[Senate Hearing 111-1176]
[From the U.S. Government Publishing Office]



                                                       S. Hrg. 111-1176

                   SMALL BUSINESS ACCESS TO CAPITAL:
                   CHALLENGES PRESENTED BY COMMERCIAL
                              REAL ESTATE

=======================================================================

                               ROUNDTABLE

                               BEFORE THE

                      COMMITTEE ON SMALL BUSINESS
                          AND ENTREPRENEURSHIP
                          UNITED STATES SENATE

                     ONE HUNDRED ELEVENTH CONGRESS

                             SECOND SESSION

                               __________

                           NOVEMBER 17, 2010

                               __________

    Printed for the Committee on Small Business and Entrepreneurship


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            COMMITTEE ON SMALL BUSINESS AND ENTREPRENEURSHIP
            
            
            
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                     ONE HUNDRED ELEVENTH CONGRESS

                              ----------                              
                   MARY L. LANDRIEU, Louisiana, Chair
                OLYMPIA J. SNOWE, Maine, Ranking Member
JOHN F. KERRY, Massachusetts         CHRISTOPHER S. BOND, Missouri
CARL LEVIN, Michigan                 DAVID VITTER, Louisiana
TOM HARKIN, Iowa                     JOHN THUNE, South Dakota
JOSEPH I. LIEBERMAN, Connecticut     MICHAEL B. ENZI, Wyoming
MARIA CANTWELL, Washington           JOHNNY ISAKSON, Georgia
EVAN BAYH, Indiana                   ROGER F. WICKER, Mississippi
MARK L. PRYOR, Arkansas              JAMES E. RISCH, Idaho
BENJAMIN L. CARDIN, Maryland
JEANNE SHAHEEN, New Hampshire
KAY R. HAGAN, North Carolina
  Donald R. Cravins, Jr., Democratic Staff Director and Chief Counsel
              Wallace K. Hsueh, Republican Staff Director
                            
                            C O N T E N T S

                              ----------                              

                           Opening Statements

                                                                   Page

Landrieu, Hon. Mary L., Chair, and a U.S. Senator from Louisiana.     1
Hagan, Hon. Kay R., a U.S. Senator from North Carolina...........    10

                               Witnesses

Askew, Bill, Senior Policy Advisor, Financial Services Roundtable     3
Arbury, Jim, Senior Vice President of Government Affairs, the 
  National Multi Housing Council and National Apartment 
  Association....................................................     3
Sight, Dan, Vice President, Reece Commercial, Kansas City, MO....     4
De Boer, Jeff, President, The Real Estate Roundtable, Washington, 
  DC.............................................................     4
Innaurato, Frank, Managing Director, CMBS Analytical Services and 
  Surveillance at Realpoint......................................     4
David, Stephen, President/CEO, People's Bank, New Roads, LA......     5
Paul, Ron, Chairman, Eagle Bank..................................     5
Minnick, Hon. Walter, a U.S. Representative from Idaho...........     5
Giller, David, Democratic Counsel, Committee on Small Business 
  and Entrepreneurship...........................................    19
Lucas, Chris, Republican Counsel, Committee on Small Business and 
  Entrepreneurship...............................................    26
McWilliams, Jelena, Republican Senior Counsel, Committee on Small 
  Business and Entrepreneurship..................................    26

          Alphabetical Listing and Appendix Material Submitted

Arbury, Jim
    Testimony....................................................     3
    Prepared statement...........................................    40
Askew, Bill
    Testimony....................................................     3
Bevis, Brewster B.
    Letter dated November 16, 2010, to Senators Landrieu and 
      Snowe......................................................    60
David, Stephen
    Testimony....................................................     5
De Boer, Jeff
    Testimony....................................................     4
    Prepared statement...........................................    52
Giller, David
    Tesimony.....................................................    19
Hagan, Hon. Kay R.
    Opening statement............................................    10
Innaurato, Frank
    Tesimony.....................................................     4
Landrieu, Hon. Mary L.
    Opening statement............................................     1
Lucas, Chris
    Testimony....................................................    26
McWilliams, Jelena
    Testimony....................................................    26
Minnick, Hon. Walter
    Testimony....................................................     5
Paul, Ron
    Testimony....................................................     5
Sight, Dan
    Testimony....................................................     4
Snowe, Hon. Olympia J.
    Prepared statement...........................................    38

 
                   SMALL BUSINESS ACCESS TO CAPITAL:


              CHALLENGES PRESENTED BY COMMERCIAL REAL ESTATE

                              ----------                              


                      WEDNESDAY, NOVEMBER 17, 2010

                      United States Senate,
                        Committee on Small Business
                                      and Entrepreneurship,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10:19 a.m., in 
Room SD-428A, Russell Senate Office Building, Hon. Mary L. 
Landrieu, Chair of the Committee, presiding.
    Present: Senators Landrieu and Hagan.
    Staff present: David Gillers, Chris Lucas, and Jelena 
McWilliams.

