $158 million with the highest concentration in Colorado (96 percent).”

HRC SVC Pool II Acquisition LLC based in New York bought the RADC assets and is an entity controlled by Hudson Realty Capital LLC, also a minority and women owned business. HRC has more than $2 billion of assets currently under management and since the formation of its initial two funds in 2002 the company has closed over $3 billion in transactions according to their website. HRC partnered with Soundview Real Estate, a private equity fund based in Stamford, CT and real estate investor JCR Capital based in Denver.

The FDIC revealed that “HRC paid a total of approximately $14.9 million (net of working capital) in cash for its initial 25 percent equity stake in the LLC holding the RADC assets; its winning bid valued the RADC assets at approximately 43 percent of the aggregate UPB of such assets. The RADC assets are comprised of 97 loans with an aggregate UPB of approximately $139 million with the highest concentration in Colorado (95 percent)."

The bidders could choose from one of two deal structures: “either a leveraged structure (for a 50 percent equity interest) and an unleveraged structure (for an initial 25 percent equity interest)....both winning bids were unleveraged, the Private Owner of each LLC initially will hold a 25 percent Private Owner Interest in such LLC and the FirsTier receivership will hold the remaining 75 percent equity interest until all equity is returned. After the return of equity, the receivership's interest in each LLC will decrease to 50% and the Private Owner Interest will correspondingly increase to 50%."

The FDIC’s stated goal with SIP is to cater to “ the small investor” by offering “smaller sized asset pools and unique structural features to make it more accessible” to smaller investors and to “increase participation in structured sales while maintaining a level playing field for all investors.”

FirsTier Bank's Last Tier

2011-07-19T15:01:00.000-07:00

2011 Structured Sales

In the late spring Commercial Real Estate Direct reported that the FDIC was planning to market $1.5 billion of assets under their structured sales program. No new FDIC sales have been announced this year. The last structured sale from 2010 (RADC/CADC 2010-2 Venture, LLC) closed in January 2011.

In particular, among the assets to be offered, were loans fresh from the January 28 closure of FirsTier Bank. The FDIC sale “involves $300 million of ADC loans on commercial properties in Colorado. They were on the books of FirsTier Bank, a $781.5 million-asset bank in Louisville, Colo.”

Commercial Real Estate Direct also indicated that at the time the FDIC planned to create “two pools, with balances of $160 million and $140 million, and expects to take offers on July 12. Its goal is to make the assets as attractive as possible for small investors. “

Portrait of a Bank Failure, How FirsTier Bank Imploded

As Heather Draper in the Denver Business Journal (February 4th, 2011) very skillfully chronicles:

Not all bank failures are the same, but the stories of troubled Colorado banks this year share a common theme.

Draper’s FirsTier timeline tells the story (we have heard before):

FirsTier, founded in 2003 by banker Joel Wiens and his son, local entrepreneur Tim Wiens, grew to seven branches and more than $900 million in assets in its first six years.

Its growth was concentrated in commercial real estate loans, particularly land and development deals.

The severity of FirsTier’s financial situation first captured regulators’ attention in July 2009. The Federal Deposit Insurance Corp. found that operating losses were rapidly depleting capital and the bank was struggling to maintain adequate reserves for loan losses, according to the findings of an emergency meeting on Jan. 27 held by the state banking board.

At that time, the FDIC concluded that the bank’s regulatory capital was overstated by $10.8 million, its allowance for loan and lease losses “was grossly deficient,” and an additional $8.5 million was required to get loan-loss reserves to adequate levels, the bank board reported.

On Jan. 22, 2010, FirsTier Bank entered into a consent order with the FDIC that required the bank to submit a plan to maintain a Tier 1 risk-based capital ratio of 10 percent of average total assets and a total risk-based capital ratio of 13 percent; to recognize losses on a timely basis; to reduce its concentration of construction and development loans; and to improve its loan underwriting and loan administration procedures.

FirsTier founder Tim Wiens was personally involved in real estate development and seemed to have a high tolerance for risk, maintaining a large concentration of commercial real estate loans long after the FDIC had advised banks in 2006 to lower those concentrations, said local banking analyst Larry Martin, CEO of Denver-based Bank Strategies LLC.

By Sept. 30, 2010, the bank had slipped to “critically undercapitalized” with total risk-based capital of 2.9 percent and Tier 1 risk-based capital of 1.59 percent. (The FDIC considers a bank “well capitalized” when it has a total risk-based capital ratio of 10 percent or more and a Tier 1 risk-based capital ratio of 6 percent or more.)

Officials from the FDIC and the state banking division conducted a special visit to FirsTier early in January, and determined that the bank needed another $10.5 million to cover loan losses, and once those losses were recognized, the bank’s Tier 1 capital would fall to a negative $2.36 million and the bank would be insolvent.

As of Jan. 27, recapitalization hadn’t occurred. The Colorado Banking Board held an emergency meeting and determined “that an emergency exists that may result in serious losses to depositors.”

At the meeting, the board approved the seizure of the bank after the close of business on Jan. 28 and the appointment of the FDIC as receiver/liquidator.

Tier 1 Capital

A bank’s Tier 1 Capital Ratio is an indicator of its strength and ability to absorb potential losses. The Tier 1 capital ratio is a measure of a bank’s core equity capital relative total risk-weighted assets. Risk weighted assets are the assets such as cash, loans, investments and other assets that the bank has invested its capital in.

As residential and commercial values dropped in 2008 and 2009, FirsTier’s risky commercial real estate loan portfolio performance quickly eroded any protective layers or tiers of capital the bank had in reserve.

The FirsTier Assets Structured Sale: A Little Good News

Sale of assets so soon after the bank failure provides an opportunity for the new investors to quickly pick up where the bank and FDIC left off, perhaps resolving credits more effectively that will not have languished nearly as long in a sometimes crippling institutional limbo.

The FDIC should be announcing the winning bidder(s) and pricing soon.

Las Vegas Loan Sale Postscript

2011-05-25T10:18:00.000-07:00

Buck Wargo in vegasinc.com reported:

Eighty-four percent of foreclosed commercial properties and bank notes up for auction this week in Nevada sold for more than $341 million, prompting analysts to suggest it will set a bottom price and spur investors to jump into the market.

Auction.com announced a 58% “overall recovery rate” and a 77.6% recovery rate on large balance notes (greater than $30 million).

Wargo continues:

Kevin Higgins, a vice president with Voit Real Estate Services, said the sales are a reflection of a lack of distressed commercial properties coming on the market and pent-up demand.

There are a lot of equity funds and other groups looking for a bigger return than the little they are earning on a money-market account, he said.

“That tells me there’s a lot of money out there looking to find a home and that people are willing to take bigger risks to get those returns,” Higgins said. “In the past, you wouldn’t have seen as much activity, so it surprised me for sure.”

Hubble Smith in the LAS VEGAS REVIEW-JOURNAL observed:

“Multifamily housing was the hot investment on the final day of an auction of foreclosed Las Vegas commercial real estate properties and delinquent commercial loans valued at $1 billion, a broker for Colliers International said Thursday.”

All of the nine multifamily notes sold.

Analyzing The Economic Island of Las Vegas

2011-05-16T10:22:00.000-07:00

What Happens in the US Ends Here

After a super steep five year decline Las Vegas may be showing signs of stabilizing following the deepest economic downturn since gaming started in the State in the 1940’s.

In the US’ most discretionary economy, the economic charts of the past few years all look like cliffs.

Gaming and tourism continue to be Southern Nevada’s primary economic engine. After peaking at $10.9 billion in 2007, Nevada’s gaming revenue dropped along with the general economic downturn to $8.9 billion in 2010. As the US economy improves gaming’s performance is expected to increase gradually, this time organically. There are no domestic economy-saving bubbles on the horizon.

Both visitor volume and gaming revenue ticked up slightly in 2010 over 2009. Traffic at McCarran Airport has also increased in March 2011 over the March 2009 and anecdotal reports indicate that convention bookings continue to firm up in 2011 (reversing the post crash trend that shamed business excess). Clark County’s population grew to a record 2.03 million in 2010.

All this is set against the global threat of Asian gaming development that is set to dwarf Las Vegas’ gaming volume and test the ultimate allure of Las Vegas as international gaming destination. The ante is always upped in the gaming business.

Even though unemployment in Nevada has dropped to 13.2 percent it is still the highest in the nation and sharply higher than the 3.8 percent unemployment rate of 10 years ago; in metropolitan Las Vegas, the unemployment rate is currently 13.3 percent. The gradual decline in the unemployment rate has come from the workers leaving the workforce or the State not from net employment growth.

While job losses increased overall (dropping from the 2007 peak), the Leisure & Hospitality sector, accounting nearly one third of Las Vegas employment base, now has nearly 260,000 employed, up by roughly 60,000 from the post crash floor established in 2009 and 2010.

No More Real Estate Driver

For the past four years Nevada led the nation in the rate of housing foreclosures. Last year, one in every nine housing units in Las Vegas received a foreclosure filing, and an estimated 25 percent of those were strategic defaults. Housing prices are forecast to drop an additional 10-20% percent in the next two years. Given the depressed state of housing, Las Vegas’ construction industry, once a significant growth driver accounting for over 10% of total employment, has dropped to 5% of the total employment base and is not expected to return to historical levels in the long term. The growth rate of hotel room inventory is expected to level off for a while too.

The Biggest Ever CRE Live Auction Format

Auction.com and loan sale advisor Archetype Advisors are auctioning $1 billion of Nevada commercial non-performing loans and REO properties this week in Las Vegas.

The simultaneous online and live auction format (like its residential counterpart) will market retail, multifamily, land, and industrial assets (mostly loans) with collateral located throughout Nevada but concentrated in the Las Vegas area. Over 50 commercial assets will be sold individually.

This is billed to be largest commercial real estate and note auction to-date, according to Auction.com.

The Super-sized Bet

In a place where no one dares to think small, hundreds of investors will be parsing inconclusive data that describes the Las Vegas economy. The jury is out. Has the bottom been reached in Las Vegas or will there be another leg down? When will sustainable economic equilibrium be reached? What will post crash growth look like?

If there ever was a place to make a long bet on the US economy, Las Vegas is it.

Cracks in the Wall: Rick Caruso’s Masterful Breach

2011-04-05T09:29:00.000-07:00

Fashion is about keeping the competition in the dark and guessing about the next break-out fashion trend. Success in retail real estate is about keeping store concepts fresh.

Shopping center owners, too, practice the art of the new when waging the heated battles to land the best tenants. This is especially true in the hyper-competitive Southern California regional mall business.

Occasionally we see an elegant execution, a lightning bolt move in the stodgy, slow moving commercial real estate world. At first we did not appreciate all of the ramifications of the full page advertisement by Rick Caruso in March announcing that Nordstrom is to leave the Glendale Galleria and to reopen at Caruso’s Americana in 2013, his adjacent Glendale project, until we thought about it and the full meaning of the message had sunk in.

Caruso’s Americana and the Grove (near the Farmers Market and Melrose) are among the malls du jour in Los Angeles; these projects are case studies of rapid commercial real estate evolution viewed in real time. In the Glendale example the mid-20th century enclosed mall phenomenon (that had gutted many 19th and early 20th century Main Streets) was now about to be mauled a bit by the Americana’s nostalgic 21st century Main Street designs.

Adding insult to injury, Caruso a few years ago had won a sizable settlement in a lawsuit with General Growth, the owner of the Glendale Galleria, over alleged (and once common) anti-competitive leasing practices.

By buying the Nordstrom anchor building, Caruso had begun the process of breaching the formidable and seemingly impenetrable walls of a very massive and successful nearby enclosed mall.

Caruso’s wedge might mean that more financial cracks in the facade could develop. There might be co-tenancy issues. Often the stability of smaller, non-anchor tenant lease terms are predicated on the presence of a minimum number of anchor tenants who, like Nordstrom, spend more money on advertising and promotion, thereby drawing traffic to the mall and benefiting smaller tenants who ending up paying a greater share of mall operating costs. We are not forecasting the collapse of such a dominant mall, just an increased level of discomfort with its neighbor.

As the proud new owner of one of Galleria’s anchor buildings Caruso has, at minimum, started the conversation with General Growth and will likely become part of the Galleria’s planning process and potential renewal effort. No wrecking ball was necessary to start, just the Trojan horse Nordstrom transaction that may force change and pave the way for at least a section of the Galleria to be repositioned.

A master stroke like this doesn’t happen in a vacuum or without strategic alliances. With public pressure he was able to acquire the additional adjacent southern parcel necessary to expand for Nordstrom. Caruso has a high political profile in Los Angeles and Glendale. Real estate is local. Public/private partnerships are necessary in long-lead mega-developments as is popular support required to win development approvals put to vote. Fluid battle plans and transparency win over the cookie cutter approach; local, decentralized management often wins over more remote centralized ownership. In the heat of battle nothing can be taken for granted.

The bottom line is that Caruso’s shopping center designs, tenant mix and open air retail experience are what the people in LA desire today. And he will continue to win until the next development step in retail real estate evolution devours yesterday’s tired fashion.

A Small Bank Visualizes the Branch of the Future

2011-03-12T14:23:00.001-08:00

The New FDIC Partner "Banks"

2011-03-11T09:31:00.000-08:00

FDIC Structured Sales Transactions

Since May of 2008, the FDIC turned to a “partnership model to sell large numbers of distressed assets (primarily non-performing single family and commercial real estate loans and related real property) held by recently failed financial institutions.”

As of March 2011, the FDIC has closed 24 structured sale transactions transferring 38,800 assets and $23.3 billion in unpaid principal balance.

The FDIC stays on as a partner in these transactions with the stated goal of capturing upside and appreciation as the loans are worked through and the economy and asset values recover.

For the borrowers of failed banks whose loans were acquired in the structured transactions, the new FDIC entities have become, in essence, the borrower’s new bank as the loans are worked out and resolved with the new owners.

Four investor groups (highlighted in yellow below) have dominated the bidding, in some cases winning multiple bids, and together accounting for nearly 60% of the book value purchased in structured transactions as well as now controlling over 50% of loans assumed by the FDIC LLC’s.

Winning FDIC Structured Sale Bidder	No. of Loans	Implied Price (millions)	Book Value (millions)
Cache Valley Bank	761	$63	$279
Colony Capital Acquisitions, LLC	5,104	$1,904	$4,035
Diversified Business Strategies	147	$205	$702
Gulf Coast Bank & Trust	733	$48	$146
Hudson Realty Capital Fund V LP	110	$19	$102
Kingston Management Services	1,112	$101	$1,120
Mariner Real Estate Partners, LLC	1,062	$264	$762
OneWest Ventures Holdings LLC	3,044	$271	$1,652
PennyMac	2,829	$215	$558
PMO Loan Acquisition Venture, LLC (OakTree Capital)	279	$695	$1,703
Residential Credit Solutions, Inc.	9,230	$1,191	$2,218
Rialto Capital Management LLC	5,511	$1,235	$3,052
Roundpoint Capital Group	6,786	$416	$1,094
Square Mile Capital LLC	57	$346	$421
Starwood (Northwest Operating Company) LLC	101	$2,725	$4,402
Stearns Bank	520	$161	$733
Turning Point Asset Management, LP	1,456	$111	$314
Totals	38,842	$9,971	$ 23,293

Last Updated 03/02/2011

After the Crisis Smaller Banks Find Their Niche

2011-02-09T14:14:00.000-08:00

‘That which does not kill you makes you stronger.’ Neitzsche

Many tough lessons were learned by the US financial community in the past three years. Now that the worst may be over, our attention has turned away from counting the countless bank failures of 2009 and 2010.

