From foreclosures to recurring revenue: Jim’s early career

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When I graduated from Boston College in 1989, I had no idea I was beginning an adventure that would position me right where I am today: Developing technology and leading the charge to re-invent the CMBS market.

I started my career in 1989 working for Fleet Bank in Providence, RI. I completed the bank’s “loan officer development program” where I learned the 5 Cs of credit.

At the end of 1989, the markets froze and they put me and two other “graduates” in the commercial and industrial loan workout group. I spent the next two years “collecting” on C&I loans including foreclosing on mortgages (commercial and residential) and UCC foreclosures on assets such as inventory, receivables, etc.

The coolest seizure I was part of was a jewelry foreclosing on gold that had been lent to a jewelry shop on 46th street in Manhattan. We went in the Wednesday before Thanksgiving and packed up all the gold in an armored car at midnight, and the place announced the liquidation the Monday after. The worst was foreclosing on a borrower’s house who had put up his home as a guarantee for spec industrial buildings that went bust.

In those first few years out of college, I saw Fleet buy Bank of New England, which failed, and saw the “once in a lifetime” event of the RTC crisis that ended up costing something like $450 billion.

Westward

Life in Providence was fine and I was able to summer in Newport, which was a blast. But my college love was from San Francisco (still married to her with two kids), and my spirit was being pulled west. So, in 1992, I packed up my Ford T-Bird and moved to San Francisco. I ended up getting a job (out of an ad in the newspaper) with Hanford/Healy, the largest SAMDA contractor on the west coast. SAMDA stood for “Standard Asset Management and Disposition Agreement” and it was literally the name of the contract RTC service providers signed to liquidate assets of the seized S&Ls.

I was assigned a portfolio of commercial real estate loans to foreclose on, and I worked the portfolio for about a year. However, in 1993 and 1994, before we could conduct a full liquidation, the RTC shifted from a work-out-each-loan strategy to a sell-the-loans-in-bulk-to-the-private-sector (Wall Street) strategy, which basically put a sunset on the SAMDA contracts.

Working for Wall Street

Hanford/Healy transitioned to working for Wall Street, and so I became a senior member of the asset management team dealing with Wall Street bankers in bidding and collecting on real estate loans.

The best deal I ever saw was called Kearny Street and was pulled off by Morgan Stanley Real Estate Funds in 1993 (MSREF). MSREF bought a portfolio of mortgages secured by Class A real estate that were made by Security Pacific (which was being acquired by Bank of America — sound familiar?!). Anyway, the simple math was, they paid $400 million for loans that had a face value of $1.2 billion (less than $.40 on the dollar), they financed the entire purchase with privately placed CMBS debt, and ended up collecting $1 billion over the course of the next few years. So, a $600 million profit on basically zero equity. I’ll take one of those. …

GateCapital is born

In 1996 Hanford/Healy was sold to GMAC-CM to become the B Piece buying platform for the “car company.” The Hanford/Healy alumni scattered, with my colleagues landing in B Piece/distressed positions in the U.S. and Japan.

I was able to leverage a H/H client, Conti Financial, to back me on starting a due diligence company. Conti put up $350,000 of initial equity for a 35% stake and became an instant client. I joined forces with another H/H senior person, Jim Kehoe, and formed GateCapital, LLC in June 1997.

Conti was riding the initial CMBS wave and had positioned itself as a “subprime” conduit lender that made loans on less desirable real estate assets but charged wider spreads. They sourced the loans through mortgage brokers, who underwrote the loans for origination in an Excel/Word template environment, then securitized them and made great profits.

The low end of the credit curve is a lonely place

Conti was an innovator is securitizing mortgages backed by self storage and mobile home properties. Our job was to take the closed loans and manually take the data out of the Word documents and put them in a Microsoft Access Database we developed so we could organize the data for presentation to the rating agencies and to the investors. Volume peaked at 100 loans a month in the summer of 1998 when disaster struck and the bond market froze in August of that year. While that “event” only lasted about 12 months, it lasted long enough to wipe out Conti Financial. When things turn conservative, the low end of the credit curve is a lonely place.

Fortunately my partner’s business was booming. He ended up bringing over a Lehman Brother’s servicing book that grew to about $4 billion, and I realized how necessary long-term recurring revenue is for any undercapitalized company.

Servicing may not be sexy, but when transactions grind to zero, the recurring revenue is like gold. We ended up doing some loan sales, and I spent 1999 in Tokyo setting up the Lehman special servicing operation known as Capital Servicing. I came back and started putting business plans together to try and ride the .COM wave.

In July 2000, we sold our Lehman servicing contract to Hatfield/Philips (although the price and terms were set by Lehman). We ended the LLC with Kehoe, forming an Asset Management company called Belrad (www.belrad.com). And I found the angel money to form this company.

The moral of the story

Looking back on my career so far, I’d say the common theme has been my ability to organize information in a way that helps determine the values of assets.

Early on, I was writing business plans to determine asset values to justify the acceptance of discounted pay-offs. As I was trained in real estate and loan valuations, I learned the underlying math and built a Web-based way (Backshop loan origination software) to do the valuation.

The power of the Web allows us to push this capability to investors and the entire CMBS community. That’s where www.cmbs.com comes in.

— — —

Jim Flaherty is CEO of CMBS.com and the creator of the Backshop loan origination system. He is a trained credit professional with experience installing enterprise underwriting systems for commercial real estate lenders, rating agencies and investors.

www.cmbs.com

www.backshop.com

The history of Backshop and CMBS.com

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It is September 11, 2008 and I have started preparing content for my soon-to-be released-blog, CMBS 2.0. The history of the company is deeply connected to September 11, 2001 and what better day than the 7-year anniversary of the attacks to chronicle that history.

