CrunchedCredit : Capital Markets Finance and Real Estate Attorneys

Community banks – long touted as the “next domino to fall” during this late unpleasantness – were expected to be a significant source of distressed assets for savvy investors.  However, many are finding the FDIC Structured Loan Sale Program a long and bumpy road for investment.

Historically, the FDIC operated to separate the wheat (failed banks’ desirable, high-quality assets (i.e. depository bases)) from the chaff (the bad – sometimes very, very bad – loan assets that caused the failure in the first place).  Two decades ago, The Resolution Trust Corporation (RTC) found homes for over $400 billion of assets during the savings-and-loan crisis. This time around, however, the FDIC – holding in excess of $600 billion in distressed assets seized from failed banks – is steering away from outright bad asset sales to thresh out the chaff, opting instead for a policy designed to force would be bank buyers to take the bad with the good.

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Notwithstanding our optimism, it appears that there was not enough support from the Senate side of the reconciliation committee to include the proposed covered bond amendment in the final financial reform bill approved by the reconciliation committee.  However, the support received by the House and some members of the Senate committee indicates that covered bond legislation may, nonetheless, find passage in the near future.

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Earlier this week, Representative Scott Garrett (R-NJ) introduced an amendment to the proposed financial reform legislation that will establish a regulatory framework for a covered bond market in the United States.  The House side of the reconciliation committee quickly passed the measure - the Senate side is now considering it.  This development is welcomed news to a banking industry that has craved a covered bond market for some time now.  For our part, we've been examining covered bond structures since the advent of the credit crises as our clients continued to try to devise a workable structure, so we're very excited by this development. 

Covered bonds, which have been part of the European financing vernacular for over 200 years, function as a cross between an unsecured corporate bond and an asset-backed security.  Typically, a financial institution will issue a direct-recourse bond which is also secured by a specified pool of assets that remain on the financial institution's balance sheet.  These are attractive to investors for many reasons, most important of which is that the investor has recourse to a specified pool of assets in the event the financial institution becomes insolvent, unlike typical unsecured corporate bonds that depend solely on the issuer's credit.

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The Senate reconvened reconciliation hearings at noon today with a deal brokered yesterday to place the new financial watchdog agency within the auspices of the Federal Reserve, rather than establishing an independent agency.  This compromise by Congressional Democrats - which is engendering strong opposition from some important constituencies - could indicate a growing desperation to get something (anything, anything at all) in front of the President before his appearance at the G-20 this weekend.  As someone who spends a good piece of my week (and some weekends) reading and writing documents that are intended to build a legal framework around unforeseeable real-word events, I can appreciate the utter impossibility of crafting legislation that will simply get it right the first time.  I’ve learned this too many times:  As complexities increase, the better can become the enemy of the good. 

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According to the Boston Globe, the owners of Boston's signature office building - the John Hancock Tower - have begun marketing a significant stake in the building.  Many will remember that the Hancock Tower represented one of the Great Recession’s first large-scale mezzanine foreclosures, falling in late 2008/early 2009 when a joint venture comprised of Normandy Real Estate and Five Mile Capital acquired the building via mezzanine foreclosure.  As other industry players were “extending and pretending”, the team from Normandy/Five Mile did their homework, called the borrower’s bluff and bought themselves a building.  And now it looks like it may be paying off.

By accurately predicting the building's value and strategically purchasing mezzanine debt at the rights levels, the joint venture was able to seize control of the mezzanine stack and force foreclosure.  The master stroke - using mezzanine controlling holder rights to de-lever a bloated (and hugely complicated) mezzanine capital stack, while keeping attractively low-priced mortgage debt in place – serves as a brilliant example of sophisticated distressed-debt investing in CMBS structures and a primer on how to fight and win “Tranche Warfare”.
 

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FASB wants to expand Fair Value to other financial assets.  That bears repeating:  FASB has published an Exposure Draft that would extend the dubious joys of fair value accounting to ALL financial assets.  I so wish I was making this up.  On May 26, 2010, FASB published this missive. Fair Value seems to hold a religious (that's born again, not Presbyterian) fascination for the academic accounting community, which seems astonishingly indifferent to the horrifying role the viciously pro-cyclical fair value process played in the late “Great Recession.”  Isn’t the definition of insanity doing something a second time and expecting a different outcome?  What are we doing here?

The proposed new rules would require all financial assets, with very few exceptions, to be subject to a mark to market  requirement.  Banks and other financial institutions would be obliged to mark all loans whether held for sale (which makes some sense) or held to maturity.  For loans, the mark would hit Other Consolidated Income (OCI) and put equity on the Fair Value roller coaster.

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Do you have any idea how often each of the House and Senate reform bills proposes to solve an intractably complex problem by simply asking the regulators to come up with rules?  I don’t, but I found at least 20.  Now it all goes to reconciliation, and my suspicion is that that number will not go down and may, indeed, go up when our duly elected representatives throw up their hands, declare victory and make someone else figure it out.  Now, Congress asking our regulators to create rules to implement policy is nothing new, and there’s nothing wrong with it, if used sparingly.  But this is wholesale delegation of hugely important stuff.

Without clarity around the rules of the game, business will not thrive.  I keep coming back to this notion.  I run a business, and I need to figure out how financial markets will function coming out of the late unpleasantness.  It’s hard enough, but when the rules keep changing, it’s worse.

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We’ve been promised that the House and Senate financial reform bills will be reconciled in a highly transparent and thoughtful way and be wrapped up and ready for the President’s signature by Independence Day.