 OPENING STATEMENT OF HON. MARY L. LANDRIEU, CHAIR, AND A U.S. 
                     SENATOR FROM LOUISIANA

    Chair Landrieu. Good morning and welcome all of you to the 
Small Business Access to Capital: Challenges Presented by 
Commercial Real Estate market and other issues that may come up 
at our roundtable. This is about our 12th roundtable that we 
have conducted since I have been chair of the Committee and I 
find them to be extremely helpful in flushing out some 
important ideas, emerging issues, and potentially emerging 
solutions that can be crafted either by this Committee in 
legislation or other Committees of the Congress that have 
jurisdiction over aspects of these topics. I am very 
appreciative of you all taking the time to come and share your 
thoughts about it.
    Let me give a brief opening statement in a more informal 
fashion, and then I would like each of you to introduce 
yourself as we begin. I am going to be with you until about 
11:00. There are three votes that have been called, and the 
staff will conduct the final 30 minutes or so of the roundtable 
themselves.
    Right before the election, we passed a groundbreaking small 
business jobs bill last year that addressed some of the credit 
concerns facing small businesses. I am proud to have had a 
leading role in that effort, and hopefully many aspects of that 
bill, as it is put into place, will become clear to the country 
on how effective and important it is.
    However, there are several issues that remain unsolved, and 
one of them is the commercial real estate market, loans 
associated with it, and evaluation of commercial property.
    Every small business has to be housed somewhere. Some small 
businesses are in garages. Some small businesses are in 
kitchens. Some small businesses operate out of automobiles, but 
many of them have some commercial connection. They either own 
the building they are in or they are leasing the building they 
are in; and so small businesses all over America, and there are 
27 million of them, have a real interest on how this issue is 
going to get resolved and work out.
    We are very honored to have Congressman Minnick with us who 
is a leading expert from the House and has his own legislation. 
He has been gracious to join us this morning to give us some of 
his thoughts.
    As some of you may be aware, the commercial real estate 
problem has been looming in the background since 2008. During 
discussions on Wall Street reform and the financial crisis, 
many suggested that an impending crisis in commercial real 
estate was around the corner.
    With more pressing aspects of the economy requiring our 
immediate attention, the commercial real estate issue has been 
largely left untouched. Approximately $1.4 trillion of 
commercial real estate debt is coming due in 2013. To give you 
context, that is about half of all outstanding commercial real 
estate which, according to the Federal Reserve, is $3.2 
trillion.
    We have a chart that shows this. If you will hold it up so 
people can actually see it, it is basically a tsunami of 
maturing commercial real estate debt and virtually no way out 
there to refinance.
    Even more pressing according to the Federal Reserve, about 
$338 billion is on the books of our community banks. This 
Committee is keeping a very close eye on our community banks 
not as regulators or oversight which we do not have 
jurisdiction in this Committee but we think of our community 
banks as partners for small business lending.
    Community banks like yours, Stephen, out in the New Roads 
area in Louisiana that know your customers and know your 
clients and are in a position to really help get credit out 
there and capital to small businesses that need to grow and 
expand.
    So we are very concerned, the Small Business Committee. We 
have already started work on this issue. In our small business 
jobs bill which the President signed into law six weeks ago, we 
tried to get at this problem by allowing refinancing of owner-
occupied commercial real estate debt through the SBA 405 loan 
program.
    However, it is limited in its size and scope. It is capped 
at $7.5 billion, while we have just established that small 
banks are holding $338 billion coming due in 2013. So while it 
is a step, it is a very small step in this direction. We were 
happy to take it but much more needs to be done.
    While I strongly believe the refinancing program is 
critical and necessary, I do not believe it will solve the 
entire problem. Because the financial melt down of 2008 
required our full and immediate attention, the problem with 
commercial real estate debt has largely been ignored.
    Now that we have passed the Wall Street reform bill, it is 
time to turn to assessing and identifying commercial real 
estate problems. How is commercial real estate connected to 
small business lending? I have gone over that.
    I hosted a Small Business Jobs Summit in Louisiana last 
month. Over 400 small businesses attended with the same 
message. Many of them still were looking for loans, some were 
looking for opportunities to finance out some of the important 
debt they were carrying.
    Small businesses across America, as I said, either rent or 
own their own small business space. There seems to be very 
limited financing available for new construction and 
development loans. Approximately 7 percent of American jobs, 
that is nine million jobs, are tied directly to the commercial 
real estate market. This includes small construction companies, 
janitorial services, heating and cooling companies, landscaping 
companies, leasing companies to name a few, and might I say, 
many of them are small businesses.
    That is why this Committee is interested and we are going 
to continue to promote and advocate for small business 
everywhere for their expansion, identifying rules and 
regulations that limit their growth, and identifying Federal 
policies that might be counterproductive in trying to work our 
way to a better atmosphere for small businesses in America.
    I have said over and over again this recession is ending. 
There is a recovery underway, but the recovery needs to be 
connected to jobs and it is going to be small businesses of 
America that create those jobs. This Committee wants to plow 
through and clear some paths for that to happen.
    I am aware of the small business bank failures or community 
bank failures that are taking place so we have got to be 
careful. There are over 800 banks on the FDIC watch list out of 
a total of 7,800 nationally.
    As of yesterday there have already been 146 bank failures 
alone this year with more expected. Last year there were 140 
total in the whole year so we are already at 146 into the third 
quarter, I guess, or last quarter of this year.
    Finally, because thousands of community banks know that in 
the next three years their borrowers will not be able to 
refinance their commercial real estate loans, they want to 
understandably protect themselves from the possibility of 
failure.
    As a result they are growing even more risk-averse about 
lending. We are already seeing some banks hold back even more 
from making loans.
    Now I know many of you want to jump straight into 
discussing how to solve the problem. But first things first. 
Let us go to introductions, and then we will open up for 
questions and opportunities.
    William, we will start with you.
    Mr. Askew. Senator Landrieu, I am Bill Askew, a senior 
policy advisor from the Financial Services Roundtable. It is an 
trade organization supporting the hundred largest financial 
institutions in America, and I commend you for having this 
meeting today and for your focus on the commercial real estate 
sector. It is a very important process.
    Chair Landrieu. Thank you, Bill.
    Mr. Arbury. Madam, I am Jim Arbury, senior vice president 
of government affairs for the National Multi Housing Council 
and National Apartment Association. The National Multi Housing 
Council represents the larger principal officers of multi-
family properties and the National Apartment Association's 
number of State affiliates. All told we represent about 6 
million apartment units around the country. I really want to 
commend you also for all of the work that you have done on 
Katrina, and post-Katrina, and all of those problems. It has 
been phenomenal. Thank you very much.
    Chair Landrieu. Thank you. It is still a work in progress.
    Dan.
    Mr. Sight. Chairwoman Landrieu, thank you for inviting me 
here today. My name is Dan Sight. I am the vice president of 
Reece Commercial in Kansas City, Missouri, and I like to call 
myself a street broker. I have been active in selling and 
leasing commercial real estate my entire career. I am here 
presenting the National Association Realtors. I am the 2011 
chair of the Commercial Committee for NAR. I want to commend 
you for your insight into the situation that we are facing as 
commercial real estate investors, brokers, and owners around 
the country. And we are here to try to help you with the 
National Association of Realtors to come up with solutions that 
will help our members and help your members as well.
    Chair Landrieu. Thank you, Dan. We so appreciate you all 
holding your annual meeting in New Orleans. I hope everybody 
had a good time. I was unable to attend the festivities myself, 
but I know that you all were there and we really appreciate it.
    Mr. Sight. You are welcome.
    Chair Landrieu. Jeff.
    Mr. De Boer. Senator, thank you. Jeff De Boer. I am 
president of The Real Estate Roundtable here in Washington, 
D.C. The roundtable, as you know, represents the CEOs and chair 
people of the top 130 publicly-held and privately-owned real 
estate entities across the country. We collectively represent 
about 5 billion square feet of developed property that is 
valued around a trillion dollars. We have about one and a half 
million apartment units and about one and a half million hotel 
spaces. I look forward to the discussion. I do want to 
congratulate you on the bill that was done this fall on small 
business lending. I acknowledge and agree with what you said 
that it is a small step but it is a good step and a positive 
step. And congratulations on beginning the process here. Thank 
you.
    Chair Landrieu. Thank you.
    Frank.
    Mr. Innaurato. First I want to say I am Frank Innaurato, 
managing director of CMBS analytical services and surveillance 
at Realpoint which is an NRSRO out of Horsham, Pennsylvania. We 
are one of the relatively new NRSROs to the business, having 
been designated in the few last years. But since roughly 2000, 
2001 we have been doing research and surveillance on all of the 
commercial mortgage-backed securities out there and active in 
the market.
    So we very much have a pulse and finger on the market and 
how things have changed very dramatically over the last few 
years within commercial real estate, and ironically in looking 
at the tsunami of maturity and the refinancing problems, we are 
very much concerned with where things will be coming in the 
next few years especially into the next year 2011 relative to 
not only the CMBS market but the markets overall as a whole.
    To just kind of give you an idea if you are not familiar 
with what we do, we have roughly 225 institutional clients that 
use our services primarily for research, surveillance, and 
rating products.
    I want to thank you for the opportunity to be a part of 
such a panel here. While we are not a direct kind of piece to 
the puzzle as many of you might be, we feel we are very much an 
indirect piece to understanding what is going on in the market. 
So I thank you, Madam Chairman.
    Chair Landrieu. And you yourself are a small business, 
right, Frank?
    Mr. Innaurato. Yes, we are. Yes, we are.
    Chair Landrieu. How many people do you have working?
    Mr. Innaurato. We are only a 35- to 45-person shop out of 
Horsham, Pennsylvania, doing surveillance on roughly 700 CMBS 
securities on a monthly basis so we are doing a lot with a 
little.
    Chair Landrieu. Good job.
    Stephen.
    Mr. David. My name is Stephen David. I am president/CEO of 
People's Bank in New Roads, Louisiana, a small $150 million 
bank, about 35 miles northwest of Baton Rouge. I appreciate the 
invitation. I am glad to be here. Also I want to note because I 
do not know if it will come in in the discussion but the SBA 
program and reduction in fees, and increase in the guarantee 
has made a big difference in allowing us to continue to make 
loans that otherwise we would not have been able to make.
    Chair Landrieu. Thank you, Stephen.
    Ron.
    Mr. Paul. Thank you, Chairwoman. I am Ron Paul. I have only 
daughters, no sons.
    Chair Landrieu. Good. Just kidding.
    Mr. Paul. I am chairman of Eagle Bank, a $2 billion bank in 
the Washington metropolitan area that specializes in small 
businesses. We have a significant concentration in real estate 
but a very well-positioned, well-capitalized profitable bank.
    Chair Landrieu. Thank you.
    Congressman.
    Representative Minnick. I am Walt Minnick, Congressman from 
Idaho and member of the House Financial Services Committee.
    Chair Landrieu. Thank you. I would like to begin now, if we 
could, with Congressman Minnick and allow each of you to expand 
on maybe three minutes, four minutes each about one or two 
points that you really want us to understand relative to this 
commercial market and the tsunami that is likely to occur and 
potential actions that Congress could take either, of course, 
through this Committee or the Banking Committee or other 
Committees that potentially have jurisdiction over some pieces 
of this.
    From those of you who could speak at it from a perspective 
of either a small business that you are yourself or from a 
perspective of small business would actually really help us to 
bring some of these issues more clearly into focus.
    Walt Minnick has been probably the leading voice in 
Congress on trying to find a solution to this particular 
problem. He served with distinction for many years in the House 
and has developed quite an expertise on this subject. I am 
happy to have invited him and very appreciative that he would 
give us some time this morning to come and share with us some 
of the outcomes of his work.
    Congressman, we will begin with you.
    Representative Minnick. Thank you, Madam Chair.
    In 2007 the value of all commercial real estate in the 
United States was $5 trillion. Today it is approximately $3 
trillion. There is roughly $3.32 trillion as illustrated in 
that chart in debt against these assets, much of it held by the 
Nation's commercial banks.
    This 40 percent decline in value has been caused by the 
ongoing financial crisis, a deep recession, and sharply 
restricted sources of credit for commercial real estate 
investments. Unfortunately the Nation's 8,000 community banks 
are much more exposed to commercial real estate than larger 
financial institutions whose business is much more diversified.
    Small business which, as you know, creates most of the new 
jobs in America relies primarily on local community banks for 
credit. If the capital of these banks becomes impaired because 
of losses from commercial real estate, small business cannot 
expand and the recession becomes deeper and longer.
    Worse yet as commercial real estate values continue to 
spiral downward and bad loans are written down or foreclosed, 
as many as 2,000 smaller banks could fail over the next several 
years. This could cost the FDIC, and indirectly the taxpayers, 
in excess of half a trillion dollars by some estimates, more 
than the net cost of TARP and the savings and loan bailout 
combined.
    Without available credit, transactions in some markets 
