Roundtable experts look up from the bottom

The Northern Colorado Business Report editorial staff convened its annual roundtable of industry experts to discuss their outlook on the coming year in the Northern Colorado economy. This year’s participants included Marc Arnusch, Weld County farmer and former board member of the Weld County Farm Bureau; Cory Carroll, M.D., Fort Collins family physician and past president of the Larimer County Medical Society; Rick Hausman with Benchmark Realty and treasurer of the Fort Collins Board of Realtors; Steve Kawulok, broker manager of Sperry Van Ness/The Group Commercial Inc.; Darrell McAllister, president of Bank of Choice; and Kelly Peters, chief operations office for the Rocky Mountain Innovation Initiative.

The 2010 Economic Roundtable took place in the community room of First Western Bank and Trust in Fort Collins on Dec. 10, 2009.

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KATE HAWTHORNE: So, how was 2009 in the banking industry?

DARRELL McALLISTER: I’ve got almost 30 years of history in the industry around the area, and 2009 probably will go down as the worst year, I think, in banking that we have seen. It sounds pessimistic, but that’s probably the reality of it. The majority of the banks are working very diligently on their troubled assets and will probably continue to do that into 2010.

KRISTEN TATTI: And how does that impact everyone’s industry here?

McALLISTER: The real estate industry is probably the largest impact. We’ve got probably – just not in Northern Colorado, but in Colorado and nationally – ahead of ourselves in real estate. So you’re basically slowing down, not doing as much, waiting for the demand to finally catch up with the supply that was out there. Medical, I’m guessing, is not hurting as much. Agriculture, you probably still find credit available. The New Frontier Bank situation took a lot of agricultural credit out, but I think that was more in the dairy industry. But I think good ag production today can still find money. The manufacturing industry today, many banks, including ours, are very restrictive on how we’ll lend, but all of us, as bankers, are looking for loans to do in that area. Most banks in the area are probably saying they would like to reduce their loan portfolios in the commercial real estate area. I know we will actually entertain, and would like to entertain, commercial industrial loans, and and we’ll look at commercial real estate owner-occupied buildings, but if it’s commercial real estate, non-owner occupied, and construction loans, it’s very difficult credit to approve at this time.

STEVE KAWULOK: The lack of liquidity is repeatedly cited by my commercial real estate industry peers as the No. 1 obstacle to getting any activity going. What’s happened in this last 12 to 18 months is people are just trying to figure out how to bring liquidity to the market, and it really requires a lot of creativity. As Darrell also mentioned, the owner-occupied deals are still finding ways to get done. There’s SBA financing available, and that’s been actually a lot of the most attractive financing. Outside of that, though, you’re looking at either seller-finance, or for troubled or distressed assets you sometimes get some financing, depending on the scenario, or for very, very strong borrowers, cash deals. So that’s very much restricted the number of transactions. They’ve fallen dramatically from just a few years ago.

MARC ARNUSCH: One year ago, many of us in agriculture thought we would be immune to the capital credit issues faced by Wall Street. Today, I would suggest that no one is immune to those blows. And as Darrell has mentioned, with the fallout from the New Frontier closure, especially those producers in Weld County will be faced with a credit crunch that they’ve never witnessed before. Many hard-working, honest farmers and ranchers will go out of business this year because they will not be able to access credit, and those that remain in the industry will be required to provide more information about their operation than ever before. And it’s an attempt for the lender to assess risk. I appreciate what Darrell had to say, certainly, about there is money to lend to those operations that have their fiscal house in order; however, I don’t think the average farmer is yet aware of what he’ll have to provide as 2010 begins. I really believe that the fallout from New Frontier Bank, at least in the agricultural industry, has yet to be felt.

