The Nation's Financial Condition

[Farfromgeneva]

Terrific thought piece on business models

https://workweek.com/2023/06/16/the-onl ... -not-play/

The Only Way to Win is to Not Play

In 1995, Jim Barksdale was pitching Netscape to a room full of investment bankers.

The company was in the final stages of going public, and Barksdale, Netscape’s CEO, was wrapping up an exhausting multi-country roadshow, trying to drum up investor interest in his company’s web browser. The last question he was asked, just before leaving the meeting to run to the airport, was, “How do you know that Microsoft isn’t just going to bundle a browser into their product?”

Barksdale’s off-the-cuff answer became the quote that he is now best known for:

“Gentlemen, there’s only two ways I know of to make money: bundling and unbundling.”

Nearly 30 years later, this statement is widely seen as being axiomatically true. However, like any axiom, the truth behind this one is often oversimplified. I think when people read, “The only ways to make money are bundling and unbundling,” what they hear is, “Bundling and unbundling are equally good ways to make money.”

This is wrong. Understandable, but wrong.

So, for today’s newsletter, I thought it would be fun to dig a bit deeper into the concepts of bundling and unbundling and seek to answer the following question – in a time of disruption, like the one that we’ve been enjoying in financial services for the last few decades, how should market incumbents respond to the threat of unbundling?

But first, let’s agree on some definitions.

Bundling and Unbundling

I define bundling as the development, packaging, and pricing of a product (or set of products) in order to optimize profit-to-value for a specific segment of customers within a static distribution environment.

That’s a bit of a mouthful, so let’s break it down.

First, the basics – a bundle is a combination of products or a single product designed to appeal to a specific set of customers. Multi-product bundles are what most people picture when they think of a bundle. A Happy Meal at McDonald’s, with the burger, fries, drink, and toy, is a good example. But the concept of bundling can be applied at the individual product level as well. Think of health insurance. The bundle isn’t the product. It’s the carefully-calibrated pool of healthy and not-so-healthy customers who use the product.

Now the second part – optimize profit-to-value. A common belief about bundles is that they are a ripoff for customers. Why, the conventional thinking goes, should a customer have to pay for 300 TV channels when all they really want to watch is HGTV?

There’s actually a very good reason for them to do so, as Shishir Mehrotra (a former executive at YouTube) explains:

Imagine there are four products each delivered as a monthly subscription. We have a choice to deliver them each a-la-carte, or to produce a bundle across all of them. Now let’s divide the population for each good into 3 parts. Imagine that for each good, each prospective customer is one of these 3:

SuperFan: This is someone who fits two criteria:
They would pay the a-la-carte price for the channel. This means that they are fairly far along the price elasticity curve for the good (perhaps to the inelastic point)
They have the activation energy to seek out the good and purchase it.
CasualFan: Someone who would value the good if they had access to it, but lack one of the two SuperFan criteria ー either they aren’t willing to pay the a-la-carte price for the good, or don’t have the activation energy to seek it out, or both.
NonFan: Someone who will ascribe zero (or perhaps negative) value to having access to the good.
Here’s a quick visual:

SuperFans, CasualFans, and Bundles
If we offered these goods a-la-carte, then:

The providers would only provide service (and collect revenue) from their SuperFans (the blue highlights), and
Consumers would only have access to goods for which they are a SuperFan
The a-la-carte model clearly doesn’t maximize value, as consumers are getting access to fewer goods than they might be interested in, and providers are only addressing part of their potential market.

On the other hand, the bundled offer expands the universe and not only matches SuperFans with the products they are SuperFans of, but also allows for those consumers to get access to products of which they may be CasualFans. From a providers perspective, it gives access to consumers much beyond their natural SuperFan base. This is the heart of how bundles create value ー it’s not about addressing the SuperFan, it’s about allowing the CasualFan to participate.

In other words, bundles make all the other channels that our HGTV SuperFan casually enjoys – your History channel and Disney channel and CNN – cheaper and more easily accessible for them than they otherwise would be.

Bundles, when done well, optimize profit-to-value for providers and their customers.

And now the third part – within a static distribution environment. As Marc Andreessen (Jim Barksdale’s old Netscape colleague) explains, the exact nature of a bundle is usually a function of the technology used to distribute it:

the newspaper bundle, the idea of this slug of news and sports scores and classifieds and stock quotes that arrives once a day was a consequence of the printing plant. Of the metro area printing plant, of the distribution network for newspapers using trucks and newsstands and newspaper vending machines and the famous newspaper delivery boy. That newspaper bundle was based on the distribution technology of a time and place.

And when new technology emerges, the opportunity to unbundle presents itself.

I define unbundling as the creation of a narrow product for a specific sub-segment of customers, which prioritizes value over profit and is enabled by new distribution technology.

Obviously, when we talk about new distribution technology that facilitates unbundling, we are talking (at least in a modern context) about the internet, which precipitated the breakup of many of the great bundles of the 20th century – music, news, and television, among many others.

And the specific sub-segment of customers? Those are the SuperFans. And the pitch to them is straightforward – let us give you just the thing you really love, cheaper and more convenient than you are getting it today.

That pitch is particularly well-suited to come from new market entrants, which are trying to take market share away from incumbents. Startups (particularly when they’re operating in a low-interest-rate environment) don’t care about profitability. They don’t have the incentive to defend the integrity of established bundles and to remind those SuperFans that they are also CasualFans. All they want to do is design the most narrowly attractive product proposition and use it as a wedge to drive growth.

This is why I would argue that while, yes, the only two ways to make money are bundling and unbundling, it is important to understand Barksdale’s axiom within the appropriate context – bundling is about profitability, and unbundling is about growth.

Unbundling the Business

An underappreciated consequence of unbundling is that it doesn’t just lead to the disassembly of the product (music albums → individual songs) but also of the business behind the product.

This isn’t always a bad thing.

I said earlier that bundles, when done well, optimize profit-to-value for providers and their customers. The problem is that, over time, most companies tend to wreck their own bundles by over-optimizing for profit at the expense of customer value. This sometimes manifests itself in simple ways, like cable companies mindlessly passing on rising carriage fees from content producers rather than aggressively negotiating on behalf of their customers. And sometimes it manifests in more nefarious ways, like when the big five record companies conspired to raise the price of CDs in the 90s. These companies probably deserved to be unbundled!

Having said that, unbundling does have consequences that can be harmful to the broader ecosystem in ways that are often difficult to appreciate in the moment.

One of the challenges with bundles is that they obscure costs. It becomes difficult, from the outside, to tell how much of the price of a bundle is going to cover the company’s costs and how much is going to their bottom line. And as we just covered, customers have good reason not to fully trust companies’ justifications for the changing prices of their bundles.

This lack of transparency makes it easy for startups to sell customers on the idea that the price of their new, unbundled product reflects the true cost of building and delivering that offering, minus all the operational inefficiencies and profiteering of their legacy competitors.

But that’s not entirely true.

Some of the costs that disruptive companies like Spotify have stripped out are, indeed, unnecessary. Digital distribution is very cheap!

However, there are also some costs that are inherent to the creation of the products themselves, and those critical input costs now can’t be fully covered by the low, unbundled prices that customers have become accustomed to paying. Just ask musicians how they feel about Spotify!

Should You Unbundle Yourself?

The classic, Steve-Jobsian answer is yes; cannibalize yourself before someone else does.

Folks working in business strategy, particularly within the tech industry, romanticize this answer. This is what smart market incumbents are supposed to do. You either take the threat of disruption seriously (remember Jamie Dimon’s famous “Silicon Valley is coming” line?) and invest in proactively disrupting yourself, or you become a dinosaur.

While I agree with this mindset generally, I think when it comes to unbundling specifically, some caution is warranted.

There are two quick examples I want to talk about.

The first is TV.

The cable TV bundle is perhaps the most successful consumer product bundle in history. At its peak in 2011, 85% of households in the U.S. paid for TV.

Then came Netflix.

(Editor’s note – Netflix was founded in 1997 and launched its streaming service in 2007, but it wasn’t until 2011 that Netflix, as we know it today, really took off. In May of 2011, Netflix accounted for 30% of all internet streaming traffic in North America.)