currently reflect declines of up to 60 to 80 percent from 2007 
valuation levels, and as the bottom feeders rush in, there is 
more trouble on the horizon. As investors buy up troubled 
assets at steep discounts, they immediately reduce rents to 
eliminate vacancy and create cash flows.
    While this strategy works for the new investors and 
distressed assets, it creates major problems for current real 
estate investors as they battle tenant relocation and a much 
higher cost structure than their new competitors. This leads 
ultimately to more distressed real estate and a new round of 
forced closures.
    The losses from commercial real estate have been slow 
materializing because of the long-term nature of commercial 
real estate leases. But make no mistake, these losses are 
coming. If commercial real estate credit markets are not 
stabilized, the losses could potentially be greater than the 
total capitalization of the U.S. banking system.
    This could trigger both an avalanche of bank failures and 
the much talked about second dip in the recession with renewed 
economic hardship for small businesses and all Americans.
    So what do we do about this looming real estate crisis? 
Like you, I do not believe in subsidies or bailouts for banks 
or commercial real estate investors. I do believe the Treasury 
and the Federal Reserve should provide a backstop program that 
assures market credit is available for all well underwritten 
commercial real estate loans.
    Instead of being the lender of first choice because of low 
subsidized interest rates and easier or reduced underwriting 
standards, the Federal Government could and should facilitate 
credit for well underwritten loans. In doing so, the taxpayer 
would be fairly compensated with substantial profits.
    I have introduced bipartisan legislation in the House of 
Representatives to deal with this in a way that will save many 
of our smaller banks and make, not cost, the taxpayer money. 
Essentially what my bill would do is create an analog for 
commercial real estate that is similar to what Fannie and 
Freddie do for residential real estate.
    It would allow large financial institutions to aggregate at 
current value existing commercial real estate loans and then to 
package them and to get a third-party guarantee, excuse me, get 
a rating from a rating agency which rating agencies can now be 
sued for negligence so it will be a good rating as investment 
grade and then to package these into a security and wrap them 
with a government loan and sell them into the market.
    The government loan guarantee would be available only at a 
hefty fee and the CBO has estimated that this program would not 
only provide credit to the market and a floor under commercial 
real estate values but also yield the taxpayer a net profit 
over the life of the program in excess of $1 billion.
    So it stabilizes the market. It provides credit to the 
market, and it makes the taxpayers money. This is a well needed 
analog which I am hopeful will be considered by you and your 
colleagues in the Senate, Madam Chairman.
    Chair Landrieu. Thank you, Congressman.
    I really appreciate the time and effort put into that 
innovative proposal, and I would like to get at sometime in the 
next hour some comments from various folks here about the pros 
and cons of an approach like that. We need to play the devil's 
advocate as well because the minute you say like create 
something like Fannie Mae and Freddie Mac I think the antennas 
go up. People are very concerned about the track record of 
those organizations and their difficulties, although there are 
outstanding benefits that they have also provided for our 
Nation. That is food for thought. We will come back to that.
    Thank you for your presentation.
    Ron.
    Mr. Paul. Thank you, Chairwoman Landrieu. As I mentioned 
earlier, I am chairman and chief executive officer of Eagle 
Bank, a well capitalized, very profitable $2 billion community 
bank, headquartered in nearby Bethesda, Maryland, specializing 
in loans to small businesses.
    While many other banks of various sizes have hunkered down, 
we have increased our loan portfolio. Loans are up 16 percent 
from a year ago. The Washington Business Journal recently 
recognized us as having made the greatest increase in overall 
loans in the Washington D.C. market. The Journal stated that 
Eagle Bank had the greatest increase in commercial real estate 
loans and the greatest increase in business loans over the same 
period.
    And we have not made the loans by sacrificing credit 
quality. Our ratio for nonperforming assets is 1.46. We are 
very proud of the fact that over the last 12 years we have 
funded $23.5 billion in commercial real estate loans and have 
written off less than $2 million.
    I have also been a real estate investor in office buildings 
and multifamily apartment buildings in metropolitan Washington, 
D.C., and around the country for the last three decades. As 
such, I have a unique perspective on the challenges facing the 
commercial real estate market today as both a lender and an 
investor.
    This Committee is well aware, as mentioned earlier, that 
there is approximately $3.2 trillion of commercial real estate 
debt in existence in the United States. Forty percent of that, 
or $1.4 trillion, is estimated to become due in the next three 
years. Of the $3.22 trillion in outstanding loans, half is held 
by banks and another 25 percent held by the CMBS market.
    One of the major issues we will all grapple with both with 
respect to loans held in portfolios as well as those loans 
maturing is the decline in value of real estate. We recognize 
that determining value is subjective and varies from appraiser 
to appraiser. It is not a mathematical calculation.
    Consider an office building that has a dozen tenants with 
leases at market rates and maturities spread over time, that 
is, picture a stabilized office building, its cash flow has 
been and is projected to continue to be more than sufficient to 
cover the debt service and operating expenses. That conclusion 
is the result of a mathematical computation.
    If I am the lender on that project, and I assure you that 
many loans in our portfolio match this description, I consider 
this a good loan. But also imagine that as a result of the CMBS 
markets evaporating and based on current regulatory standards, 
banks are not in a position to extend additional credit and 
buildings down the street are being foreclosed upon or handed 
back. An appraiser will use the value of one of those buildings 
now and it becomes a comparable sale for the building we just 
talked about. The appraised value on the stabilized project 
based on the loan to value ratio subjectively determined just 
went down by the appraiser's perspective significantly.
    But remember the building's cash flow is still more than 
sufficient to keep the current debt. The project is not in 
fault.
    I believe that Congress needs to address this issue to 
ensure that that performing loan continues to be treated as a 
performing loan. Projects that have a reasonable projection of 
continuing sufficient debt service coverage, that is, the 
borrower is projected to make each month's payment, should not 
be classified credit unworthy.
    The question presented is whether loan to value ratio 
should be the basis for a loan becoming classified if the debt 
service coverage test is met. The issue needs to be examined 
with respect to both during the life of a loan and as the bank 
considers renewing it during this time of significant demand 
for extensions and issuance of new debt.
    This all assumes that the banks are in a position to make 
loans. Even if Congress solves the issue of keeping loans in 
performing status, for those of us in stronger markets, and 
Washington, D.C., is certainly one of those markets, and 
hopefully shortly there will be many more, the issue is 
different.
    It is one of liquidity. We need to have the cash to make 
the loans. As you know, once a bank has capital, it can 
leverage that capital tenfold so $50 million in capital means 
you can lend $500 million.
    But, and it is a big ``but'', you need to have the other 
$450 million in funds available. This issue was quantified by 
the loan to deposit ratio. Eagle Bank's loan to deposit ratio 
is 97 percent. For every hundred dollars we have in funding, 
$97 is out the door already, excluding loans we have already 
committed but not yet funded.
    The American bankers published a list in September of the 
top banks nationally in terms of loan to deposit ratio. Eagle 
Bank, which recognizes its responsibility to lend, is proudly 
on it. It is going to be the strong markets and the strong 
banks that start pulling the country out of this economy and 
strong banks need liquidity to make new loans to small 
businesses along with commercial real estate.
    When a small business, say, a hardware store or a 
restaurant, comes to Eagle Bank and asks to increase its loans 
due to inventory or volume of business increasing, which is a 
good thing, the bank does not want to be in a position of have 
to say, sorry, we do not have the funds available even though 
your business underwrites.
    We need to come up with ways to increase liquidity for 
strong banks. Obviously increasing our deposits is the best 
way. The many alternatives for depositors to place the 
liquidity in markets other than banks such as credit unions 
hurts our ability to attract these core deposits.
    Additionally, the current cap with FDIC insurance coverage 
of $250,000 hurts community banks' ability to bring in larger 
deposits. The cap inhibits individuals and entities from 
putting more of their cash into banks due to risk, and I mean 
real banks, not financial service companies like Goldman Sachs 
or AIG. They do not turn around and lend money to Main Street 
America. Community banks do.
    We must also examine and explore new ways to facilitating 
alternative means of funding for well capitalized, well managed 
banks. Our regulators annually rate banks. Congress should look 
at allowing highly rated banks to have access to alternative 
funding means such as borrowing programs at the Federal Reserve 
Banks or the Federal Home Loan Bank.
    I also might add, as Stephen mentioned, that we also 
request a waiver of SBA fees to be extended at the end of the 
year since we are just beginning to see a pickup in SBA 
lending.
    On behalf of Eagle Bank and community banks across the 
country, I thank you for the interest that this Committee has 
shown in the small businesses and commercial real estate and I 
thank you for allowing me to appear before you. I look forward 
to continuing this conversation with you this morning and in 
the future as you wish. Thank you.
    Chair Landrieu. Thank you. We are going to pause just for a 
minute, Stephen, before we get to you. I would like to take a 
couple of comments about the two or three or four speakers 
because in their statement there were about four kinds of new 
big ideas that were thrown out.
    Any comments or questions that any of you have about some 
of the suggestions either made by the Congressman, I am sure 
some of you have reviewed his bill and his proposals prior to 
coming here. Some of your organizations might have already put 
out a statement or comment about the advantages or 
disadvantages of such a proposal.
    We are joined by Senator Hagan. Thank you so much, Senator. 
You have been an outstanding advocate for small businesses, and 
we really appreciate your being here. We just started and we 
are going around the room and we will come back to you. What is 
your time frame because we could acknowledge you now.
    Go right ahead.
    Senator Hagan. We have votes coming up at 11:00 so I thank 
the Chairman for holding this hearing and I am extremely 
interested in it. North Carolina, it is all about jobs, jobs, 
jobs, access to capital to be sure that industry can stay in 
business and I am very interested to listen to what you all 
have to share with us today. Thank you.
    Chair Landrieu. Thank you. I think you will be very 
interested, and we both have to leave in about 20 minutes or so 
but to really hear some of the new emerging ideas that are 
coming forward, Senator Hagan, about trying to stabilize this 
commercial estate market which, as you know, our Committee does 
not have direct jurisdiction. But as it affects small business, 
we are taking a very aggressive posture because the outcome or 
the way that the country decides to move forward hopefully as 
opposed to just standing still and running around in a circle I 
am hoping we will move forward in some direction, will have a 
direct impact on the 27 million small businesses out there.
    All of them need office or either own office space or are 
affected by the values of the commercial buildings next door. 
It really is just a corner stone of this market and a corner 
stone of our potential. I see that fragile recovery under way. 
As you and I know, it is not as strong as we would like.
    We had two presentations by the Congressman and Mr. Paul. I 
would really like comments. Jeffrey, would you start us off, 
and when you all want to speak, just set your name card up like 
this so I can recognize you or just give me a signal. Thank 
you.
    Mr. De Boer. Thank you for this hearing, and I guess I 
would say that these two opening statements really crystallize 
three of the most important issues here, one being the CMBS 
market. We have got to figure out a way to get that going 
again. It is showing some sort of nascent signs of life.
    It is going to run about $12- to 15 billion this year. That 
is off a peak of around $230 billion in 2007. We do not 
necessarily need to get back to 230 but we need to get greater 
than the 12 or 15 we are going to do here. The Congressman put 
forward some ideas. There are other things out there but 
certainly that is number one.
    This issue about value is a very troubling issue because it 
is almost like you are asking people to describe a color that 
they have never seen, and I say that because you want value to 
be determined out there but yet there are no transactions.
    Typically values are determined when there is a willing 
buyer and a willing seller. There are distressed sellers and 
there are opportunistic buyers. So we do not have a color that 
we can really see to describe.
    So this whole issue about what is value is really an odd 
component out there, and I think it is very important what Mr. 
Paul brought up about that.
    Finally, just the other very important thing is this issue 
of banks liquidity. I think, you know, the point about you can 
lend ten times your capital. Most small banks or regional 
banks, I would suggest, are ill-liquid because they have 
already lent in many cases, now there are exceptions, but they 
have already lent up to their ability to lead.
    Then you say, well, how do they create more liquidity? 
Well, they create liquidity by selling assets. But if they sell 
assets, they are going to sell assets at a loss. So for every 
dollar of loss that they sell they correspondingly will have to 
reduce capital. So it is a Catch-22 that is going where banks 
want to become more liquid. In fact, they are becoming less 
able to lend.
    And the final point that I would say that obviously, I 
mean, these banks are embedded with commercial real estate 
loans, traditional commercial real estate loans. But they are 
also embedded with small businesses who use their real estate 
as collateral to make the loans.
    These asset values are down 25 to 35 to 50 percent in some 
markets. Now, in some places they are coming back, and the big 
