Over the last year my firm, Weichert Commercial has seen a number of commercial mortgage portfolios enter the investor marketplace as bulk or specific asset sales. For the most part, these sales are existing notes and mortgages, with very little being actual real estate foreclosed upon and owned by the originating bank.
There seems to be an increase in 2012 with these sales. Are defaults increasing or have banks finally decided to rid themselves of these loans that have not been aging like fine wine. The answer is I’m not sure. What’s happening at your bank?
While there are a number of investors looking for these portfolios, based on current returns now offered in money market accounts, treasuries, equities, corporate bonds that yield little to compensate even modest risk formulas. These investors are still very specific are what they are willing to purchase and there is still a disconnect between what price an investor is willing to pay and what a bank will sell the asset for in today’s marketplace.
In the early 90’s I was the Senior Loan Officer of a $400M community bank in Northern New Jersey. For those who can remember, we experienced our own mini Lehman moment with the creation of the Resolution Trust Corporation (RTC) and the FDIC taking down mostly Savings & Loan Banks who received commercial bank powers with the deregulation of their industry by Reagan in the early 80’s. Like kids with a new toy, my S & L brethren decided they could make more money by getting in to real estate development and construction lending. The result was over 8,000 banks were closed and a tremendous amount of non-performing loans hitting the books of banks that were closed and not closed.
As the saying goes “Those who do not heed the lessons of history, are doomed to repeat it” should be engraved on the tombstones of all the banks that have failed since. To think about it, it should also be the tag line of the remaining major banks that are still in existence with their “To Big to Fail” concept.
In those days I was a buyer of those loans from both the FDIC and RTC. Our bank was in a position to purchase those assets and banks with their problem loan portfolio, and resolve the assets in a timely manner that resulted in a net gain to our bank. Unfortunately, in today’s current environmental, banks cannot buy these portfolios without buying the entire bank and making a loss-sharing agreement with the Federal Government. Not the same thing.
At that time, buying problem loan portfolios was something that was never done before and there were few “experts” who knew how to market and sell those assets with even fewer investors. That is not the case today and the market is flooded with potential buyers and so-called experts marketing these properties.
As a strategy, the sale of a non-performing loan portfolio makes more sense that completing the foreclosure process on the assets and listing these individual properties for sale. The only time the reverse makes sense is when there is a specialty real estate asset where a better return can be derived by the ultimate end user. When you weigh the cost of maintenance, taxes, litigation cost and other ancillary costs associated with real estate, the adage of “Your first loss is your best loss” will always ring true.
The major problems I see with banks imploring that strategy is as follows:
1.) Current appraisal reports
2.) Not paying real estate taxes after the loan defaults
3.) Environmental Issues that arise after the loan defaults
4.) Pursuing guarantors
5.) Last minute decisions of Bank’s CEO’s and Board of Directors
CURRENT APPRAISAL REPORTS
In all the loans I review for sale, there is always an appraisal report that is updated after the loan goes in default. I would like to say these appraisals were done prior to our engagement, but I have seen those reports 3-4 years old.
Another common mistake is to reengage the same appraiser or appraisal company that did the appraisal when the loan was first approved. A possible conflict of interest seems to be possible with the chance of still overvaluing the asset at this critical time. Most appraisals are issued to manage the write-off of the asset and in the macro, the loan loss reserve. Is your bank being truly honest about the value of the loan or are you just documenting a file for the regulators?
Of course when the bid comes in substantially under the appraisal report the bank has in their possession, they question the marketplace. The answer is if it happens once —it’s a mistake, twice——a coincidence, a third time——it’s a trend.
REAL ESTATE TAXES
Another error I see at various banks it not paying the taxes after your borrower has stopped. This is a cost that is not going away and will cost you more if payment is deferred by way of penalties and interest. In some cases those taxes are sold to investors by way of “tax sale certificates”, increasing the cost of redemption, the time it takes to redeem those certificates and impairing your lien position.
Pay the real estate taxes while litigating the loan.
POST CLOSING ENVIRONMENTAL ISSUES
Although this event happens infrequently, it is a possibility never the less. The major suspects are owner occupied buildings or single tenant buildings, that are used for manufacturing, fabricating, assembling or other ing’s that need environmental monitoring, off-site transfers of used chemicals or filtration equipment in their process.
Once your borrower is experiencing financial problems, how many coroners do you think they are short cutting to stay afloat? How will you know if you cannot get access to do an environmental audit? What happens if you foreclose and then find out? Monitoring these loans while they are still performing through site visitations or including annual environmental testing in your loan agreements is the proverbial “ounce of prevention”.
Most banks will pursue guarantors simultaneously to starting foreclosure. I agree with that strategy until you weigh the litigation process and cost, including the time to foreclose, with releasing the guarantors to obtain title to the property. In my 30 years of banking, I have rarely seen a substantial payment from a guarantor, unless you had a specific asset of the guarantor as additional collateral to your loan.
In good times with defaults a rarity, I agreed—-pursue the guarantor. But in times like this take the emotion off the table and limit your losses by obtaining the primary asset the will recover the most dollars.
BANK’S CEO’S AND BOARD OF DIRECTORS
Enviably the final decision of selling the asset in a Community Bank, whether a portfolio sale or individual asset needs approval of the Bank’s CEO or Board of Directors. Like butchers at a meat market, they cannot help themselves from putting the finger on the scale. They always want a little bit more to approve the deal, sometimes for no other reason than “because”.
I can’t tell you how many deals were lost because the bank went back to re-negotiate the agreed upon price with the buyer, and the buyer walked and would not pay any price to purchase the asset. If you go to the next winning bidder, guess what he or she is thinking? Why did the winning bid walk? What’s the matter with this asset?
Remember, “Pigs are fed, Hogs get slaughtered”