As Ben Thompson points out, legacy media companies made a huge strategic shift in trying to respond to the emergence of Netflix and other streaming competitors:

Netflix is not some new phenomenon, of course. For the first half of the decade a Netflix subscription was something you obtained on top of your pay-TV subscription, and while pay-TV did start to lose a small number of subscribers — in part because Netflix was a willing buyer of all of those expensive TV shows from the Peak TV era — the decline was very gradual.

What changed over the last five years is that nearly every media company decided to compete with Netflix, instead of accommodate it. Competing with Netflix, though, meant attracting customers to sign up for a new service, instead of simply harvesting revenue from people who hooked up cable whenever they moved house, without a second thought. The former is a lot more difficult than the latter, which meant the media companies had to leverage their best stuff to attract customers: their most interesting new shows, and sometimes even their sports rights.

The results of this shift have not been pretty.

Since the Fed started raising interest rates, Wall Street has stopped rewarding media companies for growing their streaming subscriber numbers and has started pushing on the companies to cut costs and focus on profitability. And that’s exactly what the companies have been doing:

Two big names, Comcast and Disney, have said that losses in the streaming business are at a peak or reaching one this year. And Paramount Global says investment in its streaming service Paramount+ is at a high — meaning that investors can expect it will spend less in the future.

All of that could bode well for profitability, which is increasingly a focus for investors. The stock market wiped a whopping $500 billion-plus in market capitalization from the world’s biggest media, cable, and entertainment giants in 2022.

But the long-term damage has already been done.

The number of pay TV households in the U.S. is projected to drop to less than 50 million by 2027, down from 100 million in 2013. And the evisceration of the cable bundle has had a dramatic negative impact on one of the primary inputs into scripted TV:

The union representing 11,500 writers of film, television and other entertainment forms are now on strike. It’s the first writers’ strike — and the first Hollywood strike of any kind — in 15 years. Here’s a look at the storylines the fight has spawned.

Streaming and its ripple effects are at the center of the dispute. The guild says that even as series budgets have increased, writers’ share of that money has consistently shrunk.

Streaming services’ use of smaller staffs — known in the industry as “mini rooms” — for shorter stints has made sustained income harder to come by, the guild says. And the number of writers working at guild minimums has gone from about a third to about half in the past decade.

This quote from an anonymous Hollywood executive sums up the situation nicely:

Everything became big tech — the Amazon model of ‘We don’t actually have to make money; we just have to show shareholder growth.’ Everyone said, ‘Great. That seems like the thing to do.’ Which essentially was like, ‘Let’s all commit ritual suicide. Let’s take one of the truly successful money-printing inventions in the history of the modern world — which was the carriage system with cable television — and let’s just end it and reinvent ourselves as tech companies, where we pour billions down the drain in pursuit of a return that is completely speculative, still, this many years into it.’

The contrasting example that I want to talk about is BNPL.

As I wrote about recently, credit cards are one the most ingenious product bundles in the history of the financial industry:

Credit cards work because the different groups of consumers that use them act as cross-subsidizers and risk hedges for each other. To oversimplify a bit – ‘transactors’ (those who pay their full bill every month) generate predictable, but relatively low revenue streams at a low risk. They are generally using credit cards as a combination of a debit card and a 0% interest lending facility for larger purchases. By contrast, ‘revolvers’ (those who carry a balance month-to-month) generate higher revenue streams (interchange + interest and the occasional late fee), but it is less predictable and has higher risk. They are using credit cards as rolling loans. Every credit card issuer has a slightly different strategy, in terms of the mix of customers that they target and the product levers they use to attract and incentivize behavior, but it’s all built on this mix of transactors and revolvers.

Over the last five years, driven by an incentive to grow market share at all costs, fintech companies attempted to unbundle the credit card by offering an incredibly appealing product for the credit-dependent, shopping-loving customer sub-segment – pay-in-4 BNPL:

Pay-in-4 BNPL loans have, over the last couple of years, been the closest thing in the market to free money for consumers. No interest rate. No fees (for the most part). No need for a prime or near-prime credit score. No need to worry about your credit score getting dinged up if you’re late for a payment. No need to worry about being declined because you’ve stacked up a dozen different loans from other BNPL providers.

And it has been great for merchants too! Pay-in-4 has helped them move a massive amount of merchandise ($100 billion in 2021, according to Cornerstone Advisors), much of that incremental to what they would have ordinarily sold (Shopify, which partnered with Affirm to offer BNPL, claims that merchants see a 50% increase in average order value). This is the unrealized spending that that merchants have always wanted to unlock with their customers, they just didn’t have lending partners willing to underwrite the risk … until pay-in-4 BNPL came along.

Now here’s the really interesting part – instead of reacting aggressively to the rapid growth and obvious appeal of pay-in-4 BNPL, credit card issuers mostly just stood pat.

A few of the larger issuers introduced BNPL as a feature within their credit card products, which allowed cardholders to convert transactions over a certain size, post-purchase, into fixed installment loans.

Beyond that, though? They mostly did nothing.

This was controversial! Smartass analysts like me were making fun of these banks on Twitter. Slightly-less-snarky analysts were pressuring the CEOs of these banks on earnings calls about why they weren’t taking the threat of BNPL more seriously.

Here’s how American Express’ CEO Stephen Squeri explained his company’s restrained response to BNPL:

Buy now, pay later is not really a competitive threat to us. It’s targeted at debit card issuers. As a customer acquisition vehicle it’s not the game we’re playing.

On a tactical level, that’s not really correct. As a product, BNPL is a competitive threat to credit cards, including AmEx cards. It’s free money! Delivered in an extremely convenient fashion! BNPL has almost certainly taken at least a little market share away from American Express over the last couple of years. That’s why stock market analysts were concerned.

However, on a more strategic level, Mr. Squeri’s response is exactly right. BNPL isn’t a long-term competitive threat to credit cards because, as a business, BNPL just doesn’t make a lot of sense. Its growth has been fueled by high-risk borrowers and funded by abnormally low interest rates and excessively exuberant VC investment. There is ample reason to believe that, as a standalone business, pay-in-4 BNPL will burn itself out within the next few years.

Credit card issuers can continue to just ride it out.

And you know what? Their customers won’t be mad. Customers like credit cards! According to J.D. Power, in 2022, credit card issuers saw big gains in customer satisfaction, trust, and net promoter scores. The bundle is doing just fine!

“It’s not the game we’re playing”

I hope that 30 years from now, this quote from Stephen Squeri is as well-remembered as Jim Barksdale’s quote.

What banks got right in responding to BNPL (and what media companies got wrong in responding to streaming) is recognizing that sometimes the only way to win is to not play.

[Farfromgeneva]

Would note the ending and that FFG moved to Atlanta in 2010 and FFG Jr was born in 2012-no coincidence. I do worry about my home in a dope neighborhood in-town long term but being situated near an 84an park, too 4 elementary school, Carter center, a padaeia school and golf club and a truly ungentrified bohemian commercial district makes it about as special/protected form mass swings of an area as this sterile city gets.

Wall Street Sours on America’s Downtowns

Heather GillersJune 20, 2023 12:01 am ET
Wall Street is betting against America’s downtowns.

Investors are paying less for bonds linked to New York subways and buses. Downtown-focused real-estate investment trusts trade at less than half their prepandemic levels. Bondholders are demanding extra interest to hold office-building debt.

Downtowns have been a mother lode for American cities over the years, providing billions of dollars in tax revenue along with their distinctive skylines. In turn, investors who bet on downtown office towers, or on the trains and buses delivering workers to them, could generally trust they held a winning hand.

Now, with white-collar workers spending more time in their home offices, a phenomenon that shows few signs of ending, investments linked to downtowns are trading at falling prices in volatile markets.

“You could see this as a slow-motion change or as the beginning of a slow-moving train wreck,” said Richard Ciccarone, president emeritus of Merritt Research Services, a municipal credit-analysis firm. “I hope it’s not a train wreck, but it could be.”

Investors’ dimming view of downtowns isn’t good news for cities’ finances, nor for their residents. It puts under strain some of city governments’ traditional ways of extracting wealth: collecting property taxes on office buildings, taxes on wages earned within city limits, and fares from office workers’ commutes.

