As Steve Blank noted in the current issue of ULI’s Real Estate Business Barometer, “Liquidity remains a primary concern (in real estate markets) with approximately $300 billion in refinancing per year thru 2015. De-leveraging by financial institutions continues; many remark that this will go on for many years. “
So, why aren’t banks clearing out their delinquent loans on commercial real estate, CRE, as expeditiously as in 1988-1991? Banks want to avoid:
- Upsetting their balance sheets and financial ratios with REO (real estate owned), and
- The liabilities attendant with REO (viz., condo and HOA fees, management and other operating expenses, liability for personal injury and property damage, etc.). Thus, they pretend and extend until something occurs to force their hands.
Eventually, if all else fails, bank shareholders – and there are millions of them – will pressure the bank directors to liquidate the bad loans, or they will replace the directors with those who will liquidate them. In addition, the shareholders will pressure Congress – and after next January there should be a substantial number of new faces in Congress who were sent there by these shareholders and others disgusted with the incompetence of the current incumbents.
Congress will pressure the bank regulators, the FDIC, OCC, et al, to cause the banks to deal with these loan delinquencies and defaults. Under agency pressure, the banks will begin to liquidate those loans. There are a number of scenarios, but three in particular come to mind.
· Sale of the notes evidencing the loans. This means the banks will have to steeply discount the notes in order to find a market. Sam Zell has said that he recently bought a number of such notes at 42.5 cents on the dollar. That means, for example, a note in the amount of $1,000,000, and secured by a mortgage on real property, would sell for $425,000. The bank, its shareholders, and the taxpayers (via the FDIC bailouts of the bank’s losses) will have to eat $575,000. And that’s just one note. Banks and other federally insured or guaranteed entities hold hundreds of billions of dollars in notes that are or soon will be in default. Let’s be fair, however; because of the high level and varieties of risk (market risk, political risk, structural risk, “pig-in-a-poke risk”, etc,) market-clearing prices would be pennies-on-the-dollar.
· Sale of the properties encumbered by mortgages that secure the bad loans. If done in volume, this would have a market clearing effect because the sheer volume of supply would depress prices, thus generating demand. This, together with the above-described risk elements, would result in pennies-on-the-dollar liquidations.
· Government reorganization of the banks’ bad loan situation. This is somewhat analogous to the situation involving the Resolution Trust Corporation (RTC), which was a government–owned entity created to take possession of mortgages and properties held by failed savings and loan associations (thrifts) following the recession in the late 1980s. It was charged with the responsibility for disposing of these assets, which it did initially through bulk sales, and later through equity partnerships with certain selected private sector entities. This likely is how the government would respond in today’s situation. In other words, it would retain an interest in the properties, or more appropriately, the entities set up to own and manage the properties, just as it did in the bailout of the U.S. automotive manufacturers. Unfortunately, this is another paver in the path to socialism.
o Caveat: the RTC was created to deal with the financial collapse of the thrifts and their resulting insolvency. This time around it is expected that the government would react prior to large-scale bank insolvency.
There are no coincidences!
Copyright 2010 The Falbey Institute for the Development of Real Estate
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