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None of us needs more economic doom and gloom. It's spring. There's a recovery under way (supposedly). Let's move on. Don't tell you what you know (it's still blah out there). Tell you something you don't know. And hopefully, it's good news.
It's not. Not good news. But it's important.
As this is written and for the next 80 days in Tallahassee, special-interest skirmishing is under way — centered in the Senate Banking and Insurance Committee — between bankers and commercial borrowers, the results of which will influence every Florida community's economic recovery; every local government's residential tax rates over the next five years; and Florida's ability now and in the future to attract new capital to create new jobs.
The skirmish is over the mechanics of handling commercial loan defaults, specifically, whether to give borrowers more rights. Which means taking away rights from the lenders.
For bankers, this is the proverbial stacked deck — against them. Except that the Senate president, Jeff Atwater, is a banker, and Sen. Garrett Richter, R-Naples, chairman of the Banking and Insurance Committee, is also a banker.
This should be interesting.
Before attempting to explain the tussle, background is helpful. It will give you a sense of what's really at stake. It's huge.
Here's where it starts: the state of commercial real estate in the United States. There's no need telling you it's teetering, and that's being kind. But if you read through “February Oversight Report: Commercial Real Estate Losses and the Risk to Financial Stability,” published Feb. 10 by the Congressional Oversight Panel, you can't help but gulp.
The 140-page report contains such sanguine messages as:
• “Overall, the general economic downturn, uncertainty about the pace of any recovery, and low expectations for improving commercial real estate market fundamentals mean that prospects for a commercial real estate recovery in the near future are dim.”
• “For financial institutions, the ultimate impact of the commercial real estate whole loan problem will fall disproportionately on smaller regional and community banks that have higher concentrations of, and exposure to, such loans than larger national or money center banks.”
• “The withdrawal of small business loans because of a disproportionate exposure to commercial real estate capital creates a 'negative feedback loop' that suppresses economic recovery: fewer loans to small businesses hamper employment growth, which could prolong commercial real estate problems by contributing to higher vacancy rates and lower cash flows. This loop has a considerable impact on the overall economy, considering that small businesses have accounted for around 45% percent of net job losses in this recession (through 2008) and have contributed to around one-third of net job growth in the past two economic expansions.”
• “We expect the commercial real estate debt market to show minimal net growth during the next decade,” so said Matthew Anderson and Susan Persin in a report, “Commercial Mortgage Outlook: Growing Pains in Mortgage Maturities.”
• “The largest commercial real estate loan losses are projected for 2011 and beyond.”
As the accompanying table shows, Florida is one of the four largest markets in the nation for commercial real-estate loans. If you thought the residential meltdown was bad, we still have a long way to go.
Now here's where Tallahassee comes in. What happens there will determine to some extent how far down commercial values will fall; how much local governments will have to raise millage rates; and how many investors will lose their personal net worths. Here's why:
Florida banks, many of them the independent banks with less than $1 billion in assets, as well as the multistate regional banks, money-center banks and insurance companies are holding deteriorating commercial real estate mortgages on retail centers, apartment complexes, office buildings, flex centers and warehouses. As with residential loans, many of these loans are “under water” — the borrowers owe more than the properties are worth and the conditions are deteriorating.
This triggers the usual challenges for the bankers and owners: what to do? Foreclose? Try for a workout? Sell the loans at big discounts to vulture funds?
One option that apparently is becoming increasingly common is for the banks to start with recovering any deficiencies by initiating proceedings first against the personal guarantors.
This is instead of what most borrowers would expect: That the bank would try to work out new terms or first foreclose on the property and sell it and then go after the personal guarantor at the end to make up any deficiencies.
One effect of this practice can create an unstoppable downward spiral in the value of commercial real estate. Say, for instance, a vulture-hedge fund agrees to buy large blocks of under water commercial mortgage-backed securities from Citicorp for 30 cents on the dollar. As the new owner of the mortgage, the hedge fund can initiate default proceedings against the personal guarantor. And if he wins a judgment, entitling the hedge fund to the guarantor's assets and cash, the hedge fund can recover its acquisition costs and become the owner of a commercial building at a much lower basis than many other commercial owners whose buildings have not defaulted.
But that is not so swell. The hedge fund, if it decides to keep the building and operate it, can now charge lease rates at half the price or less than the rates of his neighbors. This in turn will draw tenants out of buildings that heretofore were OK, now causing values and incomes to fall at the buildings that previously were healthy.
You get the picture. The effect of continuously falling lease and occupancy rates cascades into the public arena, lowering property-tax collections for cities, counties and schools and forcing these entities either to raise rates or cut more services.
At the same time, as the banks and hedge funds wiped out the personal wealth of the guarantors, they will have shrunk Florida's entrepreneurial and investment capital, further dampening economic recovery.
Made aware of this scenario, some of the state's leading legislators have been asked to include an amendment in a pending foreclosure bill that could prohibit lenders from going after the personal guarantors first for loan deficiencies. California, Nevada and some of the other Ground Zero foreclosure states already have “one-action rules” doing just that.
Proponents of this — not surprisingly, commercial borrowers — say it would help stabilize the commercial market. Bankers, predictably, don't see it as such a great idea.
The outcome is going to be worth billions.
To see the "Distressed Data," download the file here.DistressedData.pdf
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