CORY CARROLL: From the medical perspective, I agree with Darrell’s comment; I don’t think it’s taken a big crunch. But as a family physician, for the primary care folks, we’ve had difficulties for years. And I think this last year has just kind of nailed it. In Fort Collins, the number is approaching 17 or 18 primary care physicians that have dropped their practices or left town. And I think last year’s change of the economic system has just made (continuing in practice) much, much more difficult. The other concern for physicians in general, but mainly primary care, is that we have restrictions in how we can raise capital. (By law) we cannot go out and seek investment for our individual practices. The hospitals can, so a physician can join a hospital, and they can go raise investment. So if a primary care doctor wants to expand their clinic, they have to go to the bank and get a loan, and that’s not happening. So a lot of docs trying to expand their clinics are finding it tough to get capital and money.

TATTI: Have you heard much, Kelly, from the people you work with on the technology side, about their access to capital?

KELLY PETERS: The people I work with are high-growth startups, and debt financing is typically not at all an option. So you would think they’d be insulated from the crisis; however, angel investors and venture capital financing is also extremely hard to find right now. So they’re impacted, but not for debt financing.

TATTI: Just the overall credit market?

PETERS: Right. Larger technology firms feel it, because their suppliers cannot get the financing that they need. But these high-growth startups that I’m dealing with, it’s a different topic.

TATTI: Residential?

RICK HAUSMAN: Well, I think we probably had, in the past, too easy access to liquidity and money. I think the pendulum has swung the other way. Well-qualified, owner-occupant buyers still probably don’t have much trouble getting the money. They have to provide more information to do so, and that may be good, in some situations, versus where we were. A lot of the private banking options for first-time, high-leverage properties are gone, so there’s a lot higher percentage of FHA or VA financing happening on those first-time homebuyer transactions versus several years ago. In terms of investment property and construction, just like on the commercial side, that’s a lot harder than it was years ago, but the qualified owner-occupied borrowers can still find money.

TATTI: What about on the inventory side of residential? Are you seeing that eaten up, or are we still having some oversupply?

HAUSMAN: I think that’s one of the benefits of this area – our inventory is, relatively speaking, a lot more balanced and has been decreasing. Unfortunately, demand has been decreasing faster. But there’s various markets, like Las Vegas, where demand’s been decreasing and inventory’s been increasing. With the first-time homebuyer tax credit and access to capital, the inventory on the lower end of our market is a lot more balanced, or even closer to favoring the seller than the upper end of the market. Within that price range is where the demand’s coming from right now.

TATTI: So maybe some good news there?

HAUSMAN: Yeah. I definitely think that, if you were the seller of a single-family home, below the median price, this past six months hasn’t been all bad news for you. If you were selling a home at double, triple the median price, it may be a waiting game.

PETERS: Rick, what is the median price now?

HAUSMAN: Well, the number I’ve been using in the past year for the Fort Collins, Loveland, Windsor area is $250,000. That’s not the real number, but it’s been helpful for me to educate buyers because for single-family homes below that, the time on market toward the end of the summer in Fort Collins was probably three months or under three months, which is pretty healthy. If you double that (price), you’re well over a year (on the market), and up to 10 years, for just current demand versus the number of homes that sell for over a million. So that number is very useful, more so than it is accurate. But our average and median price have gone down, not so much because homes are losing value, but the number of homes selling on the lower end is greater.

TATTI: You said you think a lot of that has to do with the first-time homebuyer tax credit?

HAUSMAN: That, and to get a jumbo loan is a lot more difficult. And with people’s assets in other areas being decreased, the amount of activity in the higher price range seems to be slower. You know, people who may be able to buy a million-dollar home may decide they don’t want to, because they’re uncertain of what their income’s going be next year. For people buying on the lower end, the cost to rent versus to buy, the difference isn’t as great.

TATTI: I imagine each industry is facing changes in the regulatory landscape, impacts from stimulus funding, and I think it would be interesting to hear from each of you what those impacts are, if they’re positive or negative, and what are the most either troublesome or positive.

HAWTHORNE: I think we should hear what’s going to happen with health care.

CARROLL: A summary of the national scene?

STEVE PORTER: National is such a moving target right now. It’s hard to talk about.

