A: $5.2 Trillion - Remember that number! This could be a significantly under-estimated headline. Recall that banks placed a ton of toxic assets off their balance sheets, hidden in so called Special Purpose Entities (QSPE) and Variable Interest Entities (VIE). I believe Citigroup has about $1.1 Trillion in off-balance sheet assets as of late 2008. Who knows what the other megabanks have off balance sheet now that the toxic assets belonging to CountryWide, Wachovia, WaMu, Merrill Lynch, etc..have been merged with the acquiring holding company? FASB announced last June that it was delaying the vote on 'off-balance' sheet change for a year - after much opposition from Citigroup and other megabanks. Well, time is almost up.
Via Bloomberg, "FASB ‘Close’ on Off-Balance-Sheet Change, Herz Says":
The Financial Accounting Standards Board is “pretty close” to approving rules on off-balance- sheet accounting that will force banks to add billions of dollars of assets to their books, Chairman Robert Herz said.The estimate is for $900 Billion in off-balance sheet assets in 2010, as the rule takes effect. I think it would be safe to say that this estimate is highly conservative, as were most estimates of the depth of the writedowns since the beginning of this debt deflation episode. If Citigroup had over $1Trln of these assets placed off-balance sheet in mystery entities, what do you think the rest had? Understand, that banks probably used excessive leverage to finance these assets!
Rules that let the companies keep assets and liabilities including mortgages and credit-card receivables off their balance sheets “were stretched,” Herz said today at an accounting conference at Baruch College in New York. The changes would take effect next year, he said.
U.S. bank regulators examining finances of 19 large banks calculated that the institutions would record $900 billion in off-balance-sheet assets in 2010, according to a Federal Reserve report released April 24 as part of the so-called stress tests. The Fed based its calculation on data provided by the banks.
How about $5.2 Trillion? Bloomberg's David Reilly discussed the threat in late March:
At the end of 2008, for example, off-balance-sheet assets at just the four biggest U.S. banks -- Bank of America Corp., Citigroup Inc., JPMorgan Chase & Co. and Wells Fargo & Co. -- were about $5.2 trillion, according to their 2008 annual filings.As Phil Rizzuto would say....HOLY COW!!
Even if only a portion of those assets return to the banks - - as much as $1 trillion is one dark possibility -- it would take up lending capacity the government is trying to free. Whether these assets are "troubled" or "toxic," their return to bank balance sheets could slow efforts to get credit flowing again.
A: Now why would the fed want to do that?
Via Bloomberg, "Gross Says Fed ‘Saving Ammunition’ in Debt Repurchase Programs":
Bill Gross, who helps run the world’s biggest bond fund at Pacific Investment Management Co., said the Federal Reserve is “saving ammunition” by refraining from increasing purchases of Treasuries and mortgage securities at today’s policy meeting.The fed is saving its QE firepower because they know they will be forced to buy longer term treasuries to satisfy the huge demand from increasing issuance to fund our deficit, bailouts, and hometown stimulus packages. When demand from our friendly foreign funders start to wane we will have to make up for that demand internally, THE FED!
At the previous Federal Open Market Committee meeting in March, policy makers agreed to buy $300 billion of long-term Treasury debt within six months while increasing purchases of mortgage-backed securities to $1.25 trillion this year from $500 billion and doubling purchases of housing-agency debt to $200 billion.
To keep rates low, the fed will be forced to buy treasuries to stabilize that market by purchasing the assets from primary dealers at NY Fed. The effort is the modern day equivalent of printing money electronically. The fed is saving this firepower because they know they will need it in the future. Will the fed be big enough to hold down the treasury market? Doubtful.
A rollover of the treasury market and a surge in rates is seen as one of the more likely unintended consequences that come with where we are right now, and the path we chose to take. I had it listed as one of the Stages Yet To Come, in my discussion on EndGame:
STAGE 10 (Yet To Come, End Game) - Treasury Market?: massive treasury issuance to fund bailouts, nearing the end of rate cut cycle which is yet to come (I'll bet on 75-100 more bps of easing), stabilizing economic data which is far off, unwinding or slowing of treasury purchases by foreigners, rolling over of treasuries, selling of widely owned treasuries for this slowdown, and most of the damage done to equities already may all contribute to the selling of treasuries. The treasury market is arguably at the tail end of a 27 year secular bull market. What will treasury buyers demand in yields 12-24 months from now? Will treasuries still be in huge demand, as they are today, right in the center of the crisis? The end game may bring with it the end to the secular bull market in treasuries and higher yields; especially in the longer end of the curve! How will lenders and businesses adapt to higher borrowing costs should this occur and drag credit rates with it?Should that occur, the environment will have to adjust to higher borrowing costs across the board and the residual damage that comes from large holders of treasury bonds for either rate hedging purposes or safety purposes. The question is how much of an impact internal buying from our fed will cushion any bond market roll over. Are higher yields a sign of future growth prospects OR an unwinding of a crowded trade when issuance is set to soar?
We very well could be witnessing a period of the lowest lending rates that we will ever see for the next 5-7 years. Here is the trend worth watching in the 10-YR treasury via Yahoo Finance:
The US economy is not a very strong patient right now. I'm not sure we can handle an unexpected 'event' sending borrowing rates much higher right now; especially after the equity move we just made pricing in better times
A: Shorts are getting absolutely murdered on this latest rally, right at the same time bad news is being reacted to positively, and complacency slowly seeps in; the VIX is near 35 now and falling. This is not a normal stock market folks because we are bouncing from an unprecedented cliff dive, so don't interpret the euphoria that comes with a sharp bear rally to mean that any form of a V shaped recovery is at hand. That is the concern here. As stock prices rise, expectations rise with it that future growth prospects are brighter. The higher the stock price goes (forget for a moment what other forces are powering the move), the less of a value it becomes on a P/E basis - makes sense right; if AAPL stock rises from $78 to $125, would you say the stock is cheap right now after a 47% move? Depends on the future growth prospects and earnings. In my opinion, stocks are PRICING OUT THE DURATION ELEMENT of this slowdown - and that may come to hurt us later on as expectations are changed. Its the duration of this slowdown that I think will disappoint the stock market down the road.
There are real reasons why this market is rallying considering the cliff dive we came from: credit is much tighter, new home sales surged, pace of decline seems to be slowing, banks handling stress test and dilutive news positively, etc.. Its NOT the severity re-pricing that I think is wrong, rather, its the pricing out of the expected DURATION of this crisis that I think will prove wrong here.
The bottom callers on CNBC are getting their 3rd, 4th, and 5th chances to call a bottom since the equity decline began in the 4th quarter of 2007. Keep on calling it, and eventually you will be proven right. Only Mark Haines had the cahones to actually come out and call his first bottom on March 10th, with the Dow trading at 6,926. Everyone else waits for the markets to bounce 10-15% and then they say the bottom is in for fear of calling it on or near the lows.
Here are some recent news breakers and how I feel the street is interpreting it (envision a V-shaped recovery):
Citi/BAC CDS Widen on Report More Capital Needed --> No problem, its priced in. As long as this is the last round of capital raising and the government will not allow either to fail which would see common wiped out, and haircut to preferred and bondholders - no problemo!
GDP Contracts 6.1%, Worse Than Estimates --> No problem, its priced in. As long as pace of decline is slowing, inventories are being taken down, and consumers are starting to spend again, its a clear sign that the worst is behind us and future growth may in fact lie ahead. Besides, if it we don't grow that much, we can always get our government to give us another stimulus package. Consumers obviously can and will keep on spending, and that is a very good thing with no possible side effects. They will only spend more as things improve.
Bank Stress Tests Reveal 6 of 19 Banks Need More Capital --> No problem, its priced in. As long as ONLY 6 banks need capital, and this is the last feeding from the trough! The good thing is, this should be the last round of capital raising. After this, its full gears ahead! So what if rates may rise down the road and consumer credit quality is deteriorating, that won't stop us banks from churning out loans!
Commercial Crunch May Reach $1 Trillion --> No problem, its priced in. As long as it is ONLY $1Trillion, what is a few trillion amongst friends anyway!
Just to name a few. We must ask ourselves whether or not an environment of rising unemployment and deteriorating home/commercial prices will allow for a bottom in bank losses and a sustainable rise in consumer spending?
With each rally, more complacency sets in and more shorts get murdered. Shorts start out by shorting more, dollar cost averaging their positions, until they cant take it anymore and liquidate the position adding fuel to the buy side pressure. Before you know it the momentum and program trades get crowded, and forces outside of normal fundamentals start controlling the stocks markets. People scratch their heads wondering if equities have it right or wrong, hedge funds scramble to make sure they don't miss the run, and retail investors get sucked in with the hope that the economy is finally turning with growth on the horizon. Confidence is magically restored and the world is all better again only 2 months after everybody thought the world was ending! But is the world all better again? Is debt service down? Are bank balance sheets cleansed and fully capitalized?
I fear that stocks are in the process of pricing OUT the duration element of this recession - and moves are powered more by short term trading forces. What I mean is, they got the severity of the recession right by taking stocks down 57%-60% or so from peak over the course of 16 months. But now that we have rallied 30% from those lows, I fear that stocks are in the process of pricing OUT the duration of this slowdown, and instead are beginning to trade as if future growth prospects are assured. As the rally continues this sentiment grows, and so does euphoria with it - the trade is perceived as being crowded and less and less of a value discounting future growth potential - unless the growth really is there! The stock market is a discounting mechanism, nothing more, and is not always right!
Equities discounting vision was very wrong in late 2007, when credit was telling a much bleaker story, and stocks were wrong again in May 2008, when the Bear Stearns 'elimination of systemic risk' rally assured investors that the fed can & will always save the day. So, don't interpret stock rallies to mean that all is well again when they got things wrong big time twice in the last 18 months alone. I see Mish & BR talking about technical indicators of an overbought rally, but to me, it just feels like the market NEEDS to go higher right now because of the trading forces at play right now - quants, shorts, momentum traders, hedge funds getting in on the move, etc..
But did the fundamentals all of a sudden get better? Are consumer debts cleared out? Are banks all better again? And what about side effects of policy down the road? Ignoring the possible unintended consequences of policy actions taken to stem this crisis, is to believe that there are always free lunches to the tune of trillions of dollars with no side effects. The fed has seriously compromised its balance sheet by taking on riskier assets via short term credit facilities and is on a mission of printing money to buy agency MBS and treasuries right when demand might slow from private sector; the last option at their disposal to expand the money supply and keep rates as low as possible. Who knows what Pandora's box that may open later on.
In the meantime, stocks seem to be pricing in a bottom with the worst behind us - with short term and program trades ruling the field. Perhaps on the severity front, stocks may be right - the worst may be behind us. But is growth, and more importantly, sustainable growth really on the horizon? What happens to banks when good assets start turning bad? What happens when off balance sheet toxic assets and accounting tricks no longer can hide damage? What happens when fed credit facilities are removed, rates are raised, and treasury yields start to rise? How do higher borrowing costs and higher taxes as a side effect from all these steroids, affect businesses/consumers trying to increase profits and decrease debt service? State budget concerns? All those unemployed? This is why I think stocks pricing out duration are wrong!
The state of shocked disbelief seems to be lifting from the small/mid cap commercial real estate market in New York, at least anecdotally. A month or two ago business was dead. Bob Knakal of Massey Knakal (the highest volume seller of buildings in New York City) wrote in his quarterly commentary for q2 2009 that sales volume in the under $100 million market in 2008 was down 40%. Volume actually started 2008 at a decent clip and then...fell off a cliff. Massey Knakal had been projecting that turnover of building stock would hit a 1990s bear-market low level of 1.6% of total buildings or lower. They believe that Q1 2009 numbers were running at about 1.2%.
I can only report what I see and hear, but I have been sensing a much greater interest on the part of property owners to try to find some opportunities in the market....and at least pick up the phone or return phone calls.
One multi-family property owner told me "Yeah rents are down some, occupancy is down, vacancy rates are as high as we've ever seen them but we're okay, we're still alive. We're interested in distressed assets".
Another said "We're keeping busy. Just getting set to close on a property, small, only 20 units but we're paying less than $100,000 a unit."
Another building owner I recently met with told me that he had in fact pulled the trigger a few months back on investing in a new bank that was being put together last summer. He was smiling so wide I thought his face was gonna crack.
When we talk to investors today, there is no longer any resistance to the idea that there were a bunch of bad loans made even in the commercial market and that "there will be blood." Most investors, now accepting that the downcycle is here, seem to have spent recent months assessing their own condition, and if they are relatively healthy, they just want to know when over-levered properties are going to be taken back by the banks and sold, and where to get in line to bid. They wonder if there will be another RTC-type organization to deal with or whether banks will be selling properties directly.
In some cases, even these smaller investors, have long-time sources of capital and are not worried about where to get equity....but most are willing to talk about partnering with preferred equity or mezz lenders to buy distressed assets, whereas they previously wanted to keep things from getting too complicated. Some are exploring raising funds from high net worth individuals to invest.
