Archive for June, 2010

Should Lenders be Licensed Before Being Allowed to Make or Purchase Commercial Mortgages?

Thursday, June 10th, 2010

By Bruce J. Coin

America’s real estate lending community is comprised of approximately 8,000 FDIC insured banks, approximately 8,100 Credit Unions (insured by NCUSIF), over 200 insurance companies and well over 300 Pension Funds.  Then there are the Wall Street firms and the numerous mortgage broker-pseudo lender-seller conduit companies that profess to be mortgage lenders. They all process, place, sell or invest in stocks, bonds, mortgages and/or real estate and many treat Commercial Mortgage Backed Securities as bonds.  As of December 2008 the 300 largest pension funds had over $10 trillion invested in stocks, bonds, mortgages and real estate.

In light of the recent capital markets melt down and loss of confidence in the major rating agencies, that led to and caused the great recession does anyone really think that collectively these institutions and companies were or are all properly staffed with skilled, experienced and knowledgeable loan officers and underwriters or that they invested the proper amount of time and money in training their staffs?  The evidence strongly indicates that such institutions were really not very good at underwriting acquisition, development and construction (ADC) and commercial real estate (CRE) mortgage loans while failing to simultaneously keep an eye on changing economic conditions. They also invest in stocks and bonds and some were caught badly with large investments in Fannie Mae and Freddie Mac stocks when those institutions were taken over and their stock became virtually worthless. Also note that banks consider RMBS and CMBS investments to be bonds as opposed to actual mortgages and many invested heavily in those as well.

According to the FDIC’s data (, excluding banks in Puerto Rico, between January 1, 2008 and May 28, 2010 the FDIC has closed 243 commercial banks or a simple average of about 8 closures per month.  52.3% of the closed institutions were located in just four states: Georgia (38 closures-15.6%), Illinois (33 closures-13.6%), Florida (29 closures-11.9%) and California (27 closures-11.1%).  Tied for 5th place are Missouri and Washington with 9 closures each or 3.7%.   As of May 28, 2010 the FDIC also had a list of 775 “problem banks”. Also, since January of 2008, more than 48 Credit Unions have been closed.

Case studies of recently failed banks are posted on the FDIC’s Office of Inspector General’s web site ( The case studies provide detailed explanations of what led to each bank’s closure.   I reviewed eleven recent case studies looking for common causes.  While, to its credit, the FDIC often admits a failure to respond earlier and/or with stronger measures to banks with developing problems the case studies indicate that most if not all of the bank closures were caused by bad real estate lending practices especially in the ADC and CRE arenas. While the lending community can try to point to the great recession as the primary cause of declining demand for and values of real estate, they cannot deny that it was bad lending practices that led to the current great recession.

The following are direct quotes selected from the various FDICOIG’s case studies:

“Poor management and inadequate Board of Directors oversight, a high concentration in ADC lending, poor loan underwriting, weak credit administration and reliance on volatile funding sources”

“…..Board and management implemented a high risk business strategy that included rapid growth, with the focus on earnings, by investing the majority of the bank’s assets in higher-risk CRE and ADC loans while maintaining limited liquid assets”.

“…management, led by a senior bank official, pursued an aggressive growth strategy focused on acquisition, development and construction lending that coincided with declining economic conditions…”

“inadequately supervising lending units…”

“Aggressive underwriting during periods of hyper real estate market growth”

“…a high concentration in ADC lending, poor loan underwriting, weak credit administration…”

“…risks included the bank’s concentration in ADC and CRE lending and weak underwriting and credit administration policies…”.

“…the (FDIC’s) 2008 examination questioned whether the lending staff had the expertise…”

“….loan underwriting and administration practices became extremely lax…”.

“The Chief Lending Officer’s (CLO) lack of experience in ADC lending, the CEO/President’s lack of lending experience…”

“…a lack of due diligence pertaining to loan purchases and weak credit administration and loan review practices…”

“…weak oversight by management, inexperience and turnover in key positions…and concentrations in CRE and ADC loans.”

“…the bank failed to conduct proper due diligence and implement prudent underwriting of the loan participation credits”.

“…Insufficient staff resources – in need of training and/or replacement to enhance employee skill sets and experience levels necessary to implement change.”

“…lacked the personnel, depth and resources to properly monitor, assess, and manage a large portfolio of complex CRE/ADC loans….”

“Weakness in …loan underwriting, credit administration, and risk analysis and recognition practices were contributing factors in the asset quality problems that developed…”

The common threads are concentrations in ADC and CRE loans combined with a lack of skilled senior management, loan underwriters and personnel, aggressive underwriting and lack of oversight by management.

When a large private industry fails to act prudently to police itself, there has usually been a public outcry that lead to government intervention in the name of protecting the public.  Among others it’s happened to the auto, food, airline and pharmaceutical industries and don’t forget all the environmental laws since 1969. It happened to the financial industry after the great depression and it’s going on now as the House of Representatives and the Senate negotiate the differences between their versions of the planned Financial Services Reform Act to try and pass new laws regulating the financial industry.

