Pyramid Power

Are you buying time until the market recovers? If so, do you know if it is worth the investment?

2010-07-30T13:48:00.000-07:00

We are approaching the three year mark since the start of the Great Recession. The Feds have stimulated the economy and worked their best monetary policy but it feels like we are having our own Lost Decade a la Japan of the ‘90s.

ü Employment growth has been tepid at best. With the Census jobs ending and state and municipal government’s cutting upwards of 500,000 jobs and private companies in no hurry to add payroll, the recovery in jobs – the leading demand driver for real estate – is going to take a long time (Economists forecast that it will be 2014 or later before American payrolls recover to their pre-recession levels).
ü Vacancies are climbing and rental rates are declining as absorption in most commercial markets continues to be negative with reversal of these trends tied to real employment growth and proven economic recovery.
ü Financial reform and other external forces are making the process of refinancing commercial mortgage loans a long and arduous task with only the highest quality properties getting financed – a situation which will not be alleviated any time soon.

For owners of income-producing properties which have suffered, or anticipate suffering, the loss of tenants and/or the realities of lease rate reductions covering regular debt service has become a challenge with many having to fund payments from other sources.

Further, as tenants’ leases roll, financially-strapped owners do not have the funds to pay for tenant improvements or leasing commissions – thereby taking the property out of the market and putting a cap on occupancy. The volume of these buildings has grown to where they have a name – Zombie Buildings – since they are the living dead.

As an owner, if you find yourself feeding a property one way or another, you are buying time until the market recovers. The question becomes: Is it worth the investment?

Recently, I had a client approach me for advice on an 80,000 sq. ft. building which went from 100% occupancy to zero as a result of one tenant not renewing its lease at expiration and another going bankrupt. Facing an uphill battle to lease the property, my client asked the right question: Does it make economic sense to carry the building and lease it up?

The Background: My client had a $12.5 million first mortgage secured by the building which had annual debt service approximating $850,000. Real Estate taxes are $236,000 annually while insurance, utilities and maintenance ran $6.00 per square foot. As a result, holding costs are running around $130,000 per month.

To answer my client’s question I obtained the facts on the property including operating expense estimates, primary loan terms, recent leasing proposals and current marketing materials. I also gathered published third-party market information from several brokerage firms.

From the materials gathered, I gained an understanding of market rents, occupancies, absorption, lease terms, tenant improvement allowances and the contractual lease commission rates.

Using this information, I prepared two financial analyses: a Break-even Rent Analysis and a Solvency Test.

1. In the Break Even Rent Analysis, I calculated the gross rent per square foot which the building would need to achieve in order to cover operating expenses and debt service and to recover the leasing costs over an average lease term under two scenarios: One at market occupancy and one at full occupancy.
2. In the Solvency Test, I calculated a pro forma net operating income at the Property’s asking rents, budgeted operating expenses and estimated the value upon lease-up utilizing “normalized” cap rates and deducted an estimate for selling and closing costs, the mortgage balance as well as the leasing costs to determine net residual value to equity – or the Project’s Solvency.

Accordingly, in my Breakeven Rent Analysis, I determined that the break even rent would be 30% above the Property’s current asking rents at market occupancy and 6% above average asking rents at full occupancy – and both were above current sub-market asking rents. My conclusion was that the property could not achieve break-even rent in the market – currently or in the foreseeable future. In my Solvency Test, I determined that if the property only leased up to market occupancy, it was insolvent (the owner’s would lose money from the sale of the property) and that it would recover a net of $800,000 if the property were leased to full occupancy which, at the $130,000 per month burn rate, would cover roughly six months of holding costs – clearly not a feasible timeframe during which the building could be leased and occupied.

Given the current market conditions, I determined that the best option for our client was to negotiate a deed in lieu or short sale with the lender.

Real estate investors believe in their properties – that is a significant factor in buying one property over another. That belief, when combined with an optimistic perspective, can lead an owner to continue feeding a property with the hope of recovering their capital and making a return. Many times, like in the example presented above, buying time is a bad investment.

Starting with these quick analyses, owners can start making some decisions which will lead to either the development of a business plan which is used to renegotiate certain of the mortgage terms or make arrangements to give the lender the keys. Of course, extraneous facts and circumstances, like loan guarantees, additional collateral and leasing reserves, can make the decision and the action plan more difficult to effect.

As a CPA, a CRE and a FRICS with over 30 years of experience in underwriting, analyzing and valuing real properties to help clients buy, sell, finance or workout their debt, I can help you to see the risk within the numbers and to effect the most appropriate strategy. For a free one-hour consultation, phone me at 305-665-2450.

Failed Banks Had $566.9Bln of Assets, FDIC Has $33Bln Left

2010-04-27T07:49:00.000-07:00

Based on the following article in today's CRE Direct, the FDIC is succeeding in a battle against time to dispose of the assets of failed institutions it is taking over. It is still a program of the large investors buying assets in structured transactions which leaves out the everyday investor but it is working for the Feds....As expected, the market for non-performing commercial mortgages has not grown into the same feeding frenzy that occurred in the RTC days...but it is still early in the game....we will have to watch how the special servicers who are expected to have double-digit default rates by the end of the year choose to dispose of their bad loans....It may be time to re-sharpen that saw and be prepared - but then again, it may just be more of the same of what we have experienced over the past two years....May G-d be with us all.

Failed Banks Had $566.9Bln of Assets, FDIC Has $33Bln Left

Monday, 26 April 2010
Commercial Real Estate Direct Staff Report

The FDIC, which since the beginning of 2008 has taken over 205 failed banks with $566.9 billion of total assets, has only about $37 billion of those assets left to sell.

And roughly $4.2 billion of those assets are in the process of being brought to market through the agency's structured sales, where it partners with investors on large acquisitions and provides them with financing. Factor those out and the FDIC is left with about $33 billion of assets left to sell.

Interestingly, that's roughly the same volume of assets the agency had left to sell six months ago, after it had taken over 118 failed banks with $476.4 billion of assets. That indicates that its sales efforts are accelerating. And the expectation is that they'll continue to accelerate, especially because so many other institutions have issues. Indeed, 702 banks with $402.8 billion of assets were formally tagged as "problem" institutions by the FDIC at the end of last year. Those are the highest levels since 1993 and are up from 552 banks with $345.9 billion at the end of the third quarter.

And, according to Trepp, a common thread among problem banks is their relative exposure to commercial real estate.

The agency is expected to continue relying on its structured offerings to dispose of the lion's share of assets it takes over because of their relative efficiency. It's able to sell $1 billion or more of assets in one fell swoop, while retaining a stake, which could allow it to benefit if asset values climb. It has also offered financing and has been able to sell that into the market.

In addition, the agency will continue to sell assets individually through its whole-loan, or cash sales, which are handled by five advisers. It had until early this year sold commercial real estate assets on a whole-loan basis, but has since then shifted its focus to sell such assets solely through its structured packages.

And while the agency has yet to securitize assets taken from failed banks, that's expected to change. Sheila Bair, FDIC chairman, said earlier this year that "securitization will play an increasing role" in the agency's efforts to rid itself of assets from failed banks.

The reason the agency has relatively little left to sell is that buyers of deposits of failed banks have generally acquired most of their assets, largely because of the backstop against losses that the agency provides.

Until recently, the FDIC would insure up to 80 percent of any losses from failed-bank assets subject to the loss-sharing agreements. In some cases, its insurance would climb to 95 percent. But lately, it has sought to reduce the scope of its backstop. And because market conditions have improved, evidently it's been able to do just that.

When TD Bank agreed to acquire three failed banks, American First Bank of Clermont, Fla., First Federal Bank of North Florida, Palatka, Fla., and Riverside National Bank of Florida of Fort Pierce, Fla., it agreed to assume $2.2 billion of the institutions' assets. And the FDIC agreed to cover only 50 percent of the possible losses from those assets.

The $566.9 billion of assets held by banks that failed since the beginning of 2008 compares with $519 billion of assets held by the 1,043 savings and loans that failed during the S&L crisis of the early 1990s. While that volume is not adjusted for inflation, it puts the current banking issue in context. It also shows just how large some failed banks have been.

Indeed, this time around, a $307 billion-asset institution - Washington Mutual Bank - failed. No similar-sized institution failed during the last crisis. Another seven institutions had more than $10 billion of assets each.

If you exclude WaMu, the 205 banks that have failed had an average of $1.3 billion of assets. But the top 25, exclusive of WaMu, had an average of $7.5 billion of assets.

Comments? E-mail Orest Mandzy or call him at (215) 504-2860, Ext. 211.

Copyright ©2010 Commercial Real Estate Direct, a service of FM Financial Publishing LLC. All rights reserved.

Demand still outstripping supply in US nonperforming loan market

2010-04-08T06:27:00.000-07:00

Telling us what we already knew, my friends at Ernst & Young have published the results of a new survey which sheds addtiional light on an otherwise dark tunnel. This is not being handled like the RTC days or any other prior times. The nursing of toxic assets rather than quick liquidation has prevented the market from establishing a floor. Meanwhile, institutions have depositor capital tied up in bad or underperforming loans rather than in making new loans to fund acquistiions, leasing and redevelopment activities - and slowing the recovery in commercial real estate. Sooner or later Washington will find out it is a Phyrric Victory and we will have all paid a dear price for it. Check out the report - perhaps there is a pearl you can use to create something bankable. May G-d bless you!

Demand still outstripping supply in US nonperforming loan market, according to new survey by Ernst & Young

New York, 1 April 2010 – More than sixty percent of respondents to a new survey of the distressed debt market bid on or priced US nonperforming loan (NPL) portfolios in the last year, but fewer than 17.5 percent were successful in completing a transaction. This is one of the key findings in a report published today by Ernst & Young’s Real Estate Distress Services Group based on a survey of real estate investment and opportunity funds, private equity funds, institutional investors and real estate developers conducted in late December 2009.
The Ernst & Young survey portrays a US nonperforming loan market in which investors last year were eager to buy, but in which sellers were unwilling or unable to sell. Consequently, the few deals that came to market attracted multiple bids, leaving more investors foiled than fulfilled.

“The question on everyone’s mind today is whether the US distressed loan market in 2010 and 2011 will be the same as 2009; characterized chiefly by buyers waiting for sellers to turn up and transact,” said Mark Grinis, leader of Ernst & Young’s Real Estate Distress Services Group. Added Chris Seyfarth, a partner in the Real Estate Distress Services Group of Ernst & Young LLP, “The continued development of an efficient market for nonperforming loans here in the US will depend on sellers being prepared to enter the process over the next six months.”

Nevertheless, investors remain bullish about the opportunity to put out significant sums into NPL purchases in 2010 and 2011. More than half of the investors surveyed believe that conditions in the NPL market will be favorable enough for them to enter this year with almost 40%expecting to enter the market sometime after June 1. Behind this projection may be a feeling that by the second half of the year, the country’s economic recovery will be well underway and a bottoming of commercial real estate values may be within sight.

What are these investors most interested in buying? In terms of loan type, nearly three quarters of investors surveyed preferred distressed whole loans backed by office, industrial and multifamily properties. About a third of investors favor distressed residential loans such as single family and condo loans as well as Acquisition and Development (A&D) and construction loans. Some investors also want hotel, CMBS, and land loans, but none favored residential MBS loans.

The capital is clearly there for a market to develop quickly. When asked how much they had allocated to invest in NPL portfolios, two thirds of respondents indicated they would have up to US$500 million each available for purchases. Almost 5%of respondents have made US$500 million or more available for such purchases.

However, the critical piece of the puzzle for a robust market in distressed loans in 2010 is still absent, says the Ernst & Young report. Despite an increase in troubled loans and growing Congressional scrutiny of financial institutions’ loan exposure, banks generally have been slow to deal with their problem loan portfolios, most likely due to a fear of incurring losses from loan write-offs, reductions in earnings or erosion of capital. According to recent FDIC data, US banks’ provisions for loan loss reserves totaled US$61.1 billion in the fourth quarter 2009. The Ernst & Young survey suggests that respondents believe regional banks and thrifts are the most likely active sellers of commercial real estate loans in 2010.

For a comprehensive summary of the entire survey and to download a copy of the published report, “Is history repeating itself? Distressed real estate loans investor survey,” go to www.ey.com/realestate.

About Ernst & Young’s Global Real Estate CenterToday’s real estate industry must adopt new approaches to address regulatory requirements and financial risks – while meeting the challenges of expanding globally and achieving sustainable growth. The Ernst & Young Global Real Estate Center brings together a worldwide team of professionals to help you achieve your potential – a team with deep technical experience in providing assurance, tax, transaction and advisory services. The Center works to anticipate market trends, identify the implications and develop points of view on relevant industry issues. Ultimately it enables us to help you meet your goals and compete more effectively. It’s how Ernst & Young makes a difference.

About Ernst & YoungErnst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 144,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential.

For more information, please visit http://www.ey.com/.

Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients.

This news release has been issued by Ernst & Young LLP, a member firm of Ernst & Young Global Limited.

No Uptick Anytime Soon - Too Many Toxic Assets on the Books

2010-03-11T02:53:00.000-08:00

As noted in CoStar's Watch List article, banks are becoming cash strapped to cover loan losses - especially from Commercial Real Estate which means that any liquidity banks were expected to lend to the real estate investment market will not materialize and will choke any new lending and, therefore, any recovery. As I noted last summer, the extend and pretend program will be a Phyrric Victory - and will cause the pain and devastation currently being felt on Main Street to also be extended into the future. I still believe that banks will not shed toxic assets faster than their capital account and loan loss reserve will allow them....which will restrict their ability to loan new money for good new deals...did anyone say Catch 22? With more than 10% of all CMBS loans in special servicing - and growing monthly, the commercial real estate liquidity crisis is the next shoe to fall - and it has the potential of throwing the whole economy down with it - WE NEED TO ACT NOW to provide liquidity to the marketplace with a new CMBS market.....

Thinning Loan Loss Coffers May Restrict CRE Lending
Efforts To Squirrel Away More Cash Keeping the Lid on Commercial Real Estate Lending
By Mark Heschmeyer
March 10, 2010

In addition to keeping an eye on declining property values, falling rents and rising vacancy rate numbers, the commercial real estate community is also concerned over ominous signs in banking industry numbers.

One big area of concern is the fact that banks are stowing away more money to cover problem loans. The amount being set aside is rising rapidly and is now higher than it has been for a quarter of century. Meanwhile, the amount of problem loans is rising at even more than twice that rate.

The implications of the increased loan loss coverage for the commercial real estate industry is that it will likely further limit the amount of money available for borrowings. Those numbers also signify that this will continue to encourage "extend and pretend" policy that some lenders have pursued, and it may further encourage lenders to be optimistic about their recovery rates to avoid taking further losses/writedowns. And at the same time, lenders won't hesitate in demanding more money out of borrowers' pockets.

Mark Fitzgerald, senior debt analyst at Property and Portfolio Research (PPR), a CoStar Group subsidiary, keeps track of the rising levels of loan loss reserves and problem assets and the ratio between the two. Similar to what happened in the early 1990s, bad loans are piling up so fast, banks can't increase reserves fast enough without showing huge negative earnings, he said.

"It looks like the loan loss allowance to noncurrent loan ratio began declining in second half of 2006," Fitzgerald noted. "Noncurrent loans and leases began increasing in second half of 2006, whereas loan loss allowances began increasing in second half of 2007. The average from 1992-2009 is 1.33, compared to 0.58 today."

Put in dollars, that means that for the past 15 years or more, banks kept aside an average $1.33 for every dollar in bad debt they were carrying on their books. Today, banks have only 58 cents set aside.

"The biggest takeaway from those numbers is that banks will continue to need to carefully manage their way out of this --- timing of earnings, reserves, and write-offs are all critical to keeping capital ratios intact," Fitzgerald said. "As delinquencies continue to rise, reserves will need to be kept at high levels, and new lending could be restricted for some time." (See related CoStar Group coverage of recent analysts' takes on CRE mortgages and other capital markets trends.)

Patrick Fitzgerald (no relation to Mark), CCIM, vice president, REO Property at KeyBank Asset Recovery Group, has been on one of the major front-lines fighting the effects of the recession: Florida.

"There is pro-cyclicality in the reserves such that in good economic times the reserves get built up a bit as they are sparsely used and in bad they are tapped to cover losses. It's not surprising to see the coverage ratio decline," Patrick Fitzgerald said.

"During 2009, most line employees in banks spent the majority of time going through loan portfolios and figuring out exactly what they had, how much underlying collateral values had changed, and aggressively marking-down distressed and non-performing loans to reflect new recovery assumptions," Patrick Fitzgerald said. "Thus, a lot of reserves were used in 2009 as loans were charged-off (partially or in full) to essentially mark-to-market the loan book.

" In addition, KeyBank's Fitzgerald noted that federal banking regulators -- in Washington, at least - have shown banks a willingness to allocate less reserves as a percentage of non-performing loans.

This should be a bullish signal to the market, Patrick Fitzgerald said. "At a minimum it says that the belief is that things are getting less bad. We've gotten our arms around our loan book and although non-performing loans may still grow a bit, we believe the biggest write-downs are in the rearview mirror. And if this isn't the case, God help us all."

Indeed, year-end balance sheet numbers for banks do show some hope. The amount of some noncurrent loans decreased in the past quarter for the first time in years. For example, the total amount of noncurrent construction and development loans fell for the first time in four years. In addition, the average net charge-off ratio also improved after peaking in third quarter, and early stage delinquency trends showed promise.

Despite these signs of stability, the bad news is that the increase in overall noncurrent loans last quarter was driven largely by real estate. The amount of real estate loans secured by nonfarm nonresidential real estate properties that were noncurrent rose by $4.5 billion (12.2%). And such exposure will likely necessitate considerable more reserves this year. So while some forms of lending seem to be coming out of the woods, banks will still be trying to clear a path through the commercial real estate thicket.

"Loan delinquencies and defaults continue to rise as expected, but they still fail to capture the enormity of distress in the commercial real estate market, as most properties are still producing enough cash flow to adequately meet debt payments," writes Josh Scoville, Director, US Equity Research at PPR in PPR's Daily Update for March 10. "However, given the massive correction in property values, it is increasingly likely that assets with debt are upside down - i.e., the property value has fallen below the principal left on the loan. This may be all fine and dandy in our extend-and-pretend world as long as two things occur: 1) the cash flow remains high enough to continue to meet debt service, and 2) there are no major capital events required to maintain the asset. With market cash flows falling, the first requirement is under growing pressure, and this distress is directly reflected in the rising delinquency and default rates. However, the latter requirement may be an even bigger issue, as debt maturities continue to force capital events."

"The banks are trying desperately to survive the current crises without facing up to massive losses," said Robert D. Domini, MBA, MAI, president of Continental Valuations Inc. Perrysburg, OH. "With delinquencies mounting, loan loss reserves are definitely falling behind. How long [banks] can hold off will depend on how bad the commercial real estate crisis gets. Vacant, deteriorating buildings in default can't be papered over for long."

