Archives for August 2021

As of July, cannabis is legal to grow, possess and use recreationally in New Mexico.

However, the drug is still illegal at the federal level, which means that getting access to bank accounts, loans and other financial resources remains a hurdle for the growers and manufacturers expected to fuel the state’s new recreational market.

While a few New Mexico banks and credit unions have dipped a toe into the industry, many have opted to steer clear until federal reform comes, leaving cannabis dispensaries, manufacturing operations and other businesses operating in the industry with limited options.

“When you start a business, the very first thing you do (is) file your incorporation papers and you open a bank account,” said Ben Lewinger, executive director of the New Mexico Cannabis Chamber of Commerce. “It’s so fundamental to everything that a business needs to be able to do.”

Lewinger said the limited access keeps growers without other sources of startup capital out of the recreational and medical industries, and makes life harder for those already operating.

Those banks and credit unions that have ventured into working with cannabis companies are reaping the benefits of capitalizing on a sector that many of their peers won’t touch, but they acknowledged that it takes a lot of time, money and work to do it safely and securely.

“You’re either all-in or you’re not in,” said Lonnie Talbert, president and chief operating officer of Southwest Capital Bank in Albuquerque, which currently works with around 100 companies in the cannabis industry. “It’s an expensive proposition.”

Large banks pass on industry

Without substantial reform at the federal level, don’t expect to see large financial institutions like Wells Fargo or Bank of America dive into working with cannabis companies any time soon.

Chris Moya, executive vice president of the Independent Community Bankers Association of New Mexico, said large, multinational banks are regulated by the federal government, where cannabis remains illegal.

At the state level, Moya said the path is a bit murkier. Moya said New Mexico community banks are jointly regulated by state and federal regulators. In 2013, U.S. Deputy Attorney General James Cole wrote a document, known colloquially as the Cole Memo, guiding federal enforcement in states where cannabis is legal. The document, and associated guidance from the financial sector, instructs banks looking to operate in that industry to invest heavily in security against money laundering and other violations of the Bank Secrecy Act.

Moya said the effort it takes to implement those security measures have caused a lot of local banks to think twice.

“It’s not that they don’t want to serve that market,” Moya said. “It really comes down to the regulatory burden and regulatory cost to even operate in that space.”

Marsha Majors, president and CEO of U.S. Eagle Federal Credit Union, which launched a stand-alone cannabis banking program in 2019, said not having

access to a bank account forces dispensaries to deal in cash, which can make them a target for criminal activity.

“It’s about keeping our community safe, and having these funds on the street does not add to a safer community,” Majors said.

Majors added that having an account at a financial institution can also help companies protect themselves against audits by maintaining compliant banking records. Moreover, Lewinger said the current system also makes it difficult for prospective business owners to apply for loans or other funding mechanisms to get their operation off the ground.

This, in turn, can keep New Mexicans with limited financial resources, including those who have been working in the illicit cannabis market, out of the newly legal industry, Lewinger said.

The effects could be particularly hard on growers operating under so-called micro-licenses, which cap product and cost at lower rates.

“Access to capital is the single biggest challenge that new businesses, particularly micro-licenses are going to face in New Mexico,” he said.

What have banks done

Both Majors and Talbert said their respective companies have not taken a position on whether cannabis should be legalized federally, but acknowledged that working with cannabis companies is a valuable niche for them.

Talbert, a former Bernalillo County Commissioner, said Southwest Capital Bank began looking at offering banking services to cannabis businesses serving the medical market in 2014 ahead of a planned expansion of the medical plant count.

The bank, which recently sponsored the N.M. Cannabis Legalization Conference at the Albuquerque Convention Center, determined that there was demand for banking services in the industry that other banks couldn’t or wouldn’t meet.

“There are so many banks that don’t want to be involved in any sort of risky activity,” Talbert said.

Today, cannabis customers at Southwest Capital can access bank accounts with the same services as any other small business, but with an extra layer of due diligence.

The bank added new tellers to handle the cash coming in from the industry, brought in new backroom employees who could help the bank stop money laundering and enforce other provisions of the Bank Secrecy Act. Talbert added that Southwest Capital invested in technology that could help it monitor and track businesses to make sure they’re complying with state and local regulations.

Talbert acknowledged that the program has been expensive to undertake, and said the bank has been hit with two orders from state and federal regulators stipulating that the bank must make changes, one of which he said was explicitly linked to cannabis. Talbert said the bank was able to satisfy the terms of the order that was linked to cannabis, and it has since been terminated, per the Federal Deposit Insurance Corp.

Still, he said the bank’s work with the cannabis industry has been met with an “overwhelmingly positive” response from customers.

