Commercial Loans and Fun Blog

A year ago, I wrote a blog article entitled, Commercial Loans, Missiles, and the Longbow.   I just re-read it, and it's an interesting article.  

The point of the article was that a weaker force can devastate a far more powerful one, if it enjoys a longer reach.  The article goes on to describe the Battle of Crecy, when a tiny English army of longbow men and men-at-arms dismounted and took positions behind trenches and horse defenses at the top of a hill.

Over 100,000 heavily-armored French knights charged repeatedly up that hill, but the powerful English longbows, tipped with bodkin arrowheads, easily pierced the French armor.  The French knights were slaughtered.  Few got close enough to even wield their swords, axes, and maces.  The longer range of the English longbow made short work of first the French crossbow men and then the charging French knights.

The battleship in World War II became obsolete, once it was outranged by the aircraft carrier.  I don't think a single battleship from either side even fired a shot on an enemy aircraft carrier.  In the same way, the American aircraft carrier faces range obsolescence in the age of the missile.  

Ballistic missiles, particularly China’s carrier-killer DF-26, can easily outrange America’s carrier fleet.  The range of a typical carrier combat plane, with a nine-ton payload, is only 1,300 miles.  The range of the Chinese DF-26 carrier-killer ballistic missile is a whopping 2,490 miles.

Imagine a grammar school fight with the schoolyard bully.  The tough little guy wants to get close enough to land some blows on the bigger guy, but the bully can just put his palm on the smaller guy's forehead and keep his punches from falling.

The U.S. military has woken up to the problem.  We are racing to develop midair refueling drones, which would accompany our aircraft on bombing missions and refuel them in flight.  This would allow us to reach Chinese targets.  Unfortunately, we don't have these unmanned refueling drones yet, and war may break out before they ever reach the Far East theater of operations.

With the passage of its recent extradition treaty with Hong Kong, the Red Chinese have finally taken control of Hong Kong.  Any protestor in Hong Kong can now be extradited to China for "trial" and hard labor.  Those young  protestors absolutely understood the real-life effect of this new treaty.  Four Hong Kong protestors were extradited to China this week.

The next step in China's hegemonic ambitions is now Taiwan.  Hegemony is the political, economic, or military predominance or control of one state over others.  In ancient Greece, hegemony denoted the politico-military dominance of a city-state over other, nearby city-states.  

The dominant state is known as the hegemon.  For example, Sparta was the hegemon of the Peloponnese, that huge chunk of the mainland of Greece that is southwest of the Corinthian narrows, a tiny choke point.  That choke point is incredibly narrow.  My daughter and I have actually seen it.

Four years ago, Jordan, my wonderful 22-year-old old daughter, and I visited Greece, as part of her Spring foreign trip, while she attended Culver Academies.  I moved to Indiana, even though my company is located in Sacramento, California, in order to be close to our three kids while they attended this wonderful school.  

Culver Military Academy is famous for its Culver Black Horse Troop - 80 all-black horses.  I rode in President Nixon's second Inaugural Parade.  George IV rode in George W. Bush's first Inaugural Parade, and Tom rode in W's second Inaugural Parade.  Jordi rode, as part of the Culver Equestriennes, in Trump's first Inaugural Parade.  As the Equestriennes were passing in review, right past Trump and Mike Pence, the camera for CNN zoomed right in on my lovely daughter's sweet smile.  She rocked!  Haha!

Will China wait for the U.S . to develop a response to its carrier-killer missiles?  Unfortunately, there is an old military adage that generals always fight the last war.   For the past 15 years, our admirals have been preparing for another World War II in the Pacific.  Our Navy has fallen terribly far behind.

This is why I read with interest an article in the National Interest, a magazine dedicated to military matters.  The article mentioned the work of Dr. TX Hammes, a retired Marine Corps colonel and a Distinguished Research Fellow at the National Defense University’s Institute for National Strategic Studies.

35-minute time exposure of illegal fireworks
being set off in Los Angeles

The article described Hammes’ solution - to phase out America’s carriers and to replace them with a large fleet of small, inexpensive missile-armed merchant ships.  Outfitting former merchant ships with missile launchers would be a substantial cost savings for the Navy.

A mere $5 billion would be enough to create forty missile merchant ships supplied with between 1600-2000 missiles, requiring only 1,600 sailors to crew all forty of them.  According to Hammes, these merchant vessels, whether they be tankers or container ships, are more expendable, tougher, and have a lower profile than aircraft carriers or other surface ships.

Developing conversion kits and experience to quickly modify merchant ships into missile platforms would allow the U.S. to quickly mobilize, in time of war, by converting even more merchant ships.  

I fear that a missile war with China is coming.  What if the economic damage to  China from COVID and the resulting worldwide condemnation is greater than what we have been told?  What if the Chinese public starts to get restless, and the communists fear that they they are losing their grip on power?  The classic move would be to go to war with someone - this time with the U.S. over Taiwan - so that the Chinese people would rally around the flag.

Both sides know that a nuclear war would destroy most life on Earth; therefore these missiles will NOT be nuclear-armed.  These will be conventional missiles; but they will also be incredibly accurate.  The Russians are working on nuclear-powered missiles that could even reach Indianapolis.  Yikes!

Heavens, I sure hope our next President follows the advice of Dr. Hammes.  As I often tell my kids, history doesn't always happen to the other guy.

Last week, Bank of America shook up the investing world with their latest letter to their investors.

"A torrent of fiscal and monetary stimulus to fight the effects of the coronavirus, combined with already-low interest rates, will contribute to a 'Great Debasement' of the U.S. dollar in the years ahead," according to Bank of America Merrill Lynch.

"That, in turn, will make investments in commodities and emerging markets more appealing, as investors look for reliable inflation hedges and savvy ways to play a weaker greenback," BofA chief investment strategist Michael Hartnett wrote.

“Interest rate repression means investors can’t hedge the inflationary risk of $11 trillion of fiscal stimulus via ‘short bonds’ … so investors are crowding into ‘short US dollar’, ‘long gold’ hedges,” Hartnett wrote.