Cash Is King

Jeffrey Rogers, president and COO of Integra Realty Resources, the largest independent commercial real estate valuation and consulting firm in North America, said the banking numbers show that they may be out of the "crisis phase" but still have a lot of clearing out to do.

"We still have a long way to go before we have a normal banking system again," Rogers said. "We are still in a period of deteriorating assets and loan losses to work through. This will take some time. 140 banks were shut down by the FDIC last year. This year, we will have more than twice that. The weak banks must be cleared out of the system and it is a process. Notwithstanding, we are through the crisis phase of the cycle and the top thirty banks are healthier than they were a year ago today."

"No institution wants to sell an asset at the bottom of the market unless it has to. As long as the asset does not deteriorate significantly during the hold period and the asset will likely increase in value in a normal market, there is a bias to hold," Rogers said. "Moreover, when banks were at their weakest point, taking big losses on assets would have been even more perilous. Banks need time to earn their way out of this recession. They will be able to absorb losses better after recapitalization and positive operating metrics."

"In a recession and in the midst of a banking crisis, lending standards tighten significantly," Rogers said. "Nothing becomes more important than cash. There is still a lot of uncertainty in the capital markets and no one has the appetite for risk. Those with the cash will come out on top." And when it comes to getting cash, there still remains a great deal of uncertainty, Rogers said. The following are additional comments from industry observers on the state of the banking credit markets.

Stymied

Banks are willing to take a wait and see attitude, forbearance has come into play as well as blend and extend. There is an unreal expectation that values of these non or spotty performing assets is higher than what the market would pay. It is a Catch 21, wanting the assets off the books but expecting pricing to be at unusual levels. This leaves the banks with assets that require more coverage dollars than may be necessary. Taking the loss, on the heels of previous loss write downs keeps the holes from being further dug, or filled in. I think there is a stymie right now and more and greater losses on the horizon. Trish Walden, Broker-Associate, Advisor, Sperry Van Ness Florida Commercial Real Estate Advisors, Lake Mary, FL

Trying To Cope

Everybody is trying to spread the manure out, hoping that there isn't so much it just burns the plants. Folks knew in their heart of hearts that the music would stop. The party would be over, but now that it is, they're just trying to cope day by day. Charles B. Warren, MRICS ASA-Urban Real Property, Pleasant Hill, CA

Trying to Dollar Cost Down

Waiting for a real estate and economic rebound to take place before shedding "non-performing loans and assets" in an economy that is de-leveraging itself is a mistake. These large financial institutions should start taking the "hits" on these loans and troubled real estate assets now in order to raise "cash" and preserve their liquidity. There is plenty of private equity money around that would surely jump at the idea of buying loans and assets at a "discount." The amount of refinancing that will need to take place especially in 2012 with rollover of 2002 (10-year) and 2007 (5-year) money will be rather significant. Keeping borrowers on extended "life-support" with short term "workouts" is like trying to "dollar cost down" rather than "cutting your loss" and get out from a bad situation that may worsen further (i.e. The value of the asset versus the loan balance continues to shrink). Howard Applebaum, President, Corporate America Realty & Advisors, Rutherford, NJ

Hoping Time Will Heal All Wounds

I specifically know of a certain case with a local community bank (I'm assuming this is pretty "normal") where they are pushing appraisers for high values so they can minimize reserve requirements, avoid having to re-classify or foreclose the property and will just continue to extend and pretend instead of taking the adequate reserve or taking the 30% loss that they would have to take if they foreclosed and re-sold the property. They are obviously hoping that time will heal and/or that they can spread out their reserves over time. I believe that the regulators are basically OK with this because they don't have the manpower to take over the number of banks who would need to be closed if true values were recognized today. David Blain, Principal, Pacific Southwest Realty Services, Irvine, CA

Wild West

Clearly the banks are not prepared to take on any more REO property. The way they have handled the residential problem is deplorable. They clearly saw what was coming and did nothing I can see to be ready for the take backs. The short sale process is like the Wild West and we are now getting ready to try it in commercial. The only difference is that there will be fewer deals (in number) and banks and borrowers are used to creative deal structuring with commercial deals. My concern is the bank mentality and the bank bureaucracy will make the process more painful than necessary. We may have casualties we don't need to have. Let the loan originators (the production folks) who have the flair to do creative deal structuring do the workouts, not the underwriters. Set up parameters but give folks who "get it" the authority to get it done. Cindy S. Chandler, Principal, The Chandler Group, Charlotte, NC

Whamo!

After living through the many bank missteps of at least six major recessions in my 55 years of real estate experience in dealing with troubled bank assets, the Feds have neither the dough or the staff or the will to shut down the many, many troubled banks; some say at least 1,000 or more are on the watch list. This time around, banks are holding, with Fed approval, assets at appraised value or loan amount, whichever is the higher number, unlike, for example, the '80s when while doing work outs at Senior George H. Bush's son's bank, Silverado in Denver, the minute a loan was 60 days overdue, Whamo, the Feds were at my door forcing a write down to a new appraised value which discounted a projected holding period for the asset, etc., etc. Does history repeat itself, you betcha, only this time around the Feds are in deeper trouble than ever given the reluctance of Washington to admit defeat on this issue, i.e., the banking system is in a world of hurt. David C. Nilges, President, Managing Broker, Nilges Commercial*Realtors Inc., Centennial, CO

Betting on Bad Debt Becoming a Growing Investment Play

2010-02-12T07:45:00.000-08:00

With the Great Recession in mid-stream and commercial real estate being a lagging component of the economy as demand for CRE space is a derived demand once potential tenants outgrow their current space needs and feel confident in the future, the declining property fundamentals, lack of liquidity in the market and rising investor yield requirements as reflected in cap rates, a large percentage of commmercial properties are not worth the face amount of the debt.

In this week's CoStar Watch List, A weekly column focusing on distressed market conditions, commercial real estate properties, mortgages and Corporations Published by CoStar News, the opportunity to buy distressed debt is highlighted. The article is below. You can sign up for the eblast from CoStar through their website www.costar.com.

The key is to recognize that buying a loan, while based on a thorough underwriting of the collateral (the foundation is always the real estate), is not buying a property and has a different cash flow characteristics and risks. I will be addressing issues in the loan valuation/pricing process in future blogs but awareness of the opportunity is the first step for many investors.

For many this is back to the future going back to the RTC days, but for others, this is the first time to pursue the acquisition of commercial mortgage debt on the secondary market. I have significant experience in this arena - from both the buy and sale side as well as a loan sale advisor and due diligence provider. Please let me know if I can be of service.

Betting on Bad Debt Becoming a Growing Investment Play
With Distressed CRE Debt Mounting, Investors Are Scouring Loan Books for Good Property Deals
By Mark Heschmeyer
With most if not all facets of commercial real estate investment mired in the dumps, one area is burgeoning -- the market for distressed debt. Indeed, investors say the distressed debt market is more active now than it has ever been, and still nowhere near where players see it going over the next couple of years. Spurring the action is new paradigm in property acquisition. Debt buyers are keen on the notion that properties can be acquired at significant discounts to their loan values - offering even bigger savings than the cost of purchasing a property outright.

Examples of this new arrangement are abundant, with AION Partners, a real estate private equity company in New York, being just one. AION is utilizing this loan-to-own strategy as a starting point for increasing its ownership portfolio. It recently purchased a portfolio of eight loan-to-own assets in opportunistic markets throughout the Sunbelt with a value in excess of $110 million. Since acquiring the loans, AION Partners has already foreclosed, or taken a deed in lieu on five of these non-performing first mortgage loans and plans to take control of the remaining properties in 2010.

The eight loans purchased in 2009 include: a 234-unit multifamily complex in North Miami, FL; a 192-unit multifamily property in West Palm Beach, FL; a 178-unit assisted living facility in Arlington, TX; a 287,000-square-foot distribution warehouse in Chester, NY; a 150-unit multifamily complex in Phoenix, AZ; a 196-unit multifamily property in Tucson, AZ; a 480-unit multifamily community in Atlanta, GA; and a 220-unit multifamily building in Charlotte, NC.

"We are committed to building a large, national portfolio of multifamily assets and are executing this strategy through the acquisition of distressed loans and properties and then employing our experience as investors, developers and managers to stabilize and build value," said Michael Betancourt, principal of AION Partners, which also owns office, retail and condominium properties in major cities including New York, Washington, DC, and Los Angeles. "If our success during 2009 is any indication of things to come, we anticipate activity in 2010 both on the investment and asset management fronts to surpass our initial projections for our partners and ourselves."

The bulk of the distressed debt sales in 2009 were in the CMBS arena and from the Federal Deposit Insurance Corp. and industry participants expect those numbers to continue growing this year.

The FDIC alone sold about 3,500 commercial real estate loans with a book value of more than $6.1 billion last year; that compares to commercial real estate loans sales in 2008 of just $153 million. Nonperforming loans went for 37 cents on the dollar last year but November and December 2009 sales prices coming in closer to 30 cents. Performing loans sold for about 57 cents on the dollar, but with the most recent sales coming in at 44 cents.

Also, the FDIC has a growing portfolio of bad loans to deal with as regulators are closing banks in record numbers.

According to analysis by Property and Portfolio Research (PPR), a CoStar Group subsidiary, as commercial real estate fundamentals continue to deteriorate through 2010, banks with large exposure to the commercial real estate sector will face increased pressure on their balance sheets. FDIC guidelines suggest that a bank whose commercial real estate holdings exceed 300% of capital is "overexposed" to the sector. Based on that metric, PPR says there is no shortage of candidates that the FDIC could seize in 2010. As of the end of the third quarter 2009, more 1,200 banks had commercial real estate exposure of greater than 300% of capital, and 500 of these banks had exposure greater than 400% of capital. The assets of those banks total approximately $650 billion.

So as far as the growth in the amount of debt the FDIC can dispose of, Steve Miller, director of debt research and risk management at PPR, says it is limited only by the FDIC's ability to deal with the growing volume of distressed financial institutions.

CMBS loan liquidations were averaging about $108 million a month in 2008 and last year the average jumped $182 million with November's totaling hitting $255 million and December's ballooning to $585 million, according to CMBS bond rating agency Realpoint. Loans were being liquidated at losses near 66%.

In addition, the rate at which liquidated or resolved CMBS credits are replenished by newly delinquent loans is growing and remains a high concern, especially regarding further growth in the foreclosure and REO categories (evidence of additional loan workouts and liquidations on the horizon for 2010).

To the selling side of the equation, industry participants also expect to see heretofore reluctant community and regional banks begin to dispose of more of their distressed commercial real estate assets.

"The secondary market for buying loans is a crowded space right now," said Barry C. Smith, president of LoanSaleCorp.com in Scottsdale, AZ. "There are many groups seeking deals, but transactions (other than the FDIC sales) actually taking place are not as great as one might think. Bid / ask spreads are still wide, but we do see things narrowing somewhat."

"January was interesting; it is apparent that both buyers and sellers are ready to get things going after a dismal 2009," Smith said. "We see good momentum in the market currently and we are happy to report that the community and regional banks we deal with seem to be more interested in actually doing something proactive. This contrasts with what we saw in 2009. Some banks are starting to come out of their Zombie like state and explore the disposition of identified problems. This is an encouraging sign for the market."

Bill Looney, president of loan sales at DebtX in San Francisco, said the market for commercial real estate debt is as active as he has seen it in 10 years.

"That's a function of weakening conditions in the commercial real estate market and a recognition among financial institutions that they need to actively manage their portfolio to reduce risk and protect the bottom line," Looney said. "Many institutions realize that a loan sale can expeditiously dispose of a loan at fair market value. By selling, rather than holding onto the loan in workout, institutions can remove the headwind from their balance sheet and get back to the business of making profitable loans again."

In addition to selling a significant volume of non-performing loans, Looney said he also expects to sell a fair amount of performing debt start coming to market.

New York-based Mission Capital Advisors conducted $9.2 billion in loan sales last year including $571 million of CMBS loan sales, a 77% increase year over year versus 2008. "We see the market as extremely active, with the most active sellers being the healthier community and regional banks who have successfully raised capital and nearly all special servicers (regardless of financial condition)," said William David Tobin, principal of Mission Capital Advisors. "Mission's commercial loan sale business was up 57% in 2009 versus 2008 in terms of balance offered. We expect a similar increase in 2010."

"The most active buyers are localized operators teamed with high net worth individuals or groups of individuals, with a strategic use for the property (and accordingly, a price advantage over strictly financial buyers)," Tobin said. "The second most active buyer profile is $50 million to $500 million private equity / high net worth investment funds."

In terms of buyers, Bill Looney said DebtX is seeing a lot of bidding and purchasing by opportunity funds, private equity funds and hedge funds.

"In addition, we're seeing a number of equity buyers who previously owned property, but have been in cash looking to get back in," Looney said. "Because many distressed properties are mired in default or are unable to service their debt, some equity players are seeking to re-enter the property market by purchasing the loans. Finally, we're seeing local players, such as community banks, selectively buying loans. Community banks often have a local market advantage because they are tied so closely to their communities."

Barry Smith at LoanSaleCorp.com said the major buying activity presently is in the sub- and nonperforming loan space. Buyers are not showing a clear preference for property types but that clearly loans in the major metropolitan markets are of the most interest.

Ken Cohen, chairman and CEO of The Mortgage Acquisition Co. in San Francisco, which has been active buyer in the capital markets since 1990, said the current market is tremendously active and is going to stay active.

"As a buyer we look at performing and nonperforming loans, although right now we're seeing many more nonperforming situations as borrowers are starting to miss payments," Cohen said. "We look at a lot of property types, but we stay away from land loans and major lease up issues - empty retail, big box office, big box anything."

In terms of pricing, Cohen said he is looks at the underlying cash flow of the property and strength of the sponsor backing the loan.

An open letter to the Appraisal Insitute: 20th Century Valuation Techniques are not appropriate for 21st Century Finance and Investment

2010-02-05T07:09:00.000-08:00

When an economic calamity is so great it compels economists to reach for a new paradigm incorporating the value of collateral and the amount of leverage used to finance its ownership. When the understanding of commercial real estate operations and cash flow characteristics – and the ability to use computer programs to model it makes the three approaches to value – cost, sales comparison and capitalization of income – simplistic and, with one exception, anachronistic….

Δ First, the cost approach in which estimated value “is derived…by estimating the current cost to construct a reproduction of existing structure, including entrepreneurial incentive, deducting depreciation from the total cost and adding the estimated land value”* (which fluctuates based on market conditions) only works for special purpose properties as a reflection of value in use – as a factory which is designed and built to house production of a unique production process.

- Having been in a position to sell a Class B building in downtown St. Petersburg for under $15 per square foot in 1992 at the bottom of the last cycle which was empty in a time of oversupply I know that an empty building is not necessarily worth the cost of bricks and mortar and a developer adds value above replacement cost by developing and leasing the property which provides incentivized investment returns to both capital and management.

Δ Second, the sales comparison approach derives value “by comparing the property being appraised to similar properties that have been sold recently, then applying appropriate units of comparison making adjustments to the sale prices of the comparables based on the elements of comparison.”* This approach may be appropriate for owner-occupied housing where the principal of substitution is the primary basis for determining what a buyer would pay for a home; however, differences between commercial properties; including location, functionality and operational efficiency, lease structures and terms, and the capital structure, cost of capital and yield expectations of the buyer who pays “investment value” for a property; are too significant and extensive for an appraiser to be able to adequately address them in order to estimate the value of a comparable property.

- Being on the opposite side of a street or having more points of ingress can change the marketability of a property and reduce or increase market risk which should be reflected in the buyer’s yield expectation as reflected in the Internal Rate of Return and the resultant capitalization rate.

- Even if an appraiser used sales data on sales that closed as of the date of the appraisal, the information is dated since a normal commercial real estate deal takes between two and three months to negotiate and close with the purchase price generally agreed upon at the outset of the process – not the conclusion.

Δ Finally, the income capitalization approach which can be applied using two methodologies: (1) the capitalization of “one year’s income expectancy” at a “market-derived capitalization rate,” which happens to be the most commonly used method due to its simplicity; or (2) the discounting of “the annual cash flows for the holding period and reversion….at a specified yield rate.”*

- The capitalization of a one-year pro forma has the fatal flaw in that it implicitly assumes the net operating income from a property will be the same in perpetuity – and commercial real estate professionals including appraisers know that a property’s cash flow is not the same from one month to the next, much less does it remain the same for years on end. With the sole exception of a long-term absolute net leased single-tenant property, commercial real estate does not generate bond-type income streams. It has a mix quality of tenants with varying lease rollover times, vacancies and releasing costs.

- In addition, the traditional application of the income capitalization approach is to capitalize net operating income, which may be a proxy for net cash flow when there are no tenant improvements or leasing commissions to pay as is the case with apartment complexes, self-storage facilities and hotels but not with office buildings, shopping centers or industrial facilities. For commercial properties, the NOI should be reduced by an estimate of the annual expenditure for leasing costs and rollover vacancy to approximate the estimated net cash flow to be generated from the property operations. Problem is, appraisers cannot get the same information on competing properties in order to develop an appropriate cap rate.

Accordingly, the only reasonable method to establish what the accountants call “fair value” of commercial real estate is to forecast future cash flow from the operation and re-sale of the property and discount the resulting cash flows reflecting a prudent investor’s yield requirements given the cost of debt financing and the perceived market, operating and financial risk assumed through ownership in relation to other investment opportunities.

It is the 21st Century - we know better and we have the capability to estimate market value by employing the same tools investors use to establish investment value.

For the record, the generally accepted definition of market value (“The most probable price, as of a specified date, in cash, or in terms equivalent to cash, or in other precisely revealed terms, for which the specified property rights should sell after reasonable exposure in a competitive market under all conditions requisite for a fair sale, with the buyer and seller each acting prudently, knowledgeably, and for self-interest, and assuming that neither is under undue duress.”) is not at issue – the issue is that the aforementioned approaches to value are still accepted as a basis for estimating market value.

Accordingly, in my humble opinion, market value can only be based on the income characteristics of the subject property. Minimum standards would be established for the research and support used for developing the forecast assumptions used in preparing the cash flow forecast. Appraisals would be evaluated based on the assumptions used in estimating market rent, stabilized occupancy, downtime between leases, leasing costs, operating expenses, growth rates, capital improvement and replacement costs, reversionary capitalization rate and selling costs, and the yield, or discount rate, used to present value the future cash flows.

Δ The traditional cost, sales comparison and capitalization of income approaches would be used to test the reasonableness of the resulting range of values developed pursuant to the discounted cash flow approach within which “market value” is most likely to occur.

The Appraisal and Mortgage Financing Considerations

From a prudent lending perspective, the information contained in an appraisal provides many underwriting benchmarks – in addition to the traditional loan to value ratio - which provide establish loan sizing and structuring. For instance, prudent lending practice dictates that a construction loan should be capped at the cost of construction excluding land; however, in the last cycle, many non-recourse permanent loans were made based on appraised values far exceeded replacement cost which has increased the exposure to risk above which is prudent for commercial lenders: Permanent financing sizing should also be capped at replacement cost.

