Preferred Default Management Blog

Ellen Brown, January 12th, 2011

http://www.4closure.com

The Federal Reserve was set up by bankers for bankers, and it has served them well. Out of the blue, it came up with $12.3 trillion in nearly interest-free credit to bail the banks out of a credit crunch they created. That same credit crisis has plunged state and local governments into insolvency, but the Fed has now delivered its ultimatum: there will be no “quantitative easing” for municipal governments.

On January 7, according to the Wall Street Journal, Federal Reserve Chairman Ben Bernanke announced that the Fed had ruled out a central bank bailout of state and local governments. “We have no expectation or intention to get involved in state and local finance,” he said in testimony before the Senate Budget Committee. The states “should not expect loans from the Fed.”

So much for the proposal of President Barack Obama, reported in Reuters a year ago, to have the Fed buy municipal bonds to cut the heavy borrowing costs of cash-strapped cities and states.

The credit woes of state and municipal governments are a direct result of Wall Street’s malfeasance. Their borrowing costs first shot up in 2008, when the “monoline” bond insurers lost their own credit ratings after gambling in derivatives. The Fed’s low-interest facilities could have been used to restore local government credit, just as it was used to restore the credit of the banks. But Chairman Bernanke has now vetoed that plan.

Why? It can hardly be argued that the Fed doesn’t have the money. The collective budget deficit of the states for 2011 is projected at $140 billion, a mere drop in the bucket compared to the sums the Fed managed to come up with to bail out the banks. According to data recently released, the central bank provided roughly $3.3 trillion in liquidity and $9 trillion in short-term loans and other financial arrangements to banks, multinational corporations, and foreign financial institutions following the credit crisis of 2008.

The argument may be that continuing the Fed’s controversial “quantitative easing” program (easing credit conditions by creating money with accounting entries) will drive the economy into hyperinflation. But creating $12.3 trillion for the banks — nearly one hundred times the sum needed by state governments — did not have that dire effect. Rather, the money supply is shrinking – by some estimates, at the fastest rate since the Great Depression. Creating another $140 billion would hardly affect the money supply at all.

Why didn’t the $12.3 trillion drive the economy into hyperinflation? Because, contrary to popular belief, when the Fed engages in “quantitative easing,” it is not simply printing money and giving it away. It is merely extending CREDIT, creating an overdraft on the account of the borrower to be paid back in due course. The Fed is simply replacing expensive credit from private banks (which also create the loan money on their books) with cheap credit from the central bank.

So why isn’t the Fed open to advancing this cheap credit to the states? According to Mr. Bernanke, its hands are tied. He says the Fed is limited by statute to buying municipal government debt with maturities of six months or less that is directly backed by tax or other assured revenue, a form of debt that makes up less than 2% of the overall muni market. Congress imposed that restriction, and only Congress can change it.

That may sound like he is passing the buck, but he is probably right. Bailing out state and local governments IS outside the Fed’s mandate. The Federal Reserve Act was drafted by bankers to create a banker’s bank that would serve their interests. No others need apply. The Federal Reserve is the bankers’ own private club, and its legal structure keeps all non-members out.

Earlier Central Bank Ventures into Commercial Lending

That is how the Fed is structured today, but it hasn’t always been that way. In 1934, Section 13(b) was added to the Federal Reserve Act, authorizing the Fed to “make credit available for the purpose of supplying working capital to established industrial and commercial businesses.” This long-forgotten section was implemented and remained in effect for 24 years. In a 2002 article called “Lender of More Than Last Resort” posted on the Minneapolis Fed’s website, David Fettig summarized its provisions as follows:

- [Federal] Reserve banks could make loans to any established businesses, including businesses begun that year (a change from earlier legislation that limited funds to more established enterprises).

- Reserve banks were permitted to participate [share in loans] with lending institutions, but only if the latter assumed 20 percent of the risk.

- No limitation was placed on the amount of a single loan.

- A Reserve bank could make a direct loan only to a business in its district.

Today, that venture into commercial banking sounds like a radical departure from the Fed’s given role; but at the time it evidently seemed like a reasonable alternative. Fettig notes that “the Fed was still less than 20 years old and many likely remembered the arguments put forth during the System’s founding, when some advocated that the discount window should be open to all comers, not just member banks.” In Australia and other countries, the central bank was then assuming commercial as well as central bank functions.