After peering over the edge into the abyss in the darkest days, some community and regional banks have roared back from the brink of extinction and have grown to rival their more conservative regional competitors (who never veered off the road).

Lest we forget the learned lessons of pain, let’s be honest and admit that, at the bleakest point, nearly all banks (large and small) were fair game for closure by the regulators. Since then, banks have been given ample time and the many tools necessary to heal themselves.

It is no secret that survival and newly found financial strength sprang from healthy government assistance, flexible & favorable banking policies, superior scrappy salesmanship by those banks on the edge and an exceptionally large dose of new found internal risk management discipline. Like rediscovering religion, the last of this list is the best thing for the long term health of banking.

Unfortunately, in today’s hyper-competitive environment, the weak may not inherit the earth; community and regional bank survival is a take-no-prisoners multi-front all out war.

In a hyper-regulated world it will be difficult to duplicate the efficiencies of larger competitors. Real estate will be less and less necessary. Thousand of branches are going to close. Before we knew it the old bank branch has been replaced by an app on your smartphone.

Big bank consolidation of market share in the aftermath of the crash is not done but, if they have their wish, has just begun. The small bank of the past, sad to say, is an endangered species unless it can differentiate itself from the big bank mass market approach via new, competitive and customer-smart algorithms.

FDIC Structured Sales: Timing (and Leverage) Is Everything

2011-02-04T16:00:00.000-08:00

Since 2008 the FDIC has sold an estimated $22.02 billion in failed bank loans in 19 structured sales transactions.

Loan type seems to be much less a factor on the price paid for the failed bank loans

	Loan Type	Book Value (Millions)	Price/Book Value	% of Total Sales Activity
Subtotal	Acquisition Development or Construction Loans (SFR,CRE etc.)	$15,559	40%	71%
Subtotal	Commercial Real Estate Loans	$2,877	54%	13%
Subtotal	Single Family Residential Loans	$3,584	48%	16%
Total/Avg		$22,020	44%

than the timing and leverage of the transactions. Early deals closed in early 2009 were done in the midst of the crisis and were not yet financed by the FDIC.

Date Sold	Loan Type	Book Value (Millions)	Leverage	Price/Book Value
5/6/2008	Single Family Construction and Lot Loans	$146	N/A	32.80%
12/29/2008	Single Family Residential	$561	N/A	38.60%
1/12/2009	Acquisition Development and Construction ("ADC") Loans	$1,120	N/A	9.00%
2/5/2009	Residential Construction	$733	N/A	22.00%
2/20/2009	Commercial Construction	$702	N/A	29.20%
3/19/2009	Consumer Construction, Homebuilder Construction, Lot Loans	$1,652	N/A	16.40%
Total/Avg: First Deals (All Cash)		$4,914		20.40%
9/30/2009	Single Family Residential	$1,320	6 to 1	64.80%
10/16/2009	Commercial Construction	$4,451	1 to 1	62.50%
1/7/2010	Commercial Real Estate	$1,028	1 to 1	44.70%
2/9/2010	Residential ADC	$2,253	1 to 1	38.60%
2/9/2010	Commercial ADC	$799	1 to 1	45.70%
4/1/2010	Single Family Residential	$491	2 to 1	42%
5/18/2010	Commercial RE, Construction and ADC	$421	1 to 1	82.30%
6/25/2010	Single Family Residential	$314	1 to 1	35.40%
7/2/2010	Commercial Real Estate	$1,849	1 to 1	59.90%
7/9/2010	Single Family Residential	$898	1 to 1	37.40%
7/21/2010	Commercial ADC	$1,703	1 to 1	40.80%
8/26/2010	Residential/ Commercial ADC	$762	1 to 1	34.70%
Announced, Not Closed	Residential/ Commercial ADC	$817	1 to 1	23.60%
Total/Avg: Financed Deals		$17,106		50.22%

Commodity Bubble Next to Burst?

2011-02-03T14:47:00.000-08:00

Davos Déjà Vu View

Some voiced the suspicion that not enough has been done to improve the system after the global financial system melted down and was re-formed. Another system crash may occur sooner than we think.

Such bearish views, however, were not heartily embraced this year at Davos.

In an imagined meltdown envisioned in "The Financial Crisis of 2015: An Avoidable History" white paper set to occur mid-decade, "The new wave of regulations had proved ineffective at stopping another bubble from forming."

"As with any bubble, our scenario contains a compelling narrative that allows investors to convince themselves that “this time is different”. In this case it is a story of strong economic growth coming from China creating a sustainable increase in demand for commodities."

"Our scenario builds on these historical observations and has a commodity price bubble at its center. The fallout from such an emerging markets crisis could be even more severe than in previous crises, with the biggest losers coming from the developed world. Western monetary policy is looser than ever, so the bubble could be unprecedented in size. And the high levels of indebtedness in developed economies means that they are in no position to absorb a rapid monetary tightening without experiencing a massive rise in insolvencies, including perhaps the insolvency of several developed world sovereigns."

"Our worst-case scenario assumes that default rates move back up to their historical peak based on the 200 years of data....This would represent the culmination of trends that amount to a complete global rebalancing of economic power: most likely from the US and European economies to the emerging markets. From this perspective, the sub-prime crisis was merely the start of a period of economic instability engendered by this realignment."

Right back where we started from.

The sound of bearish talk, however, was drowned out in the noisy recovery euphoria of the Davos world stage. The bears were told to crawl back into their caves and go back to sleep.

Paying It Forward: Some Hopeful Signs for Failed Bank Borrowers

2011-01-31T11:44:00.000-08:00

Tom Barrack appeared on Bloomberg Television last week to discuss Colony Capital's latest successful bid on two FDIC failed bank loan portfolios totaling $820 million in residential and commercial mortgages. Based on the FDIC's disclosure, the total amount Colony has purchased from FDIC through the structured sales program has reached nearly $3.7 billion:

Date Sold	Loan Type	Quality	No. of Loans	Book Value (Millions)	Price/ Book
1/7/2010	Commercial Real Estate	Sub/Non-performing	1,184	$1,028	44.70%
7/2/2010	Commercial Real Estate	Sub/Non-performing	1,660	$1,849	59.90%
Announced, Not Closed	Residential and Commercial Real Estate	Sub/Non-performing	1,505	$817	23.60%
Total			4,349	$3,694	47.64%

In the interview Barrack manages investor expectations about just how tough these loan portfolios will be to work through:

"The reason that most people don't like these is that there's no income in
the meantime. It's not as though you're buying a loan and the loan is paying
you a coupon that just happens to be under-yielding. Just about everybody
stops paying, so every transaction is a workout."

"As a buyer, it's an ongoing business. You don't know. There's not a quick
spin here. You won't know how you really did until you resolve the last 10%
of that portfolio and that can either be 18 months or 36 months."

Barrack also identified Colony's possible approach to workouts that may give some hope to borrowers who have endured months of lender radio silence. He seems to indicate that workouts and debt restructuring are at least a possibility.

The 2 C’s of Lending: Credit and Character but what about Collateral (Asset Value)?

2011-01-27T10:11:00.000-08:00

The news broke this week that the FASB has codified and made permanent temporary measures designed to go easier on banks using valuation measures instituted during the height of the 2008 financial crisis. The eased valuation rules give banks a great deal more discretion in the way asset values are established. To boil it down, the guidance says two of the C’s of lending are important, the third, not so much. Borrower credit and character will be weighted most heavily as summarized in Accounting Today:

“The “plain vanilla” assets that would be eligible for cost accounting would be “those instruments where the entity has a relationship with the borrower and the purpose is to be repaid with the collection of interest and fees,” said FASB chairman Leslie Seidman during a webcast Tuesday.”

“While mark-to-market can be very useful for a business that trades financial instruments, the most appropriate accounting measure for a loan portfolio is the loan balance minus impairment.”

“According to a summary of the board meeting, FASB decided that financial assets for which an entity’s business strategy is managing the assets for the collection of contractual cash flows through a lending or customer financing activity would be measured at amortized cost.”

(MICHAEL COHN, “FASB Reverses Course on Fair Value”, accountingtoday.com, JANUARY 25, 2011)

Mark-to-Model, Hold-to-Maturity

Fair values for loans will based on a discounted cash flow methodology (or a modeled approach) that is called a “level 3 valuation in the fair value hierarchy”. Put very simply, level 1 and 2 methods in determining fair value use actual asset sales in very active and somewhat less active markets, respectively.

Level 3 valuation was used in inactive markets or nonfunctioning loan markets like we have had since 2008; valuations are not solely based on asset sales or trades. Fair value requires the bank to make estimates about discount rates, market conditions, expected cash flows and other future events that are based on evaluation borrower credit and are highly subjective in nature and subject to change. Adverse changes in the model assumptions result in a loan impairment deducted from book value.

Investors most assuredly would like to know about the value of the underlying collateral backing the loan too, not rely on discretionary financial modeling alone. After all, if credit and character fail to support the loan, the collateral that is trade-able and liquid matters a lot. Whether the price data is found in the body of the financial statements or hidden in the footnotes, collateral values is what investors will want to focus on. And investors don't want to have been misled by overly smoothed value estimates only to find out it is too late to react.

CRE, The Worst is Over?

CRE may indeed be coming out of the woods as an increasing quantity of non-crisis CRE trading data is becoming available. Use of arms-length trading data as a valuation guide means many more eyes and extensive ‘at-risk’ due diligence that comes to bear on the determination of asset values. Discretionary internal models, as we have seen in events leading up to the crisis, may diverge from (and possibly overstate) values compared with those derived from true, 'at-risk' positions.

There is little to fear about current distressed debt pricing. Between loss sharing arrangements that have locked $200 Billion of failed bank loans away and out of view for many years to come and FDIC structured sales of distressed debt that have inflated prices through FDIC low cost financing, everything possible has been done to prop up distressed debt prices today.

Yes the markets for financial assets are volatile. Yes markets overreact in crisis. CMBS is an example of just such a vital, reactive, volatile and liquid arms-length market: investors trading in these securities are striving to get behind the façade and assess the collateral (cash flow) as well as the credit in order to price the securities.

We think too that de-emphasizing external data and valuation in favor of internally driven models will make the already impossible job of regulating and monitoring of the banks' condition even more difficult. Level 3 accounting is obscure, to say the least. Market-derived data points are a very necessary component of the valuation mix.

Telling Stories

2011-01-19T09:37:00.000-08:00

How does one go about valuing development sites and selecting local economies (in which to invest) when some economists have made the dire, dismal predictions that some regions in California or Florida, for example, may not recover until 2030?

Where is true sustainable growth occurring or likely to occur in the US? And what places were never meant to be? The state of housing in the US is indicative of the true, sorry story about the economy and ultimately the sad financial state of the US Household:

“A new study released by the Mortgage Bankers Association's Research Institute for Housing America says the most recent recession may make many regions around the country -- especially in the South and West -- the Rust Belts of the 21st century. The burst housing bubble may mean the economy in those places never fully recovers."

(Will The Housing Bust Create New Rust Belts? by KAREN GRIGSBY BATES January 12, 2011 National Public Radio)

“Celia Chen, a housing economist with Moody's Economy.com, predicts that a full recovery in parts of California, Nevada, Arizona and Florida won't occur until 2030.

"The housing boom elevated home prices in a number of areas far, far above what can be supported by the economic fundamentals, and so prices have fallen significantly, and they will remain below their previous peaks easily for a decade, or even two decades," Chen said.

Some experts contend that foreclosures, which have pierced neighborhoods of all income levels throughout the country, are quickly turning developments on the outskirts of metropolitan areas into the nation's newest slums. Complicating any recovery for these beaten-down areas is the difficulty in predicting which neighborhoods will fare worst. That uncertainty could lead to increasing skepticism by buyers and lenders looking to make loans on homes in these areas.”

(January 06, 2011|By Alejandro Lazo, Los Angeles Times)

Investors sift through assets looking for signs of life in communities that have withstood the financial firestorm. Some continue to grow (and even boom) benefiting from “Coastal Wealth” effects or "Global Resource Demand".

The search for positive indicators leads us to find healthier “community organisms”, signs or proxies of the US’ generally strong economic backbone and conversely in search of the economic medicine needed to heal damaged, salvageable places.

Rebuilding the US Economy: Don't Count on Housing

2011-01-10T11:02:00.000-08:00

The housing industry, once a big part of the US economic growth machine, is now a much weaker contributor to US job growth and economic activity.

As NICK TIMIRAOS commented last month in the Wall Street Journal, “The U.S. has normally relied on an expanding housing market to help lift the economy as it exits a recession by fueling manufacturing, consumer spending and job growth. In the first year of all postwar recoveries, residential investment has accounted for nearly one percentage point of gross-domestic-product growth….But today, it has accounted for around 0.1 percentage point of GDP growth.”

The housing industry's anemia is being felt most acutely in large swathes of the former high growth, real estate dependent economies of California, Florida and Arizona; unfortunately speculative real estate construction activity itself fueled much of the economic activity in many parts of these states, not fundamental household demand-based growth.

The Los Angeles Times reported on August 16, 2010 that “Housing is a big business in California. Home builders employ hundreds of thousands of people, and other industries such as retail, manufacturing and restaurants benefit from the spending of those employees.

The slowdown in construction in California has muted those benefits. According to a report released Monday by the California Homebuilding Foundation and the Center for Strategic Economic Research, the economic output of the housing industry has fallen 80% since 2005.

In 2005, which the report says was near a peak in the housing industry, residential permit levels were around 205,000 units, generating 487,000 jobs and $67.7 billion in economic impact. By 2009, residential permit levels dropped to 35,000, employment hovered around 77,000. The economic benefits of housing dropped to around $13.8 billion, according to the report.”

The Long Slog

Rebuilding the housing industry will be long slog after housing's near apocalyptic self-destruction. The destruction was not only of basic housing demand (millions of US consumers were so severely hit by the meltdown and now are fighting to rebuild their credit and household net worth) but of the collapse of the entire system's infrastructure that once supported and processed all aspects the housing industry’s hyperactive (and some say slipshod) development, construction, sales and finance (bubble-making) machine.