I’m trying to be upbeat about this.  There are, after all, substantial benefits to be obtained from certainty, and once this is done, we’ll at least have rules.  We may not like them, but at least we’ll have rules. (OK, the final Bill will probably include dozens of referrals to the regulatory community to make the actual rules, but nothing’s perfect.).  God only knows what to expect when our duly elected representatives, awash in populist outrage and with the clock ticking loudly down to election day, try their hands at making sense of these two ridiculously complicated 1,400 page bills.  Barney Frank will manage the reconciliation process.  Imagine, he has now been imbued with the hopes of the financial services community for a sensical and balanced Bill.  Man bites dog.  You can’t make this stuff up. 

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I write from CREFC’s annual do with my 800 or so best friends.  We are trying to party like it’s not 2009, and you know, we’re getting there.  The government’s still playing pin the tail on the regulatory donkey, Europe’s a mess, housing and employment are not ready for prime time, and the banking system hangover goes on.  Yet…JPM got a deal done, the bonds cleared, and pricing was… well, it’s been reported that they made a few bucks.

The CREFC convention kick off is the Monday night parties, of which yours truly was a host of the annual Dechert dinner.  Note I said parties with an “s”.  We’ve had a banker party drought these past few years. I see the return of the Street parties as a leading indicator of CMBS 2.0.  We cannot wish 2.0 into existence, but let’s face it:  A robust appetite for anything to invest in with yield measured in percentage points not basis points plus good vibes can a market revive.
 

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This article was published by Matthew T. Clark and Stewart McQueen.

For 150 attendees, Day 1 of the 2010 CREFC Annual Convention ended with dinner hosted by Dechert at Shelly's Trattoria in Midtown.  We thought the turnout was exceptional, and it was great to be able to socialize and dine with so many of our clients and friends.

The sessions continued this morning.  The Investment-Grade Bondholders Forum included a spirited debate about best practices for a CMBS restart, including risk retention and streamlined information flow.  Another panel, entitled Color of Money: Raising Capital in the Current Environment - Challenges and Opportunities, was very well attended as panelists discussed the hurdles to successful fund raising in this market. 
 

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This article was published by Matthew T. Clark and Stewart McQueen.

The 2010 CREFC Annual Convention has begun in earnest.  Day 1 began for many attendees with a meeting of the Securities and Loan Investors Forum.  This meeting included a lengthy discussion of the Fair Value Purchase Option and a perceived conflict of interest existing when the special servicer holds the securitization's B Piece.  A short break was followed by a lunchtime address from Congressman Scott Garrett (R - NJ), who was vocal in his critique of the current drafts of Financial Reform Legislation that is presently the subject of Congressional reconciliation. We just left the Servicers Forum, which was led by Forum Chair Daniel Bober from Wells Fargo. The Forum is currently working to identify the lessons learned from the past 36 months and to suggest industry-wide changes as we re-imagine CMBS 2.0.  The panel discussed common document deficiencies, issues relating to decision making authority under pooling and servicing agreements and investor frustration.  Next on the agenda is the Opening General Session on CRE Fundamentals, including an overview of the current state of the CRE market and a look toward the second half of 2010.

Depicted in the photo are Dechert attorneys/ bloggers Matthew T. Clark (left) and Stewart McQueen (right) with Larry Kligman from Ventras Capital Advisors LLC

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Last Friday I moderated a panel at the 11^th Annual IMN Real Estate Opportunity and Private Investment Forum in New York.  The two-day event consisted of about 40 separate concurrent panels and drew over 800 industry participants.  The topics covered revolved around distressed debt investing – loan workouts, exit strategies, tranche warfare and distressed asset sales. 

My panel's topic was “Loan -To-Own” strategies.  Our conversation began with the panelists discussing the common characteristics of successful loan-to-own transactions.  The common areas of focus included the importance of stringent property-level due diligence, exacting legal due diligence with respect to loan documents, a realistic understanding of foreclosure processes and timeframes, accurate modeling of acquisition and stabilization costs, and the importance of the local expertise that can be gained from local developers and operators.

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We’re looking forward to the 2010 June Convention of the Commercial Real Estate Finance Council (formerly the Commercial Mortgage Securities Association) next week at the Waldorf-Astoria in New York City.  From June 14th to 16th, over 700 lenders, borrowers, investors, fund managers, servicers, attorneys, and other industry participants will gather to discuss current topics in commercial real estate finance.  This year’s hot topics will include sourcing new capital, the ongoing role of government agencies and their effect on the marketplace, the re-emergence of securitization (CMBS 2.0) and whole loan markets and on-going opportunities for distressed-asset investment.  Thirteen Dechert FRE attorneys will be in attendance to participate, learn, and meet with our friends and clients.  We will be posting live updates on CrunchedCredit from the event.

Featured blogger Rick Jones will chair the CRE Finance Council PAC Advisory Committee meeting at 9:30am on Monday, June 14th. The PAC Advisory Committee is an essential part of the CRE Finance Council’s mission to promote the ongoing strength, liquidity and viability of the commercial real estate finance markets. Stay tuned for highlights from this and other forums!
 

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There's a headline to grab attention. It’s been reported that several Chinese and other non-domestic and non-traditional lenders are rushing across the American landscape looking for deals. Take a look at the WSJ article of June 2 about the International & Commercial Bank of China’s recent loan to GE. ICBC has over a trillion dollars of assets, it’s reported to be the most profitable bank in the world and it’s ready to lend. Maybe this is just a “no duh” moment, but what a terrific business strategy for any lender not damaged by the late unpleasantness (a Southern expression still in use about the Civil War but appropriate here)! If the gnomes of Basal get their way and require US and European banks to put up massive capital over the next couple of years, strong, unimpaired semi-sovereign banks may be the best ticket in town.

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