Banks Kick Commercial Real Estate Loans Down Road ~ Messages ...

Banks Kick Commercial Real Estate Loans Down Road

'; div.innerHTML = summary; } //]]> Finance : One of our big calls in late 2007/early 2008 was the disaster that was to be happen in commercial real estate. Many REITs since then have imploded 80-90%+ before rebounding to some degree as we rejoice over the solutions of flooding paper dollars in every direction, and into every orifice; or PPP as we like to call it. [May 19: Paper Printing Prosperity Defined] It's strange how the issues in commercial real estate - while still somewhat pressing for smaller regional banks - have been tossed out the window as if they are not material or won't matter. Granted, a massive lobbying effort to help the upper crust of society (and by proxy the financial oligarchs) was a "success"...

1. [Dec 22, 2008: Wall Street Journal - Property Developers Ask for Government Bailouts]
2. [Jan 13, 2009: Bailout Nation Continues in Commercial Real Estate Land - "Lemme In on that Money"]
3. [Feb 23, 2009: Fed May Need to Recast TALF on Commercial Real Estate]
4. [Apr 17, 2009: Surprise Surprise - Federal Reserve Succumbing to Commercial Real Estate Lobby]
   
5. And... victory ---> May 19: The U.S. Federal Reserve on Tuesday further widened its safety net for downtrodden credit markets by making older commercial property loans eligible for an emergency program.

... because if anyone needs our tax dollars its guys who have multi hundred million to multi billion portfolios of commercial assets. How they would ever be able to put food on the table without Joe6Pack ponying up is beyond me.

But there seems to be more at play here. There seems to be a very similar issue as is happening in the residential market. A lot of dragging of feet by banks to actually take property back even in cases of very long delinquencies. In commercial they are just "rolling it over" - kicking the can. In the residential market on the other hand, I've read a lot of anecdotal stories of people living in homes "rent free" for month, after month, after month - far longer than the "6 month-ish" that is typical for eviction notices. Part of it a system swamped by foreclosures but there is more to the story... after all if you want to keep up appearances as a "healthy bank" the last thing you want to is to bring back property on your balance sheet and therefore have to finally take the TRUE financial hit.

Since our accounting boards (FASB) sucumbed to government pressure in March and changed the rules, we can now mark to "myth" and as long as the property is not officially foreclosed, the banks can mark it at what they perceive to be a correct value indefinitely. To put it in simple numbers

1. Gave mortgage out in 2006 at $280,000
2. Sitting on balance sheet at some value X
3. Actual value today = $170,000
4. Proceedings in foreclosure = $120,000

So I can keep it at X on my balance sheet (inflating it) or if I do the actual foreclosure I have to take the $160,000 hit as I "admit" what the value of my "asset" is. I am simplifying this a bit, but that's the 40,000 foot idea. Now multiply that "whistling past graveyard" activity across millions of homes in the United States of Bailout.

So instead, as a bank - I want to show the world I'm "healthy"; I can calculate how many foreclosures each quarter I can actually take the hit on to keep up appearances, and only proceed on those. As for the rest? Kick that can! A lot of consumers are increasing their savings rate since they are sitting in homes month after month "payment free". That's one way to get the national savings rate up - millions with no house payment. Green shoots! And if those "savers" are even more *lucky* they can continue to live rent free until one of a multitude of current or prosposed government housing initiatives comes and showers them with taxpayer money. Another win / win / win (ahem). As long as you are creating a mirage of prosperity that is.

One of my favorite terms is "kick the can" - it is represenative of so many things in the country, political to individual. When you don't want to face an issue - just kick it. Far. It appears the banks are doing it - both in residential and now similar trickery is happening on the commercial real estate side. Rents going down? Tenancy flailing? All issues that should cause us concern? That's ok - here's an extension! Come see us about it in 2012 - we'll talk then.

Let's delve into the details.