Residents of some cities are bracing for austerity. Many New York library branches expect to close an additional day each week under cuts proposed as the city faces rising labor costs and budget gaps projected to reach $7 billion in 2027. From New York to Chicago to San Francisco, residents and visitors complain about empty downtown streets and transit stops that have become way stations for the mentally ill and homeless.

City vs. suburb

Analysts at Asset Preservation Advisors, a municipal-bond management firm, are watching downtowns closely. The team remains confident of certain tax-backed bonds sold by New York City and Boston, but has grown wary about debt of some other Northern urban centers and big California cities, even bonds backed by those cities’ full taxing power.

“The suburbs are going to be one of the big winners in this, and the potential losers could be the large cities that have depended on people coming back and forth to work,” said Ken Woods, founder and chairman of the firm.

Office buildings are only about 50% as full as before Covid-19 across 10 major metro areas, according to keycard tracking by Kastle Systems, a building-security company. Federal transit data show public-transportation ridership at less than 70% of pre-Covid levels in major metro areas.

President Biden said more than a year ago it was time for America to get back to work “and fill our great downtowns again.” Yet even in the federal workforce, more than half of employees worked remotely at least one day a week last year, according to one survey.

One indication of investors’ wariness of downtowns can be seen in how they price bonds backed in part by commuter fares. The lower a bond’s price, the higher its interest yield. In New York, some bonds partly backed by bus, subway and commuter-train fares yielded a lofty 1.25 percentage points above top-rated municipal bonds on June 14, a spread 56% wider than before Covid, according to ICE Data Services, a financial analytics company.

While the bonds remain investment grade and many asset managers are comfortable holding them, Asset Preservation Advisors has stopped buying fare-backed debt of the New York Metropolitan Transportation Authority unless it matures relatively soon.

In another indication of investor worries, those who buy a common type of low-rated commercial mortgage-backed security are demanding 9.25 percentage points more interest than that on 10-year Treasurys as of June 12, according to research from Bank of America. This spread is three times as big as before the pandemic for such securities, which finance a property mix that is around 30% office space.

Office space

Subsidiaries of Pacific Investment Management and Brookfield Asset Management recently defaulted on more than $2 billion in commercial mortgage-backed securities related to office towers in New York, San Francisco, Los Angeles and other cities.

Share prices of the five largest real-estate investment trusts that concentrate on downtown office buildings were down 63% on June 15, on average, from the end of 2019. Price declines were much smaller for REITs focused on retail property (down 7%) and apartment-focused REITs (down 8%).

What has happened to the value of downtown office buildings isn’t easy to gauge, because sales have slacked and many office rents don’t adjust with shifting demand—they are locked in place by long leases.

“Over the next 10 years, we’re gradually going to come to grips with this, and the stuff will slowly reprice,” said Stijn Van Nieuwerburgh, a Columbia Business School professor.

He and colleagues at Columbia and New York University estimate that the value of office property across U.S. cities is 38% lower than before the pandemic, equaling a loss of about $500 billion.


Movers clear out an office space in San Francisco’s Financial District. Businesses there have struggled to recover since the pandemic. Photo: Shelby Knowles for The Wall Street Journal
As values weaken, some office-building owners are challenging their tax bills. If lower tax assessments result from these challenges, leading to lower tax revenue from the office buildings, big-city officials will face an uncomfortable choice: Collect less revenue or lean more heavily on other taxpayers.

Office-building property taxes make up about 10% of revenue in major cities, according to a calculation by Green Street, a real-estate analytics firm. It projects “a dire picture for future city budgets with high levels of remote work.” Older Northeastern, Midwestern and California cities with high debt loads and pension liabilities already were facing budget struggles, a contrast with sprawling metropolises in South and West states.

Los Angeles this year began charging a tax on home sales above $5 million. New York Mayor Eric Adams supports putting two newly state-authorized casinos in the city. Many ideas for reinvigorating downtowns appear years away from a financial payoff, such as converting empty office space to homes, entertainment venues or even day cares.

The cities aren’t going broke. Even those most affected by remote work remain home to many wealthy people and companies. Certain residential neighborhoods benefit from the work shift. The big price swings of publicly traded securities linked to office towers and transit will have limited significance if the underlying assets recover quickly.

Cities’ operating expenditures declined in 2022, on average, according to budget figures compiled by the National League of Cities, an advocacy group. Adjusted for inflation, cities had the largest drop in both spending and revenue in almost 40 years except for that following the 2008-09 financial crisis.

Federal aid provided when Covid struck staved off deeper budget cuts. Sales- and income-tax revenue surged in 2020 and 2021 when stocks boomed and consumers spent stimulus checks.

Both the tax windfalls and the aid money are running out.

Asset Preservation Advisors manages about $6 billion in municipal bonds for affluent households and other clients. The team—which works from the office four days a week—combs through data such as cellphone activity in downtowns and sewer hookups for new homes in expanding metro areas.

Go west (and south)

Increasingly, the team is finding opportunity in suburban bonds in lower-tax Southern and Western states that have drawn companies and workers now untethered from Northern big-city centers. Securities-industry jobs, traditionally tied to Wall Street, have increased by 20% or more in Utah, Georgia, Tennessee, Texas, Wyoming and North Carolina since 2019, according to the U.S. Labor Department.

In Florida, hedge fund Citadel Securities from Chicago moved its headquarters to Miami and Elliott Management from New York moved its headquarters to West Palm Beach. Investment giant BlackRock opened a satellite office in West Palm Beach in January.


1221 Brickell Avenue in Miami, where Citadel has offices. The hedge fund is one of several finance firms that have relocated to Florida or expanded there. Photo: Saul Martinez/Bloomberg News
One city Woods’s team has backed away from is San Francisco, where the tech industry embraced remote work early on and now is laying off employees.

“We’re seeing an emperor without clothes to a certain degree,” said Woods. “We just want to be very cautious.”

Meta Platforms, Salesforce, Yelp and Block have announced plans to sublease or not renew office space. Twitter stopped paying rent on some of its San Francisco offices, according to a lawsuit by its landlord, an affiliate of Pimco-owned Columbia Property Trust, which later defaulted on the building.

Cellphone activity in downtown San Francisco was at 32% of its pre-Covid level as of last winter, according to research from the University of Toronto.

San Francisco laid out budgetary risks when it sold bonds in March. About a quarter of its office space is vacant, according to real estate services firm CBRE, in the biggest increase from before Covid of any major city. Downtown ridership on the Bay Area Rapid Transit system in April was 34% of its prepandemic level. S&P Global Ratings downgraded some of San Francisco’s commuter rail bonds on June 1, though they remain investment grade.

There have been some signs of recovery. Downtown sales tax revenue was 19% higher in the last three months of 2022 compared with that period in 2021.

A particular concern, in Asset Preservation Advisors’ view, is a flurry of requests from landlords of downtown office buildings to reduce the properties’ tax values. A result of those appeals could be that San Francisco’s annual property-tax revenue, currently around $3 billion, will be $100 million to $200 million lower than expected in each of the next five years, according to a forecast by the controller’s office.

The firm is cautious about counting any city out, though. In the early 2000s, it decided to mostly steer clear of bonds from its hometown, Atlanta, concerned about city finances and a bribery scandal.

In 2012, its credit analysts took another look and noticed improved city governance, a rainy-day fund and pension cuts, as well as Atlanta’s population growth, bustling airport and universities. The firm soon started buying Atlanta bonds again.

Write to Heather Gillers at [email protected]

[Farfromgeneva]

Eviction Filings Soaring Above Pre-Pandemic Level In Some Cities

Placeholder
The push to evict delinquent renters is cause a rise in homelessness across the U.S.

The pandemic spurred a historic wave of eviction protection for renters in the U.S., but those days are quickly going away.

Landlords filed paperwork seeing to evict nearly 970,000 renters across the country, a jump of more than 78% compared to 2021, the Associated Press reported, citing data from Princeton University’s Eviction Lab.

Eviction filings have spiked more than 50% higher than before the pandemic in some places, according to Eviction Lab, including in Houston, Minneapolis/St. Paul, Nashville, Phoenix and the state of Rhode Island. Eviction Lab tracks filings in 12 cities and 10 states, and notes that landlords normally move to evict 3.6 million households a year.

