We’ll Eat Like Kings
[The Registry February 2011 Issue]
Waiting for the logjam of distressed loans to break and flood the market with commercial buying opportunities reminds me of a Gary Larson cartoon where two spiders have woven a web at the bottom of a child’s playground slide. One says to the other: “If this works, we eat like kings!”
While some loans and foreclosed properties have been brought to the market and snapped up at pennies on the dollar, on the whole, portfolios of loans and distressed properties sit intact and are ripening in the anemic sun of economic recovery. Because of the jiggering of FASB rule 157-e on accounting for fair value, banks have had no urgency to mark their loans to market and, for the moment, are content to wait for greater recovery in commercial real estate, which has seemed always around the proverbial corner.
Still, now that the money supply is growing again, odds have improved that commercial property prices may climb despite the significant risk of rising interest rates. Yet, even if a broad price recovery happens in commercial real estate, the question remains: Will banks deliver their troubled assets to market in supertankers or hand-woven baskets? Probably neither!
Advances in information technology and the way it is being used in the Internet age are overhauling the banking sector, including the way it disposes of distress. Coupled with the generous regulatory regime, the methods are in wild contrast to the federally sanctioned fire sale led by the Resolution Trust Corp. in the first half of the 1990s. But the same technology has the potential to remake banking more broadly, too, touching loan origination and participation practices and creating checks on rating agencies that undermine their unhealthy market dominance.
The Internet as we know it did not exist in the early ’90s. Investors had to wade through reams of paper to perform due diligence on loans and properties offered by the RTC. Today there are Internet platforms that provide identical due-diligence information electronically and efficiently. Banks with adequate capital can engage in active portfolio management, taking performing and non-performing assets to a wider audience of qualified investors more completely than ever before.
The FDIC has approved five firms to offer this secure, Web-based, market-clearing mechanism: DebtX, a Boston firm co-founded in 1999 by Chief Executive Kingsley Greenland; Eastdil Secured, with headquarters near Central Park in New York City; First Financial Network, an Oklahoma-based company formed in 1989 by Chief Executive Bliss Morris and her husband; Garnet Capital Advisors in Harrison, N.Y., formed in 2004 by Managing Director Lou DiPalma and partners; and Mission Capital, a New York City company formed in 2002 by Chief Executive David Tobin and partners.
Banks have three primary motivations to sell a note through a third-party platform, said Garnet Capital’s DiPalma. They help banks position themselves with regulators as acquiring banks, or “aggregator banks,” in the words of Sheila Bair, head of the FDIC, by ridding their balance sheets of bad assets and improving metrics such as equity ratios. Overworked asset managers can leverage the resources and experience of these platforms to ease inventory management. Finally, they aid in investor management. If non-performing assets can be pared away, balance sheets look better and investors are pleased. Stock prices are bolstered, giving banks the ability to create “currency” through secondary stock offerings. Beefed-up capital allows banks to grow their assets and deposits through acquisition of other failed banks, which, in today’s turbulent market, is better than making a loan from scratch. With likely financing and a loss-sharing agreement available from the FDIC, the acquiring bank has a much safer route to make money than the grind of lending money on a loan-by-loan basis.
Mission Capital principal Tobin says its Web-based system “allows investors sitting at their desks to perform underwriting from beginning to end and provides a level and fair playing field for all bidders.” All due-diligence documents are tagged, labeled and organized and then supplemented with real-time updates—such as revised appraisals—as Mission Capital receives them. All bidders get simultaneous notice of any new documents, and the system keeps an audit trail of who has reviewed which documents.
These platforms are evolving at a rapid pace and may begin to breed disruptive technology. Shortly, DebtX will be providing the equivalent of a FICO score for all loans sold through its platform. While not an exact equivalent of what rating agencies are supposed to provide, it has the potential to grow into a powerful tool for note buyers that also has the effect of loosening the monopoly grip that rating agencies have on this important due-diligence function.
DebtX’s Greenland emphasizes that its marketplace is “transparent.” That transparency, in turn, should spread to the banking system and help make it safer. He equates the ranking system for all of the loans listed on its site as a proxy for traditional credit-scoring methods, saying it “takes all of these heterogeneous assets, like commercial real estate loans, and makes them homogeneous.”
If this loan-scoring capability becomes ubiquitous and gives the rating agencies a run for their money, maybe—just maybe, they will be more thorough, transparent and honest in their ratings. Then again maybe it won’t snow in Minnesota this year.
There are other positive implications for these new Web platforms in loan origination and participation. Because a large number of banks are using these platforms—both as sellers of notes and, more particularly, buyers of notes—what is emerging is the potential to become a national platform for traditional loan participation among community and regional banks. Banks can now originate loans in their back yard, structure the participation agreement and find participants anywhere in the county; conversely, banks can choose to let other banks originate and simply become participants.
This will allow banks of all sizes to scale their loan origination volume up or down without committing to the fixed overhead of staff; alternatively, a bank can choose to become an active originator and specialize in a niche and supply their larger cousins with assets for a much-needed fee. This Web-based marketplace opens the doors to new profit centers that are squarely within the traditional banking realm to any bank with a little creativity and foresight. Green shoots from the ashes! “So [banks] have the ability to distribute high-quality, performing loans to other healthy banks that are plugged into the marketplace,” Greenland said. “It is really a stunning [development].”
Mission Capital’s Tobin agrees: “In effect, technology is creating more liquidity.” He cautions that the system still requires refinement: “Every commercial loan can be different, so there needs to be more standardization and regulation of the inter-creditor agreements to fully support a liquid market.” But a new day still appears on the rise. Technology disrupts, new markets form in clear light, and bidders listen. “At the end of the day the marketplace speaks for itself. It is extremely deep and extremely liquid. And it prices very, very efficiently,” Greenland says.
For the Luddites in the modern world of commercial real estate—perhaps myself included—I guess this means we will have to suck it up and learn how to program our TV remotes, for starters.
