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Managing Distressed

Assets

Odum Capital
Greg O. Odum
202.352.1207
greg@odumcapital.com
Overview
 Can you increase liquidity by 25%?

 Can you reduce restructuring and loan loss costs


by 20%?

 Can you increase Quality of Earnings?

 Can you facilitate the divestiture of pools of


assets fast enough?

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Cost + Benefit Analysis

 Yes!
Increase Liquidity by Reducing Non-Performing
Loans

 How?
 Restructure portfolio of loans + Keep on the books
 Restructure portfolio of loans + Sell portfolio of loans

Proven methodology to determine accurate asset


values for asset strategy (i.e., loan sales, property
sales, asset enhancements)
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Objective
 To assist financial institutions with the restructuring +
divestiture of troubled assets

 Why?
 A cost effective method of managing troubled assets
 To properly manage liquidity

 To provide customized solutions for restructuring pools of assets

 To facilitate the divestiture of assets

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Biography

Experience
 New Harbour Partners: Developed fairness opinions and structured
acquisitions worth over $20M for a middle-market private equity
firm.
 Wells Fargo: Structured over $15M worth of real-estate-related
transactions, debt restructurings and asset-based lending for middle-
market businesses.

Education
 MBA in Finance - Babson College
 B.A. in Communications and Economics - Michigan State University

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Cost + Benefit Analysis
 The costs associated with re-directing existing personnel
to restructurings make it worthwhile to use an
outsourcing option

 Banks need to look at their book of business and do an


internal study to determine strengths and weaknesses,
then outsource restructuring and divestiture processes

 For Example:
 In June, there were 336,173 foreclosure filings in the US, the 4th
straight month exceeding 300,000a
 Rather than completely re-engineering your operations, it's
convenient and economical to have a vendor do the outsourcing
 Instead of re-engineering operations, outsource to a vendor =>
more economical and less time consuming

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

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

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

 Commercial loans that were 30 to 90 days delinquent fell $1.97


billion to $12.77 billion in the second quarter and those for
multifamily fell $287.1 million to $2.59 billion, the picture did not get
brighter2
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Commercial Real Estate Overview contd.
 The amount of loans considered nonaccrual dwarfed the amount of
payments late 30 to 90 days2

 Loans in nonaccrual status rose by $6.53 billion to $27.76 billion for


commercial real estate

 Multifamily nonaccrual rose by $1.33 billion to $6.04 billion

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

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

Source: RealtryTrak.com US Foreclosure Report

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Expected New Foreclosures

Source: Credit Suisse

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Soaring Prime Mortgage Delinquencies

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

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HELOC + Home Equity Loans Soared During Bubble

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

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Restructuring + Divestiture Steps
 Step 1: Asset Valuation

 Step 2: Due Diligence

 Step 3: Financial Modeling + Analysis

 Step 4: Creation of Asset Pools

 Step 5: Divestiture of Assets

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Restructuring + Divestiture Steps contd.
Step 1: Asset Valuation
Evaluate portfolio of properties/loans
 Analyze underlying collateral, and how the collateral can
be positioned for short, medium or long-term value
enhancement, critical to any optimization strategy

 Utilize real-time market data such as comps, FMV and


tax assessment estimates to evaluate the asset value

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

Bank XYZ Assets June 2009 June 2008

Real Estate Owned $5M $2M

Impaired Loans $19M $5M

Residential Loans held for Sale $20M $4M

Commercial Real Estate Loans - $220M*

Provision for Loan Losses $10M $4M

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Restructuring + Divestiture Steps
Step 2: Due Diligence
 Tenant + Mortgagor survey
 Evaluate sustainability of tenants + mortgagors

 Evaluate current + sustainable cash flow generated from


asset
 Rent, parking, etc

 Evaluate asset financial sustainability


 Determine if any legal, regulatory constraints
 Lead, taxes, etc.

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Restructuring + Divestiture Steps
Step 3: Financial Modeling + Analysis
 Itemized cash flow + sustainability modeling
 State-of-the-art modeling incorporating variables necessary to
arrive at a specific strategy

 Hold vs. Sell Analysis

 Current Mortgage vs. Cash Flow-based Model

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Restructuring + Divestiture Steps
Step 4: Creation of Asset Pools

Bank XYZ Tier 1 Tier 2 Tier 3

Category Performing Loans Non-Performing Real Estate


Loans Owned

Book Value $8M $7M $2M

Units 35 34 18

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Restructuring + Divestiture Steps
Step 5: Divestiture of Assets

Tier 1 Tier 2 Tier 3


Bank XYZ

Asset Type Performing Loans Non-Performing Real Estate Owned


Loans

Book Value $8M $7M $2M

Units 35 35 18

Buyer Regional Bank REIT Private Equity


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Overview
 Can you increase liquidity by 25%?
 Yes
September
Bank XYZ June 2008 June 2009
2009

Loan Sales $1.8M $3.5M $6M

% Increase - 94% 71%

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

Bank XYZ June 2008 June 2009 $ Increase % Increase

Restructuring Costs $30k $950k $920k 3066%

Loan Loss Provision $3.5M $9.6M $6.1M 171%

Salaries $3.8M $5M $1.2M 31.6%

Total $7.3M $15.6M $8.3M 114%

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Overview
 Can you increase Quality of Earnings?
 Yes!