Section 13(b) was repealed in 1958, but one state has kept its memory alive. In North Dakota, the publicly owned Bank of North Dakota (BND) acts as a “mini-Fed” for the state. Like the Federal Reserve of the 1930s and 1940s, the BND makes loans to local businesses and participates in loans made by local banks.

The BND has helped North Dakota escape the credit crisis. In 2009, when other states were teetering on bankruptcy, North Dakota sported the largest surplus it had ever had. Other states, prompted by their own budget crises to explore alternatives, are now looking to North Dakota for inspiration.

The “Unusual and Exigent Circumstances” Exception

Although Section 13(b) was repealed, the Federal Reserve Act retained enough vestiges of it in 2008 to allow the Fed to intervene to save a variety of non-bank entities from bankruptcy. The problem was that the tool was applied selectively. The recipients were major corporate players, not local businesses or local governments. Fettig writes:

Section 13(b) may be a memory, . . . but Section 13 paragraph 3 . . . is alive and well in the Federal Reserve Act. . . . [T]his amendment allows, “in unusual and exigent circumstances,” a Reserve bank to advance credit to individuals, partnerships and corporations that are not depository institutions.

In 2008, the Fed bailed out investment company Bear Stearns and insurer AIG, neither of which was a bank. John Nichols reports in The Nation that Bear Stearns got almost $1 trillion in short-term loans, with interest rates as low as 0.5%. The Fed also made loans to other corporations, including GE, McDonald’s, and Verizon.

In 2010, Section 13(3) was modified by the Dodd-Frank bill, which replaced the phrase “individuals, partnerships and corporations” with the vaguer phrase “any program or facility with broad-based eligibility.” As explained in the notes to the bill:

Only Broad-Based Facilities Permitted. Section 13(3) is modified to remove the authority to extend credit to specific individuals, partnerships and corporations. Instead, the Board may authorize credit under section 13(3) only under a program or facility with “broad-based eligibility.”

What programs have “broad-based eligibility” isn’t clear from a reading of the Section, but long-term municipal bonds are evidently excluded. Mr. Bernanke said that if municipal defaults became a problem, it would be in Congress’ hands, not his.

Congress could change the law, just as it did in 1934, 1958, and 2010. It could change the law to allow the Fed to help Main Street just as it helped Wall Street. But as Senator Dick Durbin blurted out on a radio program in April 2009, Congress is owned by the banks. Changes in the law today are more likely to go the other way. Mike Whitney, writing in December 2010, noted:

So far, not one CEO or CFO of a major investment bank or financial institution has been charged, arrested, prosecuted, or convicted in what amounts to the largest incident of securities fraud in history. In the much-smaller Savings and Loan investigation, more than 1,000 people were charged and convicted. . . . [T]he system is broken and the old rules no longer apply.

The old rules no longer apply because they have been changed to suit the moneyed interests that hold Congress and the Fed captive. The law has been changed not only to keep the guilty out of jail but to preserve their exorbitant profits and bonuses at the expense of their victims.

To do this, the Federal Reserve had to take “extraordinary measures.” They were extraordinary but not illegal, because the Fed’s congressional mandate made them legal. Nobody’s permission even had to be sought. Section 13(3) of the Federal Reserve Act allows it to do what it needs to do in “unusual and exigent circumstances” to save its constituents.

If you’re a bank, it seems, anything goes. If you’re not a bank, you’re on your own.

So Who Will Save the States?

Highlighting the immediacy of the local government budget crisis, The Wall Street Journal quoted Meredith Whitney, a banking analyst who recently turned to analyzing state and local finances. She said on a recent broadcast of CBS’s “60 Minutes” that the U.S. could see “50 to 100 sizable defaults” in 2011 among its local governments, amounting to “hundreds of billions of dollars.”

If the Fed could so easily come up with 12.3 trillion dollars to save the banks, why can’t it find a few hundred billion under the mattress to save the states? Obviously it could, if Congress were inclined to put non-bank lending back into the Fed’s job description. Then why isn’t that being done?

The cynical view is that the states are purposely being kept on the edge of bankruptcy, because the banks that hold Congress hostage want the interest income and the control.