All components of the US housing delivery system are still being questioned, probed, pounded, critiqued, dissected, dismantled, and above all litigated. Housing’s deconstruction is not yet complete. Commercial real estate too has suffered collateral damage from the direct relationship to it’s massive, ailing residential cousin.

No one yet knows what the housing and mortgage production will look like when reconstruction takes hold in earnest. There are too many unknowns. As always there is a naïve hope that the world will be the same as it ever was, an assumption that the rules will be as they were.

We don't think so.

Policy has yet to be written for the role of the surviving mortgage financing entities Fannie Mae and Freddie Mac. The smoldering remains of these two institutions are still too hot for politicians to touch. Will these sort of private but now blatantly public institutions, that have taken over for the private mortgage market, remain public agencies or become truly private this time? Neither side of the aisle wish to be labeled socialist nor put the final nail in the coffin of the housing industry left to pure and brutal market forces.

The new world order of mortgage finance will surely be one that is well underwritten and well documented. In other words it will not be as it ever was. It will be a much smaller, slower, more laborious and a less automated industry. It will take a long time for each loan to be underwritten and approved (to be measured in many months not the seconds of a phone call loan approval of times past) and it will be way more expensive (the current, temporarily and artificially low mortgage interest rates aside).

The Underwriting Pendulum Swings-More Questions than Answers

Lenders today, understandably, have a severe aversion to risk. How do they underwrite the US borrower today? How long before the millions of foreclosure casualties begin to heal their severely wounded balance sheets?

The mortgage origination business completely broke down. A permanent stable sustainable market has yet to emerge. Only massive government involvement has maintained what is left of the residential mortgage market’s faint pulse.

Fear now rules as “Lenders clamped down on the lax standards that fueled the housing bubble three years ago by requiring larger down payments, higher credit scores and greater documentation of borrowers' incomes and assets….private lenders have ceded the market to government entities Fannie Mae, Freddie Mac and the Federal Housing Administration. Those agencies, saddled with losses, are under heavy political pressure to avoid taking any new risks.” (Wall Street Journal DECEMBER 13, 2010)

From the Post-Crash Ashes

2010-12-31T11:31:00.000-08:00

Who Gets to Rebuild America?

The Great Financial Panic of 2008-2009 is receding into the past. Most of our larger financial institutions appear, at least on the surface, to be on the mend. The economy looks to be on the road to recovery.

But not so fast. The saga of the financial collapse is not over. More damage is being done each day. It is a tale of quiet attrition wearing down the small businesses. There are still small disaster stories to tell, though they will not likely make big headlines. The legacy of loss lingers.

An Epochal Crash

By historical standards the 2007 residential real estate bust was big. Real U.S. home prices had nearly doubled between 1990 and 2006. From the rise to the fall, trillions of dollars of household equity has gone up in smoke. Home prices as measured by the S&P Case-Shiller Index of value in 20 cities is down 29 percent from the 2006 peak levels. Caroline Baum (Bloomberg Opinion from Dec 5, 2010) observed that “Owners’ equity in household real estate…fell from a peak of $13.1 trillion in 2005 to a low of $5.9 trillion in the first quarter of 2009, according to the Fed’s Flow of Funds report. That’s a whopping 55 percent decline in four years.”

While the money flowed through the US housing system and the real estate bubble inflated, land developers, home builders, banks, mortgage brokers, loan packagers, mortgage “securitizers” and rating agencies (among others) chose not to stay safely on the sidelines. We were all happily aboard the bubble machine. As a well known big banker noted, this was such sweet financial music that no one could afford to stop dancing before the music stopped.

The music stopped. And home builders, small AND big, got whacked.

Bank of Clark County, Vancouver WA

A chapter of this story began on Friday January 16, 2009 when the State of Washington shut down Bank of Clark County (“BOCC”) based in Vancouver WA. BOCC was one the first two US bank failures to occur in 2009 in a wave of closures that would see 140 banks closed in 2009 and over 150 banks closed so far in 2010.

BOCC was founded in 1999. It was a smaller bank with $446.5 million in total assets and $366.5 million in deposits. As with many community banks, BOCC had an exposure to commercial real estate in loans made to builders and developers; construction and development loans, particularly for residential development made up over 36 percent of the bank's total portfolio.

At the closure of BOCC, Umpqua Bank of Eugene Oregon agreed to assume the deposits and branches but decided not to take over the Bank of Clark County's $352 million loan portfolio. Umpqua in the past two years has very been shrewd in acquiring numerous failed banks but the BOCC commercial loans were apparently too hairy for Umpqua to take over. As a regional player, Umpqua probably had good market intelligence on the condition of BOCC portfolio.

FDIC “Multibank” Structured Transactions

To deal with the assets of failed banks that were not sold to FDIC-assisted banks via loss sharing, the FDIC has either auctioned off assets as-is in either pools or individually, or has employed a financial vehicle called the "structured sale" where the FDIC sells the assets into a joint venture with a private-sector investor/manager to wait out the bad real estate market hoping to realize higher assets price at a later date when the market had improved.

The FDIC commented in a July 2010 Bloomberg article explaining, “What we’re trying to avoid is creating the kind of financial incentives that cause the liquidation of the portfolio at fire-sale prices, which could further depress already distressed markets.... The structured transaction enables the FDIC’s managing partner to take a longer-term approach to the loans, allowing for an orderly workout period.”

The FDIC took delivery of the BOCC loans, and by the end of 2009 had pooled BOCC assets with the assets of 22 other failed banks into what the FDIC calls a “Multibank Structured Transaction” or Multibank Structured Transaction 2009-1 CML-ADC and Multibank 2009-1 RES-ADC Venture LLC (“Multibank”), in the case of BOCC. These structured transactions are but two of 16 completed and disclosed by the FDIC to date, involving the orphan bank assets of numerous failed institutions adding up to a total book value of over $18.7 billion.

The “ADC” in MULTIBANK 2009-1 RES-ADC VENTURE LLC and MULTIBANK 2009-1 CML-ADC VENTURE LLC stands for Acquisition Development and Construction Loans. These were credit facilities provided by banks and, in the case of the structured sale asset packaged by the FDIC, were loans made by smaller community or regional banks to local developers to finance the purchase, entitlement, horizontal and vertical development of raw land being transformed into residential or commercial property.

In February of 2010 the two loan pools (totaling $3.052 billion in book value) were acquired in a structured transaction by Rialto Capital Management LLC (a subsidiary of Lennar Corporation "LEN") in partnership with the FDIC for a combined (or “implied”) price of $1.22 billion, or about 40 cents of book value. The FDIC retains 60% ownership in the pool of assets, Rialto acquired a 40% position. The collateral for the acquired loans was a mix of residential and commercial land and construction projects in various markets across the US.

Deal Points

--The FDIC transaction provides the private-sector partner zero-percent financing, asset management fees to manage assets in the venture.

--In this deal the management fee is .5 percent of outstanding debt (the unpaid balance or UPB), roughly $15 million per year to begin with.

--The partnership does not allow for a partial sale or liquidation of the assets. The loans are to be "worked out".

--The FDIC’s profit split increases to 65% (from original 60%) upon the “First Incentive Threshold Event” when a 25% annualized yield has been achieved and to 70% (from 65%) at the “Second Incentive Threshold Event” when a 35% yield has been hit.

Limited Price Discovery in a Less Than Arms-Length Sale

The use by the FDIC of low cost leverage that has many outcomes, not the least of which is to increase the price of the assets. The widely held consensus is that sans the FDIC's backstopping of these deals, the assets would have likely sold for half what was paid by the venture.

As the Wall Street Journal noted in February 2010, “Undoubtedly, if someone had to purchase this with all cash, it would be 20 to 25 cents on the dollar". "The sale may prove an important bell-weather transaction for home builders and other opportunistic investors looking to take advantage of the housing carnage and snap up land on the cheap. But it may not provide much clarity about the value of commercial real estate clogging the books of the nation’s banks."

Structured Deal Workout Strategy: Opportunistic Buyers Buy High and Sell Even Higher

The FDIC/Rialto business plan is to “resolve" the loans. The loans may be either restructured with the current borrower or foreclosed on by the investor and become real estate owned (OREO) by the FDIC/Rialto partnership. The annualized yield on the investment will depend on how many years it takes to resolve the assets, how long it takes to convert the assets to cash. The seven year investment horizon is long. The expectations are for a healthy, double digit return. The math is simple. The loans or the real estate securing the loans (once foreclosed on) are a commodity that a large investor/ builder like Rialto/Lennar are expert at valuing, developing and ultimately selling.

One “Multibank” Borrower

One company that got swept up into the MULTIBANK 2009-1 vortex we will call “SmallCo”. SmallCo is a local homebuilder operating in one of the major Pacific Northwest US markets. The company had a $3 million development loan from Bank of Clark County secured by a 45-lot residential subdivision.

As SmallCo told the local press, their effort to refinance the residential development loan with other banks proved fruitless. For the most part banks today are not making new real estate loans but are purging their balance sheets as they can of any real estate development and construction loans, even if their borrowers have somehow managed to preserve their creditworthiness. Residential or commercial real estate collateral is an anathema to banks that no strong banking relationships can alter. The regulators in most cases require these loans to be written down because the value of the collateral (land) is much less than the outstanding loan balance.

SmallCo reported that it was able to refinance a few other of its bank construction loans on other projects, probably after the former bank loans had been sold by the FDIC to individual investors at all cash auctions or the banks may have 'sold' the deeply-discounted assets themselves. The cash spot market has resulted in outright assets sales, at more deeply discounted prices, providing more room to bring in new investment at a lower and sustainable cost basis.

Individual asset sales are outright do not have long term investment structure that the Multibank transactions do. The Multibank structure prohibits speculative asset sales (perhaps rightly) but the premium pricing paid for the assets may not provide for the same room and flexibility to negotiate discounts as the FDIC individual outright asset sales have.

SmallCo Gets the Word from Multibank

These are eight words no developer wants to hear from their bank: “Your loan is due and payable in full.”

SmallCo and other Multibank borrowers got this message. It has been reported that the Multibank venture had filed suit against SmallCo and other Multibank borrowers for the full amount of the money owed on their real estate loans. Multibank is likely acting well within their legal rights. Most development and construction loans are short term loans.

SmallCo told us that the value of the lots in question are now half of where they had started. At the peak the residential lots were were $100,000 each, but now were valued at closer to $40,000 to $50,000 each. Not too bad when you consider that some troubled residential developments are currently considered worthless (where the estimated cost to finish the project exceeds today's value). SmallCo offered to pay the loan off at a discount with new capital, offering 70 cents on the dollar to pay off the loan (a healthy markup on the 40% portfolio average price).

They told us they even flew to New York to meet the Multibank representatives to see if something could be worked out but no compromise could be reached.

SmallCo employs a handful of workers and has had to cut back on his crew. A foreclosure on the 45 lot property might mean bankruptcy for the company.

Small and Big But Not That Different

When you stand back and look at SmallCo and BigCo together they are not all that different. Both were building homes into the bubble and both got caught short when it burst. The big difference is simply in the vastly different scale of the respective operations, not what the small and big companies were doing.

Lennar was the second largest national builder and, at the peak in 2006, closed sales on about 50,000 homes per year and in the downturn has managed skillfully to survive and navigate the treacherous waters of the economic storm (with some help from above), positioning itself to thrive as the residential market starts to recover.

SmallCo is a family operation running just of handful smaller projects at any one time. What is missing for SmallCo is the access to the same type of financial resources (once provided by community banks) and the governmental support afforded the larger company. Resources that might help SmallCo too to weather the storm and buy time in an extremely tough economic and impossible financing environment.

Who will get to rebuild America?

The Art and Science of Bank Closure

2010-12-30T13:28:00.000-08:00

DECEMBER 28, 2010, 4:10 P.M. ET

WSJ: FDIC's Tricky Business: When To Shut An Ailing Bank

By Jean Eaglesham Of THE WALL STREET JOURNAL

More than 300 U.S. banks and savings institutions failed in the past four years. But there are huge differences in how sick they were when regulators seized them.

About a dozen of the dead financial institutions had a tangible common equity ratio, a widely used measurement of a bank's cushion to absorb losses, of more than 8% when they failed, according to an analysis by Keefe, Bruyette & Woods Inc. That isn't much worse than the median ratio of 9% among the 50 companies in the investment bank's regional-bank stock index.

In contrast, a total of 50 failed banks had negative capital by the time regulators swooped in, meaning their capital was depleted by losses. Those shutdowns came as long as two years after government officials issued their first warning about financial inadequacies, analysts at the KBW Inc. (KBW) unit found.

Timur Braziler, an analyst at Keefe, Bruyette & Woods, says the differences are a sign that "bank regulators and state officials simply can't get to these banks fast enough," citing the 860 battered institutions on the Federal Deposit Insurance Corp.'s "problem list" as of Sept. 30. "There's just not enough manpower and coordination to catch all these failing institutions at once."

Killing a bank too soon could mean getting rid of a financial institution that might recover to make solid, profitable loans. Waiting until all of a bank's capital is gone deepens the losses suffered by the FDIC's deposit-insurance fund, putting additional strain on surviving banks that pay into the fund.

FDIC officials dispute any suggestion that the agency has been overwhelmed by the U.S. banking industry's crisis or inconsistent in how it handles failed financial institutions.

The FDIC's division of resolutions and receiverships, the mortuary for fatally stricken banks and thrifts, has 2,133 employees, up from 219 in 2007. That includes more than 50 veterans of the savings-and-loan crisis who came out of retirement to deal with a new crop of dead banks.

The decision about when to seize a battered bank is complicated by the hodgepodge of regulators that oversee the nation's 7,760 federally insured financial institutions. Some state officials aren't allowed by law to close a bank unless they can prove it has burned through all its capital. Federal officials have more leeway and can shut down a bank even if it isn't yet "critically undercapitalized," the lowest rung on the regulatory ladder.

"It is always difficult for regulators to decide when to close a bank," said Thomas Vartanian, a partner at law firm Dechert LLP and general counsel of the Federal Home Loan Bank Board during the Reagan administration. "Often, they are trying to strike a balance between giving failing banks every chance of survival by allowing them time to pursue potential suitors, and seizing them too late to minimize the cost to the FDIC."

James Wigand, a longtime FDIC official, said it is a "difficult judgment to make," although "for the most, part, history will judge that the regulators got it right" during the banking industry's latest crisis. On Dec. 31, Wigand will become director of a new FDIC unit overseeing systemically important financial firms. The post was created as a result of the Dodd-Frank financial-overhaul law.

Some of the banks classified by regulators as well-capitalized at the time of their failure were dragged down by a parent company that collapsed. Two of the nine banks owned by FBOP Corp., a bank-holding company in Oak Park, Ill., had a tangible common equity ratio of more than 10% when the bank-holding company was seized by regulators in October 2009. At other banks, losses ballooned shortly after regulators examined their financial statements and loan files, causing sudden death.