“We felt that the opportunity that it presented to us, economically and obviously community-wise, safety and security-wise … made a lot of sense,” Talbert said.

On the credit union side, U.S. Eagle opted to make its cannabis banking program a stand-alone program known as Aery Group.

Majors said the credit union opted to make Aery Group a separate unit, with its own physical office space, to ensure the cannabis businesses they work with have a core group of staff to talk with, and to let regulators know that the program would not disrupt the rest of U.S. Eagle’s business operations. At the time ​it was established in 2019, Majors said the cannabis industry was “not as acceptable in our state as it is today.”

Majors estimated that setting up the program cost between $500,000 and $750,000, factoring in the cost to hire and train new employees. Aery Group currently employs four subject-matter experts who know the industry and the compliance protocols that go with it.

“We devoted a lot of time to making sure that our team is fully invested, fully trained and fully up to speed on what was required to ensure our success,” Majors said.

Additionally, Majors said Aery Group puts potential cannabis businesses through a rigorous vetting process, which includes a questionnaire along with extensive documentation on the background of the applicant.

Dan Mayfield, vice president of government affairs for the Credit Union Association of New Mexico, said in an email that Aery Group licensed the program from Safe Harbor Financial, a Colorado-based financial institution that helped pioneer modern cannabis banking. Majors added that the company has rejected applicants when issues turned up during the vetting process.

Once a customer is approved, Majors said they have access to “99%” of the services that a normal small business would get, including income validation and deposit insurance up to $250,000.

What’s next?

Now that cannabis is legal for recreational use in New Mexico, both financial institutions expect to expand their programs significantly to meet demand. Majors said Aery has seen an “onslaught of inquiries” since this spring. Aery had 18 accounts open as of June, and Majors said the company expects at least 50 open accounts by the end of the year, from across the cannabis industry.

Talbert added that he expects the recreational industry to be even more cash-intensive than the medical side, and the bank plans to expand its compliance programs to keep up.

“For us, it’s an opportunity for us to grow our customer base,” Talbert said.

As more states legalize cannabis, support is growing for substantial banking reform at the federal level.

One bill, the SAFE Banking Act, would prevent federal regulators from penalizing financial institutions for serving a legitimate business in the cannabis industry and ensures that they won’t be held liable for providing business loans, among other changes.

Moya, whose organization has endorsed the bill, said its passage would remove uncertainty and could help remove some of the regulatory burden for banks, encouraging more of them to move into the space.

Lewinger said he believes the bill could reach President Joe Biden’s desk by the end of the year. He added that making business loans a possibility could go a long way toward helping New Mexico’s burgeoning cannabis industry become more equitable down the road.

“I think there are a ton of people who just wouldn’t even consider the cannabis industry without it,” Lewinger said.

Source: “Recreational Cannabis Is Almost Here: Where Should The Stores Put Their Money?“

More owners have been able to catch up delinquent loans, which has short circuited predictions of a massive pandemic-induced distressed real estate cycle.

Mortgage delinquency rates, which have been a bellwether of distress in the commercial real estate sector during the pandemic, are continuing to improve. One area of concern, however, is that elevated levels of delinquencies in the lodging and retail sectors are expected to linger as troubled loans slowly work toward resolutions, with some defaults expected.

All property types saw slight improvement in delinquencies with the overall rate improving by 30 basis points in July to 95.5 percent, according to the MBA’s CREF Loan Performance survey. Lodging and retail property loans continue to experience the highest levels of stress. Lodging delinquencies improved from 17.6 percent in June to 16.5 percent in July, while retail loan delinquencies dropped from 10.0 to 9.0 percent. CMBS loan delinquencies also are higher than other capital sources at 8.2 percent.

Related: Finding Good Real Estate Deals Among the Ruins

There are still a lot of “what ifs” that will influence how the amount of distress in commercial real estate will play out. Some believe that distress has peaked and is gradually being worked out. Others think there could be more flare-ups of distress ahead in certain pockets, especially once forbearance and government stimulus disappears. The Delta COVID-19 variant is another wildcard that could significantly weigh on the economic recovery and stall returning momentum within property sectors, notably lodging and even offices as rising cases are causing many companies to delay return-to-office plans

Despite all of this, the massive wave of distress that some had predicted at the beginning of the pandemic has not materialized. For example, last December CoStar released data from its predictive modelling that projected 16 different scenarios for the volume of distressed asset sales that could potentially occur over the next five years based on different assumptions. Models ranged from a high of $659 billion to a low of $134 billion with a median topping out at about $321 billion. CoStar has since pulled back from those models, in large part because there are so many unique variables in the current market that are influencing the outcome of troubled loans. In addition, some downside assumptions included in the models never materialized.