There doesn't seem to be much of a hurry, or any reason at all to be precipitous, but people are raising their heads out of their foxholes and awaiting signs that it's safe to pursue emerging opportunities. Obviously the bid/ask spread is wide between sellers, who in many cases would lose all or nearly all their equity if they sold in today's depressed market and buyers who are looking for deals. So it will take the damn bursting on bank forcelosures or discounted note sales to get volumes moving. I just heard about one institution that is planning to start off-loading a bunch of loans......now I just need to find out who is left there to talk to about bidding.
Being a contrarian, I am always a little wary, when people who could not believe a downturn was coming, suddenly see opportunity in it. However, most of the people I spoke with had been sellers rather than buyers in recent years, attesting to their market savvy. Additionally, at least with commercial properties (when purchased with cap rates above mortgage constants....an old but good strategy) you get paid to wait for a turnaround.
A: Everybody wants more Manhattan real estate updates! I kind of feel like providing weekly updates on Manhattan is counterproductive, beating on a dead horse so to speak. Everybody knows what is going on in this market, whether a broker or executive babbles or not. Things are tough. Period. If JAN - APRIL is our busy season, then I can imagine many agents wanting to find a new line of work. Traffic is still fine, buyers are out looking and appointments are plentiful, and I'm even submitting bids for my buyer clients, but getting buyer & seller to agree on price and get into contract with little resistance is proving very difficult. I truly believe that most sellers feel the worst is over and couple that with reports of higher foot traffic, and all of a sudden the motivation to hit a bid that otherwise perfectly fits into where this market is trading, is dampened. That sell side psychology may come back to haunt you!
There is a common saying that the first bid is usually the best bid; sometimes that is true and sometimes it isn't. When I was trying to sell my own apartment at 245 East 93rd Street, 2M, in early 2006 I decided to test the market and price high at $1.075M. I figured, if I got close to a mil, or above it, YAY!!! I was not desperate, inventory was tight, and good products with huge terraces were hard to find, so why not!
But there is a catch:
THE MOST ACTION YOU WILL GET ON YOUR PROPERTY IS IN THE FIRST 3-4 WEEKS OR AFTER A NOTABLE REDUCTION IN PRICE (WHICH IS WHAT THE SELLER TRIES TO AVOID) - THEREFORE, IGNORING A BID IN THE FIRST 4 WEEKS MAY COME BACK TO HAUNT YOU LATER ONDo you guys remember me spilling my guts to you in October 2006, on my efforts to sell my property? I called the piece, 'Don't Mess Up In Here', referring to the scene in Casino where Joe Pesci warned DeNiro not to make a big deal over the fact that he was secretly seeing his wife:
THE FIRST 2 WEEKS (The 'Should Have' Period)That was one of my favorite personal stories + discussions on listing history that relates to the market in general in any time period. My story was that I received a bid of $950,000, some $125K below my ask, in the first few weeks that I didnt respond to. Tough guy aren't I. Well that bid walked away, and four months later (and about $6,000 extra spent on advertising costs) I reduced my asking price to $975,000 (man, that $950K bid looked really good at that time) and ultimately hit an all cash bid of $935,000. Why did I do that? Well because my traffic really started to dry up and I found that minor price drops were NOT having the desired effect. The most traffic was in the first 3-4 weeks, and turns out, the highest bid came in that time period as well!
I like to call the first two weeks of every exclusive the 'should have' period. The first 2 weeks is the period of time where you get a bunch of appointments scheduled from 'B' buyers who are trying to learn the inventory of their price point and their agents who just want to do a deal already. Maybe you'll get a few 'A' buyers too. Most likely, you'll get a low ball bid. Many times this very early bid is the nightmare for sellers 5 months later. So, I refer to it from the seller's point of view as the, "I should have accepted that bid and saved 5 months of agony" period. In hindsight, every financial decision is 20/20; including whether or not YOU, THE SELLER should accept that offer.
I SAY TO YOU, THE SELLER, DON'T MESS UP IN HERE! And if you do mess up and ignore the offer because there is so much activity and you won't sell below a certain price in the first 4 weeks, to NOT blame it on your broker for failing to move your property at the highest & best price possible down the road.
So, my advice to sellers out there now is to be very cognizant of where we are in the seasonal component of Manhattan real estate. This IS the active season and we ARE heading into the slower summer months. If you didn't sell, or you ignored a bid because you deemed it too low, seriously reconsider what your agenda is. The market is what the market is and it has become increasingly more difficult for brokers to influence buyers to raise their bid and pay a premium for any property. Does it happen, sure, but there are 11,000+ units actively for sale in Manhattan right now and it is safe to say that most are having problems getting that strong bid in. If I was wrong, we would see a big tick up in sales volume and a decrease in active inventory.
As I said in my recent State-of-the-Market piece:
"It's hard to sell a property when traffic is light. So, my view is that this countertrend pickup in activity (which is mostly foot traffic and not a surge in contracts signed) will not last for much longer. Once we enter the slower summer months, history will probably repeat itself and this market could get significantly more illiquid; similar to what the 4th quarter of 2008 saw and bad news for anyone that must sell. If this seasonal component proves correct, serious sellers will find it even more difficult than it is now and that may ultimately mean a bid will have to be hit. Therefore, I think the latter half of the 2nd quarter all the way up to the 4th quarter will show continuing sluggish sales volume and perhaps the second wave of adjustments in pricing that is only proven after the fact. Time will tell."Terry Naini describes this market perfectly with the exception of one phrase in The Real Deal's, "Agents team up to augment their business":
"A year ago, it would take one week to a month to get a listing into contract," she said. "Now it can take six months to sell a property."Yes, it is active out there, I am busy, I am submitting bids, I am showing properties, but deals are very hard to secure and there is still a disconnect between buyer & seller; as buyers have become patient & picky. Who are we to say that a buyer's offer is unrealistic if it is in the range of where this market is trading now! The term 'unrealistic' is too broad to just blame on the buy side. What if the buyer submits a bid 25% below peak levels for a property whose price point is actively trading down 20-25% below peak; like the $1M - $2M price point? To me, the bid would seem perfectly realistic and chances are the seller is being 'unrealistic' because they are not ready to take that kind of hit on the deal after calculating buy & sell side transaction fees. Cases like this are happening everyday out here and brokers, buyers and sellers are frustrated. Buyers want to price in downturn risk into bids, sellers want to get a bid at a premium to where their price point is trading, and brokers just want to move the property while satisfying their responsibilities to their client.
While the listings take longer to sell, they also require a lot more work than in the past, with more marketing and negotiating necessary for each deal. "It's very busy, but there aren't necessarily as many deals," she said. "People are coming out and making appointments, just not pulling the trigger. Or when they do, it's an unrealistic offer."
It's easy to lay blame that the buyer's offer is unrealistic, but then again, its the buyers that MAKE this market! Never forget that a property is only worth what someone is willing & able to pay for it at any given point in time - I thought my place was worth more than $950K in JAN 2006, but in May 2006, I realized it was only worth $935,000. Turns out it was ME THAT WAS UNREALISTIC in JAN 2006!
A: No, I dont think so! For those that missed Charlie Rose Sunday night, he had a great panel including Bill Ackman, Professor Joseph Stiglitz, & Andrew Ross Sorkin. One topic of discussion talked about a possible unintended consequence in the corporate bond world should bondholders take the haircuts that everybody seems to want them to take in a restructuring effort. Add that to GM's offer this morning to bondholders asking them to exchange $27Bln in a debt for equity swap, and that negative consequence becomes eerily closer. But I don't think it would adversely affect the corporate bond market because the 'debt for equity' swap concept is in fact a very viable road to recovery here, and the upside seems to far outweigh any future dilution to common stock or other consequence of being a common shareholder in a better positioned corporation. Right now it's only talks and no actions, so time will tell what happens.
Ackman & Stiglitz were their usual selves discussing the issues we are facing and explaining optionsour system offers to do what needs to be done; restructure, reorganize, bring down debt via a swap for equity. And then Andrew Ross Sorkin brings up a very important point.
As everyone (including myself) calls for corporate reorganization / haircuts / debt restructuring, Sorkin sticks in a prescient point regarding the corporate bond market as a whole and a possible unintended consequence. Lets discuss that.
I enjoy discussions like this because you must ask the right questions based on the information you have at the time, and play devils advocate every once in a while to discuss what nobody wants to discuss. At least Sorkin is asking the right questions. For a moment, lets take the stainless steel constructed Delorean and go back in time & place to spring/summer 2007. Knowing what we know now, we should all agree that the alarm bells were ringing from a seizing up of the secondary mortgage markets (mainly for subprime RMBS), as subprime borrowers started to default. However, at that time many dismissed the problem as being minor and contained. Remember? If not, allow me to refresh your memory:
MARCH 2007 - Lehman Calls Subprime Mortgage Risks 'Well-Contained' : Lehman Brothers Holdings Inc., the second-biggest U.S. underwriter of mortgage-backed bonds, said risks posed by rising home-loan delinquencies are "well contained'' and will have little effect on the firm's earnings.
MAY 2007 - Bernanke Believes Housing Mess Contained: “Importantly, we see no serious broader spillover to banks or thrift institutions from the problems in the subprime market; troubled lenders, for the most part, have not been institutions with federally insured deposits,” Bernanke said.
JUNE 2007 - Freddie Mac Says Subprime Rout 'Severe But Contained': Freddie Mac Treasurer Timothy Bitsberger said the subprime mortgage slump is "severe but contained." The owners of bonds made up of subprime mortgages are mainly "large institutional players who can withstand the loss,'' he said.
The point of bringing up these headlines is to prove to you the lack of vision and creativity to put the pieces of the puzzle together at THAT TIME, in an effort to see what might happen down the road!
Back to Andrew Ross Sorkin's comment (6:22 min into video) as he tries to do just this, put the pieces of the puzzle together, in an attempt to see what may happen if a GM fails and bondholders take a beating:
"Its funny, you say Bill the bondholder, I should say Bill Gross the bondholder from PIMCO, and he is someone who has a lot of influence, as have other bondholders, who have suggested that the moment that you effectively force these bondholder to take a haircut or take a swap out into equity, you are going to undermine the entire bond market and you are going to see some kind of cataclysmic disaster. Now I'm not sure thats the case and as you have seen in some other bankruptcies, we have gotten through that. So at the end of the day, yes this would instill more confidence (referring to Stiglitz' comment to restructure and reorganize the distressed company) but there are people on the other side that say this will kill confidence."So, Sorkin's point is that doing the right thing may have an unintended consequence to it that causes distress to the entire corporate bond market now that this type of capital really is AT RISK. He may be right and at least he is bringing up possible outcomes that not many are discussing now. I just dont agree with it.
GM bonds are already priced for a bankruptcy/reorganization. Ackman breaks down how converting more debt to equity for the largest 19 banks, should be utilized to over-capitalize the banks on a case by case basis. The whole video is worth watching.
ZeroHedge, who is on fire lately, discusses how bondholders are getting the shaft in this latest offer now that GM is in DeFacto Default:
It is odd that the administration is set on continuing its course of antagonizing creditors at the expense of bloated pension plans and workers. While Zero Hedge does not have any particular insight, bondholders are likely not going to be too happy to get the shaft, especially after the UAW (at least optically) receives yet another sweetheart deal, and, as always, bondholders have not been consulted on this development. A 90% tender acceptance ratio is likely a pipe dream but at least Obama can tell his Detroit and rust belt voters he did what he could, and it was Wall Street yet again that derailed the plan and was responsible for the massive job losses about to ensue. Scapegoat the creditors: nothing but politics.Is an unintended war coming to the corporate bond market? Perhaps, but the prospect of longer term recovery now that the proper road is being taken seems to me to outweigh the negative side effects that come with added risk to what is already risk capital. I don't think it would 'undermine the entire corporate bond market'. But at least Sorkin is discussing one disaster in advance, with the hope of avoiding another major market dislocation in the future.
A: Just wanted to throw out that the fed released the Bank Stress Test White Paper moments ago. The ADVERSE Scenario, which 'was designed to characterize a recession that is longer and more severe than the consensus expectation', anticipates a peak U3 unemployment rate of 10.3% or so by 4th quarter of 2010; we are at 8.5% currently. The BASELINE scenario, which 'reflected the consensus expectation in February 2009 among professional forecasters on the depth and duration of the recession', has unemployment peaking at 8.8% for this cycle. Clearly we can throw out the baseline scenario right away, because it is highly likely that unemployment will jump by more than 0.3% at some point by the end of 2009. Reading through the paper now.
Here are the charts showing you BASELINE SCENARIO & ADVERSE SCENARIO assumed by this test on the banks for GDP, UNEMPLOYMENT, & HOUSE PRICES:
Equity markets are clearly in an uptrend, a likely bear market rally that could last longer than expected. Program trades, momentum trades, quant trades, short squeezes, etc.. all control the markets now - making the markets a bit more irrational than they might otherwise be. I would use caution when interpreting stock market movements to mean all is well again.