public REITs are accessing capital and the big private owners 
in gateway cities are getting a little more liquid, but Main 
Street is not at all.
    So you go and you want to get a loan and your collateral 
value is down substantially. The bank is already embedded with 
all of this stuff. The regulators will come in and say do not 
make any more loans on this type of asset plus the banks 
themselves will be fearful of making these loans.
    So these are very complex, inter-related. We have got some 
ideas in addition to what Mr. Minnick suggested. These are the 
key things. How do we get the CMBS market? How do we increase 
bank liquidity? How do we have a better sense of value to make 
sure that the metrics work?
    You talk about the SBA system working because it has the 
flexibility out there now that local bankers used to have but 
do not have today. I will stop with that. I think I have gone 
on enough.
    Chair Landrieu. Excellent crystallization of these points, 
and we really appreciate it. That is what these roundtables 
are, you know, the format is meant to do.
    Jim, did you have a comment?
    Mr. Arbury. Yes. I would like to, first of all, echo what 
Jeff said but also what the congressman said. Multi-family, we 
have the great benefit of having GSE available, GSE lending 
available to us. We have had a great track record, unlike the 
single-family, I mean, we have not cost the taxpayer a dime.
    And properly underwritten with, you know, good money in the 
game. You know, we have done very well, and the taxpayer is not 
at risk. But that going forward, even though all the 
demographics are in our favor, we have got about a hundred to a 
hundred fifty billion of maturing debt coming due in the next 
year or so, more than that in the next couple of years.
    We have $872 billion total debt outstanding of which about 
a third is owned by the GSEs. The big uncertainty and the big 
risk going forward is if the government pulls the plug on the 
GSEs suddenly or way too early, there will be, we will be right 
in here in the whole mix with the rest of the commercial in 
terms of problems with foreclosures and what will happen going 
forward.
    Chair Landrieu. Bill.
    Mr. Askew. I will not repeat what Jeff said on CMBS but I 
do agree that restarting the CMBS is one of the key issues 
here. I want to reference your chart up there because I think 
your chart is the most important chart in this room and it says 
everything we can say about commercial real estate.
    Chair Landrieu. Compliments to whoever. Did you all present 
this? The Real Estate Roundtable. We have to give credit where 
credit is due.
    Mr. Askew. The size of the role of maturities is clearly 
the issue in CRE, and it is the issue we have got to face down 
and we have to do something about.
    The CMBS market has shown signs of life as Jeff says but it 
is not back, and we need it back. And so I think the issue is 
more of existing debt and how we are going to refinance that 
debt as it matures. That is the issue we have to face and that 
is the issue we have to deal with.
    And another thing that you said, Ron, about performing 
loans going to non-performers. There needs to be some changes 
and some consistency in the way that the local examiners are 
interpreting interagency guidance.
    The guidance came out in October. It actually helped it 
seemed for a while but now there is too much in differences in 
the way that guidance is being interpreted. So I think those 
are two of the key issues.
    And I just throw in the third issue as accounting policy 
right now that has thrown all of this into confusion, FASB 166, 
167, and then Dodd-Frank had set some clear guidelines on risk 
retention which, if we can follow through on how the bill was 
set up, I think we could get clarity and this will work.
    But the FDIC has come out right now with safe harbor 
explanation and then SEC has got some guidance, reg A and B, 
that throws some confusion; and so the market is confused right 
now and it could slow down what was starting to be a restart of 
CMBS. So we need clarity.
    Chair Landrieu. Hopefully it will not be that difficult to 
clarify this interim guidance. Several people have suggested 
that, and I think that is important. It may be easier said than 
done but we will see.
    Let us go now to you, Stephen David, and we would love to 
have your opening statement.
    Mr. David. Thank you, Senator.
    I almost want to say it is verbatim what Ron had to say so 
I will just sort of try to expand on that.
    The appraisal market right now is that we have appraisers 
who are in fear of their own shadow. That has been a large 
problem for us and it brings us to problems with regulators 
because when they do an appraisal, we are finding that they are 
not realistic values.
    We recently had a sheriff's sale; and that is, in Louisiana 
on a foreclosure, the method of getting back the property. It 
goes to an open bid process. The property has to be appraised 
by someone appointed by the sheriff and we also have it 
appraised.
    In this particular example, the property appraised for 
$224,000. We knew the property, thought it had a substantially 
larger value on it. We took it back, we bought it back at the 
sale, had it reappraised by a different appraiser who appraised 
it for $226,000. Within three days I had three offers over 
$300,000 for the property and sold it for $327,000.
    So the realistic part of what has happened with appraisal 
is they have always been, in my opinion, subjective. They are 
becoming more and more subjective. That plays into what issues 
we have now from a regulatory standpoint is we have loans that 
are coming up for renewal and are being pushed to get new 
appraisals.
    We know what happens if we get a new appraisal. We are 
immediately going to be underwater and then we will be facing a 
substandard classification.
    Or we have someone who wants to build something, commercial 
real estate. It could be spec houses or strip centers, things 
that we deal with in smaller towns and cities. And the 
appraisal is going to come in at less than what it is going to 
cost to do the project, cash flows no longer being the driving 
factor but market value being the driving factor.
    So that is a problem from a regulatory standpoint as well 
as the position it puts us in with the appraisals.
    Additionally, capital is an issue. Particularly in smaller 
community banks, to use that word. As we look and see which 
banks are being closed, it is very clear they are all 
community-bank size, banks that are being closed. So there is 
what we call the three C's of lending now. It is capital, 
compliance, and cost.
    We do not have a definition of what is enough capital. They 
will tell you only it is sufficient or it is not sufficient but 
never a number. Well, the more capital has put a burden on 
banks of what is available to lend. The cost and compliance 
cost, they are also, as you said, it is ten times what we can 
lend. In my small bank $150 million. In the last three years 
our compliance costs went from just over $10,000 a year to over 
$250,000 a year. Our cost of FDIC insurance premiums went from 
$17,000 a year to $220,000 a year this year. So we are talking 
about in excess of $500,000 which multiplied times ten is $5 
million.
    That is a large number for a bank our size and those are 
the dilemmas that we are facing in trying. We are a high loan 
to deposit. We are a loan-driven bank, have always been and 
hope to remain a loan-driven bank.
    I will tell you that our loan to deposit ratio has 
decreased from 120 percent to 100 percent in the last 12 to 18 
months, and not so much from inability to find loans; it is 
inability to make loans that otherwise we would have made. 
Thank you.
    Chair Landrieu. Thank you, and I really appreciate it.
    Mr. David and I had many conversations as the Banking 
Committee was doing its work. He was very instrumental in 
giving me some information that I tried to pass on to the 
Banking Committee about the effects of raising some of these 
fees on the small banks out there.
    I mean, if you are a billion dollar bank, those fees are 
pocket change. But if you are a $150 million bank, and I do not 
know how many banks, Senator Hagan, in the country that are, 
you know, small but they are in small places and they are doing 
good work in those places on Main Streets far away from this 
beltway that need our attention and need out support.
    So I am going to be looking at this fee issue. Stephen 
shared those numbers with me before so I have heard them 
before. That is why I am not shocked this morning. But it is 
just in my view unconscionable. I will just say that.
    It is just unconscionable for fees to be raised that much 
on that kind of institution. I am going to do everything I can 
to eliminate them or reduce them.
    Go ahead, Frank.
    Mr. Innaurato. Thank you again, Chairwoman. I want to 
really thank everyone for the opportunity today to participate 
in this hearing.
    Just to give you a little bit more background on Realpoint, 
obviously being the only NRSRO or Nationally Recognized 
Statistical Rating Organization in the room, we specialize in 
the structured finance market and specifically doing a lot of 
conversation about this CMBS market. We have earned our bread 
and butter and expertise focusing on commercial mortgage backed 
securities.
    Currently more than roughly 225 institutional investment 
firms subscribe to Realpoint, and we pride ourselves on our 
trusted ratings analysis of approximately $788 billion of 
outstanding CMBS which not only includes domestic CMBS but some 
of the agency portfolios, Canadian portfolios and the like.
    At Realpoint on a monthly basis we closely monitor all 
current commercial mortgage-backed security transactions in the 
United States which is close to 700 transactions on a monthly 
basis. This consists of in-depth monthly ratings reports of 
these securities, analytical performance studies, watch list 
reports, alerts, and other information about all the rated 
securities or underlying collateral for that security such as 
the property level reports.
    In terms of general market direction, we can report that, 
while commercial real estate loan defaults have slowed 
recently, they have not stopped altogether; and we really feel 
that the market will continue to show signs of distress going 
into the 2011 potentially bottoming out in 2011 and show signs 
of recovery in 2012.
    I do have some statics that I really wanted to share with 
everyone in the room relative to what we are seeing through the 
end of the third quarter within CMBS.
    Through September 2010, the delinquent unpaid balance for 
CMBS continue to exhibit moderate monthly growth, having 
increased by an additional $800 million in one month up to 
$62.2 billion.
    So I note through many of the charts that we are seeing 
just the size and the volume of loans that we are being 
concerned about not only through distress on your own balance 
sheets but within CMBS specifically. If I had a chart or a 
graph it is almost a straight line of continued growth.
    In the last few months you have seen some tempering off and 
some slowdown. But some of that has really been fueled by 
increased liquidations. Due to the decrease in value of some 
many properties, loans that are being worked out and liquidated 
in this market are experiencing average loss severities 
anywhere from 50 to 60 percent on their original loan balance.
    For the last few months of this year, just to give you an 
idea, from January through June 2010 average growth per month 
of new delinquent loans within CMBS was averaging $3 billion a 
month. So a substantial growth in the early part of the year 
has moderately tapered off a little bit in the last few months.
    Despite ongoing loan liquidations reporting on a monthly 
basis, modifications or resolutions of distressed loans, the 
90-day delinquent foreclosure or RAO within CMBS as a whole 
continue to grow on a monthly basis. They grew by another $1.2 
billion from the previous month after falling for the first 
time in almost three years from July to August 2010.
    So again not only new delinquencies but the level of 
delinquencies is being reached in CMBS loans going from 30 days 
to 60 days to 90 days. And in cases where they have been unable 
to negotiate some type of a workout or related scenario with 
the asset manager or specialist within special servicing to 
work out these loans, borrowers have been left in many cases 
just simply to default on their loan and hope that some kind of 
modification or resolution can be reached.
    Overall putting some more percentages and fuel on the fire, 
the delinquent unpaid balance for CMBS alone was up over 96 
percent from September 2010 through, excuse me, in one year 
from 2009 through 2010. So nearly 100 percent growth from the 
only $32 billion of delinquent unpaid balance that was reported 
back in 2009.
    Overall this reflects 28 times the low point for CMBS 
delinquency. Back in March of 2007 when the markets were still 
performing and the growth of aggressive lending, underwriting, 
and new issuance within CMBS delinquency was as low as $2.2 
billion.
    So when I present numbers that are as high as $62 plus 
billion you can see the magnitude within CMBS and how voracious 
the growth has been in such a short time.
    Chair Landrieu. You used the word ``growth'' you mean 
``increase.''
    Mr. Innaurato. Increase.
    Chair Landrieu. Growth is a positive word. This is not 
positive.
    Mr. Innaurato. Yes. In this case it is increase, very much 
so. I am glad you clarified that. Yes.
    Chair Landrieu. An increase in delinquencies is not a good 
thing.
    Mr. Innaurato. No, not at all. In many cases the increase 
in delinquency that you are seeing as well is fueled by loans 
that initially claimed imminent default where on the small 
commercial banking side, borrowers pick up the phone and place 
a call and say, is there something we can do, is there 
something we can work out so that I do not default on my loan.
    Within the commercial mortgage-backed securities world that 
is imminent default. So the lenders, the masters servicers and 
special servicers are left with an otherwise performing loan 
but a borrower who now realizes due to decline in values and 
decline in the performance of their underlying market, they are 
raising their hand and saying, can I get a modification, can I 
get a re-work because my property values are down anywhere from 
30 to 50 percent in a given market. My cash flow is not where I 
hoped it to be. So I might need a modification. So they 
threaten imminent default, and immediately a loan is 
transferred to an asset manager.
    In that realm of managers, special servicing, putting some 
more numbers on it just to give you an idea, this is considered 
special servicing within CMBS. The number of loans with special 
servicing was 4700 and close to $92 billion of loans that were 
requesting some form of workout status of which only $62 
billion was delinquent.
    So that left another $30 plus billion of loans that were 
still current in payment but looking for some kind of 
modification, maturity extension, new interest rate, new terms, 
based on the problems they were foreseeing.
    We have talked a lot about the impact of value declines and 
the like, and I thought one of the numbers that I would share 
with you is that year-to-date through September 2010 within the 
CMBS market, $5.5 billion of loans have been worked out within 
CMBS but at an average loss severity of over 50 percent, 
meaning that loans that were originated at a higher value and a 
higher, low LTV, higher valuation, higher UPB are losing nearly 
