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Home › Forums › Financial Markets/Economics › Leverage (still) Pays: An example from a recent bank failure

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  • March 11, 2009 at 6:28 PM #15281
    davelj
    Participant

    I have a friend/acquaintance (he’s actually the brother of a friend) that runs a real estate investment firm, and his lender failed and was put into receivership a few months back. This is how he and his partners made out like bandits.

    His firm had a $45 million relationship with the bank and was deeply underwater on his properties. Three years ago the appraised value of his firm’s properties was about $56 million, supporting the $45 million in loans. Three months ago the appraised value had fallen to about $34 million based on higher cap rates and vacancies (re: lower cash flow). Anyhow, about eight months ago he stopped paying on the loans. The bank was buried so deep in the doo doo that they were never able to actually foreclose and collect on the personal guarantees supporting the loan behind the collateral (they wouldn’t have gotten much, this guy and his partners would have been broke).

    Anyhow, this bank failed several months back. Shortly thereafter his loans, along with certain other non-performing loans, were sold by the FDIC to an investment group (re: vultures) for $21 million. Anticipating that something like this might happen, my friend had already approached another bank to see what someone would be willing to lend against his properties. The answer was $27 million. So, when the vulture group came to see him to collect, he (eventually) offered them $27 million, they accepted, he went to the (recently approached) bank, re-financed his properties for $27 million and handed the money over to the vulture group. The vultures made a 29% return in about four months’ time for very little work, and my friend (and his partners) ended up with $7 million in equity (for now, at least) on properties for which they were previously $21 million underwater.

    I don’t recommend it, but leverage still pays if you play it right.

    Who pays? All bank customers in the form of lower deposit rates, as the banks have to pay higher deposit fees to replenish the FDIC Insurance Fund, which is gonna have a big hole in it by the time this mess is all over with.

    Privatize gains; socialize losses. Ain’t life grand?

    March 11, 2009 at 6:38 PM #364243
    patientrenter
    Participant

    This sort of thing happens a little all the time. What’s different now is that it is approved and supported by the govt, and is happening on a massive scale. I am really beginning to think all this “save the economy” crap is just a cover for massive looting by net borrowers, with pols and professional money men along for the ride.

    March 11, 2009 at 6:38 PM #364530
    patientrenter
    Participant

    This sort of thing happens a little all the time. What’s different now is that it is approved and supported by the govt, and is happening on a massive scale. I am really beginning to think all this “save the economy” crap is just a cover for massive looting by net borrowers, with pols and professional money men along for the ride.

    March 11, 2009 at 6:38 PM #364689
    patientrenter
    Participant

    This sort of thing happens a little all the time. What’s different now is that it is approved and supported by the govt, and is happening on a massive scale. I am really beginning to think all this “save the economy” crap is just a cover for massive looting by net borrowers, with pols and professional money men along for the ride.

    March 11, 2009 at 6:38 PM #364723
    patientrenter
    Participant

    This sort of thing happens a little all the time. What’s different now is that it is approved and supported by the govt, and is happening on a massive scale. I am really beginning to think all this “save the economy” crap is just a cover for massive looting by net borrowers, with pols and professional money men along for the ride.

    March 11, 2009 at 6:38 PM #364836
    patientrenter
    Participant

    This sort of thing happens a little all the time. What’s different now is that it is approved and supported by the govt, and is happening on a massive scale. I am really beginning to think all this “save the economy” crap is just a cover for massive looting by net borrowers, with pols and professional money men along for the ride.

    March 11, 2009 at 7:26 PM #364263
    davelj
    Participant

    I think there is (obviously) massive looting going on, but I think a lot of it is unintentional. That is, my friend’s brother and his partners didn’t set out to loot. I’m sure they would rather have had things work out as their original plan dictated (rents grow, property values grow, loan gets paid off, etc.). The problem is that the system is full of bad incentives. And people respond to incentives. If you incent folks to lever, they will.

    I’m hopeful that in all the coming reform and re-regulation of the financial system that the issue of incentives will be addressed, because that will solve a lot of the underlying problems.

    Interestingly, these guys actually got quite lucky. Had they defaulted over a year ago there’s a good chance the bank would have had time to foreclose on the properties and collect what they could on the personal guarantees, thus BK-ing the partners. The same would have happened had they defaulted when they did and had the bank not gone into receivership. Likewise, had they waited until after the bank went into receivership, the vultures would have probably overpaid for the loan (it would still appear to be performing, thus a smaller discount to face value would have been applied) and would have had to squeeze them for more money to get a return. So, really, they got very lucky.

    March 11, 2009 at 7:26 PM #364551
    davelj
    Participant

    I think there is (obviously) massive looting going on, but I think a lot of it is unintentional. That is, my friend’s brother and his partners didn’t set out to loot. I’m sure they would rather have had things work out as their original plan dictated (rents grow, property values grow, loan gets paid off, etc.). The problem is that the system is full of bad incentives. And people respond to incentives. If you incent folks to lever, they will.

    I’m hopeful that in all the coming reform and re-regulation of the financial system that the issue of incentives will be addressed, because that will solve a lot of the underlying problems.