You are going to start hearing major criticisms about the ADVERSE scenarios assumed over the next few days, and rightfully so. In meantime, expect the unexpected from stocks for a while longer as any news is reacted to positively.
Yesterday one of our Urban Digs readers pointed out an interesting article from the Financial Times. The article notes that REIT prices in the U.K. have declined significantly below their net asset values and that these declines have exceeded the price declines of the underlying real estate that REITs own.
Just a quick review for newbies: A REIT is a tax advantaged vehicle for the ownership of real estate. It can be a private, essentially traded by appointment, or a public REIT with shares quoted on an exchange daily. The REIT is entitled to its tax advantage because it pays out 90% of its net income each year to shareholders. As a high income instrument, REIT's returns to shareholders are comprised of the substantial dividends they pay, topped off by any increase in the value of the stock. (The significant income component is not a new concept. The whole stock market was yield oriented years ago and much of the long-term returns of stocks are based on the dividend component).
There was a flurry of activity in the late 90s when many REITs came public. After a while the street worried that the capital they raised would be used to overbuild new properties and the REIT stocks tanked. This also coincided with the Asia crisis and some interruptions in capital market liquidity (yes this is not the first time that the CMBS market has gone kaflooey). Further, internet stocks were just starting to become all the rage, temporarily distracting folks from the value of big fat dividends. A big correction in REITs left valuations quite low. Taking their signal from the street, REIT managements pulled back on the development reigns and didn't significantly overbuild. This set up a major buying opportunity in the late 90s. For about six years thereafter my father in law thanked me for the heads up I gave him to this opportunity. Being an income seeking investor he loved the dividend increases he got.....and didn't mind the capital appreciation of the shares either, though he had no plans to sell them. Fast forward to today. My father in law won't speak to me....LOL....just kidding, he has actually hung in there and continued to clip his dividend coupons (until some recent dividend policy changes I will discuss shortly).
As most people know, REIT stocks have been shellackered as the markets began to anticipate the seriousness of the commercial real estate debacle that is now unfolding (View image). Recall, however, that, as stocks, REIT shares tend to anticipate the future. I commented on the REIT indicator back in January of 2008. At the time REIT stocks had begun to trade at significant discounts to their net asset values (NAVs). That is, the market caps of the companies began to fall well below the value of the properties they owned, less the debt on those properties (as well as corporate debt). The REIT indicator says that when this happens, the commercial real estate market is about to catch down to REIT prices. In the latest instance one can only say the REIT indicator was spot on in predicting a downturn in the commercial real estate cycle.
The REITs had a bit of an uptick late last year when many of them decided to pay their dividends in stock rather than cash (and the IRS deemed this strategy to be kosher). This demonstrated that liquidity risk was on the minds of investors as the shares appreciated despite the unappetizing prospect that this income instrument was going to pay in stock not cash. It probably helped that many folks were short the stocks and hoping they would go to zero. The efforts made by REIT managements to conserve cash pushed out that prospect at the very least, thus boosting REIT shares.
Lately REIT stocks have perked up again, particularly those that have been able to issue new equity. Stocks like Kimco Realty, Simon Property Group and AMB Property have issued shares in order to give themselves breathing room relative to upcoming debt maturities. The table below shows the REITs with the biggest debt maturities over the next couple of years, courtesy of an article that was published late last year by Commercial Real Estate News. These REITs were under some of the greatest price pressure and had large short positions because there was the potential that they would not be able to roll over maturing debt and end up defaulting.....this had little to do with the actual debt service capacity of the REITs in several cases. As noted in my recent piece Loan Extensions - Bridge to Nowhere, it appears that General Growth Properties, which was apparently able to service its debt, went under for just this reason.
Yesterday the Wall Street Journal ran a piece about how the U.S, vehicle of Israeli real estate investor, Chaim Katzman, Equity One, is apparently making aggressive moves towards shopping center REIT Ramco-Gershenson. In the article Rich Moore, analyst at RBC Capital, opines that according to his estimates an acquirer who took the company over at today's prices would be paying only a 12.7% cap rate for the underlying properties. Now according to Ramco's most recent 10K, the firm owned 89 properties, 86 of which were community shopping centers, 39% of which were in Michigan. It's key anchor tenants included (19) TJ Maxx at 3.6% of rents, (12) Publix at 2.9%, (4) Home Depot at 2.1%, (5) Wal Mart at 2.1% and (12) Office Max at 2%. Anchor tenenats constituted 51% of rents and Non-Anchors 49.3%. National chains were 68.4% and local retailers constituted 18.2% All-in-all not the best mix of assets (with the significant Michigan exposure), but not the worst either and likely pretty reasonably priced for whatever risk lies ahead at a 12.7% cap rate.
Interestingly, from what I hear shopping centers are selling today at cap rates around 7 - 8%, with PricewaterhouseCoopers Korpacz real estate investor survey reporting Q1 2009 cap rates for strip shopping centers at 7.63% up 14 basis points, with national power centers at 7.98% up 41 basis points. They project a rise of 25 to 125 basis points over the next 6 months for these assets. On that basis, Katzman's play seems to make some sense and depressed REIT shares may start to become attractive to other investors. If there were a way to short commercial real estate and go long REITs I think you could make some real low risk money, this may actually be possible in Europe where there is a more active real estate derivatives market that I believe trades based on appraised values of a basket of buildings. Perhaps some Urban Digs reading macro hedge fund guys can tell us if this trade is actually feasible or could even be pulled off some other way.
"Hope is not an exit strategy"
Stacey Berger CMBS special servicer 2009
Stalling tactics! Everywhere I look I see them. The Fed accepting shakier and shakier assets as loan collateral, mortgage forbearance programs and, increasingly, bank loan extensions. In fact, the whole TARP/TALF/PPIP monstrosity embodies it.
The supposition behind all of this activity is that asset values are, somehow, temporarily depressed, true fundamentals are much better than what markets are giving them credit for and ......if we just give everyone a little time, things will work themselves out. Unfortunately, we continue to see evidence that the markets have things more right than wrong. Are there some securities that are oversold? Certainly. All you need to look at is the big bouncebacks we are seeing across markets to know ceratin parts of the market got oversold, yet the breadth of problems related to excessive use of leverage worldwide continues to surprise.
As a result of the number of old maids being exposed with each new turn of the cards, creditors are not generally receptive to the idea that they should just give debtors a little more time. We saw this sentiment on display big time in the spectacle of General Growth's bankruptcy last week. Tom Nolan, the President and COO of General Growth, the largest property company bankruptcy in history, told MSNBC that the only reason the firm was declaring bankruptcy was due to the inability to roll forward debt that is maturing. According to General Growth, the firm's malls are very well occupied, the firm's cash flows are strong and it is current on its debts, and he noted "We have not had to materially re-write leases and we don't expect to." You can see the video here. Now I'm not close enough to the General Growth story to argue the veracity of the content of the video or comments above, and lord knows we have seen people in high places put a lot of lipstick on porcine situations as of late, but away from that debate, the bottom line is that the market participants that have a choice are not in a forbearing or rescuing mood.
In contrast, there is a large group of market participants who don't really have a choice. Those are the banks and other highly levered entities that are already sitting on piles of loans that could potentially go bad and they just can't afford to let that happen without blowing up their own balance sheets. (Our creditors China, Japan and others included.....fortunately). In many cases they don't want back assets they would have to sell into a bad market. They are not in the business of managing businesses or real estate for the long-term, and they may be best served by extending debt for as long as they can and/or submitting to some form of cram down of their principal in a bankruptcy, if it produces a debt structure that can be supported by the company over time. In this way the bank will at least get a better chunk of its money back than if it foreclosed on the asset and tried to manage it and market it.
Loan extensions to companies that participate in the public markets are highly visible and here is a short list of those that have shown up in the news in recent weeks:Borders, Chipmos, MGM Mirage, Craig Wireless, Park Plaza, Macerich, Hines REIT, OZ Minerals, Sky Europe, Canwest Global Communications, and Centro. But I know from my own business that loans are being extended/restructureed right and left in the commercial real estate world. I even ran across an article about a school district, which is trying to rejigger its debt due to cash flow problems and difficulties servicing it's debt as currently structured. Reasons for banks to extend loans include the inability of developers of new properties to sell them or get a permanent mortgage to pay back a construction loan or the end of an interest-only or interest reserve period where the anticipated repositioning of a property has improved cash flows enough to support the purchase money mortgage.
Now comes some straight talk by William Mack, Chairman of Mack Cali Realty and Chairman of AREA Partners previously (known as Apollo Real Estate Advisors), who told Bloomberg a couple of weeks ago "Landlords who financed purchases with at least 60 percent debt are now dangerously close to zero equity." FYI purchasing with 60 percent debt was seen as conservative in many circles as recently as.....yesterday.
With banks perilously close to having no equity, property owners perilously close to having no equity and a flood of debt coming due and properties likely for sale, it's no wonder that those who do have money to invest are sitting on their wallets. In acknowledgment of some conflicting opinions by wise men, I will mention that Sam Zell told an NYU conference that real estate values are now "below any rational analysis." I will also mention that while there are very few investors as intrepid as hedge fund manager William Ackman, of Pershing Square Management. He has been buying the equity of companies with maturity default risk and even offering debtor in possession financing to the same firms if/when they go chapters, he believes that equity value will be preserved through the bankruptcy process in many cases.
The General Growth bankruptcy does not augur well for the refinancing of $90.5 billion of CMBS debt coming due this year. We will get another datapoint on the market's willingness to forebear with MGM Mirage seeking financing to forestall a potential bankruptcy filing. The complexities of trying to work out a defaulted CMBS loan as well as the daunting schedule of maturities has prompted many to suggest that there will be significant extensions of these loans as opposed to foreclosures. Stacey Berger, executive vice president at Midland Loan Services, a master and special servicing subsidiary of PNC Financial Services Group explained the process and mindset of CMBS servicers in a recent Financial Times article
Should a mortgage become delinquent, the servicer will transfer the loan to a special servicer, Berger said. The special servicer will take any action that yields the highest recovery for the CMBS bond holders, he added.
Those actions include a modification, a restructuring, or a liquidation of the asset, Berger said. In less dysfunctional markets, resolutions don’t take too long, but because the current commercial real estate market is so challenging, the resolutions have taken much longer, he said.
Those resolutions could include forbearances on defaults or extensions of the mortgage maturities, Berger said. However, forbearances should not be predicated on the hope that the market turns around and financing becomes available again, he said.
“There is a fairly well-known concept: hope is not an exit strategy,” he warned.
Not to fear though, rumors are rampant that an announcement is coming soon regarding the inclusion of commercial real estate assets in the TALF program. Apparently, the $2 Trillion or so of loans coming due by 2012 and the moribund securitization market has impressed those in Washington that something has to be done. Recently, Jeffrey DeBoer President & CEO of the Real Estate Roundtable was quoted in The Real Deal saying; "“we don't expect the CMBS market to come back in its old ways any time soon. So we said we need a credit facility; in other words -- in effect -- a gigantic credit card that would help finance new loans, new originations,"
More stalling tactics?
Stall Tactics, Loan Restructurring & Debt Conversions From the Blogosphere
Distress Checks In
Are Bank's Withholding Foreclosed Homes to Prop Sales?
Las Vegas Braces for Commercial Foreclosures
Owners of Small Commercial Buildings in San Fran Behind on Payments
Don't Blame Banks for Credit Crunch, M&T's Wilmer Says
U.S. May Convert Bank's Bailouts to Equity Share
$14B BankUnited Equity Wiped Out - Seeks Merger or Buyer
A: About to head out for a few days, but hopefully Jeff will publish some articles he has been working on the past week or so. Before I go I just want to re-iterate the nature of this recession, debt deflation, and that with unemployment levels rising the way it is we must expect consumer credit quality to deteriorate as well. This is not an environment we should want banks to aggressively lend into and certainly we don't want lending standards to be loosened just to 'get things going' again. It seems we have become a society that fears recessions, instead of embracing them for what they are: healthy and normal disruptions of economic growth (normally brought on by tighter monetary policy to cool overheating economies) necessary to ensure longer term sustainable growth. We must purge the excesses, reform the system that allowed the excess to occur, write down the bad debts that came out of the old system/boom, restructure the bad companies that no longer are viable without the old system, allow poorly managed firms to fail, and see risk capital take haircuts - not pass on all the crap to the taxpayer. Because of the nature of the parabolic credit boom that we experienced and the excess that came out of it, this purging/deleveraging process will take longer than most think. Lets just be prepared for that.
This is an overall debt problem in a society that has become very comfortable with buying now & worrying later. Lets face it, Americans tend to live above their means and use credit like it was an endless luxury. Not so. As we all have learned, when the party stops it is not so much fun anymore to realize how much debt we actually built for ourselves.