half of their dollar amount in today's workout scenario.
    $5.5 billion loan workouts just in the first nine months 
within CMBS is the highest that has ever been realized in the 
history of CMBS. This is legacy CMBS. These are deals that were 
originated mostly during the peak of the market, from 2005 
through 2008, mid year, and most of the delinquency and the 
problems that we are seeing in the market today are coming from 
the aggressive underwriting and lending that went on during 
that time.
    In addition to all these loans, though, however Realpoint 
through its surveillance efforts continues to monitor daily 
many watchlisted loans, loans that remain current in payments 
but have been transferred to special servicing. I have 
highlighted a lot of that.
    But in our opinion many of these loans may ultimately 
default again, not just loans that have already asked debt 
relief but loans that we have not seen default yet.
    An interesting point to kind of add something to some of 
the previous conversations is with CMBS most of the traditional 
loans and deals, much higher balance in unpaid, is for the 
individual loans.
    Whereas if you were a $3 to 5 million loan, you would not 
refinance into a new deal especially if the conduit markets 
were dead. You are just not going to get into that type of 
universe right now. The deals that are being produced and the 
new CMBS deals that are coming to market, very well 
underwritten, highly scrutinized, but you are seeing higher 
balance loans still within these transactions, not to the 
extent of the 2007 or 2008 deals but traditionally when loans 
got to a smaller level they would refinance through a community 
bank. This is a big problem within CMBS right now. A large 
portion of what you are seeing by way of the maturity risk that 
is coming due is because many of these loans that have 
amortized down, many of these loans that have done nothing that 
Mr. Paul said performed from the day one until now. They have 
paid their debt service. They have consistently had a good 
DSCR, debt service covered ratio, maintain a high level of 
occupancy, but there is no one willing to lend.
    So they are left to either ask the CMBS world for an 
extension, a modification, or default and turned over the keys 
after doing nothing for five to ten years but pay on their 
loan.
    Chair Landrieu. That will make people very angry, and we 
are going to try to avoid that because they are angry enough. 
So we are looking for some solutions and if you wrap up in 30 
seconds so we can call on the others and throw out maybe one 
solution that you might see or do you think that anything Mr. 
Minnick or Mr. Paul or Mr. David said might work in your view?
    Mr. Innaurato. Definitely. 2010 we have seen the re-
emergence of the secondary or conduit market, not to the levels 
that we hoped to see in volume and size. But as of mid November 
there had been six conduit deals placed or in the process of 
being placed which is very very good.
    Really our suggestion is we feel at Realpoint that we were 
not part of the problem. We want to be part of the solution. 
Being relatively new to the rating of new issuance CMBS, I 
think we very much agree that with quality on the writing and 
with the right packaging of these loans that this CMBS market 
can be revitalized.
    However, there has to be a willingness to lend. There has 
to be the availability of capital. There has to be quality 
underwriting but there also has to be investors willing to 
purchase the CMBS in the secondary market.
    So it is one thing, two pieces of the pie really need to 
come together for it all to work.
    Chair Landrieu. We hope your experience will be valuable to 
us in crafting a solution.
    Jeffrey, we will do this real quick.
    Mr. De Boer. I guess I sort of said the key points earlier. 
But just if you wanted to get a couple of solutions on the 
table in addition to what Mr. Minnick has put forward, some 
people talk about this liquidity and the losses the banks have. 
Maybe a solution here would be to allow or an idea would be to 
allow banks to amortize the losses on the sale of these assets 
over a seven- or 10-year period rather than recognize them 
immediately. That might encourage some of these assets to move.
    The key thing, you have to clear the bank balance sheet of 
toxic assets. You have to create more equity into the system, 
both for the lenders and for the borrowers. And, you know, you 
have to encourage risk taking.
    The bottom line here is, you know, all of this, look, we 
went into this problem with commercial real estate relatively 
in balance. Okay. Supply and demand was relatively in balance 
meaning, you know, there was not huge vacancy rates for office, 
not large vacancy rates for retail or multifamily or anything 
else.
    Why is there a problem now? Because the demand has fallen 
off. Why has the demand fallen off? It is not a secret. There 
are no jobs. And so the key to this whole thing--really we can 
talk about a lot of esoteric things. But as you well know, 
jobs. We need a solid program to encourage jobs.
    And like I said, on the equity side, look, lenders need 
more equity. There are a lot of people sitting on the sidelines 
that want to put equity in. Some of these happened to be 
configured in private equity funds.
    Now, I understand private equity is a negative word up here 
for some reason and with the regulators, but the fact of the 
matter is they have got capital. They would like to invest in 
institutions, and there are regulations that inhibit their 
ability to do that.
    On the borrowers' side of things, look, these people, many 
of these borrowers are out of equity because they originally 
bought an asset for $100. They put $70 of debt on it. The asset 
is now worth $60. Their equity is gone. They have been hanging 
on because the interest rate environment is low; and so even 
though their vacancy rates have increased, they have been able 
to perform under the loan.
    They are running out of juice. So they need equity 
investment either from the private world here in the United 
States, domestic people, or also from foreign investors. We 
have talked about how we could reduce the tariff for global 
capital to come into the U.S. real estate markets under this 
FIRPTA thing. And Senator Hatch and Senator Menendez and others 
are looking at that.
    One final thing. Any time I am up here, you know, the main 
thing is, boy, do not do anything that would encourage risk 
taking or further put a boot on real estate as it is trying to 
recover here, and institutions trying to recover.
    That gets into this carried interest debate that we do not 
need to talk much about it. But the bottom line there is this 
would be a severe impediment to a lot of very small real estate 
partnerships that are struggling to hang onto their properties 
and suddenly their tax laws are going to be changed many times 
retroactively.
    So I just say let us find the way to increase liquidity. 
Let us find a way to bring in some equity and let us not, for 
god sakes, make things worse for struggling partnerships across 
the country.
    Chair Landrieu. Excellent points. Any comments? I will have 
to turn it over to David. I have five minutes left in the vote 
and it takes me about five minutes to walk to where I have to 
vote. So I am going to leave in just a minute. And I will turn 
this over to David.
    Bill.
    Mr. Askew. If I could just add a comment to Stephen's and 
Jeffrey's.
    Chair Landrieu. Go ahead.
    Mr. Askew. On the fee issue, it is not just small banks. It 
is not just community banks. Fees are impacting all of the 
banking system. And if you look at the FDIC, just take that one 
item for a minute, if you look at the assessment last year, 
they added $15 billion to the industry. It took out all of the 
industry's profit, the entire financial industry's profit last 
year just going back to that fund.
    So those fees. And then you add on the burden of the 
regulatory reform that we are going to have to follow, those 
fees are significant in this process so I just want to second 
that point.
    Chair Landrieu. Thank you for clarifying that.
    I am going to turn it over to David. He is going to conduct 
this for another 10 or 15 minutes. This has been extremely 
helpful. Obviously we are not going to find the solution this 
morning.
    But I would like, Congressman, for you to add a few points 
as we close because I think that there have been several good 
suggestions and solutions put forward, and we are going to 
continue to work on this issue and present our findings not 
only to the staff here but to staffs on other committees as 
well because there is some urgency about this and we need to 
push this issue very hard through the lame duck, through the 
beginning of the next Congress so we can get something together 
and out there that would be helpful and supportive.
    I turn it over to David. And thank you all.
    Mr. Giller. Thank you, Senator.
    One crucial point, and perhaps, Mr. Paul, Mr. David, Mr. 
Askew can speak to, is to clarify why this issue, why the 
challenge of commercial real estate affects banks across the 
board. So even healthy, profitable, strong banks such as 
yourselves are dealing with this issue as well. I think it is 
an important issue to clarify. Commercial real estate is not an 
issue for everyone but it is not limited to, let us say, weaker 
banks. I would just like to clarify why this is such an issue 
even for the strong, healthy banks such as yourselves.
    Mr. Paul. Thank you, David.
    I think the position that Eagle Bank and I think most 
community banks would have is that most banks in today's world 
are substantially concentrated in real estate. Certainly in the 
Washington metropolitan area real estate is not a very popular 
word.
    The fact of the matter is if I could sit with a piece of 
real estate that has a first trust that nobody could take away 
from me, that is a whole lot more security than receivables or 
other inventory that could disappear very easily.
    The real question in my mind comes down to how we resolve 
this loan to value side so it is not forcing banks to write 
down a very subjective evaluation. I still, as I mentioned in 
my testimony, am a firm believer that for an interim period, 
consideration should be given as to valuations being focused on 
debt service coverage, as Stephen mentioned, as opposed to a 
very subjective loan to value.
    The issue as it is relates to banks, how it affects banks 
is that clearly a well capitalized bank, if they are forced to 
write down that phantom loss which is again that subjective 
loss, now all of a sudden takes a very well capitalized bank 
and puts them into a potentially much weaker capitalized bank.
    That also, obviously, prohibits the future lending. And as 
the economy gets stronger, it is the community banks that are 
going to get us out of this. With all due respect to a lot of 
people around this table, we are at $2 billion. I define 
community banks at really $10 billion and under. I think those 
are the banks that are going to jumpstart this economy because 
it is all about jobs.
    And when the restaurant needs that loan, it is going to be 
a community bank that makes that loan to be able to support 
their employee growth.
    So I do believe that the 8000 community banks that we have 
are in serious jeopardy even if they are extremely well 
capitalized if we do not focus on this loan value issue. Thank 
you.
    Mr. Giller. Mr. Askew.
    Mr. Askew. David, I will add to that. I agree with his 
point but I will add to that. If you look at the market right 
now, it is a trifurcated market in commercial real estate. 
There are the larger assets that price is actually improving on 
a little bit right now, albeit a little bit.
    Then there is the distressed market which continues to 
fall. Those prices continue to fall. And then you have those 
assets in the small owner-occupied businesses that are just 
flat, and they are holding steady.
    If you look at the large banks, to your question, to your 
point, we have been through those stress tests. We have taken 
those hits. We are in the state of recovery so to speak from 
the commercial real estate side.
    But the issue is jobs. This whole issue with commercial 
real estate is 12 million jobs. I think it is more than that. 
This is just what we have identified. There is indirect support 
of jobs in the commercial real estate sector. If we do not get 
the jobs back, then we are going to go through this recession 
slower than we should. Those jobs impact all of us. I do not 
care which bank you are in. I do not care how big you are or 
how small you are, you cannot recover, you cannot get stronger 
unless the job market comes back.
    Mr. Giller. Dan.
    Mr. Sight. Thank you, David.
    Again I am here representing the National Association of 
Realtors. Most of our realtors are small business oriented and 
54 percent of our transactions are a half million dollars are 
less. So we have got two extremes of the market. We have the 
CMBS and then we have what the commercial realtors are doing 
with NAR.
    Our sales are down 80 percent from 2007, and as a result, 
43 percent of our commercial realtors have not completed a 
single sales transaction this year.
    According to our research at NAR, commercial real estate 
prices have plummeted as much as 45 percent from their peak. 
Let me take us back to Main Street as the Senator said.
    I have a project in Kansas City. It is a small office 
warehouse project. Around $900,000 project, multi-tenant, seven 
tenants. The thing was going great. Did a 20-year amortization, 
five-year balloon. Went through the five-year balloon. We are 
looking great. We are starting on a short amortization 
schedule.
    Two years ago crisis hit. So what am I doing as an 
investor? Just as I tell my clients, make a deal. My rents have 
come down. My job as an owner, as a broker as well, put 
somebody in there. So my rents have gone down, my vacancy has 
gone up. The cap rates that the appraisers are coming up with 
have gone up as well.
    That property has gone down in value, hopefully not as much 
as the 45 percent but arguably somewhere in that range.
    I come back to Mr. Paul or Stephen in two years when my 
note comes due. What are they going to do with me? I have made 
my payments, never missed a payment. My partners and myself are 
well capitalized. What kind of push are you going to be on to 
renew that note. You are going to look at it and go, well, the 
value is down. How do we refinance that, which is a real issue.
    There are a lot of these projects like this all around 
America. A couple of things that NAR has proposed are term 
extensions so that these bankers are not penalized for me 
extending this loan.
    Let us let the market take care of itself. Let us create 
some jobs. Let us fill up our vacancies. Let us get our rents 
back up but let us renew that note. Let us not take it into my 
REO property. Let us keep it going. So we are a real advocate 
for term extensions that will not penalize our lenders.
    Another thing that we talked about is mortgage insurance 
for loans that are performing. There is an equity gap maybe 
between what they are valued at, what the loan is. Maybe we 
should look at some private mortgage insurance that could be 
paid for by the bank. It could be paid for by the borrower, 
mostly by the borrower. But to ensure that that money is there 
to keep the market moving and going.
    Something else we talked about, jobs. Lawrence Yun, our 
economist, did a presentation for us in May this year. 2007 
everything was pretty rosy in commercial real estate. Sales 
