Lehman Brothers will not live to see its 159th birthday. Merrill Lynch will continue to exist in brand name only. The recent turmoil on Wall Street is just more evidence that our banking system is horribly dysfunctional.
Conventional lenders such as banks, Wall Street brokers and Hartford insurance companies traditionally originated commercial mortgage loans and then sold them into the secondary market where they were bundled, turned into MBS (mortgage backed securities) and sold to investors, large and small. That ship has sailed, now it has sunk; there is (virtually) no secondary market for mortgage bonds anymore. Volume in CMBS (commercial mortgage backed securities) is off by more than 90% year-over-year and the pipeline of new deals is dry.
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Banks are severely undercapitalized today due to the sudden and sustained devaluation of the real estate and real estate derivatives they hold. They can not afford to let a dime out the door. They can't borrow against their mortgage assets anymore nor can they sell them; nobody wants them! With no market ready or willing to buy new commercial mortgages, banks will not write any new commercial mortgages. In simple terms; banks are not lending and won't be lending again anytime soon.
We are in the midst of a severe liquidity crisis that is evolving quickly into a capital crisis. Capital disappears as-fast-as it's raised as real estate backed assets continue to plunge in valuation. If this keeps up there won't be enough money to go around. Even the Federal Reserve Bank is feeling the pinch, having committed more than $300B to shore up faltering institutions the Fed is down to it's last half trillion. And it may very well get worse before it gets better.
With traditional lenders and conduits out of the picture, commercial property owners and developers are turning to private lenders for the financing they so desperately need. Many private, hard money lenders are "portfolio lenders", meaning they lend their own money for their own account. These unique mortgage lenders are not dependent on the secondary market for their funding; they remain undaunted by the ongoing problems in the bond markets. Private mortgage lenders make money by charging high rates and many points for their capital and they protect themselves by writing loans at low LTVs (loan-to-value ratios).
Private lenders include, hedge funds, private equity groups, wealthy individuals and privately held financial firms with money to lend. They are able to be very nimble and responsive and can close good deals in just a few weeks. They can be highly flexible in their lending standards, generally underwriting loans based on the amount of equity in the target property rather than the credit or balance sheet of the borrower. The sad fact is that banks and brokers are unable to close deals. Cash rich private lenders have been the financial savior to many, many good projects over the last 18 months.
The banking system has malfunctioned and will take months to get back on track. In the meantime commercial real estate investors will have to depend on the private lending sector to provide them with much needed capital.
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