A week ago I discusses whether or not we were "Out of the Woods - Loan Loss Provisions Being Taken":
A few questions we must ask ourselves: are defaults starting to decelerate - are defaults spreading to higher quality debt classes - are banks taking the proper loan loss provisions to cushion against future losses?This is why I think the markets got the severity of this crisis right, but not the duration of it right.
Lets take Bank of America's latest earnings report, which comfortably beat estimates. Did you know that they set aside an additional $5Bln in loan loss reserves from the 4th quarter of 2008 to cushion against what they see coming? The Wall Street Journal reports, "BAC Posts Profit, Says Credit Quality Still Weakening":
Chairman and Chief Executive Ken Lewis said that the company welcomed the profit amid the harsh economic environment, adding that "we continue to face extremely difficult challenges primarily from deteriorating credit quality driven by weakness in the economy and growing unemployment."Right there, "...deteriorating credit quality and weakness in the economy & growing unemployment" + "...Credit-card losses increased to 8.62% from 5.19% and total nonperforming assets jumped to 2.65% from 0.9% in the prior year and 1.96% in the fourth quarter". Non performing assets jumped big time, and is something to watch as time goes on.
Credit-loss provisions more than doubled to $13.38 billion and climbed from the prior quarter's $8.54 billion, while the net charge-off rate rose to 2.85% from 1.25% a year earlier and 2.36% in the fourth quarter. Credit-card losses increased to 8.62% from 5.19% and total nonperforming assets jumped to 2.65% from 0.9% in the prior year and 1.96% in the fourth quarter.
Banks are hesitant to lend to a consumer that is experiencing deterioration in credit quality and already laden with debt. As unemployment rises, savings will increase and consumers will work to pay down debts and repair their balance sheets. Not the American way, is it? After all, we are a spend spend spend economy, not a saving one. This is debt deflation, a contraction of credit, all occurring at the same time that banks balance sheets are in complete disarray after suffering ginormous losses in the shadow banking system. This is why the fed is gaming the system to help the banks recapitalize - and leading many to worry about the future unintended consequences of such policies on the broader economy. It's an adverse feedback loop in which one stage feeds on the another.
But what about the PPIP plan which uses FDIC powered leverage to get private investors to participate in the market for toxic assets? Well, I am hearing rumors of VERY LITTLE INTEREST in this program. Add that to little interest in the TALF program and we have two huge programs that may not work at all! Besides, even if the PPIP turns out to be a big winner, it does NOT change the fact that there are still good assets on the books of financials that are quickly turning bad; that is, starting to non perform! As the economy continues to struggle, it is clear that what started out as subprime is now spreading to higher quality debt classes; proving the broad nature of this crisis.
Only the bottom of the 4th Inning? So says ZeroHedge based on a Ken Rogoff / Carmen Reinart report:
This epic report examined 15 other credit contractions and asset deflations in the past, and found that the bear markets in equities last an average of 3-1/2 years, with the bear market in house prices lasting an average of roughly six years. So, when asked “what inning are we in?”, the answer we’ve been giving, on this basis, is “the bottom of the fourth”.Time, good policy that removes future unintended consequences from occurring, corporate restructuring, letting bad firms fail, letting risk capital take haircuts, writing down of bad debts, is what we need to get through this. Band-aiding over every new laceration that is revealed will only defer the recovery and prolong the recession because it prevents the natural forces from doing what needs to be done. I don't think the administration understands this, or it is just not politically correct to see America go through pain; even if that means we end up in better shape in the long run.
A: Jeff Bernstein doing his 'reality check' in today's front page story on NY Times. Jeff joined UrbanDigs about 2 years ago and his presence here has proven to be incredibly beneficial for all readers. We will continue to monitor this market and offer commentary on the fast changing macro environment, and how that may impact our local real estate marketplace. While its not the best sales tactic to tell it like it is in a commission driven industry, we are on a mission to make Manhattan real estate more transparent and to offer a venue where reality trumps babble. Lets continue to keep it real!
Front Page NY Times Real Estate, "Don't Even Say The Words":
New Yorkers have moved from a love affair with real estate to a “short-term hate” phase, said Jeffrey Bernstein, a former Wall Street analyst and a partner in a real estate investment banking firm, Guild Partners in Armonk, N.Y.I totally agree with Jeff. What marks bottoms, is when nobody wants to even discuss the asset anymore, the market is sluggish, and frustration is high - sellers just want to get rid of the asset to eliminate the stress of trying to sell it. We are not there yet. Markets usually do not go from peak to trough in a straight line (except it seemed that the cliff dive crude oil did from mid 2008 - early 2009 was a straight shot from 145 to 30 or so). Rather, there are a number of waves or adjustments and then the market takes a breather as the new comfort zone is reached. For Manhattan, I'm positive there are deals happening right now that will define the next wave down when closings are recorded, ushering in a new round of price discovery. The most surprising deals will be found in the high end & mid/high end market. This includes the Classic 6s, 7s, & 8s, and larger trophy properties that must be sold for whatever reason. I think the next round of price discovery will occur in JUN/JULY, right at the time this market normally slows significantly - the seasonal component of Manhattan real estate I discussed in Friday's State-of-the-Market piece: "
“You’re in a short-term hate market when you have prices coming down 30 to 40 percent, but there’s still some feeling you can make some money out of this,” said Mr. Bernstein, who has blogged about the psychology of asset cycles for UrbanDigs.com, which examines the New York City residential market through a macroeconomics lens. Whether the asset in question is oil, tech stocks or condos, he said, “this is all part of the cycle.”
A hate market, he said, is not a market bottom. That, he explained, will be marked by a sustained period of apathy — and quiet.
“Apathy is when people are so turned off they’re just not interested anymore,” he said. “That means all the speculative juices are wrung out and the only buyers are true buyers who need shelter and might even be grudgingly buying.
“Apathy means there are no expectations and maybe the market gets a little bit better, but really over two to three years there is not much progress. And finally no one is talking about real estate as the great wealth-building vehicle anymore. That is what makes a really good bottom.”
...my view is that this countertrend pickup in activity (which is mostly foot traffic and not a surge in contracts signed) will not last for much longer. Once we enter the slower summer months, history will probably repeat itself and this market could get significantly more illiquid; similar to what the 4th quarter of 2008 saw and bad news for anyone that must sell. If this seasonal component proves correct, serious sellers will find it even more difficult than it is now and that may ultimately mean a bid will have to be hit. Therefore, I think the latter half of the 2nd quarter all the way up to the 4th quarter will show continuing sluggish sales volume and perhaps the second wave of adjustments in pricing that is only proven after the fact."If you have not read Jeff's previous discussions on the Psychology of Asset Cycles & Waiting for the Hatin', the links are provided.
UrbanDigs also got some press recently in the following publications, but I was too busy to add to our PRESS page. Enjoy!
NY Mag: Flipped or Flopped -
Normally, apartments are priced based on “comps”—similar sales nearby, adjusted for layout and condition. But now that we’re a year into the market slowdown, the data pool is big enough that the gurus at Streeteasy.com can go beyond that inexact science. They’ve isolated a list of individual apartments that sold at the peak (mostly in 2006 and 2007) and then again in the past few months. “It’s a true apples-to-apples comparison, assuming a property hasn’t changed considerably,” says appraiser Jonathan Miller. “The only variable is time.” Adds Noah Rosenblatt of Urbandigs.com: “It clears out the noise and gives you a pure look.”Investors Business Daily: Manhattan Housing Hurts Amid Job Losses -
But buyers are "pricing in further downturn risk," said Noah Rosenblatt, publisher of Manhattan housing blog UrbanDigs.com.
"Generally, nobody likes to buy a depreciating asset," he said. "There are value-hunters out there. But the bids they are putting in are not where the seller at this point is willing to go ."
A: Want to have a quick discussion on what brokers see out there and provide some of my feelings on this market today and looking foward. It's best to do this every once in a while, because what I see and discuss here is only a very tiny crack of the overall picture. The market is way too big for me to accurately interpret on my own. Mainly, I am looking at how this market reacted to the first stage down and what buyers are thinking as we head closer to summer. If there is one takeaway I can come up with, it is that buyers are still lacking motivation to submit aggressive bids. Forgetting for a moment why they are lacking this motivation, what does this mean for sales volume as we enter the normally slower summer months. Will we see a spike month to month that is interpreted too optimistically? Or will we see continuing negative data/headlines that enhance these distractions to buy side mindsets? Will the comfort zone hold? Lets do a quick check around the brokerage community (sorry, only got 4 colleagues to participate here), and see what brokers are saying about today's Manhattan real estate marketplace.
Todd Stevens, Senior VP, Douglas Elliman
QUOTE: "The market would quickly get better if all realtors demanded checking account statements of 20% price of each home's price from any buyer that’s wants to view a property. For Harlem, Mayor Bloomberg just needs to demand 125th Street vacant building and land owners to build or be triple-taxed. With these demands, the buyer demand will indirectly have a quick rise."
Rosemarie Deane, Senior VP, Halstead Property
QUOTE: "I see the market coming back to life. Phones are ringing, agents are running out to show properties. Sellers are becoming more grounded, accepting the new reality of lower prices. Deals are being made at 5%-27% off summer 2008 prices. The savvy buyers are buying now."
Christine Toes, VP/Associate Broker, Corcoran
QUOTE: "Buyers and sellers are still 10% apart on price. There are a lot of buyers are getting into the market but they're all hoping to buy at the "bottom" and no one knows where that is. Some people think there will be a gradual leveling out / increase in prices after the "bottom." But with all of this buyer activity (I speak mostly of the under $1.5M market), it's possible that there could be more of a U shaped curve where a lot of buyers who are trying to get in while rates are low may jump in at once. Only time will tell."
Broker I Know & Trust Who Chose To Remain Anonymous
QUOTE: "Deals - Deals are being done but they are moving very slowly. That's not such a bad thing - buying your home is a major investment and it was crazy trying to do a deal from the middle of a stampede like the 2007- 2008 market. The starter end of the market is the most active and the top end is the softest. Buyers - The downside for my buyers is that it is more difficult to get a mortgage and the financing process takes longer. In this market, it's crucial for buyers to get a handle on the financing side even before they start their search. On the upside, I can now show buyers a better selection of apartments than I could have done at any other time over the past four years. I'm definitely seeing a trend of renters, who felt locked out of the Manhattan property market over the last years, finally seeing this as their opportunity to own their home. Sellers - My sellers are being realistic about pricing - since early 2008 I have been refusing to work with sellers who aren't. There are opportunities but it requires realistic buyers and realistic sellers - both of whom are negotiating from solidly researched data points."
UrbanDigs Two Cents: I think the Manhattan real estate market hit a comfort zone in its first initial snap down move from peak trades, during the first four months of 2009. Moving ahead, lets get a bit detailed and see how things may play out in medium term as the process continues.
As I noted before, this is a high end recession for our local marketplace due to the nature of the crisis that we are dealing with. The high end market is significantly more illiquid than the sub $1M market, and therefore you will see the sharpest price declines from peak occurring in that segment of the market. This leads me to believe that at some point in the next few quarters you will see a bunch of quality Classic 6s, 7s, and 8s, looking mighty attractive!
Right now, do not be surprised to see some high end or even mid/high end properties trade for up to 35-40% below peak - as a seller feels no choice but to hit a bid. The problem is that almost all buyers expect to get a deal in that range regardless of price point and property features; and that is just not the conditions that this market is operating under right now. Not all, but many buyers want protection against future downside risk and are pricing that into bids. This explains the disconnect between buyers & sellers that I mentioned before - buyers are picky and patient if they don't get their price & terms. Even though a price point seems to be trading down X% from peak, that is not to say a seller is eager to hit the bid that comes in around that level!
The fact that this market is quite active right now could lead to a sell side unintended consequence because it is happening at the same time that buyer confidence is still depressed. Crazy right, but hear me out. What I mean is, there is a lot of foot traffic for my listings and I am setting up a lot of private appointments for my buyer clients - but buyers are still patient. Brokers I talk to are reporting a similar trend across the board; with some agents doing many deals, but more agents doing fewer.
Now, take this environment a step further to see the issue that it may cause. Sell side brokers are seeing this activity and passing along the feedback to their seller clients. This affects sell side psychology - how could it not! So, if a 3M property is trading in this market down 25-30% or so and that is where the most willing & able bids are coming in at, the seller's motivation to hit that bid may get muted by feedback of increased activity that is accurately being reported by the listing agent. Hope sets in that perhaps tomorrow will bring a stronger bid, making the seller less motivated to 'hit a bid' that otherwise represents exactly where the market seems to be trading right now! The point is a psychological one: reports of higher traffic give the seller one reason to expect more because of where this market has come from in the past 8 months.