were good. Market was good. We were just rolling along. Then 
when he started overlaying our job losses, it became really 
clear to me as a simple person what happened to the commercial 
real estate market. We lost jobs, do not have as much demand 
for office, do not have as much demand for retail, do not have 
as much demand for industrial. We really need something in this 
country to get people back to work that will help fill up our 
spaces and will help stabilize the values of commercial real 
estate.
    Mr. Giller. Before we move on to the next question, does 
anyone else want to clarify? I think it is an important to 
clarify why the commercial real estate issue is not just a 
problem for underperforming banks, it affects all banks 
nationwide even strong, profitable performing banks.
    Mr. Arbury. I think what we really have gotten into is sort 
of a valuation nightmare. I mean we went from a period prior to 
the bursting of the bubble where the big financial institutions 
refused to recognize that values have dropped and now we have 
gone the other way and now we have got values, whatever 
appraised values, based on the few sales that exist being way 
under what the discounted cash flow value is of a property.
    And so that leads to liquidity and you will never get jobs 
back, you will never get construction back, for example, 
multifamily. We have got a huge demand looming out there and we 
will never be able to meet it unless we get liquidity back. 
Valuation is a big problem.
    Mr. Giller. In a minute I want to turn it over to my 
Republican counterparts to ask a few questions but I realize 
the two of you have not had an opportunity to present your 
opening statements. Would you like to do so now?
    Mr. Arbury. I will do one minute.
    Having been a former Senate staffer, I know not to go too 
long here. The news from multifamily is pretty good. I mean I 
can see growth, the growth being that occupancy is up. The 
demographics are out there.
    But I think that a number of financial institutions have 
gone from being risk managers to be risk-averse, and being 
risk-averse means you probably have to turn down just about 
every loan that comes to you, either forced on you by the 
regulators or by whatever financial position you are in at the 
time.
    Multifamily is the ultimate small business. 55 percent of 
apartment properties are owned by individuals. So there is 
great competition. But without liquidity, and we have got to 
get through this financial crisis, but without more financial 
liquidity we would just not be able to meet the demand going 
forward that is there because the demographics have definitely 
changed. And multifamily gives workers much more flexibility in 
terms of being able to move around the country to find a job as 
opposed to being stuck where they own something.
    I will stop right there.
    Mr. Giller. I want for a moment to check back in with the 
Honorable Congressman Minnick to see whether you have any 
observations or comments on what has been discussed.
    Representative Minnick. Well, the problems that affect 
banks of all sizes but are particularly acute for our smaller 
banks all involve capital liquidity or concentration or some 
interconnection of those three. And the problem of capital 
adequacy is exacerbated by declining asset values and that is 
the big problem when you have commercial real estate that is, 
was at one time worth $5 trillion and now is approaching less 
than $3 trillion.
    It seems to me the solutions on the capital side, there 
have been a lot of good ones that have come out in this forum, 
include term extensions for performing loans without an 
intermediate write-down even if the asset values are 
questionable. Acceptance of an MPV-based assets as opposed to, 
valuation as opposed to last distressed sale comps makes a lot 
of sense.
    The suggestions slightly more controversial in my mind that 
you allow the amortization of recognized losses certainly has 
merit particularly when it is coincident with a period to raise 
capital. It is easier to raise capital if you do not have to 
take an immediate write-down.
    I think one of the things we have not hit on as hard as we 
might is the problem of pro-cyclical regulation. We have the 
FDIC. Chairman Frank and I sent a letter to the regulators 
earlier this year, saying let us not use belt and suspenders 
regulation. Let us enforce. Just because you have had bad 
experience that does not mean you should pile on the pro-
cyclical regulation.
    So all of those things affect capital adequacy, and in 
combination, can deal with the shortfall and make it possible 
to raise capital and save half of these 2- or 3000 banks that 
will be at risk.
    The other questions of the liquidity and concentration are 
addressed by jumpstarting the CMBS market, and several comments 
have been made that the CMBS market is coming back. But let us 
recognizes it is barely coming back. We are talking about $8 to 
10 billion this year as opposed to $207 billion before the 
crash, and the properties involved are mostly large trophy 
properties. They are not Main Street properties.
    The problem is, I think everybody on this panel has 
remarked, is Main Street creates jobs. And small business 
relies on the Main Street banks for their capital. So if you 
want the smaller banks to have the liquidity, particularly if 
the regulators says they are over concentrated, you need 
something other than a distressed market to provide a way to 
sell property that they have their loan against whether it is 
performing or nonperforming.
    The bill that I have sponsored would jumpstart the CMBS 
market for the smaller properties, hopefully get back to that 
$2- or 300 billion worth of capacity that we need to refinance 
this onslaught and do it in a way where the banks can sell it 
at fair value, not distressed value.
    And with respect to concentration, if the FDIC says you 
should be one to one and you are three to one or four to one, 
this gives you a way to reduce your concentration without 
having to stop, with impairing your capital and without having 
to cease making new loans.
    You can sell off the loans to get the proper concentration 
that the regulator specifies and then you can sell somewhere in 
order to get the liquidity to make the next loan. It seems to 
me in combination with all of these things we can, this is a 
catastrophe that is going to happen but it is entirely 
preventible if we take the right regulatory and legislative 
steps to do so.
    And I think the ideas coming out of this forum really 
provide the list of things that needs to be done by both 
regulators and the Congress over the next six to eight months.
    I would like to see it between now and the end of the year.
    Mr. Giller. Just to follow up on one of those issues, the 
pro-cyclical nature of regulatory action and Mr. Askew 
mentioned this issue of the October 2009 guidance that all the 
regulators came out with, the prudent commercial loan workout 
guidance. And before your Committee, Chairman Bernanke said, 
yes, our examiners should be following this guidance. They 
should focus on values or cash flows and not values of the 
collateral. But we are hearing that every examiner in the field 
is sponsoring this.
    I know that you and Chairman Frank have requested a GAO 
study on that issue. If you could just talk a bit more about 
what has motivated that request for GAO study and what you are 
hearing about the regulators in the field.
    Representative Minnick. No examiner ever got fired by being 
too tough on a financial institution. They only get a black 
mark on their job evaluation if an institution that they have 
accessed subsequently fails.
    So there is a natural human interest, when times are tough 
and examiners had a bad experience, to ensure that it does not 
happen on my watch again. So even though the regulators who 
come before congressional committees, both in person and in 
hearings, and say, yes, we are following these regulations. It 
is not pro-cyclical. We have not gotten tougher. That is not 
the experience that our bankers see the next time the examiners 
show up.
    So I am from Missouri with respect to whether or not this 
guidance is in fact. It sounds good when you hear it but on the 
ground the experience is very different. I think that goes 
through to the ability of senior managers and regulators to 
enforce the idea that it is okay to take a few risks as an 
examiner because you do not want to cause ten banks to fail 
because of your regulatory assessment when, if you had more 
sensible regulation, one or none would fail. And that is the 
experience and the problem we have on the ground. It is ground 
truthing what we are told in testimony.
    Mr. David. Just to comment, I think Jeffrey made a comment 
about a possible suggestion being writing things down over a 
period of time. We are dealing with capital appraisals, all of 
a subjective nature, and it appears time is an enemy. And with 
using things such as giving it time to write things down, use 
time as an ally because the values were here, they are here, 
they will go back up in time. So the more time that we are 
allowed to write down a property, the better the outcome will 
be because the economy will come back. How much time it will 
take or when that will be is certainly uncertain.
    If we are able to create more jobs, it will come back 
quicker. When that is done, then the total losses get cut 
substantially. So I think we need to find solutions where time 
is an ally, not an enemy.
    Mr. De Boer. Just a couple quick points. You had asked, 
David, about why should healthy banks be concerned about this 
as opposed to a bank that is heavily laden with real estate 
losses or something like that.
    It reminds me of a time I sat next to a banker at a dinner 
and asked him how, I said you must be under stress. This was 
around early 2008. He said, oh, no. Life is good. We did not 
make any subprime loans.
    They quickly were under problems a short time later. So it 
is sort of a contagion. If your building next door is exactly 
the same as the building that you are in but it loses tenants 
and it loses value, you are going to lose value as well even if 
you are well-tenanted. It is a very contagious type of 
situation.
    As far as why are small banks more affected than larger 
banks, we talked about the stress test and so forth, smaller 
banks, this is the life blood for jobs in small business in 
local communities.
    The banks used to have the flexibility to work with local 
businesses to make sure that they had the credit to grow and 
create their businesses. A lot of these loans were not what 
might be called extensions, just strict extension of credit.
    I think these gentlemen would say they are an investment in 
the business plan of that borrower and they believe in that 
person. These business plans, because of what is happening in 
the macro economy, because of the loss of jobs and so forth, 
these business plans have now been put on hold. But that is all 
they have been put on in many cases. They have been put on 
hold.
    What has been suggested here is once you get the economy 
going and you get time, and time is an ally, these business 
plans will come back. I think it was suggested here in an 
example where, you know, you were going to do something and you 
put it on hold for a while.
    This stuff will come back if you have time to allow it to 
do so. So I think some of this flexibility is very very 
important. It is a systemic problem that has been mentioned.
    I guess I would make one other point about the CMBS market. 
I am a big proponent of the CMBS market. I think it is a very 
important source of capital for commercial real estate and for 
the economy.
    I also do not believe that a lot of the small business 
loans are necessarily securitizeable or securitized loans. 
These are loans that, small business loans are more made on 
transitional assets. Again you are starting your business. You 
are starting to grow. You have not tenanted up your building 
yet and you need financing to get through.
    The securitized loans by and large are made on stabilized 
assets. They are made by the money center banks. They are made 
by life companies, the securitized lenders. They have a very 
important role to play but it is not this role. I think that is 
an important thing to just note for you, David.
    Mr. Giller. I appreciate that. Just one quick one before 
you go on.
    For the purposes of this conversation, I think it is 
important to highlight the crucial role that the CMBS market 
does play for providing liquidity to the commercial real estate 
market. In general but again from our perspective for the Small 
Business Committee, for small business lending, yes, 
peripherally small business lending is affected by the CMBS 
market but really we are primarily focusing on the non-
securitizeable loans, a couple hundred thousand dollars, a 
couple million dollars, 10, 15 million which, to your point, 
are not directly affected by the CMBS market.
    Mr. Sight. A couple of other things I wanted to mention. 
Yesterday I was at a lunch at a regional bank in Kansas City. 
They had their economist there and I met a gentleman who had a 
small manufacturing, not so small, 300 employees, growing the 
business. They make decals and all sorts of fun bumper stickers 
and things like that.
    I mentioned to him that I was coming up here. I said, how 
is your business? He goes it is good, and I go, well, are you 
hiring anybody? He goes, no. I said, do you plan to? He said 
not until I know what the playing field is.
    So I talked to him. I talked to other business owners. What 
are my health care costs going to be? Do not know what they are 
going to be. So I am worried about that. I am worried about 
government regulation. I do not know what the playing field is. 
I am not going to make business decisions on growing my company 
until I know where it is.
    That is one thing I wanted to make you all aware of. The 
other thing I wanted to mention is something that is very 
disturbing to myself and the National Association of Realtors 
of the change in FASB laws on lease accounting.
    I am sure you have looked at it and researched it. We 
cannot really find anything that is going to be very helpful to 
commercial real estate in that proposal. I know that is not 
something that the Senate can regulate or do a whole lot about. 
But I am really concerned about that issue about putting leases 
on balance sheets.
    For my banker that I talk to about that he said that is 
great. We are going to put it on there as a liability. The 
lease then becomes an asset but in reality is it an asset? They 
are going to discount that asset. So it is going to muck up, if 
you will, a business owner's financial statement. It is not 
good for commercial real estate in an already down situation.
    Mr. Lucas. Thank you very much. Unfortunately Senator Snowe 
cannot make it today due to another commitment, but she is very 
engaged on the issue, extremely concerned, and thanks all of 
you for coming.
    One thing that really stuck in my head was something that 
Mr. David said when he talked about appraisers and how they are 
scared of their own shadow. I think we have a situation, and 
Congressman Minnick touched on it a little bit, where we have 
an issue with regulation and maybe over regulation.
    Is there something we can do to steel their spines when it 
comes to appraisals to prevent this sort of thing from 
occurring? Is that part of the solution you see to the problem 
in commercial real estate?
    Mr. Paul. I am a firm believer for an interim period of 
time appraisers, if in fact that is going to be the gold 