CARROLL: It’s beyond moving. I think the health-care dilemma is behind not everything but a significant amount of what we’re seeing now. The costs that occur, and the number of people that are involved, and how it’s affecting our population is huge. Obviously, the fact that we need to reform it is there, and that’s what we’re hearing in Washington. I think we have to reform this system, but I think the potential of Washington coming out with something that will actually fix the system is not reasonable. It’s not gonna happen. I do think it’s a step in the right direction that we’re dealing with it, and as many things that are going to occur, it’ll kind of have to go through a lot of turbulence before we kind of settle on anything.

From the state level, everybody is waiting to see what Washington is going to do. My hope is that there will be some initiatives that will allow states to do some experimentation with the system. We have lots of restrictions, ERISA and other things, that decrease the ability for states to try different experiments in health care. I hope that part of this package will include a provision that will allow states to experiment, whether they want to go to a single-payer model or different other things. I think if that comes out of Washington, that’s going to be very beneficial. And then hopefully what we can see is some states find which systems are actually working better, and I think that’s going to be how health care will evolve in the next decade or so.

KAWULOK: This wait-and-see element in health care, we’ve seen it in commercial real estate. Private practitioners are just not expanding, they’re not moving, they’re staying put, so we’ve seen good medical space stay on the market for 18 months now without being filled, and that’s very unusual for our area. And outside of the activity centered around the hospitals – MCR and Poudre and Banner – from what we see, the private independent docs just do not feel they can make business decisions right now, given the state of health-care reform, perhaps, and also, perhaps, because their patients aren’t able to pay them. And so, if anything, they’re talking to us about consolidation, not expanding the practice. And they’re looking to dramatically lower their costs, because they’re concerned about what’s happening in the future.

PETERS: Health-care reform directly impacts job creation, as well, in stymieing innovation, because a person would rather stay and keep their day job at Intel versus go out and launch their business and create more net new jobs. So I definitely believe that health-care reform is critical for entrepreneurship and further job creation.

CARROLL: The real dilemma is that, even with insurance, 75 percent of bankruptcies occur in people that have insurance. I agree, if we had a system that was fair and equitable, it would inject our economy with huge amounts of capacity. I think we’d see lots of people branching out. My humble opinion is, if we don’t control costs in health care, no matter what we do, it’s failed. And I think the medical community needs to step to the table and really start solving some of these problems ourselves. We have to try to improve our quality, decrease the excessive costs. I think that’s happening in little pockets. In Grand Junction, they have a very good system with the Rocky Mountain HMO that basically worked to put all of the patients in that region into one system, and they have lowered the costs, and they delivered the care. There’s entities out there that’s doing a very good job. We just have to figure out a way of putting that to the rest of the community.

PETERS: But there is an issue of going from a group plan to an individual plan and a huge leap in costs there. Leaving from insurance in a group or a larger firm to go to start a new one, it’s just unaffordable.

ARNUSCH: That’s exactly what agriculture, for the most part, is facing: being able to afford a reasonable health insurance policy that doesn’t have a deductible that’s $5,000 or $10,000. Especially here in Colorado, where the average age of our producers is over 60, the health-care debate very much is being watched by most farmers and ranchers. The other issue, and maybe it was more of a promise by Washington, is that access to affordable and quality health care for rural areas was going to be a focus. In my mind, I haven’t seen that yet. For myself, I live 35 miles northeast of Denver. I can access some pretty good hospitals and clinics if I need to, but some of the producers that live two and three hours away from our Front Range are struggling even with simple procedures such as X-rays, throat cultures and blood tests. And so I see this issue about affordable health care really resonating within the agricultural community. If we can’t retain the quality individuals within agriculture, we’re going to stand to lose a lot of proprietary knowledge, background and work ethic. And so it’s just what Kelly talked about, if we can’t start to provide good, reasonable insurance that can be affordable as individuals, how are we going to begin to provide them for our employees too?

TATTI: Sounds like the health-care question kind of spreads across a lot of industries. Are there any other legislative issues, Kelly, that you have seen recently, or are keeping an eye on? Or how has the stimulus even impacted what you are doing?

