The Real Rialto
The Wall Street Journal reported the other day “Lennar Is in Advanced Talks to Sell Its Real-Estate Lending unit, Rialto Capital.”
Lending unit? Really? A Greenwich, CT outfit called Stone Point Capital is reportedly interested in buying Rialto. The WSJ describes Rialto as “a real-estate investment and management company that focuses on distressed assets. It was launched in 2007, after the property market began to teeter, by Lennar and Jeffrey Krasnoff, a former Lennar executive.” End of story.
However, that’s not what Rialto is (or was) at all. Rialto Capital Advisors conducted day-to-day management and workout of 3.05 billion in loans the Federal Deposit Insurance Corporation (FDIC) received after it closed down banks during the financial crash. The RE Action Committee explained,
Lennar (Rialto) acquired indirectly 40% managing member interests in the limited liability companies created to hold the loans for approximately $243 million (net of working capital and transaction costs), including up to $5 million to be contributed by the Rialto management team. The FDIC is retaining the remaining 60% equity interest and is providing $627 million of non-recourse financing at 0% interest for 7 years. The transactions include approximately 5,500 distressed residential and commercial real estate loans from 22 failed bank receiverships.
You might call this a government give away or crony capitalism, but its not a lending unit. The FDIC did the lending at 0% for 7 years. And, the math would indicate the “partnerships” “purchased” the loans at 29 cents on the dollar.
Attorney Bryan Knight wrote an insightful piece entitled “Lennar-Rialto Incentive Analysis” in 2011.
He called the Private-Public Investment Programs (“PPIP’s”), such as Lennar/Rialto “ the biggest waste of government spending and most damaging program to the American public.”
Mr. Knight explained.
The FDIC and companies like Rialto seek to flush out all troubled assets of failed banks by immediately filing suit, refusing to work out the loan and refusing to agree to a payment plan that benefits all parties. This uncompromising and litigious strategy is implemented by Rialto because it produces the most money for them...
A number of my ex-borrowers were forced to deal with Rialto and I know what Mr. Knight claims is true. What follows is the rest of his analysis.
There is an inherent conflict of interest between Lennar/Rialto and their duties to collect on loans of failed banks. First, Lennar/Rialto are paid asset management fees based on the amount of assets under management, which provides incentive for them to either do nothing or sue, rather than work out a settlement with the borrower. If a settlement if achieved, Lennar/Rialto do not get paid management fees.
Second, Rialto was given a $600 Million interest free non recourse loan by the Federal Government to purchase assets of failed banks. Therefore, Rialto has no risk in collecting on assets because no interest is accruing and Rialto is not liable to pay back the loan since the loan is a non-recourse. This gives Rialto even more incentive to refuse loan workouts and to collect asset management fees. It is not rocket science, a bank that has risk of taking a loss is more likely work with a borrower. Here Rialto has no risk.
Typically when a bank fails the FDIC allows other banks to bid on the assets. The winning bank then enters into a Loss-Share Agreement where the FDIC agrees to pay 85% of any losses the bank takes on the assets.
This structure gives the bank incentive to work out a loan and entertain settlement because they have the potential for a 15% loss. This is how the first of the failed banks were handled by the FDIC. The PPIP program stemmed from the onslaught of bank failures. Unlike the loss-share agreements, PPIPs like Rialto have no risk of a loss due to the interest free non-recourse loan, giving them no incentive to compromise.
Third, Rialto is paid at least 60% of its attorneys’ fees and sometimes 100%. Given the fact that Rialto will incur little to no attorneys’ fees motivates Rialto to sue first and ask questions later because instituting litigation keeps the assets under management for years. Even if Rialto is required to pay a portion of their attorneys’ fees, it is paid by the Federal Government’s $680 Million dollar interest free, non-recourse loan.
Inequitable federal laws provide the FDIC and Rialto with additional leverage against borrowers because almost all defenses and counterclaims are precluded by D’Oench Duhme Doctrine and the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIERREA”). The D’Oench Duhme doctrine stems from D’Oench, Duhme & Co. v. FDIC, 315 U.S. 447, 459 (1942), which is a product of the Great Depression and the creation of the FDIC.
This case sought to invalidate secret agreements between borrowers and a failed bank.
The purpose of the D’Oench Duhme doctrine is to provide the FDIC with notice of any loan modifications or variances from loan documents. D’Oench Duhme prohibits any claim or defense against a predecessor bank or the FDIC unless it is: (1) in writing, (2) executed by the bank, (3) approved by the board of directors of the bank and (4) the writing was maintained as an official record of the bank. Porras v. Petroplex Sav. Ass’n, 903 F.2d 379 (5th Cir. 1990).
This doctrine precludes all claims and defenses against the bank or FDIC that don’t meet all four elements, which include verbal loan extensions, modifications and payment modifications, fraudulent representations by the bank and negligent lending practices.
For instance, if a bank tells a borrower that their loan will be extended, modified or that lesser payments will be allowable and then the bank is taken over by the FDIC, the borrower cannot enforce these representations.
An even more egregious example is if a bank induces a borrower to enter into an acquisition and development loan with the promise that the bank will provide a construction loan and later refuses, the borrower is stuck with the loan and cannot claim damages resulting from the fraudulent representation.
During the Savings and Loan crisis of the 1980′s Congress passed FIERREA to provide powers and procedures for the FDIC to follow, See 12 U.S.C. 1821.
One procedural hurdle, codified by 12 USC 1821(d), requires a borrower to file any claim against a predecessor bank or the FDIC within 90 days of the FDIC taking over the predecessor bank, even though the FDIC does not have to give notice of this requirement. See FDIC v. Vernon Real Estate Invs., Ltd, 798 F. Supp. 1009, 1017 (S.D.N.Y. 1992); McCarthy v. FDIC, 348 F.3d 1075 (2003).
If the borrower fails to make a claim with the FDIC within 90 days of take over, all claims are waived. Here, there are due process concerns since the FDIC does not even have to give notice of this procedure.
Most citizens are not aware of FIERREA and almost always waive their claims.
D’Oench Duhme solely affects those borrowers that have trusted relations with their banks, such that would not require written modifications or documentation for payment adjustments. Most banks that have been taken over by the FDIC are small community banks that tend to have this precise relationship with their clients.
FIERREA wipes out a borrower's ability to make any kind of claim even if it is in writing sufficient to pass D’Oench Duhme. Everyday citizens cannot be expected to know about this 90 day deadline. The FDIC at the very least should be responsible for sending notice of the claims deadline.
These two legal doctrines have in essence invalided hundreds of years of legal precedent concerning contract and tort law, which gives Lennar/Rialto tremendous leverage against borrowers, because borrowers are stripped of any defense or counterclaim and left to the mercy of Lennar/Rialto who take full advantage of this power.
The big picture is that no one could have foreseen the real estate crash or this financial crisis, which is why the federal government bailed out the big banks that were too big to fail. However, the everyday citizen has received no semblance of help, but instead has been forced to bare the brunt of these negligent lending practices.
Rather than give Rialto $600 Million in interest free loans and millions in asset management fees, the federal government should put that money into programs to help workout these loans to keep citizens from financial ruin and businesses from closing, similar to Obama’s mortgage laws.
So, this is what Lennar is selling--a company at the center of a dark chapter in America’s financial history that very few people know anything about.