U.S. dollar depreciation is “well underway as the default narrative for a US economy with excess debt, insufficient growth, and maxed-out monetary and fiscal stimulus,” he added.

"Holy Poopski!" as they say in Russia.  In my lifetime, the dollar has always been the strongest currency in the world.  Now Bank of America is saying that the value of the dollar will be falling steadily in the coming years.  This means we will start to suffer inflation again, after decades of disinflation, as imports cost more and more.  

But what was The Great Debasement?  Debasement means mixing more of a common metal with the precious metal (usually gold or silver) that gave the coins its worth, while maintaining the face value of the coin.

The reasoning behind debasing the coinage was to be able to make more coins and therefore create more money.  However, the side effect was inflation, with people hoarding the older coins that contained more of the precious metals.

The Great Debasement (1544–1551) was a currency debasement policy introduced in 1544 in England, under the orders of Henry VIII.  The Great Debasement saw the amount of precious metal in gold and silver coins reduced, and in some cases, the precious metal replaced entirely with cheaper base metals, such as copper.

By 1551, the coinage was worth one fourth to one-sixth what it had been before Henry VIII began the debasements.  Eventually the layer of silver had become so thin that it would wear off, revealing the copper below.  This happened particularly on Henry VIII’s nose on his image on the coin, giving him the nickname, Old Copper Nose.

Delta aircraft that was diverted in NYC due to hail from a thunderstorm.

Overspending by Henry VIII to pay for his lavish lifestyle and to fund foreign wars with France and Scotland are cited as reasons for the policy's introduction.  The main aim of the policy was to increase revenue for the Crown, at the cost of taxpayers through savings in currency production, with less bullion being required to mint new coins.

During debasement, gold standards dropped from the previous standard of 23 carat to as low as 20 carat.  Silver was reduced from 92.5% sterling silver to just 25%. Revoked in 1551 by Edward VI, the policy's economic effects continued for many years until 1560, when all debased currency was removed from circulation.

In defense of Henry VIII, the countries of Europe had been debasing their own currencies for decades.  A common practice of the period was the clipping of coins, or removing some the valuable metal from their edges.  This is why the edges of later coins were eventually given those scores of vertical groves, to expose any evidence of clipping.

Because English currency had not yet been debased, it was, prior to 1544, the envy of Northern Europe.  Unfortunately, English currency kept disappearing from circulation.

Think about it.  You owe a debt that must be repaid with a one-ounce gold coin.  You have two coins.  One is a French gold florin that is 50% gold.  The other is an English gold sovereign that is 88% gold.  Which will you likely use to repay your debt?  Which coin will you keep?  This leads us to Gresham's Law.

Gresham's Law is the tendency for money of lower intrinsic value to circulate more freely than money of higher intrinsic and equal nominal value.  Nominal here means face value.  In layman's terms, “Bad money drives out good.”  Debased coins drive good coins out of circulation.

When merchants worldwide lost confidence in the English mint, English traders were financially punished.  If they had a coin that was 20 carat, it traded at an even lower exchange rate, say 18 carat.  Since England was a trading nation, and its merchants were losing money on every exchange of coinage, the debasement was eventually ended.

But that didn't immediately end the problem for English merchants.  English coinage had lost the confidence of the world.  The discrimination against English coinage continued for another nine years.  Finally the Crown was forced to buy up all of the debased coins - sort of like when the U.S. eventually redeemed all of the greenbacks issued during the Civil War.  The debased coins had to be melted down and replaced with totally new coinage.  

Okay, so what do we with this new knowledge?  If Bank of America is to be believed, investors should buy gold and international stocks, located in countries that are debasing their own currencies slower than the United States.  How humiliating!  Geesch.

I am looking for an expert witness in a commercial real estate lending case.  You will be paid an expert witness fee for your time, and qualifying as an expert looks great on your resume or your website.  Here are the details.

Lesson From Business School:

Have you ever wondered why Elon Musk is so hell-bent on building new battery giga- factories all over the world so quickly?

The reason why is because that manufacturers have learned that the more experience they garner in building widgets, the lower their cost of building each widget.  

As they build widget after widget, they learn a little trick here and a shortcut there.  Pretty soon these little tricks and shortcuts add up to some real cost savings.  This leads us to The 10% Rule.   

The 10% Rule:

Every time a manufacturer doubles the number of widgets that he has ever constructed, his cost to manufacture each widget falls by 10%.  In some cases, his cost per widget falls by 15%.

It is important to appreciate the word, "ever."  If Elon Musk had manufactured one-hundred thousand electric auto batteries in the entire life of Tesla, at a cost of $1,000 per battery pack, by the time Tesla had manufactured TWO-hundred thousand batteries, the company could reasonably expect to be able to manufacture each battery pack for just $900 each.

The Japanese taught us this lesson.  In the late 1980's, the Japanese were eating our lunch in manufacturing.  Their cars were cheaper, and their quality was outstanding.  Japanese chip makers were rising to rival Intel, Advanced Micro Devices, and Texas Instruments.

Their bread-and-butter D-Ram computer chips were as good as ours, and they were selling them at less than their cost.  "Dumping!" cried Texas Instruments, in a complaint and lawsuit before the Federal Trade Commission.  "They are bidding against us on big computer chip orders, and they are quoting prices that are lower than their cost.  They are dumping D-Ram chips at less than their cost, just to steal market share!"

Oops.  By the time the case reached trial, however, the Japanese were able to prove that they had actually made a handsome profit on that big order.  Even though their cost per chip was $100 at the time they bid on that big order, and they bid $99 per chip on that big order, the order was so large that by the time they delivered the chips, their cost had fallen to just $90 per chip.

They Japanese literally "schooled" us, and that is why this manufacturing lesson is now taught in most U.S. business schools.

So whenever Tony Stark... oops, I mean Elon Musk... opens another huge battery giga-factory somewhere in the world, just nod your head and say, "You go, Elon!  Pull even further ahead in lowering your costs."

Did you know that Elon Musk actually did a cameo in one of the Ironman movies?   Haha!  Anyone else out there think that Gwyneth Paltrow, playing Pepper Potts, looked absolutely outstanding in that white outfit?