The objectively-created cash flow forecast used in an appraisal provides lenders with a timeline for potential default events like tenant rollover or major capital improvements or replacements enabling the loan officer to structure the loan with appropriate rollover and capital reserves. Further, the lender can determine a property’s ability to cover debt over the anticipated loan term and size the loan using a debt coverage ratio-based mortgage payment reflecting the minimum cash flow generated after unreserved leasing and capital costs including lost rent during rollover.

If an appraisal is being conducted for purposes of a loan application, the cash flow forecast should be for a minimum term of the loan plus at least two years. This timeframe allows a lender to fully evaluate the risk of default at maturity that may result from a major tenant rolling over immediately subsequent to the proposed loan maturity. Further, the lender can structure the loan with appropriate reserves and shorter amortization term to reduce the balance to reduce the default risk to an acceptable level.

It is clear from the impact escalating market value of commercial real estate based on unrestrained market liquidity and investor demand that the 20th Century valuation methods embraced by the Appraisal Institute and the financial community leads to ever escalating values in boom periods and draconian values in recessionary periods does not provide a prudent basis for loan sizing and structuring.

New loans, and loans to be restructured, need to reflect the property-specific risks of the collateral as reflected in an appraisal that appropriately reflects the cash flow characteristics of the property and the risks and returns of ownership.

- For instance, the interest rate and loan sizing parameter, loan to value ratio, would be influenced by the credit risk in the property’s tenancy and lease tenure, or rollover risk in the rent roll.

- The physical reserves would be structured to provide fro un-depreciated replacement cost in the year the expenditure is expected to occur as, ideally, the reserve and capital expenditure forecast would be obtained from a current property condition report.

The considerations in establishing the size and terms of a commercial mortgage loan extend far beyond loan to value and debt service coverage ratios – and it is time for mortgage lenders to fully utilize the information in the appraisal to minimize default risk.

Conclusion

The objective of policy-makers, regulators and bankers in the wake of the Great Recession is to provide prudently underwritten loans to qualified borrowers which will serve to eliminate, or at least moderate, market bubbles. Updating the appraisal methodology to reflect anticipated property performance is one of the first places to start. It is clear that the traditional approaches to estimate market value do not result in a value estimate appropriate for prudent loan underwriting and sizing.

My prediction is that issues involving collateral and collateral value will be at the forefront of financial and real estate industry concerns as we reach for the new economic paradigm. While traditional appraisals and broker’s price opinions will provide financial institutions a value benchmark, they will not provide the basis for the new economy.

It is time for the Appraisal Institute to effect a paradigm shift in the appraisal process of a commercial property – it is time for valuation methodology and loan underwriting to enter the 21st Century!

This is my first eblast this year but it is not my first post to my blog. I welcome your comments and opinions and look forward to continuing the dialogue.

We know real estate and we understand commercial mortgages - let me know if we can be of service.
Best regards,

Paul Jones, CPA, CRE, FRICS

* NOTE: All definitions are from The Dictionary of Real Estate Appraisal, Fourth Edition, Appraisal Institute, 2002.

Rule Makers Remove CMBS Market's Accounting Linchpin

2010-01-15T07:01:00.000-08:00

Until now, issuers of CMBS bonds would assemble a pool of mortgages and then create a Qualified Special Purpose Entity (QSPE), usually a trust, which would then issue bonds and sell them to investors in order to "buy" the loans from the issuer. The sub-institutional rated bonds and the first-loss position, or non-rated bonds, were sold to a "B-piece" buyer who typically acts as special servicer and has ultimate control of the disposition of the mortgages.

Qualifying special-purpose entities (QSPEs) generally are off-balance-sheet entities that are exempt from consolidation. The new standard eliminates that exemption from consolidation. Many qualifying special-purpose entities that currently are off balance sheet will become subject to the revised consolidation guidance in the proposal on consolidations of variable interest entities.

The new standard requires a company to provide additional disclosures about all of its continuing involvements with transferred financial assets. Continuing involvement can take many forms—for example, recourse or guarantee arrangements, servicing arrangements, and providing certain derivative instruments. The new standard also requires a company to provide expanded disclosures about its continuing involvement until it has no continuing involvement in the transferred financial assets. A company will also need to provide additional information about transaction gains and losses resulting from transfers of financial assets during a reporting period.

It is the B-piece buyer who is severaly impacted by this new accounting rule as they will now have to record the full face value of the mortgages and related bonds as assets and liabilities on their balance sheets which will make B-piece investing unattractive.

So, in the event of a CMBS issuance, who will now buy the B-piece? The bottom line: If there are no buyers, there can be no CMBS!

And because this affects all legacy deals, what happens to the existing pool of B-piece buyers?

Following is an artcle that appeared in this morning's CREDirect.com.....for your edification.

Rule Makers Remove CMBS Market's Accounting Linchpin

Thursday, 14 January 2010
By John Covaleski, Commercial Real Estate Direct Staff Writer

A new accounting rule that requires B-piece buyers of CMBS loans to record on their balance sheets the entire value of the bonds they handle has taken effect.

The Financial Accounting Standards Board, or FASB, has formally codified its FAS 167 standard, which eliminates qualifying special-purpose entities, or QSPEs, an accounting concept that's been the linchpin for CMBS.

The QSPEs allowed controlling-class investors to buy bonds from transactions without having to book the entire deals on their balance sheets. That in turn has enabled bond issuers to sell, for accounting purposes, the loans that they packaged into CMBS. They otherwise would have to carry the bonds' entire value on their books.

FAS 167, which also sets new reporting rules for the securitization of other types of assets, applies to existing CMBS as well as new issues. An overview of the rule is available on FASB's Web site.

It foists the responsibility to record CMBS bonds' total values on their controlling class investors or other entities that receive significant fees for managing the bonds' performance.

Both those definitions apply to B-piece buyers.

The codified version of FAS 167 is virtually identical to what FASB proposed last summer, stoking widespread fear that CMBS issuance and management would be severely crippled.

The new rule means that a B-piece buyer of a bond consisting of hundreds of millions or billions of dollars worth of loans would have to record the bond's entire value on its balance sheet, even though it may only own a stake worth say 2-3 percent of that value.

"This issue has not changed since last summer. QSPEs are gone," said Tom Barbieri, a partner in the assurance services practice of accounting firm PricewaterhouseCoopers.

FASB, the accounting rule maker for the United States, had been considering reining in CMBS issuers' user of QSPEs ever since the Enron accounting scandal. The credit crisis that began in 2007 heated regulatory interest in the issue this go-round.

The rule technically took effect Jan. 1 for companies that report by calendar years, and the first fiscal year beginning after Nov. 15, 2009, for all other companies.

"For the most part, issuers are in a discovery process to see what's going to have to go on their balance sheets. We have yet to see a lot of discussion of how they will deal with the rule," Barbieri said.

Loopholes could emerge from the rule's later interpretations. Barbieri said there could theoretically be cases in which a servicer's stake in a bond is too small and the performance-based component of its fees too small to consider it a controlling investor.

To be sure, he said those cases would be rare and that the SEC will closely monitor the management of CMBS deals for changes made to sidestep FAS 167.

The rule may also be modified somewhat in negotiations that FASB is having with the International Accounting Standards Board regarding converging their respective rules. FASB has deferred money market funds from having to meet the FAS 167 rules until after the convergence project is completed later this year.

Meanwhile, the rule is expected to be a major and costly accounting headache for CMBS B-piece buyers. Rick Jones, chairman of the Commercial Mortgage Securities Association's political action committee, last summer noted, "It will be extremely expensive to meet these reporting standards and it will not make financial statements more understandable."

The FDIC last month issued its own rule that gives banks a year to phase in their implementation of FAS 167 so they can meet the agency's risk-based capital standards.

Fed issues Beige Book Survey Finds Continued Weakness in Commercial Real Estate

2010-01-14T07:05:00.000-08:00

Reviewing the Beige Book gives an indication of the economy and, especially, the Fed's viewpoint on it....It should be good reading for all....

Fed Survey Finds Continued Weakness in Commercial Real Estate
Wednesday, 13 January 2010
Commercial Real Estate Direct Staff Report

Commercial real estate remains weak throughout the country, according to the Federal Reserve's beige book survey of its 12 districts.

The Fed, which surveys its district offices eight times a year and reports its findings in what is commonly referred to as its Beige Book, said conditions in non-residential markets in each of its districts "remained soft," with some district offices, namely New York, Philadelphia, Kansas City and San Francisco, reporting declines in demand for commercial and industrial space. The bank's Richmond, Va., district office reported that leasing of office and retail space appeared to have "picked up."

But as data from various providers has shown, vacancy rates have continued to climb, while rents have fallen across the board. The Fed noted that some of its district offices had reported that tenants were now able to extend existing leases at low rents and with allowances as property owners strived to retain their tenants.

The Fed said that economic conditions overall had "improved modestly," but remained at low levels.

For a copy of the full report, go to: http://www.federalreserve.gov/FOMC/BeigeBook/2010/20100113/fullreport20100113.pdf

Fed: It's Time the Market Stands on its Own

2010-01-11T09:42:00.000-08:00

It seems the fixed income securities arena as it relates to real estate needs to be through rehab by the end of the first quarter as the Fed is no longer going to be a crutch......I do not see how we will be ready but understand that it cannot last forever....The true test of the CMBS and RBS markets - especially the secondary market will occur once the Fed pulls out....Now is the time to adopt the Boy Scout credo and "Be prepared "

Fed: It's Time the Market Stands on its Own

April 1 will be the first day that the Federal Reserve will end its debt purchase program and allow the struggling U.S. mortgage market to operate unassisted. As a result, the Fed believes mortgage rates will rise about three-quarters of a percent to about 6 percent, Boston Fed President Eric Rosengren said Saturday.Fear of a worldwide perception that the U.S. government is simply printing money to use to purchase mortgage-related securities is a big reason the Fed has pulled back, analysts say. If that fear caused a sell-off of U.S. government bonds, it would push borrowing costs substantially higher and derail the economic recovery."We are still in uncharted waters," Fed Vice Chairman Donald Kohn said in an unrelated speech Saturday. "We will need to be flexible and adjust as we gain experience."Source: Reuters News, Pedro Nicolaci da Costa (01/08/2010)

America's Route to Recovery

2009-12-29T10:05:00.000-08:00

Continuing to look for solutions to the Great Recession, the report on America's Road to Recovery was released by Reuters today and it provides great insight into the way out of this economic morass as well as the life of the future which all of us, even us gray-beards, need to recognize for our own survival. The Reuters report is fairly long but worth reading.

On this occasion, may the new decade be good to you and your family!

SPECIAL REPORT-America's route to recovery
Tue 29 Dec, 2009
Reuters

(For the Reuters multimedia project Route to Recovery, a team of journalists toured America to examine the impact of the recession and posted their reports online. The following story is the last installment in the series that can be found at www.reuters.com/routetorecovery)

(To hear Nick Carey discuss the project on Reuters Insider TV please click on http://link.reuters.com/nec88g)

Successive bubbles masked underlying economic woes
Chasing smokestacks no longer the key to prosperity
Renewed focus on small business and education
By Nick Carey

YOUNGSTOWN, Ohio (Reuters) – When Bob Hagan was a boy people hereabouts equated the coke dust they swept off their doorsteps each day with opportunity, for it came from the steel mills that built this city.

After graduating from high school more than 40 years ago, Hagan worked briefly at one of the local steel mills that dominated the local economy. In 1971, he became a locomotive engineer at railroad company CSX Corp, switching rail cars in every mill and yard in the area over the years.
The job afforded him a ground-level view of the slow-moving disaster that would tear out Youngstown’s heart over the next decade and a half — as it did many other towns in America’s Rust Belt.

“In my rides through this valley on the train, I used to watch the fires of prosperity burn,” said Hagan, 60, an Ohio state representative since 1986 who still works for the railroad when not in session. “And then, years later, I watched the lights go out.”

On September 19, 1977 — remembered locally as Black Monday — Sheet & Tube Company laid off more than 4,000 workers in a single day. In the following years, the steel industry all but died here.

In hindsight, the big mistake was trying to save it.

“We have spent the past 20 to 25 years looking in the rearview mirror,” said Jay Williams, the city’s 38-year-old, independent mayor. “Letting go of the past has been difficult for many people because the past was so good.”

Today, the city immortalized by Bruce Springsteen’s 1995 Rust-Belt anthem “Youngstown” is moving on. Among other things, it has created an incubator to attract the types of small businesses that are expected to drive future growth. Despite the thousands of vacant homes that serve as reminders of a traumatic past and turbulent present, some business and civic leaders think this heartland city has a chance to lead the U.S. into its next era of prosperity.

Getting to there from here, however, won’t be easy — for Youngstown, for Ohio, for the nation.

BURST BUBBLES

Youngstown is an extreme but by no means unique case in America. On a basic level, it represents some of the challenges facing the country today in the wake of the longest and deepest downturn since the 1930s.

After two economic expansions based not on sustainable growth but on asset bubbles — the dotcom boom of the 1990s then the far more damaging housing mania this decade — longstanding problems have been brought into sharper focus.

Even during the recent good times, the U.S. manufacturing sector, the muscle behind U.S. post-war economic might, was buffeted as corporations shipped low-cost production overseas.

“The easy, blue-collar shot to the middle class is gone,” said Mike Rollins, president of the Austin Chamber of Commerce. “It’s going to take a lot more work to get there now.”

In short, the world’s largest economy is at a crossroads.

With a smaller manufacturing sector and a consumer base less able to keep leveraging future earnings, where will sustainable, long-term prosperity come from? And more immediately, where will jobs come from?

This is a debate that is taking place at the local level around the country, from Youngstown to El Centro, California, and many places in between. But it is also a discussion that few see taking place at the national political level.

“Washington just doesn’t get it,” said Shane Savage, a real estate agent in Pensacola, Florida, smoking a cigarette outside the home of a client who needs to sell fast in a down market. “It’s going to take a long time to fix the mess that we’re in and our politicians don’t have a clue how bad it really is out here.”

REINVENTING A NATION

Local politicians and businesses acknowledge that the answers to America’s primary problems have been long known.

The country has to get smarter and send more people to college, making it more able to compete in the global high-tech “knowledge economy” of the future. And America needs to keep attracting the world’s best and brightest to help it prosper.

Manufacturers must also continue moving up the value chain, switching to niche production that cannot be easily transferred to China or Mexico. In the future, the sector will involve fewer but more-educated workers.

Now civic and business leaders are looking closely at another part of the economic equation. After seeing the impact that the departure of large corporations can have, there is a renewed focus on fostering small businesses instead.

The reasons are simple: They create more jobs and can be more easily replaced if they leave.

According to the U.S. Small Business Administration, companies with fewer than 500 employees accounted for 64 percent of new jobs from 1993 to the third quarter of 2008.
Small firms also tend to be more involved in their local communities than major corporations.

“We have forgotten in this country that there is so much more to capitalism than just the exchange of goods and services,” said Amy Kedron, who runs Buffalo First, which sells books of coupons promoting businesses in this city at the far northern end of New York State. “It’s also about community.”

“And local businesses are the best at building communities,” she added, “because their owners are in it to make a living, not a killing.”

The other, not unrelated new focus is the “green” economy. Wind farms, solar panels and geothermal power plants will require someone to manufacture them, plus a trained workforce to run and maintain them. And if the private sector and government agree on anything, it’s that this industry must and will become increasingly relevant.

So at a time when critics have been quick to dismiss the U.S. economy as a has-been, some see the makings of an eventual if not immediate resurgence.

“America’s greatest ability has always been its capacity to reinvent itself,” said Diane Swonk, chief economist at Chicago-based financial services firm Mesirow Financial. “We may be able to emerge stronger and better, to the possible anger and envy of some parts of the world.”

But getting there will take a lot of time, effort and money in a nation not renowned for patience and long-term planning.

“Neither our political system nor our capital markets are used to anything but a short-term view, and fixing K through 12 is a long-term proposition,” Swonk said. “Not addressing the issue is an option we don’t have. There is a difficult decade ahead of us.”

The first step toward inventing the future, as Youngstown has found, is acknowledging that the past is gone.

“The thing we’re starting to understand is that the prosperity of the steel mills was the past,” Hagan said. “So let’s accept it and let’s move on into something that makes it even better.”

CASTLES BUILT ON SAND

What sets America’s current downturn apart from most past recessions is that the Great Recession has been national in scope. “Other recent recessions have been regional in nature,” says Swonk. “But this time, there is nowhere to hide.”

Data from the U.S. National Association of Realtors shows the median home price rose every year from 1989 to 2006 before the slide began in 2007. According to real estate website Zillow.com, as of the third quarter of this year 21 percent of all American homeowners owed more than their homes are worth. That equates to 12.4 million single-family homes with mortgages in negative equity, Zillow.com said.

Real estate gains have been a major source of wealth creation and class mobility, so the hangover from the recent binge is likely to prove more painful than usual.

“I keep telling people this is not a housing downturn,” said Al Muller, a partner at Pensacola, Florida-based Metro Market Trends Inc, which tracks real estate markets in Florida and Alabama. “We are in the middle of the bursting of the biggest real estate bubble in the history of this country.”

The wealth destruction in Florida, which along with California has been among the hardest hit by the property tailspin, has been staggering.

“In the years of easy credit we all thought that we had more money,” Muller said after flicking through a wad of papers that included the names and addresses of the 3,018 foreclosures for the first 10 months of 2009 in Escambia and Santa Rosa counties where Pensacola is located.

“The people in foreclosure could be your neighbors, your friends or you could go to church with them or work with them,” Muller said pointing to the papers with evident sadness.

“We all thought (in the boom) that we could live in a bigger house. But we never realized that we were not getting any wealthier… Now there’s simply less money everywhere.”

From its peak in 2005 to the second quarter of 2009, U.S. home equity fell 37 percent, or $4.7 trillion, according to the Federal Reserve. To put that into context, China’s economic output in 2008 totaled around $4.3 trillion.

By the second quarter of 2009, Americans’ total net worth had shrunk 17 percent or $10.7 trillion from its peak in 2007.

FEWER JOBS EVERYWHERE

As well as their money, many have lost jobs. Unemployment stood at 10 percent in November after hitting a recession high of 10.2 percent in October. More than 7 million Americans have become unemployed since the recession began in December 2007.

For areas like Wilmington, Ohio, the job losses involved a single major employer.

This town of 14,000 was home for two decades to express delivery company Airborne Express. In 2003, Airborne was bought by DHL, a unit of German post office operator Deutsche Post, which was looking to take on America’s homegrown package giants FedEx (FDX.N: Quote, Profile, Research) and UPS (UPS.N: Quote, Profile, Research) on their home turf.

After spending billions of dollars, DHL gave up and shut down its U.S. domestic operations in January of this year, with a cost of 9,500 jobs.

DHL was the biggest employer not just in Wilmington, but in the five surrounding counties. The shock waves are being felt in communities filled with people who were able to make a good living with relatively little education.