• For the past six months or so, Wall Street has been bracing for what many fear may be the next shoe to drop on the already battered U.S. economy: a U.S. commercial real estate bust that could rival the housing market collapse.
• Yet, lenders have been keeping that shoe in the closet -- forestalling foreclosures by extending loans, despite rapidly rising mortgage default rates. "In today's environment, it's obviously not very attractive to foreclose on a borrower," said Matthew Anderson, co-founder of real estate consulting services firm Foresight Analytics.
• The U.S. commercial real estate sector has been grappling with a credit crisis that has dried up some of its most important sources of lending. That has left many borrowers unable to refinance maturing mortgages. Even when they can obtain financing, borrowers are often obtaining much less than they need.
• But banks have been loathe to foreclose on the mortgages and are extending them. "They're taking loans that don't have a cash-flow problem, but definitely have a valuation problem, and they're pushing those out to the future," Anderson said. Banks account for about $1.7 trillion, or half, of U.S. commercial mortgages outstanding.

Here is the key.. foreclosed loans as a % of nonaccruals is lower NOW than 3 years ago when the economy was "roaring". Just amazing...

• Yet foreclosed loans as a percentage of nonaccruals has been declining, down to 19.7 percent in the first quarter from over 30 percent three years ago, according to the most recent statistics from Foresight.
• The practice of extending loans has become so prevalent, it has earned its own catch phrases -- "push-outs," "kicking the can down the road" and "a rolling loan gathers no loss." (I love the last one)

Banks have many reasons not to foreclose.

1. First, it's an expensive processes.
   
2. Secondly, banks are not in the business of owning real estate. When they sell a property, they face the same distressed market their borrowers would face, leaving them saddled with more losses. They also have learned a "perverse lesson" from past commercial real estate downturns, Anderson said. After they dumped bad loans in the early 1990s, banks watched as buyers of the distressed loans, such as Goldman Sachs Group Inc's Whitehall Funds, made a fortune when the market rebounded.
3. Banks already are dealing with losses from other sectors, such as home mortgages and credit cards delinquencies. Pushing the commercial real estate problem further into the future may allow banks to be in a stronger position when they finally face the issue.

So it appears the problem is "fixed"... err..

• "Rolling it over does not solve the issue," Daniel Penrod, senior industry analyst for the California Credit Union League said. "But at this point, adding another negative to the current economy could be disastrous. If this were the only factor in the economy that was struggling, we could let it play out with all the other factors. Allowing it to catch its breath for six or 12 months may help shorten the current recession."
• Property values could fall should loan extensions not be long enough to give borrowers confidence that they will retain the properties. A three to nine-month extension could discourage a borrower from paying for needed maintenance and improvements.
• Postponing foreclosures may compound a bigger problem of loan maturities ahead. Some $270 billion to $275 billion of loans are set to mature next year. Ultimately, the refinancing of the rolled over loans may soak up the available capital at the expense of new loans.
• "If it continues, essentially for most of the next decade, we're really just going to be dealing with today's and yesterday's debt," Anderson said.

To conclude, some crazy old school thinking at the end of the article - the horror of such a concept ... to be whispered out loud in this day and age. Please avert your eyes.

• "If a borrower can't get additional financing, it should be foreclosed and liquidated," Parkus said.

*GASP*

[Apr 2, 2009: US Office Vacancies Surge, Rents Biggest Drop in 7 Years]
[Mar 30, 2009: WSJ - Commercial Property Faces Crisis]
[Jan 27, 2009: As Hotel Vacancies Rise, So Do Risks of Default]
[Jan 6, 2009: New York Times - As Vacant Office Space Grows, So Does Lenders' Crisis]
[Nov 20, 2008: Commercial Real Estate Finally Hitting Home in Financial Media]
[Nov 11, 2008: General Growth Properties Looks to Join Its Tenants]
[Jul 21, 2008: Add Mervyn's to Our Growing list of Retailers Heading to the Great Sunset]
[Mar 4, 2008: WSJ - Building Slowdown Goes Commercial]
[Dec 2007: Credit Downturn Hits Malls]

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