By Jim Freer
This year, reality is sinking in at many community banks that have high ratios of noncurrent land development and other real estate loans.
"They realize," said Kingsley Greenland, chief executive officer of the Boston loan-sale adviser DebtX, "that the values, not just of the loans but of the collateral, are not going to come back any time soon."
Thus, many such banks are looking to sell some of these loans — a change from their previous strategy of continuing to restructure weak credits while trying to delay writedowns.
Some are turning to advisers like DebtX that market bank loans to institutional investors.
Others are speeding up their real-estate-owned sales, provided the discounts are not too steep on undeveloped land and stalled housing tracts. Their goal is to sell properties this year rather than incur tax liabilities and other costs as they wait for a housing market rebound.
The $7 billion-asset United Community Banks Inc. in Blairsville, Ga., began that strategy last year because "we cannot predict when prices will start reversing," said David Shearrow, executive vice president and chief risk officer.
Some bankers and advisers expect a new round of banks' and their holding companies' setting up "bad bank" subsidiaries to hold noncurrent loans and REOs.
One example is BankAtlantic in Fort Lauderdale, Fla., which in March transferred $101.5 million of noncurrent loans to a newly formed asset workout subsidiary of the $6 billion-asset parent, BankAtlantic Bancorp.
Almost all the loans were so-called land bank loans to Florida residential developers whose builder clients did not carry out deals to buy lots after the housing market began to soften in late 2006.
Alan Levan, the chairman of BankAtlantic and its holding company, said using an entity that is not part of the bank adds flexibility for timing loan sales. The subsidiary could become a joint venture partner in some developments after the housing market begins to rebound, he said.
Meanwhile, some banks are turning to traditional-style auctions, complete with bidding and the hammer falling, to unload housing construction loans and undeveloped properties.
J. Durham & Associates in Albany, Ga., is to hold the first in a series of Atlanta-area auctions of bank-owned commercial real estate properties and undeveloped land in late June.
Many publicly traded banks are among those that have decided to sell loans and REOs quickly — rather than face the prospect that prices may still be falling late this year and into 2009.
Analysts and investors "are comparing these banks to their peer groups and asking, 'How are you managing your nonperforming assets and REOs?'," Mr. Greenland said. "A way to stay ahead is to not wait to foreclose but to sell the loan before it gets to foreclosure and mitigate your losses."
A growing number of banks are taking a "pay now rather than pay later" approach to selling loans and accepting discounts, said Christopher Marinac, the director of research at the Atlanta investment bank FIG Partners.
DebtX, which also sells nonproblem loans to institutional investors, sold loans for about 100 banks last year.
That total could double this year, Mr. Greenland said.
Cowlitz Bancorp. in Long-view, Wash., with about $500 million of assets, has been selling real estate and commercial loans through DebtX since 2003.
Its latest DebtX sale was an acquisition and development loan to a developer near Portland, Ore., for which it received "just under 50 cents on the dollar," said Cowlitz president and CEO Richard Fitzpatrick.
The single-family home project stalled because several builders had backed out of contracts to buy lots.
Cowlitz might have spent three to five years trying to sell the project if it had taken it through foreclosure, Mr. Fitzpatrick said.
"We sold, received some cash, and moved on," he said.
Still, in sales before this year, including some of nondistressed loans, Cowlitz had gotten "north of 85 cents on the dollar" on some DebtX sales.
This year, Cowlitz took possession of another home building project near Portland that it is marketing itself — again willing to accept a discount rather than absorb several years' holding costs.
Some banks with problem loans and their borrowers are turning to private lenders, such as Forman Capital in Delray Beach, Fla.
Forman Capital's lending in Florida and other states has been on nondistressed commercial properties.
Now, with the number of noncurrent bank loans growing, CEO Brett Forman said his company will consider buying distressed housing development loans. Mr. Forman and other private lenders have more flexibility than banks in structuring loans, including those for distressed debt.
Data from the Federal Deposit Insurance Corp. show the market for distressed bank real estate debt has grown.
From Dec. 31, 2006, and Dec. 31, 2007, the industry's noncurrent ratio for all real estate loans grew from 0.80% to 1.71%. The noncurrent rate on construction and development loans soared from 0.71% to 3.15% during those 12 months.