standard, that the appraiser should be required to work off of 
the debt service coverage and not true valuation.
    What we are consistently hearing around this table is that 
the property that was valued at a million dollars and the cash 
flow is the exact same today as it was five years ago, there is 
no reason that an appraiser because there was a problem with 
the building next door should all of a sudden discount that the 
$600,000.
    It goes back to David's earlier comment that when it goes 
from a million to 600,000, and that bank has to write off that 
400,000, clearly that has an impact on what it is going to be 
able to do in the future in terms of additional lending.
    So by far, the debt service coverage should be the 
governing rule for a certain period of time, as Stephen says, 
to give us the opportunity of time to get through this crisis. 
Thank you.
    Ms. McWilliams. Would you recommend this be done only for 
performing loans that so far the debt to service coverage would 
be sufficient to cover the monthly loan payments?
    Mr. Paul. Yes. I believe that if you can look at a 
performing building and accept the fact that there is no 
expected dramatic change in that cash flow so in other words 
you do not have a major tenant coming up for renewal in three 
months that if it can be demonstrated that that cash flow is 
projected to continue in the foreseeable future or certainly 
during this moratorium period that it be considered a 
performing asset and that would go, even current loans that are 
in the nonperforming standard should be reevaluated to be able 
to move to a performing standard.
    Mr. David. I think another issue, and we just finished a 
safety and soundness exam, and what I am seeing in the field 
and hearing from other bankers also is, and one of the things 
that Dan alluded to, is when you try to reschedule the loan if 
it had been on a 15-year pay out, because income or rents are 
down, that you may want to go to a 20-year. Or if you allowed 
him to pay an interest-only payment, what we are seeing from 
the examiners is that has immediately become a substandard loan 
whether the values are there or not.
    And so that is an issue that I just went through. I mean we 
literally finished a week ago with an FDIC safety and soundness 
exam. So that is an issue that needs to be addressed.
    Ms. McWilliams. If I can follow up on the question of bank 
examiners and the Federal regulations. From most parties that 
we spoke with, we heard that the 2009 guidance was actually 
very helpful and useful in this process, but the issue is that 
examiners on the ground are not following the guidance to a 
``T'' for a number of reasons, as Representative Minnick 
outlined.
    Apparently what we are hearing is that the appraisals are 
playing a huge role in the inability of banks to refinance 
these loans, followed by the strict bank examining procedures 
on an ongoing basis. If the bank examiners were to follow the 
guidance to a ``T'', what portion or percentage of the problem 
would be eliminated?
    Mr. Paul. A major, major, major part of the problem. We 
stress test our real estate portfolios by, on a quarterly 
basis, increasing our interest rates by 200 basis points and 
decreasing our rental income by 10 percent. And with that 
stress test, 90 percent of our portfolio continues to perform 
as negotiated in the loan documents.
    I wish that the regulators focused on that stress test as 
opposed to requiring appraisals to be done on a regular basis. 
The stress test in my mind is indicative of where the project 
is going in the future and, therefore, I should not be required 
to write down a loan if, in fact, the debt service coverage is 
being maintained and that stress test confirms that it will 
continue to be maintained.
    Mr. Giller. Just on that issue I feel like we would be 
remiss if we did not quote Chairman Bernanke, who, in front of 
the House Financial Services Committee, the semi-annual 
monetary policy address to Congress, February 24th of this 
year, he stated, ``We have issued guidance in commercial real 
estate which gives a number of ways of helping, for example, 
instructing banks to try to restructure troubled commercial 
real estate loans and making the point that commercial real 
estate loans should not be marked down because the collateral 
value has declined.''
    And this is the key line here.
    Quote, ``It depends on the income from the property, not 
the collateral value.''
    This is precisely the issues you were talking about. It is 
precisely the issue that Chairman Bernanke refers to in the 
October 30th, 2009 guidance. And for whatever reason, as 
Congressman Minnick has suggested, there is no consistent 
implementation of this guidance.
    Is anyone hearing that there is consistent implementation 
of this guidance on the ground?
    [Pause.]
    Okay. That is a fairly universally accepted truth.
    Mr. Askew. David, you may expand that to say, is there any 
consistent interpretation of the guidance, and that is what is 
lacking. They interpret it different ways. That is the problem.
    Mr. De Boer. Bill, that is an interesting point in the 
sense of what this group might able to be assisting here is to 
underscore the thoughts and give more flesh, if you will, to 
the guidance so that the examiners feel a more compelling case 
in what they are supposed to really do. It is a little murky. 
Although we think that language is clear, I think they have 
room for interpretation, and perhaps some underscoring or 
sharpening of that, polishing might be useful.
    Mr. Paul. I think we all discussed the regulatory side of 
this and how the regulators are not following the quote that 
you just gave. But I believe going back to your point earlier, 
David, is that we really need to drill down to the small 
businesses and understand exactly what impact the current 
banking issue is with regard to small businesses.
    There is a chart that I hope everybody could read that 
looks at the loan to deposit ratio. On a national basis, we are 
at an 85 percent loan to deposit ratio. And for those bankers 
that have been around for a long time, that was pretty much the 
norm 20 years ago. That is where you wanted to be.
    If you look at the strong markets, you will see that 
Washington, D.C., as an example is 96 percent. So when the 
markets come back in the other areas, we are going to get back 
to that 96 percent area.
    In my opinion, from a regulatory perspective, that is not 
the place that anybody wants to be. I think it is not anecdotal 
that what Jim was talking about earlier that the strongest 
market is multifamily, and multifamily is as strong as it is 
because there is a place currently to be able to place that 
debt. If that disappears, that is going to be a major, major 
problem on the multifamily side. And I think what we are 
talking about is how do we find that same opportunity to create 
liquidity within the smaller size of loans, not only in the 
real estate side but on the overall business side.
    Mr. Giller. Just to follow up on that and to steer it 
really back to this issue of small business lending, there are 
some numbers on the bank concentrations that I would just like 
to read.
    This issue does have a kind of disproportionate effect on 
the small banks and on small businesses. Dennis Lockhart, 
president of the Atlanta Fed, has spoken about this. You have 
got roughly 4000 banks between a $100 million in assets to $10 
billion. This community bank, not including under $100 million, 
and again this is out of about 7800 banks nationally.
    So on average these 4000 banks are considered by the 
regulators as being commercial real estate concentrated, which 
means that their commercial real estate holdings are about 300 
percent, as you know, of tier one capital.
    Unfortunately for the small businesses, these 4000 or so 
banks with the high real estate concentrations also provide 
proportionally higher amounts of small business lending, so 
about 40 percent of small business lending in the country is 
through these smaller banks, the community banks.
    So just to focus the issue and kind of highlight why this 
is such a big issue, what happens to small business lending if 
these 4000 community banks suffer in the next three years? I 
would like to get your sense of what the worst-case scenario 
is, best case scenario is, how many bank failures we are 
talking about, will this lead theoretically to a double dip 
recession, is it not that severe?
    Just get your take generally in context, putting this in 
the context of greater kind of the financial crisis, how 
serious this issue is specifically for the small business 
owners.
    [Pause.]
    Mr. Paul. I guess I win by default.
    I think the answer to that is that if, as we all sit around 
this table, is that it is clearly the small businesses that are 
going to jumpstart the economy and supply the funds to be able 
to build employment and growth.
    The concern that I have is whether it is a liquidity issue 
or it is a write down of capital because of the commercial real 
estate valuation side. It will impair the opportunities for us 
to make those loans to the restaurant or the manufacturer or 
whatever the case might be to when the economy comes back.
    I believe what will happen is that you are effectively 
tying both hands behind the economy's back because if you do 
believe that it is the community banks that will provide that 
source of funding to allow the economy to grow but at the same 
time you are hitting the capital side, not providing the 
liquidity, how do you expect, in fact, that liquidity to go 
back into the small businesses.
    So I think it is a very dicey, risky position that we are 
in right now if we do not address my two biggest concerns being 
liquidity and valuations.
    Mr. Giller. Thank you. I want to turn to Mr. Askew to get 
the Financial Services Roundtable perspective specifically on 
this issue of liquidity, scope of this problem, and what your 
folks are thinking about the issue.
    Mr. Askew. Okay. Clearly commercial real estate is a bigger 
issue in the smaller banks. That is a true statement. I want to 
go back to something that Jeffrey said about this CMBS that I 
want to kind of caution everybody about.
    Remember where the majority of your small business loans 
are still made. They are made in the larger banks. And remember 
where half of your commercial real estate is in those larger 
banks, or maybe a little bit higher.
    But the fact is when a CMBS, the way a commercial real 
estate property works, back to the idea of your property is 
performing and you have got your rents paying the cash flow, 
the property is cash-flowing, if the property across town or in 
the same area or even close goes dark, what happens is it is a 
downward spiral because what they wind up doing is opening that 
up at half the rates of the other property.
    And so you wind up with bringing down, the leases move out 
of one property and they move into another, and it is a process 
where we all have to be in this together.
    We have to get this entire commercial real estate market 
well. I do not care which property type because we are in those 
same markets that the community, our community banks are in 
those markets. They are a third or a fourth or higher of that 
market so they are part of those local markets too.
    But the point about the economy, I do not think it is going 
to cause a double dip recession. I think Ben Bernanke and Tim 
Geithner and our people who are leading that have said they are 
not going to have special commercial real estate policy. They 
are too smart that they are going to allow this to double dip 
this economy. They know a lot more than I do about it.
    But I do believe it is going to be a drag on the economy. I 
do believe that chart you had put up there shows what a drag it 
is going to be. If you let interest rates go up, right now 
interest rates are an all-time low. That is what is keeping, 
that is why the commercial real estate market is doing as well 
as it is and that is why you saw some improvement in prices 
earlier in the year. It is because of interest rates.
    But if those interest rates were to go up dramatically, 
then you would have a different story. It is going to be a drag 
on the economy but most important it is going to be a drag on 
jobs, David.
    And I am talking about jobs, not just jobs to fix the CRE. 
I am talking about jobs related to the CRE, jobs related to 
servicing commercial properties, jobs related to apartment 
buildings, jobs related to hotels. Those are the 12 million 
jobs I am talking about.
    So if that begins to answer your question. I think it is an 
issue for all of us to deal with.
    Mr. Giller. I would love to assume that the Small Business 
Committee and the Senate have jurisdiction over monetary policy 
but no one in Congress does. Thank you.
    Mr. Lucas. I do think that is a great point and it is very 
sad and tragic that we do not have jurisdiction over that but 
it helps inform us in terms of the policies we look to craft.
    So I just wanted to ask, Mr. Innaurato, as you are looking 
at rating the CMBS market generally speaking, are you looking 
at that as something that is a concern? If it does occur, which 
it looks like it might, what sort of damage could that do? And 
if anybody else generally wants to speak on that.
    Mr. Innaurato. One of the problems that we see very easily, 
you have a performing loan. Let us say it has a debt service 
coverage ratio above 1.2, occupancy 85-90 percent. It has been 
cash flowing. Loses one of its tenants. Finds out that the 
tenant is gone because, as was described, the tenant went 
around the corner to a vacant property and got half the rent.
    The next thing you know there are co-tenancy clauses within 
the structure of the leasing, and more of the property goes 
downhill, and now within a six-month time frame, you had a 
property that was performing for the last five years is now 
underperforming.
    And because it originated in a lower cap rate environment, 
from a valuation standpoint based on even stabilized income, 
you had concerns about the value. Now you have substantial 
concerns about the value.
    I think overall from our perspective we have a delicate 
balance in trying to be conservative but not overly 
conservative because we are seeing transactions occur not only 
for distressed properties but willingness for your more savvy 
investors to step in and say we see the upside in this 
particular property, in this particular market and do not 
believe in the valuations that are being published for these 
properties today.
    Because of that, you are seeing what you would think would 
be unheard of cap rates being reported on some of the 
transactions. Properties changing hands as low as 3 to 4 
percent on today's income which is distressed but with the 
upside of growing in a more stabilized market.
    So from a ratings perspective, we are trying to say, for 
lack of a better term, stabilized, how we are approaching the 
nonperforming assets versus the assets that are really kind of 
on the edge because, in theory, anything that was originated 
from 2001 to 2008 at a 6 percent cap rate even performing 
today, if I value it at an 8 or 9 percent cap rate, you go from 
a 70 percent loan to value to over 100.
    So, in theory, if you were doing it just for book purposes 
you have a loss on every property that was originated during 
the peak of the market.
    I am speaking in generalities. One of the pieces of my 
testimony that I did not get a chance really to focus on I 
think that affects all the banks, whether of large scale or 