“I hate to say it, but you have to wonder whether in the long run it was a good thing having DHL and Airborne Express here,” said Katy Farber, president of the Chamber of Commerce in nearby Highland County.

Some 2,800 people out of a population of 42,000 in Highland County lost their jobs when DHL left. The county had Ohio’s highest unemployment rate in October — 15.9 percent. Unemployment in the area before DHL began ratcheting down operations in May 2008 had long been around 3 percent.

“For decades our children were able to make $50,000 to $60,000 a year throwing boxes without even a high school diploma,” Farber said. “We have to retrain our workforce because those jobs are gone.”

It’s a challenge to which Michigan, home of the automobile, has become accustomed.

“The hardest thing for many auto workers who’ve been doing the same job for 25 years or so to accept is that instantly, permanently, their standard of living has been ratcheted down 80 percent,” said Douglas Stites, chief executive of Capital Area Michigan Works, a career center in Lansing, Michigan. “You may have been making $25 an hour making widgets for years, but now your skill set means you’re worth $8 an hour.”

The center is a hive of activity, with people filing in to make job applications and sign up for retraining courses.

Stites recalls a group of Hmong men who turned up after being laid off at an auto supplier. Although they moved from Southeast Asia to America decades ago, their low-skilled jobs meant they never had to bother learning English.

“What do you tell people like that?” he said. “There is no way they’re ever going to be able to sustain the lifestyle they’ve become accustomed to.”

Accepting that many of the easy, high-paid jobs of the past are gone is the first step in a process that some communities have taken toward reinvention. Youngstown, for instance, spent many years looking for a way to revive the steel industry.

“We have had to embrace the fact that we are going to be different and there is no going back to where we were,” said Mayor Williams. “But being smaller can also be better.”

Part of Youngstown’s Plan 2010 strategy involves trying to revitalize neighborhoods that can be saved and — in a city with 4,500 vacant homes — letting go those that cannot.

“We are aiming to focus on the neighborhoods that can be saved,” said Phil Kidd, a community organizer at the nonprofit group Mahoning Valley Organizing Collaborative. “But we have to accept the fact that we are going to have to wind down some neighborhoods gracefully.”

From a peak of 28.3 percent in 1953, manufacturing’s share of U.S. Gross Domestic Product fell to 11.5 percent in 2008.

Much of that decline in the recent past has been due to production moving overseas to developing nations like China or across the U.S. southern border into Mexico.

This is a source of frustration and anger for workers like the 1,100 former employees at the Whirlpool (WHR.N: Quote, Profile, Research) refrigerator plant in Evansville, Indiana, which has said it will shut in 2010 as the company shifts production to Mexico.

“It was like a punch in the gut,” said Natalie Ford, 42, of the announcement in August. Ford worked at the plant for nearly 19 years, while her husband Jim, 47, counts 18 years there.

“After all we have done for Whirlpool, I feel like we’ve been betrayed,” she added, her eyes misting over.

A NEW REVOLUTION

Leslie Taito is executive director of Rhode Island Manufacturing Extension Services (RIMES), a nonprofit that provides consultation for small and medium-sized manufacturers in Rhode Island, a state of 1 million people.

Rhode Island was the home of America’s first mechanized cotton mill, but since Taito arrived 16 years ago, the number of manufacturers here has fallen to 1,945 from 2,800. Still, she believes that all of those that are left can be helped to survive and thrive — and the best way is to get smart and not try to compete with low-cost Chinese producers.

“Manufacturers have to specialize and find a niche where they develop high-end goods that are not sold just based on cost,” Taito said. “Sure, China can make it cheaper than we can,” she said, while weaving in and out of traffic en route through the heart of Providence. “But what they don’t have is the design or engineering capabilities that we do.”

One of the companies that RIMES has worked with in the past is Pawtucket-based Blow Molded Specialties, which makes products from hot plastic that is blown into molds where it sets. Its clients are predominantly in the healthcare sector.

President and majority owner Tom Boyd describes how the company’s largest customer switched production of a basic product to Mexico because it could be made there for 2 cents apiece instead of 8 cents in the United States.

That company had accounted for some 35 percent of business. “That was nearly the end of us,” Boyd said with a wry smile.

So instead of trying to compete on low-cost products, Boyd’s company specializes in high-end, complicated and intricate products, and even develops products for customers.

In the company’s meeting room, he shows off some of the firm’s products including one which looks almost like a plastic accordion and is about the same size, with evident pride.

This, he explains is a plastic bellows his firm developed for a healthcare company, whose name he says he cannot divulge. It has a special function. Conventional practice in organ transplants has been to ship organs on ice. But Boyd says it has been found that a better way to ship organs is to keep them functioning, and the bellows he holds in his hands is part of a device to keep a set of lungs pumping while in transit.

Asked how much Blow Molded charges for a pump like this, Boyd shrugs his slight shoulders. “Maybe a few dollars each. And we only sold a few of them.”

But then he leans forward with right eyebrow and right forefinger raised. “Ah, but you see, the money’s not in the product,” he said, his grin widening. “The money’s in the engineering. We bill our customers for the development work we do.”

Communities around the country say they want to attract small firms like Blow Molded rather than focus on major corporations, for the simple reason that when a giant plant shuts down, it is almost impossible to replace the jobs lost.

The classic example is Wilmington, Ohio, where empty store fronts on Main Street are grim testimony to what happened when DHL axed nearly 10,000 jobs.

“When a big company like that goes, it leaves a very large hole to fill,” said Mayor David Raizk (pronounced “risk.”)

“I’d rather see 200 small companies with 50 employees each than one big one,” he said. “You can lose one, two or even 10 of those and find a way to replace them. Big companies are great when they’re in town, but when they leave they devastate communities.”

One such small firm is Computer Technology Solutions Inc, the largest privately-held software firm in Alabama, which has added some 40 jobs this year and now employs 150 people. “If that’s what we can do in a recession, imagine how we can do when the economy improves,” said president Sanjay Singh.

CTS got its start in a business incubator run by the University of Alabama in Birmingham. Singh said that unlike big corporations — which tend to be bureaucratic, slow-moving and inclined to withhold responsibility from young employees — CTS gives its 20-something employees multimillion-dollar projects to run on their own.

“If you give young people responsibility, they deliver,” he said. “We don’t hang over our employees’ shoulders waiting for them to get things done, we just let them do it.”

GREEN ECONOMY A LONG HAUL

There are great expectations that alternative energy or the “green economy” will help move America forward.

According to Lisa Frantzis, managing director for energy at Navigant Consulting Inc, in 2009, 7,000 megawatts of wind power was installed in America with the creation of 70,000 jobs — 50,000 direct and indirect jobs, plus 20,000 service-related jobs. Solar power saw 300 megawatts installed with the creation of 60,000 jobs.

Jay Paidipati, a Navigant managing consultant who works with Frantzis, said because of the industry’s breadth and relative youth, it is hard to make forecasts. “I would feel comfortable saying that the number of green jobs will be in the millions,” he said. “Just how many millions, I don’t know.”

It will be years, however, before that potential is realized. One of the main problems is the mass of rules and regulations that make building plants a lengthy process.

Imperial County in southern California has hit on a novel way to get around red tape, using a provision of state law that allows local authorities to streamline the approval process for building a plant, as long as it is under 50 megawatts.

This loophole enables officials to handle the approval process in as little as a year, compared to several years at the state level.

“Getting anything done in California is hard,” said Imperial Valley Economic Development Corporation CEO Tim Kelley, at his office in El Centro some 100 miles (160 km) east of San Diego. “But it is less hard to get it done here.”

This area has 360 days of sun a year and has suitable geological conditions for geothermal power — there are 10 such plants already. Thirty others for solar, geothermal and wind facilities, are in the process of acquiring permits.

Red tape is not the only challenge.

Paul Rich is Chief Development Officer at Deepwater Wind LLC, which aims to develop America’s first offshore wind farm, in Rhode Island. The farm, which would eventually provide 15 percent of Rhode Island’s electricity, should come in two phases. The first test phase with six to eight turbines could be installed off the coast by 2012. By around 2015 the wind farm would contain around 100 wind turbines.

Rich described the coast between Maine and Maryland as the “Saudi Arabia of wind,” predicting an “enormous, exponential leap in jobs, manufacturing and infrastructure.”

Part of the reason for the long lead time is the need for extensive tests of local wind conditions, he said.

“It won’t happen overnight,” Rich said. “We are trying to create a truly new industry here and it has to be done right.”

“A far bigger concern for us is finding a qualified workforce to run and maintain the wind farm when it becomes operational.”

In blighted states like Michigan, many former manufacturing workers are already training for green jobs, even though relatively few have been created.

Matthew Derra, 41, lost his job at struggling auto supplier American Axle & Manufacturing Holdings Inc (AXL.N: Quote, Profile, Research) in July 2008. Now he is taking an associate degree in renewable energy and wants to find a job maintaining wind turbines.

“There’s nothing out there in my old field of work,” he said. “And there will be thousands of people out there chasing every green job, but I have to try.”

“I can’t just sit home and watch television.”

Even in California, which has America’s most aggressive climate change regulations, just 159,000 of the state’s 18 million jobs are considered “green” as of the start of 2008, according to public policy group Next 10.

Still, there are encouraging signs that money is flowing into renewable energy even in a sluggish economy.

Bill Gibson, is a business broker and principal of Gibson & Associates Inc in Pensacola, Florida. Gibson finds buyers for companies that want to sell.

He noted that companies selling luxury items are having trouble finding buyers because gun-shy banks won’t lend for that kind of investment, but he has noticed a lot more interest in renewable or alternative energy firms.

“There are definitely going to be haves and have-nots,” Gibson said. “Green energy is part of the future.”

The green energy industry is also seen as an opportunity for manufacturing firms to retool.
“What concerns me is when I hear people talking about manufacturing in the past tense,” said Virg Bernero, mayor of Lansing. “If we want wind turbines, someone here should manufacture them.”

GEEKS AT THE TABLE

Laurie White, president of the Greater Providence Chamber of Commerce, keeps a board covered in bad news — headlines from The New York Times, The Washington Post, The Boston Globe and The Economist about how badly the economy of the state has been faring. Rhode Island’s unemployment rate was 12.7 percent in November, the second highest in the country after Michigan.

“Our problems have made not just national but international headlines,” White said. “That motivates me to find a new way forward.”

Rhode Island is pinning its hopes on a strategy dubbed “Strengthening Providence’s Knowledge Economy.” It has involved bringing together local and state government, the Chamber of Commerce, the Rhode Island Economic Development Corporation (RIEDC) and hundreds of small hi-tech software companies.

“The geeks have finally been offered a seat at the table,” said business consultant Jack Templin.
White said there was an easy explanation: “The geeks are just about the only ones creating jobs right now.”

Companies like Working Planet, which handles algorithmic online market research for its clients, are now at the table.

“Up until a few years ago the chamber was focused on major companies and its existing membership base,” said Working Planet Marketing Group Inc president and co-founder Soren Ryherd. “Over the past three years the chamber has done an about face and is now also about the smaller companies that are creating jobs.”

“We have also become more organized because we need to reach the local universities so we can find and retain top talent,” he added.

Mike Saul is the interim executive director of the RIEDC and has spent much of his career as a “turnaround guy” taking poorly performing companies and making them thrive. He wants to do the same here, in part because three of his four children, like many of the state’s offspring, live outside Rhode Island because there was no work here for them.

“In any turnaround that is going to work you have to ask where is the enterprise value that I can push forward,” he said. According to Saul, the state’s education system and its wind potential create much of its enterprise value.

“Rhode Island’s attempts at economic development have been episodic in the past, but this time everyone is on the same page,” Saul said. “A crisis makes things happen. It helps individuals reinvent themselves and will help this country reinvent itself.”

‘CHASING SMOKESTACKS’

The idea of the “knowledge economy” is a common thread in different parts of America.
Commercializing research and leveraging highly-qualified university students, plus helping create small businesses via incubators has become a major focus in many communities.

The University of Alabama at Birmingham, for instance, has an incubator called the Innovation Depot, which provides low-cost space and resources for small startup firms. The incubator is currently home to around 70 small companies.

UAB’s annual research budget of around $400 million is 80 percent focused on biomedical research, followed by engineering and the physical sciences.

Birmingham, like Youngstown, was once a steel town. The city’s population has dropped more than 30 percent to 230,000 from 340,000 in 1960 and it has focused too frequently on trying to lure back big industry, according to Richard Marchese, vice president of research at UAB.

“The city has done its fair share of chasing smokestacks,” he said. “Birmingham has undergone an important adjustment by realizing that it needs to transform itself from an industrial based economy into an economy driven by innovation.”

Youngstown, like Birmingham, is betting part of its future on an incubator, the Youngstown Business Incubator, which has 28 business-to-business software firms in its portfolio with some 300 employees. The incubator occupies three renovated buildings in downtown Youngstown — which was mostly dead a few years ago — and will move into a fourth in 2010.

“We didn’t want to have a broad range of industries that we couldn’t serve properly,” said James Cossler, the incubator’s CEO. “We wanted to pick one sector and be a world class incubator… We picked software because it is in almost everything we use.”

One condition for startups to receive benefits and resources, including deferred and reduced rent and paid utilities for furnished offices, is they must share their expertise and resources with other member companies, even after they “graduate” and move out.

Craig Zamary owns Green Energy TV, which he describes as the “YouTube of the green movement.” It takes videos from around the world on innovations in alternative energy.
Zamary said that not long after Green Energy TV moved into the incubator in early 2008 he told a fellow business owner he was having trouble with code for his website. The next day the fellow business owner turned up with the code he needed.

“I was wondering what he was going to bill me for it, but he said ’That’s not how we do things around here,’” Zamary recounted. “Some day if he needs something from me I’ll be able to repay the favor.”

Cossler said office space in Youngstown’s incubator costs $8 per square foot compared to $200 in Silicon Valley, while “programming talent” costs about 60 percent more in California. There are also several universities within an hour’s drive, including Youngstown State University a few blocks away.

Cossler said criticism of the incubator — that it will not return Youngstown to its former size — has been misguided.

“We’re not going back to where we were,” he said. “Nothing can take us back and we have had to embrace the fact that we are going to be a smaller city.”

“But it’s absolutely realistic to expect that within a few years we could have 2,000 to 3,000 people employed here,” at the incubator or around it, he added. “This could be very powerful and very transformational for Youngstown.”

Youngstown’s Plan 2010 was developed by Youngstown State University in conjunction with the city and reflects a common thread between this city and other parts of the country like Rhode Island, Birmingham, or Austin, Texas, in that all of them have developed a strategy requiring cooperation between the authorities, local businesses and a local university.

MIND FACTORY

Unlike Youngstown, Birmingham or Rhode Island, Austin has had a business development strategy in place since the 1980s.

“We made a very clear and conscious decision that above all we were going to kowtow to the creative classes,” said Lee Cooke, a former mayor.

From food to music and entrepreneurial opportunities, Austin has focused on attracting creative people.

“It’s very simple. Creativity begets creativity,” said local state senator Kirk Watson.

Austin’s strategy has paid off. The city’s population has tripled to around 750,000 in 2009 from 250,000 in 1970. According to the U.S Bureau of Labor Statistics, the city of Austin had the highest level of job creation in America from 2003 to 2008. Private sector jobs overtook public sector ones — it is the Texas state capital — in the mid-1990s.

Austin has become known as a city of entrepreneurs — Michael Dell founded computer maker Dell Inc (DELL.O: Quote, Profile, Research) while studying at the University of Texas in 1984 — and has grown as people have flocked here looking for jobs.

While the inflow has slowed during the recession, the city is still a magnet for people like Norbert Wangnick. An entrepreneur who sold his niche recruitment firm in Germany at the peak of the market in 2007, Wangnick, 45, moved to Austin late in 2008. After a year off, he is looking to either invest in a company or start a new one.

“Austin has so much energy,” he said. “It’s a great place to be if you want to start a business.”

The city, which hosts the annual SXSW live music festival and considers itself a cultural oasis in Texas, is a strongly Democratic city in a Republican state. Former mayor Cooke, a Republican, said Austin’s political leanings are not in line with his own or the more conservative business establishment. But he added that this fact is irrelevant.

“The choices we have made concerning the economic future of this city transcend politics,” he said. “This is about everyone pulling together.”

Cooperating for the good of the community is something Cooke said is lacking at the national level in America.

“I’d like to get rid of all 535 politicians in Washington and get rid of all the politics of the last 75 years,” he said. “Washington is all about the politics of self-perpetuation, not doing what is right for the country.”

The cornerstone of Austin’s strategy is coordination among the city, businesses and its biggest asset — the University of Texas at Austin. With 50,000 students, it is one of the country’s largest universities and a research powerhouse — biomedical science, engineering, math, physical sciences. UT vice president for research Juan Sanchez estimates some 10 companies graduate from the university’s incubator every year.

Senator Watson said Austin’s fortunes have been a mixture of luck and the sense to capitalize on its “enterprise value.”

“We were lucky in that we weren’t like Detroit, we didn’t have an old industrial factory to protect,” he said. “In places like Detroit it’s understandable spending a lot of energy trying to save the old factory because it means jobs for local people. What we have here is UT.”
“UT is our mind factory.”

Watson describes that “mind factory” in largely industrial terms, even referring to students as “natural resources.”

Watson and Gary Farmer, chairman of Opportunity Austin — a regional economic development strategy — recall visiting Samsung Electronics Co Ltd <005930.ks> in South Korea in 2005 with UT’s Sanchez to persuade the world’s top maker of memory chips to choose Austin for a new semiconductor plant.

Watson and Farmer say a critical moment came when Sanchez informed Samsung executives that there were hundreds of Korean students at UT. In April 2006 Samsung said it would invest $3.5 billion in a plant here creating nearly 1,000 jobs.

“The authorities in Austin, the business community and the university have marched in step for a long time,” Sanchez said. “Much of this has been based on the recognition of UT’s potential.”
Sanchez said such recognition is growing in America.

“There is a growing understanding that intellectual capital is going to be at least as important as manufacturing and natural resources,” he said.

FIXING ‘K THROUGH 12’

Conversations with civic and business leaders around the country support that statement.

In Evansville, Indiana, while Mayor Jonathan Weinzapfel laments Whirlpool’s decision to move production abroad, the company’s decision to keep its research and development facility here is something he says the city can build on.

In cooperation with colleges like the University of Southern Indiana, Weinzapfel argues Evansville may be able to attract other R&D operations. “You have to find what your strengths are,” he said. “And you have play to those strengths.”

Locals around Bentonville, Arkansas — home to America’s biggest private employer Wal-Mart Stores Inc (WMT.N: Quote, Profile, Research) — say it is no coincidence that while Arkansas has one of America’s worst education systems, this local area’s school system is among the better performers.

“Walmart has provided a lot of support for the local school system,” said Jonathan Watson, pastor at the Bella Vista Assembly of God in nearby Bella Vista. “This is no accident, as Walmart uses the schools as a feeder system for providing well-educated future employees for its headquarters.”

