Managing Distressed Assets

Managing Distressed Assets

Odum Capital Greg O. Odum 202.352.1207 [email protected]

Overview 

Can you increase liquidity by 25%?



Can you reduce restructuring and loan loss costs by 20%?



Can you increase Quality of Earnings?



Can you facilitate the divestiture of pools of assets fast enough? Odum Capital www.odumcapital.com

Cost + Benefit Analysis Yes! Increase Liquidity by Reducing Non-Performing Loans 



How?  

Restructure portfolio of loans + Keep on the books Restructure portfolio of loans + Sell portfolio of loans

Proven methodology to determine accurate asset values for asset strategy (i.e., loan sales, property sales, asset enhancements) Odum Capital www.odumcapital.com

Objective 

To assist financial institutions with the restructuring + divestiture of troubled assets

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Why? 

A cost effective method of managing troubled assets

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To properly manage liquidity

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To provide customized solutions for restructuring pools of assets

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To facilitate the divestiture of assets

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Biography Experience 

New Harbour Partners: Developed fairness opinions and structured acquisitions worth over $20M for a middle-market private equity firm.

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Wells Fargo: Structured over $15M worth of real-estate-related transactions, debt restructurings and asset-based lending for middlemarket businesses.

Education 

MBA in Finance - Babson College



B.A. in Communications and Economics - Michigan State University

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Cost + Benefit Analysis 

The costs associated with re-directing existing personnel to restructurings make it worthwhile to use an outsourcing option

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Banks need to look at their book of business and do an internal study to determine strengths and weaknesses, then outsource restructuring and divestiture processes

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For Example: 

In June, there were 336,173 foreclosure filings in the US, the 4th straight month exceeding 300,000a  

Rather than completely re-engineering your operations, it's convenient and economical to have a vendor do the outsourcing Instead of re-engineering operations, outsource to a vendor => more economical and less time consuming Odum Capital www.odumcapital.com

Commercial Real Estate Overview 

An est. $400 billion in commercial real estate loans will mature through the end of 2009 with the pace of maturities increasing over the succeeding years1

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The default rate of bank loans for shopping centers, office buildings, warehouses and hotels rose to 2.8% in the second quarter, up 0.63 percentage points from the prior quarter2

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The default rate for apartment buildings rose 0.68 percentage points in the second quarter to 3.13 percent2

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Commercial loans that were 30 to 90 days delinquent fell $1.97 billion to $12.77 billion in the second quarter and those for multifamily fell $287.1 million to $2.59 billion, the picture did not get brighter2 Odum Capital www.odumcapital.com

Commercial Real Estate Overview contd. 

The amount of loans considered nonaccrual dwarfed the amount of payments late 30 to 90 days2

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Loans in nonaccrual status rose by $6.53 billion to $27.76 billion for commercial real estate

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Multifamily nonaccrual rose by $1.33 billion to $6.04 billion

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Research firms expects the commercial real estate default rate to climb to 4% by year end, 5.2% by end of next year and peak at 5.3% in the fourth quarter of 2011

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For apartment buildings, Real Estate Econometrics sees the default rate reaching 4.5 percent in the fourth quarter of 2009 and peaking at 5.5 percent at the end of next year. The default rates are not expected to be below 4 percent through 2013 Odum Capital www.odumcapital.com

Number of Foreclosures

Source: RealtryTrak.com US Foreclosure Report

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Expected New Foreclosures

Source: Credit Suisse

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Soaring Prime Mortgage Delinquencies

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$2.4T est. in ALT-A Ready to Re-Set

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HELOC + Home Equity Loans Soared During Bubble

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Commercial Real Estate Losses Commercial Real Estate losses are estimated to be in the $1.7* trillion

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Restructuring + Divestiture Steps 

Step 1: Asset Valuation

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Step 2: Due Diligence

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Step 3: Financial Modeling + Analysis

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Step 4: Creation of Asset Pools

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Step 5: Divestiture of Assets

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Restructuring + Divestiture Steps contd. Step 1: Asset Valuation Evaluate portfolio of properties/loans 

Analyze underlying collateral, and how the collateral can be positioned for short, medium or long-term value

enhancement, critical to any optimization strategy 

Utilize real-time market data such as comps, FMV and tax assessment estimates to evaluate the asset value