The Keefe, Bruyette & Woods analysis includes failures from February 2007 to July 2010. A total of 157 banks have been seized in 2010, up from 140 in 2009.

Imperial Savings & Loan Association, based in Martinsville, Va., failed in August, more than a year after losses left the tiny thrift with negative capital. The demise is expected to cost the FDIC's insurance fund $3.5 million.

William Cody Spencer founded Imperial in July 1929, using $300 of savings from fellow Baptist church members, running the minority-owned thrift from his home for 30 years. In 2008, the Office of Thrift Supervision, or OTS, issued a formal warning about Imperial's deteriorating financial condition.

Daniel Thibeault, co-founder of a student-loan business in Cambridge, Mass., said he made "six or seven submissions" to OTS in an effort to buy Imperial before it was seized, offering to pour in $6 million in capital immediately and an additional $6 million within 18 months.

"Short of popping the champagne, we were 98% close to getting this deal," he says, complaining he "never got a straight answer" from the OTS about why he was spurned.

In a statement, the OTS says the "potential acquirers were unable to demonstrate the viability of their proposals by showing they possessed the expertise and the financial resources to operate a financial institution." The agency says it made "an extraordinary effort over several years by working aggressively with multiple groups of potential investors interested in acquiring Imperial."

Ronald Haley, president of River Community Bank, a unit of River Bancorp Inc., also of Martinsville, that bought Imperial after it failed, says "it was just too small to function in the banking world today."

-By Jean Eaglesham, The Wall Street Journal

FDIC Sells Four Loan Portfolios Totaling $1.22 Billion

2010-12-29T06:45:00.000-08:00

By Mark Heschmeyer

December 27, 2010

http://www.costar.com

In the first deal, the FDIC sold a 40% equity interest in a newly- formed limited liability company created to hold assets with an unpaid principal balance of approximately $204 million from 12 failed bank receiverships.

The winning bidder of the FDIC Multibank CRE Venture Loan and REO Structured Transaction 2010-2, Northern Pool was ColFin Milestone North Funding LLC, a consortium of investors organized by Los Angeles-based Colony Capital. The purchase price was 27% of the unpaid principal balance. The Cogsville Group LLC of New York is minority-owned and partnered with Colony.

As an equity participant, the FDIC will retain a 60% equity interest in the LLC and share in the returns on the assets. The FDIC offered 1:1 leverage financing to the LLC, which will issue to the FDIC purchase money notes of $28.5 million. The sale was conducted on a competitive basis with the FDIC receiving bids for either a 40% ownership interest or a 20% ownership interest in the LLC.

The FDIC as receiver for the failed banks will convey to the LLC a portfolio of approximately 557 distressed commercial real estate loans, of which more than 50% are non-performing. Collectively, the loans have an unpaid principal balance of approximately $204 million. About 82% of the collateral in the portfolio is in Michigan. As the LLC's manager, Colony will manage, service, and ultimately dispose of the LLC's assets.

All of the loans were from banks that failed during the past 20 months.

In a second deal, the FDIC closed on a sale of a 40% equity interest in a newly- formed limited liability company created to hold assets with an unpaid principal balance of approximately $137 million from five failed bank receiverships.

The winning bidder of the FDIC Multibank CRE Venture Loan and REO Structured Transaction 2010-2, Western Pool is Colony Milestone Co-Investment Partners LP, a consortium of investors also organized by Colony Capital. The purchase price was 60.10% of the unpaid principal balance. The Cogsville Group again partnered with Colony.

As an equity participant, the FDIC will retain a 60% stake in the LLC and share in the returns on the assets.

The FDIC offered 1:1 leverage financing to the LLC, which will issue to the FDIC, as receiver, purchase money notes of $42.6 million. The sale was conducted on a competitive basis with the FDIC receiving bids for either a 40% ownership interest or a 20% ownership interest in the LLC.

The FDIC as receiver for the failed banks will convey to the LLC a portfolio of approximately 198 distressed commercial real estate loans, of which more than 38% are non-performing. Collectively, the loans have an unpaid principal balance of approximately $137 million. About 78% of the collateral in the portfolio is in Utah. Colony will manage, service, and ultimately dispose of the LLC's assets.

In a third deal, the FDIC sold a 40% equity interest in a newly-formed limited liability company (LLC) created to hold assets with an unpaid principal balance of approximately $279 million from nine failed bank receiverships. The winning bidder of the Western Residential Acquisition and Development pool of the 2010-2 Multibank Structured Transaction was Cache Valley Bank in Logan, UT, with a purchase price of 22.22% of the unpaid principal balance.

As an equity participant, the FDIC will retain a 60% stake in the LLC and share in the returns on the assets. The FDIC offered 1:1 leverage financing to the LLC, which will issue to the FDIC a purchase money note of $30.6 million. The sale was conducted on a competitive basis with the FDIC receiving bids for either a 40% ownership interest or a 20% ownership interest in the LLC.

The FDIC as receiver for the failed banks will convey to the LLC a portfolio of approximately 761 distressed residential acquisition and development loans, of which more than 50% are delinquent. Collectively, the loans have an unpaid principal balance of approximately $279 million. About 81% of the collateral in the portfolio is in Utah, Arizona, California, and Nevada. Cache Valley will manage, service, and ultimately dispose of the LLC's assets.

All of the loans were from banks that failed during the past 14 months.

Lastly, RoundPoint Financial Group purchased a 40% stake of a $603 million mortgage loan portfolio from the FDIC in conjunction with RBS Financial Products Inc.

The FDIC retains a 60% equity interest in what is a newly created venture that will acquire the pool of mortgages. RoundPoint Capital Group and RoundPoint Mortgage Servicing Corp. will oversee the management and servicing of all loans in the portfolio.

Wall Street Journal Analysis: Small Banks Still Suffering

2010-12-27T08:56:00.000-08:00

DECEMBER 26, 2010

Bailed-Out Banks Slip Toward Failure

Number of Shaky Lenders Rises to 98 as Bad Loans Pile Up; Smaller Institutions Hit Hardest

By MICHAEL RAPOPORT, Wall Street Journal

Nearly 100 U.S. banks that got bailout funds from the federal government show signs they are in jeopardy of failing.

The total, based on an analysis of third-quarter financial results by The Wall Street Journal, is up from 86 in the second quarter, reflecting eroding capital levels, a pileup of bad loans and warnings from regulators. The 98 banks in shaky condition got more than $4.2 billion in infusions from the Treasury Department under the Troubled Asset Relief Program.

When TARP was created in the heat of the financial crisis, government officials said it would help only healthy banks. The depth of today's problems for some of the institutions, however, suggests that a number of them were in parlous shape from the beginning.

Seven TARP recipients have already failed, resulting in more than $2.7 billion in lost TARP funds. Most of the troubled TARP recipients are small, plagued by wayward lending programs from which they might not recover. The median size of the 98 banks was $439 million in assets as of Sept. 30. The median TARP infusion for each was $10 million, federal filings show.

"We certainly understand and recognize that some of the smaller institutions are experiencing stress," said David Miller, chief investment officer at the Treasury Department's Office of Financial Stability, which runs TARP. He noted that Congress mandated that banks of all sizes be eligible for TARP, adding that the government's TARP investment as a whole is performing well.

Chris Cole, senior regulatory counsel at the Independent Community Bankers of America, a trade group, said small banks are "turning around slowly." Smaller TARP recipients are in worse shape than larger banks because the larger ones got help in addition to TARP, Mr. Cole said. Bank of America Corp. and Citigroup Inc. tapped the Federal Reserve's emergency-liquidity programs frequently during the crisis.

The troubled banks identified by the Journal all have either a Tier 1 capital ratio under the "well-capitalized" 6% level; both a total risk-based capital ratio of under the "well-capitalized" 10% threshold and nonperforming loans of over 10% of their portfolio; or a regulatory order requiring the bank to monitor or boost its capital.

A Federal Deposit Insurance Corp. spokesman declined to comment on the Journal's analysis, which also calculated that 814 of the nation's 7,760 banks and savings institutions are troubled according to these standards, up from 729 at the end of the second quarter. The FDIC's official list of problem banks, which uses different criteria from the Journal's analysis, includes 860 financial institutions. The banks aren't publicly identified.

In a response to the GAO report, the Treasury Department said it would consider the GAO's recommendations to improve its funding process if it ever has a program similar to TARP again.In October, the Government Accountability Office said 78 banks on the FDIC's troubled-bank list as of June 30 were TARP recipients, up from 47 at the end of 2009. Dozens of TARP banks were "marginal institutions" that were financially weaker than other recipients and should have gotten more scrutiny before receiving taxpayer-funded infusions, the GAO said.

In comparison, the first eight banks and securities firms receiving TARP got a total of $125 billion. All have repaid the funds Arthur Wilmarth, a George Washington University law professor and expert on banking regulation, said a lot of smaller TARP recipients are burdened with risky commercial-real-estate loans tied up in troubled strip malls and the like, and that makes it hard for them to raise new capital. "A lot of them are in kind of a frozen position," he said.

One example of a TARP recipient in deep trouble: closely held Legacy Bank of Milwaukee. The bank had $205 million in assets as of Sept. 30 and got $5.5 million in TARP funds in January 2009. But more than half of Legacy's loans were in commercial real estate, and its nonperforming loans have escalated to 23% of its portfolio. It has posted eight straight quarterly losses, for a total loss of $11.6 million.

Last month, the Federal Reserve declared Legacy "significantly undercapitalized," giving the bank until mid-January to either sell itself or raise more capital.

José Mantilla, Legacy's president and chief executive, said the bank lends to an underserved, lower-income customer base. During the recession, those customers "have suffered, and they have fallen behind," Mr. Mantilla said.

Legacy is working to raise capital, and "we still feel optimistic" about the bank's chances, he said.

CommunityOne Bank of Asheboro, N.C., got $51.5 million in TARP funds in February 2009 through parent FNB United Corp. The company has suffered nine straight quarterly losses, sapping its capital. In July, the Office of the Comptroller of the Currency said the bank had engaged in "unsafe or unsound banking practices."

R. Larry Campbell, the bank's interim president and chief executive, said CommunityOne is "fully engaged" in efforts to boost its capital.

Write to Michael Rapoport at Michael.Rapoport@dowjones.com

Banks That Went Bust

Track U.S. bank failures since January 2008.

Assessing the Loss of Community Banks

2010-12-26T15:14:00.000-08:00

On bank failures, 'Don’t Ask, Don’t Tell' still rules

By: Neil Hrab 12/20/10 5:22 PM

Http://Washingtonexaminer.Com

The year just about to end hasn’t been a great one for US banks. The Federal Deposit Insurance Corporation (FDIC) has had to participate in the closure of 157 banks in 2010, out of the roughly 7,800 banks and savings associations with deposits insured through the FDIC.

Few of the bank failures in 2010 have been front-page news, outside their immediate communities. If a New York- or Los Angeles-based bank were to fail, that would be one thing – the implications for economic confidence in general are clear.

But bank failures in places like Lino Lakes, MN, or McCaysville, GA or Batesville, AR (which all saw small local banks close last Friday) just don’t get much attention or analysis.

It’s as if the MSM has collectively decided not to ask many questions about why, two years into the Great Recession, small banks continue to fail.

And as for whether Washington, or the state governments, could be doing more to help these banks keep their doors open long enough to repair their balance sheets – no one seems to be able to tell.

On community bank failures, beyond reassuring nervous customers that the FDIC will protect their bank deposits, “Don’t Ask, Don’t Tell” seems to suit the MSM just fine.

One of the best ways that the MSM could improve its coverage of bank failures would be to focus more on how failures affect local entrepreneurs who had borrowed money from failed banks. The FDIC even has a handy pamphlet that touches on some of the relevant issues.

Looking at bank failures from the perspective of borrowers, particularly entrepreneurs, raises important questions that reporters could explore, such as:

How many entrepreneurs who have borrowed money from a failed bank find it hard to identify a suitable replacement lender? That is - how many are tagged (fairly or unfairly) as shady customers of the failed bank, and shunned when they go out to seek new loans?

And how many of these entrepreneurs are forced to sell assets in order to raise capital as a result, because they cannot find a replacement lender? What does this mean for efforts to spark a US economic recovery?

Finally – to end on a positive note, since it’s almost Christmas – how often does a bank failure benefit local entrepreneurs?

For example, if a local community bank is badly run, and it is taken over by a healthier bank as part of an FDIC-assisted process, how often does the new bank’s entry into the market result in local entrepreneurs finding it easier to get loans?

With the MSM’s “Don’t Ask, Don’t Tell” position on bank failures, readers and viewers are not getting the whole story.

This needs to change.

A Not So Wonderful Life for Community Banks

2010-12-23T08:46:00.000-08:00

December 22, 2010

So Long, Bailey Building & Loan

By ROB COX, New York Times

This is the time of year when families gather to watch Jimmy Stewart play George Bailey, the small-town banker who learns the value of extending credit to his neighbors with a little angelic intervention in “It’s a Wonderful Life.” Though Mr. Bailey remains emblematic of a benign banking system, most Americans probably don’t realize he’s the most endangered species in finance.

Hundreds of community banks, a fixture of small-town America, have failed or sold out to bigger rivals in the last year. But many more of the country’s 7,650 smaller banks will disappear in the next few years — a consequence, unintended or otherwise, of government and regulatory decisions codifying the biggest banks as infallible.

As sad as that may sound, it may not be such a disaster for regulators, shareholders and, perhaps surprisingly, consumers. That’s not to say the extinction of a species is to be blithely welcomed. Policy makers should certainly be asking whether there is a net negative consequence to rules and regulations that hasten the demise of the small, independent financial institution.

In some respects the spike in disappearing banks — up to 300 this year — simply represents a return to a long-term shift toward ever larger institutions that had slowed in the boom years of the last decade. At the beginning of the 1990s, the Federal Deposit Insurance Corporation oversaw 16,074 institutions. Within a decade that number had fallen to 10,222, an average net loss of 585 banks a year.

Over the next 10 years, however, the decline slowed. At the end of 2007, the number of institutions overseen by the F.D.I.C was shrinking at an average of 240 annually, mostly a result of mergers and acquisitions. The rate accelerated from 2008, thanks largely to failures — 157 this year compared with three in 2007.

The beneficiaries of this trend have been the biggest banks. At the start of the 1990s there were 59 institutions with more than $10 billion in assets holding 31.8 percent of the nation’s stock of banking assets. Today, their ranks have nearly doubled to 109, while their share of assets has marched upward to 78.6 percent.

It won’t stop there. For one, the F.D.I.C.’s troubled bank list covers 860 institutions — including many of the 600 or so that have yet to pay back bailout funds. While not all of them will be seized, many will wind up in the arms of larger, better-capitalized rivals.

Even healthy community banks are in for leaner times.

One of the reasons fewer banks vanished in the years leading up to the financial crisis was their reliance on commercial and residential property loans, which worked fine when prices were rising. But now they are being hit with big write-downs on those loans — and can’t see where they can profitably deploy future funds.