“Across the country, low-income renters are in an even worse situation than before the pandemic due to things like massive increases in rent during the pandemic, inflation and other pandemic-era related financial difficulties,” Eviction Lab research specialist Daniel Grubbs-Donovan told the AP. “Protections have ended, the federal moratorium is obviously over and emergency rental assistance has dried up in most places.”

While the rate of rent growth has slowed this year, average rents continued to tick upward a little more than 4% year-over-year for the past nine months to an average of $1,995 per month as of May, according to Rent.com.

The federal government’s $46.5B in emergency rental assistance has all but dried up with Congress failing to inject further rescue dollars, and eviction moratoriums also have largely lapsed across many U.S. cities. The National Low Income Housing Coalition said there is a shortage of more than 7 million housing units priced for households earning 30% or less of an area’s median income.

The push is leading to a rise in homelessness across the nation. But at the same time, the rise in homeless camps and tent cities in many cities is generating a political backlash, with many cities increasing policing and sweeps of homeless camps, Next City reported.

The AP reported that renter and eviction protections that have remained in place in some cities, such as New York and Philadelphia — including sealing eviction records, forcing mediation to resolve cases and legal representation for tenants — have tamped down evictions by more than 30% from pre-pandemic levels.

[youthathletics]

Here in DC, we are starting to see more businesses start a mandatory back to the office which includes a flex schedule of 2-3 days remote. Our office is doing the same. We just renovated down to a smaller sq/ft, redesigned with more of a home / feng shui feel, and will have each department work on being in there together as a team...much like a family Sunday dinner vibe. We'll see how it goes....I like it b/c I can not stand being tethered to tech.

I know the new amazon headquarters in Crystal City is pushing for mandatory return to work. The amazing part, is traffic is still effed up and yet most buildings are less than 50-75 of capacity.....people are just running around hanging out I guess.

https://www.bisnow.com/national/news/of ... dium=email

https://www.bisnow.com/washington-dc/ne ... dium=email

[a fan]

Here in DC, we are starting to see more businesses start a mandatory back to the office which includes a flex schedule of 2-3 days remote. Our office is doing the same. We just renovated down to a smaller sq/ft, redesigned with more of a home / feng shui feel, and will have each department work on being in there together as a team...much like a family Sunday dinner vibe. We'll see how it goes....I like it b/c I can not stand being tethered to tech.

I know the new amazon headquarters in Crystal City is pushing for mandatory return to work. The amazing part, is traffic is still effed up and yet most buildings are less than 50-75 of capacity.....people are just running around hanging out I guess.

https://www.bisnow.com/national/news/of ... dium=email

https://www.bisnow.com/washington-dc/ne ... dium=email

The thing I don't get about remote working, is that it's ASSUMED that you've worked in-person before. How the F do you teach new hires how to manage people if they've never been in the same room with their team?

All the little interactions------water cooler stuff-----that builds trust and understanding? It's gone in the remote work Zoom world. I don't see this as a positive thing.

[youthathletics]

Here in DC, we are starting to see more businesses start a mandatory back to the office which includes a flex schedule of 2-3 days remote. Our office is doing the same. We just renovated down to a smaller sq/ft, redesigned with more of a home / feng shui feel, and will have each department work on being in there together as a team...much like a family Sunday dinner vibe. We'll see how it goes....I like it b/c I can not stand being tethered to tech.

I know the new amazon headquarters in Crystal City is pushing for mandatory return to work. The amazing part, is traffic is still effed up and yet most buildings are less than 50-75 of capacity.....people are just running around hanging out I guess.

https://www.bisnow.com/national/news/of ... dium=email

https://www.bisnow.com/washington-dc/ne ... dium=email

The thing I don't get about remote working, is that it's ASSUMED that you've worked in-person before. How the F do you teach new hires how to manage people if they've never been in the same room with their team?

All the little interactions------water cooler stuff-----that builds trust and understanding? It's gone in the remote work Zoom world. I don't see this as a positive thing.

Agreed, which is why businesses are starting to make it mandatory to return at least a few days/wk.

Anecdotally, I am working on splitting my current team up into two teams. Upper management is not asking me to do this, it is on my own accord. My team has grown to a point where I no longer have enough touch points with each of them and I am seeing slippage in growth/skill set with the younger associates. It is really hard to break up a highly productive team that has worked together so well, to the point they no longer really need you. I was once told by a mentor, that is when you know you have done well, when your team would not really miss you if you were gone, b/c they are self-reliant, accountable and supportive to one another.

More to your point, the management/leader role encompasses so much more these days with all the HR 'schtuff' that trickles down and making sure the new hires are getting what they need.....I have certainly noticed that they demand far more time and investment than any other group I've worked with.

[a fan]

Agreed, which is why businesses are starting to make it mandatory to return at least a few days/wk.

Anecdotally, I am working on splitting my current team up into two teams. Upper management is not asking me to do this, it is on my own accord. My team has grown to a point where I no longer have enough touch points with each of them and I am seeing slippage in growth/skill set with the younger associates. It is really hard to break up a highly productive team that has worked together so well, to the point they no longer really need you. I was once told by a mentor, that is when you know you have done well, when your team would not really miss you if you were gone, b/c they are self-reliant, accountable and supportive to one another.

We started fully educating our staff right as the pandemic hit, and working on making me superfluous. My production manager is on a path to get his MS in Distilling from a school in Scotland. The other is two years in to taking the UK's Master Maltster exam. The rest are being trained and taught to make decisions for themselves as fast as possible. What we do at our shop is incredibly complicated, and completely different from any other distillery in the world. So....it's a LOT of work and education.

More to your point, the management/leader role encompasses so much more these days with all the HR 'schtuff' that trickles down and making sure the new hires are getting what they need.....I have certainly noticed that they demand far more time and investment than any other group I've worked with.

Our systems are designed to take care of our people so well that the very idea of leaving to go to another distillery is laughable. We've only lost production staff to a change in careers that we knew was coming....and worked with our co-workers to get them there. Paid the tuition for one to get his MS in Computer Engineering. He now lives in Germany with his military spouse (a Nurse)....he works for Zoom.

[youthathletics]

Agreed, which is why businesses are starting to make it mandatory to return at least a few days/wk.

Anecdotally, I am working on splitting my current team up into two teams. Upper management is not asking me to do this, it is on my own accord. My team has grown to a point where I no longer have enough touch points with each of them and I am seeing slippage in growth/skill set with the younger associates. It is really hard to break up a highly productive team that has worked together so well, to the point they no longer really need you. I was once told by a mentor, that is when you know you have done well, when your team would not really miss you if you were gone, b/c they are self-reliant, accountable and supportive to one another.

We started fully educating our staff right as the pandemic hit, and working on making me superfluous. My production manager is on a path to get his MS in Distilling from a school in Scotland. The other is two years in to taking the UK's Master Maltster exam. The rest are being trained and taught to make decisions for themselves as fast as possible. What we do at our shop is incredibly complicated, and completely different from any other distillery in the world. So....it's a LOT of work and education.

More to your point, the management/leader role encompasses so much more these days with all the HR 'schtuff' that trickles down and making sure the new hires are getting what they need.....I have certainly noticed that they demand far more time and investment than any other group I've worked with.

Our systems are designed to take care of our people so well that the very idea of leaving to go to another distillery is laughable. We've only lost production staff to a change in careers that we knew was coming....and worked with our co-workers to get them there. Paid the tuition for one to get his MS in Computer Engineering. He now lives in Germany with his military spouse (a Nurse)....he works for Zoom.

Well Done > Well Said !

[Farfromgeneva]

Reviewing an older essay relative to this fast moving topic and figure it’s interesting to share as it opens up some insights into lending and technology

https://newsletter.fintechtakes.com/p/t ... ss-lending

The Future of Small Business Lending

A Digital Experience + Vertical Specialization.

Alex Johnson
The COVID-19 pandemic has completely upended small business lending. Nearly 100,000 small businesses in the U.S. have permanently closed since the beginning of the pandemic. Banks and fintech companies — understandably nervous about lending in this environment — pivoted to distributing over $500 Billion in Paycheck Protection Program loans. Several of the largest fintech companies focused on small business lending — OnDeck and Kabbage — found exits.

