Plan C as in Commercial Real Estate - FDIC: 115 Bank Failures in 2009. Total Assets of FDIC Insured Banks $13.3 Trillion. $3 Trillion Backed by Shaky Commercial Real Estate.
It is one thing when a few analysts say that commercial real estate, that $3 trillion elephant in the room, is going to experience trouble starting next year. It is another thing when billionaire investor Wilbur Ross comes out and states that commercial real estate is going to crash and burn. We’ve been looking at commercial real estate for sometime and the U.S. Treasury has already had talks regarding a preemptive CRE bailout called “Plan C.”
The commercial real estate sector is even more fragile than residential real estate because commercial space is a direct reflection of the health of the economy. In other words, how much office space do you need without workers? How many strip malls can you fill without shoppers? Not many. Commercial real estate is also financed in a unique way where loans are refinanced typically on five year terms. Many are coming due starting next year. Friday’s multiple bank failures, 9 in one day and a cost of $2.5 billion to the FDIC fund, was the most closures in one day since the recession started. Even with this giant number, most of the assets at FDIC insured banks sit with a few banks:
The FDIC insures over 8,000 banks covering $13.3 trillion in assets. In reality, 100 banks hold over $10 trillion of those assets. The banks that are failing typically do not fall in the top 100. And many of these recent bank failures are starting to show signs of commercial real estate fatigue. Ross summed up the overall scenario well:
“(FT) All of the components of real estate value are going in the wrong direction simultaneously,” said Ross, one of nine money managers participating in a government program to remove toxic assets from bank balance sheets. “Occupancy rates are going down. Rent rates are going down and the capitalization rate - the return that investors are demanding to buy a property - are going up.”
There is some form of twisted irony in the above. The government has tunnel vision focus on residential real estate. The Federal Reserve has bought nearly $1.25 trillion in GSE MBS thus keeping mortgage rates at historical lows. Not enough? What about a nice $8,000 tax credit? Still need more? What about going with FHA insured loans that only require 3.5 percent down? In other words, the government has stepped into the vacuum left by the toxic mortgage lenders. So we shouldn’t be surprised when FHA insured loans, Fannie Mae, and Freddie Mac loan portfolios start showing historic amounts of defaults. Yet the consequence of pushing many renters to homeownership, is you speed up the crash in commercial real estate. We should be honest and admit that not everyone can be a homeowner. And this is okay. They can rent. Nothing wrong with that. But now we are seeing enormous apartment vacancy rates because we are temporarily shifting some into homes they cannot afford. They will only default later as we have seen with the current decade long housing bubble.
Commercial real estate is a gigantic line item of the FDIC insured banks:
In fact, if you add up nonfarm residential, construction and equipment, and commercial/industrial loans the number is approximately $3 trillion. Contrast this to the $2 trillion in more conventional residential loans. In other words, this has the potential of being bigger than the residential downturn. Commercial real estate values took longer to fall than residential property values, but not only have they caught up, they have surpassed the percentage amount of declines:
With many of these loans coming due in the next few years, the question will focus on the ability of companies to get the loans refinanced. But who will take on a loan of an empty commercial building? For residential property, the government for better or worse has a big mechanism through Fannie Mae, Freddie Mac, and FHA insured loans to buy up these loans. The government currently backs 95 percent of all residential mortgages. It is the market. Yet with commercial real estate, there really isn’t a government mechanism fortunately (that is, unless the U.S. Treasury plows through with Plan C and starts bailing out this industry).
The FDIC and other agencies are trying to jump out in front of this freight train. Maybe it isn’t call Plan C but something is in the works:
“(AP) WASHINGTON - Banks must accurately identify their potential losses when modifying troubled commercial real estate loans under federal guidelines issued Friday.
Regulators have warned that rising losses on commercial real estate loans pose risks for U.S. banks, with small and mid-size banks especially vulnerable. Nearly $500 billion in commercial real estate loans are expected to come due annually over the next few years.
Agencies including the Federal Deposit Insurance Corp., Federal Reserve and Office of Thrift Supervision released the new guidelines for banks, which emphasize that modifying loans in a prudent fashion is often in the best interest of both the bank and the creditworthy commercial borrower.