At the same time, their costs are rising, and earnings are coming under increased regulation. Just last week the Independent Community Bankers of America protested the Federal Reserve’s plan to cap debit interchange fees to comply with the Dodd-Frank financial reform act, saying it would put small banks at a disadvantage and make “the concept of ‘free checking’ a thing of the past.”

Big banks are also dealing with more red tape, but their size, diversity of businesses and loan portfolios gives them economies of scale to absorb such expenses without doing away with free checking to new depositors. From a policy perspective, it is arguably a terrible turn of events that megabanks bailed out during the crisis are now luring customers away from the George Baileys of the world.

But look at it another way: having a few, heavily regulated banks might actually be safer. Canada is dominated by five giant institutions. But because they were regulated like utilities, the country’s financial system averted the need for big bailouts. It’s also more profitable for shareholders. According to the F.D.I.C.’s third-quarter industry survey, big banks have better efficiency ratios and generate higher returns on assets and equity.

Finally, consumers might benefit from a smaller universe of stronger banks competing for their affections. At the least, there might be more credit available to them. In the second quarter, for every dollar of deposits customers stowed in the vaults of big banks, 86 cents was extended to borrowers, according to SNL Financial. Smaller banks lent out just 79 cents for every dollar of deposits.

George Bailey may have been a nice banker. But he just might have been more effective working as a senior loan officer for Bank of America’s Bedford Falls branch.

ROB COX

Big Banks Push Off Basel Capital Requirements

2010-12-22T09:44:00.000-08:00

Bloomberg News

Banks Best Basel as Regulators Dilute or Delay Capital Rules

Dec. 22 (Bloomberg) -- More than 500 representatives from 27 nations, including top regulators and central bankers, met dozens of times this year to hammer out 440 pages of new rules to govern the world’s banks.

What’s not in the documents published by the Basel Committee on Banking Supervision, and the escape hatches that are, may have more impact on how financial institutions will operate following a global credit crisis that led to $1.8 trillion in bank losses and writedowns.

The committee’s most significant achievement, members say, an agreement to increase the amount of capital banks need to hold, won’t go into full effect for eight years. Other measures that regulators had hoped would prevent future crises -- liquidity standards, a capital surcharge on the biggest lenders and a global resolution mechanism for failing firms -- were postponed, allowing banks to escape the toughest rules that would force them to change the way they do business.

“There will be changes, but not fundamental changes to the banking model,” said Sheila Bair, who as chairman of the U.S. Federal Deposit Insurance Corp. sits on the Basel committee’s top decision-making body. “Hopefully there’ll be some pressure for banks to get smaller and simpler.”

Bair, 56, is one of five U.S. representatives on the board. She has assailed bankers for exaggerating the impact of planned regulations in an effort to scare the public and politicians. In an interview in June, she questioned “whether regulators can place any reliance on industry analysis of the impact of proposals to strengthen capital rules.”

Bank Lobbying

Banks carried out a yearlong campaign to blunt international regulations, arguing that efforts to rein them in would curb lending and impede economic recovery. The lobbying effort was led by the Institute of International Finance, which represents more than 400 financial firms around the world and is chaired by Josef Ackermann, Deutsche Bank AG’s chief executive officer. Ackermann and other IIF members wrote hundreds of letters to the Basel committee, met with regulators and addressed forums from Seoul to Washington.

In June, the group published a report estimating that the proposed capital rules would result in 9.7 million fewer jobs being created and erase 3.1 percent of global economic growth -- estimates the Basel committee later challenged.

“There is no question that increased costs to banks of core capital and funding will have to be largely passed along, which inevitably will take a macroeconomic toll,” Ackermann, 62, said when he presented the report.

Battle Lines

Banks also reached out to their home regulators, arguing that some rules would disadvantage them more than other nations’ lenders. That helped draw the battle lines inside the Basel committee, according to an account pieced together from interviews with half a dozen members who asked not to be identified because the deliberations aren’t public. Germany, France and Japan led the push for softening rules proposed last December and stretching out their implementation. The U.S., U.K. and Switzerland opposed changes or delays.

The committee agreed in July to narrow the definition of what counts as bank capital, focusing on common equity, which includes money received for selling shares and retained earnings. During the crisis, other forms of capital permitted under current rules, such as future benefits from servicing mortgages and tax deferrals, failed to provide a buffer against losses. Those are mostly disallowed under Basel III, as the rules published last week are known.

Canada Switch

The capital requirements might have been stricter had it not been for Greece. Escalating concern that the country wouldn’t be able to service its debt, culminating in a May bailout by the European Union and a $1 trillion rescue package for other member states that may need it, darkened prospects for economic recovery. That led some committee members to bend to bank pressure, according to policy makers, central bankers and others involved in the process.

By September, when the committee met to set the actual capital ratios, the U.S. was pushing to require that banks have common equity equal to 8 percent of their risk-weighted assets, members said. It ended up at 7 percent, after Canada switched sides at the meeting, tipping the balance toward the German camp. Canada’s banks pressed their regulators to lower the ratio because they said they would be punished unfairly as healthy lenders that survived the crisis unscathed, the members said.

Even after being weakened, the new ratios and definitions would require banks to hold about $800 billion more capital, the committee said last week. Most lenders will be able to raise the money by retaining profits before the rules go into effect.

Leverage Ratio

In addition to pushing for a higher capital ratio, Bair also argued for a global leverage ratio that would cap banks’ borrowing -- something the U.S. has had on its books since the 1980s. In July, when the committee was debating how to define capital, the U.S. agreed to some easing in exchange for Germany and France accepting a leverage ratio, some members said.

Proponents of the leverage ratio, or equity as a percentage of liabilities, say it’s a more straightforward way to prevent lenders from becoming too indebted. Unlike capital ratios, which are based on risk-weighting and can be manipulated, the leverage ratio counts all assets regardless of their risk.

The more bankers borrow the more they can maximize profit per share, a yardstick for determining compensation. The more they borrow the higher the risk that a small decline in asset prices can wipe out equity and make the bank insolvent.

No Correlation

The Basel committee adopted a 3 percent leverage rule in July, meaning that for every $3 of capital, a bank can borrow no more than $97. While the percentage is tentative and subject to review before it goes into effect, it has since come under attack by banks in Europe and Asia, which say it will restrict their borrowing capacity and inhibit lending.

The EU may exclude the leverage ratio when it converts Basel rules into law next year. Several member nations have advocated dropping the rule, people close to the discussions said last month. A majority of the 27 EU countries oppose adopting the ratio, these people said.

“The argument is that this will restrain lending -- I hope our colleagues in Europe don’t buy into this,” Bair said in an interview earlier this month.

Recent academic research supports Bair. A July paper by Jeremy Stein, a professor of economics at Harvard University, and two colleagues looked at data going back to the 1920s and found no correlation between higher capital ratios and costlier lending by banks. An October paper by Anat Admati and three other professors at Stanford University concluded that increased equity levels don’t restrict lending.

‘Continuing Bickering’

“In the long run, higher capital has small impact on lending,” said Stein in an interview. “But banks don’t like to go out and get it. And regulators bought the banks’ arguments on this. They could have been tougher.”

Bair, who first advocated the idea of an international leverage ratio in a speech to committee members in Merida, Mexico, in 2006, said she still expects global adoption.

Barbara Matthews, managing director of BCM International Regulatory Analytics LLC, a Washington-based company that advises on financial regulation, said the leverage ratio may not make it in the end.

“Beyond tightening the definition of capital, nothing can be really counted as having been achieved,” Matthews, a former bank lobbyist, said of the Basel committee’s work this year. “There’s continuing bickering over liquidity and leverage regimes. They’re still studying too-big-to-fail issues, and it might be too late to finalize them as events take them over.”

$6 Trillion

The Basel committee, established in 1974, proposed its first liquidity standard, which would require banks to hold enough cash or easily cashable assets to meet their liabilities for up to a year. Running out of cash was behind the 2008 collapse of Bear Stearns Cos. and Lehman Brothers Holdings Inc. in the U.S. and Northern Rock Plc in the U.K.

After banks showed they’d have to raise as much as $6 trillion in new long-term debt to be in compliance, the committee delayed a final decision on the rule, setting up an “observation period” of four to six years. It will likely be revised, according to members.

“Liquidity is very important and still an outstanding issue,” said Douglas Elliott, an economics fellow at the Washington-based Brookings Institution and a former JPMorgan Chase & Co. banker. “They’re trying to do it in the next couple of years, but it could take many more years. Or it might never get done if it proves too contentious.”

Resolution Mechanism

Lehman’s collapse also showed the need for a cross-border mechanism to wind down failing banks that have a global reach. More than 80 proceedings against the firm, involving hundreds of subsidiaries worldwide, have complicated recovery by creditors and destroyed much of the value of its assets.

The Financial Stability Board, which includes most Basel committee members as well as finance ministers from the Group of 20 nations, struggled to come up with such a resolution mechanism this year. The FSB postponed a decision until next year after divisions among nations proved too wide to bridge, members said. The group has been unable to agree on how to distribute losses among countries when a global bank fails and how different legal jurisdictions can recognize a single authority to pay creditors, the members said.

Too Big to Fail

The FSB is also responsible for determining which banks are systemically important and whether to impose additional capital requirements on them. The group may propose setting up national resolution authorities, rather than an international body, members said. Instead of a global accord on a surcharge for the largest banks, it may suggest a menu of options.

“Nobody’s been able to fix too-big-to-fail around the world because nobody knows how to do it,” said Hal Scott, a Harvard Law School professor who also is director of the Committee on Capital Markets Regulation, a nonpartisan group of academics and business executives. “Even figuring out how to resolve giant banks nationally is tough. How can you do it internationally? That was the biggest lesson of the crisis, systemic risk, but that’s still unresolved.”

Many issues may never be resolved, said Frederick Cannon, co-director of research at Keefe, Bruyette & Woods Inc. in New York, a firm that specializes in financial companies. G-20 leaders meeting in Seoul last month sounded as if they were claiming victory for regulatory reforms, even if they weren’t completed, Cannon said.

“Before Seoul, I was expecting more reforms to be concluded next year,” he said. “But now, more and more, I believe this is what we’re getting, nothing more. They got a 7 percent common equity requirement -- the rest is all uncertain to ever happen.”

‘Glass Half Full’

Charles Goodhart, a former Bank of England policy maker and professor at the London School of Economics, said he is more optimistic that differences will be resolved in coming years.

“There is still lots to be done, but we haven’t lost the momentum,” Goodhart said. “We’re 50 percent of the way there. We need to see it as the glass half full.”

Bair, who is stepping down from her FDIC position when her term expires in June, said she hopes the reforms will continue after she leaves the Basel committee. One remaining challenge, she said, is the reliance on banks’ internal models for measuring risk.

While smaller banks use standard risk-weightings prescribed by Basel, the largest banks use their own formulas to determine how much risk to assign their assets in calculating capital ratios. That leads to wide variations in how risk-weighted assets are tallied, Bair said.

“We have to get beyond too much reliance on banks’ internal models, their own views on risk,” she said.

To contact the reporter on this story: Yalman Onaran in New York at yonaran@bloomberg.net .

To contact the editor responsible for this story: David Scheer in New York at dscheer@bloomberg.net .

Wells Fargo reaches agreement with California to modify risky mortgages

2010-12-21T09:24:00.000-08:00

The bank will make modifications valued at as much as $2.4 billion on 'pick-a-payment' mortgages. It also will pay $32 million to 12,000 borrowers who had such loans and lost their homes to foreclosure.

By Alejandro Lazo, Los Angeles Times

December 21, 2010

Wells Fargo & Co. reached an agreement with the state of California to make mortgage modifications valued at as much as $2.4 billion on risky mortgages that let borrowers decide how much they would pay each month.

The bank also will pay $32 million to more than 12,000 California borrowers who had such loans and lost their homes to foreclosure, according to the accord, announced Monday with Atty. Gen. Jerry Brown's office. The $32 million works out to an average of about $2,650 for each former homeowner.

Some of the promised modifications, to be made over the next three years, are expected to include reductions in the balances owed by borrowers. But that does not appear to be a significant concession by Wells Fargo because it already has modified more than 50,000 so-called pick-a-payment mortgages in California, reducing the balances on those loans by a total of $2.9 billion.

The San Francisco bank inherited the loans, known generically as pay-option adjustable-rate mortgages or option ARMs, when it purchased troubled Wachovia at the end of 2008 during the financial crisis. At that time Wells Fargo wrote down the value of the Wachovia portfolio before taking it onto its own books.

As a result, the loan modifications haven't generated painful losses for Wells Fargo. The company indicated Monday that it didn't expect the newly promised modifications to force it to further write down the portfolio.

"What they are doing now is more public relations," Rochdale Securities analyst Richard Bove said. "If the only economic impact is that they are going to give roughly $2,600 to $2,700 to a few thousand people, and if that is going to cost them on the order of $32 million, that's peanuts."

Pick-a-payment loans proved to be problematic for many borrowers, particularly in California, where many of the loans were made. Losses on the loans were a major reason Wachovia was forced to find a healthier bank to buy it.

The option ARMs allowed homeowners to essentially choose how much they wanted to pay on their loans each month. Many borrowers opted for the smallest payment, which didn't even cover the interest accruing each month. That meant the balance on the loan rose instead of fell. But once the balance reached a certain level, the required payment was reset automatically, often ballooning to a level that the borrower couldn't afford.

The settlement with California follows similar agreements that Wells Fargo struck in October with nine other states: Arizona, Colorado, Kansas, Florida, Illinois, Nevada, New Jersey, Texas and Washington.

The agreement is unrelated to an investigation that all 50 state attorneys general are conducting into the foreclosure practices of major lenders. That probe was sparked by revelations that several major lenders had employed people who had legally attested to the accuracy of foreclosure documents without reading them.

The bank also will pay the attorney general's office $1.8 million "for the investigation and prosecution of consumer protection matters, for consumer education and outreach, and to pay any costs incurred to distribute payments to eligible foreclosed borrowers."

alejandro.lazo@latimes.com

Los Angeles Times

FDIC Cuts Budget

2010-12-21T08:29:00.000-08:00

FDIC Cuts Budget

Philip van Doorn

12.15.10

TheStreet

WASHINGTON (TheStreet) -- The Federal Deposit Insurance Corp. on Wednesday announced that it board of directors had approved a $4 billion operating budget for 2011, which was down slightly from the 2010 budget.

FDIC Chairman Sheila Bair said in a statement that the agency's staff had "met the challenge to find savings to offset a portion of the additional resources needed to carry out our new responsibilities under the Dodd-Frank Act," adding that "the FDIC's operating budget does not in any way involve the use of taxpayer funds," since the budget is fully funded by deposit insurance premiums paid by banks and thrifts.