According to Andreas Schleicher, the Paris-based head of the indicators and analysis division of the Organization for Economic Cooperation and Development (OECD) — a group of 30 mostly high-income, democratic nations — the problem with primary and secondary education in the United States, known as K through 12, is that it has been in suspended animation.

“For decades America has mostly been treading water while the rest of the world has been working hard to get ahead,” he said.

In 2007, some 78 percent of U.S. high school students graduated, slightly below the OECD average of 82 percent.

OECD data from the 1960s shows that 80 percent of American children graduated from high school then, compared to just 37 percent in South Korea. Now some 97 percent of South Korean children complete high school.

“America has been falling behind,” Schleicher said. “By the age of 15 a quarter of American students have problems with math and science, which foreshadows the problem many have completing high school.”

He added that although America spends more on education than many countries, its school systems are far more uneven in quality, particularly in inner cities. The graduation rate in some inner cities in America in 2008 was 50 percent or below.

“We’ve known about problems with America’s education system for the past four decades, but we haven’t had to deal with them,” said Mesirow Financial’s Swonk. “We were able to just stick under-educated people in factories and not worry about dealing with the problem. That is no longer an option.”

Sheldon Steinbach, a senior counsel in the postsecondary education practice at Washington-based law firm Dow Lohnes, said the United States has plenty of top-quality colleges and universities, but the problem does not lie there.

“As the old saying goes, if you put garbage in you get garbage out,” he said. “America’s K through 12 system has been broken for a long time and I am not sure if can be fixed because there are too many different authorities, federal, state and above all local, involved.”

UT’s Sanchez said if more young people make it to higher education, the pieces are in place for long-term growth.

As he notes, according to the OECD America still leads the way in research and development (R&D) spending. In 2007, the latest year for which data are available, America accounted for around 41 percent of R&D spending in the OECD. Japan was next with 26 percent. China’s R&D spending was equivalent to around 11 percent of the OECD total.

“It was not so long ago that China spent nothing on R&D,” Sanchez said. “Now they are a major power.”

“America is still clearly the global leader by a long way,” he added. “But we can’t afford to rest on our laurels.”

Two of the problems with the U.S. college system, however, are that it is expensive and too little is done to prepare school children to apply. State colleges and universities charge on average close to $20,000 a year, while some private institutions charge $30,000 to $50,000, Steinbach said.

David Kyvig, a distinguished research professor in the history department at Northern Illinois University, whose specialties include the Great Depression, notes that President Franklin D. Roosevelt’s New Deal in the 1930s helped but did not solve the country’s economic ills. World War Two lifted the economy thanks to massive government spending, funded by higher taxes. The U.S. government deficit stood at $10 billion in 1939 but hit $100 billion in 1944.

“The myth today is that Americans will never accept higher taxes,” Kyvig said. “But the deficit during the war was funded by higher taxes and Americans were willing to pay more because they knew it had to be done.”

He said that a large chunk of government spending went on the GI Bill — passed in 1944, it provided returning World War Two veterans with a college or vocational education.

“The GI Bill was the backbone of a quarter of a century of American prosperity and helped create America’s middle class,” Kyvig said. “It was not cheap, it cost an awful lot of money. But it paid off.”

Former Austin mayor Cooke, a Republican, agrees something like the GI Bill could help now.
“Americans will pay more in taxes if they know what they’re paying for,” he said.

In 2002 some 52 percent of high school graduates went on to tertiary education. That figure reached 62 percent in 2009 and is expected to hit 64 percent in 2010.

“We still have a long way to go,” said Opportunity Austin chairman Farmer, echoing state senator Watson’s analogy: “We need to develop a better pipeline for our mind factory.”

ATTRACTING THE BEST AND BRIGHTEST

The six-minute plus video that Mary Tribble prepared for the annual meeting of the Charlotte Chamber of Commerce is aimed at encouraging business to embrace another changing dynamic in the U.S. economy — immigration.

As technicians bustle about preparing for the meeting, Tribble plays the film, making a slightly nervous gesture that says “humor me, please.” A music video appears entitled ‘I see,’ featuring ordinary residents of Charlotte, many of them Asian, Hispanic or black.

“This is a major departure for the chamber,” said Tribble, owner of Tribble Creative Group, an event organizing firm. “The cast of this film does not reflect the composition of the audience that will see it.”

What she means is while those in the video are ethnically diverse, the audience will be almost entirely white.

“Charlotte has changed a lot over the past few decades and the people here need not just to be aware of that fact, they should embrace it,” she said. “If we embrace diversity, more people will come and keep our local economy growing.”

Charlotte saw its white, non-Hispanic population decline to 55.3 in 2008 percent from 70 percent in 1990. Its black population edged up to 28.7 percent from 26.3 percent during that period but its Asian population more than doubled to 3.9 percent and Hispanics soared to 10.2 percent from 1.3 percent.

It’s a similar story nationwide. In 1900 one in eight Americans was not white, by 2000 that number was one in four. Census Bureau projections put whites in the minority by 2050.

Immigration has become a hot button issue, especially when it comes to low-skilled Hispanic workers from south of the border. Critics complain these immigrants steal American jobs.

But many people warn against shutting the doors to newcomers, noting that a big part of America’s success has been its ability to attract the highly educated people who can contribute to future U.S. prosperity.

“The last generation of immigrants in has a tendency to want to close the door behind them,” said Swonk. “But if we descend further into populism we risk losing that ability.”

Since the al Qaeda attacks of Sept. 11, 2001, the visa process for foreign students has become tougher, and the system also makes it hard for many to stay after they graduate.

CTS’ Singh in Alabama describes himself as the “poster child” for what America has represented to the world.

Revealing a history he says he has preferred not to divulge over the years, Singh said he came to America in the mid-1980s as a college dropout from India. While flipping burgers for a living, a chance meeting with an academic who interrogated him about the courses he had taken in India led to an invitation to enroll in an MBA course at Georgia College & State University in Milledgeville, Georgia. After his MBA , he did consulting work for some large southern corporations.

“Here I was advising the CEOs of big companies two years after flipping burgers,” Singh said.

“The point being that with an education anything is possible in America.”

He said on recent visits to India he has talked to young, well-educated Indians who feel less inclined to come to America because of visa difficulties, plus growing employment opportunities closer to home as the Indian economy grows.

“America’s two biggest strengths have been its ability to reinvent itself and its ability to attract the best and brightest from around the world,” Singh said. “The moment that stops being the case, it’s over.”

DETERMINATION

There is no doubt the world’s largest economy faces a multitude of challenges. But many are convinced they can be overcome. The feeling among many Americans is that the United States must embrace what needs to be done and move forward.

In Youngstown, U.S. Congressman Tim Ryan believes that thanks to its software incubator and other local businesses, “this area could lead the recovery.”

State representative Bob Hagan — who watched this city stagger and fade as the steel mills left — is also convinced that Youngstown, and America, will emerge stronger.

“We can make a better future for our children,” he said. “But it won’t be quick, it won’t be easy and at times it will be painful.”

“We will get there. But we’re not there yet.”(Editing by Jim Impoco and Claudia Parsons)

Holiday message 2009

2009-12-17T07:49:00.000-08:00

Dear friends, clients and colleagues,

As the first decade of the 21st Century draws to an end, America is in the midst of an economic recession destined to change our economy, fighting two wars and trying to manage at least two rogue nations (Iran and North Korea) seeking to produce nuclear weapons, while coming to grips with universal health care, global warming and a whole host of other adversities. Our social, political and economic fabric is changing radically.

We, as a nation, are facing many challenges – with a large number of Americans facing the challenge of providing for their family – a circumstance we all thought was part of the past – not the present. And, yet, our country was born in adversity….lest we forget:

A week before Christmas '77 Washington's army took up winter quarters at Valley Forge on the west side of the Schuylkill. Although the General's choice of location was sharply criticized, the site he had selected was central and easily defended. Then came a cruel race with time to get huts erected before the soldiers, barefoot and half naked, froze to death. Hundreds of horses did in fact starve to death, and for the army starvation was a mortal danger. "No meat, no meat!" was the constant wail. Improvements came about after Nathanael Greene assumed the duties of Quartermaster General on March 23rd.

Yet, despite the ever-present fear of mutiny, no real disaffection occurred. As Hessian Major Baurmeister conceded, the army was kept from disintegrating by the "spirit of liberty." Men and officers accepted their tragic plight with a sense of humor and extraordinary forbearance, but it was an ordeal that no army could be expected to undergo for long. Nathanael Greene wrote to General Washington, "God grant we may never be brought to such a wretched condition again." - The Spirit of 'Seventy Six*

From the Revolutionary War and the travails of Valley Forge, a new nation was formed as a contract among men which grew to become a leading nation among the nations of the world. And out of the Great Depression where 25% of Americans were unemployed and another 25% were “underemployed” came the Empire State Building, the Hoover Dam, the Chrysler Building, the Golden Gate Bridge, Rockefeller Center, the SEC, FDIC, Ginny Mae, Fannie Mae, Freddie Mac, the 30-year mortgage and Social Security among other significant and revolutionary institutions.

Do not lose heart for we have seen from our past experience that we can, and will, survive this ordeal and we have the opportunity to grow from the experience into better people. It is a tough environment, one which those of us younger than eighty have not experienced first-hand, but we have a collective memory and a strength of spirit to survive – and soon to prosper once again – is unfailing. The question soon will be: What have we created and built as a result of the Great Recession? Will it be Green buildings, less volatile financial markets, alternative energies, universal healthcare, a global spiritual consciousness or all of the above?

My prayer this holiday season is for you and yours to enjoy good health, love, peace and hope – hope for a future without fear for as President Roosevelt said in his first inaugural address: “…the only thing we have to fear is fear itself.”

May God be with you during these times and may you remember that “Happiness lies not in the mere possession of money; it lies in the joy of achievement, in the thrill of creative effort. The joy and moral stimulation of work no longer must be forgotten in the mad chase of evanescent profits. These dark days will be worth all they cost us if they teach us that our true destiny is not to be ministered unto but to minister to ourselves and to our fellow men.” **

As always,

Paul L. Jones, 12/7/09

* Excerpt from: http://americanrevwar.homestead.com/files/VALLEY.HTM** Excerpt from the Inaugural Address of Franklin D. Roosevelt, January 1933

Banks Report CRE Exposure Risky but Manageable

2009-12-03T08:42:00.000-08:00

A new eblast service I receive is from CoStar: It is a WatchList which is a weekly column focusing on distressed market conditions, commercial real estate properties, mortgages and Corporations Published by CoStar News. I highly recommend it...

The following article which was published today shows the disparity in the views of bankers who think their problems are manageable and those of real estate practitioners who believe that they are living with their head in the sand with the depth of the problems for CRE loans. A key part of this article is that banks are reducing their exposure to CRE which means that they are not making any loans to new borrowers anytime soon.....which is contrary to the goals of the bailout our Federal government initiated and explains why things are not getting any better....money is currency and needs to flow for it to grow....but there is always next year, right?

Banks Report CRE Exposure Risky but Manageable
Multifamily Lending Showing Signs of Turning a Corner
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By Mark Heschmeyer
December 2, 2009
For the U.S. banking sector overall, commercial real estate exposure remains a significant risk. But it appears the risk level is becoming generally more manageable -- more so among the largest financial institutions than regional mid-size and smaller banking institutions, according to the Federal Deposit Insurance Corp.

As of Sept. 30, FDIC-insured commercial banks and savings institutions held $1.1 trillion of nonresidential commercial real estate loans and another $216.5 billion in multifamily loans. Of that exposure, approximately $149.3 billion of that had been charged off, was delinquent or the collateral backing the loan turned over to the banks, according to the FDIC.

Overall, the amount of commercial real estate and multifamily loans becoming delinquent has stopped increasing. While they are still much higher than June 2008, nonresidential income-producing property loans becoming delinquent have seemed to hit a plateau.

Noteworthy, too is that multifamily delinquencies have started to decline. Equally encouraging is that banks have also begun disposing of foreclosed-upon multifamily properties. The total volume of such assets has dropped from $1.58 billion three months ago to $1.44 billion. Banks also again increased their lending on multifamily properties in the last three months, marking the second quarter the amount has risen. The total outstanding loan volume on multifamily properties has increased from $210.6 billion at the end of March to $216.5 billion at the end of September - a nearly 3% increase.

However, banks have not shown equal leniency on nonresidential income producing properties. The amount of such properties being foreclosed upon or taken over by banks continues to escalate rapidly - more than doubling in the past year to $5.84 billion.

According to the Federal Reserve's October Senior Loan Officer Opinion Survey on Bank Lending Practices, conditions in the nonresidential construction sector generally remained quite poor. Nonresidential construction and employment continued to decline. Also, bank lending standards and terms tightened on commercial real estate loans because of widespread paydowns and charge-offs. At the same time, demand for new commercial construction as developers are reluctant to begin new projects or purchase existing projects under current poor economic conditions, which include a surplus of office space as firms downsize and vacancies rise.

Nearly all of the nation's 22 largest banks reported to the U.S. Treasury that they were actively reducing their exposure to commercial real estate loans, because they expected delinquencies to persist. The outstanding balance of commercial real estate loans among the 22 banks decreased 1% in September. However, they continued to show a willingness to renew loans to existing customers. Total renewals of commercial real estate accounts increased 18% from August to September.

Fitch Ratings completed a review of commercial real estate exposures across its universe of rated U.S. banks in November. In that review, Fitch estimated that simply taking into account assumed vintages by origination year and average changes in actual and expected values of commercial real estate, this total balance is exposed to a potential impairment of 10%. This level of impairment reflects the amount current loan balances may need to be written down in the future to support an assumed loan-to-value ratio of 75%.

Notably, Fitch said that does not mean it expects banks to report charge-offs in their commercial real estate portfolios of 10%. Rather, the 10% is Fitch's attempt to quantify the problem, which in this case represents the difference in value between current loan balances and the level such loans would need to be adjusted to achieve an underwriting standard of a loan to value of 75%.

A 10% reported loss rate would be a high water mark for this asset class and would exceed the levels of losses reported by the industry in the commercial real estate crisis of the late 1980s and early 1990s. Fitch said it does not believe the magnitude of the problem in today's commercial real estate portfolios exceeds the levels of past crisis levels in aggregate.

Fitch's analysis shows that a relatively small 20% of this impairment, or 2% of total outstanding, is represented by loan balances in excess of assumed collateral values (i.e. loan to value greater than 100%). The remainder of this impairment, which is the majority of the balance, represents loan balances that are protected by collateral values, but at levels that Fitch would view as at risk until meaningful improvements in commercial real estate values become evident.

Importantly, these amounts exclude the roughly $500 billion of construction loans, including residential construction loans, that are subject to even greater risk.

While a 10% impairment would appear manageable even after accounting for the greater risk exposures represented by the construction portfolio, the size, geographic concentrations, and product mix of individual bank portfolios differ materially and need to be evaluated on a case-specific basis, Fitch noted, for example, that none of the four largest U.S.-based banks (assets in excess of $1 trillion) have commercial real estate in excess of 10% of total loans.

Overall, commercial banks and savings institutions insured by the Federal Deposit Insurance Corp. (FDIC) reported aggregate net income of $2.8 billion in the third quarter of 2009, but loan balances declined by the largest percentage since quarterly reporting began in 1984. Quarterly earnings were more than three times the $879 million the industry earned a year earlier and represented an improvement over the industry's $4.3 billion net loss in the second quarter of 2009. More than 26% of all insured institutions reported a net loss in the latest quarter, up slightly from nearly 25% a year earlier.

The number of institutions on the FDIC's unpublished "problem list" rose to its highest level in 16 years. At the end of September, there were 552 insured institutions on the "problem list," up from 416 on June 30. This is the largest number of "problem" institutions since Dec. 31, 1993, when there were 575 institutions on the list. Total assets of "problem" institutions increased during the quarter from $299.8 billion to $345.9 billion, the highest level since the end of 1993, when they totaled $346.2 billion. Fifty institutions failed during the third quarter, bringing the total number of failures in the first nine months of 2009 to 95.

The U.S. thrift industry broke even for the second consecutive quarter in the third quarter of 2009, the Office of Thrift Supervision (OTS) reported. The industry's profit of $1.3 billion for the third quarter was a significant improvement from the losses of 2008 and early 2009. However, $1.1 billion of the third quarter profit resulted from a non-operating gain at one thrift. Without that gain, the industry's net income would have been $200 million - essentially breaking even.

The number of problem thrifts was 43, up from 40 in the previous quarter and 23 one year ago.

Download this story and all of the stories in the Watch List Newsletter here. The Adobe pdf version also includes all of this week’s leads of distressed properties and loans of concern, lease cancellations applied for in bankruptcy proceedings, local and national facility closures & layoffs, banks with distressed real estate portfolios and lists of loans approaching their maturity date. Plus the pdf version contains bonus news items not found in these columns or the CoStar Group web news pages.

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Fed Reserve's TALF Program Backs First New Issue CMBS

2009-11-19T07:15:00.000-08:00

The creation of CMBS 2.0 has not even begun but evidence that demand for the bonds exists was demonstrated this week as Developers Diversified and Goldman Sachs issued the first CMBS deal in over a year - of course it is backed by the TALF program which will have time limits. So, while this transaction brings hope, it is not a evidence that we have developed a panacea for the long-term....much like taking an aspirin to cure a head ache caused by a brain tumor....Below is a description of the transaction as provided by Co-Star on its Watch List eblast.

Developers Diversified, Goldman Sachs Put CMBS Deals Back in Action

By Mark Heschmeyer
November 18, 2009

Town Center Plaza in Leawood, KS, benefited from the first new CMBS deal in more than a yearThe first new-issue commercial mortgage backed securities (CMBS) supported by brick-and-mortar properties in nearly two years successfully sold this week.

DDR Depositor LLC Trust 2009 Commercial Mortgage Pass Through Certificates, series 2009-DDR1 represents the beneficial interests in a trust fund established by affiliates of Developers Diversified Realty Corp. The trust fund will consist primarily of a single promissory note secured by cross-collateralized and cross-defaulted first lien mortgages on 28 of Developers Diversified Realty's properties. Goldman Sachs Commercial Mortgage Capital originated the $400 million loan.

The deal sold at its asking price and saw strong investor demand. The word on the street was that the deal was up to five-times oversubscribed. The capital markets had been looking to this deal as a measure of investors' appetite for risk involving commercial real estate assets and, in some ways, as a sign of the potential strength of the recovery.

As sold, DDR's five-year loan would bear an interest rate of less than 6% after factoring in all fees and expenses. As a result, the strong demand for this deal could prompt other potential borrowers to pursue CMBS financing, according to Opin Partners LLC, an investment house in New York. In fact, DDR is said to have another upcoming securitization, and other REITs are also expected to come to the table including, Fortress Investment Group, which may have as much as $650 million in commercial mortgages to package into a new-issue CMBS eligible for TALF funding.

The Federal Reserve's TALF (Term Asset-Backed Securities Loan Facility) was key to the deal. The Federal Reserve created TALF to help market participants meet the credit needs of households and businesses by supporting the issuance of asset-backed securities collateralized by commercial mortgage loans, auto loans, student loans, credit card loans, equipment loans, floorplan loans, insurance premium finance loans, loans guaranteed by the Small Business Administration, or residential mortgage servicing advances.