The opposing side is claiming that obtaining an MAI appraisal is not enough when making a commercial real estate loan.  They are claiming that every commercial lender should obtain two additional broker's professional opinions, in addition to the expensive MAI appraisal.

If you currently work as a commercial real estate loan officer or as a senior commercial real estate lending executive for either (1) a commercial bank; (2) a credit union; (3) a nonprime ABS/Wall Street lender, such as Silverhill, Cherrywood, Velocity, etc.; or (4) a hard money commercial lending shop, you might be a good candidate to testify in this case as an expert.

Sorry, guys, but the testimony of a typical commercial loan broker might not help, unless have been an unusually successful commercial loan broker for more than twenty years.

The good news is that you will almost certainly not have to travel anywhere.  In this time of COVID, the entire case will probably be held using Zoom, so we are just talking about three or four hours of depositions and testimony before a computer screen.  

Obviously you will receive an expert witness fee for your time, and having testified as an expert witness looks great on a resume and your website.

Will you serve a good cause?  If so, would you kindly write to me at the email address below, telling me of your current employment, your commercial real estate lending experience, and to what you might testify on the subject of the standard of care for commercial real estate lenders in connection with MAI appraisals.

I receive on average 1,350 emails per day, so it is critical that your Subject line please read exactly as follows, "Expert Witness."  

Thank you.

George Blackburne III, Esq.
574-360-2486
george@blackburne.com

Last week I wrote a well-received article about commercial real estate CLO's.  Thank you for all of your positive and kind comments.  

You will recall that CLO stands for collateralized loan obligations, which are bonds backed by a collection of loans.  You can tell from the title of this article that some of these CLO's are in trouble; but it is important to note that the troubled CLO's are NOT the ones backed by bridge loans on commercial real estate.  The troubled CLO's are the ones backed by junk bonds.  More on this later.

I was writing a training article this week about trust deed investing.  I pointed out to our prospective trust deed investors that real estate values tend to crash about once every ten to twelve years.  The lesson for the day was that trust deed investors should be very aware of where they are in the real estate cycle.

Trust deed investors can be very aggressive right after a financial crisis, after real estate values have already plunged by 45% and finally found a bottom.  Examples of financial crises include the S&L Crisis, the Dot-Com Meltdown, and the Great Recession.

But when it has been ten to twelve years since the last financial crisis, the wise trust deed investor should dial back his aggressiveness on his loan-to-value ratios.  He should be content with lower yields in order to compete for safer deals.  

Curious, I started doing the math.  Let' see, the Great Recession was in 2008.  Today is 2020.  Twenty-twenty minus 2008 works out to ... holy crap... twelve years!

Then I read yesterday the most important article about the economy that I've read in five years.  It was an article in the Atlantic Magazine entitled, Will the Banks Collapse?  I strongly urge you to read the full article.

The gist of the article is this:  America's largest banks are in serious danger.  They have a poop-ton of money invested in CLO's - even more than they had invested in subprime mortgages in 2007.  These investments could easily evaporate, and the losses would wipe out 50% to 80% of their capital - the dough they've retained to act as a protective buffer against loan losses and which protects depositors.

Think back to Lehman Brothers.  The crash in subprime mortgages wiped out their capital.  Poof.  Bye-bye, Lehman Brothers.  See the picture at the top of the article.

What's so wrong with CLO's?  First of all, in order to distinguish between commercial real estate CLO's (which are fine) and the troubled CLO's backed by junk bonds, I am going to call the latter, junk bond CLO's.

Normally big corporations, when they need money, can either borrow from a bank or issue bonds in the corporate bond market.  Corporate bonds with a maturity date of less than 270 days are known as commercial paper.  The commercial paper market has little appetite for bonds rated BB or lower, which we know as junk bonds.  

These high-yield junk bonds are instead bought up by companies in the CLO business known as asset managers.  There asset managers bundle them into portfolios, create different tranches (slices of the portfolio which take different levels of risk), get the various tranches rated by a rating agency (Moody's, Standard & Poor's, etc.), and then sell off these rated bonds to institutional investors.  The high-yield bond market is also known as the leveraged loan market.

The riskiest tranches offer sky-high yields, but they will be the first to absorb any losses in the portfolio.  The lowest-yielding tranche, however, will often be rated AAA. Think about that.  You have a collection of junk bonds, issued by companies which are sometimes close to bankruptcy, and yet somehow some AAA-rated bonds magically emerge.

About now, some of you may be asking yourselves, "Hey, wait a minute.  I think I've heard this song before."  Yup.  These are the same shenanigans that took place in the years leading up to the Great Recession with subprime mortgages.  As Dr. Phil might ask, "How did that work out for you?"

The author then goes on to point out that the theory behind junk bond CLO's is that the default correlation is low.  The default correlation is a measure of the likelihood of loans defaulting at the same time.

"The main reason CLOs have been so safe (in recent years) is the same reason (why) CDOs seemed safe before 2008.  Back then, the underlying loans were risky too, and everyone knew that some of them would default.  But it seemed unlikely that many of them would default at the same time.  The (subprime residential) loans were spread across the entire country and among many lenders.  Real-estate markets were thought to be local, not national, and the factors that typically lead people to default on their home loans—job loss, divorce, poor health—don’t all move in the same direction at the same time.  Then housing prices fell 30 percent across the board and defaults skyrocketed."

Right now the U.S. economy is reeling from the coronavirus and the lockdown.  Name brand companies are filing for bankruptcy or closing stores in big bunches.  The default correlation today is far from low.  The Coronavirus Crisis has depressed the economy so badly that we are having a tidal wave of corporate defaults.  The losses in junk bond CLO's are likely to wreck havoc, even in the the AAA tranches of large CLO's.

During the Great Recession, Congress and the U.S. Treasury bailed out the big banks.  The author points out in his article that when the big banks report their losses in CLO's, Congress and the American people may be far less forgiving than in 2008.  Instead of just Lehman Brothers, Congress and the Treasury may let a whole bunch of big banks fail.  The author suggests that the result may be lots of smaller banks focussed primarily on traditional business, like taking deposits locally and lending to local companies known to the bank. 