All of which leaves us with a question — what does the future of small business lending look like?

Technology Isn’t Enough

For the purposes of this analysis, let’s assume we’re operating in a post-pandemic world where economic conditions for small businesses and lending conditions for banks and fintech companies have returned to some semblance of “normal”.

A lesson that I’ve learned from the last 15 years — since the emergence of online lenders like Lending Club, OnDeck, and Kabbage — is that technology can’t fully address the needs of small businesses.

Now, of course, those online lenders would disagree:

“At our very core, the focus has always been on automation and technology," Petralia [Kabbage co-founder and COO] says. "We ask the same exact questions that the banks ask, but we use data in a different way to get there faster."

They would argue that automation and data-driven underwriting dramatically lowers the costs of small business lending and enables them to profitably serve entrepreneurs that banks never could.

The pre-COVID data certainly supports the belief that small businesses will flock to the speed and certainty provided by such automation:

32% of small businesses applied for credit from online lenders in 2018, up from 24% in 2017 … Speed of decision making and perceived chance of funding were the top reasons firms applied to online lenders.

And yet, there’s a problem:

79% of small businesses that borrowed from small banks came away satisfied, compared to 67% for large banks and 49% for online lenders … Online lender applicants were most dissatisfied with high interest rates.

According to the data, small businesses are addicted to the speed and convenience offered by fintech lenders, despite the fact that loans made by those providers are generally worse for them financially.

Which tells me that technology alone cannot fully deliver the outcome that small business borrowers want — fast, convenient loans at fair prices.

Never Tell Me the Odds

So how do we deliver that outcome? To answer that question, we first need to answer a related question — why is pricing risk in small business lending so hard?

What is it about lending to small businesses, specifically, that makes big banks so conservative in their approval rates (small business owners view big banks as least likely to approve them for loans according to SBA data) and fintechs so excessive in their loan pricing?

The answer is simple — starting a small business is irrational.

Half of small businesses fail within five years. 70% within ten years. To start a small business requires a Han Solo-ian level of confidence.

star wars statistics GIF
At a societal level, this type of confidence and ambition is critical. Our economy is built on it. In many ways it’s the purest expression of the American Dream.

But at a risk management level, it often looks utterly insane.

The Difference Between Data and Understanding

Here’s a quick example.

Let’s say we have an investment banker, living in Santa Fe, who hates her job. As a hobby, she starts making donuts on the weekends. Her friends love her donuts so much that word starts spreading and soon she’s being asked to cater a few weddings and birthday parties. She does so out of her house, using the equipment she already has, and making enough money to pay for her expenses and keep a little extra. At this point, the financial performance of her “business” (modest) matches her credit needs (nonexistent).


Then, with ample encouragement from her friends, she decides to quit her job as an investment banker and start a full-time donut business — Port-hole-io (sorry). Her first order of business is buying two industrial fryers and an industrial oven — a $20,000 capital expenditure — for which she seeks a loan from her bank.


And here we hit our problem. Our investment banker-turned-baker’s ambition, while perfectly rational to her based on her personal experiences, looks irrational from her bank’s perspective. The available data — cashflow, business history, collateral — doesn’t justify the risk.


What’s needed, to bridge this gap, is understanding; the ability to analyze the available data (requested loan amount, cashflow, business history, collateral) within the context of the business opportunity that the entrepreneur is so passionately pursuing.

This is why, in spite of their technology deficiencies, community banks are actually pretty good at small business lending and why small business owners are most satisfied working with them. They analyze data within the context of the opportunity — can a new donut business succeed in Santa Fe? Their knowledge of the community (and the local donut scene) helps build a bridge between the their risk management worldview and the investment banker-turned-baker’s entrepreneurial worldview.


Small Businesses Are Like Early-Stage Startups

The concept of ‘understanding’ as a risk evaluation tool in a data-deficient environment isn’t radical nor is it new to the world of entrepreneurship.

In venture capital investing, it’s called vertical specialization. Here’s Ali Hamed at CoVenture on why vertical specialization in VC investing can be advantageous:

It allows you to invest in a company before there is data that validates the company is on to something. … When I see a deal in a space I know well… like in lending — I don’t have to wait for the company to have customer data before making an equity investment. I have seen so many companies in the space that I know what default rates will probably look like, costs of origination, servicing, collections, and whether or not borrowers will take the money. I know if the company will be able to access debt capital markets.

The Ideal Small Business Lender

So what does the ideal small business lender look like? In my opinion, there are two primary criteria:

Ability to deliver a streamlined digital lending experience.

Vertical specialization.

Most big banks and the current generation of fintech lenders excel at digital, but aren’t structurally well-suited for specialization. Community banks struggle mightily with delivering streamlined digital experiences and their specialization is rooted in geography rather than industry expertise.

What’s really needed is a fintech company that is hyper-focused on a specific vertical.

Something like Karat:

Karat’s first product is the Karat Black Card, designed specifically for influencers, with credit lines starting at $50,000. Its perks can be customized (gamers get cash back on streaming services; beauty influencers get perks for product purchases), and the credit limits are determined by an influencer’s social metrics, revenue streams, and cash in hand.

The influencer market is big and growing quickly:

The influencer market will be, by some estimates, worth close to $15 billion in just a few years, with hundreds of thousands of people earning sizable income from viral videos and social posts. By Karat’s own count, there are over a million professional full-time creators globally who earn at least $80,000 a year

And Karat’s cofounders — Eric Wei and Will Kim — evince a deep and nuanced understanding of it (Eric Wei worked at Instagram):

Each social media platform has different options for monetizing an audience, and some are more lucrative than others. “I’d rather have a million followers on YouTube than 10 million on TikTok,” says Wei, since YouTubers can get money from both ad revenue and channel subscriptions, while TikTok has no direct monetization options and makes it difficult to follow specific creators. Engagement is also critical. An influencer with 1 million followers and 10 percent engagement will do better than another with 10 million followers and 1 percent engagement, because engagement doesn’t scale linearly. In gauging creditworthiness, Karat also looks for signals that the creator has “professionalized” (incorporating their business, responding to emails on time) and the ways they have diversified their revenue (affiliate links, AdSense, sponsorships, subscriptions, and merchandising). It’s essential to see that they’re not mono-platform, Kim says, since “creators who are too reliant on any one platform struggle when something goes wrong with that platform.”

The Embedded Finance Advantage

As bullish as I am on Karat conceptually, it will face the same challenge that every B2C fintech startup faces — acquiring customers in a crowded market.

You know who won’t have that problem? Toast, a restaurant technology provider based out of Boston:

Toast has launched Toast Capital so its customers can secure loans, with restaurant-specific quirks in mind, like “seasonality and restaurant profit margins,” according to Tim Barash, chief financial officer at Toast. Toast will offer loans between $5,000 to $250,000 to restaurants that already work within the Toast network

Like Karat, Toast evinces a deep understanding of the unique challenges of running a restaurant and how those challenges should influence loan product design:

if a restaurant brings in, say, $5,000 on a Monday, but on Tuesday it brings in $10,000, the restaurant “will pay less on the day they made less.” So it’s a model where you pay a percentage of what you make each day.

Unlike Karat, Toast already has a large customer base to cross-sell its new loans to, which will significantly lower its acquisition costs. And as Andreessen Horowitz points out, vertical-specific software companies tend to have especially large and receptive customer bases:

the vertical SaaS business that can best serve the needs of a specific industry often becomes the dominant vertical solution and can sell both software and financial solutions to their core customer base.

With the growing maturity of fintech infrastructure and banking-as-a-service providers, I anticipate that the next decade of small business lending will be dominated by niche fintech startups and vertical-specific B2B service providers.

Good news for our hypothetical investment banker-turned-baker.


Short Takes

(Sourced from This Week in Fintech)

Chasing After Kids

Chase introduced a new bank account for kids (and their parents), focused on building healthy financial habits, powered by Greenlight.

Short take: Debit cards for kids is suddenly quite a crowded field, but Chase’s participation will elevate the concept to a new level. I’m a fan. The days of your parents sitting you down and showing you how to write a check are over. We need new ways to teach kids about the mechanics of financial services.