Eligible borrowers on the DDR deal can borrow Fed funds for the five-year fixed period at a rate of 3.5427%. TALF funds can only be used for the purchase of AAA-rated class of securities. Of the $400 million DDR deal, Fitch Ratings rated $323.5 million as AAA ($41.5 million was rated AA and $35 million A). The DDR deal is expected to close officially next week at which time, the loans will also be funded.

Some of key ratings drivers cited by Fitch Ratings included:

Loan-to-Value Ratio (62.4%): The Fitch stressed value is $641 million, based on a Fitch weighted average cap rate of 8.7%.

Debt Service Coverage (1.44x): The Fitch-adjusted cash flow for the 28 properties was $55.6 million, approximately 16.% less than the trailing 12 months net operating income.

Strong Tenancy and Mix: A majority of the portfolio is anchored by national or large regional tenants, with Wal-Mart representing the largest tenant exposure at 10.3% of the total square footage and 5.4% of base rent. The top five tenant concentrations, which represent 23.2% of total square footage (and 15.2% of base rent) are all investment-grade rated. Other top tenant concentrations include TJX Cos., Lowes, Home Depot, and Bed Bath & Beyond.

The 10 largest properties backing the deal and their allocated loan amount are listed as follows:

Town Center Plaza, Leawood, KS; 649,696 square feet; $54.3 million; Hamilton Marketplace, Hamilton, NJ; 956,920 sf; $44.4 million; Plaza at Sunset Hills, Sunset Hills, MO; 450,938 sf; $30 million; Brook Highland Plaza, Birmingham, AL; 551,277 sf; $26.4 million; Crossroads Center, Gulfport, MS; 545,820 sf; $26.4 million; Mooresville Consumer Square, Mooresville, NC; 472,182 sf; $19.5 million; Deer Valley Towne Center, Phoenix, AZ; 453,815 sf; $18.9 million; Downtown Short Pump, Richmond, VA; 239,873 sf; $13.4 million; Abernathy Square, Atlanta, GA; 129,771 sf; $13 million; and Wando Crossing, Mt. Pleasant, SC; 325,907 sf; $12.8 million.

Regulating Financial Companies: The House Committee Draft

2009-11-11T03:06:00.000-08:00

This week the US House of Representatives issued its draft legislation on regulating financial companies...which has significant implications for the future of banks, mortgage REITs and CMBS issuers....from Dewey & Le Beouf:

The Discussion Draft (the “Draft”) on financial stability released by the House Financial Services Committee combines many of the proposals originally made by the Obama administration but frequently changes their force or emphasis. In the course of this bill-drafting process, Congress appears to be gradually creating a more general system of financial regulation, changing in potentially fundamental ways the basic orientation of regulation in the United States from one focused on a specific industry or product to one concerned with the effects and importance of financial activities and products in general, regardless of their history or specific characterization. In the Draft, this change manifests itself in the near omnipresence of the defined term “financial company” and its variants and in the generality of the proposed remedies. In certain portions of the Draft, the word “company” alone (without the modifier “financial” and without appearing in the defined form of “financial company”) plays a significant role, at least in circumstances in which the entity being subjected to regulation engages in significant financial activity. To accommodate institutions whose activities might be dramatically affected by an abrupt implementation of more general financial regulation, the Draft also creates an unusual transitional or grandfathering mechanism.

For more, click on the following link:

http://www.deweyleboeuf.com/~/media/Files/clientalerts/2009/20091110_RegulatingFinancialCompanies-TheHouseCommitteeDraft.ashx

FDIC Adopts Guidance on Prudent Commercial Real Estate Loan Workouts

2009-10-30T13:33:00.000-07:00

The much anticipated FDIC guidelines for loan workouts was published today. The key word in their title is "prudent" which is the standard which banks will be held to when doing a workout.

This policy statement stresses that performing loans, including those that have been renewed or restructured on reasonable modified terms, made to creditworthy borrowers will not be subject to adverse classification solely because the value of the underlying collateral declined.

It provides guidance to examiners, and financial institutions that are working with CRE borrowers who are experiencing diminished operating cash flows, depreciated collateral values, or prolonged delays in selling or renting commercial properties. It also recognizes that during these difficult economic circumstances, continued credit availability to businesses, especially small businesses, is challenging, even where borrower performance has been acceptable. This policy statement reflects the appropriate balance of prudent credit practices and meeting legitimate credit needs.

Believe it or not, the Feds recognize that prudent loan workouts are often in the best interest of both financial institutions and borrowers, particularly during difficult economic conditions. This policy statement details risk-management practices for loan workouts that support prudent and pragmatic credit and business decisionmaking within the framework of financial accuracy, transparency, and timely loss recognition. Financial institutions that implement prudent loan workout arrangements after performing comprehensive reviews of borrowers' financial conditions will not be subject to criticism for engaging in these efforts, even if the restructured loans have weaknesses that result in adverse credit classifications.

The policy statement includes examples of CRE loan workouts. The examples, provided for illustrative purposes only, reflect examiners' analytical processes for credit classifications and assessments of institutions' accounting and reporting treatments for restructured loans. The policy statement reiterates existing guidance that examiners are expected to take a balanced approach in assessing institutions' risk-management practices for loan workout activities.

To download a copy of these guidelines, go to: http://www.fdic.gov/news/news/financial/2009/fil09061a1.pdf

Let the mayhem begin

Open Letter to the CMBS Industry

2009-10-20T11:28:00.001-07:00

We are all looking for solutions: Solutions to the economic situation, solutions to the investment equation, solutions to our personal financial condition, solutions to problems we never knew we had.

The loss of jobs together with household wealth and income that has occurred over the past two years has only one precedent in our country’s history: The Great Depression.

The government reaction with regard to the commercial mortgage market has been underwhelming. With over $290 billion of commercial mortgages maturing in 2009 and 2010, the credit crunch is real and is forcing banks, special servicers and insurance companies to extend and amend….pretending that capital will return to the marketplace by the time these loans come due again – as well as the deluge of loan maturities already scheduled to occur over the next three years – which will not happen without the revitalization of the CMBS market.

It is clear that the banks and insurance companies cannot replace the capital lost when the CMBS market collapsed. Everyone in commercial real estate has a vested interest in the creation of a new and improved structure for mortgage-backed securities which uses the tremendous infrastructure that has been developed and provides appropriate safeguards in order to make CMBS attractive to investors, profitable for the participants and practical for the borrower.

Many of our industry organizations like the CMSA, the MBA, the Real Estate Roundtable and others are weighing in on these matters but the bondholders, the B-piece buyers, the servicers (primary, master and special), the rating agencies, the SEC, the IRS and the FASB are all working in a crisis mode – and buried under legacy asset issues….such that it is difficult for them to look into the future without a jaundiced eye.

We all recognize that the mechanisms put in place to prevent a meltdown did not work so we have to start with a clean slate. The following issues all need to be addressed:

Ø Creation of Generally Accepted Rating Principles including standardized underwriting standards and an industry oversight mechanism which could be modeled after the accounting profession;;
Ø A bond structure whereby loan originators and investment banks retain an interest in the bond pool to prevent aggressive and sloppy underwriting and execution;
Ø Imprudent loan structures that do not provide for future cash needs, like leasing reserves, or aggressive underwriting or sizing should result in the need for increased subordination levels over deals that do not provide these protections;
Ø REMIC rules and Pooling and Servicing Agreements need to be written to enable timely portfolio and asset management when loans become troubled.
Ø Bond pools and loan structures need to be simpler whereby conflicts of interest are eliminated;
If we are to resurrect the CMBS market, these issues and many more must be addressed. We need to start a dialogue to bring out the best and brightest ideas to establish a workable structure to revitalize the Commercial Mortgage Backed Securities market. With hundreds of billions of loans maturing in the next five years, this is one of the most critical projects we can execute to provide an exit for the legacy assets on the books today.

I implore our industry organizations and government regulators to start an open dialogue with all industry professionals – through blogs, conferences, meetings and any other way for us to get the great CMBS financial engine running again.

Please let me know your thoughts

Bad boys parts I, 2 and 3....

2009-10-12T11:08:00.000-07:00

The "Bad Boy" carveouts hang over the heads of real estate investors who sunk their life savings into buying properties and using a conduit loan to finance it...If the ownership enity files BK, then the loan becomes recourse to the guarantor which is typically the principal in the investment. So, you either turn over the keys and walk away, or risk the family farm if you try to save your investment through the courts and fail....that is the choice...Well, GGP proves that you cannot tell a book by its cover and each circumstance needs to be evaluated on the facts and circumstances of the specific transaction....Investors have significant equity investments in properties that are suffering cyclical stress....all you have to look at is the increase in value realized from 1991 to 1996 and beyond to know that the current values are just that - current - which means that they are not reflective of tomorrow's value....We know that without liquidity, property values are going to continue to decline - and where that liquidity comes from is yet to be seen - but we all just know that we have to be close to the bottom, we just have to be....The following article raises the issue of the "bad boy" carveouts.... do they work or don't they, it depends....

Mon 12 Oct, 2009, Commercial real estate's bad boys: Agnes T. Crane, a Reuters columnist. The views expressed are her own -

NEW YORK (Reuters) – The bad boys are back, but whatcha gonna do when they come for you? That’s a song investors in commercial real estate shouldn’t have in their heads thanks to “bad boy” provisions built into loan agreements that aim to protect their interests.

Yet, at least two high-profile cases have quashed the idea that investors in commercial real estate debt can rest easy that the collateral backing non-recourse loans won’t get tied up in messy legal proceedings. When financing finally returns to the beaten-down sector, lenders should demand more concrete concessions from borrowers — like more equity and higher interest rates — rather than rely on personal pledges by borrowers to stay out of court.
Like many assumptions cherished during the credit boom — home prices never fall, credit default swaps can cushion the financial system against shocks and securitization helps minimize risk — personal guarantees in the commercial real estate market could turn out to be just as flimsy.

“Bad boy” provisions are intended to protect lenders from the antics of an irresponsible borrower by making someone — usually a principal — personally responsible for the loan. Most loans funded by bond investors and insurance companies are non-recourse, meaning the borrower can walk away without putting his other assets at risk. The guarantees helped lenders sleep better at night since they’re handing over millions, if not billions, of dollars to fund a project, purchase or development.

The types of behavior deemed bad are many, including failing to properly maintain the property, fraud and environmental liability, and of course, bankruptcy.

Lenders hate bankruptcy. They would rather an underwater borrower turn over the keys and foreclose on a property then force creditors into a protracted battle in court. After the savings and loan crisis, lenders started to demand a no-bankruptcy pledge from borrowers in exchange for the non-recourse loan that often carried with it cheaper financing.

The bankruptcy provision, however, doesn’t look so iron-clad anymore.

Take David Lichtenstein and his attempt to dodge a $100 million personal liability he agreed to when buying Extended Stay. Lichtenstein filed for bankruptcy in June, just two years after he bought the hotel chain from Blackstone Group (BX.N: Quote, Profile, Research) for $2 billion. By striking a deal with some of his creditors, Lichtenstein hopes to wiggle out of his bad boy clause.

The bad boy provisions are just one piece of a larger issue of “bankruptcy remote” — that collateral backing the loans and by extension bonds can be sealed off from bankruptcy proceedings.

The bankruptcy of General Growth Properties, one of the nation’s largest REITs, though upended the whole concept of bankruptcy remote — namely that collateral backing commercial real estate loans would be safe from bankruptcy proceedings if it is tucked away in special purpose entity.

There are likely to be other cases as the commercial real estate sector, unlike other areas of the economy, is extremely weak. Not all borrowers will be successful in shirking their personal pledges, and lawyers note that courts have been sticklers in ruling in favor of lenders when it comes to other bad boy guarantees.

But, it could — and should — have a lasting impact on lending terms.

Real Estate Impact Huge Under Accounting Changes

2009-10-01T08:01:00.000-07:00

I first heard about the proposed changes in accounting for leases last spring when the ICSC picked up on the issue from the on-going discussions between FASB who is sets the accounting standards and the International Accounting Standards Board to create a uniform accounting standard around the world. CB Richard Ellis has published a report on the potential impact of the change in accounting. Globe St. published a special report summarizing this study which is below. The full report can be accessed at: http://www.cbre.com/NR/rdonlyres/8D7AEFC0-1154-472A-8521-6323B02AE3A6/777874/FAStalkingCBRE082009.pdf

By Bob Howard GlobeSt.com EXCLUSIVE Last updated: October 1, 2009 10:05am
LOS ANGELES-New accounting standards requiring property to be marked to market and proposed changes in lease accounting rules could have an immense impact on the balance sheets, income statements and overall financial outlook of US corporations, many of whom are unprepared for the changes, according to a new report from CB Richard Ellis.

The white paper by CBRE, titled "FAS Talking--Unpacking Real Estate's Impact on Financial Statements," says that the estimated balance sheet impact of the proposed lease accounting changes alone could be well in excess of $1 trillion for US companies. The report says that the combined effects of mark-to-market and the lease accounting changes hold the potential to negatively impact earnings, capital requirements, debt covenant ratios, credit ratings and other measurements of corporate financial health.

Todd P. Anderson, CBRE senior managing director of global corporate services who co-authored the report along with CFO Michael M. Omiya of Boeing Realty Corp., explains to GlobeSt.com that the changes in accounting standards are "a continuation of the effort to have greater financial transparency, in particular in the financial statements for publicly traded corporations."

The white paper analyzes the potential impacts of both the mark-to-market requirement and the proposed lease accounting changes--which could go into effect as early as 2011 or 2012--and discusses courses that corporations can purse in order to mitigate the effects of the changes. The mark-to-market requirement, known as FAS 157, went into effect for financial assets as of Nov. 15, 2007 and for non-financial assets including real estate as of Nov. 15, 2008.

Anderson explains that one of the problems corporations face in marking down the real estate they own is that when a property is marked down, the write-down not only reduces the asset's value on the balance sheet, it generates a pre-tax loss on the income statement. The issue is further complicated by the difficulty of valuing real estate in a market in which few if any comparable sales are available because so few properties are trading. One of the steps that corporations can take to prepare for the impact of mark-to-market, Anderson says, is to review its properties before the end of the year to determine which ones have the potential to create write-downs.

"In the absence of comparable sales, you have to figure out how to establish a value for your property," Anderson says, and the time for a corporation to do that is before the end of the year when it is busy with so many tax and accounting duties that it will be hard-pressed to complete the tasks on time. "The corporate real estate department, if it understands what's going on in the mark-to-market arena, can come in early and start to take a look at its properties and basically create an argument for why it is valuing properties the way it is," he says.

The CBRE white paper points out that, "If a corporation has the financial wherewithal to carry the property until normalized market conditions return, the argument exists that the company should be able to avoid a distressed sale scenario in which the asset would be valued at a fire sale price."

Regarding the proposed changes in lease accounting, Anderson explains that the new rules would reclassify "operating" leases as "capital" leases, which in turn would require the operating leases to be reflected on corporate balance sheets instead of held off the balance sheet as they are now. Anderson comments on what a far-reaching change this could be: "Many companies can have as much liability for operating leases as they do for all of their other liabilities on their balance sheet, but operating leases today are not on the balance sheet," he says.

Under current practices, the only item that companies record on their income statements regarding operating leases is one year's worth of rent expense. "If you have a 10-year operating lease on a building, you will show nothing on your balance sheet and only one year of rent on your income statement," Anderson points out. He says that the argument in favor of reclassifying these as capital leases--which are reflected on balance sheets--is that operating leases are like bank loans, which are reflected on balance sheets. The argument is that an operating lease, like a loan, is an obligation of the corporation, not just for one year but for the entire duration of the lease. "The regulatory bodies are starting to say that such an obligation is too much of a financial component of a company to not be represented on the financial statements," Anderson observes.

Under the proposed accounting changes, corporations would compute the present value of all of their future lease payments and record them as both assets and liabilities on their balance sheets. "Just doing those two things alone could throw off debt covenants and various financial ratios that could have significant implications for a company's credit rating and other impacts," Anderson says.

The proposed changes would also affect how leases are treated on income statements, producing both depreciation and interest expenses, which would be greatest during the first half of the lease. The upshot is that corporations would take hits on their balance sheets in terms of performance ratios such as return on assets and debt covenant ratios, and they would also take hits on their income statements for the first half of the lease term.

The proposed changes in lease accounting have myriad implications for how companies structure and manage their real estate, Anderson points out. Not every company has the same proportion of owned versus leased properties, so the lease accounting changes would have very little effect on a company that owned the majority of its properties. A competitor that leased the majority of its properties, on the other hand, would suffer significant hits to its financial statements. One answer for such a company would be to execute shorter-term leases, which would show up as lesser obligations on the balance sheet, but the solution isn't always that simple: Not all real estate is suitable for short-term leases because the user may require long-term control of the property, Anderson points out. For properties that a corporation might need for 10 years or longer, it might be more practical to buy rather than lease because of the depreciation advantages of ownership.

Although the new lease accounting rules would not go into effect until 2011 or 2012, corporations should be looking at their real estate now to prepare for the potential impacts of the rules changes, Anderson advises. "Most companies are only beginning to understand these changes," he says.

Anderson notes that the accounting changes address only the user side of leases. "One of the big unknowns is what will this do to the landlord/investor side of the market," he says. Accounting standards boards have yet to tackle that question, so the answer "is truly an unknown right now," Anderson says.

Ratings Agencies May be Held Liable for Fraud for Misleading Ratings

2009-09-29T12:29:00.000-07:00

From NYC attorneys Crowell Mornig comes the news of a precedent setting court decision involving the rating of a privately placed loan portfolio which failed.

The failure of the rating agencies to maintain prudent underwriting standards in support of their CMBS and RBS ratings has been a key contributor to the low-cost of funds resulting from those ratings and the shrinking subordination levels. For the bonds, the rated portions carry a much lower cost of capital than the unrated portions which results in an overall lower cost of capital much like the cheap mortgage and mezzanine financing which funded up to 95% of the purchase or value of commercial properties reduced the cost of capital to a purchaser and facilitated the low cap rate environment we experienced during the 2-3 years prior to the market meltdown. This law suit may (and should) result in a complete restructuring of the rating process as part of the revitalization of the CMBS market. Check it out:

"In a recent decision, the United States District Court for the Southern District of New York, in Abu Dhabi Commercial Bank v. Morgan Stanley & Co. Inc., et al1 denied a motion to dismiss fraud claims brought by certain noteholders against Moody's and Standard & Poors ("Rating Agencies"), in connection with the defendants' ratings of certain mortgage and asset backed securities. Departing from the general rule, the Court rejected the Ratings Agencies assertion that liability based upon their ratings is prohibited under the First Amendment right to free speech.