PETERS: Well, right now I’m watching the SBIR, STTR grants, and making sure that those stay on the table, because our companies – there are 18 in the incubator currently – all of them are writing grants right now. But as far as the Recovery Act, every researcher I know, especially earlier in 2009, wrote grants to solicit some of that money. So it’s been a very good thing for the research community. And on a positive note, the angel tax credit legislation did pass (in the Colorado legislature). That’s going to allow, starting in January, over two years of 30 percent tax credit to people investing in startups in a technology space. So that’s a very big positive.

KAWULOK: Commercial real estate has a lot of concern about tax policy coming up in two areas in particular: One is called carried interest, and that affects commercial real estate because a lot of commercial real estate is done through partnerships. The sponsor of that partnership, which is usually the point person who takes equity interest – basically it’s sweat equity from putting the deal together and managing it and executing it – that interest would be taxed not at a capital gains rate, but at twice that rate or more, based on personal income tax rate. Most of the commercial real estate that you see around town has partnership elements, and that would stymie the lead partner whose reward for their hard work and sponsorship is usually a piece of the equity. If they’re going to be taxed at double the rate they anticipated, they won’t like that.

The other is, indeed, capital gains. Capital gains is the tax on a gain of a property when you sell it, compared to your cost base, so the difference, the profit you may make, gets taxed right now, at a 15 percent rate. The industry seems to be able to work with that, but there’s a lot of concern that, as Washington looks to find new sources of tax income to offset all the stimulus, capital gains (tax rate) could even double. And that, again, puts a damper on an industry that’s pretty down right now.

HAWTHORNE: Darrell, do you think some of the regulation that’s been going on in the banking industry has gone too far?

McALLISTER: That’s a tough one. You know, bank regulation has been there for years, and it’s been fairly extensive. A little bit of the regulation issue that’s happening with banking is more of an overreaction to investment bankers. Most of your Main Street banks, which is what everybody around here pretty much deals with, are fairly well regulated, and lots of changes in those regulations are probably not needed to effectively control and administer the local banks. I do believe that the administration has found out they have no control at all over the much larger, too-big-to-fail banks and the investment bankers, so they are looking at some changes there to figure out how to try to control that. As a Main Street bank, we’re a little concerned that some of the things proposed would be pretty negative to us, and maybe detrimental with one regulatory agency, the Consumer Protection Act pieces.

ARNUSCH: Darrell, I guess my question would be for those who are asking for additional regulations within the banking industry. How do you compare it to what took place at New Frontier Bank and maybe some of the proclaimed mismanagement? What do you say to those who are asking for this regulation when you say that regulation really doesn’t need to increase?

McALLISTER: To diplomatically answer that, if regulation is properly watched over, I would probably suggest that maybe New Frontier Bank wouldn’t have happened to the level it did. I think the regulators get a little less active in how they oversee a bank in a good economy. But when a bank is growing at over $500 million in a year, they consider that a high-risk situation. And to have not taken steps to slow that growth and some of those issues down sooner would be a question, in my mind, as to why that didn’t happen. But that happened for two years in a row. I know if any bank grows over 7 percent in a year, it comes up on their radar, and they usually have a pretty close look. Especially on Main Street banks, which even though New Frontier had $2.2 billion (in assets) would still be considered a Main Street bank, those rules and regulations are there in order to be able to supervise that properly. But it still takes somebody actually administering those rules and regulations.

TATTI: Did you want to comment on any legislative issues that agriculture is seeing?

ARNUSCH: There are a number of legislative issues that affect us at the state level, where we are going to try to defend what we have now instead of trying to ask for more. I think the two main ones that I’d like to talk about are more of a national debate. One is cap-and-trade legislation or the climate-change discussion. That type of legislation, if fully implemented, would devastate agriculture from an energy-use standpoint. Agriculture consumes a lot of energy, and not just fossil fuels and electricity, but also a lot of chemistries in agriculture that are dependent upon energy. It’s really a double-edged sword. In one respect, we could see costs escalate anywhere from 20 to 70 percent. But by the same token, we could also benefit from that type of legislation in being paid for many of the operations we do already, through carbon sequestration, capturing much of that carbon and putting it back into the earth through the plants that we grow and the practices that we follow. So much of this is a blind faith in Washington, and as a producer, I’m very skeptical of any legislation that would offset this potential devastation through energy costs. But what I see is that cap-and-trade legislation caps our opportunities, our ability to grow, and it caps our ability to produce the food, fiber and fuel for this nation. And so that certainly is one of our biggest concerns.