Focusing on the sell side, the problem I see is one of timing and where we are in the seasonal aspect of this market. If a seller is serious and needs to sell or really wants to sell, they should be very cognizant of the fact that we are rapidly approaching summer when traffic usually slows dramatically! Do not ignore a bid just because you think higher traffic will produce a higher offer in the near future. For stocks, the saying goes, "Sell in May & Go Away" - well, one could argue that saying should also apply for sales in Manhattan. Whereas an open house today might procure 10+ prospective buyers, once we get into JUNE/JULY/AUG that usually falls closer to 2-3 prospective buyers; unless of course the price is uber-aggressive compared to competition in the price point - something most sellers hope to avoid. It's hard to sell a property when traffic is light. So, my view is that this countertrend pickup in activity (which is mostly foot traffic and not a surge in contracts signed) will not last for much longer. Once we enter the slower summer months, history will probably repeat itself and this market could get significantly more illiquid; similar to what the 4th quarter of 2008 saw and bad news for anyone that must sell. If this seasonal component proves correct, serious sellers will find it even more difficult than it is now and that may ultimately mean a bid will have to be hit. Therefore, I think the latter half of the 2nd quarter all the way up to the 4th quarter will show continuing sluggish sales volume and perhaps the second wave of adjustments in pricing that is only proven after the fact. Time will tell. Nothing moves in a straight line and there will be deals at every price along the way. By the end of the 4th quarter of 2009 and more likely the 1st quarter of 2010, I think the bulk of the adjustment will be complete - unless the world changes again by some unforeseen event.
For now, just like stocks had countertrend bear rallies embedded in a larger move downward, I think Manhattan real estate will follow a similar pattern until pricing is more in line with trending macro fundamentals, incomes/affordability, and price/rent ratios sparking buy-side demand - basically, the new world. To visualize this, I plotted a chart of the DOW since the beginning of this crisis to show you the bigger trend, and embedded inside that a number of countertrend rallies that brought with it both hope and bottom calls:
Some macro/psychological factors that I think will power the continuation of this adjustment process for our local market include:
1) rising unemployment
2) rising taxes & maintenance / city budget issues
3) rising inventory / sluggish sales volume
4) local auctions
5) deteriorating commercial sector / empty retail spaces
6) zombie condos / lawsuits against developers
7) household deleveraging / selling because you are forced to - many will do anything to avoid the decision to sell their home, and sometimes that emotion works to build an uglier situation down the road
Its hard to argue these forces although I am way less bearish today than I was only a year ago on Manhattan real estate because the process is happening. It must happen. It will happen. And we will get through it! I look forward to the day that I can say with clarity the worst is already behind us. For now, lets keep it real.
So General Growth Properties has gone tapioca! who cares? Goldman Sachs conveniently changes it's fiscal year and vanishes a dreadful month of December from it's financials, doanworryboutit! The market is set to open higher. From what I hear fast Eddie Hyman's ISI survey of professional money managers, (both hedge funds and vanillies) shows the pros have not supported this rally to any great degree, yet the market is as overbought as it has been in a year on a 12,26 week Moving Average Convergence/Divergence (MACD) basis (View image). It may not matter. Spring is here and people who spent not a nickel in September to December are coming out of their bunkers, gassing up the SUV and getting the barbeque ready for summer. Blood flow has returned to the economy, despite the fact that TARP accepting banks are lending less. (This trend can only get worse from what I see, but that's the subject for another post). For now things feel better because they aren't getting much worse. I personally sold a little bit of stock yesterday.....which assures that this rally will continue for a while.....and why can't it? We made it through the panic zone by printing a few Trillion $, no harm no foul.
But let's beware how comfortable we become. The banking system is still broke and getting broker, and if the General Growth bankruptcy is any indication, bank extensions of loans in search of some improvement in the economy or entry of rescue capital may be a "bridge to nowhere." (also subject for a future post) The States are broke and getting broker, their new bond guarantor the Oracle of Omaha is even said to be worried about insolvencies.
How do we turn an inventory replenishment cycle into a self sustaining expansion, with enough moxie to pay off our personal, corporate, state and federal debts? Some players think we can't....period.
I'm no conspiracy theorist. Although I admit to being long some Gold, In the past I have dismissed a lot of the Gold bugs rap by arguing that there physically isn't enough of the shiny metal to actually substitute for a reserve currency, even if the world wanted off of the dollar. But now it looks like even if they can't move off the dollar some of our global business partners are looking for a way to diversify away some of their billions.
According to the Financial Chronicle of India, China and India are pushing the IMF to sell its $100B gold hoard over the next 2 - 3 years.......to help impoverished nations. That's a good one. How about? Hey IMF we want to buy all your gold so we can hold less dollars, Jay Aron is our commodities broker, let's do a trade.
I don't expect to make any money in Gold over the next few months.....but I'm a buyer on the weakness.....I think I may be in good company.
A buddy of mine from an old New York City real estate family recently returned from a trip to Florida. He's been quite bearish on all things real estate having sold much of his family's multi-family portfolio in New York City over the last few years. He has kept busy since, helping others do financings across the country and has had a ringside seat to the unfolding debacle. He has been ahead of me most of the way through this in predicting massive commercial real estate losses and an eventual mass expunging of debt through the foreclosure and REO process. He called me today and said "have you heard about the Miami Falcons?" Now I'm a football fan, but not a fantasy aficionado. Surely I hadn't missed news about the Atlanta franchise relocating. "No" he said, it had nothing to do with football. "The Falcons are the only tenants in the penthouses of all the new empty luxury towers in north Miami Beach. They hang out on the roofs looking out at the nature preserve for rats to swoop down on."
Well I've been doing my own Falcon routine here in New York, working on a catalog of zombie condos that could potentially make good rental buildings if purchased from the bank financiers at the right prices. The theory being that any condo project that has not sold out and closed on a substantial number of their units as of today is in grave danger of becoming a zombie. A zombie being a condo, where some of the units have actually closed, but the condo developer is likely to default on their construction loan: the bank is likely to come in and take over the building and rent up the unsold units, finally selling the building to an investor, who would run it as a rental until such time as value could be maximized by selling the rest of the units.
The problem with partially sold condo projects today is threefold: first, many folks who have not closed on new condo purchases are trying to get out of contracts; second, many units won't appraise at the contracted value (and therefore will not be eligible for mortgage financing or will have to be re-negotiated by the sponsor) and lastly, with Fannie and Freddie no longer allowing conventional mortgages in condominium buildings in which less than 70% of the units have been sold, most lenders for jumbo loans have taken the same tack, essentially killing any projects in this position. I'm not finished with the project, but enough of the results are in to report back a couple of findings. To cut to the chase for those of you who don't want to geek out on the varied aspects of the data; there are not that many zombie condos lurking in Manhattan's future from the analysis I have done so far. However, those that do exist had high expectations for sell-out prices and significant amounts of leverage employed, such that however their situations are resolved....it's gonna leave a mark on someone's balance sheet.
With that, first some background on my methodology. I went back and got all the condo filings for Manhattan for the period June 2007 to June 2008. My thinking being that in order to market a condo you had to make your condo filing, and only a developer who had gotten their construction loan and was somewhat into the process, would spend the money and go through the trouble of filing their condo plan.
At the outset of my work I spoke with an attorney from one of the biggest New York law firms about the condo filing process....she judiciously requested to go nameless, which I am sure her very large and active clients will appreciate her for. I was told that while a sponsor must file their condominium offering plan in order to begin signing contracts, this does not in any way suggest that ground has or will ever be broken. On the other hand, a significant amount of construction may have taken place before a filing is made. Once 15% of the units have been sold, the plan can be declared effective, but it doesn't have to be until 80% of the units are sold.
So here are the early results. There were 182 residential condo filings made in Manhattan between June of 2007 and June of 2008 and recorded in the city's database system. These filings do not guarantee that the project was a new ground-up development as many were conversions from rental to condo, and many of the filings were not initial filings (the city's database is something of a blunt instrument and you can't really screen for initial filings). So while 182 sounds like a big number, not all of these were "brand new" projects. Additionally, the median number of units in these buildings was 16, and the average was 55. Notably, a few very large projects drag the average number up significantly.
Of the filings that were made over the period, price expectations were only included in 141 of them. This is likely because a good number of the filings were not the initial filings, but were supplemental filings; in some cases when prices were changed the expectations were included, in other cases where the filing was for other reasons, they were not. In any event the mean price per square foot expected was $1,134, with the median at $1,200, suggesting some very low-priced projects were skewing the average down. Now please understand that these filings were from all over Manhattan from Harlem to downtown. It is still interesting to note that the $1,000 per square foot threshold is increasingly being breached to the downside even in more desirable neighborhoods in Manhattan, according to recent reports.
Now for my purposes - targeting potential bank REO - the acquirers will be looking to value these projects as rentals. There are two issues here. I previously discussed the dire consequences for valuations that this perspective implies in my piece Zombie Condos: Day of the Charge-Off . Suffice it to say, that values of rental properties are way lower than condo project values and generally way lower than construction costs (that's why very few people can afford to build rental buildings in New York City). Secondarily, an acquirer is really going to look for a project with enough scale to make managing the asset economical. So only buildings with 40 or more units are really worth looking at (give or take.....don't anybody get mad, of course smaller guys who are willing to roll up their sleeves and manage the properties personally can go much lower). There were only 48 developments with this kind of scale. Of the 48 developments of scale, I narrowed the field further (actually Noah did the work for me here) by eliminating those where the New York City MLS system showed that more than 70% of the units had been closed. I also eliminated projects by the city's very largest developers, who I expect will not be forced to cough up their projects regardless of how underwater they currently appear.....to be sure, some may choose to "give back the keys" anyway, but I'm not assuming that. This process left 26 potential target properties. I was able to use the city's database to find out what the outstanding debt was on these properties. This requires a somewhat torturous odyssey through various mortgage filings. In my short experience looking through mortgage spreaders, blanket loans etc, etc., I believe that my data reflect the minimum debt on these properties and that in many cases the total debt may in fact be greater than what can be easily identified. Interestingly, the debt per square foot of residential space averaged $515, with a median level of $441, reflecting a few highly levered projects, dragging the overall average up.
Now I know of a few projects that are in progress, and are so far along that the structures will be finished, that did not fall into my screen of condo filings between June 2007 and June 2008. I am therefore going to bring my study of condo filings up to current day over the next few weeks. I will report if I find anything radically different. I am also going to study the zombies of Brooklyn, which I'll bet promises a lot more gore.
Guild Partners is working with real estate investors interested in distressed opportunities in New York City. We even have access to a new "Real Estate Falcon's Line of Credit" that can get building owners set up to make cash bids on opportunities that raise their heads without having to go to hard money lenders or wait for traditional bank credit approval processes. Let us know if you're a Falcon! (we prefer the graceful raptors to vultures anyway).
I told myself I wouldn't do this, but what the hell! I added a DIGS on TWITTER to the right side of urbandigs.com, underneath the Data Widget + Floorworks NY ad. I will add updates when I can (not annoying ones I promise) and it will only show the last update. This is like a test to see if anyone is interested. I must admit, when I first heard of twitter people told me, "you microblog, 140 characters or less, about what you are doing every minute of the day". My answer, 'who the hell cares'! I still kind of feel that way, but Ill try.
I will twitter about random thoughts for possible discussions I will write here on urbandigs, plus what I am hearing about the markets or trading for that particular day. If I hear something juicy, Ill add it to the twitter thingy. If I hear about something in regards to Manhattan real estate, Ill twitter that too. Anything that I think is remotely interesting. I will not twitter that I am about to shave, or that I am about to get a haircut; I would need hair to be able to say that.
Anyway, if you want to FOLLOW ME ON TWITTER, click the link! Ill be back in few hours to write today's post.
A: Yes, everybody knows the banks are having a killer quarter with a zero interest rate policy in place, a refi boom, and backdoor counterparty bailouts from taxpayers to the banks via AIG - how could banks NOT have a monster quarter. Wells kicked off the earnings season with a nice surprise, and I'm sure JPM/BAC/GS will follow suit with monster earnings as the week goes on. The stocks flied on a percentage basis because of the incredible plunge that the sector has dealt with since the beginning of this crisis, and instant clarity is provided for very near term! But is the worst really behind us? Are future loss provisions being set aside for what may lie ahead? Is this a one-time bump or a sustainable recovery in banks earnings? A few questions we must ask ourselves: are defaults starting to decelerate - are defaults spreading to higher quality debt classes - are banks taking the proper loan loss provisions to cushion against future losses ? T2 partners has its latest report out showing us some graphs of what lies ahead; hat tip Rolfe @ OptionARMageddon.
