QE3 - To Infinity and Beyond!

The recent news from The Federal Reserve reminds me of a saying by Buzz Lightyear. You remember ol' Buzz, the toy astronaut, in the movie series Toy Story. Every time he lept from a piece of furniture, he would proclaim with great fanfare, "To infinity and beyond!!"

That's more or less what Ben Bernanke said recently and I might add with about the same enthusaism. The Fed will try a new round of quantitative easing to jump start the economy. And Mr. Bernanke implied there is no cut off to this third round. He'll do it as long as it takes to get the desired results. Hence, to infinity and beyond is a good interpretation of his policy.

My friend Kevin Geraci of Zions Bank wrote a well written article recently on this subject. I don't normally quote verbatim news articles but I thought his was deserving. So here goes:

 

Two weeks ago, the Federal Reserve announced its third round of quantitative easing, more commonly called QE3, whereby the Fed essentially prints money and then buys assets with it in order to add liquidity to the financial system and bring down interest rates.

 

The ultimate goal of this monetary policy tool is to spur economic growth and lower the unemployment rate—the same promise we got in QE1 and QE2.   Further, the Fed also announced that it is also changing its interest rate forecast and now sees the Fed funds rate remaining exceptionally low through mid-2015 (previously it was late 2014).

 

The announcement of QE3 is wearisome for many and for many reasons.  While the stimulative policies are temporary and artificial, the laws of macro-economics typically are not.  Asset prices have been artificially manipulated and do not reflect long-term economic reality. So what?

 

Two weeks ago, commodity prices rose again as investors sought to hedge themselves against a falling U.S. dollar.  Quantitative easing serves to dilute the money supply still more, and naturally the value of the money declines.  This may be good news if you are an exporting business, but the falling dollar will cause commodities to rise even higher, exactly what we do not need in a recovering economy as essential commodities like food and fuel get much more expensive.

 

The FOMC, of which Ben Bernanke is Chairman, now employs a staff of about 450, about half of whom are Ph.D. economists.  Perhaps that is the problem - the lack of common sense in the ‘monetary market place’.  Perhaps Bernanke should employ a few middle-class workers on his staff as a ‘reality barometer’ to see first hand what is working and what isn’t!

 

And now the Fed states that instead of purchasing customary Treasury Bonds, it is going to purchase large quantities of Agency Mortgages (Fannie, Freddie and Ginnie), up to $40 billion per month worth, in hopes of stabilizing the housing market and creating more jobs.  As if the Government debt situation isn’t bad enough, the Government will own huge pools of 30-year fixed rate agency mortgages that over time (certainly before they mature) will be at interest rates less than the Government’s own Fed funds rate.  Now that is a good investment!

 

Little has taken place in the economy here, and elsewhere in the world for that matter, as a result of QE 1, 2 and likely 3.  Meanwhile, our national debt now exceeds our Gross Domestic Product for the first time since WWII.  So when our creditors start feeling confident enough in their own economies to start cashing in their T-Bills for higher yielding investments, where does our Government get that money?  Or, when our Social Security Fund, the only Federal Budget item that is funded via dedicated funding sources, wants to cash in its Treasury Bonds to pay for your retirement or disability, can we pay them?

 

Is it time to ask the wise men at the FOMC what they're doing?!

 

Be Proactive and Anticipate Financing Road Blocks Before they Happen

In the past, a borrower was typically asked to provide a simple financial statement with a credit check, and that was the extent of the credit items required.  Ah, the good old days.  In today’s environment, lenders have upped their borrower documentation considerably requiring an extensive amount of information on the borrower. 

I’m continually surprised by most borrowers who don’t know the necessary documentation they need to provide in order to get a lender interested in them.  They could avoid many of their financing problems if they anticipated the financing road blocks before they happen.  Shown below are seven of the more common examples of issues to watch out for:

1.   Minimum Net Worth to Loan Ratio – Each lender has different requirements but they typically require the borrower’s net worth to be equal to the loan amount.  Some require a borrower’s net worth to be as much as two times the proposed loan amount.  Find out what your lender requires before signing the application.  

2.   Minimum Number of Months of Debt Service Required of Liquid Assets - Again each lender is different but they typically require liquid assets showing on the borrower’s balance sheet equal to 6 to 12 months of debt service.  Find out what your lender requires before signing the application. 

3.   Complete the REO Schedule with all the Details Filled In – Many lenders are now creating a global cash flow spreadsheet on the borrower.  They want to see if the prospective borrower is generating a positive cash flow or slowly draining himself of all his cash.  Much of the detail required to determine his global cash flow comes from the real estate owned schedule.  Prepare the REO schedule before you begin talking to lenders so that when they ask for it, it’s ready for them.  If you need a copy of a REO schedule contact me and I’ll email you one. 

4.   Credit Rating & Explanations of 30 Day Late Payments – Run a credit report on yourself before you start looking for a lender.  Find out your credit score.  Most lenders require that your credit score be a minimum of 680.  If yours is not that high, you better have a good explanation.  Also you need to explain every payment that is 30 days late or more.  Put it in writing before they ask. 

5.   Explain Past Tax Liens, Judgments, Litigation – have written explanations with back up documentation already prepared before you sign the application.  Give the prospective lender your explanations and have him verify in advance of signing your application that your explanations are satisfactory and will not impact loan approval.  Do it before you sign the application when you have the most negotiating power, not after when you have little or none. 

6.   Tax Returns, not just Schedule 1040s, signed and dated including all K-1s – Lenders want all of your federal tax returns, not parts of them.  Typically, most borrowers forget to sign and date their tax returns and most times it takes two or three attempts to get all of their K-1s.  To speed up the process get it done correctly the first time. 

7.   Thoroughly Read the Application and Ask Questions Prior to Signing the Application – It is imperative that you understand every clause in the loan application.  Lenders become frustrated, and rightly so, when borrowers and their legal counsel voice issues at the closing table about lending requirements that were disclosed on the loan application.  Negotiate any onerous lending requirement prior to signing the application.

One of the truest statements ever uttered about commercial real estate is, “Time kills deals.”  A lengthy, drawn out loan underwriting process will at the very least move your deal to the bottom of the pile.  It has the potential of killing the deal altogether.  Many of these seven issues can be avoided if the borrower will be proactive and anticipate what the lender is going to require.  A good borrower, a good mortgage broker should work towards making the lender’s process as easy as possible to avoid ever hearing the words, “I’m sorry to inform you, your loan has been turned down.”  

Source: From the Analyst Chair: Anticipate the Road Blocks in Commercial Real Estate Finance by Metropolitan Capital Advisors Blog, September 4, 2012. 

CRE Delinquency Rates Continue to Plummet

The commercial real estate market is getting better.  What we've sensed was happening has numbers to prove our thinking.  There are two very insightful charts by SNL Financial that show the slow but steady decline in delinquency rates over time on commercial real estate loans.

U.S. commercial banks reported a delinquency rate of 5.28% on CRE loans compared to a high of 10.76% nine quarters ago.  Oregon has fared even better with a delinquency rate of only 3.04% on CRE loans. 

The asset quality of CRE loans has been improving at a faster pace than one-to-four-unit plexes (considered residential).  However, residential loan delinquencies have also declined by about 200 basis points to 12.66% as of the end of the 2nd quarter of this year. 

Looking at delinquency rates by state shows that the Northeast, the Plains states, Alaska and Hawaii have fared the best, while the Southeast and the state of Nevada have the highest overall delinquency rates.   

Source: CRE delinquencies continue to plummet; by Harish Mali and Robert Clark, SNL Financial, August 29, 2012