Everything will be All Right in the End
by David Urban | October 16, 2008
PrintBack in 1987, I was a college freshman at Drexel University, hanging out in the Finance Department on my first work study assignment, waiting for some papers to copy for the professors. At that time, we did not have a Bloomberg or Reuters terminals and Al Gore had yet to invent the Internet so we had to rely on FNN for our financial news as CNBC was just a minor player at the time. Black Monday came upon us suddenly and as the day unfolded one of the professors walked in and told me that he felt sorry for me as we were about to enter a Great Depression and my degree was going to be useless.
We were all awestruck by the magnitude of the decline, and in the months that followed the market rallied before falling back to retest the low and then rallied back during 1988. We were just ending the Cold War and the Reagan legacy was the focal point of the election. The economy did not collapse and a depression did not occur but changes were implemented in the following years to strengthen the structure to ensure the 1987 crash did not occur again. The regulations, unlike Sarbanes-Oxley, helped strengthen the markets and moved us forward in the 90’s leading to one of the greatest bull markets in history.
A few years later I found myself working for New Jersey National Bank (a part of CoreStates which ended up becoming a part of Wachovia through a variety of mergers) as a Loan Accountant during the S&L crisis. One weekend, the FDIC came to the CEO of CoreStates and told them that they were ‘buying’ Constellation Bank, a medium sized bank in North Jersey who had become overburdened with bad real estate loans. We were to assume all of the branches, deposits, and loans with the stipulation that we could return any loan to the FDIC for no reason at all. The returned loans were then placed into the RTC where they were packaged and sold to investors at auction.
My lending group was in an area with a significant amount of Constellation branches and we acquired a rather large portfolio. When the loan and collateral files were transferred some files were complete but most were empty with maybe a loan and if you were lucky, a copy of the mortgage or a guarantee. In fact, quite a few of my files were empty and we had to rebuild the loan file from scratch. Going back to the client and asking for copies was asking for trouble. What would you think if your bank came back to you asking for a copy of the mortgage on your house or condo?
One of my problem files was for a property out in the then rural area of North Jersey. The developer had been playing the ‘old shell game’ where you borrowed money for property improvements backed by fee revenue from the housing communities. The money was actually used to purchase property for the next development project. You then went to the bank after the property was purchased and borrowed money for the purchase, flipping the property bought with property improvement money (making a little profit) and paying off the previous loan. Next, you then borrowed money for developing the property backed by future sales which paid off the purchase and development loans. Finally, money was borrowed for property improvements and the cycle repeated itself.
Our borrower was holding the bag when the music stopped and we were left with a plot of land with no collateral file. One day I took a trip up with the lender for a site assessment with a backhoe to obtain soil samples in order to make a complete file (Superfund was a big deal back then and New Jersey is infamous for Superfund sites.) As my lender and I were figuring out our checklist and everything we needed the group went to work digging a hole. As soon as the backhoe hit the soil, we heard a metal on metal ‘thunk’ and the backhoe lifted up to reveal a punctured oil drum. The site foreman took one look and told us ‘If I go any further we are going to find Jimmy Hoffa.’ My lender turned to me, said ‘Superfund’ and we left. On the drive back to the office we debated the viability of going to a local men’s store for new suits and burning our clothes.
Another file was for a person who owned a small building in one of the suburban areas. Her building consisted of 3 ground floor retail shops and 6 apartments above the shops. 2 of the retail shops and 5 of the apartments were occupied. Due to the new credit requirements in place, we were going to be forced to raise the interest rate on her variable rate loan by 3 percent. The properties financials showed that she was just able to get by under her current loan agreement but when she went to refinance her loan after the adjustment period the monthly payment would jump to a point where she would be unable to keep the loan current even if she found tenants for the unoccupied spaces.
The lender knew the property like the back of his hand as he drove by it on the way to work and home every day. He was a bit upset because we were about to turn the loan over to the RTC. He told me that he knew the client and the property and if we were able to keep the interest rate flat with a 30 year term the client would be able to stay current but under current credit policy we have to either raise the rate or turn it over to the RTC. If it was sold by the RTC a group would have purchased this loan in a package with other loans like the one mentioned earlier. The group would be able to workout this loan with minimal disruption to her business.
In the auction, you were given a ‘prospectus’ with information regarding each loan in a particular tranche and groups placed bids on tranches, usually in the pennies on the dollar range. Most of the loans were complete garbage but there were good loans in the RTC portfolios (like the one mentioned above). If you did your homework, you were able to do very, very well. But the key was doing your fundamental homework on each tranche.
Back in the early 90’s, a small well capitalized bank in North Carolina called North Carolina National Bank or NCNB for short surprised everyone by taking over a much larger Texas bank in 1990, First Republic Bank Corporation, who had significant problems during the S&L crisis. The transaction, and subsequent giveback of loans to the RTC, allowed NCNB to acquire C&S/Sovran an Atlanta-based bank which fell prey to bad loans in 1991. NCNB renamed themselves NationsBank and became one of the largest banks in the USA. NCNB later merged with Bank of America and became the Bank of America we are familiar with today.
In short, the system survived back then and will now. The key factor is time. It took years to work all the RTC loans and bad banks through the system and it will take years here as well. Same for the MBS and CDO markets as well. There will be good tranches and bad tranches with each tranche being assessed on an individual basis to determine the relative value of the underlying loans. Those that understand this will do very well in coming years.
In the banking industry, well capitalized banks will acquire their weaker competitors, grow larger, and survive. Bad loans will eventually be worked out, written off, and the system will move forward. The key we all have to understand is that this will take a time frame in the range of years. But the system will survive and we will move forward.
Back then the world financial system faced massive challenges but the system survived, moved forward, and thrived.
Copyright © 2008 David Urban
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David Urban | Kingston, PA USA | Email | Website
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