Now, before we look at some of these charts we must put some pieces together that are actually favorable. Mainly, there is a refi boom going on right now that is helping all those with resetting ARM's or other adjustable rate products to lock in at a much lower rate. So, the damage that is priced in for some of these Option ARM's + the refi boom may paint a rosier picture than what these charts suggest. Besides, I'm not worried about the reset, I'm more concerned with the recast of the loan that will bump up minimum monthly payments for those with higher loan principals than from origination; yes, there are many of these out there. So while the lower rate helps, what happens when the recast kicks in? The prime, alt-a issues, HELOCs, jumbo prime, CRE, credit cards, auto loans, etc..that is a different story - this NEVER was just about subprime:
When taken separately, this chart shows you how subprime sparked the credit crisis. Now that the fire has been raging for 18 months, higher quality debt classes are starting to kick in - spreading the fire around:
This is where fed policy can only do so much. The system is being gamed to help the banks (recapitalize & steepen) right now, with the hopes that earnings can help recapitalize balance sheets enough to comfortably absorb future losses. But how does this stop the debt snowball that already rolled down the mountain - it can't! As bank equity prices surge from the euphoria that comes with 'worst is over' speeches, watch out for capital raises! Goldman Sachs already started the trend with an announcement that a shareholder dilutive capital raise is likely to help pay off TARP funds. So while the capital raising is highly dilutive to shareholders, the euphoria of being free from government and free from capital assistance seems to trump the concerns that may still be in the pipeline - the stock may continue to rise w/ their earnings expected to destroy consensus estimates. In fact, as each bank comes out and re-iterates how great the quarter was, all logic as to why the quarter was so great goes out the window and the bull market equity party drinks get passed around (momentum trading, short squeezes, institutional moves all could power a rally much further than most think possible - stocks will move in the direction of least resistance until it doesn't anymore). Who cares why or what may lie ahead, lets PARTY! BABY!!!
Just beware of the kool-aid and the nature of this crisis. Are the banks setting enough provisions aside to account for expected future loan losses? This was the basis for Mayo's report last week that there will be another wave of bank pressure ahead of us as other areas of banks' balance sheets continue to deteriorate. Ask yourself, is the world really all better again? To look at these charts, no, it isn't and we have a few more waves of this credit tsunami still ahead of us. That is NOT to say these charts reflect what is happening now (a refi boom) and that what may look ugly in a chart may not turn out to be so ugly in reality. But clearly we see there is nothing to get too excited about here and caution is in order when predicting sustainable or accelerated future growth prospects.
The MEW (mortgage-equity-withdrawal) powered economy is now behind us. What is left is lower asset values for people's homes and higher debts on consumer balance sheets (shown below). This must be repaired before any sustainable economic growth is to be expected. See for yourself the path we led ourselves on:
This is all part of a larger process where deleveraging/unwinding/writing off of debts reigns king. Its not a fun process, but a necessary one when you take into account where we came from, and the system in place that allowed it to occur. We are not out of the woods yet, and we must wonder how the banks are preparing for future loan losses with the great quarter they seem to be having. Many people have been burned by the banks' 'adequately capitalized' forecasts and 'contained losses' speeches in 2008; now that they are actually making money, we must be a bit creative when we look ahead and see if this is sustainable and the worst is really behind us! I don't think all is well again, yet, as it is just too early to declare anything with certainty for the above noted reasons.
We recently had a reader inquiry about the New York City retail market and its impact on building revenue in co-ops. Back in February, Crain's ran an article about how rising maintenance charges were impacting Coop and Condo owners. According to the Crain's article "Income derived from renting retail space and levying charges on unit sales is plummeting, and the number of owners defaulting is starting to rise". Faith Hope Consolo of Prudential Elliman, a dean of New York City retail leasing was quoted in the article commenting on the big spike in retail vacancy rates in Manhattan residential buildings, so I decided to catch up with her as well as Cushman Wakefield's Gene Spiegelman to get an update.
First let's go through some macro statistics:
According to Marcus Millichap's recent 2009 National Retail Report, New York City ranked 6th among major MSAs down from 4th in 2008, in their National Retail Index, which ranks cities by 12-month forward looking supply and demand indicators. These factors include forecast employment growth, vacancy, construction, household formation, retail sales, rent growth and an analysis of local housing market conditions. San Diego (1), San Francisco (2) and Portland (5) are reported to be long-time supply constrained markets. New York has likewise been considered a supply constrained market for time immemorial. It is for this reason that Marcus Millichap believes that New York City will experience less draconian rent declines than most other markets nationally. Specifically, Marcus & Millichap writes "Job cuts in banking and finance will weigh on property performance in New York City (#6), but supply constraints continue to restrict construction keeping vacancy in check and supporting one of the more modest rent declines in the country this year".
CoStar Group just put out their national Q1 retail real estate trends report. Trends across the country are somewhat bleak, with negative absorption (net move outs) of 23.8 million square feet, versus positive absorption (net move ins) of 22.9 million square feet in Q1 of last year. According to CoStar, 60.3 million square feet of new retail space is under construction nationwide. The average total vacancy rate is 7.2% at the end of the first quarter, the highest since CoStar started tracking data in 2000. The vacancy rate rose 50 basis points quarter-to-quarter and 100 basis points year-to-year. As far as New York City goes, it was cited as the city with the lowest average retail vacancy rate nationally at 2.4%. Further, New York City was one of only 5 markets that notched a decline in vacancy rate in Q1, down 22 basis points. However, New York City did make last place in the top ten rankings for markets with new retail space coming to market with 1.49 million new square feet. Unfortunately for New York City, Northern New Jersey and Westchester/Southern Connecticut, with which the city vies for retail dollars, ranked numbers two and three for new retail space additions at 5.4 million square feet ad 3.6 million square feet respectively. Interestingly, a recent Real Deal article cites a Prudential Douglas Elliman estimate of retail vacancies citywide hitting 12.4 percent this year, versus 8.7 percent in 2008. I confirmed with Faith Hope Consolo that those numbers are for the five boroughs, with Manhattan being below 10% (still reflecting a healthy market, though weaker than what CoStar is implying). With regard to the weaker retail trends in the boroughs, a recent survey by Congressman Anthony Weiner's office found a 14.1% vacancy rate in Brooklyn, a 12.2% vacancy rate in Queens, a 9.7% vacancy rate in Staten island and a 9.1% vacancy rate in the Bronx.
Considering, Manhattan's relatively better retail performance than much of the nation thus far in the economic downturn, it is not surprising that I found both Consolo and Spiegelman in the glass half full camp on Manhattan retail. Much more importantly to Urban Digs readers, neither believed that retail rent declines, however severe, would be a significant burden to significant numbers of coop and condo owners in Manhattan, for several reasons.
According to Consolo, the old 20% rule, which limited the income of cooperatively owned real estate corporations to 20% from non-residential real estate activities - if they wanted to be able to deduct property taxes and mortgage interest from their taxes like other residential real estate owners - had a couple of impacts on retail real estate in coop buildings. The first is that some buildings made the choice to turn their retail units into condops and sell the units to outsiders, thus relieving themselves of the issue and bringing in a one-time cash injection. The number of buildings that did this was said to have been small, but they had good market timing - better lucky than smart. Future maneuvers of this nature were rendered unnecessary recently due to the Mortgage Forgiveness Debt Relief Act of 2007, which created several ways for coop buildings to get around the 20% rule (read here). The second and more important impact was that for many years coops signed long-term leases of 20 - 30 years in duration at below market rents and often without significant annual inflation adjustments. Many of these leases are now coming up for renewal. It is true that the timing of the expiration of many of these leases could be worse for the retail tenants (like 18 months ago). Consolo recently saw one expiration where the coop was charging $50 per square foot in a $300 per square foot market. In this situation, current softness in the market seems beside the point.
Away from the market distorting impact of the 20% rule, retail around Manhattan though soft, is by no means dead. Gene Spiegelman, of Cushman Wakefield, believes that we are too early in the cycle for retail to really make a firm judgment on how low rents will go. According to Spiegelman, "retail rents actually held up well through 2008, but since New Years, you have seen a big decline in leasing velocity". He thinks it's still hard to say exactly where rents settle out, with most transactions he is seeing still in the proposal phase. Spiegleman makes an important point regarding the difference between the office and retail asset classes. Office space is much more of a commodity so when space comes back on the market through sublets deals pricing gets hammered across the board. In retail, location is critical and product is by no means a commodity, additionally since landlords often participate in the success of tenants businesses through percentage rents (a piece of the revenue driven by the retailer), the leases have very specific limitations on use, requirements for signage etc. As a result, although about 25% of the space currently available is for assignment or sublease, it does not have anywhere near the corrosive effect on rents that subleased space has on the office market.
Spiegelman notes that retail south of 96th Street remains supply constrained and that there is significant contrast between various Manhattan neighborhoods and even more so the boroughs. Spiegelman offers that 3rd Ave between 57 - 79th street has seen availability tick up, but it's still at a somewhat reasonable 7 to 9%. Fifth Avenue is still very supply constrained and one of a couple of locations worldwide where retailers feel they have to be to be an international brand. However, where this drove rents to $2,300 per square foot at the peak, they may settle back to $1,500 to $1,700....still incredible numbers, but I would note a near 35% decline on the lower end of the range. Broadway between 59th and 86th Streets, is still holding at a 5 - 6% availability rate, and SoHo still holding at 7 - 8% despite a speedy turnover rate in that boutique driven market. Surprisingly, the posh Madison Ave shopping district, famous for shishi designer brands saw availability hit 13% in mid 2007 and stay there, versus a normal 6% to 7%. Apparently, as with apartment prices, luxury retail seems to be taking on the chin harder as people trade down. Some have attributed this in part to a Madoff effect.
Consolo also commented on the "trading down" phenomenon, but noted that lower rental rates are enabling lower price point retailers to get into New York City for the first time. As a result she sees a dozen new openings for every chain store closure. Sure Circuit City and Virgin MegaStores are closing, but the likes of youth retailer Forever 21, who is replacing Virgin in Times Square, are coming into these sought after slots. She sites the opening of the city's first JC Penney in the moderate price category as another example. Teen retailing, which remains a relative bright spot has kept Hollister (recently took down 20,000 square feet at Houston and Canal), Zara and Mangos (new Lower east side unit) rolling out new stores in the city. Newcomers like Topshop of the UK are absorbing large blocks of space including 40,000 square feet of space in SoHo for 1 of 3 new stores planned this year.
The Wall Street Journal had a piece yesterday on the Chicago's Magnificent Mile, discussing the increasing vacancy rate on Chicago's major retailing thoroughfare. One longtime retailer was quoted as saying "The stores that had declining sales but wanted to keep a presence for marketing purposes are rethinking their strategy". Fortunately for New York City, the conflict between the need to have a marketing presence in the "world's capital" is not in conflict with the need to generate profits. According to Consolo, New York stands apart from Rodeo Drive, Worth Ave and the Magnificent Mile, in that the sheer density of the New York City population drives sales per square foot much higher than in any other area of the country and allows profits to be generated even in a poor economy. For this reason she believes it is even more recession resistant than any other prime retail location in the country.
Even the retail banking industry appears to be pulling back somewhat less than expected in New York City. Spiegelman offered a couple of comments on bank branch consolidation fears which he sees as having been a bit overblown. According to Spiegelman, banks had been consolidating space for the past 2 years and the combinations that have happened are less negative than some that were contemplated. My piece on potential bank branch blight which considered the impact of a Citi/Wachovia deal and Chase/Wamu marriage was a bit premature. With Wachovia going to Wells Fargo instead of Citibank, there will likely continue to be branch growth in that system, versus overlaps and closures. While JP Morgan is closing some Wamu branches, many of those will actually be mid-block locations and not the coveted corner spots. Meanwhile, Citi, TD and Doral Bank continue to expand, he even goes so far as to say that the banks are being careful not to give the public the perception that they are widely shuttering branches.
So at the current time, while a lot has been made of the "missing teeth" that darkening retail windows resemble in some buildings, the market does not seem to be in a complete meltdown, like office, hotel and new build residential. I admit to leaning towards the pessimistic in most cases of late (which I think has served my prognosticating well thus far) due to my overall concerns with the economy.
That said, although retail is normally supply constrained in New York City making it a "demand driven" market as it is in the hotel, office and residential market. We know that weak demand can still cause significant downturns even in the "greatest city on earth". To wit, here is a little reference to history in the form of some text from a New York Times article circa mid-1988, after the last Wall Street debacle gave unemployment a big boost.
AFTER almost a decade of heady growth, store rents in many Manhattan neighborhoods are beginning to decline as landlords sitting with large blocks of space grow nervous.
The leading broker of retail space in Manhattan, Garrick-Aug Associates Store Leasing, reported a 24 percent drop in average negotiated rents between the second half of 1986 and the same period in 1987. Since then, average rents have continued to slide - especially along such trendy stretches as West Broadway and Columbus Avenue - despite stability within a few retail districts.
''Landlords today are concession minded,'' said Charles Aug, president of Garrick-Aug, ''whereas a couple years ago their attitude was: You better rent the space now, without any concessions, because it'll be more expensive tomorrow.''
