It seems like the worst may yet be over.  The Congressional Oversight Panel recently released its February Oversight Report entitled, “Commercial Real Estate Losses and the Risk to Financial Stability”.  You can read the full report HERE.  While the initial wave of destabilization came from the larger institutions (think AIG, Lehman Brothers, Etc.), this looming round could come from the nations’ small to mid-sized banks.

The report estimates that in the next 4 years over $1.4 trillion (with a “T”) of commercial loans will come due and need to be retired or refinanced.  In one half of those cases, the value of the underlying asset is now worth less than the amount owed on the loan.  They are “underwater” and they are a problem.  Losses to the lending institutions could total over $300 billion.  That’s not the amount that will default.  That’s the loss realized after foreclosing on the property, finding a buyer and selling it for whatever can be achieved.

But wait, we ran the Stress Test and our banks have the capital reserves to weather this storm.  Unfortunately, the Stress Test only looked through 2010.  The vast majority of these loans will become a problem for the banks in 2011-2014.  Plus, the Stress Test was only run on the larger banks.  The small and mid-sized banks were never subjected to the Stress Test.

On the plus side, there has been an insane amount of equity raised to acquire these troubled assets.  Once the banks have foreclosed on the assets and they are brought to market, there should be a willing pool of buyers.  The question then becomes, will there be so many buyers that the value get bid up to a point where the “distressed buyers” are no longer interested.  My best guess is that you see an initial round of sales at very attractive pricing.  As buyers flock to this sector, the demand and valuations will go up and the transaction volume will go down.

Recently GlobeSt.com ran an article about several national brokerage houses adding auction services to their line up of available product lines.  After reading the article, I had the opportunity at lunch to discuss the trend with one of the regions most active investment sales brokers.  It was a very interesting discussion as we tried to hash out whether auctions would take off as a trend for institutional level assets, or whether it would be solely reserved for the smaller, private equity transactions.

I’ll fill you in on the results of our conversation later (I don’t want to bias your comments), but I would be very interested in hearing some of your thoughts on Auctions as a buying and selling tool for institutional investors.

So, on with the comments…

The link: LINK

The Story: In an effort to stem the bleeding from America’s financial institutions, the incoming Obama administration has proposed, as one potential solution, a government run “aggregator bank”.  This bank would take the troubled assets off of the lending institutions balance sheet using taxpayer funds.

The Analysis: There is little doubt that US banks are in serious trouble.  The residential housing crises has been in full swing for over a year now, but the commercial side has only just begun.  With over $500 billion of CMBS loans coming due in the next 3 years and asset values falling, the situation will get worse before it gets better.

However, the idea of an “aggregator bank” (AB) has left me with more questions than answers.  Let’s just assume for the sake of argument that the government sets up the AB and funds it with $300 billion of TARP money.

How, exactly, does the AB plan to transfer that money to the troubled banks and what are they receiving in return?  Will they purchase the loans or hard REO assets?  At what value will they purchase the assets – issuance, book or market?  If the answer is “market”, then let the market buy them directly and have the banks take the loss – not the taxpayers?  Is the government really set up to own, operate and reposition billions of dollars of real estate assets?  Is that the business they should be in and is it the best use of my taxpayer dollars?

There are literally hundreds of real estate funds that have been established in the past year to specifically invest in distressed assets.  How does the AB plan get those assets into the hands of the funds that really want to own them?  Finally, wouldn’t the government be better off directly issuing low cost loans to individuals and investment funds that wanted to buy distressed assets?  Using government funds to set up an auction website would be better than taking direct ownership of the assets.

At some point, some group is going to have to pay the price for the bad business decisions made over the past few years.  Without a bailout or AB plan, that group will be the lending institutions.  With the AB plan, that group will be the American taxpayers.  I personally would rather see my tax money be used to fund better schools and infrastructure.