by Calculated Risk on 12/05/2007 01:00:00 AM

"The party is over"
Jerry Anderson, President, Irvine-based commercial real estate brokerage

From Jon Lansner at the O.C. Register: Commercial real estate ‘party is over’

Stan Ross, chair of USC Lusk Center for Real Estate ... said today that the nation likely will have a weaker economy next year, and “that spills over into the commercial sector.” Ross stopped short of predicting a commercial downturn. ...

Commercial real estate “will clearly be impacted” by a weaker economy, Ross said. “The question is how much and where and what products.”
...
Jerry Anderson, newly appointed president of Sperry Van Ness, an Irvine-based commercial real estate brokerage ... forecast an end to a 7-year-long boom, saying that “the party is over.” issued a prediction today that commercial real estate values will decrease by 10% to 12% next year. ... “It’s been a wild ride, but now it’s over.”

Historically non-residential investment in structures follows residential investment by between 3 and 8 quarters; with the normal lag of about 5 quarters. Based on this typical relationship, at the end of 2006 I started forecasting a slowdown in CRE at the end of '07.

Click on graph for larger image.

Investment in non-residential structures continues to be very strong, increasing at a 14.3% annualized rate in Q3 2007.

This graph shows the YoY change in Residential Investment (shifted 5 quarters into the future) and investment in Non-residential Structures. In a typical cycle, non-residential investment follows residential investment, with a lag of about 5 quarters (although the lag can range from 3 to about 8 quarters). Residential investment has fallen significantly for six straight quarters. So, if this cycle follows the typical pattern, non-residential investment will start declining about now.

Due to the deep slump for CRE during the business led recession in 2001, CRE is nowhere near as overbuilt as residential - even though the CRE lending standards were very loose. Still, it appears there is a slowdown in non-residential investment starting now.

The second graph shows the YoY change in nonresidential structure investment (dark blue) vs. loan demand data (red) and CRE lending standards (green, inverted) from the Fed Loan survey.

The net percentage of respondents tightening lending standards for CRE has risen to 50%. (shown as negative 50% on graph).

The net percentage of respondents reporting stronger demand for CRE has fallen to negative 34.6%.

Loan demand (and changes in lending standards) lead CRE investment for an obvious reason - loans taken out today are the CRE investment in the future. This report from the Fed also suggests an imminent slowdown in CRE investment.

Data Source: Net Percentage of Domestic Respondents Reporting Stronger Demand for Commercial Real Estate Loans

by Calculated Risk on 12/05/2007 12:01:00 AM

Kudos to Brian who caught this last Thursday: ETrade ABS Haircuts

From the NYTimes: In E*Trade Deal, Pain Went Far Beyond Subprime

... here is a point worth considering: Only about $450 million of E*Trade’s $3 billion portfolio was made up of the riskiest kinds of securities — C.D.O.’s and second-lien mortgages — that have made headlines recently.

What was the other $2.6 billion or so? In E*Trade’s own words, it was “other asset-backed securities, mainly securities backed by prime residential first-lien mortgages.”

In other words, E*Trade’s enormous haircut went far beyond subprime.

A large part of E*Trade’s basket of assets was securities backed by high-quality mortgages — loans to homeowners with strong credit ratings and reasonably large equity cushions. That could raise troubling questions on Wall Street about the true value of “prime” mortgage assets, especially when they need to be liquidated in a hurry.

The picture becomes clearer when you look at this breakdown, which E*Trade shared with investors in October. It shows that more than $1.35 billion of E*Trade’s asset-backed portfolio consisted of prime, first-lien residential mortgages rated “AA” or better — hardly toxic sludge by any stretch of the imagination.

So consider this: Even if E*Trade got nothing — not a cent — for anything but these top-quality mortgage securities, it still sold $1.35 billion in prime mortgage assets for $800 million, or less than 60 cents on the dollar.

That’s just a back-of-the-envelope calculation, but a potentially unnerving one.

by Calculated Risk on 12/04/2007 05:15:00 PM

From Reuters: Subprime bond losses to climb to 20 pct -analysts (hat tip Cal)

Moody's Investors Service on Tuesday raised its forecast for expected losses for U.S. mortgages known as "Alt-A" residential mortgage debt. Loss estimates for Alt-A bonds reviewed by Moody's increased by an average of 110 percent from initial expectations, with some loss estimates up by as much as 270 percent, Moody's said in a report.

Well, I'm stunned, but not surprised.

by Calculated Risk on 12/04/2007 05:10:00 PM

From the WSJ: Fannie Looks to Raise $7 Billion, Cuts Common-Stock Dividend

... Fannie Mae said Tuesday that it planned to issue $7 billion in non-convertible preferred stock and cut its quarterly common stock dividend by 30% in an effort to boost capital and "conservatively manage increased risk in the housing and credit markets."