Now let's add a few more incendiary goodies to our explosive mix.  We still have not seen the wave of articles in the financial press talking about declining worldwide sales of raw materials and goods to China, the world's number two market.  China was hurt pretty badly by the Coronavirus Crisis and the resulting worldwide condemnation.  I can't imagine too many companies moving their manufacturing plants to China now.  Then we have China's contracting money supply, when banks continue to rake in loan payments but fail to recycle the money into new loans.  So far China has successfully covered up their declining GDP, but sooner or later investors will realize that China is reeling.

Then we have the Presidential election.  It is looking more and more likely that Donald Trump could lose.  The left controls most of the press, so Mr. Trump could make a tough but probably wise decision (like encouraging governors to re-open their states before the U.S. economy completely cratered), but the liberal press would simply characterize the act as both the act of a dictator and as a failure of leadership at the very same time.  Haha!

With the coronavirus still active, Trump can't bypass the press by holding huge rallies, like he did in 2016.  Perhaps the final nail in Trump's coffin was when Twitter and Facebook began censoring and censuring his posts and political ads.  When it becomes clear that Trump might lose, the markets are not going to like it.

The only good news is that the Fed is flooding the markets with trillions and trillions of dollars.  The Fed is even buying up a bunch of junk bond CLO's.  It has often been said, "Never fight the Fed."  But what happens after the election, when the spigot of money is tightened?

My recommendation is to watch the price of gold.  Gold goes up, not so much during periods of inflation, but rather when investors lose confidence in the ability of corporations to make the payments on their bonds.  Unlike bonds, gold cannot default.  It will never go to zero (because women look so gorgeous wearing it).  I urge you to look at gold prices as the canary in the coal mine for the coming financial crisis.

A CRE CLO stands for a commercial real estate Collateralized Loan Obligation, and it is a security that is backed by a pool of commercial loans.  The individual borrowers make their payments to the issuer – the company that made and pooled the loans – and then the issuer makes payments to the investors who invested in the bonds backed by the CLO.

A typical commercial al real estate CLO (“CLE CLO”) lasts somewhere between two to four years.  In order to create a CLO, the issuer – also known as the collateral manager - begins by securing a warehouse line to acquire the commercial loans.  Once this warehouse line has been secured and the new commercial loans have been made, the collateral manager begins issuing the CLO securities to investors.  The proceeds from the issuance of these securities (CLO bonds) are then used to pay off the warehouse line, and the excess proceeds are used to purchase additional loan assets.

This brings up an interesting point.  Whenever an issuer (think of the issuer here as the lender) securitizes the loans, the issuer sells the bonds for more money than the amount of the loans.  The issuer earns a premium.  The issuer might make $300 million in loans and sell them off for $320,000.  This extra $20 million (premium) is the issuer’s whole incentive for securitizing the deal.

CLOs are separated into several tranches, which are separate slices of the pool of loans. They are differentiated by risk based on the priority of its claim on the payouts and the exposure to risk of loss from the loan pool.  The investors who invest in the lowest yielding tranche get paid first.  If there is any money left over, the second lowest yielding tranche gets paid, and so on.  Given the varying levels of risk, each tranche is typically assigned a different credit risk rating.

CLOs can be actively managed or static.  Managed CLOs allow the collateral manager to buy and sell individual loans for the collateral pool of the CLO to increase the gains of the security.  Static CLOs, on the other hand, invest in a pool of loans without any reinvestments once those loans mature, and typically feature a shorter term than actively managed CLOs.

CRE CLOs are primarily made up of bridge loans on properties that are in a transitional phase, such as a renovation, expansion or repositioning.   This differs from other common financing options like real estate mortgage investment conduits (REMIC), which pool mortgages together in order to issue mortgage-backed securities.   REMICs are significantly more restrictive, in that renovations or any changes to the properties affecting value may not be permitted.   

Additionally, since CRE CLOs can be static or managed, collateral managers can change the collateral of the CLO throughout its reinvestment period.  REMICs, on the other hand, do not allow changes to the pool of loans throughout its entire lifetime.  This is due to the federally tax-exempt nature of REMICs, which can be lost if significant changes are made to the collateral.  CRE CLOs have proven to be a flexible option for borrowers, lenders and investors alike.

Did you know that if you have as conduit first mortgage that you are not allowed to improve the value of the collateral?  Suppose you own a shopping center, with a 20-acre vacant parcel behind it.  If you add 120 self-storage units onto that vacant land, thereby increasing the income generated by the property by $10,000 every month, that the conduit lender will likely foreclose on you!  It’s an IRS requirement.

In recent years, the issuance of commercial real estate (CRE) collateralized loan obligations (CLOs) has slowly increased.  After a record year in 2018, issuance was over 30% higher in 2019, signaling that the growth continues to accelerate.  The CLOs that have emerged after the financial crisis of 2008 have significantly different collateral, primarily comprised of transitional, first lien secured mortgages rather than the mezzanine and discounted debt that was seen prior to the crisis.

Prior to the financial crisis, CRE CLOs, previously known as collateralized debt obligations (CDOs), were structurally much different. Issuers typically did not have much risk at play in terms of equity in the security, and they were primarily used as a way to take advantage of arbitrage opportunities.  Many times, CDOs would be packaged with discounted subordinate bonds from commercial mortgage-backed securities (CMBS), thus taking highly leveraged, non-investment grade securities and repackaging them into highly rated CDOs.  There was very little exposure to transitional, first lien collateral.  These issues, among others, caused a high level of fear of these products within the market.  (This is a polite way of ways they were darned risky speculations.)

Following the financial crisis of 2008, many changes have been made to CRE CLOs.  As previously mentioned, the CLOs that have recently emerged have different collateral.  They are now primarily comprised of transitional, first lien secured mortgages instead of mezzanine and discounted debt.  

Many times, issuers of CRE CLOs are the lenders who raise money by issuing the CLO bonds and offering equity to outside investors for the issuance of loans to borrowers seeking transitional loans.  Recent issuers typically hold a notable amount of equity in the CLO, opening themselves to losses.  In plain English, modern issuers of CRE CLO’s have a ton of skin in the game.