The second is we have a lot of those that are not associated with animal agriculture trying to preach to producers how to humanely treat our animals. And recently the Humane Society of the United States was effective in banning, over a period of time, gestation crates and other practices that we use in the state of Colorado, because they’ve viewed it as being inhumane. The fact of the matter is we do those things with our animals to protect them, to keep their safety at a highest level, and to keep their health stable. In the state of Ohio, they recently, on a ballot measure, overwhelmingly approved an advisory board that will develop the mass management practices for livestock producers in Ohio, where all of those industry partners and experts can come together and develop what we would perceive as humane treatment of animals, where all voices can be heard, and standards for the industry can be developed. And I believe that’s a very proactive approach to trying to mitigate some of the concerns, while also providing for a profitable and equitable treatment of the animals.

HAWTHORNE: That sounds like what Dr. Carroll was talking about, the industry, itself, getting out in front of some of the issues. Do you think that’s going to be something that might be happening throughout the economy in the next year?

KAWULOK: Oh, it is right now, especially around the banking industry, and how that affects our industry and so forth. After a couple years of very challenging times, our industry is trying to get out in front and dialogue with legislators and other people in the industry. There’s something called the Real Estate Roundtable, which does exactly that: It brings voices from all aspects of the industry together so that we have a unified voice. And they have been testifying in front of Congress as these stimulus plans are debated and so forth. So they’ve very much taken a seat at the table.

Commercial real estate has some huge challenges still ahead of it. There’s a trillion dollars of loans that are coming up for renewal in the next few years, and there’s not a trillion dollars of liquidity in the system to refinance those loans. The Promenade Shops (at Centerra), for example, that’s part of the issue of not finding a refinance person to come in and refinance that loan. Boy, the only solution is to really proactively approach it, because after a couple years of not having solutions, I think the survivors in this industry realize they have to get very active and figure out some solutions.

HAWTHORNE: You mentioned the Promenade Shops (which entered the first phase of foreclosure proceedings in November). What does that situation do to the rest of the market?

KAWULOK: Well, I think it’s kind of a symbol. It doesn’t directly affect others, but people watch that, because it’s very public. What’s happening, and has happened already locally, is there’s a repricing of real estate assets, and so the question is, when you have to reprice the asset to today’s market, who takes the loss? So it’s quite a chess game to find out who’s going to do that. What seems to be happening this time around is that the lenders are the ones taking the haircut. In the past, when the savings-and-loan crisis occurred, the federal government more or less stepped in with the RTC and created what some people call a toxic-asset bank. But this time around, it appears that the lenders are the ones that are taking it in the shorts. In some cases, the borrowers have some good negotiating power, because it’s a question of either you work with us or you go ahead and take the asset back. And the lenders who take the asset back, nationally, we’re finding they get about a 60 percent recovery rate. So if they take the asset back, they’re probably looking at a 40-cents-on-the-dollar loss by the time they ultimately dispose of the asset. While some situations just occur because there’s no liquidity to replace the old liquidity, no capital out there, there’s also a lot of negotiating going on to find out who’s going to absorb the ultimate repricing of the asset.

HAWTHORNE: And I take it that will be continuing through the new year?

KAWULOK: Oh, it’s happening locally in a lot of cases. We’ve already dealt with about half a dozen distressed or troubled assets, either through short-sale mechanisms or through the lender taking the property back and reselling it at the current market price. We just finished our first FDIC sale. Our market’s going to see this for a couple years yet, where there will be troubled assets coming into the marketplace and having to be disposed of at current pricing. And some of it will be FDIC-controlled assets, which means that the FDIC took the hit, and some will be lenders who take the hit, and some will be owners of other assets who just have to take the hit and reduce their exposure. So there’s probably at least three years ahead of us, I think, where these troubled assets are going to become front-page news.