Among banks with assets of $1 billion to $10 billion, the noncurrent ratio for all real estate loans rose from 0.67% to 1.53%, and from 0.76% to 3.05% on construction and development loans.
The FDIC had not released its first-quarter industry data by press time, but if earnings reports of publicly traded banks are an indication, the numbers are likely to get worse. Many community banks' quarterly earnings included significant increases in noncurrent loans to home builders.
United Community Banks reported that its ratio of nonperforming assets to total assets rose from 0.56% at the end of last year to 1.07% at March 31. Its noncurrent loans and REOs are primarily for housing construction in the Atlanta market.
United has been able to sell REOs aggressively because it exceeds all measures required for being considered well-capitalized, Mr. Shearrow said.
Writedowns have ranged from "0 to 20%" on sales of completed projects and "anywhere from 15 and 20 to 50%" on lots and undeveloped land, he said. Buyers usually are local developers and individuals, he added.
United uses its own staff to find buyers and tries to get properties off its books within 90 days of foreclosure. It prefers to foreclose and sell properties rather than try to sell problem loans before they reach foreclosure. In addition to being behind on loan payments, housing developers often are owed money by subcontractors and have liens, Mr. Shearrow said.
Setting up a subsidiary for problem loans is another strategy that requires a bank to exceed well-capitalized levels, said BankAtlantic's Mr. Levan.
The bank and its holding company satisfy the requirement. The holding company added to its capital in March by selling 2.1 million shares of Stifel Financial Corp. for $82.2 million and used much of the proceeds to buy loans from the bank.
"As opposed to being concerned about capital at the bank level, we can be more creative in working with borrowers and in completing foreclosures as the case may be," Mr. Levan said.
Steven Fritts, the FDIC's associate director for risk management policy, said the agency is not hearing much about banks setting up "bad bank" affiliates. Still, he said, "It can make sense to isolate those assets. It allows loan officers to focus on developing new business."
State laws on corporations and Federal Reserve and Office of Thrift Supervision rules on holding companies are what Mr. Fritts calls the "dominant legal drivers" for setting up such subsidiaries.
Taking foreclosed properties to auction is an alternative to managing them in a bad bank setup.
The Martin Realty Advisors in Alpharetta, Ga., and joint venture partner J. Durham & Associates have recently been advising several banks in southeastern states about auctions. "This is at an early stage," said Joe Durham, the president of J. Durham Associates. "We will start seeing more banks realize that they need to sell now because the markets are not getting better."
Mr. Durham said the first auction featuring bank assets will include undeveloped land, stalled condominium projects along the Florida Panhandle coastline, and stalled single-family projects around the Southeast.
Those kinds of properties are prominent as collateral for loans that DebtX sells in an online bidding process to more than 3,500 institutional investors. Mr. Greenland said he anticipates vacancies rising at numerous "marginal shopping centers," and that loans on retail properties could be the next to falter.
DebtX's business includes a five-year agreement with the FDIC, signed last year, to sell real estate assets that are in receiverships.
Thursday, May 29, 2008
Friday, May 16, 2008
ON THE PATH TO BECOME A PRIVATE ANNUITY TRUST
COUNSELING CLIENTS
What strategies can planners suggest for clients who already own multiple homes in overvalued markets? If the bubble has not deflated in your area, you might counsel clients to sell their second homes if they want to get top dollar.
"We have a client who just sold a vacation home and an adjoining lot in Tahoe," says Stone, referring to the area around the lake that spans the California-Nevada border. "He wasn't using it enough to keep it, and he got a good price: $1.2 million." The price was so good, in fact, that the client would have had an $800,000 gain and a steep tax bill. "To defer the tax, we suggested this client sell the property to a private annuity trust," Stone says.
In this arrangement, the real estate is sold to a trust, which in turn makes a sale to a third party. The trust then reinvests the proceeds and pays lifetime income to the original owners as well as any balance to designated heirs. This way the client can defer income tax on the sale, effectively provide the heirs with a basis step-up and remove any funds left in the trust from the seller's taxable estate. But there are potential gift tax consequences, depending on the seller's age and the cash flow paid by the trust (see "Going Private," below).