Employees Are People Too

PayPal CEO Dan Schulman commissioned a study and found that more than 10,000 people inside of PayPal struggle to make ends meet. He is working to change that.

Short take: It’s baffling to me why more financial services companies don’t invest in their employees’ financial health. A.) it’s the right thing to do. B.) it’s the profitable thing to do (PayPal’s investments in financial health have decreased employee attrition). And C.) it gives you an opportunity to experiment with financial health services that can then be extended to customers.

Double Secret Investment

Standard Chartered's fintech investment unit has made an undisclosed investment in passwordless authentication outfit Secret Double Octopus.

Short take: Passwordless multi-factor authentication is cool and definitely needed (passwords have long been recognized as a major weak link in corporate information security), but honestly I just wanted to write the name ‘Secret Double Octopus’ in my newsletter and point out how similar its logo is to SPECTRE’s logo in the James Bond franchise.

[Brooklyn]

497,000 new jobs!

Thank you, Mr Biden!!!

[Farfromgeneva]

Stopped dropping this in after a few 1st fridays of the month but major labor data this am is out again (8:30am first Friday of each month as a reminder) - looks solid but daily Goldilocks on the surface which will make the late month Fed meeting interesting but I still think they’re upping another 25-50bps in late July.

JUL
07
Payroll employment increases by 209,000 in June; unemployment rate changes little at 3.6%
Total nonfarm payroll employment increased by 209,000 in June, and the unemployment rate changed little at 3.6 percent. Employment continued to trend up in government, health care, social assistance, and construction.

https://www.bls.gov/news.release/pdf/empsit.pdf

[KI Dock Bar]

Although the jobs number is encouraging, Fed Chair Jay Powell needs the economy to slow to get to his stated goal of 2% inflation. This week he shared that probably would not happen until 2025. On November 2nd the rate was raised 75 basis points to 4%, since then he has raised the rate 125 basis points to the current level of 5.25%. Most analyst think two more 25 basis point hikes are forthcoming and the market has priced these in.

It’s easy to forget that the Fed was holding the federal funds rate at around zero as recently as the first quarter of 2022. The Fed was also still buying billions of dollars of bonds every month to stimulate the economy. All despite 40-year highs in various measures of U.S. inflation.

“Without price stability, the economy does not work for anyone,” Federal Reserve Chair Jerome Powell said at an August 2022 speech at Jackson Hole. “In particular, without price stability, we will not achieve a sustained period of strong labor market conditions that benefit all.”

[a fan]

Although the jobs number is encouraging, Fed Chair Jay Powell needs the economy to slow to get to his stated goal of 2% inflation. This week he shared that probably would not happen until 2025. On November 2nd the rate was raised 75 basis points to 4%, since then he has raised the rate 125 basis points to the current level of 5.25%. Most analyst think two more 25 basis point hikes are forthcoming and the market has priced these in.

It’s easy to forget that the Fed was holding the federal funds rate at around zero as recently as the first quarter of 2022. The Fed was also still buying billions of dollars of bonds every month to stimulate the economy. All despite 40-year highs in various measures of U.S. inflation.

“Without price stability, the economy does not work for anyone,” Federal Reserve Chair Jerome Powell said at an August 2022 speech at Jackson Hole. “In particular, without price stability, we will not achieve a sustained period of strong labor market conditions that benefit all.”

I don't get why they think that interest rates are the only tool in the drawer.

Raise taxes, especially on corporations. It claws back money to the Treasury without putting people out of work......and if you believe that it's borrowed spending (too much printed money in circulation), that takes care of the inflation.

They're saying the economy is too hot, right? Too much demand? Well, then that's the perfect time to raise taxes and kill some debt.

We blew almost $500 Billion last year on interest payments, FFS.

[youthathletics]

I don't get why they think that interest rates are the only tool in the drawer.

Maybe because the rate is so low, they can borrow money, invest it in damned near any market, and make profit, without lifting a finger or plugging in a widget maker, which keeps demand up becuase supply stays low? Keep in mind, this, coming from someone not well versed in finance.

[a fan]

I don't get why they think that interest rates are the only tool in the drawer.

Maybe because the rate is so low, they can borrow money, invest it in damned near any market, and make profit, without lifting a finger or plugging in a widget maker, which keeps demand up becuase supply stays low? Keep in mind, this, coming from someone not well versed in finance.

You'll find this interesting-----our local bank all but told us not to borrow money for anything real estate/construction. It's that bad right now.

Instead? They'll throw money at us at good rates for anything equipment. Total reversal of 20+ years of banking.

[Farfromgeneva]

I don't get why they think that interest rates are the only tool in the drawer.

Maybe because the rate is so low, they can borrow money, invest it in damned near any market, and make profit, without lifting a finger or plugging in a widget maker, which keeps demand up becuase supply stays low? Keep in mind, this, coming from someone not well versed in finance.

You'll find this interesting-----our local bank all but told us not to borrow money for anything real estate/construction. It's that bad right now.

Instead? They'll throw money at us at good rates for anything equipment. Total reversal of 20+ years of banking.

Because they have a ton of balloon maturities coming in CRE, every bank, many of which aren’t refinanceable. 25-30yr amortization with some Interest Only, valuations are going to drop because the multiplier is tethered to the 10yr UST (different types carry different spreads, multifamily and industrial are 200-300bps (2-3%) over the 10yr for capitalization rate which is the denominator to net operating income of a property to derive value, office is +400-500 as is Hotel, retail somewhere in between but more sensitive to market than most other types).

Every bank has a massive CRE issue that’s going to tie up their balance sheets for the next three years. Cant add more long duration loans. Equipment is all floating rate and self liquidating or fully amortizing over 3-7yrs mainly (some 10yr) so the loans average life is short and balance declines much faster. It’s funny I was recently asked by an advisor to help source $6mm of “let’s make a deal” priced mezzanine debt to support the refinance of a $105mm senior mortgage made 2yrs ago by Goldman on a hotel redevelopment in Chi. The new first mortgage sized to $69mm, they’re using $38mm in C-PACE and a 3yr look back provision on eligible improvements and then because of working capital and interest reserve needs there’s still a $6mm hole. And goldman is still one of the nest risk managers on the street.

It’s bad enough the various regulators out out interagency guidance recently on how to address the coming wall of term balloon maturities.

https://www.fdic.gov/news/financial-ins ... 23034a.pdf

Summary:

The Federal Deposit Insurance Corporation (FDIC), along with the Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System (Board), and National Credit Union Administration (NCUA) (collectively, the agencies), in consultation with the Federal Financial Institutions Examination Council State Liaison Committee, are issuing the interagency Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts (Statement). The Statement is a principles based resource for financial institutions to consider when engaging with borrowers experiencing financial difficulties.

Statement of Applicability: The contents of, and material referenced in, this FIL apply to all FDIC-supervised financial institutions.

Highlights:

In the third quarter of 2022, the agencies, in consultation with the state bank and credit union regulators, published for comment a proposed Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts.
After careful consideration of comments received, the agencies are issuing the Statement that will replace the Policy Statement on Prudent Commercial Real Estate Loan Workouts (2009 Statement) adopted by the agencies and the Federal Financial Institutions Examination Council State Liaison Committee, and the former Office of Thrift Supervision.
The Statement discusses the importance of working constructively with CRE borrowers experiencing financial difficulty and is appropriate for all supervised financial institutions engaged in CRE lending.
The Statement addresses sound principles and supervisory expectations with respect to a financial institution’s handling of loan accommodations and workouts on matters including (1) risk management, (2) classification of loans, (3) regulatory reporting, and (4) accounting considerations, and includes updated references to supervisory guidance.
The agencies recognize that prudent CRE loan accommodations and workouts are often in the best interest of both the financial institution and the borrower. Accordingly, the Statement reaffirms the key principles from the 2009 Statement: (1) financial institutions that implement prudent CRE loan accommodation and workout arrangements after performing a comprehensive review of a borrower’s financial condition will not be subject to criticism for engaging in these efforts, even if these arrangements result in modified loans that have weaknesses that result in adverse classification; and (2) modified loans to borrowers who have the ability to repay their debts according to reasonable terms will not be subject to adverse classification solely because the value of the underlying collateral has declined to an amount that is less than the outstanding loan balance.
The Statement also includes the following changes compared to the 2009 Statement: (1) addition of a new section on short-term loan accommodations; (2) information about changes in accounting principles since 2009; and (3) revisions and additions to examples of CRE loan workouts.