BackgroundIn Abu Dhabi Commercial, the Ratings Agencies were hired by Morgan Stanley, the arranger and placement agent for the notes (the "Placement Agent"), to rate notes in connection with the issuance of three categories of notes under a structured investment vehicle. These ratings were included with the knowledge and approval of the Ratings Agencies in information memoranda and other documents distributed to specific potential investors, but not disseminated to the general public.

The Ratings Agencies worked directly with Placement Agent to structure the notes in a manner to ensure that they received the highest ratings. As a part of that structure, the Ratings Agencies were responsible for ensuring certain minimum and maximum percentage requirements of rated assets backing the notes were met. These percentage requirements, however, were not met, resulting in riskier notes than the ratings suggested. In particular, the structured investment vehicle failed meet its guaranteed minimum percentages "AAA" and "AA" collateral assets and exceeded its maximum percentage of residential mortgage backed security investments.

Subsequently, the issuer, not being able to service its debt, filed for bankruptcy. As a result, the notes produced little to no recovery for the noteholders.

Court RulingThe Abu Dhabi Commercial Court denied the portion of the Ratings Agencies motion to dismiss the noteholders' fraud claims finding, among other things, that these ratings were not protected speech under the First Amendment. In reaching this result, the Court held:
the First Amendment protects rating agencies, subject to an 'actual malice' exception, from liability arising out of their issuance of ratings and reports because their ratings are considered matters of public concern. However, where a rating agency has disseminated their ratings to a select group of investors rather than to the public at large, the rating agency is not afforded the same protection.2

Here, the lack of wide spread dissemination of the ratings was pivotal in the Court's finding that the First Amendment protections were in applicable.

Conclusion: In short, this decision steps away from the traditional treatment of ratings as protected First Amendment speech and opens a new avenue for noteholders to seek redress for claims such as fraud. As many similar securities offerings are so targeted, this case may have wide reaching repercussions."

For a full copy of this "noteworthy" decision: Go to: http://www.crowell.com/PDF/Abu-Dhabi-Commercial-Bank_v_Morgan-Stanley.pdf

As the Fed sleeps

2009-09-24T02:51:00.000-07:00

Every now and then a columnist has an opinion which is spot-on....this one hits the bulls eye. We need continued action to realize the fruits of our labor....caution does us no good now....there will be time to rest in the future...sooner if we can keep the recovery actions moving now....

By Christopher Swann
NEW YORK (Reuters) – It’s not even October and the Federal Reserve already appears to be going into policy hibernation.
Today’s statement appears intended to attract as little attention as possible. Even the more gradual tailing away of mortgage purchases by the Fed seems calculated to assist the Fed’s quiet retreat.
There will be no further efforts by the Fed to accelerate the pace of growth. Given the grim economic outlook this is a shame. Today’s Fed statement pointed to a pickup in growth, but the Fed’s own economic forecasts still scream out for stronger action.
Even through 2010 unemployment is expected to hover close to 10 percent. Core inflation meanwhile could go below 1 percent in 2011. This is the kind of outlook that would normally prompt the Fed to stamp on the accelerator.
Sadly, the Fed no longer has this option. Ben Bernanke is hemmed in on two fronts.
The first is a political constraint. The doubling of the Fed’s balance sheet during the crisis alarmed many in Congress. As the financial crisis has receded, there seemed less justification for such extraordinary action.
The Fed now badly needs to win back support in Congress. The stakes are high as lawmakers prepare to overhaul the regulatory framework. Not only does the central bank hope to win the new role as systemic regulator, they may need to fight hard to avoid encroachments on their independence by Congress.
They will be particularly keen to prevent oversight by the Government Accountability Office. Such political pressures explain why the Fed’s last significant public announcement was a populist initiative to curb financial sector bonuses.
The second limitation is of their own making. It results from a failure of nerve. The Fed was too quick to sound the retreat on credit easing. Soon after financial conditions started to normalize and fears of depression eased, the Fed indicated that the balance sheet would not expand any more than had already been planned.
This was premature. The Fed could have added another trillion dollars to its holdings without generating inflationary risks or unsettling the markets. By raising the potential ceiling on their asset purchases Fed officials would have given themselves much more room to pursue the goal of full employment.
Now, however, the Fed appears to be locked into its sleepy strategy. To reverse course and expand asset purchases would throw the market into turmoil and undermine Fed credibility. The damage to the Fed’s inflation-fighting credentials could actually push up interest rates — more than offsetting the impact of further credit easing.
Bernanke can claim a good deal of credit for hauling the United States from the brink of disaster. But he swung too swiftly from boldness to caution — putting the Fed on the sidelines. Barring an unexpected downswing, is now powerless to help accelerate recovery and bring down unemployment.

IRS Gives Servicers Flexibility to Modify CMBS Loans

2009-09-16T09:32:00.000-07:00

Important update from Commercial Real Estate Direct Staff Report

The Internal Revenue Service has granted servicers of securitized commercial mortgages greater flexibility to extend those loans and otherwise modify their terms.

Effective Wednesday, servicers can extend and change the interest rates and other payment terms on securitized mortgages more than a year in advance of their maturity dates, if they foresee that the loan will not be paid off at maturity.

The IRS revised a rule that had limited servicers from modifying loans that are performing even though the paralyzed debt markets would make it unlikely for the borrower to get the new financing needed to take out the loan at maturity. Doing so would have caused the trusts that own the loans to lose their real estate investment mortgage conduits, or Remic, status, which exempts their entity-level profits from taxes.

Servicers have not been able to modify performing loans until after determining the borrower would be unable to find new financing or other alternatives to avoid defaulting at maturity.
Under the IRS rule that changes Wednesday, that determination has been difficult to reach in time to grant the extension that could avert default.

In its rule change, the IRS noted, "It may be possible to foresee the risk of foreclosure even when no payment default has yet occurred."

In addition to extending securitized loans more than a year in advance of their maturities, the ruling also allows servicers to change loans' interest rates and amortization schedules, and forgive some of their principal payment. It also sets detailed criteria that servicers must meet in determining that a loan requires modifications.

The Real Estate Roundtable had been lobbying for the change since last year, noting the stalled credit markets has significantly reduced borrowers' access to new financing to take out maturing loans. Extending the maturity of securitized loans was not a major concern while debt markets were free-flowing before 2008.

In addition to the obvious benefit to the CMBS market, the IRS change is also a property-sales issue since the additional flexibility should help servicers avoid being forced to foreclose on loans and ultimately offer the loans or the properties backing them at discounted prices.

"This change removes a significant disincentive for the revision of commercial mortgages," said Sam Chandan, head of the New York research firm Real Estate Econometrics. "By reducing the cost of managing distress in mortgage portfolios, the adjustment has the potential to ameliorate outcomes for legacy CMBS, in particular."

The IRS revision does not address another Remic change sought by special servicers - the ability to originate loans from within existing trusts to facilitate the sale of foreclosed properties that had backed loans that were securitized through those deals.

Comments? E-mail John Covaleski or call him at (215) 504-2860, Ext. 208.

Copyright ©2009 Commercial Real Estate Direct, a service of FM Financial Publishing LLC. All rights reserved.

Stemming the Rising tide of foreclosures plaguing the Middle Class with the Guaranteed Mortgage Assistance Program (gMAP)

2009-09-14T02:44:00.000-07:00

In an email blast regarding my blog, I introduced the following proposed solution to the continuing housing crisis which a friend and colleague, Jud Ireland, and two esteemed colleagues, Michael Intrillgator and Kyle Martin, created. The following article regarding this program was published today in the Huffington Post.....it is truly a solution we all need....please tell the President and your representatives in Congress...GET INVOLVED!

A slogan on the White House website states "A Strong Middle-Class = A Strong America."
Vice President Joe Biden, recently gave a speech at the Brookings Institution on the status of the economic stimulus plan and shared several examples of how the American Reinvestment and Recovery Act is starting to benefit the economy, including middle-class Americans.
We applaud the positive points he addressed. However, the truth remains that millions of middle-class Americans are still on a collision course towards losing their homes. The objectives of this paper are three-fold: 1) to put this problem into perspective, 2) to address why the existing program is not working effectively and 3) to propose a bottom-up solution that could be readily implemented for the benefit of not only middle-class America but also the nation as a whole.
The Scope of the Problem:
Recently many articles have expressed optimism that the recession is ending. While we all want this, foreclosures are still an enormous problem with many adverse secondary repercussions. Unless proactive measures are taken quickly, this problem will escalate. The flood of foreclosure filings continues to rise according to the latest data from RealtyTrac. Les Christie of CNN Money recently reported that between June and July of this year, the number of foreclosure filings rose by 179,599 or 9% in one month alone. This foreclosure rate is up 93% above the rate recorded in July of 2006. Right now there are at least 15 million Americans who are out of work. This number is expected to rise and by the end of the year1.3 million Americans will lose their unemployment benefits and tens of thousands of these are destined to lose their homes unless a more effective program is implemented quickly. Twelve percent of mortgages are now delinquent. RealtyTrac's® July 2009 U.S. Foreclosure Market Report™, indicated that in July 360,149 U.S. properties were in default and received foreclosure filings, default notices, or were scheduled for auction and bank repossession.
This represents an increase of 32 percent from July 2008. The report also shows that one in every 355 U.S. housing units received a foreclosure filing in July. "July marks the third time in the last five months where we've seen a new record set for foreclosure activity," noted James J. Saccacio, chief executive officer of RealtyTrac. The problem is acute and, as Biden's speech revealed, is not getting proper attention from the Obama administration. For example, the payroll tax cuts which Biden referenced do very little to prevent unemployed homeowners from losing their homes as they only benefit those who have jobs. The program we propose benefits unemployed homeowners who are striving to become positive contributors to the nation's GDP.Through June of this year, aggregate wages and salaries are down 4.7%. This problem is compounded because 25% of all homes in the U.S. are now worth less than the mortgages against them. Thus there is often little incentive for homeowners to keep their homes when they are struggling just to make their mortgage payments. Coupling this "upside down" status of homes with the employment situation, it is no wonder that over 844,000 homes were foreclosed on by May 2009. Even though the economy may be starting to show signs of a weak recovery the glut of upside-down properties will put a major drag on this recovery. In quantitative terms, the Conference Board Consumer Confidence Index has been rising: From a low of 23.5 in February 2009 to 47.4 in July and now 54.1 in August. So, although the trend looks like it is moving in the right direction, the reality is that it takes a reading of 90 to indicate that economy is on solid footing. A reading of 100 or more means that the economy is growing. This is prima facie evidence that the U.S. economy is not on solid footing and has a long way to go before returning too normal. So, if we are going to end the recession now, we need to do something different.
Deficiencies with the Existing Housing Recovery ActThe Housing Act does not directly address those who have lost their jobs. For example, a job loss may put the homeowner in even more jeopardy of not qualifying for assistance! The applicant must comply with several conditions. Even then, there is no guarantee the applicant will receive assistance since the program is voluntary and lenders are not required to participate in it. The program's scope is also too narrow. Through the Federal Housing Administration (FHA), an estimated 400,000 borrowers who are in danger of losing their homes will be able to refinance into more affordable government-insured mortgages. This number is by no means acceptable. In California alone, foreclosures scheduled for sale in July rose to 124,874, a 10.4 percent increase from June, and a 93.3 percent increase year-over-year from July 2008. Although the American taxpayers bailed out banks, these banks have not reciprocated in a commensurate manner and have been rejecting too many applications for loan modifications. For example there have been incidents where Aurora Loan Services has rejected requests for home loan modifications from clients who are in need of help due to losing their job, but, have tenaciously continued to make all their payments on time. With the proposal we introduce in this paper, such clients would be guaranteed assistance in making their mortgage payments.
Our Proposed Solution to Stemming the Rising Tide of ForeclosuresIn a Financial Times article, Paul Krugman, the most recent Nobel Prize laureate in economics, candidly stated "Damned if I know," in response to an inquiry per what the most promising short-term investments would be for promoting the recovery. We have an answer to this question, which addresses a major subset of the overall macroeconomic problems. Specifically, in this paper we present a solution to the problem of middle-class Americans losing their homes. The primary objectives of this program are to prevent homeowners from losing their primary residence while simultaneously enabling these homeowners to focus their energies on obtaining new jobs and being productive members of society. If not these homeowners will waste productive energy on the hardships of relocation associated with foreclosure. Further, this program will provide homeowners positive incentives and help shore up the balance sheets of the banks and other financial institutions that are holding the mortgages.
We term this program "The Guaranteed Mortgage Assistance Program" (GMAP). The basic concept for this initiative involves guaranteed loans for making mortgage payments in the form of mortgage vouchers. Here we: 1) articulate the framework for the rapid mass implementation of this initiative, 2) provide an example of how this program could benefit a typical middle-class homeowner, 3) estimate in aggregate how much this program would benefit America as a whole, and 4) propose the recommended next steps towards implementing this program. To date, most of the Federal government's initiatives have been of the "top down" variety, which resulted in billions of dollars being pumped into banks, and insurance companies with the hope there would be trickle-down benefits to the middle-class. But hope is not a strategy! These rather startling initiatives included the unprecedented funding of foreign banks, the relaxing of accounting rules and even the funding of private corporations. However, it was the Cash for Clunkers program which worked the best. In magnitude it was miniscule in comparison to the TARP bailout. Specifically, the $3 billion allocated to the Cash for Clunkers program is only 0.381% of the $787 billion TARP bailout. But Cash for Clunkers put approximately 17,000 people back to work on automotive assembly lines. This program worked because it was bottom-up; that is the investment was focused directly on those who were the beneficiaries. It had the triple-benefit of:
* Saving Americans up to $4,500 per vehicle purchased
* Putting thousands of Americans back to work
* Decreasing Greenhouse gas emissionsAmericans have witnessed that bottom-up programs are a much more effective use of capital than top-down programs. In a manner corollary to Cash for Clunkers, our proposed guaranteed mortgage loan voucher program is a triple-benefit "bottom up" approach which would get right to the core of solving the housing crisis while simultaneously helping the banks and stimulating the economy; but at no long-term cost to the government. We now discuss the program in detail.
The Mortgage Payment Voucher ProgramWe propose a fresh new and innovative solution that hasn't yet been tried. This initiative is aimed at benefiting middle-class taxpayers; who for the purpose of this initiative we define as individuals with personal or family incomes of no more than $250,000 with this number selected based on President Obama's definition of the middle-class during his campaign. These loans will be limited to a) primary residences and b) to a maximum of 10% of the mortgage amount of the home. The bottom-line objective of this program is to enable homeowners to be able to make their mortgage payments without losing their homes. This program would have the secondary benefit of enabling the homeowner to focus on finding another job without the stress and dilution of focus caused by the pending loss of one's home. This program would have the immediate benefit of putting a stop to the majority of primary residence foreclosures.
The basic structure of this program is that the government grants 10-year loans to homeowners to help pay their mortgages in the form of a Guaranteed Mortgage Assistance Program (GMAP). These GMAP loans will be fully repaid because they can be secured in the same fashion as a tax lien, so the program is deficit neutral, and hence at no cost to the government.
In terms of specifics, there are three primary time-staged phases to this program, which would work as follows: Phase 1: After successful completion of an application, the government provides a voucher to the homeowner who in turn transfers the voucher to the bank. The homeowner uses this voucher as an equivalent to dollars, which, together with their payment, makes up the total monthly mortgage payment .
Phase 2: The government reimburses the bank for the amount of the vouchers over an extended period of time.
Phase 3: The homeowner reimburses the government for the loan at the end of 10 years as a balloon payment that could be funded either by the homeowner's accrued savings or by taking out a second mortgage against the property or selling the home.For example, if 10 percent of the homeowners elect to participate In this program (roughly correlates with the unemployment rate) at the program limit of 10% of the outstanding mortgage balance, the program will have an upper limit of $100 billion. This number was computed based on the $10 trillion total outstanding residential mortgages. If the government elects to reimburse the banks at the 5% rate then the upper-limit cost to the government is $50 billion over the course of 10 years, which would be fully collateralized and fully repaid by the homeowners. We envision that this program would immediately begin to increase housing equity for the following reasons: When the government announces this program Americans will see that the end of the housing crisis is in sight. With government now backstopping the fall in prices, a large number of potential buyers on the sideline will jump in, driving up demand and leading to further rising prices.
Benefits of the GMAP ProgramThe banks benefit by converting non-performing loans into performing loans, thus shoring up their books. This will significantly contribute to a further thawing of the credit markets by enabling the banks holding GMAP loans to loan against them (like a Treasury asset) at a reasonable multiple of value, thereby further stimulating the economy with new loans. The banks redeem GMAP funds back to the government at a rate of 5 or 10 percent of the principal value per year. Under the 5 percent per year plan, the government would be required to pay the bank a balloon payment of 50% in the tenth year. This is at the same time the homeowner is paying the government the entire loan amount, at the end of the term. The 100% repayment by the homeowner may require taking out a second mortgage. However, after ten years the equity in the home is likely to increase. Thus we have proposed a solution to stem the rising tide of foreclosures at virtually no cost, which would also significantly contribute to stabilizing the banks.Other bottom-up programs should also be considered by the Obama administration. These include small business loans and an initiative for funding pre-school education. For example, University of Chicago Professor of Economics and 2000 Nobel Prize winner Dr. James Heckman states in his prescient paper The Productivity Argument for Investing in Young Children "Enriched pre-kindergarten programs available to disadvantaged children on a voluntary basis, coupled with home visitation programs, have a strong track record of promoting achievement for disadvantaged children, improving their labor market outcomes and reducing involvement with crime." [http://jenni.uchicago.edu/Invest/FILES/dugger_2004-12-02_dvm.pdf] The details associated with implementing these two other programs are beyond the scope of this paper. However, the authors intend to expand on the details of these programs in future papers. Conclusion:This continuing economic disaster can be dramatically mitigated with the GMAP program that serves as a triple catalyst for increased equity in housing, stronger bank balance sheets, and no increase in government debt. This program is based on providing a little short-term reprieve to struggling homeowners while counting on them to have full accountability by fully reimbursing the government. As we see it, it is now time to adopt the GMAP initiative and other such bottom-up economic solutions to address the recession so as to avoid an economic relapse or a prolonged recession like the "lost Decade" in Japan in the 1990's.
Michael D. Intriligator is Professor of Economics, Political Science, and Public Policy at UCLA; Jud Ireland an investor; and R. Kyle Martin Is an accredited investor and a consultant to institutional investors with a focus on companies in the technology sector.

Fed's Beige Book offers some positive news reads the headline

2009-09-10T12:33:00.000-07:00

The Federal Reserve says it's “cautiously positive” about the economy in its widely watched regular report called the Beige Book.Eleven of the Fed’s 12 regions called economic activity in the area “stable,” “showing sings of stabilization,” or “firmed.”

Analysts said the economy is growing in the third quarter at an annual rate of 3 percent to 4 percent because businesses are spending more.

But the market for homes continues to be weak. In most areas, buyers are first timers and others purchasing the lowest-cost properties. Philadelphia was an exception: Sales there are up even for expensive homes.

In the commercial real estate market, sales were down, and construction was off in all parts of the country.

