Last week, Zero Hedge attempted to make a tortuous connection between the sales prices of “performing” commercial real estate loans being sold by the FDIC and the book value of performing CRE loans held by healthy financial firms – presumably the likes of JP Morgan Chase, Goldman Sachs, Morgan Stanley and others. Aside from creating a new platform from which to bellow about “very startling” and “very hypocritical” dealings in the financial world, I failed to understand the purpose.
My Own Experience With FDIC Loan Sales
Having bid on performing and non-performing CRE loans with real money (my own), and having worked directly with two of the intermediaries that the FDIC has hired to dispose of these loans, my real world, practical view is that there is absolutely no connection to be made.
“No floor floaters” would be really interesting if they were part of a hip hop performance, but not if they are real estate loans at LIBOR plus 150. “No floor” simply means that there is no floor on the loan’s benchmark rate. In the case of a no floor floater at L+150, the new owner of that loan would get a coupon of about 1.85%. In today’s market, that’s a zombie loan. Add in a crooked borrower with bad collateral, and I’ll show you a loan on blocks sitting forever unsold on Indy Mac’s front yard.
One of the other revelations in the post was that even performing CRE loans were being sold quick, call the SEC! at an average of 51 cents on the dollar. But whether a loan is “performing” or “non-performing” is really not relevant: it is simply a bureaucratic classification for the current payment status of the loans.
If it Sounds to Good to be True…
In the real world, many of these “performing” loans are doomed. They were promoted by borrowers and mortgage brokers on the basis of NOI assumptions that can no longer be achieved, underwritten by loan officers who had no idea what they were doing, and ultimately sold to investors whose profit motive (in many cases) was collecting management fees, not interest income. In that case, why not lever yourself silly and buy all you can?
A couple of the loans I looked at had unpaid principle balances that were completely disconnected from the true value of the collateral. The reason: underwriting that seemed to be done by a kindergartner, and probably was.
One of the loans, against a 1960’s vintage 164 unit apartment building, assumed that operating expenses would be almost 30% below the national average. Nevermind that launching the Apollo program would be cheaper and easier than fixing the leaks constantly springing from this property’s creaky 45 year old plumbing system. Effective gross income also showed red against the original underwriting – something about renters unwilling to pay a premium for kitchens that hadn’t been updated since Jack Ruby gave Lee Harvey Oswald a new address.
Another was a Fannie Mae DUS deal in which the borrower had racked up negative retained equity of $2MM in just 4 years. In the most recent year, the borrower lost $250,000 just from trying to meet the property’s monthly nut. That loan is current and matures in 2012, so it is classified as “performing”. Neverthelesss, there’s no way it will get refinanced at par, assuming the borrrower makes it that far, because the property is worth much less than par. How could the loan be worth anything more?
So, You Want to Bid on an FDIC Loan Sale? Look Before You Leap…
So what happens when you bid on one of these loans? The FDIC does not allow property inspections of any sort. Buyers are afforded the opportunity to review the original loan files, which contain such helpful information as the original, hopelessly out of date appraisal. Assuming you have enough local market knowledge to formulate a bid and “win”, you’ll have just 7 days to close. There is no futzing around with surveys, title reports and good standing opinions – we’re talking an all-cash close on a 7-day fuse.
Once you own the loan, you’ll eventually need to foreclose. Quantifying the risks around that is practically impossible. Convincing the borrower to enter into a deed-in-lieu of foreclosure is about the best outcome you could hope for. Assuming the borrower does not declare bankruptcy, in which case you are totally screwed, expenses on a “clean” foreclosure will run you at least 4-5% of the face amount of the loan.
Then you finally get the deed, but it won’t be the normal “general warranty” deed that you want. It will be a “limited warranty” deed, meaning the seller (the FDIC) will not vouch for the deed’s marketability. This is ideal, as everybody Vladimir Putin and Caesar Chavez likes limited marketability.
After that happens, the town/county/governing authority comes in and wants to authenticate the Certificate of Occupancy. In the case of the 164 unit building above, the county condemned 32 units right off the bat yes we can! So now the purchaser, a small private equity fund in Connecticut, is suddenly 20% vacant just for the privilege of a handshake with the local building inspector. Meanwhile, they’re stuck paying property taxes based on some inflated value from 2006. But that’s OK – they have unfathomably deep pockets and lots of spare time, and according my friends at Zero Hedge, they’re a co-conspirator! Shameless Plug: Chris Germain San Francisco
Update: This post received over 30 intelligent, knowledgeable comments, but when I updated my software and moved to a new location on the server, they did not automatically port over to the new location. I have republished them in bulk below, under my name. I added a few line breaks for legibility, but they are otherwise unedited. Cheers, REIT Wrecks
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