[a fan]

I don't get why they think that interest rates are the only tool in the drawer.

Maybe because the rate is so low, they can borrow money, invest it in damned near any market, and make profit, without lifting a finger or plugging in a widget maker, which keeps demand up becuase supply stays low? Keep in mind, this, coming from someone not well versed in finance.

You'll find this interesting-----our local bank all but told us not to borrow money for anything real estate/construction. It's that bad right now.

Instead? They'll throw money at us at good rates for anything equipment. Total reversal of 20+ years of banking.

Because they have a ton of balloon maturities coming in CRE, every bank, many of which aren’t refinanceable. 25-30yr amortization with some Interest Only, valuations are going to drop because the multiplier is tethered to the 10yr UST (different types carry different spreads, multifamily and industrial are 200-300bps (2-3%) over the 10yr for capitalization rate which is the denominator to net operating income of a property to derive value, office is +400-500 as is Hotel, retail somewhere in between but more sensitive to market than most other types).

Every bank has a massive CRE issue that’s going to tie up their balance sheets for the next three years. Cant add more long duration loans. Equipment is all floating rate and self liquidating or fully amortizing over 3-7yrs mainly (some 10yr) so the loans average life is short and balance declines much faster. It’s funny I was recently asked by an advisor to help source $6mm of “let’s make a deal” priced mezzanine debt to support the refinance of a $105mm senior mortgage made 2yrs ago by Goldman on a hotel redevelopment in Chi. The new first mortgage sized to $69mm, they’re using $38mm in C-PACE and a 3yr look back provision on eligible improvements and then because of working capital and interest reserve needs there’s still a $6mm hole. And goldman is still one of the nest risk managers on the street.

It’s bad enough the various regulators out out interagency guidance recently on how to address the coming wall of term balloon maturities.

https://www.fdic.gov/news/financial-ins ... 23034a.pdf

Summary:

The Federal Deposit Insurance Corporation (FDIC), along with the Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System (Board), and National Credit Union Administration (NCUA) (collectively, the agencies), in consultation with the Federal Financial Institutions Examination Council State Liaison Committee, are issuing the interagency Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts (Statement). The Statement is a principles based resource for financial institutions to consider when engaging with borrowers experiencing financial difficulties.

Statement of Applicability: The contents of, and material referenced in, this FIL apply to all FDIC-supervised financial institutions.

Highlights:

In the third quarter of 2022, the agencies, in consultation with the state bank and credit union regulators, published for comment a proposed Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts.
After careful consideration of comments received, the agencies are issuing the Statement that will replace the Policy Statement on Prudent Commercial Real Estate Loan Workouts (2009 Statement) adopted by the agencies and the Federal Financial Institutions Examination Council State Liaison Committee, and the former Office of Thrift Supervision.
The Statement discusses the importance of working constructively with CRE borrowers experiencing financial difficulty and is appropriate for all supervised financial institutions engaged in CRE lending.
The Statement addresses sound principles and supervisory expectations with respect to a financial institution’s handling of loan accommodations and workouts on matters including (1) risk management, (2) classification of loans, (3) regulatory reporting, and (4) accounting considerations, and includes updated references to supervisory guidance.
The agencies recognize that prudent CRE loan accommodations and workouts are often in the best interest of both the financial institution and the borrower. Accordingly, the Statement reaffirms the key principles from the 2009 Statement: (1) financial institutions that implement prudent CRE loan accommodation and workout arrangements after performing a comprehensive review of a borrower’s financial condition will not be subject to criticism for engaging in these efforts, even if these arrangements result in modified loans that have weaknesses that result in adverse classification; and (2) modified loans to borrowers who have the ability to repay their debts according to reasonable terms will not be subject to adverse classification solely because the value of the underlying collateral has declined to an amount that is less than the outstanding loan balance.
The Statement also includes the following changes compared to the 2009 Statement: (1) addition of a new section on short-term loan accommodations; (2) information about changes in accounting principles since 2009; and (3) revisions and additions to examples of CRE loan workouts.

Fascinating. Thanks! Thanks for coloring in the shaky picture I had in my head....."they're getting beaten down by commercial property loans on offices that no one wants".

[Farfromgeneva]

I don't get why they think that interest rates are the only tool in the drawer.

Maybe because the rate is so low, they can borrow money, invest it in damned near any market, and make profit, without lifting a finger or plugging in a widget maker, which keeps demand up becuase supply stays low? Keep in mind, this, coming from someone not well versed in finance.

You'll find this interesting-----our local bank all but told us not to borrow money for anything real estate/construction. It's that bad right now.

Instead? They'll throw money at us at good rates for anything equipment. Total reversal of 20+ years of banking.

Because they have a ton of balloon maturities coming in CRE, every bank, many of which aren’t refinanceable. 25-30yr amortization with some Interest Only, valuations are going to drop because the multiplier is tethered to the 10yr UST (different types carry different spreads, multifamily and industrial are 200-300bps (2-3%) over the 10yr for capitalization rate which is the denominator to net operating income of a property to derive value, office is +400-500 as is Hotel, retail somewhere in between but more sensitive to market than most other types).

Every bank has a massive CRE issue that’s going to tie up their balance sheets for the next three years. Cant add more long duration loans. Equipment is all floating rate and self liquidating or fully amortizing over 3-7yrs mainly (some 10yr) so the loans average life is short and balance declines much faster. It’s funny I was recently asked by an advisor to help source $6mm of “let’s make a deal” priced mezzanine debt to support the refinance of a $105mm senior mortgage made 2yrs ago by Goldman on a hotel redevelopment in Chi. The new first mortgage sized to $69mm, they’re using $38mm in C-PACE and a 3yr look back provision on eligible improvements and then because of working capital and interest reserve needs there’s still a $6mm hole. And goldman is still one of the nest risk managers on the street.

It’s bad enough the various regulators out out interagency guidance recently on how to address the coming wall of term balloon maturities.

https://www.fdic.gov/news/financial-ins ... 23034a.pdf

Summary:

The Federal Deposit Insurance Corporation (FDIC), along with the Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System (Board), and National Credit Union Administration (NCUA) (collectively, the agencies), in consultation with the Federal Financial Institutions Examination Council State Liaison Committee, are issuing the interagency Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts (Statement). The Statement is a principles based resource for financial institutions to consider when engaging with borrowers experiencing financial difficulties.

Statement of Applicability: The contents of, and material referenced in, this FIL apply to all FDIC-supervised financial institutions.

Highlights:

In the third quarter of 2022, the agencies, in consultation with the state bank and credit union regulators, published for comment a proposed Policy Statement on Prudent Commercial Real Estate Loan Accommodations and Workouts.
After careful consideration of comments received, the agencies are issuing the Statement that will replace the Policy Statement on Prudent Commercial Real Estate Loan Workouts (2009 Statement) adopted by the agencies and the Federal Financial Institutions Examination Council State Liaison Committee, and the former Office of Thrift Supervision.
The Statement discusses the importance of working constructively with CRE borrowers experiencing financial difficulty and is appropriate for all supervised financial institutions engaged in CRE lending.
The Statement addresses sound principles and supervisory expectations with respect to a financial institution’s handling of loan accommodations and workouts on matters including (1) risk management, (2) classification of loans, (3) regulatory reporting, and (4) accounting considerations, and includes updated references to supervisory guidance.
The agencies recognize that prudent CRE loan accommodations and workouts are often in the best interest of both the financial institution and the borrower. Accordingly, the Statement reaffirms the key principles from the 2009 Statement: (1) financial institutions that implement prudent CRE loan accommodation and workout arrangements after performing a comprehensive review of a borrower’s financial condition will not be subject to criticism for engaging in these efforts, even if these arrangements result in modified loans that have weaknesses that result in adverse classification; and (2) modified loans to borrowers who have the ability to repay their debts according to reasonable terms will not be subject to adverse classification solely because the value of the underlying collateral has declined to an amount that is less than the outstanding loan balance.
The Statement also includes the following changes compared to the 2009 Statement: (1) addition of a new section on short-term loan accommodations; (2) information about changes in accounting principles since 2009; and (3) revisions and additions to examples of CRE loan workouts.