The birth of Backshop

The company was incorporated in July 2000 with $500,000 of “Angel” money. We used that money to convert our starting technology (that we created at my first company, GateCapital) from Microsoft Access to Microsoft SQL and ASP (a desktop application to a Web based enterprise application).

By early 2001 we had a product that was functional (albeit grossly deficient in underwriting tools) and started the effort to sell the software. Right away we realized how hard it was going to be because we had two big strikes against us.

First, we were an undercapitalized “.com” from San Francisco (this was well after the internet bubble burst) competing against well capitalized competitors ($50MM each for CapitalThinking and MortgageRamp).

Second, we were trying to convince lenders that their Excel models were useless and they needed to dump those models and join Backshop.

In fact, I used to go into meetings with a button that had the word Excel on it with a line through it and was preaching my “No Excel” mantra. Needless to say, we could not find any banking executives who had vision and confidence in our ability to deliver on the promise of “Goodbye Excel”. So we started looking at other ways to survive.

Tough times

In the summer of 2001 I had (I thought) found it. A local Bay Area company called LoopNet (a commercial real estate multiple listing service) was going through a tough time as a result of the .com crash. They were forced into a merger with a competitor, had investors screaming for better cash flow and did not have a proven revenue model.

In August 2001, I put up $75,000 and signed a contract to buy a division of LoopNet called LoopLender. The strategy was to link our newly created loan origination software with the equity listings on LoopNet to create deal flow which, in turn, would help us close software business because the banks would not only get a no-Excel, kick-ass system, they would also get deal volume.

So, on September 10, 2001, with the LoopLender business plan fresh off the printer, I took the “pink” eye to New York, Checked in to the Soho Grand (Canal and W. Broadway), and woke up bright and early on Tuesday the 11th to go and raise the money to fund LoopLender.

My 9 a.m. meeting was on Wall Street with Steve Schwartz at JPMorgan/Chase, and I had a 10:30 a.m. meeting ON THE 26th FLOOR OF TOWER 1 with Jim Kehoe, my old GateCapital partner. In fact, Kehoe and I had talked about a breakfast meeting at Windows On The World before the JPMorgan meeting but, thank God, we are both a bit too lazy for that so we settled on the 10:30.

On my way to my 9 o’clock on Wall Street, the first plane hit, and I witnessed firsthand the destruction of that day. The explosions, the realization it was a not an accident but a terror attack, the people jumping from the burning towers, and then, the collapse of the towers. I went back to my room, called my family to tell them I was OK, and then slept until 4 o’clock that afternoon. For the next few days (I did not leave New York until Friday), I lived 10 blocks from Ground Zero and spent time with all sorts of people who had similar stories of close calls. In the days immediately following the attack, the spirit of New Yorkers was amazing and I built on that vibe for my healing process.

So, when the realties of the event sunk in, I realized that the deal I had cut to buy LoopLender was not going to get funded. Of course I should have just taken my $75k hit and walk away. But, being the optimistic entrepreneur, I figured if I could get LoopNet to lower its price, maybe I could close it. I ended up chasing the deal for another 6 months, throwing another $125k in deposits to keep the deal alive while I was trying to close the equity. While I had negotiated hard and got the pricing way down, I could not get my equity to close (Wimps!), and ultimately lost $200,000 when I could not close without them. Ouch!

For those of you who don’t know, Loopnet had (is having) a happy ending. They dominate the commercial MLS space and had a successful IPO. Check them out on the NYSE under the ticker “LOOP.”

Time to rock

After a rough couple of months and a move out from an office in San Francisco to a desk in Sausalito, I finally got a break in November 2002. Through an introduction from Chris Tokarski of Coastal Capital (and later Countrywide), I met Perry Gershon at RBS Greenwich Capital (now of Loan Core Capital). He had just been brought in with Mark Finnerman to ramp up the real estate group.

I went in for my sales call, gave my “No Excel” pitch, and finally got the response I had been praying for: “You’re the first guy who knows what he is talking about.”

Perry had developed an Access database at Nomura under Ethan Penner, so he knew the value of getting out of spreadsheets and getting the business into a database. And he is one of the smartest folks in the business.

Over the next 12 months, we built out the deficient pieces of Backshop (we called it cUnderwriter back then) so you could do lease-by-lease underwriting and everything you needed to originate and securitize loans on stabilized properties.

We started marketing the product in January 2004. We signed up our second client (Chris Tokarski and his partners at Countrywide) in April and have been rolling ever since. We were lucky enough to get different types of clients who needed discounted cash flow modeling for properties other than stabilized real estate in the United States. So, we built out the multiyear cash flow models and construction lending models, and we could account for different currencies and date formats, etc.

We also made two significant acquisitions. First, we acquired Conquest bond modeling software and CMBS database from Standard and Poor’s in late 2005. This acquisition has positioned us to become a content as well as software provider. Second, we acquired DealCentral from MortgageRamp / CapMark in 2007 (one of our $50MM funded competitors). We consolidated DealCentral clients onto Backshop and eliminated a competitor.

Transparent standards — today!

And now, we embark on perhaps our biggest challenge: the adoption of a transparent standard for the real estate finance industry.

This mission is bold but necessary.

We are committed to making the software widely available to all who want to join the standard. We hope, with continued widespread adoption, we can balance the transparency requirements with privacy issues and create a more credible, open standard for the resumption of the CMBS business.