Under the guidelines, loans to creditworthy borrowers that have been restructured and are current won’t be classified as high risk by regulators solely because the collateral backing them has declined to an amount less than the loan balance.”
This will be a fascinating challenge here. Jean Paul Getty had it right when he said, “If you owe the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.” And the banks have a gigantic problem. You can expect workouts but what can you workout with a property that is completely vacant? Is there any price point that will work? We are going to find out soon enough.
The commercial real estate debacle is coming in line with the appearance of a stabilization in the residential market. The CRE debacle has the potential to destabilize the market again. Expect to see more banks go under because of horrible CRE loans.
Dow Jones Largest Fall Since April of 2009: Current Rally based on V-Shaped Recovery Hopes and Sustained Spending. Credit Card Mail Offers Fall from 2.1 billion in Q3 of 2006 to 391 million in Q3 of 2009.
The Dow Jones Industrial Average falling 249 points on Friday was a significant turning point in this rally because it came on the back of a 200 point jump just the subsequent day. On Thursday the GDP numbers were released showing a strong 3.5 percent jump. Yet digging into the data, 1.6 percent of this growth was based on front loading auto sales (the 30 year average for the auto sector each quarter is between .1 and .2 percent) and massive government spending. Yet that is what stimulus is for. On Friday however, consumer spending and income fell leading to the reality that without the government, the average American is tapped out and is unable to juice up those credit cards anymore.
Let us first take a look at the biggest down days for the Dow since the rally started in early March:
This was the biggest drop since April of 2009. That is significant. It took us nearly six months to have a down day of over 249 points. And if you really think about it, the news wasn’t all that bad. In fact, the GDP numbers should have kept things going. But again, the reality is setting in that there will be no V-shaped recovery and 27 million unemployed and underemployed Americans benefit little from the current stock market rally. Most don’t get their monthly money from the stock market but an actual W-2 job.
This rally has also seen a significant number of up days:
Since the rally, we have yet to see a 300 point down day. We have seen a nearly 500 point gain right after the low point was reached in early March and a 379 point rally the next day. So nearly 900 points were made up in two days off the low bounce.
The Dow peaked in this rally at 10,081 and we currently stand at 9,712. It will be interesting to see what happens next week with the BLS job report coming out. The market expects a 9.9 percent official rate but there is a strong possibility of going over 10 percent. You can expect a 10 percent unemployment rate to psychologically change the feel of the market. Hard to believe in a rally when the unemployment rate (official) is at 10 percent. Yet even now, we hear more and more people using the U-6 rate in official figures and that is already at 17 percent.
What we saw on Friday is a real true test of this rally. Is this for real or simply a juicing of the markets by Wall Street and the government? The figures coming out on Friday are starting to believe this rally is simply based on fumes. An adrenaline shot from the government and Wall Street won’t sustain an economy since many average Americans are already tapped out on spending.
Notice how you are receiving less and less of those credit card offers in the mail? There is a reason for this:
Source: Paul Kedrosky
Direct mail credit card offers peaked in Q3 of 2006 with approximately 2.1 billion being sent out. In Q3 of 2009 only 391 million have been sent out. In other words, credit card companies definitely don’t believe in the recovery and they certainly don’t believe in the American consumer. On top of this drop, credit card companies are now jacking up fees on good standing customers, adding annual fees for inactivity, and basically acting like your local loan shark. At times they are even charging 79.99 percent interest rates that would make Tony Soprano blush. If we really look at the data, the economy is doing anything but recovering. Actually, it is recovering but for those on Wall Street and the banks. The average American is merely subsidizing their party. By the way, the banks are largely the reason for the decade long housing bubble.
If you really want to see how much insiders believe in this rally, let us look at some details from last week. Insiders for the week with data from Thomson Reuters bought 8.2 million dollars worth of stock during last week. How much was sold? 184 million dollars. This pattern has been occurring the entire rally. Now wouldn’t you think insiders would have a better sense of the true nature of this economic recovery?
Next week will be important and the jobs report number may go over 10 percent because many people hearing this good news, are now back looking for work but very few jobs are out there. In other words, they will move from the shadows of the 2 million workers that have given up into the actual official pool.