Related: CMBS Borrowers Face Refinancing Challenges

“There are still a lot of uncertainties to monitor, but my new expectation is that the distressed loan volume will be dramatically reduced if we can keep the recovery speed that we have right now,” says Xiaojing Li, managing director Risk Analytics at CoStar.

There are a number of factors why the distress is less severe and steps to resolve loans have been more effective. The government stimulus and forbearance have played a big role in curbing distress. In addition, properties across the board are generally carrying lower leverage debt and pre-pandemic underwriting on valuations was sound, which puts borrowers in a better position for recovery.

A path forward for troubled loans

There are different solutions for troubled loans. In some cases, a borrower simply needs more time and continued recovery to move that loan back to performing. Another option is to bring in new equity and/or restructure the loan. The third route is for that troubled loan to be liquidated through a discounted payoff or foreclosure and REO or note sale.

Historic stimulus programs along with lender forbearance and moratoriums on litigation have given borrowers more time to resolve distressed situations. “We’ve seen the majority of lenders choosing to delay decisions over the last 18 months simply because they could afford to wait,” says Patrick Arangio, vice chairman of the national loan and portfolio sale advisory practice at CBRE.

At the same time, abundant liquidity coupled with the prolonged low interest rate environment is also affording borrowers more options. “There is a historically significant volume of capital earmarked for investment by institutions that are specifically targeting opportunistic investing through loan sales, distressed real estate sales, recapitalizations, etcetera,” says Arangio. “That level of liquidity, in combination with this interest rate environment, limits the volume of distressed product. As such, we have seen, and continue to see, a pronounced supply versus demand imbalance.”

That capital is circling troubled lodging and retail in hopes of capturing some opportunistic deals. Hotels were very much “risk-off” during the height of the pandemic, notes Arangio. “In the last three quarters we have seen a significant influx of both debt and equity capital with the express goal of investing in hospitality,” he says. “We expected that it would happen, but the speed and scale of the return to the sector has been notable.” The overarching caveat is that there is a flight to quality. The pool of interested bidders on distressed hotel loans tends to be smaller for full-service hotels dependent on group bookings and convention business, as well as older capital-intensive hotels, those with ground leases and hotels with unionized labor. “That said, we continue to see very active participation for any opportunistic transactions,” he adds.

Retail is facing vastly different challenges as the sector was impacted by the pandemic, as well as underlying issues related to increased competition from e-commerce and changing consumer behavior. The distress that has emerged is concentrated in high street retail in major CBDs and class-B regional malls. “We’re anticipating that it is going to take longer for some of the high street retail to recover, and frankly, some of the B and C malls may never recover,” says Jack Howard, executive vice president in the National Loan & Portfolio Sale Advisory practice at CBRE. So, there is likely to be more troubled loans ahead for B and C malls, he notes.

Deep discounts remain rare

Delinquencies in lodging and retail could remain elevated for some time. For a property to fully move through the process of delinquency to foreclosure, REO and an eventual sale it can take up to three years, notes Li. “In this case, I think it will take longer because of the level of forbearance that will further delay some of the resolutions,” she says. The additional time, whether it is from forbearance or lenders willing to be patient, could end up benefitting borrowers, because it will give borrowers more time to recover, she adds.

CoStar conducted a historical comparison of troubled loans following the Great Financial Crisis in 2009-10 and the COVID-19 downturn in 2020. The results show that 35 percent of the CMBS loans that became delinquent 12 months after the financial crisis were liquidated, either resolved through note sales or REO property sales. At month 24, the percentage of delinquent loans that were liquidated rose to 54 percent. The same analysis of troubled loans that occurred following the COVID-19 downturn shows very different results. Only 5 percent of delinquent CMBS loans were liquidated at month 12. It remains to be seen how much those numbers might rise by month 24. However, the early data shows a dramatically different scenario to date, notes Li. Li expects the percentage of liquidated loans to remain muted, likely staying below 10 percent.

In addition, the deep discounts that many investors had hoped for on distressed REO and note sales have not materialized to a significant extent. Although there have been anecdotal examples of deeply discounted loan sales, the majority of values have held up fairly well. Limited service hotels are one sector that bounced back very quickly. For example, CBRE recently had bids north of 95 percent of the outstanding principal balance on the sale of a non-performing limited service hotel loan. “So, you could argue that some of the distressed product isn’t trading at distressed pricing,” says Howard.

Values have held up in large part from simple supply and demand fundamentals. The amount of capital raised for opportunistic investments far outweighs the volume of distressed assets that have emerged. “We are seeing record participation in loan sales which reflects the amount of capital that has been raised and continues to support loan values,” adds Howard.

Source: “Commercial Real Estate Mortgage Delinquencies Continue to Decline”