The jury is still out on just how bad retail in Manhattan will get. At this point the impact on coop and condo cash flows seems to be minimal. Retail is certainly worse in the boroughs and will undoubtedly have some impact on mixed use properties there.
From the Blogosphere:
Manhattan Rents Slide Down
Help for Atlantic Avenue Retailers To Keep Storefronts Open
Brooklyn Stores Hit Hardest By Retail Slump
Buyers Are Precious on Retail Strips
Banks' Rental Sanity
A: And the dance continues. Remember, its not just a subprime problem but an overall debt problem covering commercial MBS, HELOCS, credit cards, auto loans, option arms, cosi/cofi neg am loans, alt-a, prime, jumbo prime, lbo's, etc..As Mike Mayo mentioned yesterday, as one area of the banks balance sheet is cleansed, another seems to deteriorate faster reflecting a 'rolling recession by asset class'.
Via Housingwire.com, "S&P Warns on CMBS; CRE Bust Here?":
Standard & Poor’s Ratings Services warned Tuesday morning of a coming slide in commercial mortgage-backed securities, as the economic recession appears set to take a bite out of one of the few remaining real estate asset classes to survive much of the turmoil in financial markets worldwide.Reality sets in. Only last week did we witness the John Hancock Tower in Boston foreclose and sell at auction for a 65% haircut -
“Since September/October 2008, Standard & Poor’s has witnessed significant deterioration in the credit performance of the CMBS transactions it rates,” said credit analyst James Manzi. “The economic recession combined with the absence of readily accessible financing in the capital markets has, in our opinion, skewed the credit risks related to the performance of CMBS sharply to the downside, and in excess of what we expected at origination or in our prior scenario analysis.”
“Recent-vintage CMBS fared the worst in the analysis, with the 2005-2007 vintages posting PLLS in the double digits,” said Harris Trifon, a credit analyst with S&P.
MISH - "...This property sold for $1.3 billion in 2006 and $935 million in 2003. Today's price is $660 million, a 50% haircut. But that's only part of the story. A friend writes "Don't forget the value of the financing that Normandy now gets to assume: $640 million mortgage at a rate of 5.6%. Thus the real price the Hancock sold at foreclosure is more like $470 million not $660 million. That is a 65% haircut in three years."Calculated Risk discussed the plunging MIT CRE Price Index early in February:
Transaction sale prices of commercial property sold by major institutional investors fell by more than 10 percent -- a record -- in the fourth quarter of 2008, according to an index developed and published at the MIT Center for Real Estate that also posted a record 15 percent drop for the year.CR follows, "The price declines will impact property owners who are now underwater and can't refinance, and also impact banks and other investors in CMBS who will experience see higher default rates. The coming decline in non-residential investment will impact GDP and construction employment, but that decline will probably not be as severe as after the S&L related boom."
The 10.6 percent drop in the transactions-based index (TBI) for the fourth quarter is the largest quarterly decline in the gauge's history, which dates to 1984. The previous record was a 9 percent drop in the fourth quarter of 1987. The 15 percent fall in 2008 is also a record, topping the 10 percent and 9 percent declines in 1992 and 1991, respectively.
Richard Parkus, head of CMBS research for Deutsch Bank, released his 2009 Commercial RE Outlook and offers us this doozy of a chart showing aggregate CMBS delinquency rates visualizing the performace of this sector:
So lets see here: prime is starting to deteriorate faster than subprime, Jumbo prime faces $241 Billion of downgrades, lawyers are reporting of CRE deals falling apart mid-stride, office rents are falling and vacancies are rising, delinquency rates on more than $700Bln of securitized loans backed by office buildings/hotels/stores/other more than doubled since Sept 2008, and now S&P warns of the worse-than-expected credit deterioration of CMBS. Well, at least Jim Cramer said the depression is over, so, look away, nothing to see here!!
A: Interesting reading that this blogger can certainly relate to. Telling it like it is in Manhattan is a tough thing. You see the brokerage industry is a sales industry that plays the role of a service industry on TV. Our job is mostly service based, but the fact remains that we only get paid if/when we close the deal! We do not get paid up front to provide a service independent of the overall decision. Rather, we work for free in the hopes of earning our commission at the close of the deal (the sale). So, we have a vested interest in getting that deal done no matter how the near term outlook on the market you are buying/selling in appears. That is the root cause of the lack of trust and the deteriorating reputation of the brokerage industry. When times are good, sales volume is high and fees are made. When times are tough, sales volume is slow and fees collected drops. No sales industries like bear markets. So, to hear that a brokerage firm advised their agents not to talk about what is going on in this market & pull a publication that is trying to report on real time trends, proves to you what the agenda is - paint a good picture & get that sale! Thats fine by me but if you want to keep it real without bias, you keep it right here at UrbanDigs! The fight for transparency is ON!
Publisher's note from The Real Deal (via Curbed):
From the April issue: It has come to my attention that the principals of two firms have advised their brokers not to cooperate with The Real Deal's reporters and have pulled the magazine from some of their offices. We always knew we had a tremendous impact on the city's real estate industry, but this came as a surprise even to us. When we talked to the principals, they essentially said they didn't like that we weren't sugarcoating what's going on in the market. So let me set the record straight: The Real Deal covers the New York City real estate market more thoroughly and accurately than any other media outlet in the five boroughs. Maybe these principals would prefer if we wrote about how many Girl Scout cookies brokers are buying and how great the market has been this month. But that wouldn't be fair to our readers, because we have a responsibility to report what's actually happening in the market — even when it gets ugly.I don't know the conversation or the firms that caused such a response over at TRD, but I do know that brokers have earned a reputation of babbling, sugar-coating, bait & switch, and pretty much any tactic that is associated with a sales based industry. But should all brokers be subject to such a generalization?
Here in Manhattan there are many agents that are honest, ethical, tell it like it is, and out there to fully service their buyer/seller clients - understanding that good service is good business which produces sales. But we also know there are many more mired with their own agenda to see with any clarity, what is actually happening in the market they sell in.
In my opinion, there is nothing wrong with telling it like it is because in the end the market is bigger than all of us media folk! The market will do what the market wants to do, and even the fed and the treasury are powerless to change it. Haven't we all learned this by now?
Therefore, knowing this, it's just a matter of what level of service any buyer or seller is looking for. Maybe a seller is looking for an agent that has no problem 'testing the market' even in this environment. Maybe a buyer already decided to make the purchase, but they want to get their friend who is a broker involved to get some action! Maybe a seller really needs to sell and is looking for cut-throat advice/consulting in terms of pricing and marketing. Or maybe the first time buyer just wants an agent for emotional support, and guidance through the stressful process of buying and closing on your first home. The needs vary so greatly. Not everyone wants to buy the bottom or trade this market like its a game. There are buyers at every price!
I just view the market as a trade, and I write about what I think here. I talk about trends, macro, future possibilities, unintended consequences, etc., all in an effort to try to put the pieces of the puzzle together as fast as possible to see what the picture may be. Where will the trend go? Thats what interests me. So I talk about it.
If the market is slow, if the news ain't good, if the jobs market is weak, if the taxes are being raised, if the auctions are coming, if the sales volume nosedived, if the bids are low, we should be able to talk about it. Clearly, TRD feels the same way. They write the good quotes and the bad ones. When I talked about how I felt this recent pickup is only a countertrend surge embedded in a larger correction, they broadcast it. Transparency is good, and honest consulting has a place in this brokerage industry. If the big boys fail to see that, and continue to steer towards sugar-coating, they will insult the intelligence of the very customers they are trying to service! It's time we all suck it up and have the courage to address the issues we face, because trust me, one sugar coated line from a broker is NOT GOING TO CHANGE THE COURSE THAT THE MARKET IS DESTINED TO FOLLOW!
A: This latest equity rally is bringing with it the normal amounts of hope and euphoria that the 'bottom is in' and 'the depression is over'. First off, we had a depression only once in the last 100 years and that equity bear lasted 3 years (14 months for us so far) and the economic side effects another 5-6 years after that. If this is a depression, no way its over now. Second, lets stop trying to declare that whatever we are in is over when we do not know how unhealthy the banks are, how gov't programs will work, how many good assets will eventually start going bad, and how corporate America/consumer will handle the very weak jobs market, higher savings and personal deleveraging to shore up balance sheets. Let us at least admit that there are simply too many uncertainties to declare anything with certainty right now. Mayo's note out of Calyon Securities, reminds us that while the bad assets are taking all the headlines recently, their is a growing trend of deterioration in the good assets - and the jumbo good stuff too! This has never been a subprime-only crisis, rather a broad overall debt crisis that encompasses higher quality debt classes too.
I think the stock market got the severity of this crisis priced in correctly, but I'm not sure they have the length of the problem right. Why? Well, while the PPIP program works to cleanse the troubled banks balance sheets of legacy whole loans & securities, what happens about the good stuff ("...spreading of toxicity to higher quality debt classes as more performing loans deteriorate") held? What if that starts to go bad? I mean, after all we have been through, are people still out there keeping their head in the sand that higher quality debt classes are unaffected by this slowdown?
Bloomberg states, "Mayo Says Loan Losses Will Exceed Depression Levels":
“While certain mortgage problems are farther along, other areas are likely to accelerate, reflecting a rolling recession by asset class,” Mayo wrote. “New government actions might not help as much as expected, especially given that loans have been marked down to only 98 cents on the dollar, on average.”Not sure how he confirmed that the whole loans were only marked down to an average of 98 cents on the dollar, but from what I am hearing many of these loans are marked down more and sitting on 'accrual (hold) books', which are marked on the spot based on loan defaults and overall book performance - you are not selling, so mark-to-market is meaningless. By the nature of being a hold book this is nothing new, illegal or other - just how it is. Loan loss provisions are done on a quarterly basis, not as assets stop performing.
If the total loans in the book deteriorated 5%, well then the entire book is remarked down 5% from the previous mark or par. It's backward looking. In this regard, Mike Mayo is correct to assume future adjustments because only the eternal optimist would think that higher quality debt classes are completely unaffected by this slowdown; heck the low bids for these loans are telling you that there is downside risk not priced in properly. So it is fairly safe to say that whole loan books considered good with no plans to be resold in PPIP, are behind the curve in terms of their current market value and present a valid concern for the future. In addition, if banks are allowed to suspend mark to market accounting on these loans and carry them at par or close to it then PPIP will have no influence since there will be no upside for the banks to take something off the books.
Moving on to the point, while one toxic area of the banks books gets cleansed by PPIP we should expect another area to start increasing in toxicity due to the nature of this crisis. Bankruptcies are rising, unemployment is rising, consumers are cutting back, banks are rolling back credit, everything is tighter, and for many, borrowing costs are rising (or at the very least, not falling as much as you would think given all fed's actions) due to the deterioration of credit quality as a result of the current environment. The core of the crisis is causing a loop whereby one stage feeds from another.
To get through this crisis we need good old fashioned withdrawal from the drugs that caused this whole mess (using debt to solve a debt problem seems very stupid to me) - unfortunately, its not politically correct to 'bring on' the symptoms of withdrawal to the very people that elected you into office. Last I checked, for most people their job security has deteriorated, incomes were pressured or lost, and yet the debt obligations remain. So we need to let the bankruptcies and restructurings occur so that the banks have sounder entities (consumers & corporations alike) to lend to - and occur it will! As it does, the banks need to take the writedowns, stop hiding the bad stuff, stop refusing to mark down the good stuff, then recapitalize and restructure to the new world. By hindering one of the steps in this 'cleansing' process, you increase the likelihood of having zombie banks infected for years - prolonging the duration of the economic slowdown because of the adverse feedback loop created when banks cut back on credit, instead of expanding it. Its a lose-lose sure, but one scenario gets it over & done with at a sharper pace, and the other strings the process out for many years.
Its not that equities mis-priced the severity of this cycle, rather, I think they have not correctly accounted for the length of the crisis for the above noted reasons.
I apologize for the error in the UrbanDigs Manhattan Data Widget that is powered by Streeteasy.com. It seems a significant amount of addresses became 'hidden' on listings based on changes in some feeds. As you know, the widget that displays data here has some internal rules to add to the accuracy of the data, one of which is that only listings with exact addresses are included. This excludes open listings that are usually advertised as 'W 70s Condo' or 'UES Lux New Dev 1BR', etc..
Rest assured, the SE team is on the issue and hopefully data will be back up soon. Sorry for inconvenience. To answer many questions that I received via email, NO, a foreign buyer did not come in and scoop up 1,300 listings overnight!
If all goes well, UrbanDigs 2.0 will be launched by 4Q of 2009 or so with many new upgrades for monitoring the real time trends in Manhattan real estate. It should be wicked cool, but it will take time to build correctly.