After the great depression of 1929 there was government intervention and regulation of the financing industry that covered the activities of Wall Street firms, banks and real estate companies.

In 1933 the Federal Deposit Insurance Corporation (FDIC) was formed to provide insurance up to $2,500 per individual savings account to restore confidence in the banking system.

Also in 1933 the Glass-Steagall Act was passed to:” separate investment and banking activities” citing that banks had become too greedy by taking big risks (in the stock market) seeking big rewards.  In 1956 it was amended to prevent banks from underwriting insurance.

In 1934 the Securities and Exchange Commission (SEC) was formed to: “regulate the stock market and prevent corporate abuses relating to the sale of securities and corporate reporting”.  It was given the power to license and regulate stock exchanges, the companies whose stock was traded on an exchange and the brokers and dealers that conducted trading.

Between 2002 and 2007 weren’t the investment banks and commercial banks doing the same with real estate lending that that pre-depression era banks were doing in the stock market?  Seems obvious to me.

Over time, and particularly during the Reagan and Clinton administrations, many of the post depression regulations were diminished or were even repealed such as the 1999 repeal of the Glass Steagall Act.  It was replaced by the Gramm-Leach-Bliley Act which repealed part of the Glass-Steagall Act and opened the market between banks, investment banks, securities firms and insurance companies and facilitated the legality of mergers between them that were previously illegal. The banking industry was cited as trying to have the Glass-Steagall Act repealed since the early 1980s. They obviously succeeded.

To look a little deeper into possible bank failure causes I investigated what it takes to start a bank.

In order to start a bank a sponsoring group usually starts by applying to their local state initially requesting approval to become a state chartered bank. Later, based on growth and success they can apply to become a federally chartered national bank.  The requirements to become a bank vary by state, especially the initial minimum capital requirements needed.  That currently appears to be in the range of approximately $6,000,000 to $10,000,000 noting that I did not investigate the requirements of the 50 states. The state requirements I reviewed reference meeting the minimum federal requirements and require application to the FDIC for insurance.  The application process I reviewed for three states (among other requirements) all basically stated that the initial stockholders and/or board of directors of the proposed institution had to include experienced bankers.  The requirements did not elaborate or say that including experienced real estate mortgage lenders was a requirement, commercial or residential.   I then reviewed the FDIC’s insurance application. Among its numerous other requirements those that I found that could be germane to mortgage lending are directly quoted below:

“Provide a list of the organizers, proposed directors, senior executive officers, and any individual, or group of proposed shareholders acting in concert, that will own or control 10 percent or more of the institution’s stock. For each person listed, attach an Interagency Biographical and Financial Report, a fingerprint card, and indicate all positions or offices currently held or to be held…”

“Describe each proposed director’s qualifications and experience to serve and oversee management’s implementation of the business plan”.

“Describe each proposed senior executive officer’s duties and responsibilities and qualifications and experience to serve in his/her position”.

“Discuss any plans to engage in any subprime or speculative lending, including plans to originate loans with high loan-to-value ratios”.

“Describe the institution’s plans to engage in any secondary market/mortgage banking activity, including loan participations.  Discuss any plans to use forward take-out commitments or engage in loan securitization.  Describe any plans to use hedging activity to mitigate the risks of this activity. Also discuss plans to retain recourse and servicing.”

“Describe the loan review program, addressing independence, scope, frequency and staff qualifications.”

“Discuss how the institution will identify and measure interest rate risk”.

According to DSC’s (Division of Supervision of Consumer Protection)  Risk Management Manual of Examination Policies: “the quality of management (of a bank) is probably the single most important element in the successful operation of a bank.” Despite that statement there appears to me to be no formal requirement for a founder, director or even a senior officer to possess real estate lending knowledge.

I was unable to find any detailed guidelines concerning what the FDIC would consider acceptable qualifications and experience. There are very few programs that “certify” real estate loan officers. Personally, in my 40+ years experience I have never met a “certified” commercial mortgage loan underwriter.   So when it comes to a group’s application to become approved for FDIC insurance as a bank, it appears that the FDIC can apply a subjective standard to determine if the founders and officers of a new bank are qualified.

So why have so many of these institutions proven to be very poor at underwriting and investing in ADC and CRE loans?

Greed, competition, earnings pressures, changing economic conditions and mortgage fraud can only partially explain what happened.  There are greater reasons.  I personally believe the main reasons they fail is a combination of four things:

  • Not having truly highly experienced mortgage loan officers and underwriters
  • Failing to invest in ongoing education for mortgage loan officers and underwriters
  • CEOs, Presidents and senior management not being knowledgeable mortgage loan officers, investors or underwriters themselves and imposing imprudent lending and investment decisions on subordinates
  • The institution not being required by law or by the FDIC to have and maintain truly highly experienced loan officers and underwriters and on-going education programs

Despite losing billions of dollars in bad ADC and CRE loans and investing in RMBS and CMBS without performing proper due diligence many of the larger banks are now making major good profits while still writing off and selling their bad loans and bad RMBS and CMBS investments. While more rating agencies may be coming on to the scene the three major firms; S & P, Moody and Fitch continue to be allowed to rate mortgage issues and appear to be escaping damages from law suits that are being dismissed by the courts.  Many of the Wall Street firms led, by Goldman Sacks and Bank of America’s Merrill Lynch, are again ramping up to sell pools of RMBS and CMBS.

