Monday, March 30, 2009

WSJ: Commerical Property Faces Crisis

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More news flow coming down the pike on one of our favorite topics... again keep in mind the one "saving grace" here is the Federal Reserve, which should only be putting high quality SHORT TERM collateral on their balance sheet... but is now is willing to take just about anything. Displaying once more as the highly connected in this country demand [Dec 22, 2008: Wall Street Journal - Property Developers Ask for Government Bailouts], they shall get. [Feb 23, 2009: Fed May Need to Recast TALF on Commercial Real Estate] - all under the guise of "it helps everyone folks!" While that shuffling of toxic assets won't help vacancy rates or rents, it will keep some of these companies from facing their "free market" fate. Just remember to keep repeating the party line as you do your taxes - it's in ALL our interest for tax payer money to be sacrificed so the commercial real estate financiers, many of which are among the wealthiest in all the land, are saved from capital deals done at super leverage, and high risk. They do not deserve to suffer from risk... only the lowly peasants shall suffer from mistakes. We can't be without 6x more retail space than any other country on the globe can we? Too much office space, too much hotel space - but please swig the Kool Aid and fork over your money. I just find it bemusing a country run on "let the free market decide, hence we need to deregulate everything" now clings to the teat of mother country (taxpayer) for all its "bull case scenarios". [Jan 13, 2009: Bailout Nation Continues in Commercial Real Estate Land - "Lemme In on that Money"]

Again I'd like to point out the evil of what the Federal Reserve is doing: it will suck up all these (ahem) "AAA" debt onto its balance sheet... the same debt crumbling on banks balance sheet, and somehow, someway on the magical balance sheet of the Fed it won't degrade or cause major impairments. We'll be told - "if you just hold it for a long time, the taxpayer will make money". Then, in 4,5 years when your attention is elsewhere - the Fed (who in the end is YOU) will quietly take the losses and say... well that was the thesis anyhow. Our models went wrong - who could ever see this coming? This whole farce that loans are solid enough for the Fed, but not solid enough for our banks would be so funny if not for the perverseness of it all. But it now our status quo as the peasant class is here to do their thing.

Via the WSJ
  • Commercial real-estate loans are going sour at an accelerating pace, threatening to cause tens of billions of dollars in losses to banks already hurt by the housing downturn. The delinquency rate on about $700 billion in securitized loans backed by office buildings, hotels, stores and other investment property has more than doubled since September to 1.8% this month, according to data provided to The Wall Street Journal by Deutsche Bank AG. While that's low compared with the home-mortgage delinquency rate, it's just short of the highest rate during the last downturn early this decade.
  • Some experts say it now looks as if the current commercial real-estate slump will rival or even exceed the one in the early 1990s, (I'm not an 'expert' and I was able to see that over a year ago.... thanks experts) when bad commercial-property debt played a big role in dragging the economy into a recession. Then, close to 1,000 U.S. banks and savings institutions failed. Lenders took about $48.5 billion in charges on commercial real-estate debt between 1990 and 1995, representing 7.9% of such debt outstanding.
  • Since late 2007, a total of 47 banks and savings institutions have failed, of which a dozen or so had unusually high commercial-mortgage exposure. Foresight Analytics in Oakland, Calif., estimates the U.S. banking sector could suffer as much as $250 billion in commercial real-estate losses in this downturn. (I know what you're thinking - heck ONLY $250 Billion? That's how immune to the numbers we've become... heck we could finance a few years of war in Iraq for those numbers, but if it's not a trillion+ we don't even bat an eye - after all money is now free, it comes from the heavens) The research firm projects that more than 700 banks could fail as a result of their exposure to commercial real estate.
The bulls case? The so called "6 months from now we'll be fine" - the same case I've been hearing since spring 2008.
  • Commercial property may not be hit as hard as many fear if the economy pulls out of recession more quickly, driving up rents and occupancy rates. And greater availability of financing -- a key goal of the Obama administration -- could lift property values.
Onward to reality...
  • The problem was underscored when Moody's Investors Service downgraded Bank of America Corp. Wednesday, citing likely increases in souring "credit cards, residential and commercial real estate loans."
  • Commercial real-estate debt is potentially more dangerous to the financial system than debt classes such as credit cards and student loans because of its size. The Real Estate Roundtable, a trade group, estimates that commercial real estate in the U.S. is worth $6.5 trillion and financed by about $3.1 trillion in debt. Partly because the commercial real-estate debt market is nearly three times as big now as in the early 1990s, potential losses in dollar terms loom larger. (thankfully the Federal Reserve balance sheet is now limitless compared to the, dare I say, almost conservative actions of the early 1990s)
Again, I find it almost bemusing to watch all these finance chiefs racing to pay back TARP money when so much damage is still to come. It shows you truly whom public companies, even those in the most mortal of danger, are run for. Not the shareholders, not the workers - but the chiefs. Once you threaten their pay - gosh darnit, that government assistance is no longer needed. Even lowly Bank of America who has come to the government for multiple bailouts now is gleefully singing songs of TARP repayment... and soon. Even if you believe all the songs of unicorns, mermaids and rabbit foots - wouldn't a conservative outfit say, "just in case" we'll keep this TARP money as a safety net for the next 18 months? Just in case we're wrong? Not that banks are ever wrong in their models or assessements... just sayin'.
  • According to an analysis of bank financial reports by The Wall Street Journal, the broad shift to real-estate lending can be seen by comparing commercial real-estate loans -- including both mortgages and construction loans -- with banks' so-called Tier 1 capital, a key indicator of a bank's ability to absorb losses. In 1993, less than 2% of the nation's banks and savings institutions had commercial real-estate exposure exceeding five times their Tier 1 capital. By the end of 2008, that had risen to about 12%, or about 800 financial institutions. A higher ratio means a thinner cushion for loans that go sour.