June 2009 July 2009 – December 2009


Bank XYZ

Bank XYZ Costs


$8.3M -

New Bank XYZ Costs - $810K - $1.2M

Savings - $7M ~

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

• Private Equity
• Hedge Funds
• Investment Banks
• Domestic + Foreign Real Estate Funds
• REITS
• Other Institutional Investors
• Regional Banks

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Tax Implications

 In the residential real estate sector, the U.S.


Congress, Treasury Department and IRS have
taken steps to mitigate certain tax consequences
that otherwise would impede efforts to
restructure residential mortgage loans that pose
a risk of going into default

 The commercial real estate sector has tax barriers


regarding modifications and restructurings

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Questions?
Contact

Odum Capital
Greg O. Odum
202.352.1207

greg@odumcapital.com

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Appendix

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

 The debt is settled at the time of restructuring

 The debt is continued but with modified terms

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Solution 1: Settle Debt Option
The Debtor’s Gain = the Carry Amount of the Debt -the Value of the
Asset(s) transferred to settle the debt. Any gain is reported as an
“extraordinary item”.
Example:

A bank holding a $50 million note agrees to accept a land valued at $40
million from R.J. Company, which is in severe financial difficulty, as
a settlement of the $50 million debt.
 Assume that the carrying amount of the land is $32 million. The
following journal entries are recorded for this troubled debt
restructuring:

 Land ($40M -$32M) = $8M


Gain on disposition of assets = $8M (ordinary gain)

 Note Payable = $50M.


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

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

Example 2:
 Assume a 10% interest on the $50M note in question and interests
(i.e. $50M x 10% = $5M) are payable in December of the two
remaining years. In addition, R.J. failed to pay $5 million of
interest for the year just ended. Therefore, the carrying amount of
the debt is $55M.

 The accounting treatment for this type of restructuring depends


on the total amount of future cash payments.

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Solution 2: Modified Debt Terms Option

Case I :
Total future cash payments < The carrying amount of the
debt
Accounting Treatment
Recognize Extraordinary Gain = Carrying amount of the
Debt -Total Future Cash Payments;
 Reduce the carrying amount of the debt to the total future cash
payments.
 Assume that all interests have been eliminated
 All subsequent cash payments are payments for the debt itself.

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Solution 2: Modified Debt Terms Option
Case I contd.

Assume that the bank agrees to the following terms:

 Eliminate the accrued interest of last year;


 Reduce the remaining two interest payments from $ 5 million each to $3
million each; and
 Reduce the maturity value from $50 million to $40 million

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

* $3M x 2 + $40M = $46M

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Solution 2: Modified Debt Terms Option
Case II
Total cash payments exceed the carrying amount of the
debt
Continued with example 2, assume that the bank agrees to:
 Delay the due date for all cash payments until maturity date and
accept $57,222,000 at maturity date.
 Since $57,222,000 exceeds the carrying amount of the debt ($55M),
the new agreement still require an interest payment.
 A new effective interest rate needs to be calculated: $55,000,000 /
$57,221,927=0.96117
 The new effective interest rate is 2% (via present value).
 At the debt restructuring date, no entry is required.

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Tax Implications
At the end of the first year following the restructuring:
 Interest Expense (2%x$55M) = $1,100,000
 Interest Payable = $1,100,000

At the end of the second year:


 Interest Exp.*= $1,122,000
 Interest Payable = $1,122,000
 * 2% x ($55million + 1,100,000)

At maturity date:
 Note Payable= $50M
 Interest Payable = $7,222,000
 Cash = $57,222,000

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SFAS 157
 Investment securities: The fair values for investment
securities are determined by quoted prices for similar
assets or liabilities (Level 2)
 Residential loans held for sale: The fair value of loans held
for sale is determined using quoted prices for a similar
asset, adjusted for specific attributes of that loan (Level
2).

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Sources + Citations
 Sources:The Real Estate Round Table, December 2008 1 ; Real Estate Econometrics, August
2009 2 (The research firm breakout multifamily homes separately because of their residential
use.The report was based on 8,195 institutions)
 Sources: Federal Reserve Flow of Funds Accounts of the United States, IMF Global Financial
Stability Report October 2008, Goldman Sachs Global Economics
 Paper No. 177, FDIC Quarterly Banking Profile, OFHEO, S&P Leverage Commentary & Data,
T2 Partners estimates
 1 See section 860G(a)(3)(A)(i) of the Internal Revenue Code of 1986, as amended, and Treas.
Reg. sec. 301.7701-4(c). Hereinafter, all statutory and regulatory references are references to
the Internal Revenue Code of 1986, as amended (the “Code”), and the regulations there
under.2 Id. See also section 860F(a)(1) (prohibited transactions tax)2. Treas. Reg. sec. 1.860G-
2(b)(3)(i).4 Treas. Reg. sec. 1.1001-3 (the debt modification regulations).
 Sources: 5 Treas. Reg. sec. 1.860G-2(b).6 See Treas. Reg. sec. 1.1001-3(e).7 Prop. Treas. Reg. sec.
1.860G-2.8 Rev. Proc. 2007-72, 2007-52 IRB 1257; Rev. Proc. 2008-28, 2008-23 IRB 1; Rev.
Proc. 2008-47, 2008-31 IRB 272.9 Rev. Proc. 2007-72, Rev. Proc. 2008-47.10 Rev. Proc. 2008-
28.

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