A: I usually don't report on these numbers anymore because the financial blogosphere is filled with discussions on it, and I try to keep the focus here on Manhattan (by the way I'm checking on the total inventory widget # that seemed to drop by 600 today). But it was something that Bill Gross of PIMCO was just discussing on CNBC when talking about the jobs report and the recent rally that motivated me to write this. He said, '...we are in for a NEW NORMAL'. I don't normally plug the guy at the firm who is going to be a major beneficiary of treasury/fed actions, but in this case he is exactly right. The new world is going to be much less sexy than the world we got used to over the past five years or so, just be prepared.
First off, the unemployment rate has spiked to a 25-year high if we use the U3 measure of employment; here is the visual on that:
But the U3 doesn't paint the entire picture because it excludes those who are working a part-time job but wish to work full-time and can't find one, and those disgruntled workers who simply gave up looking for a job altogether. That measure is the U6 measure, and that rate hit 15.6%. Bloomberg reports, "Unemployment in U.S. Increases to 8.5%, 25-Year High":
The U.S. unemployment rate climbed in March to the highest level since 1983 and the economy lost more than 650,000 jobs for a fourth consecutive month, a sign renewed reductions in spending might slow a recovery.Should GM be placed into a pre-packaged bankruptcy, the unemployment rate could tick up even more with the amount of jobs lost as part of a restructuring effort tied to the automaker and the residual side effects at the suppliers, dealers, etc.. I think I am on record for expecting the U3 rate to hit mid 9% or so by years end, and peaking around 10% or so. It's highly possible I have to revise that higher.
The jobless rate increased to 8.5 percent, as forecast, from 8.1 percent in February, the Labor Department said today in Washington. Employers cut 663,000 workers from staff, bringing total losses since the recession began to about 5.1 million, the biggest slump in the postwar era.
Back to Gross's comment on the new normal. Stages 7 & 8 seem to be IN PROGRESS now of the 11 stages of the slowdown discussed last October:
STAGE 7 (Early In Process) - Economic Data: This is where we start to see confidence reports really dive, GDP really contract, Unemployment really rise, manufacturing contract, etc..Time goes slow and it feels like these lagging reports don't ever get better.When STAGE 9 is upon us, regulation, we will see that, "The new world will be a lot less sexy than when credit was on its way to its peak." Just like Gross said this morning! Nobody likes a crisis like the one we are facing, and unfortunately the actions that are taken by treasury/fed/congress to stem this crisis could have unintended consequences that kick in right when things seem to be turning around. That is the reasoning behind STAGES 10 & 11 of the cycle. Let us be prepared.
STAGE 8 (Early In Process) - Mainstreet Blues / Saving / Capacity Reductions / Budget Crises: the real pain of job losses, and the slowdown hit the people. Time slows down and it feels longer than it is. However, this time it is likely to be longer than past recessions. Saving increases, and spending decreases. This makes the economic data noted above continue for longer than expected. The cycle feeds on itself for an economy that is driven 70% by the consumer. Capacity is reduced to adjust to the slowing demand. With the slowdown comes less revenue for cities and states. Traffic volume is down a record 5.6% in August as consumers cut out unnecessary spending/driving; driving costs money. The Terminator already called for a special session as California's budget shortfall surpasses $3Bln. It would be narrow sighted to think they are the only one in trouble.
A: And here we go. Lucky for UrbanDigs readers, you were prepared for this exact report way back in July of last year, when I said, "expect to see ugly year-over-year comparisons and average price drops starting in 2-3 quarters; I would say starting as early as 4Q 2008, but more likely around 1Q 2009!". Well 1Q 2009 reports are out today, and with that begins the media effect of a market that just fell off a cliff. The reality is, the market started experiencing a shift in buy side psychology (confidence) way back in late 2007, and low ball bids and cold feet in mid 2008. Of course, brokers would never talk about this but I'm sure they will join the party now to protect their credibility as 'market experts'.
Bloomberg reports, "Manhattan Co-Op Prices Fall Most Since 1995 as Demand Plummets":
Manhattan co-op prices dropped the most since 1995 and transactions for all apartments plummeted 48 percent in the first quarter from a year earlier as the recession and Wall Street unemployment cut demand.Any broker hanging on to the median rise of prices, fueled by closings of high end new developments signed into contracts way way closer to the peak of the market, simply doesn't get it. If you want to know how strong or weak a market is, take a look at sales volume, inventory trends, and where contracts are being signed. I can care less about what the market was like 12-18 months ago when deals were signed for pre-construction properties that are only closing today. We are at now now, and the past is meaningless. If Im going to consult for a buyer or seller, they need to know what is happening NOW! Denial doesn't help anyone.
The median price for co-operative apartments fell 22 percent to $587,500, according to a report today by New York appraiser Miller Samuel Inc. and broker Prudential Douglas Elliman Real Estate. The median for all apartments rose 3.1 percent to $975,000, led by sales of new luxury condominiums. The median price of condos, which account for about one- third of New York’s owner market, climbed 5.8 percent to $1.23 million, Miller Samuel said.
As Jonathan Miller accurately states, "Sales activity is the barometer for the health of the market -- not price". So how is sales activity in this great city? Slow. As Miller continues to state: Transactions dropped to 1,195, the fewest since the fourth quarter of 1994, according to Miller Samuel. That's about 48% lower than the 1st Quarter of 2008.
Folks, when the bid disappears this is what happens. For years brokers, buyers and sellers were used to a market with very tight inventory, tons of buyer demand, bidding wars, easy financings and closings, and quick deals. But where most go wrong is understanding how this world has changed, from that previous world that powered our markets from say 2003-2007 or so. It's all about the buyers, always has been and always will be. The seller can set the price wherever they want, but the property is only worth what a buyer is both willing & able to pay for it at any given point in time. So to really understand the markets and where its trending, we must do our best to go into the minds of those that make this market work, the buyers!
Today starts the negative media effect that I discussed a while ago. In both boom markets and bear markets, the media plays a role by enhancing the effect of the trend in the mind of the buyer. In boom times, there were articles discussing all those ever-lasting forces that were working together to make Manhattan prices go up forever with no chance of stopping. That helped to increase confidence in those buying real estate here, and even worked to bring in foreign demand and speculators to buy buy buy with no chance of a reversal in the trend. The result was tight inventory, high sales volume, bidding wars, and rising prices with each new sale. When the music stopped, the buyers went away and trend reversed. Now the headlines are working to further dampen confidence, and no doubt we will hear from sellers & brokers that the mass media is causing this downturn to go where it otherwise shouldn't. So, we will hear stories of how its a great time to buy, which happens to be the same sales pitch doled out when the market was at its peak. Ain't that something? I mean, is it ever not a good time to buy in the eyes of a broker or a brokerage firm executive?
The market will do what the market wants to do, and in the end you must understand that we overshot to the upside as a result of a parabolic credit boom that has now gone bust. Its very possible this market overshoots to the downside as well. Savvy buyers will be called 'vultures' and 'bottom fishers' for expecting a deal, and many will fail to see that this is simply a market where buyer and seller are simply not on the same page. Its tough on everyone involved in the transaction - the buyer that wants the deal, the seller that wants their price, and the broker that wants their commission.
Deals ARE happening and will continue to happen at every price as the adjustment plays out. Right now I would generalize that this market is trading around:
HIGH END ($5M+) - down aprox 25% - 40% from peak
HIGH/MIDDLE ($2M - $5M) - down aprox 25% - 30% from peak
MID END ($1M - $2M) - down aprox 20% to 30% from peak
LOWER END (Under $1M) - down aprox 15% - 25% from peak
This is where I see trades occurring today but unfortunately Manhattan properties vary so greatly in regards to the following features:
- Views / Exposures
- Natural Sunlight
- Monthly Carry Charges
- Building Amenities
- Building Policies
- Raw Space
etc., that it is virtually impossible to apply a single number to any single property and say that the apartment should trade there. That is the art of the buy side consulting process, taking into account where this market is right now and where this market might be trending.
If this is the active season in Manhattan and the sales volume is down 48% from this period last year, what do we expect to happen as we enter the slower months? Where will the bid be if you don't sell after May? What forces may affect buy side confidence as our local economy deals with the side effects of this crisis. What will happen with city tax collections from a very slow residential sales market? How will the income/bonus tax thing play out? How will an equity rally or re-test of the lows affect confidence/bids? How will condo auctions fare and how will buyers react to the fact that auctions are taking place in our backyard? How deep will job losses ultimately go as the wall street dismantling spreads to other local retail businesses? These are the questions we must focus on if we are to continue keeping it real!
All I know is that the process is taking place at great speeds, and I would not be surprised to see the bulk of the adjustment complete by this time next year. After that, a muddled L shaped market is highly likely for years as we as a nation deal with the unintended consequences of policy actions and over-regulation taken to both stem this crisis and ensure that it never happens again. I'm way less bearish today than I was 12 months ago now that the process has started and equities have adjusted. Manhattan prices will rise again but only after this correction plays its course, household balance sheets are repaired, excess is removed, and job security is no longer a concern. The future world may be a less sexy one, but that is to be expected after what we just went through.
A: Why not let it stand for that? Stocks are rallying ahead of the FASB 'mark-to-market' decision that will be made tomorrow. Equity investors are thinking that with relaxed rules and the PPIP plan, even if trades occur below current marks, it may not affect banks' balance sheets too greatly. The latest treasury PPIP, public-private investment program, is flawed because it allows a homerun for banks that are holding toxic assets to participate and buy their own toxic assets + bondholders of these troubled banks to participate to protect their larger investments from going sour. As Mish accurately points out, this plan does not increase lending, offer a fair market for valuing these assets, help the troubled homeowner meet debt obligations, or protect taxpayer interests. Lets discuss.
According to WebCPA, "FASB Caves on Mark-to-Market":
The Financial Accounting Standards Board has bowed to pressure from lawmakers and banking interests and put forward a proposal to relax fair value standards.It seems the market & banks will get what they want to help cushion the blow to balance sheets as price discovery continues and equities react positively. Perhaps we may even get markups. My thoughts? Just another temporary fix for the markets that further clouds transparency and makes it harder for investors to know exactly what the assets on the books of a company are worth. If a company is to be liquidated, how will anybody know the real value of the assets held?
The board has formally scheduled a vote for Thursday on the proposed revisions to the standards, but the outcome seems to be a foregone conclusion at this point. Financial institutions want the ability to avoid further steep write-downs on impaired assets such as mortgage-backed securities and the exotic but hard-to-sell financial instruments clogging their balance sheets.
Investors have good reason to be worried about the financial statements the banks will be issuing as a result of the changes. Banks will be able to start keeping the “other than temporary impairments” on their troubled assets out of net income and reclaim billions of dollars they had previously written down.
By changing mark-to-market, you can allow banks to value illiquid securities using models that may paint a very misleading picture. Kevin Drum notes:
"...allowing banks to value assets using models that can be tweaked so egregiously that they bear only the vaguest relation to reality. That's how IndyMac could claim it was "well capitalized" right up until the day it was taken over and shown to be a shell of its claimed self."But stocks are down, banks are hurting, and people want CHANGE! Unreal how easily the powers that be can be pushed. On to the PPIP.
The latest Geithner plan is the PPIP, so called public-private investment program that is a HUGE incentive for banks holding toxic assets. First let's break down the gist of the plan. The plan involves a 1-1 government match of private capital that is then levered up by the FDIC 6:1, to buy toxic assets at marks way higher than current bids. The FDIC loan is a non-recourse loan, meaning if the toxic asset purchased at inflated levels turns out to really be worth much less, well, the taxpayer is out of luck.
Those with a vested interest in cleansing their own toxic assets or protecting their bonds in a mismanaged company, will have GREAT interest in this regardless if the new investment pans out - the goal is to save bigger losses elsewhere. The taxpayer does not fit into either of these categories.
I referenced a Steve Waldman quote a week ago, on how the plan to rescue these banks from nationalization is a big saving grace for those holding billions of corporate bonds in these troubled institutions:
Steve Waldman - "Under Geithner's plan, PIMROCK's $10B permits a $10B equity investment from the Treasury. Then the FDIC levers the whole thing up, providing $6 of debt for every one dollar of equity. So, $140B of bad loans are lifted from J.P. Citi of America, nearly $90B of which is sheer overpayment to the bank.
Why would PIMROCK go along with this? Because they feel it is their patriotic duty to work with the government for the good of the financial system, even if that involves accepting some sacrifices. And because they hold $100B in J.P. Citi of America bonds, and they've received assurances that if we can get the nation out of the financial pickle it's in, there will be no haircuts on those bonds. "Shaking hands with the government" means that nothing ever has to be put in writing.
This PPIP concept helps get rid of the toxic stuff at more reasonable prices than the current bid, at the taxpayer expense and using FDIC leverage, while minimizing the risk to the private investor. The banks come out healthier and the bondholders are one step closer to be saved. Therefore, its a no brainer for those holding the toxic assets to participate as a private investor, get the government match, and then get the FDIC leverage to pay a higher than market price for these assets to get them off the books of the same players that are participating! Amazing what a little creativity can do right?