On July 30, 2008 the federal government passed the Secure and Fair Enforcement for Mortgage Licensing Act of 2008, aka, The SAFE Mortgage Licensing Act of 2008. Among others the act required states to pass licensing standards for residential mortgage loan originators by July of 2009. State licensure is to be based on national standards, require passage of a qualifications test and include registration and continuing education. Can you guess who is exempt? BANKERS ARE EXEMPT, i.e. any individual (that originates residential mortgages) that is an employee of; a depository institution; a subsidiary that is owned and controlled by a depositor institution (e.g. a bank owned mortgage company) and regulated by a Federal banking agency or an institution regulated by the Farm Credit Administrator.  They are not innocent purchasers that need to be protected from unscrupulous “sellers” (mortgage brokers, wall street brokers and mortgage bankers) they make or purchase commercial mortgages every business day and in many cases originate the business themselves.  Remember that one bad $9,000,000 commercial mortgage is the equivalent of having thirty, $300,000 residential mortgages all go bad at the same time.  You do the math.

The industry continues to fail to police itself.  Many banks still lack truly highly experience mortgage loan officers and underwriters.  Many still employ or are re-hiring those that were involved in the bad loan decisions that led to the capital markets collapse. The Safe Mortgage Licensing Act does nothing to change that. The act principally targets mortgage brokers and mortgage companies that originate residential mortgages but not those that ultimately actually lend the money or buy the loans. Mortgage brokers do not lend money.  Privately owned mortgage companies may close a loan in “their own company’s name” but always with the concept of pre-selling or selling the loan shortly after loan closing.  While they can be at risk they are not true lenders.

The government fails to see the need to require bank and investment bank loan officers and underwriters be certified and licensed and take continuing education like numerous other professionals.  Nothing in the proposed Financial Reform Act currently being negotiated addresses that.

Realtors must take classes, pass an examination to be licensed and then in most states take continuing education in order to renew their licenses.  In 1989 most of the existing appraisal organizations got together and formed the Appraisal Foundation that, with the support of the government, established education and experience requirements for appraisers, required them to pass an examination to be licensed and take continuing education to renew their licenses.  The SEC requires securities dealers to pass an examination to be licensed and take continuing education to renew their licenses. All of these actions and requirements were implemented in the name of “protecting the public”.

I could not find any formal requirements for bankers or investment bankers to have any amount of formal commercial mortgage underwriting and appraisal knowledge and education, meet minimum experience requirements, pass a test to be licensed (as no such licensing exists) or take continuing education to renew such licenses.  In addition, while there are a variety of licenses that securities dealers and their brokerage licensed firms can hold, there appears to be no requirement for them to have expertise in mortgage loan underwriting or appraising or a separate level of licensing because when packaged into pools mortgage loans are sold as securities and their existing licenses permit them to do that.

When questioned about past practices, many of the bankers and investment bankers that cost the public billions of lost dollars continue to espouse that they did nothing wrong. To borrow a line from Shakespeare; “The lady doth protest too much me thinks”.  What do you think? In furtherance of again protecting the public isn’t it time for more to be done?

In December of 2009 I sent letters advocating implementation of a program of educating, requiring experience, testing, and licensing of mortgage loan officers and underwriters followed by continuing education for license renewal purposes to the following:

  • Federal Reserve Chairman, Ben Bernanke
  • SEC Chair, Mary Schapiro
  • FDIC Chair, Shelia Bair
  • Treasury Secretary, Timothy Geither
  • Senator Frank Lautenberg-D. NJ (e-mail)
  • Senator Robert Menedez-D.NJ (e-mail)

The letters were timed so that the concept could be incorporated within the Financial Reform Act now being negotiated. I can personally see no reason other than a lack of wisdom or intestinal fortitude by the legislators and undue influence from the banking and investment banking industry why these members of the financial community that are the primary analysts, processors and often approvers, buyers and sellers of mortgage loans are not required to meet and live up to the same standards as other industry professionals.  There is no excuse, not even the cost of creating such a program.  Such a requirement would not inhibit the flow of capital or retard economic expansion or growth. The cost of implementation would pale by comparison with the losses it may have prevented.   I submit that had such requirements been in place on or before the post 911 runaway capital markets, much of what happened to cause the financial meltdown would have been avoided.

If you agree with the forgoing write to all of the above, your local Senators and members of the House and even President Obama.