Another tax-effective move is for clients to sell their primary residence and move into what had been a second home. The $250,000 home-sale exclusion ($500,000 for married couples) would shelter gains from the sale as long as the seller had lived in the house for at least two of the previous five years. If the clients decide to sell the former vacation home after living in it for two years, they would qualify for another $250,000 or $500,000 tax break.
"A married couple I represent did this recently, moving from the San Francisco Bay area to Tahoe," says Jane Williams, chief executive officer of Sand Hill Advisors, a wealth management firm in Palo Alto, Calif. "They sold their primary residence and moved into their vacation home." Williams works with many people who are experiencing a major life transition, such as a divorce or the death of a spouse. "The family home, which is often a major asset, can be an expense rather than an income-generator," she says. "For people with more real estate than they can maintain, we encourage downsizing."
What strategies can planners suggest for clients who already own multiple homes in overvalued markets? If the bubble has not deflated in your area, you might counsel clients to sell their second homes if they want to get top dollar.
"We have a client who just sold a vacation home and an adjoining lot in Tahoe," says Stone, referring to the area around the lake that spans the California-Nevada border. "He wasn't using it enough to keep it, and he got a good price: $1.2 million." The price was so good, in fact, that the client would have had an $800,000 gain and a steep tax bill. "To defer the tax, we suggested this client sell the property to a private annuity trust," Stone says.
In this arrangement, the real estate is sold to a trust, which in turn makes a sale to a third party. The trust then reinvests the proceeds and pays lifetime income to the original owners as well as any balance to designated heirs. This way the client can defer income tax on the sale, effectively provide the heirs with a basis step-up and remove any funds left in the trust from the seller's taxable estate. But there are potential gift tax consequences, depending on the seller's age and the cash flow paid by the trust (see "Going Private," below).
Another tax-effective move is for clients to sell their primary residence and move into what had been a second home. The $250,000 home-sale exclusion ($500,000 for married couples) would shelter gains from the sale as long as the seller had lived in the house for at least two of the previous five years. If the clients decide to sell the former vacation home after living in it for two years, they would qualify for another $250,000 or $500,000 tax break.
"A married couple I represent did this recently, moving from the San Francisco Bay area to Tahoe," says Jane Williams, chief executive officer of Sand Hill Advisors, a wealth management firm in Palo Alto, Calif. "They sold their primary residence and moved into their vacation home." Williams works with many people who are experiencing a major life transition, such as a divorce or the death of a spouse. "The family home, which is often a major asset, can be an expense rather than an income-generator," she says. "For people with more real estate than they can maintain, we encourage downsizing."
Tuesday, May 06, 2008
Inflation first aid: Gold, oil and real estate
Inflation first aid: Gold, oil and real estate
By ROB CARRICK Globe and Mail Update
The arch-enemy of all investors is threatening a comeback after a long time away.
Inflation hasn't been a top-of-mind consideration for investors since the early 1990s, and today it's hardly noticeable. But there's growing concern that soaring prices for oil and food products are within the next year or so going to push the inflation rate higher than we've seen it in years.
This edition of the Portfolio Strategy column is all about inflation-proofing your portfolio, which is more problematic than you may think. Some investors automatically look to real-return bonds if inflation's a threat, but there are good reasons to avoid them. Gold and commodities are classic inflation defences, but neither is any sort of a bargain right now.
The first thing you need to understand about inflation is that it's a global phenomenon, even if the cost of living here in Canada in March was just 1.4 per cent ahead of where it was a year earlier. The inflation rate in the United States in March was 4 per cent, and other regions are comparable or worse.
“In Europe, inflation is running over 3 per cent, and in the emerging markets it's on fire,” said Alec Young, an equity market strategist with Standard & Poor's in New York. “In Russia, you've got 12 per cent and you've got 8 per cent in China. It's accelerating.”
Expect the usual carnage if inflation flares up here. The bond market will be hammered as interest rates rise, and the stock markets will struggle. The trouble for stocks arises from the fact that inflation makes investors more conservative about what they're willing to pay for a company's shares. Price-earnings ratios tend to fall, and that means lower share prices.
The market sectors that buck this trend are the ones that are based on gold and commodities such as oil and gas, metals and fertilizer. The psychology here is that commodities are hard assets that hold their value when prices are rising.
