David Tobin — Reading the Bad Paper Tea Leaves
David Tobin is in the business of selling bad paper. His company, Mission Capital Advisors, has advised on more than $26 billion of loan sales since it was founded in 2002.
Mission is deeply involved in the secondary mortgage market, putting David in a good position to spot trends developing before they make headlines. I ask David based on the transactions he's seeing is the worst behind us in the real estate loan markets.
DT: In the loan markets both on the residential and commercial side the worst is definitely behind us. But there is a much longer process going up than going down unfortunately. The key component of the secondary market for loans in both the residential and commercial real estate space is the underlying collateral value. Those collateral values are going to take a while to make it back to parity. Meaning, that at a point the mortgage to the loan would be worth par.
LL: How many years until we reach that parity?
DT: I always use a study by Local Market Monitor which tracks crashes and subsequent rebounds at different markets at different times. Like the oil patch crash, the problems we had in New York City during the late eighties, early nineties and the problems California had in 1994, 1995 — generally the real estate markets fall between two to four years and then take about six years to eight years for them to come back. So if you look as your starting point — the apex of the market (2006, 2007), we're at or past the bottom in most cases, but it will be a six to eight year process to get there.
And I would caveat that this six to eight year process has one important difference this time around versus the banking crisis in the late 80's early 90's. This time, many banks are stuck with land development and construction loans where in certain cases, the value of those loans will not come back- even in this generation.
I'm talking about things that are way beyond the exuberant ring of different communities like out in the desert of Arizona, Central Florida, the deep woods of Arkansas, Utah and in Nevada.
There are a lot of loans that are sitting on bank's books that were speculative property and were to be developed into homes and housing developments and resort developments in the middle of no where. These loans will never come back.
LL: What does that mean for the banks? They can "kick the can" for only so long with these loans?
DT: That's really where regulators will end up drawing a line in the sand to the extent of where a bank has a sufficiently strong portfolio and is able to make money on an operating basis and amortize away dead loans or losses incurred on dead loans.
Right now thanks to the Fed easing and the low interest rate environment- this will allow those banks to work though their portfolios to survive. But for those banks whose concentration in really deeply discounted loans is too high, they will end up unfortunately being taken over by regulators.
LL: What's the big head line coming out of your business right now?
DT: Our volume has been the strongest it has been over the last two years and the sale of discounted loans is really the primer to get the pump started within a large segment of this economy.
Coming out of the banking crisis in the late eighties, early nineties, the whole discount loan trading environment which included the RTC private entities and all the banks that were selling into it really created the underpinnings for the securitization market and for the whole system of credit system repair. We've got the best system out there internationally and we've always had. Its a product of the RTC times.
Something like eight or nine percent of our economy is involved in real estate in one way shape, form or another and its going to continue to be that way. Its a self fulfilling prophecy. As banks are healthy enough to sell non-performing loans, the banks get healthier, investors buy them, pension funds are investing in those investors and it becomes a virtuous cycle.
LL: In terms of this segment of the industry being a harbinger for good news, where's the silver lining?
DT: Somewhere between 1992 and 1994 was really the bottom the last time around. By 1997, 1998, the economy was really cruising', the securitization market was in balance and the lending markets were robust.
So you went from no money to a good amount of money during that time. If you measure sort of the middle of last year and look out three, four, five years, I think you are in a really healthy lending environment and I also think this year was obviously better than last year economic wise and next year should be better than this year. I'm not a big believer in double dips. I just think those are just short term events.
LL: So 2012, 2013?
DT: I would say 2013 would be a healthy economic environment. 2012 would certainly be better than this year in terms of loans and lending in general. As these banks sell loans, they start making loans and as banks start lending again, the economy starts growing and we start to figure out what's the next industry that's going to push the U.S.
economy ahead. Probably something dealing in energy. Alternative energy is one of the types of industries that we can be competitive at because it has enough high technology development that's not based solely on low labor costs. Coming out of 1992, 1993 and 1994, we moved into the tech boom which has really carried us. We need to keep on doing that and hopefully take the lead energy wise. We use the most energy so we need to figure out ways to be the most efficient about it.
LL: What kind of over hang will this have on the economy going forward?
DT: One of the things I see is vacancies are not decreasing across retail, office, industrial property. They are decreasing in multi family but that's unfortunately a factor of the amount of foreclosures across the country. There is a movement back into rental housing. I understand economists say we are out of a recession but when you really get on the ground and look at the commercial real estate market- has there been a meaningful change in rents and occupancies?
The answer is no.
That's really what's going to drive value increases. A lot of the activity in the capital markets we are seeing this year and last year is driven by low interest rates. But we will get to the end of what's re-financeable in this extremely low interest rate environment and you won't be able to kick the can anymore so to speak.
The difference between this time around and the early nineties is in the early nineties we were coming out of a decidedly higher interest rate environment. A mortgage was ten percent. Commercial real estate loans were ten, eleven, sometimes twelve percent. This time around we have very little coupon to work with and it looks a lot more like what happened to Japan where they cranked interest rates down to zero and sort of didn't recover for a long, long, time.
LL: If you want the private sector to get back into the mortgage industry, should the government keep artificially deflating interest rates?
DT: At some point you have to stop cranking down interest rates. You have to end the party. I think the private sector is starting to have more of a hand in it. I think there will be always be a need for the GSEs or some sort of government sponsored entity in a properly functioning mortgage market.
The GSE market from our vantage point has been very important helping banks recover because they have been able to sell seasoned performing loans to Fannie and Freddie at (give or take) at par pricing which has allowed them to reduce the size of their balance sheets and assist in conforming their capital to proper ratios.
But I think there will come a point in time where we start to see some actual economic activity. And this activity would not be a product of low interest rates. At that point in time we'll be able to increase rates slightly and sort of wean the housing market off of government support.
LL: What do you think the government should do with Fannie and Freddie?
DT: Certainly having two companies has always been somewhat positive in that they competed against once another and it kept them a little honest. There has always been that private sector competition between the two. But whether you cut it up into a sort of bad bank, good bank or shut it down and convert it into one giant entity, I don't know.
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A Senior Talent Producer at CNBC, and author of "Thriving in the New Economy:Lessons from Today's Top Business Minds."