Whatever the reason, Congress is standing down while the nation is sinking. Congress must summon the courage to take needed action; and that action is not to impose “austerity” by cutting services, at a time when an already-squeezed populace most needs them. Rather, it is to create the jobs that will generate real productivity. To do this, Congress would not even have to go through the Federal Reserve. It could issue its own debt-free money and spend it on repairing and modernizing our decaying infrastructure, among other needed works.  Congress’ task will become easier if the people stand with them in demanding action, but Congress is now so gridlocked that change may still be long in coming.

In the meantime, the states could take matters in their own hands and set up their own state-owned banks, on the model of the Bank of North Dakota. They could then have their own very-low-interest credit lines, just as the Wall Street banks do. Rather than spending or selling off valuable public assets, or hoarding them in massive rainy day funds made necessary by the lack of ready credit, states could LEVERAGE their assets into a very strong and abundant local credit system, following the accepted business practices of the Wall Street banks themselves.

The Public Banking Institute is being launched on January 13 to explore that alternative. For more information, see http://PublicBankingInstitute.org.

Holly Bolling is the President of Preferred Default Management, Inc. (Preferred) Preferred has been the “go to team” for foreclosures, lenders, mortgages, investors and investors on real and personal property since 1989. Preferred is the advisor for lenders to process and collect delinquent and default loans and notes. Preferred provides counsel advice and implementation of tools techniques and collection for collections Nationwide. Ms Bolling can be reached at 949-228-3296 or by email at PreferredForeclosure@gmail.com or Holly@4closure.com.  Protecting Lenders Since 1989. We stand as your first line of defense throughout the foreclosure process by recognizing and defusing problems quickly and efficiently. The right trustee is critical to asset recovery success in terms of time, costs and results.  Call us for personalized services including judicial & non-judicial foreclosures, Deeds in Lieu of Foreclosure, HOA Foreclosures, Bankruptcy, Forbearance Agreements, Lost Document Retrieval, Evictions, Collections and warrants.                                           We process foreclosures efficiently!

Holly Bolling, President

PREFERRED DEFAULT MANAGEMENT, INC.

3920 Birch Street, #102

Newport Beach, CA 92660
(949) 228-3296 direct
Holly@4closure.com

www.4closure.com

Banks See Some Asset Growth, Lessened Loss; Half Profitable

FINANCE: Banks based here deal with loans, capital issues

Download the 2010 OC COMMERCIAL BANKS List (pdf)

The largest banks based in Orange County saw moderate growth in assets for the 12 months through June as the industry continues to search for healthy borrowers amid tight lending conditions.

The 25 largest OC-based banks grew assets nearly 4% to $8.4 billion for the 12 months through June from a year earlier, according to this week’s Business Journal list.

The list ranks OC-based banks by assets, including loans, cash and investments such as real estate and stocks.

Financial information for banks on the list comes from the Federal Deposit Insurance Corp.

The banks added about $300 million in assets from a year earlier. Acquisitions and investor financing led the surge.

The increase in assets comes as local banks, which mostly serve businesses, work to strengthen balance sheets and compete with big banks that have far greater lending power.

The locally based banks, which accounted for 11% of the $74 billion in deposits in the county as of June 30, compete with large national banks that dominate the market here, as well as midsize regional banks.

Fourteen banks on the list increased assets, while 11 saw drops.

Profits were just as mixed, evidence that many banks still have to clean their balance sheets of bad commercial real estate loans that larger rivals already have written off.

Thirteen banks posted a profit for the six months through June, a sign the worst likely is over and a recovery is in the works.

Twelve banks lost money as lower loan demand and fewer creditworthy businesses continue to pose challenges for lenders.

Local banks primarily make money through interest and fees along with business, real estate and other loans.

Low interest rates continue to dampen earnings with banks making less on loans.

The entire group lost about $1.6 million for the six months through June, an improvement from $20 million lost a year earlier.

Stringent regulatory requirements led banks to set aside more cash to cover potential loan losses. Higher fees paid to the FDIC for its bailout fund also hampered bottom lines.

The banks reported a lower return on assets. The average was a negative 0.3%, which was better than the 1.7% decline a year earlier.

The banks employ 1,116 people here, up 14% from a year earlier. The uptick supports a larger trend of professional and financial services hiring in the county in the past 12 months.