TATTI: Darrell, do you want to comment on that at all, from the banker’s point of view?

McALLISTER: Sure, and maybe just a little clarification. The RTC was really to handle the problem assets left after the banks’ failure, because when customers try to negotiate with the bank they expect us to take a portion of the loss, and if we do too many of those suddenly we’re out of business, and the FDIC takes us over and then they basically have to dispose of those assets. Do they someday create an RTC again? I don’t know. But that’s basically the problem.

So, from a lender’s standpoint, we will work with our customers, but we’re not real excited about taking back assets, because the customer’s probably the best person to dispose of and get the best price for those. What Steve is saying, though, is somewhat true. I think there will be a lot of work-through of asset valuations over the next one, two, three years. And who will be left holding the bag? I’m not quite sure. But the customer that owns the property is going to have to put a little in, maybe the bank takes some hit on a short sale. It’s all across the board as to where that goes.

Now, how does that affect consumers? Banks can’t just throw money down the well forever, so we have to figure out how to charge higher rates on loans, there has to be a way to survive in these times. If it’s the FDIC that takes the hit, the industry, technically, takes that hit, because our cost of FDIC insurance goes up, which we have to somehow pass on to the consumer. People have a tendency to think of banks as an endless bucket of money, but we have our limits too, and so we have to manage what we can take as losses on those properties. I think you’re going to see a lessening of property values, cap rates. People are expecting better returns, so that’s driving down the prices.

CARROLL: As the non-financial guy here I have to ask, is anybody around this table surprised at what happened last year? I mean, are we just blown away that things fell apart?

McALLISTER: As a financial guy, I’m blown away by how far things have blown apart.

KAWULOK: Yeah, I think the scale of it is more than anyone would have anticipated. And I think we thought, perhaps, in Colorado we had some isolation from that, but we’ve caught the same flu as the rest of the country. You know, we’re not wholly owned inside the state or even inside the cities here. We have ownership ties that go even international. So I think the surprise is probably as to the scale. I mean, everyone was talking about maybe we were building too much, there was too much speculation. I don’t think anyone anticipated the fall off the cliff.

TATTI: The signs kind of started in residential real estate, so, Rick, do you want to talk about that?

HAUSMAN: I think our residential construction wasn’t as overbuilt as the markets you read about in the paper a lot, because we had a mini-recession in the 2001-02 timeframe, and our appreciation rates were under 10 percent per year, whereas the Los Angeles, Phoenix, Las Vegas areas were over 20 percent, which added fuel to that fire of speculation and overbuilding. So, as bad as it is here, the positive is that it’s a lot worse other places; we had a more realistic appreciation rate prior to this current crisis.

One thing Colorado did fairly well was our foreclosure hotline. Local companies have been involved in that – Neighbor-to-Neighbor and what they’re able to do for people is astounding – and the rate of return versus the community investment has been great. We were one of the earlier adopters of that program, first in the nation. So I think we need to continue to fund that.

Two legislative things going forward for the residential industry: the Home Valuation Code of Conduct, there’s a lot in the news on appraisals in that process right now. I think we need to focus on the people who actually qualify for loans, to be able to get them the capital they need so we don’t slow down the business cycle more, and some of the guidelines in there might be slowing down that process. So, granted, there’s probably going to be some government regulation, but we don’t want to exacerbate the problem by over-regulating.

And then on the local level, continuing to create a climate where we can encourage startup jobs, and I don’t know that our local government sometimes gets distracted from being business-friendly. There’s talk, again, of licensing rentals in some areas in Northern Colorado, and that’s going to further decrease margins on an asset that may be depreciating in value. So those would be two things that I’d kind of watch for in the next year to two years in the short term, to see if they slow the recovery of the business cycle, or how they’re implemented.

McALLISTER: Rick, we actually do see, on a positive standpoint, some construction and some house lots selling. It’s not a robust market, but we see that, as a trend, a few of them are starting to sell. We’re actually doing a few lower-end construction loans. Not a lot, but there is a little bit of activity in that market. And, obviously, you’