When the inflation rate surged into double digits in the 1970s, commodities were the place to be. The problem with commodities today is that they've already experienced a gigantic runup in price. In fact, rising oil and fertilizer prices are key reasons why inflation is globally on the rise. The price of crude oil, for example, has jumped about 75 per cent in the past year to its current range of around $116.
“Traditional inflation hedges don't look like attractive bargains right now, so the past may not be prologue this time around,” Christopher Davis, an analyst with the Chicago-based research firm Morningstar, wrote in a commentary this week.
Mr. Davis suggested a dollar-cost-averaging approach for getting into commodities, where you make small, regular purchases every month or quarter. That way, you get to take advantage of the sort of pullbacks we saw this week in oil and gold prices. Long term, there are commodity price forecasts out there that make a case for buying at current levels. Last month, CIBC World Markets issued a widely quoted forecast that crude oil prices would rise to $200 (U.S.) a barrel over the next five years, and that gasoline prices would jump to $2.50 (Canadian) a litre.
Be prudent when adding commodity exposure to your portfolio. Many Canadian investors already have substantial exposure to oil, metals and gold through their mainstream equity funds, exchange-traded funds and individual stocks. Both sectors together accounted for 47.8 per cent of the S&P/TSX composite index as of March 31.
Gold is the classic inflation hedge because of its intrinsic value, but S&P metals analyst Leo Larkin believes the price is heading lower in the months ahead. The price of gold surged 32 per cent last year and another 23 per cent in early 2008 to a peak of $1,030 (U.S.). It has since fallen to the $855 range, and Mr. Larkin said it's possible it might decline to $730 at worst.
From there, Mr. Larkin expects gold to head sideways for six months or so before mounting a comeback that could see it revisit the highs of earlier this year. “If inflation is kicking up, I don't see why ultimately it wouldn't surpass the old highs maybe some time in mid-2009.”
An inflation-resistant sector you can buy into now at cut-rate prices is commercial real estate, which is mainly represented in the stock markets by real estate investment trusts. Recent financial market volatility has made investors leery of REITs on a global basis, and concerns about slower economic growth are a problem as well.
Here in Canada, the S&P/TSX capped REIT index is off about 18 per cent over the past 12 months. However, CIBC World Markets issued a report earlier this month saying the selloff of Canadian REITS belies some strong underlying fundamentals such as low vacancy rates and only a trickle of new properties hitting the market this year and next.
While the stock markets are averse to inflation, bonds are strongly allergic. Rising prices will goad central banks into increasing interest rates, and that always sends bond prices lower. Your best bet, says BMO Nesbitt Burns fixed income strategist Michael Herring, is to invest in short-term bonds. They'll hold up better than long-term bonds in a rising-rate environment.
The obvious bond choice for the year ahead would seem to be real-return bonds, which adjust their semi-annual interest payments and the amount you receive on maturity to account for higher inflation. But Mr. Herring advises against real-return bonds because they're a suspect value based on current prices. “My point of view is that people are overpaying for the inflation insurance that real-return bonds give you.”
Another thumbs-down for real-return bonds comes from Sheldon Dong, fixed income strategist at TD Waterhouse. He doesn't recommend them for retail investors because they behave like long-term bonds and thus have a tendency to be disturbingly volatile on a month-to-month basis.
“I've never been a big proponent on these things,” Mr. Dong said. “Most people own stocks, and most people own oil. That's their inflation protection right there.”
©
© Copyright CTVglobemedia Publishing Inc. All Rights Reserved
By ROB CARRICK Globe and Mail Update
The arch-enemy of all investors is threatening a comeback after a long time away.
Inflation hasn't been a top-of-mind consideration for investors since the early 1990s, and today it's hardly noticeable. But there's growing concern that soaring prices for oil and food products are within the next year or so going to push the inflation rate higher than we've seen it in years.
This edition of the Portfolio Strategy column is all about inflation-proofing your portfolio, which is more problematic than you may think. Some investors automatically look to real-return bonds if inflation's a threat, but there are good reasons to avoid them. Gold and commodities are classic inflation defences, but neither is any sort of a bargain right now.
The first thing you need to understand about inflation is that it's a global phenomenon, even if the cost of living here in Canada in March was just 1.4 per cent ahead of where it was a year earlier. The inflation rate in the United States in March was 4 per cent, and other regions are comparable or worse.