Before the crisis, many issuers had little to no loss exposure, creating situations of moral hazard in the pursuit of arbitrage.  Additionally, the terms of CLOs prior to the crisis were typically around ten years, while current terms are around three years on average.

CLOs offer several improvements to other CMBSs, including interest coverage tests and over-collateralization tests, so that the successive structure of the payments waterfall can be adjusted to divert the payments away from subordinate tranches and into senior tranches to avoid losses.

In late 2019, before COVID, highly-rated tranches of CRE CLOs with a two-year maturity were earning approximately 110 basis points over benchmark rates, while CMBS’s were earning just 50 basis points over benchmark rates.  The shorter duration and the floating rate nature of CRE CLOs is attractive to investors in a rising rate environment relative to CMBSs, that were previously enjoying higher demand.   Additionally, CRE CLO collateral managers are often involved in the loan origination and servicing processes for the loans making up the collateral, which can have a strong impact on loan performance and potential workouts.  In plain English, the same guys who brought the elephants to the parade have to clean up after them.  

Pre-COVID Outlook For CRE CLOs

Before the coronavirus crisis, the demand for CRE CLOs was increasing.  This rising liquidity was allowing lenders to borrow at cheaper rates, which in turn lowered the rate at which borrowers could obtain loans.  Bloomberg indicated that there were 20 active issuers of CLOs as of July 2019.  In 2019, CLO issuance reached $19.2 billion, a 40% year-over-year growth since 2016.  As new issuers entered the market, borrowing options were growing as more issuers competed on offerings.   

Post-COVID Update:

Collateralized Loan Obligations in the commercial real estate market are a major underpinning of the bridge loan sector.  It has been virtually shut down since early March as no bond buyers were active.  

Activity has started up again in the past few weeks, as some pools of selected pre-COVID originated loans are being successfully securitized.  Spreads are wider, for example: pre-COVID pricing for AAAs was approximately LIBOR + 100.  Those bonds are now selling at about L + 235 with oversubscribed buyer interest.

Look for bridge loan programs offering 80% LTC loans at L + 275-300 pre-COVID to now offer 60-70% LTC at L + 450 – 550.  And the now familiar stratification of product types will be in effect: multifamily and industrial in favor, with office needing a good story, retail very selective and no hotels.

Guys, I would love to be able to say that I was smart enough to write this article; but in truth, I stole much of this great material from a wonderful article on the subject by an obviously competent law firm.  I have tried to translate some of the more complex language into baby language, which is the only language I understand.

The Post-COVD Update was stolen from my wonderful friends at George Smith Partners, who issue a wonderful, free newsletter, FinFacts, to which every aspiring commercial loan broker should subscribe.

Think back to that wonderful musical, "Grease."  On the last day of high school, the kids came running out of Rydell High School and broke into the song, "We'll Always Be Together."  Oh, the pure joy of summer vacation!   Warm days.  Blue skies.  It's hard not to feel euphoric

That's how we all feel right now, being released from quarantine, and it has me worried.  There is a gawd-awful amount of bad news out there, and I fear that investors, in their emotional euphoria, are ignoring it.

Emotions play a huge role in economics.  [Please read that last sentence again.]  During the latter half of the Great Depression and afterwards, the economic disciples of John Maynard Keynes, known as Keynesians, tried to apply mathematical formulas to macroeconomics - the study of the big stuff in the economy, like the rate of growth, the direction of interest rates, and the likely unemployment rate.

Keynesian economic formulas worked pretty well, if not perfectly accurately.  They at least pointed us in the right direction, like the need for fiscal policy to end the Great Depression.  Fiscal policy (think deficit spending) refers to the use of government spending and tax policies to influence economic conditions, especially macroeconomic conditions, including aggregate demand for goods and services, employment, inflation, and economic growth.

President Franklin Delano Roosevelt ("FDR") grasped the importance of emotions in economics.  "The only thing we need to fear... is fear itself."

FDR also understood the need to create jobs during the depths of the Great Depression.  His New Deal created such agencies as the Works Progress Administration (WPA) and the Civilian Conservation Corps (CCC), which dispensed emergency and short-term governmental aid, provided temporary jobs, employment on construction projects, and youth work in the national forests.  He also created the Tennessee Valley Authority, which built a number of hydroelectric dams and provided desperately needed power to middle America.

Before 1935, the New Deal focused on revitalizing the country’s stricken business and agricultural communities.  To revive industrial activity, the National Recovery Administration (NRA) was granted authority to help shape industrial codes governing trade practices, wages, hours, child labour, and collective bargaining.

This is pretty funny:  The U.S. Supreme Court eventually struck down the WPA and the CCC as unconstitutional, and when it was poised to strike down the National Recovery Administration, FDR told them, "Listen, Buckos, the country needs this economic help.  If you interfere one more time with the New Deal, I am going to stuff the Supreme Court with five new justices dedicated to making your weak-ass, obstructionist votes irrelevant."  Maybe he used kinder, more gentle words, but the Supreme's got the message.  The Commerce Clause of the U.S. Constitution, and hence the power of the Federal government, was greatly expanded as a result.

Now please don't get lost in this long, boring economic history.  I am leading you to an understanding of the importance of group emotions in economics and why you need to be pretty careful right now with your retirement savings.

The Keynesians ruled the roost among economists for decades, until President Richards Nixon took the U.S. off the gold standard in 1971 and until the first Arab Oil Embargo in 1973.  Suddenly, inflation was everywhere.

Nobel Prize winning economist, Milton Friedman, the patron saint of the Monetarist School of Economics, became the economic star of the hour.  He once famously said, “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”

Milton Friedman was also full of poop.  The Fed created... are you ready for it... FOUR FLIPPING TRILLION DOLLARS in new money during the Great Recession, and yet inflation went nowhere.  We could barely keep inflation positive.

Modernly, the Austrian School of Economics is the rising star.  The Austrians scoff at idea of charts and graphs (not really, but please humor me here for the sake of simplicity).  The Austrian School instead advances the proposition that social phenomena, like the confidence of consumers and business owners, is the greatest single influence on economies, and social phenomena results exclusively from the motivations and actions of individuals.  "It's the Little Guys, Stupid."