Core Capital Ratio

Core capital or leverage ratios, which measure the cushion banks have against bad loans, came in at an average of more than 11%, which is considered healthy by regulators.

The county’s largest homegrown bank, Pacific Mercantile Bank in Costa Mesa, saw a 4.8% drop in assets to $1.1 billion as of June 30.

The bank has spent the better part of a year ridding itself of bad loans tied to real estate and foreclosed properties.

“I think the worst of it is over,” Pacific Mercantile Chief Executive Ray Dellerba said.

Consent Order

Earlier this year, Pacific Mercantile’s parent company agreed to a consent order with federal and state regulators to reduce problem loans and assets while strengthening capital reserves.

Pacific Mercantile’s loans were down nearly 5% to $775 million as of June 30.

The bank approves about 1 in every 25 loans today, down from 1 in 7 before the recession, according to Dellerba.

Deposits rose more than 4% to $978 million as of June 30.

The bank lost $10.2 million for the six months through June, the most of any on the list. That total skewed income figures for the entire group, which was profitable without Pacific Mercantile in the mix.

Pacific Mercantile was hit with FDIC insurance premiums eclipsing $4 million because of its portfolio of nonperforming assets, mostly loans 90 days or more past due.

The bank’s number of bad loans is gradually decreasing, according to Dellerba.

“We’ve taken the majority of hits we’re going to take,” he said.

The bank sold more than $8 million in foreclosed properties in the third quarter and expects to double that this quarter, Dellerba said.

Pacific Mercantile lost $125,000 in the recently ended quarter, down from a $3.8 million loss a year earlier. It expects to turn a profit in the fourth quarter, according to Dellerba.

“That’s the sign of a turnaround,” he said.

The bank has the lowest core capital ratio on the list at 6.75% as of June 30. Pacific Mercantile has a risk-based capital ratio—a broader measure—of 11%, which is considered well capitalized.

Centennial

No. 2 Fountain Valley-based Centennial Bank also saw assets drop. They fell 6.3% to $811.7 million for the 12 months through June.

The bank, which lends to business, apartment owners and others, was issued a cease-and-desist order from the FDIC in February to shore up its management team, improve its capital position and reduce risk exposure.

Centennial doubled its profit from a year ago to $2.4 million for the six months through June.

Acquisitions helped No. 4 Tustin-based Sunwest Bank grow assets 41% to $659.3 million, the biggest gain by percentage and actual dollars on the list.

Sunwest acquired three failed banks last year. One of those acquisitions was Pacific Coast National Bank of San Clemente, which ranked No. 19 on last year’s list.

For the six months through June, Sunwest posted the highest profit of any bank on the list at $4.8 million. Sunwest’s profit was up 224% from a year earlier.

The bank avoided speculative real estate and construction lending during the 2000s boom, which put Sunwest in a position to pick up some pieces of the wreckage.

The bank, which boosted loans 53% to $323.6 million as of June 30, has written off only a handful of bad loans this year.

California Republic

No. 9 California Republic Bank jumped nine spots on the list, the biggest gain. The Newport Beach-based bank grew assets 73% to $321.7 million.

“We have a 100% clean portfolio,” Vice Chairman John DeCero said. “That’s why we’ve been growing as well as we have. We haven’t been distracted by workouts or bad loans.”

The bank has yet to see an underperforming loan or late payment, DeCero said.

California Republic Bank President Jon Wilcox said he credits the bank’s numbers to hiring industry veterans who have long business ties in OC.

“This is the culmination of years of hard work,” he said.

The bank posted its first quarterly profit in the second quarter since opening its doors in 2007 and followed that with a $2 million profit in the third quarter.

It’s common for new banks to lose money in the first few years as expenses outpace revenue. Without a lot of loans and clients, banks can’t earn money through interest and fees.

California Republic raised $52 million in 2007 before getting regulatory approval.

The one newcomer to the list is No. 12 Opus Bank, which has its on-the-books headquarters in Redondo Beach but is run from Irvine.

The Business Journal opted to include Opus on the list since Chief Executive Stephen Gordon and others run the bank from here.

Gordon led a recent $460 million investor refinancing for Opus, which had been known as Bay Cities National Bank.

He said he hopes to grow the bank to 75 branches across California, up from five now, all in the South Bay area of Los Angeles County.