Fascinating. Thanks! Thanks for coloring in the shaky picture I had in my head....."they're getting beaten down by commercial property loans on offices that no one wants".

Even multifamily will have issues with over valuation and cash flows but yes office is the largest concern. But I see net negative absorption coming on industrial (new Sq Ft delivered > than leased in a period is negative absorption), retail has e-commerce issues we saw 15yrs ago coming but no one prepared for. Even Manufactured Home Communities (the nice new name for Mobile Home Parks) we’re trading at 20-22x income (4.5-5% capitalization rates) for basically land.

June update on CMBS

https://www.trepp.com/hubfs/Trepp%20Del ... a55e62943c

[Farfromgeneva]

Father in law says yes supply chain is an issue but they can and do create workarounds on that but labor is the real friction on them these days. Keep turning down a MSFT project in NC because they’re not comfortable they can staff it. And thy use exclusively IBEW Labor.

Big Tech Tenants Push Data Center Developers To Stay On Schedule As Supply Chain Woes Linger

Data center developers continue to struggle with supply chain problems, and their largest tenants are paying close attention to who has answers.

Placeholder
Persistent supply chain headaches remain a central challenge for data center developers, particularly providers focused on leasing entire facilities or campuses to big tech hyperscale tenants.

Wait times for key equipment — from generators and transformers to cooling and power systems — remain long and unpredictable. Global suppliers are struggling to keep pace as an artificial intelligence arms race drives the world’s largest data center tenants to seek ever-larger facilities on shorter development timelines.

Tech giants such as Microsoft — who have bet their futures on technologies like generative AI and are frantically trying to scale up the infrastructure to support it — have identified supply chain problems delaying new capacity as a significant risk factor that could limit their competitiveness.

Microsoft Senior Program Manager Kartik Atyam, who works on expanding the tech giant’s data center portfolio, said that Microsoft has identified this continued supply chain volatility as the most significant challenge to successfully executing the company’s digital infrastructure strategy.

“Timelines are still extending, and even if some elements are coming in faster there are others that are taking longer,” Atyam said at Bisnow’s National DICE Construction, Design and Development West summit last month. “The capacity and flow-through rate to be able to support the builds that we desire is just not there."

Data center developers and tenants at the event said these hyperscalers have begun paying much closer attention to which data center providers have the supply chain savvy to deliver capacity on time, and that those able to successfully navigate these stubbornly choppy supply chain waters will be the beneficiaries of the accelerating wave of AI-driven hyperscale demand.

“We looked at three different [requests from hyperscale tenants] we received over the last three or four weeks, and all had one thing in common: They wanted to know what is our supply chain plan, do we have our [long lead-time equipment] ordered, what is the timeline for it, and what is our risk mitigation plan in the event that we see additional delays there?” Brett Severson, vice president for real estate at data center provider Evoque Data Center Solutions, said at the DICE event, which was held at the San Jose Marriott.

“It has become a major theme," he added.

More than three years after the onset of the pandemic wreaked havoc on global supply chains, data center builders continue to face long lead times for equipment from major suppliers, and expected wait times that shift dramatically from week to week. That can mean waiting anywhere between 12 and 18 months for emergency generators, while backup power systems, switching gear, and the chillers and HVAC equipment needed to cool data centers are all looking at lead times of close to a year, industry insiders told Bisnow.

Power infrastructure like transformers and substations, increasingly the responsibility of developers instead of utilities, often has lead times measured in years, not months.

Why has this supply chain bottleneck continued to plague the data center industry?

While developers and tenants said there are a range of factors at play, most pointed to one as the most significant: Data centers are getting bigger, faster.

Placeholder
Bisnow

Microsoft's Kartik Atyam speaks at Bisnow's National DICE Construction, Design and Development - West summit in San Jose. He is joined by CloudCenters' Craig McGahey, Yondr's Éanna Murphy, Cologix' Jon Gibbs and Evoque's Brett Severson.

It is not news that data centers have been getting bigger over time. A five-megawatt data center development would have been considered a large project just four years ago, whereas hyperscalers now rarely lease buildings under 30 megawatts, with large projects in the hundreds of megawatts.

But data center experts said that the past six to eight months have seen a rapid increase in the scale of facilities that hyperscale tenants are looking for. This means more generators, more transformers and more HVAC systems — new demand that suppliers have yet to scale up to meet. At the same time, hyperscale tenants want shorter timelines for building those facilities out to full capacity, with speed to market becoming a growing priority.

“Traditionally, you were looking at projects that had longer-term ramp schedules, where they'd build out to 50 megawatts and then lease up over a 10-year period or 36 megawatts over three years on the hyperscale side of things,” said Andy Cvengros, a managing director on JLL’s data centers team. “In the past six to eight months, right now what you're seeing is really massive requirements with people looking for gigawatts of power for AI.”

Indeed, generative AI has been the driving force behind hyperscalers’ desire for greater scale and at a faster pace. Locked in an AI arms race, firms like Microsoft, Amazon Web Services, Google and Meta are scrambling to build out or lease the data center infrastructure needed to host the massive computing power these technologies require. Delays in the delivery of new data center capacity means potential delays of AI products and services that are increasingly central to the business models of the world's largest tech companies.

“We’re building for generative AI, and it’s just faster, bigger, as soon as possible and as much as possible,” Microsoft’s Atyam said. “When we’re looking at the AI space, whether it's on the inference or on the training models, wherever we can find the capacity, we're building now. If there is an open space that we think customers will come in, we're saying please move aside. We're going to build.”

With such significant risk for tenants tied to potential supply chain-driven delays, companies like Microsoft are taking an increasingly proactive approach to avoiding supply chain disruptions and ensuring the consequences of any delays that do take place are felt primarily by the data center provider.

Atyam said Microsoft is expanding teams devoted to evaluating supply chain and other development risks and is increasingly engaged with data center providers to better understand their ability to navigate supply chain issues before sitting at the negotiating table. The company also insists on contract terms for capacity under development that levies significant penalties on developers for any delay in delivery.

“When it comes to putting the onus of the risk on the lease providers, that's absolutely what we're doing: We sign a contract with the expectation of capacity at a certain date,” Atyam said. “What's really valuable to us is just getting that capacity up as soon as possible … we're definitely taking a close eye and working much more closely with our lease providers to understand what the risks are, and if they're going to push out their delivery then we're looking at other lease providers to also make up that gap. “

It’s not just Microsoft. Evoque’s Severson said multiple hyperscale tenants are increasingly focused on reducing their exposure to risk from supply chain problems and have been ramping up their due diligence on providers’ capabilities when it comes to managing disruptions.

He said data center providers need to get comfortable with this increased scrutiny if they want to capture a piece of the AI-driven demand surge that has only just begun.

“The customer is taking an active role in their risk mitigation by putting the onus on us to figure those things out, and we should be able to,” Severson said. “We’ve got to have that dialed in and we've got to have a risk mitigation plan so we can be a long-term solution that's going to be delivering on time.”

[PizzaSnake]

Weird mix: muni-bonds and privatized college housing.

“ NCCD-College Station Properties LLC failed to make a complete payment due July 1 for bonds issued to build the complex near the Texas A&M University campus in College Station, according to a regulatory filing.

The project, known as Park West, has struggled despite fast-growing enrollment at the school. While the complex boasts volleyball courts, three resort-style pools and a clubhouse, it is located in an area that’s far away from restaurants and entertainment venues.

An audit of the borrower by accounting firm Maxwell Locke & Ritter LLP last year said failure to refinance the debt or boost its revenue to meet the debt payments “could result in the company having to curtail or cease operations.”

A Texas conduit agency sold over $360 million of municipal bonds for the project on behalf of the company in 2015, and most of that is still outstanding, according to data compiled by Bloomberg. The sole member of the LLC is National Campus and Community Development Corp., a nonprofit that finances student housing projects.”

https://finance.yahoo.com/news/texas-lu ... 21758.html