If banks are feeling confident enough to lend, and if consumers and small business owners are feeling confident enough to borrow, the money multiplier can expand to as high 12 times.  The Money Multiplier is the ratio of outstanding bank loans (the best measure of the country's money supply) divided by bank reserves at the Fed.

While snorkeling in Mexico 25 years ago with my two young sons,
a Moray eel lunged at me out of a reef.  I backed out quickly,
and to this day, my boys joke that I abandoned them.  Haha!

Guys, this Practice Course is my finest work.  Get me
10 commercial real estate loan officers working for BANKS,
and I'll give you the course for free (gotta pay shipping).

The Money Multiplier has a huge influence on inflation, and we desperately need inflation.  The Money Multiplier has fallen from a high of 12 thirty-years ago to just 4 today.  And this is with the public euphoric right now.

What happens when the news from China shows that their economy is crumbling?  China was the great new market for companies worldwide.  Today?  Not so much.  We sell lots of products to Brazil, for example.  What happens when Brazil's sale of raw materials to China falls by 60%.  Will they have enough dough to buy our products?

My friends, the forces of deflation are massing on our borders.  Today's current euphoria among investors is the driving force of this latest stock market rally, not earnings!  The news should start appearing, in the next two-and-half weeks, that China got b-slapped by this virus and by the world's reaction to their cover-up.  (I actually think that they did a helluva job with very incomplete information.)

I might be as full of beans as Milton Friedman (the Monetarist guy).  But I think this current stock market rally is being driven by the happy students of Rydell High School.  Be careful out there.  This stock market could fall 45% from here.

The good folks at George Smith Partners, in their FinFacts newsletter dated May 13, 2020, wrote:

"Some more green shoots are visible as the bridge lenders are starting originations also.  The warehouse lending market (big banks lending to debt funds) has started up again, with more cautious leverage.  The warehouse lenders will also monitor loan collateral more closely."

George Smith Partners is an old-time commercial mortgage banking firm.  The difference between a commercial mortgage banker and a commercial mortgage banker is that commercial mortgage bankers service many of the loans that they originate, normally for life companies.

The money in commercial real estate finance ("CREF") is in loan servicing fees.  As I often say, "It's the loan servicing fees, silly."   An easy way to remember this is that mortgage bankers are rich, and mortgage brokers are poor.  Want to start earning huge loan servicing fees?

So where do debt funds get their dough their large commercial bridge loans.  We are talking here about bridge loans from $5 million to $100 million.

You may recall that this is Evander Holyfield, the former world
heavyweight champion.  Mike Tyson bit off part of his ear.

The general rule is that the sponsors of a debt fund will put up several million dollars of their own dough.  Then they will go out to wealthy individuals that they know, using a private offering, to raise, say $200 million.  They will make, say, $160 million in bridge loans.

Then they will go to a commercial bank and pledge the first mortgages in their portfolio for a $200 million to $250 million line of credit, giving them $400 million to $450 million in lending capital.

As the debt fund makes a profit, some of the earnings are retained as equity, giving the debt fund the ability to borrow even more.

But where do the sponsors of the debt fund go to raise their original $200 million?  Who invests equity into a debt fund?  The answer is mostly wealthy investors, family offices, hedge funds, and opportunity funds.

But what is a hedge fund?  A hedge fund is a limited partnership of investors that uses high risk methods, such as investing with borrowed money, in hopes of realizing large capital gains.  Investopedia defines a hedge fund as an aggressively managed portfolio of investments that uses leveraged, long, short and derivative positions.

There are two cool things about a hedge fund.  First of all, these public offerings do NOT have to be registered with the SEC.  Registration is a phenomenally expensive process, required before a company can go public, that involves extensive audits going back several years and immense legal documents.  The process can take almost two years, and the up-front cost is well in excess of $1 million  There are also ongoing legal costs of another $1 million per year.  Yikes.

Geez, I hope this was photoshopped.

Now remember, hedge funds do NOT have to be registered.  Why?  Because every investor in a hedge fund needs to an accredited investor, i.e., have a net worth, exclusive of his personal residence, of at least $1 million.  The SEC assumes that accredited investors are either smart enough to understand the risk or can afford to pay an advisor.

The second cool thing about a hedge fund is that a hedge fund can publicly advertise for more investors.  They just need to make sure that every investor is accredited.  This freedom to advertise is a huge deal.  

So what is an opportunity fund?  An opportunity fund invests in companies, sectors or investment themes depending on where the fund manager anticipates growth opportunities.  In plain English, the manager invests wherever the opportunities lie.

Important note:  Opportunity funds often buy shares of stock in companies, known as equities.  In contrast, most hedge funds invest primarily in debt instruments.

Another difference between a hedge fund and an opportunity fund is that hedge funds investments are not publicly-traded investment instruments.  Opportunity funds, in contrast, are public offerings, offered to the general investing public.  In other words, you don't have to be accredited to invest in an opportunity fund.  Interests in opportunity funds are typically offered by insurance plans, mutual funds, and other investment firms.

Some opportunity funds focus on real estate itself, REIT's, and real estate debt instruments, such as mortgages, debt funds, mezzanine debt, and preferred equity.

Another concept to grasp is the concept of one fund investing in another fund.  A hedge fund might invest in a debt fund.  An opportunity fund might invest in a debt fund.  Therefore most debt funds are a fund of funds.

Now where the debt fund makes its dough is that it can often borrow for as little 3.5% to 4.0% and then make loans at 6% to 9%, plus loan fees.

Clearly debt funds are leveraged, and if the bank holding its credit line gets freaked out and calls its line of credit, the debt fund could be forced into liquidation.  The recent report by George Smith Partners that the warehouse lending market is loosening up is great news for debt funds and the availability of large commercial bridge loans.

This quarantine has been hard for everyone.

Commercial Mortgage Rates Today:

Here are today's commercial mortgage interest rates on permanent loans from banks, SBA 7a loans, CMBS permanent loans from conduits, and commercial construction loans.