small scale, is the warehousing risk for a bank.
    Many of the small community banks that were available to do 
refinancing for loans that were coming out of CMBS or loans 
that had amortized over time or through relationship lending, 
granting an easy extension, the fear today is that, from a 
warehousing perspective, if I grant these terms today and 
something in my market a week later, a month later, causes an 
appraiser to come in and now say, well, you valued the asset 
here. We are now hitting at another 10 to 20 percent. None of 
the banks want to take on that risk.
    That is slowing down the resurgence in the CMBS market 
because of the warehousing risk of originating loans and not 
having the ability to immediately put them into a new 
securitization.
    Many of the deals that we have even looked at this year 
from a new issuance standpoint, that has been an issue. The 
investment banks do not want to sit and hold these loans for a 
long period of time because historically they have been used to 
originating them, putting them together, putting them into a 
CMBS. Move on to the next transaction.
    And I think for the community banks where more of that 
relationship lending went on, I think the fear is that we want 
to do more business but what is the impact a month from now, 
six months from now if, in this market, I do not have the 
liquidity I need to support your loan or I do not have the 
flexibility based on the limitations that are being presented 
to me to do so.
    So I kind of talked in a little bit of a circle to try and 
address all of them. From a pure ratings perspective on new 
issuance CMBS for us it really comes down to quality of 
underwriting.
    The aggressive lending that was prevalent during the peak 
of the market and the aggressive underwriting per se on what 
was termed pro forma loans, loans that you hoped would generate 
levels of cash flow through new tenancy there is no existence 
of that today.
    So unless you are bringing loans to the markets that are 
very stable and have shown low leverage, high tenancy, it is 
very hard to securitize today's market.
    We are hoping that as we go into next year that the 
momentum that is starting to build will continue to grow and we 
will see more traditional conduits.
    Ms. McWilliams. If I can just follow up on something you 
said and you repeated it from an earlier statement--that a 
number of these loans were based on very aggressive 
underwriting standards. Some of them should not have been made.
    The underwriting on commercial real estate loans is not as 
bad as on residential real estate and subprime, and we 
recognize that, but do you have any indication or data to 
support a statement that a certain percentage of these loans 
should be allowed to fail or default because they were not 
properly underwritten?
    Mr. Innaurato. I do not have statistics to back up that 
statement per se. Oftentimes even our investor clients have 
been unable to identify throughout the legacy CMBS deal which 
loans were considered pro forma underwriting versus traditional 
underwriting.
    What we have tried to do in house is look at the loans 
that, say, for a period of time, say from 2004 to 2006, if this 
level of cash flow was consistent, and this level of 
performance was consistent, why, as part of the underwriting, 
did you expect it to go up 20 percent, and then why did you 
lend at that time, at 20 percent higher level expecting the 
growth?
    When the markets collapsed, as I alluded to a little bit, 
those 70 percent loan to value immediately, almost overnight, 
became 100 percent loan to value loans. So in this market, in 
my opinion, if more stabilization was presented to community 
banks and to larger banks and larger institutions to not be 
fearful that loans that are generating enough cash flow to 
cover their in-place debt service and in-place interest rates, 
especially with the support of a lower interest rate 
environment, if there was not that fear that they may be taking 
on a loan that could be requesting a modification or debt 
relief in the near-term, you would see more lending, you would 
see more securitization because if you attend any of the 
industry conferences that we are a part of, there is a lot of 
money still sitting on the sidelines from an investment 
standpoint that wants the CMBS market to return, maybe not to 
the levels we saw during the peak because we might not have to 
get to that level if the community banks can pick up the slack 
on the refinancing that is due to come.
    Ms. McWilliams. If I can just ask you one more question, 
what would represent a healthy CMBS market in your view?
    Mr. Innaurato. A healthy CMBS market would probably be 
closer to what we saw from, say, 2001, pre 9/11 2001 through, 
say, 2003 and 2004. They were averaging probably $50 to $75 
billion issuance per year.
    It really was not until we got into 2005 through mid 2008 
that you saw the lending get to such an aggressive standpoint 
that every month even for my business as it was, at the time 
again focusing on small business, we were a 35, 40 person shop 
and every day a new CMBS transaction was coming to market, that 
our investor clients were coming to us and saying, break down 
the real estate, tell me what is going on.
    But for a large period of time because the markets were 
good not everyone was concerned about the underlying real 
estate and the performance. As the market turned and more loans 
got into distress, a typical conduit loan or conduit deal of 
150 to 200 loans, anywhere from $3 to $5 billion, if you start 
saying that 40 to 50 percent of that transaction is now in 
distress, the volume of work definitely picked up.
    I think that from a stabilized standpoint, our hope is to 
optimistically get to the level that we saw in the early 2000s.
    Mr. Paul. One additional comment I want to make on that is 
many of the CMBS loans that were made were also made at 
incredibly low interest rates. So at some point at the peak of 
the market in 2006, 2007, it was not unusual to be able to get 
a 10-year CMBS loan at 80, 90 basis point over 10-year 
treasuries.
    I do not think anybody sitting around this table would make 
that type of a loan at the interest rate at this point. So 
should rates go up as somebody was mentioning earlier, when 
that loan does become up for renewal, there is a significant 
sensitivity that we have to look at because of the difference 
in the current interest rate environment versus what it was 
underwritten at.
    Ms. McWilliams. Would you say then that an improvement in 
the CMBS market would help even the community banks that keep 
the loans in their portfolio?
    Mr. Paul. I could speak to Eagle Bank. Eagle Bank has an 
average commercial real estate loan of $1,312,000. That average 
loan is obviously not going to be a CMBS participant. So I go 
back to the two points.
    Obviously as we have grown, the loan requests that we had 
have gotten larger but I do not think that it is going to be 
those trophy-type projects that are going to be brought to a 
community bank. They are not going to be the type of projects 
that, Dan, you mentioned earlier. It is a warehouse, we have 
some issues, can you help me, those are the type of projects 
that are going to be brought to a community bank. It is not the 
trophy projects that will go to the CMBS side.
    Mr. Innaurato. Just for clarification, the majority of CMBS 
loans are under $10 million that are on the books today, and so 
not to confuse that all CMBS loans are large or huge loans. 
They are under $10 million, so just for clarity.
    Mr. David. I think it is important to remember from a 
community banking standpoint, we are talking about CRE, by 
definition CRE, things that qualify. But I think it is real 
estate in general. A lot of the loans that the banking industry 
makes to its businesses are not CRE loans.
    When we talk about regulation and we talk about appraisals 
and all of those things and we talk about job creation, those 
are the issues that I face. Buying loan portfolios secured by 
real estate is probably close to 90 percent but maybe 40 
percent of it is true commercial real estate. The other ones 
maybe a loan to a local grocer. That building and the property 
is the collateral but it is not a commercial real estate loan 
from a regulatory standpoint.
    I think it is important that we keep in mind that it is all 
real estate. For a lot of them it is their home that they may 
own, and that is what I will use as collateral to do the 
business. That is where the job creation comes from. It is not 
just commercial real estate but real estate in general.
    Mr. Giller. And we are hearing that there is some confusion 
from a regulatory perspective on specifically those types of 
loans, loans secured by commercial real estate but really it is 
a working capital loan.
    So it is not a real CRE loan but there is some confusion 
among the regulators who are classifying this as CRE.
    Mr. David. That is happening because they gleaned their 
numbers straight from the call reports that are filed with the 
FDIC. They are looking and saying everything on that line item 
is commercial real estate so they are doing their formulas 
accordingly as that divided by the capital. If you are 
exceeding 300 percent or not, but not everything that is listed 
on that line is, by definition, commercial real estate. It is 
real estate to a commercial borrower.
    Mr. Giller. Thank you. Just to wrap it up, we understand we 
have been discussing several issues. The main issue seems to be 
this valuation nightmare. There is downward pressure from the 
regulatory environment, downward pressure also from appraisers.
    Related to it or even a separate issue, there is this issue 
of liquidity for the smaller banks. That ties into the CMBS 
market. I guess an open question is for the smaller banks how 
directly they are impacted by the CMBS market, and if folks 
have final thoughts that you would like to leave us with, we 
can go around, and also we are going to be leaving the record 
open for about a week. If there are additional written 
statements or pieces of information or data that you would like 
to submit, it will be left open for another week.
    If there are folks who would like to leave us with some 
parting words of wisdom that we should bear in mind as we tried 
to address this.
    Mr. De Boer. David, there were a lot of terrific points and 
this is a great discussion to have. It is very circular, is it 
not? I mean, it is jobs, values, credit, growth, jobs, and 
instead of focusing on any one of those, you have to focus on 
all of them.
    We have talked about the need to get jobs all across the 
economy, not just for community banks or for small businesses 
but for the macro economy. It is all interrelated.
    Your question about, you know, does the CMBS market 
directly benefit smaller banks? Maybe it does not but just like 
a healthy building is infected by an unhealthy building next 
door so to speak, if we can create more credit for the overall 
commercial real estate marketplace even with those assets that 
are CMBS quality but may not be of the size that Mr. Paul is 
doing, that will help the whole system.
    It is that whole circle that I think you need to think in 
terms of. How do we expand credit availability across the board 
and encourage entrepreneurship? How do we encourage jobs across 
the board? How do we work on this value issue across the board?
    Value is an interesting thing. We are talking about 
depressed values in this conversation but the reality is, as 
Frank mentioned, in parts of the marketplace there are almost 
irrational high values because there is a shortage of quality 
assets that are coming onto the marketplace in strong gateway 
type cities that are well leased.
    When those assets come on the marketplace, you have got 
this tremendous amount of capital waiting to play, and so they 
bid up the price, bid down to cap rate, and so we have this 
bifurcation that is going on that we talked a little bit back 
there.
    Again there are no conclusions but I think this is a really 
good forum to get a discussion and maybe you have come up with 
some ideas that will help all of us.
    Mr. Askew. David, if I could just add that with that 
circular idea in mind which I agree with 100 percent, I will 
submit our white paper paperwork which I have given to you for 
the record because we did spend the last year with the trade 
organizations focused on commercial real estate builders and 
investors and banks and insurance companies and we did come up 
with 51 recommendations. This circle is going to take a lot of 
issues. I think we have covered, and I do not mean to sound 
like we have the answer to everything, but we did cover most of 
the issues that were discussed in this room today. So I will 
submit that for your gleaning and looking at, consideration.
    Mr. Paul. Just as a last comment also, I truly appreciate 
the opportunity to do this. I think there has been a lot of 
great discussions.
    Bill, I hope that we can all get copies of that white paper 
because I think it would be very interesting.
    Just as a final comment, obviously I am a huge proponent of 
community banking and believe in the tremendous need of 
community banking. And my biggest concern right now is that if 
we do not react very quickly to the points that have been made 
today, I see a tremendous amount of transfer of wealth going 
from the community organizations, the strong community people 
that support the community and being shifted back into Wall 
Street.
    And I see if foreclosures continue with the huge 96 percent 
that you mentioned on the increase of the delinquencies and 
requests for the structuring of the CMBS market, if there is 
something that is not dramatically done, you will have a 
transfer of wealth back to Wall Street which is, I think, 
exactly where we started from which we are desperately trying 
to avoid reoccurring.
    I say that we have a limited period of time in order to 
address these issues and hopefully the community banking world 
can participate in helping that but not under the current 
circumstances.
    And again I thank you for the opportunity.
    Mr. Arbury. I think if we stay in a risk-averse mode for 
much longer which I understand why we are there because of not 
being reasonable risk managers going into the bubble and 
through the bubble, it will be a long time coming out of this 
and what Ron just said will probably occur. But we have got to 
get back to reasonable risk management and away from being 
totally risk-averse which are two totally different things.
    Mr. Sight. Just to finish up, I think from a lender's 
standpoint, from a borrower's standpoint, from a realtor's 
standpoint, from tenants' standpoints, business standpoints, 
what would really help all of us is confidence from the 
government, confidence that the U.S. is still working, the 
world is still spinning, this is still a fantastic country to 
be in and to start a business, and we need that confidence from 
our leaders so that people are willing to go out and risk and 
to start new companies, to grow their companies, and that 
would, I think, really help all of us in this country.
    So thank you.
    Mr. Giller. Thank you all for participating. I know it is a 
weekday and so thank you so much for your time.
    We look forward to continuing to work with all of you and 
to continuing this conversation as new ideas or other thoughts 
come to you. We would like to talk about next steps on how now 
do we get around this problem.
    Thank you very much.
    
    [Whereupon, at 12:19 p.m., the roundtable was adjourned.]
    
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