The agency's board authorized a staffing level of 9,252 employees for 2011, increasing about 2.5% from 2010.
The decrease in the FDIC's budget comes at a very busy time for the agency, as it develops new regulations to implement the Dodd-Frank Act, and also faces continued findings by its Inspector General's Office that the agency could have taken earlier and stronger actions over the years leading up to some bank failures.

For example, in the Material Loss Review for Westernbank Puerto Rico, which failed on April 30, with most of its assets purchased from the FDIC by Banco Popular de Puerto Rico, which is the main subsidiary of Popular (BPOP ).

The Inspector General said that "In hindsight, initiating an informal supervisory action in response to the 2006 examination and imposing a stronger supervisory action in response o the 2007 examination findings may have been prudent."

While hindsight is always 20-20, Westernbank's failure cost the deposit insurance fund an estimated $3.31 billion.

Colony Closes Structured Deal

2010-12-20T16:41:00.001-08:00

$341M In Unpaid Loans Sold By FDIC

Collections & Credit Risk | Monday, December 20, 2010

The Cogsville Group LLC, a private equity firm, and Colony Capital LLC purchased from the Federal Deposit Insurance Corporation (FDIC) two portfolios of more than 700 commercial real estate loans. The two portfolios have an aggregate unpaid principal balance of approximately $341 million.

The FDIC had acquired the loans as the receiver of 14 failed financial institutions.

The transactions, which include both performing and non-performing loans, are the second and third purchases by Cogsville and Colony under a public-private partnership.

In the deal announced Monday, a portfolio with loan concentrations in western states, was purchased at 60% of the unpaid principal balance. A portfolio with loan largely based in northern states, was purchased at 27%.

Colony and Cogsville partnered with entities affiliated with WL Ross & Co. LLC and Invesco Ltd. and Mount Kellett Capital to acquire the portfolios. Milestone Advisors, LLC was hired as financial advisor to the FDIC on the sale of these assets.

Donald P. Cogsville, CEO at The Cogsville Group, says in 2010 his company and Colony acquired more than 2,300 commercial real estate loans with balances exceeding $2 billion.

"I believe this [transaction] is a unique opportunity to purchase distressed real estate assets of commercial banks holding more than $250 billion of non-performing loans, and of special servicers holding another $70 billion," he says. "We expect these numbers to grow over the next two years as more of the $1 trillion of commercial real estate loans originated since 2005 come due in a market that has seen prices fall more than 40%."

Merger Pressure

2010-12-20T10:20:00.000-08:00

Regional US banks looking to mergers

By Francesco Guerrera, Justin Baer and Helen Thomas in New York
Published: December 19 2010 19:48 | Last updated: December 19 2010 19:48

Financial Times

US regional banks are preparing for consolidation as the hangover from the financial crisis and the sluggish economic recovery put pressure on underperforming lenders to raise capital or sell to a rival.
Bankers and their advisers say the next two years could witness several mergers among the 7,000-plus banks that make up the backbone of the US banking system.

On Friday, Marshall & Ilsey, a troubled mid-western lender, agreed to a $4.1bn all-stock takeover by Bank of Montreal, a Canadian bank that avoided large losses during the crisis.

Analysts say that this type of deal between struggling local lenders and healthier, bigger competitors could be a template for future takeovers.

“We expect a wave of . . . bank consolidation to emerge within the next 12-18 months after a dearth of deals during and immediately after the financial crisis,” wrote Christopher McGratty, at Keefe, Bruyette & Woods, in a note to clients.

With the “big three” national banks - JPMorgan Chase, Bank of America and Wells Fargo - still digesting the large acquisitions made during the turmoil, buyers are likely to be large regional players with solid balance sheets and robust earnings.

KBW analysts said banks such as Pittsburgh-based PNC, US Bancorp, the fifth-largest commercial bank in the US, and BB&T, a North Carolina lender, were among the companies that could hit the takeover trail to boost profits.

Canadian banks such as BMO and TD Bank Financial Group could also be among the acquirers.

Bankers said potential targets included banks whose recovery from the crisis has been slow because of their exposure to soured mortgages and commercial real estate loans.

Among the possible sellers, industry experts named Regions Financial Corporation, a loss-making lender with more than $130bn in assets and about 1,800 branches in the south and midwest of the US; Synovus, a smaller bank with exposure to the troubled real estate markets of Georgia and Florida; and Atlanta-based SunTrust.

SunTrust and Regions are among the largest remaining recipients of government aid, with $4.9bn and $3.5bn outstanding under the Troubled Asset Relief Programme. The two are part of a group of banks undergoing “stress tests” by the Federal Reserve to determine whether they are healthy enough to repay Tarp.

Regions, SunTrust and Synovus declined to comment.

US banks have often been a fertile source of deals. Despite a raft of takeovers that helped create today’s financial powerhouses such as BofA, JPMorgan and Citigroup, the industry remains fragmented.

Bank deals slowed to a crawl in 2008 as the crisis set in, with government-assisted takeovers of failing lenders the only source of activity. But as the worst of the downturn receded, many banks rebuilt their balance sheets and churned out higher profits. Their recovery has stood in stark relief to some banks still reeling from loan losses and tepid fee income.

Financial Times

2010 Tally 157

2010-12-19T11:14:00.000-08:00

Bloomberg 12.18.10

U.S. Bank Collapses Reach 157 This Year as Six More Lenders Are Shuttered

Regulators shuttered six banks holding a total of $1.23 billion in assets, including three in Georgia and one each in Arkansas, Minnesota and Florida, as real-estate losses drive this year´s bank failures to 157. Florida has lost 29 lenders this year while 21 banks in Georgia were seized, the Federal Deposit Insurance Corp. said today in statements on its website. Regulators have closed 322 banks since the start of 2008. Today´s six closures cost the FDIC´s deposit-insurance fund a total of $267.6 million. "We´re over the hump in terms of number of failures and the average size, and potentially in the cost of them," Bert Ely, a banking consultant in Alexandria, Virginia, said in an interview. The crisis is "far from over but we´re making headway." This week´s failures may be the final closures for 2010 because regulators seldom shut down banks on holiday weekends, Ely said. The next two Fridays are Christmas Eve, a market holiday in the U.S., and New Year´s Eve.

Regulatory Turf: FDIC Muscles In On Fed Territory

2010-12-19T10:44:00.000-08:00

Philip van Doorn

http://www.thestreet.com

12/15/10 - 04:12 PM EST

WASHINGTON (TheStreet) -- The Federal Deposit Insurance Corp. on Wednesday announced a director for the new Office of Complex Financial Institutions, the next step in giving the FDIC regulatory powers normally reserved for the Federal Reserve.

The FDIC announced that Jim Wigand would be appointed to the position effective December 31. Wigand is currently the FDIC's deputy director for Franchise and Asset Marketing in the Division of Resolutions and Receiverships, handling the disposition of failed banks since 1997.

The new office is responsible for the "continuous review and oversight of bank holding companies with more than $100 billion in assets as well as non-bank financial companies designated as systemically important by the new Financial Stability Oversight Council," as required by the Dodd-Frank Wall Street Reform and Consumer Protection Act.

This means the FDIC will now have supervisory authority and will have a continuous presence at the nation's largest bank holding companies. That regulatory authority that has been the sole bailiwick of the Fed but now affected financial firms will have another set of regulatory relationships to manage.

The Office of Complex Financial Institutions will also be responsible - along with the Federal Reserve - for reviewing and approving resolution plans for large banks and non-bank financial institutions.

The Financial Stability Oversight Council is chaired by the Secretary of the Treasury, and the Comptroller of the Currency and chairs of the Federal Reserve, the Securities and Exchange Commission, Federal Housing Finance Agency, the National Credit Union Administration and the FDIC are among the members of the council.

There are over 50 U.S. bank holding companies, investment banks, insurance companies and specialty finance companies with over $100 billion in total assets. The largest include Fannie Mae and Freddie Mac, which were taken into government conservatorship in September 2008. Other large, systemically important companies with over a $1 trillion in assets apiece include Bank of America (BAC ), Citigroup (C ), JPMorgan Chase (JPM ) and Wells Fargo (WFC ).

FDIC Chairman Sheila Bair said she was pleased with Wigand's appointment, as his decades of experience in resolutions, asset sales, structured finance and financial institution regulation uniquely position him to lead the CFI at a critically important time."

---

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

157 Banks Closed in 2010

2010-12-17T17:29:00.000-08:00

Regulators close banks in Ga., Fla., Ark., Minn.

(AP) – 2 hours ago

WASHINGTON (AP) — Regulators on Friday shuttered three small banks in Georgia and one each in Florida, Arkansas and Minnesota, raising to 157 the number of U.S. banks brought down this year by the struggling economy and soured loans.

The Federal Deposit Insurance Corp. took over the three Georgia banks: Appalachian Community Bank of McCaysville, with $68.2 million in assets; Chestatee State Bank, based in Dawsonville, with $244.4 million in assets; and Atlanta-based United Americas Bank, with $242.3 million in assets.

The FDIC also seized Bank of Miami, based in Coral Gables, Fla., with $448.2 million in assets; First Southern Bank of Batesville, Ark., with $191.8 million in assets; and Community National Bank of Lino Lakes, Minn., with $31.6 million in assets.

Florida has been the hardest hit state for bank failures, and Georgia also has registered many shutdowns. Bank of Miami was the 29th bank to fail in Florida this year, while the failures of the three Georgia banks brought the number in that state to 21 in 2010. Other states that have seen large numbers of bank failures are California and Illinois, amid an avalanche of bad loans, especially for commercial real estate.

Peoples Bank of East Tennessee, based in Madisonville, Tenn., agreed to assume $67.5 million of the assets and most of the deposits of Appalachian Community Bank. Bank of the Ozarks, based in Little Rock, Ark., is assuming all the assets and deposits of Chestatee State Bank. State Bank and Trust Co., based in Macon, Ga., is acquiring the assets and deposits of United Americas Bank.

Boca Raton, Fla.-based 1st United Bank is assuming $442.3 million of the assets and all the deposits of Bank of Miami. Southern Bank, based in Poplar Bluff, Mo., is taking $152.8 million of the assets and all the deposits of First Southern Bank. Farmers & Merchants Savings Bank of Manchester, Iowa, is assuming the assets and deposits of Community National Bank.

In addition, the FDIC and Peoples Bank of East Tennessee agreed to share losses on $46.4 million of Appalachian Community Bank's loans and other assets. The FDIC and Bank of the Ozarks are sharing losses on $195.3 million of Chestatee State Bank's assets. The agency and State Bank and Trust Co. are sharing losses on $195.8 million of United Americas Bank's assets.

The FDIC and 1st United Bank agreed to share losses on $313.5 million of Bank of Miami's assets.

The failure of Appalachian Community Bank is expected to cost the deposit insurance fund $26 million. The failure of Chestatee State Bank is expected to cost the fund $75.3 million; that of United Americas Bank, $75.8 million; that of Bank of Miami, $64 million; First Southern Bank, $22.8 million; and Community National Bank, $3.7 million.

The 157 closures nationwide so far this year tops the 140 shuttered in all of 2009 and is the most in a year since the savings-and-loan crisis two decades ago.

The 2009 failures cost the insurance fund about $36 billion; the failures so far this year have cost around $21 billion, less because the banks failing in 2010 have on average been smaller. Twenty-five banks failed in 2008, the year the financial crisis struck with force; only three succumbed in 2007.

The growing bank failures have sapped billions of dollars out of the deposit insurance fund. It fell into the red last year, and its deficit stood at $8 billion as of Sept. 30.

The number of banks on the FDIC's confidential "problem" list jumped to 860 in the third quarter from 829 three months earlier. The 860 troubled banks is the highest number since 1993, during the savings-and-loan crisis.

The FDIC expects the cost of resolving failed banks to total around $52 billion from 2010 through 2014.

Depositors' money — insured up to $250,000 per account — is not at risk, with the FDIC backed by the government. That insurance cap was made permanent in the financial overhaul law enacted in July.

The Associated Press

Big Restructures

2010-12-17T09:27:00.000-08:00

COMMERCIAL REAL ESTATE

DECEMBER 17, 2010

Blackstone Reworks $7 Billion in Debt

Deal Is Struck to Restructure Cash Owed on Purchase of Sam Zell's Equity Office Properties Trust

By LINGLING WEI And ELIOT BROWN, Wall Street Journal

Blackstone Group LP has reached an agreement to restructure about $7 billion of the remaining debt tied to its epic 2007 purchase of Sam Zell's Equity Office Properties Trust, the largest leveraged buyout ever, according to people familiar with the matter.

The deal marks the second major restructuring Blackstone has pulled off this year as the credit markets have thawed, enabling well-capitalized owners to restructure properties that were purchased near the top of the market.

In the other deal, Blackstone reworked the balance sheet of Hilton Worldwide Inc., the firm's single-largest investment, cutting Hilton's $20 billion debt load by nearly $4 billion.

Under the Equity Office deal, which is expected to be finalized by year's end, the maturity of the debt will be extended to 2014 from 2012, the people said. In exchange, Blackstone will pay down the $7 billion debt by 10% and the interest rate on the remaining debt will increase by one percentage point, these people said.

The deal represents the latest chapter in the story of Blackstone's purchase of Equity Office for $39 billion, including debt and equity. In retrospect, that top-of-the-market deal could have hurt Blackstone because values tanked shortly afterward.

But immediately after the acquisition, Blackstone sold about $30 billion of properties to raise cash and reduce the debt taken on for the buyout.

Most of those who picked up the buildings from Blackstone in 2007—the list reads like a Who's Who in real estate—have hit financial problems because they were overwhelmed by the debt they took on to do the deals.

The 149 Equity Office buildings Blackstone held on to had $7 billion of debt, including $4.9 billion of mortgages that were packaged and sold as commercial-mortgage-backed securities, or CMBS, and about $2.1 billion of "mezzanine," or junior, debt that fills the gap between the first mortgage and the equity.

The buildings are generating enough income to service all their debt, and their debt doesn't mature until 2012.

But, like most of the properties in the Equity Office portfolio, they likely have dropped in value even though property values have rebounded in recent months.

The debt extension is expected to make it easier for Blackstone to come up with an exit strategy for the remaining EOP portfolio, which largely is made up of top-tier buildings in Boston, New York and California.

Blackstone could choose between selling the entire portfolio in an initial public offering or selling it in parts to deal-hungry investors such as publicly traded real-estate investment trusts and sovereign-wealth funds.

The largest building in the portfolio, valued at about $1 billion by some estimates, is 1095 Ave. of the Americas in Midtown Manhattan, whose tenants include insurer MetLife Inc. and law firm Dechert LLP.

The Hilton acquisition was more of a problem for Blackstone because of the huge debt load it took. Nevertheless, Blackstone pulled off a coup earlier this year when it cut Hilton's $20 billion debt load by nearly $4 billion while putting $800 million of new equity into the deal.

Many of the developers and real-estate companies that purchased Equity Office properties from Blackstone have been working through their problems.