  • The Federal Reserve and the Treasury are moving to adapt a funding program to make it attractive for investors to buy debt backed by office buildings, hotels, stores and other income-producing property. The program, called the Term Asset-Backed Securities Loan Facility, or TALF, was begun to finance purchases of debt backed by consumer credit, and officials will expand its use to include commercial-property debt. (i.e. the Fed is now taking over the shadow banking system - a nearly "risk free" behavior of course - with that magic balance sheet they have)
  • The Fed is an institution that traditionally makes short-term debt available. In TALF, federal loans run three years, already a duration Fed officials are uncomfortable making. But even that might not be long enough to spur investor demand for commercial mortgage securities, which typically mature over 10 years. (what's 5 years? or even 10 among friends? I mean this is a win/win/win for everyone) The government officials are considering extending the TALF to accommodate the needs of the commercial real-estate industry but no decisions have been made. (I have a pretty good idea what the decision will be...) In a statement Monday, the Treasury suggested the Fed might alter the terms of its loans to investors to make them more attractive for long-term securities. (bingo)
Further...
  • As recently as last summer, delinquency rates on commercial mortgages were at historically low levels, and many experts thought problems wouldn't be as bad in this downturn. (those expert's models again.... see, when you don't even acknowledge its a recession or that prices could fall nationally, you can believe in a lot of excellent outcomes)
  • But owners could borrow so much on the expectation of rising property values and cash flows that some are at risk now that rents and occupancy are falling. "In just seven months, we've gone from the best of times to the worst of times," said Richard Parkus, head of commercial mortgage securities research at Deutsche Bank.
  • Even some performing loans could face trouble because of a fall in values of the properties, making it hard for owners to refinance when loans come due. Currently, many banks are agreeing to grant short-term extensions on loans. But "that's just kicking the can down the street for awhile," said William Rudin, an owner of New York City office buildings. "That doesn't solve the problem." (ah! kicking the can down the road - my favorite policy)
  • Of $154.5 billion of securitized commercial mortgages coming due between now and 2012, about two-thirds likely won't qualify for refinancing, Deutsche Bank predicts. (well in that case, hide it on the balance sheet of the taxpayer and just say we'll all make money as long as we hold it for 5+ years - because as you know housing prices, commercial rents, occupancy will all be going back to bubble levels by then)
  • The bank estimates the default rates on the $700 billion of commercial-mortgage-backed securities could hit at least 30%, and loss rates, which figure in the amounts recovered by lenders, could reach more than 10%, the peak seen in the early 1990s.
  • Besides securities backed by commercial real-estate loans, about $524.5 billion of whole commercial mortgages held by U.S. banks and thrifts are expected to come due between this year and 2012. Nearly 50% wouldn't qualify for refinancing in a tight credit environment, as they exceed 90% of the property's value, estimates Matthew Anderson, partner at Foresight Analytics. Today, lenders generally won't loan over 65% of a commercial property's value.
  • In contrast to home mortgages -- the majority of which were made by only 10 or so giant institutions -- hundreds of small and regional banks loaded up on commercial real estate. As of Dec. 31, more than 2,900 banks and savings institutions had more than 300% of their risk-based capital in commercial real-estate loans, including both commercial mortgages and construction loans. (so either we can give these losses to the FDIC out in the open or hide them in the Federal Reserve to be suffered, over time, in dark closets- you can guess where most are going)
So let's conclude with the review:

Bear case - everything
Bull case - the Federal Reserve is our savior and we can hide all this non performing junk on the balance sheet of the taxpayer under the guise of (a) if we hold it long enough we're all winners and (b) if we don't bail out those in the upper 0.4% with the money of the other 99.6% what sort of country are we really? We are not that cruel. Stop your class warfare - this is how capitalism is supposed to work!

Invest accordingly.

[Jan 27, 2009: As Hotel Vacancies Rise, So Do Risks of Default]
[Jan 6, 2009: As Vacant Office Space Grows, So Does Lenders Crisis]
[Dec 15, 2008: Commercial Real Estate - You Can't Go Wrong]
[Nov 20, 2008: Commercial Real Estate Finally Hitting Home in Financial Media]
[Nov 12, 2008: REITs Continue to be a Gold Mine on the Short Side]
[Nov 11, 2008: General Growth Properties Looks to Join Its Tenants]
[Oct 18, 2008: CNNMoney: Mall's Demise Could Doom Communities]
[Jul 21, 2008: Add Mervyn's to Our Growing list of Retailers Heading to the Great Sunset]
[Mar 4, 2008: WSJ - Building Slowdown Goes Commercial]
[Dec 2007: Credit Downturn Hits Malls]

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