Small-balance specialists and other real estate investors have frequently lamented that the Federal Deposit Insurance Corp. hasn’t exactly pushed the innovation envelope when it comes to disposing of loans it inherits as receiver for failed banks.
And we’re talking about an ever-growing count of loans: performing, non-performing and otherwise. To wit, the FDIC has taken over roughly 130 banks so far this year, boosting casualties to nearly 300 since the beginning of 2008.
And even when the agency’s disposition directors do get creative in aiming to return assets to purely private hands, investors have complained that its innovative (and ever-evolving) "structured transaction" program limits access to a relatively short roster of deep-pocketed mega-opportunists.
But decision-makers are responding to this issue with a planned series of relatively small regional pool participation opportunities chock full of small-balance loans and REOs. For instance, the FDIC just began offering through Milestone Advisors 900+ commercial loans with a collective balance exceeding $500 million (and averaging $564,000 per) split into three regional sub-pools, according to Commercial Real Estate Direct.
These include a $211 million northern pool, a $190 million western pool, and a $111 million southeastern pool. The offerings will presumably draw plenty of interest from bidders teaming cash equity with regional small-balance asset-management expertise.
The FDIC has already cut structured transaction arrangements aimed at resolving nearly $21 billion worth of loans once held by institutions the agency has absorbed.
Loan pools on which the agency is now partnering with consortia headed by the likes of Starwood Capital and Colony Capital sum to $4.5 billion - the biggest being the infamous condo-heavy Corus Bank portfolio. The average size of structured transaction pools to date is $1.2 billion.
But the upcoming regional pools are targeting more manageable balances of $200 million or less as the agency aims to open up bidding to shallower-pocketed investment groups. Sources that prefer not to discuss FDIC activities on the record suggest savvy teams could potentially obtain winning bids with as little as $15 million in cash.
As has been the case with the most recent larger structured transactions, the agency would look to sell 40 percent stakes to winning bidders, and retain commensurate shares of profits that asset managers are able to tease out of the properties in the course of resolving the distress. FDIC in some cases provides very attractive financing to help the partnering consortium acquire its stake - and fund various asset management activities with working capital.
As an example of how the math has worked on a larger scale, Lennar Corp. won the bidding on a managing member stake in a $3 billion portfolio for $243 million. Similarly, Mariner Real Estate placed a winning $52 million bid on a $760 million structured transaction. The equity on both of these deals works out to less than 10 percent.
Winning teams on smaller deals will presumably need to demonstrate ability to manage and simultaneously resolve several dozen distressed assets. While the FDIC won't discuss the size range of assets likely to populate the regional offerings (citing SEC regulations regarding pending securities offerings), chances are the number of assets in a $200 million pool could easily approach triple digits.
Investment brokerage Marcus & Millichap's Special Asset Services group reports that 82 percent of all distressed real estate assets sold during the current cycle have fetched less than $5 million - and failed banks held a whole lot of loans with balances in the $500,000 to $2 million vicinity.
And as M&M also reports, the vast bulk of capital pooled to date for distressed real estate investment has had an aversion to small-balance assets. After all, costs related to resolving assets of $1 million or $2 million aren't that much different from $10 million or $20 million transactions - but profits tend to be commensurately lower.
So we'll expect to see small-balance specialists jump on opportunities to participate with regional pool investors in resolving and stabilizing the underlying properties. And of course that process will ultimately put hundreds of stabilized small-cap properties on the market in the not-too-distant future - rather than frozen in the FDIC's huge distressed-debt holdings.