Be sure to bookmark our new Commercial Loan Resource Center, where you will always find the latest interest rates on commercial loans; a portal where you can apply to 750 different commercial lenders in just four minutes; four HUGE databanks of commercial real estate lenders; a Glossary of Commercial Loan Terms, including such advanced terms as defeasance, CTL Financing, this strange new Debt Yield Ratio (which is different from the Debt Service Coverage Ratio), mezzanine loans, preferred equity, and hundreds of other advanced terms; and a wonderful Frequently Asked Questions section, which is designed to train real estate investors and professionals in the advanced subject areas of commercial real estate finance ("CREF").

Did you bookmark it?

Beer Drinking With George:

Two weeks ago I held my first Zoom beer drinking session to just chat, share, and gossip about the amazing happenings in commercial real estate finance.  There was no cost to attend, but each of our 38 attendees was required to hold up a beer, a wine, or a mixed drink to show that he or she grasped the spirit of the occasion.

I was thrilled to see - one hour and forty minutes later (it was only supposed to last 40 minutes) - that 31 guys and ladies were still on the line.  I hope you guys had as much fun as I did.  Oh, the hangover...

I'm getting ready to hold another Zoom beer drinking meeting in the coming days.  If you would like to attend, please write to me, George Blackburne III (the old man), at george@blackburne.com for your Zoom instructions.

I literally get 1,350 emails every single day, seven days per week, so it is please VERY important that your subject line read, "Beer Drinking With George."

The time to buy is when there's blood in the streets.
— Baron Rothchild, 1815, Member of the Rothchild banking family.

There is an interesting story about this quote. Baron Nathan Rothchild was one of five sons of Mayer Amschel Rothchild.  Mayer was the founder of the famous and incredibly wealthy Rothchold banking family.  They made Sam Walton's kids (Wal-Mart) look middle class.

Each of Mayer Rothchild's five sons headed up a huge merchant bank in a different country.  Nathan Rothchild headed up the Rothchild Bank in Britain.

One way the Rothchild's made big money was by syndicating huge bond offerings for their respective national governments.  There have even been suggestions (probably untrue) that the Rothchild's encouraged war between countries so that each son could earn huge bond syndication fees selling war bonds.  George IV is in California, and Tom is here with me in Indiana.  Maybe I should encourage a big snowball fight between the states, and then have The Boys sell ice makers to each side.  Haha!

Okay, so the year was 1815.  Napoleon had just escaped from the Island of Elba, and the French king kept sending army after army to snuff out Napoleon’s little rebellion.  Napoleon had started out with just 30 members of his old Imperial Guard, but as soon as any French force would march on Napoleon, the troops would let out a great cheer, turn around, and join Napoleon’s side.  “Would you fire on your Emperor?” he once asked Marshall Ney.  Finally Napoleon sent a message to the restored Bourbon king, “There is no longer any need to send more armies after me.  I have all the troops I need.”  Haha!

The restored Bourbon king fled, and for the next 100 days, Napoleon mobilized all of France.  He reassembled the Grande Armeee, an army of 100,000 men.  The British, the Prussians, the Austrians, and the Russian were totally freaked out.  They had just fought Napoleon for almost twenty years, and they had finally defeated him.  Why won’t this little sucker just die?!

The aristocracy of Europe was gathered in Belgium to party, dance, and divide up the spoils.  Beautiful women, in fancy gowns, danced with their handsome officers to a wonderful orchestra - until a messenger staggered into the ballroom.  “Napoleon has stolen a march on us.  He has defeated the British at Quatre Bras.  Our army is in full retreat.”  Women screamed.  Some passed out.  Officers scurried everywhere.  The Duke of Wellington, who had never been defeated in battle, famously commented, “I have been humbugged.”

Wellington marshaled his beaten, but unbroken, troops, and emplaced them on the reverse slope of a row of hills overlooking the little town of Waterloo.  Placed there, Napoleon could not accurately aim his famous artillery at them because his gunners couldn’t see the British troops.  They had to fire blind.  The next day, as the Prussians rushed to help Wellington, Napoleon sent infantry division after infantry division marching up those hills.  Each time, the British drove them back.

I really admire Wellington because, even though he was personally a cold fish, he took wonderful care of this troops.  He had them lay down to present the smallest possible target to Napoleon’s endless artillery cannonade.  The French cavalry tried charging the British infantry, but the incredibly brave Redcoats quickly formed into squares and presented the French cavalry with a bristling wall of bayonets.  Horses will not commit suicide by hurling themselves onto bayonet points, so six different cavalry attacks came to naught.

But each time the Redcoats formed square, they became a perfect target for Napoleon’s artillery.  Thousands of brave British boys were blown to pieces, and as the Redcoats formed square each time, the squares became smaller and smaller.  Finally, the British were ready to be broken.

The Shark Dentist, aka "Stumpy"

“Vive L’Empereur,” shouted Napoleon’s never-beaten Imperial Guard, as they marched up that apparently deserted hillside.  When they were almost to the very top, with victory just steps away, Wellington shouted, “Stand up!”  The exhausted and decimated British survivors rose up like ghosts out of the mist and formed their famous "thin red line.”

Napoleon’s columns were twelve men across and hundreds deep.  The dense formation was designed to punch through any enemy line, but only a few Frenchmen could fire their weapons from this formation.  Wellington’s thin red line had only two men to a file, and every man could fire.  They wrapped themselves around the head of the French column and fired volley after volley into it.  The fresh French troops were stopped cold.  “Fix bayonets!” shouted the few surviving British officers, who had bravely stood in place as their troops had lain down.  “Charge!”

The Imperial Guard broke and ran.  After the battle, Wellington made his laconic but famous comment, “It was a close-run thing.”  Four days later, Napoleon surrendered for good.

Nathan Rothchild had been hard at work as well.  His pre-assigned agent jumped onto a fast mail packet the instant the Battle of Waterloo was over, so Nathan had a jump-start on the markets.  At the time, Consols - the British equivalent of Treasury bonds - were struggling because of the British loss at the Battle of Quatre Bras the day before.  Who wants to own the debt of a country that is about to be overrun by Frenchmen?