Opus had assets of $273.1 million as of June 30.

First Vietnamese American Bank in Westminster, which ranked No. 24 last year, didn’t make this year’s list.

The bank, which opened with fanfare in 2005 as the first bank to specifically target Vietnamese-Americans and their businesses in Little Saigon, is under fire from regulators.

The California’s Department of Financial Institutions in July approved the sale of First Vietnamese to Charles and Michael Lhuillier, brothers who run one of the largest pawn shop and jewelry operations in the Philippines.

The FDIC, which has declared First Vietnamese critically undercapitalized, still needs to approve the acquisition.

About Holly Bolling:

You can find her by email at Holly@4closure.com or by calling Preferred Default Management, Inc at 949-228-3296.

Holly Bolling is the President of Preferred Default Management, Inc. (Preferred) Preferred has been the

“go to team” for foreclosures, lenders, mortgages, investors and investors on real and personal property since 1989.

Preferred is the adviser for lenders to process and collect delinquent and default loans and notes. Preferred provides

counsel advice and implementation of tools techniques and collection for collections Nationwide. Ms Bolling can

be reached at 949-228-3296 or by email at PreferredForeclosure@gmail.com. Protecting Lenders Since 1989. We

stand as your first line of defense throughout the foreclosure process by recognizing and defusing problems quickly

and efficiently. The right trustee is critical to asset recovery success in terms of time, costs and results. Call us for

personalized services including judicial & non-judicial foreclosures, Deeds in Lieu of Foreclosure, HOA

Foreclosures, Bankruptcy, Forbearance Agreements, Lost Document Retrieval, Evictions, Collections and warrants.

We process foreclosures efficiently! Preferred Default Management, Inc.

PreferredForeclosure@gmail.com Holly Bolling

www.4closure.com 949-228-3296

Opportunities and Risks of Buying Distressed Debt

Preferred Default Management, Inc.

In the past few years it has become increasingly popular for hedge funds to purchase distressed debt as an investment. Many of these distressed debts are found in the form of commercial and real estate loans, originally made by banks and other financial institutions, which are now in default— because the borrower is either not making the agreed upon payments, or is in default on other covenants in the loan documents. These can be excellent investment opportunities as many of these loans will ultimately be paid in full.

Banks will agree to sell these loans for less than face value because, for regulatory reasons, they want to reduce the number and monetary amount of problem loans on their books.  For this reason, the acquisitions of “problem loans” often yield above-market rates of return. For example, if a borrower is paying a default rate of interest of 14% on the outstanding principal of a loan, and a hedge fund purchases that loan for 80% of its face value, the hedge fund can realize a rate of return of 17.5%. The rate of return can often be even higher because of the various fees borrowers can be obligated to pay under the loan documents.

Every investment, including buying a problem loan, includes specific risks. The most obvious risk for this type of investment is that the borrower can fail to repay the loan and the hedge fund will be unable to collect the loan in full from the collateral or guarantors. A hedge fund may also run the risk of becoming liable to the borrower, other creditors or the government if it acts improperly in managing the loan after it has acquired it. Accurately evaluating a problem loan before purchasing it and managing the loan correctly after purchasing it are necessary steps to minimize these risks.

Evaluating the Problem Loan

There are a number of issues for a hedge fund to consider before investing in a problem loan.  A hedge fund evaluating a problem loan prior to purchasing it should examine the underlying strength of the borrower, the quality of its management, the value of its assets, and the likelihood that the borrower will have the financial capability to repay the loan. The hedge fund must also take into consideration a problem loan’s “restructuring risk”.  The fundamental nature of a problem loan is that the borrower is in default on its obligations and the loan will usually have to be restructured. The evaluation of this “restructuring risk” should be a critical part of any assessment of a problem loan.  This can be accomplished through a legal analysis of the loan documents as well as an analysis of the lender’s legal position with respect to other creditors. The terms of many commercial and real estate loans are heavily negotiated at the time they are made, during these negotiations the lender may have made concessions which will limit the ability to collect from the borrower or give other creditors priority against the borrower’s assets. Also, many states have laws that affect what the lender may do to recover the loan from the borrower, notwithstanding what the loan documents say. California’s one­form-of-action, security-first and anti-deficiency laws, which apply to loans secured by real estate, for example, are particularly problematic and are different from those of any other state.