    Interestingly, these guys actually got quite lucky. Had they defaulted over a year ago there’s a good chance the bank would have had time to foreclose on the properties and collect what they could on the personal guarantees, thus BK-ing the partners. The same would have happened had they defaulted when they did and had the bank not gone into receivership. Likewise, had they waited until after the bank went into receivership, the vultures would have probably overpaid for the loan (it would still appear to be performing, thus a smaller discount to face value would have been applied) and would have had to squeeze them for more money to get a return. So, really, they got very lucky.

    March 11, 2009 at 7:26 PM #364709
    davelj
    Participant

    I think there is (obviously) massive looting going on, but I think a lot of it is unintentional. That is, my friend’s brother and his partners didn’t set out to loot. I’m sure they would rather have had things work out as their original plan dictated (rents grow, property values grow, loan gets paid off, etc.). The problem is that the system is full of bad incentives. And people respond to incentives. If you incent folks to lever, they will.

    I’m hopeful that in all the coming reform and re-regulation of the financial system that the issue of incentives will be addressed, because that will solve a lot of the underlying problems.

    Interestingly, these guys actually got quite lucky. Had they defaulted over a year ago there’s a good chance the bank would have had time to foreclose on the properties and collect what they could on the personal guarantees, thus BK-ing the partners. The same would have happened had they defaulted when they did and had the bank not gone into receivership. Likewise, had they waited until after the bank went into receivership, the vultures would have probably overpaid for the loan (it would still appear to be performing, thus a smaller discount to face value would have been applied) and would have had to squeeze them for more money to get a return. So, really, they got very lucky.

    March 11, 2009 at 7:26 PM #364742
    davelj
    Participant

    I think there is (obviously) massive looting going on, but I think a lot of it is unintentional. That is, my friend’s brother and his partners didn’t set out to loot. I’m sure they would rather have had things work out as their original plan dictated (rents grow, property values grow, loan gets paid off, etc.). The problem is that the system is full of bad incentives. And people respond to incentives. If you incent folks to lever, they will.

    I’m hopeful that in all the coming reform and re-regulation of the financial system that the issue of incentives will be addressed, because that will solve a lot of the underlying problems.

    Interestingly, these guys actually got quite lucky. Had they defaulted over a year ago there’s a good chance the bank would have had time to foreclose on the properties and collect what they could on the personal guarantees, thus BK-ing the partners. The same would have happened had they defaulted when they did and had the bank not gone into receivership. Likewise, had they waited until after the bank went into receivership, the vultures would have probably overpaid for the loan (it would still appear to be performing, thus a smaller discount to face value would have been applied) and would have had to squeeze them for more money to get a return. So, really, they got very lucky.

    March 11, 2009 at 7:26 PM #364855
    davelj
    Participant

    I think there is (obviously) massive looting going on, but I think a lot of it is unintentional. That is, my friend’s brother and his partners didn’t set out to loot. I’m sure they would rather have had things work out as their original plan dictated (rents grow, property values grow, loan gets paid off, etc.). The problem is that the system is full of bad incentives. And people respond to incentives. If you incent folks to lever, they will.

    I’m hopeful that in all the coming reform and re-regulation of the financial system that the issue of incentives will be addressed, because that will solve a lot of the underlying problems.

    Interestingly, these guys actually got quite lucky. Had they defaulted over a year ago there’s a good chance the bank would have had time to foreclose on the properties and collect what they could on the personal guarantees, thus BK-ing the partners. The same would have happened had they defaulted when they did and had the bank not gone into receivership. Likewise, had they waited until after the bank went into receivership, the vultures would have probably overpaid for the loan (it would still appear to be performing, thus a smaller discount to face value would have been applied) and would have had to squeeze them for more money to get a return. So, really, they got very lucky.

    March 12, 2009 at 8:10 AM #364504
    TheBreeze
    Participant

    This is pretty disgusting all around. What’s most disgusting is that these jokers probably think they’ve ‘earned’ that money, when in reality, all they have done is loot the public coffers.

    Yep, this is what passes for ‘capitalism’ in this country. I’m surprised that FLU and AN, the Beavis and Butthead of socio-capitalism, aren’t in this thread defending these douches’ against any and all taxes.

    March 12, 2009 at 8:10 AM #364791
    TheBreeze
    Participant

    This is pretty disgusting all around. What’s most disgusting is that these jokers probably think they’ve ‘earned’ that money, when in reality, all they have done is loot the public coffers.

    Yep, this is what passes for ‘capitalism’ in this country. I’m surprised that FLU and AN, the Beavis and Butthead of socio-capitalism, aren’t in this thread defending these douches’ against any and all taxes.

    March 12, 2009 at 8:10 AM #364948
    TheBreeze
    Participant

    This is pretty disgusting all around. What’s most disgusting is that these jokers probably think they’ve ‘earned’ that money, when in reality, all they have done is loot the public coffers.

    Yep, this is what passes for ‘capitalism’ in this country. I’m surprised that FLU and AN, the Beavis and Butthead of socio-capitalism, aren’t in this thread defending these douches’ against any and all taxes.

    March 12, 2009 at 8:10 AM #364984
    TheBreeze
    Participant

    This is pretty disgusting all around. What’s most disgusting is that these jokers probably think they’ve ‘earned’ that money, when in reality, all they have done is loot the public coffers.

    Yep, this is what passes for ‘capitalism’ in this country. I’m surprised that FLU and AN, the Beavis and Butthead of socio-capitalism, aren’t in this thread defending these douches’ against any and all taxes.

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