Earlier this month, Beacon Capital Partners, which paid $6.3 billion to Blackstone for buildings in Washington, D.C., and Seattle, gained a five-year extension of a $2.7 billion securitized loan, agreeing to put up $200 million in new collateral.

And on Monday, MPG Office Trust Inc., the firm formerly known as Maguire Properties that bought 24 Blackstone properties, announced it would default on a $470 million loan it is trying to restructure for the 54-story Two California Plaza tower in Los Angeles.

Other buyers of the onetime EOP portfolio have been forced to sell some of the properties to stay afloat, or simply to hand over the keys to lenders.

Macklowe Properties, which bought seven buildings in New York from Blackstone in 2007, defaulted on $7 billion in debt and turned them over to lenders in 2008 when the firm couldn't refinance a short-term loan.

Write to Lingling Wei at lingling.wei@wsj.com

Commercial Mortgage Backed Securities Surge Back

2010-12-17T09:23:00.000-08:00

Bloomberg News

Goldman Deal Pushes CMBS Sales Past $11 Billion Mark

Dec. 16 (Bloomberg) -- Goldman Sachs Group Inc. and Citigroup Inc. sold $876.45 million of bonds linked to U.S. commercial real estate, pushing 2010 sales to $11.5 billion as strategists forecast next year’s offerings will quadruple.

Property owners are pushing banks to offer better loan terms as more lenders vie for a share of the $650 billion commercial-mortgage bond market. Between 20 and 25 institutions are seeking to originate loans they plan to package into securities, up from about five competitors a year ago, New York- based Standard & Poor’s said in a Dec. 2 report. Issuance plunged to $3.4 billion in 2009 from a record $234 billion in 2007 after the financial crisis froze credit markets.

“The CMBS lenders came back quickly, and borrowers are benefiting,” Greg Michaud, head of real estate finance at ING Investment Management Americas in Atlanta, said in a telephone interview. “Twelve months ago, borrowers were happy to get anything. Now they are really shopping around.”

Today’s sale, tied mostly to payments on shopping center and office-building loans, priced to yield 140 basis points more than the benchmark swap rate for a top-rated $376 million slice maturing in 9.84 years, according to a person familiar with it. The securities were initially marketed to yield between 130 and 135 basis points over swaps, said the person, who declined to be identified because terms aren’t public.

Michael DuVally, a spokesman at Goldman Sachs, and Danielle Romero-Apsilos, a spokeswoman for Citigroup, declined to comment.

Interest-Only Loans

The Goldman Sachs-Citigroup offering included a higher percentage of so-called interest-only debt than sales earlier this year, according to a Dec. 9 report from Fitch Ratings. Such loans are considered riskier than mortgages that require the landlord to pay down a portion of the principal. About 85.4 percent of the pool sold today pays principal during the life of the loans, compared with more than 90 percent of offerings earlier this year, Fitch said.

Today’s deal still marks a “material improvement” compared with those from the boom ended in 2007, according to Fitch. That year, as much as 87 percent of commercial mortgages packaged into bonds delayed principal payments for at least a portion of the life of the loan, according to Morgan Stanley.

Relaxing Underwriting

Underwriting standards are usually the first metric to loosen as lending rivalry increases, JPMorgan Chase & Co. analysts said in a Nov. 24 report that forecast CMBS issuance may reach $45 billion in 2011.

“The competition is healthy because it means you have more dollars chasing these loans,” said Roger Lehman, an analyst at BofA Merrill Lynch Global Research. “Financing is a key component of the recovery in commercial real estate. It’s not a cash market.”

U.S. commercial real estate values peaked in October 2007, when the Moody’s Real/Commercial Property Price Index touched 191.9. The measure bottomed at 105.4 in August, marking a 45 percent drop.

To contact the reporter on this story: Sarah Mulholland in New York at smulholland3@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net

WWWSD: What Would Wall Street Have Done?

2010-12-16T10:41:00.000-08:00

DECEMBER 16, 2010

'Vultures' Give U.S. Good Mark

By MATT WIRZ, Wall Street Journal

The credit crisis made Uncle Sam the largest distressed-debt investor in financial history, as the government piled into a $388 billion patchwork portfolio of U.S. banks, insurers, car companies, and even a fast-food franchise.

Granted, the Bush and Obama administrations were more focused on stabilizing the financial system when they began their purchases in Sept. 2008. But based on the unvarnished principles of "vulture" investing—buying into broken companies that other investors avoid—how has the government fared as it begins unwinding its big positions?

Thirteen distressed specialists polled by The Wall Street Journal give the U.S. a begrudging "B" in Vulture Investing 101, with room to earn a "B+" depending on results of upcoming stock sales in General Motors Co. and American International Group Inc.

Most of those interviewed praise the government for getting so much of its money back in less than two years.

"It's remarkable that they've made any kind of a decent return given that they didn't have any time to do real due diligence," said Wilbur Ross, founder of WL Ross & Co. and a distressed investor in global, steel, textile and automotive manufacturers. WL Ross participated in the recapitalization of the banking system through co-investments with the FDIC and through the $40 billion Public-Private Investment Plan, and its automotive portfolio company supplies GM.

But others pointed out that the government could have extracted greater profits and restructured bailed-out companies more aggressively.

The Congressional Budget Office estimated in November that the U.S. will lose $25 billion on the $388 billion disbursed through the Troubled Asset Relief Program, or TARP. That's down from the $50 billion hit Treasury projected in October and the $105 billion it forecast earlier in the year.

Like all investors, distressed-fund managers evaluate themselves first and foremost on the returns they make relative to the risks they take. They also pride themselves on how well they restructure operations, how quickly they can exit their positions and how effectively they bargain—or bully—at the negotiating table, all of which contribute to profits.

Treasury reported one of its strongest investment performances yet in early December with a total profit of $12 billion, or 27%, on the $45 billion it sank into Citigroup beginning in October 2008. That stacks up quite well against the 28% that the Hedge Fund Research Distressed/Restructuring index returned over the same period.

On the other side of the ledger are Freddie Mac and Fannie Mae, which have yet to return principal on government loans and remain mired beneath underwater residential mortgages. The bailout of the two mortgage lenders has already cost taxpayers $134 billion on top of TARP.

Meanwhile, 123 banks missed November dividend payments on their TARP loans, according to SNL Financial. Those banks collectively have received $3.3 billion in TARP aid, SNL said.

That leaves the remaining asset and stock sales by AIG and GM as the main outstanding measures of profitability. Treasury has said it expects to generate positive returns on both, but it currently faces a paper loss of $9 billion, or 18%, on its $50 billion investment in GM. After committing $120 billion in aid to AIG, the government hopes to eventually turn a profit by selling off the insurer in parts.

Treasury Secretary Timothy Geithner and his advisers earned high marks for the pace they set in restructurings. "If you ask the question, 'did they get in there and establish order quickly?' I think the answer is yes," said one fund manager who invested in the debt of some of the bailed-out companies.

The speed of the workouts—GM exited bankruptcy in 40 days, a record for a company that size—owes a lot to the unparalleled political clout the government brought to bear in the restructurings it initiated. Many restructuring experts argue that Treasury trampled on creditor rights in the bankruptcies of Chrysler and GM just as it swept aside preconceptions about limits to its authority in aiding AIG, Freddie Mac and Fannie Mae.

Some investors still resent the Obama administration's write-off of loans and bonds in the auto restructurings, while at the same time protecting union benefits and bank creditors. But they grudgingly respect the way the government played its cards and forced opponents to fold, something veteran vultures spend years building reputations for.

"I think the government played it very well," said New York University business professor Edward Altman. In the case of GM, creditor treatment may have been unfair, but that gave the company the best shot to survive, and that gave confidence to the market, he said.

The game theory from Treasury's perspective was simple. It could afford to impose haircuts on lenders to the auto manufacturers because GM and Chrysler didn't depend on the owners of its debt for day-to-day funding, as did many banks.

In the case of financial institutions, the government focused on co-opting creditors rather than strong-arming them. "Banks depend on the confidence of their creditors for their day-to-day operations," said Jim Millstein, Treasury's chief restructuring officer. "You can't seek to impair creditors of a financial institution unless you're prepared to liquidate."

By holding back from a wholesale nationalization of the banking system and introducing a credible stress test, the U.S. triggered the virtuous cycle that buoyed capital markets for the past 18 months. It also avoided significant restructuring of the core cause of the crisis, the overleveraged real-estate market.

That bears directly on the one category where distressed-investing pros graded the government most harshly: companies' operational improvements. Many toxic mortgages remain on banks' balance sheets, and the bulk of those now on Uncle Sam's books remain unaddressed given the foreclosure and refinancing morass.

The government has taken much of the prospective mortgage losses from the private banks onto its own balance sheet by funding the lion's share of refinancings since 2008 through Fannie Mae, Freddie Mac and the Federal Housing Authority.

"If you take a bad mortgage and have the FHA refinance it so it comes off one of these bank's books, and then the government takes a loss there, it's really hard to see how that's a success," said Greenlight Capital President David Einhorn.

—Shira Ovide contributed to this article.

The True Cost of Systemic Guarantees

2010-12-16T09:46:00.000-08:00

Treasury Guarantees Are Too Good to Be Free
By Alex J. Pollock
American Banker
Thursday, December 16, 2010

A lesson that everybody has drawn from the debacle of Fannie Mae and Freddie Mac is that free guarantees from the Treasury Department, and therefore from the taxpayers, are a bad idea. Everybody now agrees that Treasury guarantees should be both explicit and explicitly paid for.

Now let's consider the Federal Deposit Insurance Corp., which benefits from a free Treasury guarantee.

As originally conceived, deposit insurance corporations, including the FDIC, were expected to stand on their own. In reality, of course, they had an implicit Treasury guarantee, like Fannie and Freddie. When faced with the financial collapse of the Savings and Loan Deposit Insurance Corp. in the 1980s, Congress made the deposit guarantee explicit. The taxpayers then paid $150 billion to cover the failure of FSLIC.

That is why the sticker you will see in every bank no longer merely says that deposits are protected by the FDIC. Instead, it says, "Backed by the full faith and credit of the United States government." This guarantee has enormous value to the FDIC and its member banks, but is not paid for.

In the current financial bust, the FDIC has publicly reported its insolvency for some time, with a negative net worth of billions of dollars. But nobody worries about it and no depositor cares. Why? Because of the Treasury guarantee. How valuable is that? Very valuable!

Add to this that the Treasury has protected the FDIC in other ways. Imagine the state of the FDIC without Tarp investments to shore up banks and AIG, or without the tax advantages Well Fargo got in its takeover of Wachovia, or without extraordinary assistance to Citibank. Only one failure of a really big bank would have made the FDIC insolvency dramatic indeed.

So what is the explicit guarantee of the FDIC by the Treasury worth? A lot, without question. What should the FDIC pay the Treasury and the taxpayers for it? Not nothing, that's for sure.

We should set ourselves the task of calculating and then charging the fair price.

Alex J. Pollock is a resident fellow at AEI.

You can find this article online at http://www.aei.org/article/102906

New Office Fundamentals?

2010-12-15T11:00:00.000-08:00

latimes.com

Office walls are closing in on corporate workers

Businesses used to provide 500 to 700 square feet of work space per employee, but the average is down to 200 square feet — and shrinking. The recession and an emphasis on teamwork accelerated the trend, and younger staffers prefer less.

By Roger Vincent, Los Angeles Times

December 15, 2010

The walls are closing in on white-collar workers — their office environments are shrinking, propelled by new technology, a changing corporate culture and the age-old imperative to save a buck.

Although personal workstations won't disappear, the sprawling warrens of cubicles and private offices that have defined the workplace for the last few decades are heading the way of Rolodexes and typewriters. The shift is of tectonic proportions, experts on the workplace say.

In the 1970s, American corporations typically thought they needed 500 to 700 square feet per employee to build an effective office. Today's average is a little more than 200 square feet per person, and the space allocation could hit a mere 50 square feet by 2015, said Peter Miscovich, who studies workplace trends as a managing director at brokerage Jones Lang LaSalle.

"We're at a very interesting inflection point in real estate history," Miscovich said. "The next 10 years will be very different than the last 30."

Companies have been gradually dialing back on office size and grandness for years, but the recession accelerated the trend as sobered owners let go of their old floor plans and tried new ways to speed productivity, attract talent and cut costs.

There are other factors at play in the push to make work spaces smaller and more communal. Many companies are emphasizing teamwork, and younger employees accustomed to working anywhere but at a desk are turning up their noses at the hierarchical formality of traditional offices. In addition, familiar technologies such as laptop computers, cellphones and videoconferencing are finally beginning to affect the way offices are laid out.

"These tech advances and different ways of working are occurring in parallel with the recession — and then there is the generational shift," Miscovich said. "lt's all sort of happening at once."

Office tenants who renew their leases these days often cut their space total 10% to 30%, according to Jones Lang LaSalle. The term "restacking" has emerged to describe the common process of making offices more efficient by changing the floor layout, reducing paper file storage space and introducing smaller, uniform workstations.

A case in point is Southern California Gas Co., which is remaking its headquarters in downtown Los Angeles. The utility arrived in 1991 as the prestigious anchor tenant of the new 50-story Gas Co. Tower, setting up offices that were among the best corporate America had to offer.

"When we moved in almost 20 years ago, the office was really on the cutting edge of space design," said Pamela Fair, the utility's vice president in charge of support services.

That old space plan put most workers in three-sided cubicles with walls too high to see over. Each is like a mini office with room for a personal computer and large monitor. There are ample file drawers and additional storage cabinets nearby. Managers' offices with spectacular views line the outer walls.

Now, having renewed its lease in its namesake tower, the Gas Co. is cutting its space from 15 floors down to 12 in what may be the largest office makeover underway in Southern California. (The office also has about 12% fewer employees than in 1991.) Among the changes will be fewer private offices and more compact standardized workstations for those who spend their days in the office.

Workers such as account executives who spend the bulk of their time in the field will use small "touch down stations" placed invitingly in front of big windows when they do visit the office. Cubicles will be laid out in a manner meant to encourage collaboration, and there will be more "teaming" rooms, like small conference rooms, where small groups can work together.

Informal meeting spaces and comfortable common areas where workers can plug in laptops are becoming standard fixtures for many businesses, said Larry Rivard, area sales director for office furniture manufacturer Steelcase Inc.

"A lot of people want to get away from the cubicle," he said.

Part of the reason is economics. Although cubicles have shrunk from an average of 64 feet to 49 feet in recent years, Rivard said, companies are looking for more ways to compress their real estate footprint. They also want to encourage worker collaboration and present themselves as forward-thinking businesses capable of attracting the best young talent.

Age makes a difference, workplace experts say. Baby boomers longed for a corner office and expected to separate their work lives from their home lives.

"Younger workers' lives are all integrated, not segregated," Rivard said. "They have learned to work anywhere — at a kitchen table or wherever." Many don't feel a need to spend time in company quarters.