Another important aspect to consider is whether or not the borrower could go into bankruptcy and how that could affect the existing debt. This step is crucial because the Bankruptcy Code contains conditions that can supersede terms in the loan documents, changing things like the amount that the borrower is obligated to pay and the timing of each payment.  Purchasing a loan without reviewing it for these pitfalls will most certainly result in failure.

This also brings to mind the important task of evaluating the terms of the purchase agreement by which the hedge fund purchases the problem loan.  Purchase agreements such as these are fairly standard in many respects, but they may vary in aspects like the representations and warranties made by the seller, and the remedies available to the purchaser if those representations and warranties turn out to be incorrect.  During the restructuring process, reviewing the representations and warranties can be vital to a hedge fund’s evaluation of a problem loan because there are many facts not apparent from the face of the loan documents (e.g., information on whether the borrower has asserted claims that, if correct, would reduce its liability on the loan), and the purchaser can be subject to that the borrower has against the original lender.

Managing the Problem Loan

Although the vast majority of loan agreements allow the lender to recover from the borrower any costs and attorney’s fees incurred in managing a problem loan, a successful hedge fund will want to be proactive to increase the chances of being repaid.  It is important not to view the acquisition of a problem loan as a passive investment.  Circumstances that affect the borrower’s ability to repay a debt can change significantly.  For this reason, the hedge fund should remain continually informed of any developments that could negatively affect the loan’s repayment.

The hedge fund’s role will differ depending on whether the borrower is in bankruptcy. In a non-bankruptcy restructuring, there is no court oversight and the parties have substantial freedom in making any decisions. This freedom, however, comes with significant legal risks if the lender acts inappropriately.  A sensible investor will not make any major restructuring decisions without legal advice regarding the propriety and structure of the proposed course of action. If not handled properly, a restructuring decision may run the risks of absolving guarantors from liability on their guarantees or causing the hedge fund’s security interest to lose priority to other creditors.  Further, if the hedge fund becomes too deeply involved in the management of the borrower, it may incur liability to the borrower if it makes bad business decisions.  Becoming too deeply involved in managing the borrower may also incur liability to governmental agencies if the borrower fails to pay taxes or violates environmental laws or other government requirements. Furthermore, if the hedge fund decides to foreclose on its collateral, it may incur liability to the borrower and other creditors if it fails to act in the manner prescribed by law.

If the borrower is in bankruptcy, restructuring and other significant decisions almost always require bankruptcy court approval. Bankruptcy courts have considerable discretion to make decisions within the constraints of the Bankruptcy Code. A hedge fund that is considering asking a bankruptcy court to approve a course of action should always keep in mind what the bankruptcy court likely would or would not approve, and devise a strategy taking with that in mind. Also important is the fact that a bankruptcy court has the power to make decisions that could jeopardize the hedge fund’s position against the borrower and other creditors.  To minimize the chances of that happening, the hedge fund should monitor, and participate in, the bankruptcy proceedings.

Buying distressed debt can be a lucrative investment for a hedge fund. It involves certain risks, however, and a prudent investor can, and will, act to minimize those risks.

Holly Bolling is the President of Preferred Default Management, Inc. (Preferred)

Preferred has been the “go to team” for foreclosures, lenders, mortgages, investors and investors on real and personal property since 1989. Preferred is the advisor for lenders to process and collect delinquent and default loans and notes. Preferred provides counsel advice and implementation of tools, techniques, and collection for collections nationwide. Ms. Bolling can be reached at 949-228-3296 or by email at PreferredForeclosure@gmail.com. Protecting Lenders Since 1989. We stand as your first line of defense throughout the foreclosure process by recognizing and defusing problems quickly and efficiently. The right trustee is critical to asset recovery success in terms of time, costs and results. Call us for personalized services including judicial & non-judicial foreclosures, Deeds in Lieu of Foreclosure, HOA Foreclosures, Bankruptcy, Forbearance Agreements, Lost Document Retrieval, Evictions, Collections and warrants.

We process foreclosures efficiently! Preferred Default Management, Inc.

PreferredForeclosure@gmail.com Holly Bolling

www.4closure.com 949-228-3296

PDM-EBook-Problem Loans in Turbulent Times