September 1, 2011
Bliss Morris, CEO
We recently relocated our corporate headquarters to a new facility here in Oklahoma City, after having spent almost 18 years at the same office property. As part of that process, I was cleaning out my desk and stumbled across an interesting quotation from Lamar Kelly, who was responsible for leading and supervising the Asset Management and Sales division of the Resolution Trust Corp., including the management of a 4,500 person staff that managed and disposed of over $450 billion in assets, back in the early to mid-1990s. Speaking to loan sales at the time, his quote read: "What we see is the elimination of the large overhead of real estate and real estate related loans that were in those institutions… those assets are back in the hands of the private sector where they belong."
It's surprising how relevant this statement is today, some 20-odd years later. We are now in the midst of yet another clearing process, with the private sector leading the charge. And while we’ve learned certain lessons since the last downturn, there are still some speed bumps ahead. As it stands now, the FDIC is probably still retaining anywhere between 35 billion and 40 billion in assets, which will ultimately need to be sold off. But, clearly, this isn't going to happen overnight.
Part of the problem with dispensing loan pools is that bankers are trying to balance their loan loss reserves, which means they need to write down their book values each quarter. Oftentimes, investors will express frustration because the banks aren't willing to sell their loans. One of the prevailing theories for this is that bankers don’t understand the value of their loans, but I beg to differ. Most of the bankers do, in fact, clearly understand what has happened to the value of their loan product. However, they can't take the loss until they get the loan down to a level where the book value and market prices are in accord. So it takes time for a situation to occur where the amount a group of investors is willing to pay for whole loan products meets up with what the bank can accept.
The number of bank failures has also given reason for pause, as it is on track to hit 2010's 157 figure. Thus far in 2011, 47 banks have failed, and it appears the closings are increasing as the year goes on. Most of these banks, not surprisingly, have been in the state of Georgia, with Florida following not too far behind. The Northeast, by comparison, has held up fairly well. If the number of bank failures ends the year near 2010's tally, especially if there is not some sort of turnaround in our community banking system, the amount of closures will continue to grow.
Compounding matters is the higher-than-hoped fourth quarter 2010 delinquency rate, particularly for the top 100 largest banks. Residential institutions are showing an 11.03% delinquency rate, while commercial banks come in at 8.61%. The numbers here are particularly alarming because historically most institutions want to keep their delinquency rates for nonperforming loans less than 2%.
Despite all of this, there is reason to believe that private sector participation is picking up. FFN is predicting that the number of loan sales will likely double this year as private sector participation increases. In 2010, $26 billion in various loans were offered for sale with about 50% selling. In 2011, that number will jump to $50 billion with close to 70% clearing. This is partly due to a flattening in whole loan pricing as well as enhanced pricing predictability, the latter of which is especially important. In fact, I'm optimistic that book values will continue to drop this year and investor confidence will increase.
Also aiding the current recovery has been local investor involvement, which we didn’t see as much of in the last downturn. Many developers that have retained capital and are interested in helping their communities are buying whole loans and working with those borrowers to foreclose or acquiring the property with an eye to developing it when the market improves. You often see this on the real estate side, but it is a relatively new trend in terms of whole loan sales.
Although it's been nearly 20 years since Lamar Kelly made his remark about the savings and loan crisis, the statement still rings true today. A recovery of any meaningful proportion is absolutely dependent upon private sector participation. And we’re finally starting to see this ramp up.