Rob Jernigan, an architect and baby boomer, calls them "the backpack kids" because they grew up in an age when they could carry everything they needed at school or elsewhere in their backpacks. "Laptops can do what a computer the size of a house used to do," he said.

Jernigan's firm, Gensler, is designing offices that squeeze together workstations while setting aside a few rooms where employees can conduct meetings or have private phone conversations. Ideally, such designs create workplaces that are more efficient and pleasant while utilizing fewer square feet per employee.

Not that increased togetherness is always welcome, of course. People who talk too loud on the telephone can disrupt dozens of co-workers, some of whom might long for more personal space and privacy.

"We have a lot of people who spend full time here, and many of them like to have a place go to," the Gas Co.'s Fair said. "We need to recognize that."

The company gave employees a chance to comment on which type of new workstations they like best. Their feedback is still being analyzed. "If there are major red flags, we'll see what we can do," Fair said.

Nevertheless, the more compact, collaborative workplace is here to stay, industry observers said. Space is becoming less of a status symbol.

"A lot of people who grew up in workstations find it effective to manage out on the floor and have less need to be isolated in an office in order to show power and control," said Judy Caruthers of Jones Lang LaSalle, who helps companies plan their space needs.

More dramatic change is on the way, her colleague Miscovich said.

"We are just now becoming accustomed to the PC," he said. "It may take us another 30 years to fully engage and adapt with mobility, [but] the mobile Internet may be bigger than electricity as a technological advancement."

roger.vincent@latimes.com

Are cubicles going extinct?

The cubicle was once the norm in an office setting, but times are changing. Not only are the workspaces getting smaller, but the whole idea of cubicles themselves -- closed off, with walls -- may be disappearing altogether.

Inside Mr. Youth's cubicle-less office. (Courtesy of Mr. Youth)

TEXT OF STORY

KAI RYSSDAL: This is the time of year when people start looking ahead to try to get some feeling for what the future might bring. Take the office, a place we spend a lot of time. It's been changing quite a bit as businesses try to save space and money.

Today the Los Angeles Times observed the cubicle is shrinking. We sent reporter -- and cubicle veteran -- Stacey Vanek Smith to explore the cubicle of the future.

STACEY VANEK SMITH: Full disclosure: I love my cubicle. But evidently, that makes me a workplace throwback. Tom Polucci is director of interior design for arichitecture firm HOK.

TOM POLUCCI: The Dilbert cartoon where everyone's working in a cubicle farm, that's really disappeared.

Polucci says cubicles are shrinking-most now are 6 feet by 6 feet. Part of it is money. Office space is a company's biggest expense after salaries. But it's also just the way we work now.

POLUCCI: Workplace has become much more collaborative. Now it's you might be sitting in a smaller personal space, or what I like to call a me space, because you're tending to work more in an environment when you're shared with your colleagues. And I like to refer to those spaces as we spaces.

One workspace with a lot of we-space, social marketing firm Mr. Youth and CrowdTap. Most people work at tables or have their desks in clusters. Company CFO Dan LaFontaine says it's fun and practical.

DAN LAFONTAINE: It's incredibly efficient. Rather than have some formal meeting, it's very easy just to grab a couple of people and stand around one area very quickly and get done what you need to get done.

LaFontaine's workers are young -- average age? About 26. He says they don't really want the privacy of an office or a cubicle.

LAFONTAINE: They're putting their whole lives up on Facebook and on Twitter and everywhere else anyway. There's no real reason they should hide behind a cubicle wall.

Still, LaFontaine says, the office of the future does have some drawbacks.

LAFONTAINE: Sometimes it gets a little bit noisy and there are those days when you want to walk in and just have peace and quiet and get things done. Did a microwave just go off? That was a microwave, I believe that's popcorn you smell.

In New York, I'm Stacey Vanek Smith from Marketplace.

The Hard to Read State of Commercial Real Estate

2010-12-15T09:50:00.000-08:00

Bloomberg News

Real Estate Avoids 'Catastrophe' as Yields Drop: Credit Markets

Dec. 15 (Bloomberg) -- Investor confidence in U.S. commercial property is the highest since the 2007 market peak, a sentiment reflected in bonds of real-estate companies that own everything from New York skyscrapers to California strip malls.

Yields on debt issued by real-estate investment trusts average 210 basis points more than Treasuries, the least since Nov. 12, 2007, according to Bank of America Merrill Lynch index data. The debt has returned 13.2 percent this year, trumping a 8 percent gain by investment-grade bonds.

The debt of companies that own offices, shopping centers, apartments and warehouses has rallied as a dearth of new development spurs demand "little by little," according to billionaire investor Sam Zell, chairman of Chicago-based apartment owner Equity Residential. The Moody's/REAL Commercial Property Price Index has been little changed since October 2009 after plunging 45 percent in two years.

"If there is no new supply, then the catastrophe that everybody was expecting isn't going to happen," Zell, 69, said in a telephone interview. "Commercial real estate is not suffering and is in fact getting better," said Zell, the founder of Equity Office Properties Trust, the biggest U.S. office owner before Blackstone LP bought it in a record-breaking leveraged buyout in 2007.

REITs have issued $17.7 billion of bonds this year, the most since 2006, Bloomberg data show. The sales helped refinance existing debt and bolster balance sheets as rents and occupancies stabilize, debt-research firm CreditSights Inc. said in a report last month.

Nothing Built

"Real estate is all about supply and demand," said Zell. "We haven't built anything in this country since July '07. We're not building anything right now."

Rally Over

The improvement belies predictions by investors including Inland Real Estate Group Inc. Vice Chairman Joe Cosenza that the commercial property market had further to fall.

'Double-Dip'

In an interview at Bloomberg LP's Chicago office in July, Cosenza said a "double-dip" in the commercial real estate market could have come as soon as September.

The turnaround is being driven in part by the relatively slim list of distressed properties coming up for sale and quicker-than-expected rebound in fundamentals such as rents and vacancy rates, according to Newport Beach, California-based Green Street Advisors, an independent real estate research firm.

HCP Inc., the biggest U.S. health-care REIT by market value, said late Dec. 13 it would pay $6.1 billion for 338 nursing homes from Carlyle Group's HCR ManorCare Inc. in the largest REIT deal in three years.

The acquisition is "a good example of public REITs buying from private-equity firms looking to monetize investments from a few years ago," said Craig Guttenplan, a London-based analyst at CreditSights, which recommends buying REIT debt.

Boston Properties

Boston Properties Inc., the U.S. office REIT led by Mortimer Zuckerman; and Toledo, Ohio-based Health Care REIT Inc. led $2.63 billion of bond sales for the industry in November, the most since March, Bloomberg data show.

Sales of bonds linked to commercial real estate loans are beginning to recover as well. About $10.6 billion of the debt has been issued this year, up from $3.4 billion in 2009, according to data compiled by Bloomberg. Issuance may reach $45 billion in 2011, according to a Nov. 24 report from JPMorgan.

Americold Realty Trust, the warehouse operator owned by Ron Burkle's Yucaipa Cos., sold $600 million of bonds backed by commercial-mortgage debt, a person familiar with the transaction said Dec. 9. The offering was secured by refrigerated warehouses, compared with recent transactions that have been backed primarily by shopping malls and office buildings.

U.S. apartment vacancies dropped for the first time in almost three years in the third quarter, suggesting the trend of people moving in with family or friends might be abating, New York-based research firm Reis Inc. said.

Fewer Vacancies

Office vacancies in U.S. central business districts declined for a second consecutive time in the third quarter, reaching 14.7 percent compared with 14.8 percent in the previous three months, as tenants signed leases for additional space, according to broker Cushman & Wakefield Inc.

The average rent per square foot of REITs operating in central business districts, including Boston Properties and Vornado Realty Trust, increased in the third-quarter, while declining for REITs focused on suburban area properties, like Highwoods Properties Inc. and Mack-Cali Realty Corp., according to CreditSights' Nov. 22 report.

"Those non-urban office buildings might be quite a way from ever being rented again, but everything in New York and the other 24/7 cities continues to get better every day," Zell said.

To contact the reporters on this story: Sapna Maheshwari in New York at sapnam@bloomberg.net John Detrixhe in New York at jdetrixhe1@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net

Even with a Higher Premium, FDIC May Take Long Time to Build Up Reserves

2010-12-14T17:14:00.000-08:00

HEARD ON THE STREET

DECEMBER 15, 2010

FDIC Fund Is in for a Long Wait

By DAVID REILLY, Wall Street Journal

Let's hope that the next financial crisis is 17 years away. That's how long the Federal Deposit Insurance Corp. estimates it will take before its deposit-insurance fund is close to fighting fit.

That's based on a rule approved Tuesday by the FDIC's board that sets a new, higher target reserve level for the fund, 2% of insured deposits.

Previously, the level was capped at 1.5%. That and other funding limitations left the insurance fund unprepared for the financial crisis, which led to the failure of 315 institutions. As a result, the fund was $8 billion in the red as of Sept. 30, even as there are 860 institutions on the agency's problem-bank list.

That explains the need for a higher reserve level. But 2%, which would be about $108 billion based on deposits of about $5.4 trillion, doesn't cut it.

The FDIC itself noted in its rule that a 2% level prior to past crises "would barely have prevented the fund from becoming negative." The point of the reserve is to keep that from happening. And the agency's analysis didn't include the possible failure of too-big-to-fail banks bailed out by the government last time around.

The FDIC's statements imply the level should be higher than 2%. Banks wanted it lower to avoid paying higher fees. The final result is a poor compromise. For too long, banks, especially the biggest ones, have paid too little for FDIC insurance. This needs to change, the quicker the better.

Write to David Reilly at david.reilly@wsj.com

Agency Raises Capital

2010-12-14T08:11:00.000-08:00

FDIC Plans to Sell $1 Billion of Bonds Tied to Real Estate

By Jody Shenn - Dec 13, 2010, Bloomberg

The Federal Deposit Insurance Corp. plans to sell almost $1 billion of securities tied to residential and commercial real-estate debt once held by failed banks, according to a person familiar with the transaction.

The agency is selling guaranteed notes backed by the debt, said the person, who declined to be identified because the transactions are private.

The FDIC is offering bonds from three securitizations through Barclays Capital, the person said. Two are tied to residential debt, and total $160.2 million and $135.7 million, the person said. An additional $679 million of bonds are tied to commercial-property debt, the person said.

In March, the FDIC began raising cash through the bond market for the first time since the early 1990s. The Washington- based agency’s completed sales this year have totaled more than $4.15 billion, according to data compiled by Bloomberg.

David Barr, a spokesman for the FDIC, declined to comment, saying any possible bond sales would be considered private placements.

“The FDIC’s position on such private placements is to not comment or confirm the marketing of them,” he said.

Informa Global Markets reported on the deals earlier today.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net

Spiraling Down: Housing Recovery Make Take Time

2010-12-12T21:45:00.000-08:00

DECEMBER 13, 2010
Housing Shaky as Lenders Tighten
By NICK TIMIRAOS, Wall Street Journal

Economists are worried that the housing sector may be heading into another downdraft as mortgage lenders continue to tighten already restrictive lending standards.

Such a scenario seemed less likely earlier this year, when home-buyer tax credits fueled a surge in sales. But sales have plunged in the second half of the year after those credits expired. New and existing home sales were down by more than 25% in October from a year ago.

Meanwhile, applications for mortgages have hovered near their lowest levels in more than a decade since May, even though mortgage rates have tumbled to their lowest levels in 60 years, with average 30-year, fixed-rate loans bottoming at 4.21% in October.

"We must realize that having very tight credit at the bottom of the cycle is a mistake. We are retarding the recovery," says Kenneth Rosen, a housing economist at the University of California at Berkeley.

The U.S. has normally relied on an expanding housing market to help lift the economy as it exits a recession by fueling manufacturing, consumer spending and job growth. In the first year of all postwar recoveries, residential investment has accounted for nearly one percentage point of gross-domestic-product growth, says Doug Duncan, chief economist at Fannie Mae. But today, it has accounted for around 0.1 percentage point of GDP growth.

Given the glut of foreclosures that will continue to hit the market, "at a time when you need more borrowers, you actually have less," says Laurie Goodman, senior managing director at Amherst Securities Group LP.

Lenders clamped down on the lax standards that fueled the housing bubble three years ago by requiring larger down payments, higher credit scores and greater documentation of borrowers' incomes and assets.

Economists say lending standards typically ease at this point in the business cycle as banks look for new business. But that isn't happening now because private lenders have ceded the market to government entities Fannie Mae, Freddie Mac and the Federal Housing Administration. Those agencies, saddled with losses, are under heavy political pressure to avoid taking any new risks. "The general feeling is, 'Let them be as tough as they want,' " says Guy Cecala, publisher of Inside Mortgage Finance.

During the third quarter, 13% of bank loan officers surveyed by the Federal Reserve reported that standards had grown tighter, while fewer than 4% said standards had loosened.

"Right now, we're in that vicious cycle where we tighten, which makes things worse, so we tighten, which makes things worse," says Bob Walters, chief economist at Quicken Loans. "How do you get out of that cycle? Folks in government are going to have to stand in and make some calls."

Banks have become more restrictive in part because Fannie and Freddie are stepping up demands for banks to buy back defaulted loans when they can prove that the mortgage didn't meet underwriting guidelines, an expensive proposition for banks.

"Originators are scared to death. We are being intensely cautious because we understand that the franchise could be on the line," says Mr. Walters. He says tightening could continue "for at least a year, maybe longer."

Loan officers say one of the biggest problems right now is a requirement that borrowers prove their incomes by relying on at least two years of tax returns. That often trips up self-employed workers and small-business owners who take deductions that shrink their taxable income. It could also sink borrowers who were unemployed for a short time or had a recent salary reduction.

The consequence is that lending is bifurcating into two worlds. Salaried workers who can easily document their earnings are able to qualify for mortgages with down payments as low as 3.5% through the FHA. Self-employed borrowers are having a harder time even if they have assets stashed away.

Ivy Zelman, chief executive of housing research firm Zelman & Associates, says there are reasonable concerns that the government has provided "too much liquidity" in some markets through the FHA. But she says it's also the case that originators aren't always taking a careful look at an individual's ability to repay a loan, "and that could be preventing some truly good borrowers from getting loans."

Another worry is that the industry has also come to rely too heavily on credit-score cutoffs, something loan officers say can inhibit common sense underwriting. While the FHA has a minimum credit score for low-down-payment loans of 580, many banks won't sponsor loans with credit scores below 640. Average credit scores for borrowers with FHA-backed loans surpassed 700 in October for the first time.

No one wants a rerun of the past five years, when carelessness in underwriting fueled a painful explosion in mortgage liquidity. But the inverse carries its own dangers today: By imposing rigid standards that shut out qualified borrowers, banks and the government risk making it harder for the housing market to dig out of its hole.

Write to Nick Timiraos at nick.timiraos@wsj.com