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Restructuring + Divestiture Steps contd. Step 1: Asset Valuation Example

Bank XYZ Assets

June 2009

June 2008

Real Estate Owned

$5M

$2M

Impaired Loans

$19M

$5M

Residential Loans held for Sale

$20M

$4M

Commercial Real Estate Loans

-

$220M*

Provision for Loan Losses

$10M

$4M

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Restructuring + Divestiture Steps Step 2: Due Diligence 

Tenant + Mortgagor survey 

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Evaluate sustainability of tenants + mortgagors

Evaluate current + sustainable cash flow generated from asset 

Rent, parking, etc

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Evaluate asset financial sustainability

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Determine if any legal, regulatory constraints 

Lead, taxes, etc. Odum Capital www.odumcapital.com

Restructuring + Divestiture Steps Step 3: Financial Modeling + Analysis 

Itemized cash flow + sustainability modeling 

State-of-the-art modeling incorporating variables necessary to arrive at a specific strategy

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Hold vs. Sell Analysis

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Current Mortgage vs. Cash Flow-based Model

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Restructuring + Divestiture Steps Step 4: Creation of Asset Pools Bank XYZ

Tier 1

Tier 2

Tier 3

Category

Performing Loans

Non-Performing Loans

Real Estate Owned

Book Value

$8M

$7M

$2M

Units

35

34

18

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Restructuring + Divestiture Steps Step 5: Divestiture of Assets Bank XYZ

Tier 1

Tier 2

Tier 3

Asset Type

Performing Loans

Non-Performing Loans

Real Estate Owned

Book Value

$8M

$7M

$2M

Units

35

35

18

Buyer

Regional Bank

REIT

Private Equity Odum Capital www.odumcapital.com

Overview 

Can you increase liquidity by 25%? 

Yes Bank XYZ

June 2008

June 2009

September 2009

Loan Sales

$1.8M

$3.5M

$6M

% Increase

-

94%

71%

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Overview 

Can you reduce restructuring and loan loss costs by 20%? Bank XYZ

June 2008

June 2009

$ Increase

% Increase

Restructuring Costs

$30k

$950k

$920k

3066%

Loan Loss Provision

$3.5M

$9.6M

$6.1M

171%

Salaries

$3.8M

$5M

$1.2M

31.6%

Total

$7.3M

$15.6M

$8.3M

114% Odum Capital www.odumcapital.com

Overview 

Can you increase Quality of Earnings? 

Yes! June 2009

July 2009 – December 2009

$8.3M

-

New Bank XYZ Costs

-

$810K - $1.2M

Savings

-

$7M ~

Bank XYZ Bank XYZ Costs

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Overview 

Can you facilitate the divestiture of pools of assets fast enough? 

Yes

• Private Equity • Hedge Funds • Investment Banks

• Domestic + Foreign Real Estate Funds • REITS • Other Institutional Investors

• Regional Banks Odum Capital www.odumcapital.com

Tax Implications 

In the residential real estate sector, the U.S. Congress, Treasury Department and IRS have taken steps to mitigate certain tax consequences that otherwise would impede efforts to restructure residential mortgage loans that pose a risk of going into default

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The commercial real estate sector has tax barriers regarding modifications and restructurings

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Questions?

Contact Odum Capital Greg O. Odum 202.352.1207

[email protected]

Odum Capital www.odumcapital.com

Appendix

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Solutions A trouble debt restructuring can be one of the following: 

The debt is settled at the time of restructuring

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The debt is continued but with modified terms

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Solution 1: Settle Debt Option The Debtor’s Gain = the Carry Amount of the Debt -the Value of the Asset(s) transferred to settle the debt. Any gain is reported as an “extraordinary item”. Example: A bank holding a $50 million note agrees to accept a land valued at $40 million from R.J. Company, which is in severe financial difficulty, as a settlement of the $50 million debt.  Assume that the carrying amount of the land is $32 million. The following journal entries are recorded for this troubled debt restructuring: 

Land ($40M -$32M) = $8M Gain on disposition of assets = $8M (ordinary gain)

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Note Payable = $50M. Land(at fair value) = $40M Gain on debt restructuring = $10M (extraordinary gain)

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Solution 2: Modified Debt Terms Option In this case of debt restructuring, the bank allows the debt to continue but modifies the terms of debt agreement (i.e., reduce or delay interest payments; reduce or delay maturing amount, or a combination of these concessions Example 2: 

Assume a 10% interest on the $50M note in question and interests (i.e. $50M x 10% = $5M) are payable in December of the two remaining years. In addition, R.J. failed to pay $5 million of interest for the year just ended. Therefore, the carrying amount of the debt is $55M.