The Feds are seeing a light when in the depth of the tunnel and think it is daylight...those of us who are living in this environment see the light and know it is someone's candle flickering before going out....In what world can you look at increasing unemployment, significant underemployment a multi-billion dollar commercial mortgage liquidity crisis yet to happen and homes selling for $9,000 (that is not a typo) are things improving?! This is further evidence that the powers that be do not know any more now than they did two years ago when we were told that the sub-prime crisis was contained....in the end, we, the public, will get an education that we will be paying for through taxes for many moons to come....welcome to the 21st century!

US commercial property boom decades away - JLL

2009-09-02T09:15:00.000-07:00

The end of summer is always slow...but in the Summer of '09, that is business as usual. If a recent report by Jones Lang LaSalle (JLL) is correct, our summer of discontent will last long into the next decade. Unless and until we are able to restructure and resurrect or replace the CMBS and RBS investment vehicles, liquidity will not return to the market and we will see continued declines in property pricing and no significant momentum in the market.

As reported today by Reuters, JLL recently issued a report that concluded the "level of U.S. commercialreal estate deals seen in the boom years of 2005 through 2007may take a generation to return."

It comes as no surprise to real estate practitioners that US commercial property sales in the first half of 2009 were down 80% from the same period in 2008 to $16 billion which is a whopping 93% decrease in volume from the $231.4 billion recorded in the first half of 2007 according to JLL's US Mid-Year Capital Markets bulletin. Of course, without momentum and cheap debt, prices are off 30 to 55% from prior periods.

- At just $5.2 billion, the second quarter sales activity was the lowest in recent years and down from $30.7 billion in 2Q08 and $114.7 billion in 2Q07 (an incredible 95% reduction in volume - no wonder appraisers are having trouble finding comps). With no CMBS market to turn to for cheap capital -and prospects for a quick recovery not promising, sales or properties are not expected to be robust anytime soon. Jones Lang LaSalle predicts that U.S. investors will slowlybegin to return to the market by mid-2010, though a return tothe boom years of 2005 through 2007 will take a generation orlonger. Instead of $231 billion a year in deals, U.S. commercialreal estate sales are likely to hover around $100 million onaverage for the first several years of the next decade.

JLL reports that cap rates have moved up a full 2.5 percentage points. Based on where cap rates were, this means that a property generating the same NOI could be worth up to one-third less. My opinion is that with increasing expensive capital being the only source and with the on-going perceived risk in the asset class, cap rates can be expected to increase until the rental market shows sign of recovery.

NOTE: the effects of the recession is being felt in the rental market as well as from the peak of the market to the end of the second quarter 2009, U.S. office asking rents fell on average 10% to 25%. Office leasing is down 25% to 50%.

Given all this, JLL predicts that prices for office buildings are not expected to begin to recover until at least 2012 because commercial real estate performance, which is based on job growth, lags the economy. The retail and lodging markets also will need additional time to recover as they depend on consumer spending and business travel.

This is an important point...demand for real estate lags the demand for the goods and services it houses as firms need to expand and employ to fill up their current space which typically is underutilized in a recession before they lease new space....

Be well and God-speed my friends...

Fed Agencies seek comments on proposed accounting standards

2009-08-27T02:47:00.000-07:00

As previously highlighted, the FASB (Financial Accounting Standards Board) has drafted updated accounting standards affecting how financial institutions account for CMBS transactions. Since these changes will significantly affect regulated institutions, Fed Agencies like the FDIC have proposed modifications and are seeking comments from interested parties. Here is the text of their request for comment and a link to their analysis....

Agencies Seek Comment on Proposed Regulatory Capital Standards Related to Adoption of Statements of Financial Accounting Standards No. 166 and 167

The federal banking and thrift regulatory agencies are seeking comment on a proposed regulatory capital rule related to the Financial Accounting Standards Board's adoption of Statements of Financial Accounting Standards Nos. 166 and 167. Beginning in 2010, these accounting standards will make substantive changes to how banking organizations account for many items, including securitized assets, that are currently excluded from these organizations' balance sheets.

The agencies are issuing the proposal to better align regulatory capital requirements with the actual risks of certain exposures. Banking organizations affected by the new accounting standards generally will be subject to higher minimum regulatory capital requirements. The agencies’ proposal seeks comment and supporting data on whether a phase-in of the increase in regulatory capital requirements is needed. It also seeks comment and supporting data on the features and characteristics of transactions that, although consolidated under the new accounting standards, might merit an alternative capital treatment, as well as on the potential impact of the new accounting standards on lending, provisioning, and other activities.

Comments on all aspects of the proposed rule are due within 30 days after its publication in the Federal Register, which is expected shortly. ###

Attachment: Notice of Proposed Rulemaking Regarding Risk-Based Capital Guidelines; Impact of Modifications to Generally Accepted Accounting Principles; Consolidation of Asset-Backed Commercial Paper Programs; and Other Related Issues - PDF (PDF Help)

FDIC-PR-151-2009

Media Contacts:
Federal Reserve
Barbara Hagenbaugh
(202) 452-2955
OCC
Dean DeBuck
(202) 874-5770
FDIC
Greg Hernandez
(202) 898-6984
OTS
William Ruberry
(202) 906-6677

CRE deleveraging - a preview of coming attractions

2009-08-20T07:57:00.000-07:00

We all know that the prices paid for commercial real estate in the past reflected a premium for the cheap non-recourse debt available at high LTVs....and that the upcoming cycle of maturing and defaulting loans will reflect significant "deleveraging." In article he wrote for CRE Direct.com, a email news service focusing on commercial real estate and structured finance, my friend, Orest Mandzy, its managing editor, used a recent example of a the sale of Hawthorne Works Shopping Center located in Cicero, IL. The property was sold for $30 million to the Sterling Organization. Prudential had recently sold a $36 million mortgage secured by the property which was "performing" at the time it was offered for sale. The estimate is that the loan traded at a 30% to 35% discount from face.....The property purchase was financed in part with a new $19 million mortgage provided by Unum Group.....As Mr. Mandzy observes: " the transaction is a strong example of the deleveraging taking place in the commercial real estate market. The loan that Pru sold had been performing. But it clearly represented a very high level of leverage for the property, part of a former manufacturing facility that was redeveloped into a shopping center in the late 1980s. What had previously supported $36 million of debt now supports only $19 million." OR JUST OVER HALF THE PRIOR PRINCIPAL BALANCE....This is a preview of things to come....

To access the full article, go to:
http://www.crenews.com/index.php?option=com_content&task=view&id=62515&Itemid= or send me an email at pjones@pyramidrealty.com

2009-08-17T06:28:00.000-07:00

From Reuters....Sun 16 Aug, 2009...a view of the week ahead....and possibly the next quarter....

GLOBAL ECONOMY WEEKAHEAD-Cheer the recovery, mind the setback
By Emily Kaiser

WASHINGTON (Reuters) – Japan could very well become the third major developed country to pull out of this global recession and, as happened in Germany and France, it may be investors rather than policymakers cheering the loudest.

Japan’s preliminary look at second-quarter gross domestic product is due on Monday morning Japan time, Sunday in the United States (2350 GMT on Aug 16), and is expected to show the economy grew by 1 percent in the April-to-June period.

That would be the strongest advance in two years, and the first positive reading in five quarters.
Yet the Bank of Japan kept its benchmark interest rate barely above zero last week and cautioned that a recent pickup in demand may fade once government stimulus programs end.
Barclays Capital economist Kyohei Morita thinks Japan’s economy will hit a “temporary soft patch” at the start of 2010, a payback from this year’s stimulus efforts. While they temporarily helped to lift demand for items such as eco-friendly appliances and fuel-efficient cars, they did not boost household income, which means demand will stay subdued.

“Without an improvement in purchasing power, we have to expect a reactionary decline in consumption in the first half of 2010,” he wrote in a note to clients.

It is a similar story in Germany and France where reports last week showed GDP turned positive in the second quarter, sparking stock market rallies around the globe. Yet some government officials warned against getting overly enthusiastic because the economy remained far below pre-crisis levels.

TJ Marta, founder of research firm Marta on the Markets in Scotch Plains, New Jersey, thinks the U.S. economy could also return to growth in the current July-to-September period. But he worries that the recovery is resting almost entirely on government supports, such as the $3 billion “cash for clunkers” program that offers incentives to buy new cars.

“We can get a positive GDP print but that’s just the morphine talking. That’s ‘cash for clunkers’ and stimulus coming through,” he said. “There is still no underlying U.S. consumer to support this economy.”

The concern about sustainable growth helps explain why central bankers don’t seem to share the stock market’s confidence in the economic recovery. The U.S. Federal Reserve said last week the economy was “leveling out” but stopped well short of declaring an end to the recession.

Fed Chairman Ben Bernanke is scheduled to give a speech on Friday at the central bank’s annual economic symposium in Jackson Hole, Wyoming. Judging from the title — “Reflections on a Year of Crisis” — the speech will be largely retrospective, but he will probably offer up at least some sense of where he thinks the economy is headed.

TRADE, BUT WHO IS BUYING?

Disappointing reports on U.S. retail sales and consumer confidence last week added to concern that consumption — which accounts for about 70 percent of the country’s economy — remained quite weak. British retail sales data for July, due on Tuesday, are likely to look lackluster as well.

The message is that consumer spending probably won’t be the driving force behind the recovery.

What will be is unclear. President Barack Obama wants the U.S. economy to be more export-driven, something economists have been advocating for many years.

But in the short term, that poses a problem. Domestic demand is weak in most major economies, including Britain, Germany and Japan, which means many countries are also looking to exports to compensate for poor demand at home.

Obama has told the world not to count on the “voracious” U.S. consumer to propel the global economy, yet there is no obvious choice to replace that demand.

Eurostat trade data on Monday will provide some insight into how Europe’s exporters are coping with weak U.S. demand. Germany, by far Europe’s biggest exporter, got an economic boost from trade last quarter but only because imports fell even faster than exports.

While it is highly unlikely that U.S. consumers will bounce back quickly after losing trillions of dollars in real estate and investment wealth, a pickup in the housing market would certainly go a long way toward repairing household balance sheets and restoring confidence.

A string of reports on the housing sector this week, starting with a survey of home builders on Monday, housing starts on Tuesday, and existing home sales on Friday, will be key for gauging whether the market is on the mend.

Still, a full recovery is probably a long way off. Sal Guatieri, a senior economist with BMO Capital Markets, pointed out that home foreclosures reached new highs in July.

“It goes without saying that until savings, unemployment and foreclosures stop climbing, credit-constrained consumers will retain a bunker mentality,” he said.

“While the Great Recession may be history — thanks to inventory rebuilding, renewed export growth and pulled-forward demand — a not-so-great recovery is likely the offspring.”(Editing by Kenneth Barry).

For all news, data, research and analytics, go to www.reutersrealestate.com

2009-08-12T10:19:00.000-07:00

"Hold the celebrations and put the champagne away. A sustained recovery in the UK commercial property market is likely more distant than it might seem, as lingering economic hazards threaten a long-awaited rebound." That is the warning from Reuters Real Estate writers Sinead Cruise and Daryl Loo as certain economic indicators paint a picture of recovery in the United Kingdom...the one everyone around the Globe are anxious to witness....This warning is true in the US as well - where the spin doctors put the con into consumer confidence. Heed the advices of the experts quoted in this article:

“People need to be wary of getting too carried away with the potential of the upturn, because the problems of refinancing are lurking over the rest of this year and into 2010,” Ed Stansfield, property economist at Capital Economics, said.

Keith Steventon, head of research at BNP Paribas Real Estate UK, told Reuters: “We’ve been here before. We know it takes time. It’s not zeal we want, but patience.”

FYI: The risk of a double dip recession is increasing on the lips of noted economists around the world....Hold onto the bar, we are in for a long, turbulent ride....

For a complete copy of the referenced article, go to http://www.reutersrealestate.com/monitor/story/152922/1368 or contact me at pjones@pyramidrealty.com with the request.

2009-08-10T07:09:00.001-07:00

Last week we had two views of the world appear...first, we had a Deutsche Bank economist predict that the residential real estate market was going to have another, more severe, decline in value while the Feds reported that the unemployment rate fell .01 percent...As my colleague, Steve Felix noted in his weekly On the Road series..."More than not, our colleagues’ feel that another shoe is yet to drop in the commercial real estate industry. With the stock market having had a very good week (although the conversion rate of Canadian to U.S. dollars dropping which is pissing me off) perhaps things are picking up. However, as a taxi driver reminded me this week, “There are still more and more jobs being lost, more and more people losing their homes and more and more people struggling to get by.” So I guess there are two stories in this naked country; those promulgated by the media and our elected officials and those that are the grassroots truth. No one I know is adding to their wardrobe these days, even with ‘sale’ signs as plentiful as weeds in flowerbeds where the gardener has been cut back from every week to every month. This business with the car industry I just don’t know how I feel about it. What makes them so special that they deserve this kind of incentivization just so they can make sales? How about all the other businesses, those owned by individuals (not individuals owning stock but individuals owning and operating the actual business). How about all those businesses closing? Don’t those folks deserve the same help that these characters in Detroit and elsewhere are getting? I just don’t get it. I must be missing something." We do have a dichotomy....and I contend that the unemployment rate is understated are the independent business operators, contractors, brokers and agents who do not qualify for unemployment benefits but are not employed plus those whose benefits have expired and still cannot find a job are no longer considered unemployed.....Talking up the economy may help consumer confidence but when you look at your bank balance and your work in process, it is hard to get encouragement from the statistics and the pundits....what we need is to continue the process of putting a floor to this recession....and the floor is open for ideas.....

2009-08-06T09:05:00.000-07:00

Donald Nicolaisen, former chief accountant of the Securities and Exchange Commission, and Financial Crisis Advisory Group Co-Chairman Harvey Goldschmid are emphasizing the importance of independence in setting accounting standards. A report released by FCAG on July 27 made recommendations on how regulators, accounting standard setters and chief financial officers can help prevent another financial crisis by fixing "weaknesses" in standards. "It seems clear that accounting standards were not a root cause of the financial crisis. At the same time, it is clear that the crisis has exposed weaknesses in accounting standards and their application," the report said....Changes in accounting standards from fair value to recording of CMBS and RBS transactions and the accounting for leases are being proposed as GAAP is being merged with IFRS (International Financial Reporting Standards). While the move toward a global set of standards is past-due, it is important for all real estate industry participants to understand the real-life impact these changes will have on the market and our future. Get informed and let your industry group know so they can advise FASB and IFAC on how these changes affect you...

To read the aforementioned article in its entirety, go to: http://www.cfo.com/article.cfm/14155093/1/c_14156779.

2009-08-04T08:14:00.001-07:00

The FDIC Chair, Sheila Bair, is once again speaking before Congress. Today it is to the Committee on Banking, Housing and Urban Affairs about the strengthining and streamlining of prudential bank supervision. It seems that there is a proposal before the committee to restructure our bank regulatory system under one roof and would include non-bank financial providers (i.e. securitized bond pools). In her testimony, she will conclude that "A single regularot is no panacea for effective supervision" and that a "unified supervisor would undercut the benefits of diversity that are derived from the dual banking system...." Just as the reforms put in place during the New Deal have created the reality we all have known to date, the reforms being proposed will affect our lives for generations to come....YOU NEED TO BE AWARE -inform yourself and act to protect your future....

For a complete copy of the testimony Chairman Bair is giving today, email me @ pjones@pyramidrealty.com or go to http://fdic.gov/news/speeches/chairman/spaug0409.html

2009-08-03T06:58:00.000-07:00

Today, Reuters reported that MIT's real estate index declined 18.1% on increased transaction volume in the 2nd quarter of 2009. The index is down 39% from its mid-2007 peak - and has matched the value decline realized in the 1989-93 real estate recession....This follows last week's GlobeSt. report on the statistics published by RCA in which the headline read "Trillions in Assets on the Hook." As with all cyclical asset purchases, those made at the peak of the market suffer the greatest - and with the leverage used to acquire these assets, that adds significantly to the financial risk.

With this dramatic price decline - and we are not even close to the bottom yet - the wave of commercial mortgage defaults is only a matter of time; however, this time is going to be different from the RTC days. First of all, the securitized loans were predominantly non-recourse loans made to special-purpose, single asset entities - with a "bad boy" recourse carveout that makes the loan recourse to the principals if the borrower voluntarily files bankruptcy. With cash management agreements, it is more difficult for borrowers to accumulate a stash of funds to fight foreclosure. Further, the changes with the bankruptcy law make it a less friendly and more expensive place for borrowers. Consequently, we are going to be in a scenario where lenders will either extend the loan if there is any daylight (equity) at the end of the tunnel or take the property in a friendly foreclosure if there is not....Special servicers are overloaded now, but the tsunami is coming...The only way to minimize it is to re-establish a source for inexpensive refinance capital - and soon. In other words, we need to have investors, special servicers, rating agencies, the Treasury Department, the SEC and other Federal regulators, the Administration and real estate professionals and others work together to create a stucture that works and allows the securitization of commercial mortgages to come alive again....

Please email me at pjones@pyramidrealty.com for a pdf version of the articles mentioned herein.

2009-07-30T06:53:00.000-07:00

The FRB has just published its Beige Book which provides reports from each of the 12 Federal Reserve Districts. The FRB Open Market Committee uses the Beige Book as one of its primary sources of ecnomic analysis for making decisions affecting monetary policy. The reports "suggest that economic activity continued to be weak going into the summer, but most Districts indicated that the pace of decline has moderated since the last report or that activity has begun to stabilize, albeit at a a low level." It also noted that laber markets were extremely soft....and we all know that any recovery has to be built on job growth and job security....so, while the economy may technically be stabilizing and getting ready to turn the corner - most people will not feel the recovery any time soon - and for those of us in commercial real estate which lags the general economy, we are no where near seeing the light at the end of the tunnel....demand for our products needs to return and we have a lot of issues to resolve to bring capital back to refinance our maturing loans...Still, this is good bedtime reading....It is available at: http://www.federalreserve.gov/FOMC/BeigeBook/2009/20090729/fullreport20090729.pdf

2009-07-28T10:36:00.000-07:00

Last Thursday, the Chair of the FDIC, Sheila Bair, testified before the Committee on Banking, Housing and Urban Affairs on "Establishing a Framework for Systemic Risk Regulation." The status of the FDIC in this economic recession and the role it will play in the recovery are key elements to understand when managing a property or portfolio and looking ahead to how the mortgage finance business will be operated. In this speach, Ms. Bair makes the case for significantly expanded authority of a new "Financial Services Oversight Council" and that no entity should be "too large to fail." In contrast with the Administration's penchant for buying time and procrastinating on the true resolution of "toxic" legacy assets, she concludes with"Perhaps the greatest benefit of hte FDIC's process is the quick reallocation of resources. It is a process that can be painful to shareholders, creditors and bank employees, but history has shown that early recognition of losses with closure and sale of non-viable institutions is the fastest path back to economic health." Hear, hear

For full text of the statement of Chair Sheila Bair, go to: http://fdic.gov/news/speeches/chairman/spjuly2309.html