“In Europe, inflation is running over 3 per cent, and in the emerging markets it's on fire,” said Alec Young, an equity market strategist with Standard & Poor's in New York. “In Russia, you've got 12 per cent and you've got 8 per cent in China. It's accelerating.”
Expect the usual carnage if inflation flares up here. The bond market will be hammered as interest rates rise, and the stock markets will struggle. The trouble for stocks arises from the fact that inflation makes investors more conservative about what they're willing to pay for a company's shares. Price-earnings ratios tend to fall, and that means lower share prices.
The market sectors that buck this trend are the ones that are based on gold and commodities such as oil and gas, metals and fertilizer. The psychology here is that commodities are hard assets that hold their value when prices are rising.
When the inflation rate surged into double digits in the 1970s, commodities were the place to be. The problem with commodities today is that they've already experienced a gigantic runup in price. In fact, rising oil and fertilizer prices are key reasons why inflation is globally on the rise. The price of crude oil, for example, has jumped about 75 per cent in the past year to its current range of around $116.
“Traditional inflation hedges don't look like attractive bargains right now, so the past may not be prologue this time around,” Christopher Davis, an analyst with the Chicago-based research firm Morningstar, wrote in a commentary this week.
Mr. Davis suggested a dollar-cost-averaging approach for getting into commodities, where you make small, regular purchases every month or quarter. That way, you get to take advantage of the sort of pullbacks we saw this week in oil and gold prices. Long term, there are commodity price forecasts out there that make a case for buying at current levels. Last month, CIBC World Markets issued a widely quoted forecast that crude oil prices would rise to $200 (U.S.) a barrel over the next five years, and that gasoline prices would jump to $2.50 (Canadian) a litre.
Be prudent when adding commodity exposure to your portfolio. Many Canadian investors already have substantial exposure to oil, metals and gold through their mainstream equity funds, exchange-traded funds and individual stocks. Both sectors together accounted for 47.8 per cent of the S&P/TSX composite index as of March 31.
Gold is the classic inflation hedge because of its intrinsic value, but S&P metals analyst Leo Larkin believes the price is heading lower in the months ahead. The price of gold surged 32 per cent last year and another 23 per cent in early 2008 to a peak of $1,030 (U.S.). It has since fallen to the $855 range, and Mr. Larkin said it's possible it might decline to $730 at worst.
From there, Mr. Larkin expects gold to head sideways for six months or so before mounting a comeback that could see it revisit the highs of earlier this year. “If inflation is kicking up, I don't see why ultimately it wouldn't surpass the old highs maybe some time in mid-2009.”
An inflation-resistant sector you can buy into now at cut-rate prices is commercial real estate, which is mainly represented in the stock markets by real estate investment trusts. Recent financial market volatility has made investors leery of REITs on a global basis, and concerns about slower economic growth are a problem as well.
Here in Canada, the S&P/TSX capped REIT index is off about 18 per cent over the past 12 months. However, CIBC World Markets issued a report earlier this month saying the selloff of Canadian REITS belies some strong underlying fundamentals such as low vacancy rates and only a trickle of new properties hitting the market this year and next.
While the stock markets are averse to inflation, bonds are strongly allergic. Rising prices will goad central banks into increasing interest rates, and that always sends bond prices lower. Your best bet, says BMO Nesbitt Burns fixed income strategist Michael Herring, is to invest in short-term bonds. They'll hold up better than long-term bonds in a rising-rate environment.
The obvious bond choice for the year ahead would seem to be real-return bonds, which adjust their semi-annual interest payments and the amount you receive on maturity to account for higher inflation. But Mr. Herring advises against real-return bonds because they're a suspect value based on current prices. “My point of view is that people are overpaying for the inflation insurance that real-return bonds give you.”
Another thumbs-down for real-return bonds comes from Sheldon Dong, fixed income strategist at TD Waterhouse. He doesn't recommend them for retail investors because they behave like long-term bonds and thus have a tendency to be disturbingly volatile on a month-to-month basis.
“I've never been a big proponent on these things,” Mr. Dong said. “Most people own stocks, and most people own oil. That's their inflation protection right there.”
©
© Copyright CTVglobemedia Publishing Inc. All Rights Reserved
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