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The accounting treatment for this type of restructuring depends on the total amount of future cash payments. Odum Capital www.odumcapital.com

Solution 2: Modified Debt Terms Option Case I : Total future cash payments < The carrying amount of the debt Accounting Treatment Recognize Extraordinary Gain = Carrying amount of the Debt -Total Future Cash Payments;   

Reduce the carrying amount of the debt to the total future cash payments. Assume that all interests have been eliminated All subsequent cash payments are payments for the debt itself.

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Solution 2: Modified Debt Terms Option Case I contd. Assume that the bank agrees to the following terms:   

Eliminate the accrued interest of last year; Reduce the remaining two interest payments from $ 5 million each to $3 million each; and Reduce the maturity value from $50 million to $40 million

Extraordinary Gain:   

Carrying Amount= $55M Future Cash Payments*= $46M Extraordinary Gain= $9M

* $3M x 2 + $40M = $46M Odum Capital www.odumcapital.com

Solution 2: Modified Debt Terms Option Case II Total cash payments exceed the carrying amount of the debt Continued with example 2, assume that the bank agrees to: 

   

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Delay the due date for all cash payments until maturity date and accept $57,222,000 at maturity date. Since $57,222,000 exceeds the carrying amount of the debt ($55M), the new agreement still require an interest payment. A new effective interest rate needs to be calculated: $55,000,000 / $57,221,927=0.96117 The new effective interest rate is 2% (via present value). At the debt restructuring date, no entry is required.

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Tax Implications At the end of the first year following the restructuring: 

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Interest Expense (2%x$55M) = $1,100,000 Interest Payable = $1,100,000

At the end of the second year:  

Interest Exp.*= $1,122,000 Interest Payable = $1,122,000 

* 2% x ($55million + 1,100,000)

At maturity date:   

Note Payable= $50M Interest Payable = $7,222,000 Cash = $57,222,000 Odum Capital www.odumcapital.com

SFAS 157 

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Investment securities: The fair values for investment securities are determined by quoted prices for similar assets or liabilities (Level 2) Residential loans held for sale: The fair value of loans held for sale is determined using quoted prices for a similar asset, adjusted for specific attributes of that loan (Level 2).

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Sources + Citations 

Sources:The Real Estate Round Table, December 2008 1 ; Real Estate Econometrics, August 2009 2 (The research firm breakout multifamily homes separately because of their residential use.The report was based on 8,195 institutions)

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Sources: Federal Reserve Flow of Funds Accounts of the United States, IMF Global Financial Stability Report October 2008, Goldman Sachs Global Economics

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Paper No. 177, FDIC Quarterly Banking Profile, OFHEO, S&P Leverage Commentary & Data, T2 Partners estimates

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1 See section 860G(a)(3)(A)(i) of the Internal Revenue Code of 1986, as amended, and Treas. Reg. sec. 301.7701-4(c). Hereinafter, all statutory and regulatory references are references to the Internal Revenue Code of 1986, as amended (the “Code”), and the regulations there under.2 Id. See also section 860F(a)(1) (prohibited transactions tax)2. Treas. Reg. sec. 1.860G2(b)(3)(i).4 Treas. Reg. sec. 1.1001-3 (the debt modification regulations).

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Sources: 5 Treas. Reg. sec. 1.860G-2(b).6 See Treas. Reg. sec. 1.1001-3(e).7 Prop. Treas. Reg. sec. 1.860G-2.8 Rev. Proc. 2007-72, 2007-52 IRB 1257; Rev. Proc. 2008-28, 2008-23 IRB 1; Rev. Proc. 2008-47, 2008-31 IRB 272.9 Rev. Proc. 2007-72, Rev. Proc. 2008-47.10 Rev. Proc. 200828.

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