By Josh Anderson, partner and COO,
The Roseview Group
As advisors to banks, the question my colleagues and I are asked most often by real estate investors, and even by lenders themselves is: How far along are we in the cycle? How much progress have banks made in working through their troubled commercial real estate (CRE) assets?
On the whole, our assessment as of the third quarter of 2012 is that we are in the 7th inning stretch.
What this means for the banks is that, although the end is in sight, the game has become more complicated. As baseball fans know, the last few innings are when the toughest managerial decisions need to be made. Pitching changes, offensive substitutions, shifts in defensive coverage — all have the potential to have a dramatic impact on the final outcome.
For the first six innings — dating back to 2008, the game was painful for banks, but it did have the virtue of simplicity. CRE groups became “lending” organizations in name only. In reality, they served as full-time work-out and REO shops, with management focused on finessing the trade-offs each quarter between the only two numbers that really mattered: the dollar amount of nonperforming assets that could be moved off their books, and the dollar amount of losses incurred in the process.
Today, banks are being forced to consider a wider array of strategic questions. They can no longer afford to focus exclusively on loss mitigation.
Instead, their shareholders are looking to them to drive earnings growth. But, how should they strike the right balance in resource allocation between new originations and the resolution of the distressed assets that remain?
Who exactly do they want to be going forward: The same lenders as before the market crashed? Or, ones that make different kinds of loans? To different customers? And, is the team that has been working through the crisis the right one to build a new book of business?
For real estate investors and borrowers, this is the point in the game when things get most interesting, and the least predictable. Here’s what they can expect to see from the banks in these last two and a half innings:
A new mandate to lend. Make no mistake, at most banks today, especially the larger ones, commercial real estate is being looked at as a major potential source of earnings growth, and CRE lending groups are being driven to put loans on the books in a way that they haven’t been for five years. They may be out of practice and gun-shy after spending four years living through every way a loan can go bad, but would-be borrowers should be patient with them. They should expect to see some pitches they can hit for a change.
New players and old faces in new places. A typical example is a client of ours, a large regional bank that lent heavily to home builders and land developers pre-crash but is now focused on income-producing properties and a different target client base. As a result, this client is hiring bankers from their new competitors, rather than just redeploying their existing workout teams. This dynamic will create opportunities for borrowers to develop new lending relationships.
Trades. One of the most interesting trends heading into the end of the cycle is the reshuffling of performing portfolios among banks. It’s a case of one man’s trash being another man’s treasure, although “trash” is a misnomer because the trades are generally happening at par or even better. As banks reset their strategies, even loans that never went bad may now be viewed as a distraction.
Meanwhile, European banks are coming under so much stress at home that they are being forced to divest themselves of even many of their best U.S. real estate assets.
One bank client of ours exemplifies the trend: In the past three months, they have purchased a portfolio of larger loans from a European bank that is winding down its New York City-based operations, and sold a portfolio of smaller loans in the Carolinas – that they now view as “non-core” — to a local community bank for whom the borrowers are a great fit. In that chain, the European bank is the only net seller, the other banks are both driving hard to grow their loan books.
Different approaches to the endgame. As they enter the bottom of the seventh, some banks are shifting to a more patient approach to working out their distressed assets, and some borrowers who have been able to hold on this long may find their tenacity rewarded. At the same time, however, other banks see an opportunity to accelerate their return to “offense” and send a positive signal to shareholders by holding “going out of business” sales of their NPL and REO portfolios, creating some of the best buy-side opportunities of this cycle.
How long will the last two and a half innings take? Our sense is 12 to 24 months, a window of time during which real estate investors and borrowers should expect to see better opportunities emerge from their dealings with banks than they have for the last four years.
So stand up, stretch your legs, and get ready. The most interesting part of the ballgame is about to begin.