Taking advantage of his prior knowledge, Rothchoild started to sell Consols short in huge quantities.  “Oh, my God. Rothchild knows.  Rothchild knows (that we lost at Waterloo).  Sell my consols at any price!” shouted hundreds of traders. …  A terrible run on Consols began.

Until Rothchild suddenly changed position and bought up enormous quantities of Consols for pennies on the dollar.

I am not telling you guys to run out and buy stocks because there is blood in the streets.  In three weeks, I predict that the new, hot story in the final press might very well be about how orders from China, the world's second largest market, are down by 60%.  This may initiate the second down leg in the stock market, which I fear will bring us about 20% lower than our recent lows.

No, I wrote this article for for my private investors, urging them to snap up our hard money first trust deeds.  

"Right now just about every bank in the country - almost all 4,000 of them - is out of the commercial mortgage market.  While commercial loan demand has plummeted, we are seeing some very, very attractive deals."

"Folks, you have to be smart.  Until this crisis, 4,000 commercial banks and another 5,000 credit unions were competing against us in the small balance commercial loan market.  Poof!  They were suddenly and completely gone.  For the next few months, we have the market largely to ourselves."

Commercial Mortgage Rates Today:

Here are today's commercial mortgage interest rates on permanent loans from banks, SBA 7a loans, CMBS permanent loans from conduits, and commercial construction loans.

Be sure to bookmark our new Commercial Loan Resource Center, where you will always find the latest interest rates on commercial loans; a portal where you can apply to 750 different commercial lenders in just four minutes; four HUGE databanks of commercial real estate lenders; a Glossary of Commercial Loan Terms, including such advanced terms as defeasance, CTL Financing, this strange new Debt Yield Ratio (which is different from the Debt Service Coverage Ratio), mezzanine loans, preferred equity, and hundreds of other advanced terms; and a wonderful Frequently Asked Questions section, which is designed to train real estate investors and professionals in the advanced subject areas of commercial real estate finance ("CREF").

Did you bookmark it?

Beer Drinking With George Tonight

Tonight (May 4th) at 5:00 p.m. Eastern Time, I am going to hold a Zoom BS session to just chat, share, and gossip about the amazing happenings in commercial real estate finance.

There is no cost to attend, but I would really like it if each of you would hold up a beer, a wine, or a mixed drink to show you truly grasp the spirit of the occasion.  This chat is supposed to be, first of all, fun; but I suspect we will all learn some interesting things as well.

There is no fixed agenda.  This is not a training class.  I'll make a few observations about how to survive and prosper in a weird market like this, but after that, the floor is open to anyone to chat about anything related to commercial real estate finance.

To get into the meeting, please write to me, George Blackburne III (the old man), at george@blackburne.com for your Zoom instructions.

I literally get 1,350 emails every single day, seven days per week, so it is please VERY important that your subject line read, "Beer Drinking With George."

We have 31 people signed up for tonight, and I am going to cut it off at 35.  If you don't get an invitation, I'm sorry, but you missed the cutoff.  You'll just have to get drunk on your own.  Darn!

I am using the free version of Zoom, so they will cut me off after only 40 minutes.  I urge those of you who have signed up not to be late.  It would be great if some of you could please bring either some hot commercial lenders to recommend or some related observations to share.  Thanks!

One of the things I miss about working in San Jose, California years ago is that after work, the guys in my lending industry would meet for a beer.  I would often learn more from my buddies in one beer session than I would from weeks of actually working in the industry.

I miss those days.

Therefore this Monday, at 5:00 p.m. Eastern Time, I am going to hold a Zoom bullshit session to just chat, share, and gossip about the amazing happenings in commercial real estate finance.

I truly believe that this is one of the greatest money-making opportunities of our lives. The competition has been devastated, leaving the whole market ripe for us commercial loan guys.

There is no cost to attend, but I would really like it if each of you hold up a beer, a wine, or a mixed drink to show you truly grasp the spirit of the occasion.  This chat is supposed to be, first of all, fun; but I suspect you'll learn some interesting things as well.

I have no idea idea if any of you guys will be interested in just sitting around drinking for awhile, so maybe only two or three of us will show up.  On the other hand, perhaps many of you are as bored as I am.  Maybe there will be ten of us.

There is no fixed agenda.  This is not a training class.  I'll make a few observations about how to survive and prosper in a weird market like this, but after that, the floor is open to anyone to chat about anything related to commercial real estate finance.  

To get into the meeting, please write to me, George Blackburne III (the old man), at george@blackburne.com for your Zoom instructions.

I literally get 1,350 emails every single day, seven days per week, so it is please VERY important that your subject line read, "Beer Drinking With George."

Once again, there is no cost to join us; but you are expected to knock back a few drinks, just to keep the jokes and laughs coming.  We're all just a few buddies meeting for a beer after work.  You even get to tell your wife, "Honey, I know its only 2:00 p.m. on the West Coast, but George is making me drink."  :-)

I'll ask everyone to turn on their cameras, so we can bond.  I'll be wearing sweat clothes, and I'll have bed hair, so please don't worry about your appearance.  Ladies, feel free to wear your bikini's, as you visit Porcho Myarda. :-)

Once again, to get into the meeting, please write to me, George Blackburne III (the old man), at george@blackburne.com for your Zoom instructions.  Please make sure your Subject Line says, "Beer Drinking With George."

Commercial Mortgage Rates Today:

Here are today's commercial mortgage interest rates on permanent loans from banks, SBA 7a loans, CMBS permanent loans from conduits, and commercial construction loans.

Be sure to bookmark our new Commercial Loan Resource Center, where you will always find the latest interest rates on commercial loans; a portal where you can apply to 750 different commercial lenders in just four minutes; four HUGE databanks of commercial real estate lenders; a Glossary of Commercial Loan Terms, including such advanced terms as defeasance, CTL Financing, this strange new Debt Yield Ratio (which is different from the Debt Service Coverage Ratio), mezzanine loans, preferred equity, and hundreds of other advanced terms; and a wonderful Frequently Asked Questions section, which is designed to train real estate investors and professionals in the advanced subject areas of commercial real estate finance ("CREF").

Did you bookmark it?