Fannie does a Freddie.

by Calculated Risk on 12/04/2007 04:26:00 PM

Jon Lansner at the O.C. Register reports: Outlook dimmer for commercial real estate in 2008, forecast says

The boom that boosted commercial real estate ... is expected to slow in 2008 in the face of a slowing economy and a credit crunch ... according to the 29th annual forecast by PricewaterhouseCoopers and the Urban Land Institute.
...
A panel of local industry leaders noted that values for commercial properties in Orange County will decline next year from 3% to 15%, depending on the type and quality of the building. The panel provided the following outlooks for Orange County’s office, apartment, retail and housing markets:
...
William Flaherty, senior vice president for marketing, Maguire Properties Inc. on the office market: The outlook for the O.C. office market is cloudy, while a year or two ago it was incredibly bright. Today vacancies are under 10%, but they are expected to go up due to the collapse of many subprime lenders based here (New Century was a tenant of Maguire’s until it went bankrupt) and to new construction. Flaherty added that the global credit crunch has crunched demand and prices for office buildings, which had quickly traded hands at the start of 2007. “It’s clear that the world’s changed on Aug. 2 with the credit crunch,” he said.

They could have just read this blog earlier this year!

by Calculated Risk on 12/04/2007 03:45:00 PM

Here is an interesting question for the Wall Street firms: Was it worth it? Were the recent losses just a small price to pay for the outsized profits in previous years? Goldman and Deutsche Bank say yes, they made money. Citi says no.

From Bloomberg: Citi's Losses `Greatly Exceeded' Profits for Subprime

Citigroup Inc. ... lost more money than it made from financial instruments based on U.S. subprime mortgages, a senior company executive said in a meeting at the British Parliament.
...
``Our losses greatly exceeded the profits we made in this field over several years,'' Mills said at a hearing of the Treasury Committee today.
...
Gerald Corrigan, the managing director in charge of risk management at Goldman Sachs Group Inc., said that his bank had fared better than Citi.

``On balance, we probably made money,'' Corrigan told lawmakers. ``We have had a measure of success in hedging some of our exposure.''
...
Deutsche Bank probably made more money from marketing CDOs than it lost, said Charles Aldington, chairman of its London unit.

by Calculated Risk on 12/04/2007 02:16:00 PM

From Bloomberg: Citigroup SIV's Junior Sedna Debt Cut to CCC by Fitch (hat tip FFDIC)

Citigroup Inc.'s Sedna Finance Corp. had $867 million of junior-ranking debt downgraded 12 levels to CCC by Fitch Ratings after declines in the structured investment vehicle's assets.
...
Sedna's net asset value has fallen to 54 percent, eroding nearly all the protection the downgraded ``second priority senior'' notes gets from ranking above the lowest layer of debt, Fitch said in a statement today.

12 levels? Yikes!

by Calculated Risk on 12/04/2007 11:45:00 AM

Last week I posted a chart (see Goldman Sachs on Housing) from First American CoreLogic that showed the distribution of home equity among US mortgage holders at the end of 2006:

Click on graph for larger image.

Since the end of 2006, U.S. home prices had fallen about 3.6% (by the end of Q3 2007), according to the S&P/Case-Shiller® U.S. National Home Price, and will probably decline 5% for all of 2007.

The price decline in 2007 would move the dashed line one column to the right, putting another 4% of U.S. homeowners into the no / negative equity category.

But what do these percentages mean in actual numbers? According to the Census Bureau's 2006 American Community Survey (see table here) there were 51,234,170 household with mortgage in the U.S. in 2006.

The following graph shows the number of homeowners with no or negative equity, using the most recent First American data, with several different price declines.

At the end of 2006, there were approximately 3.5 million U.S. homeowners with no or negative equity. (approximately 7% of the 51 million household with mortgages).

By the end of 2007, the number will have risen to about 5.6 million.

If prices decline an additional 10% in 2008, the number of homeowners with no equity will rise to 10.7 million.

The last two categories are based on a 20%, and 30%, peak to trough declines. The 20% decline was suggested by MarketWatch chief economist Irwin Kellner (See How low must housing prices go?) and 30% was suggested by Paul Krugman (see What it takes).

To put these price declines into perspective, this graph shows 15% and 30% nominal price declines for the S&P/Case-Shiller U.S. National Home Price Index and the OFHEO, Purchase Only, SA index.

A 15% nominal price decline would take prices back to late 2004 for both indices. A 30% price decline for Case-Shiller would take prices back to mid-2003; 30% for OFHEO would take prices back to late 2002.

Not all areas will see the same price declines, but this does provide a gross estimate of the number of homeowners with no equity based on various price decline assumptions. This number is important because homeowners with little or no equity are very vulnerable to negative events - they will have difficultly selling their home, and they can't borrow from their home to meet emergency needs.

This will also impact consumption, because for these homeowners, the Home ATM will be closed.

Finally, given the potential number of homeowners with negative equity, this raises the question if the HUD projections of "two million foreclosures by 2008 or 2009" are too low.

by Calculated Risk on 12/04/2007 10:20:00 AM

From MarketWatch: H&R Block, Cerberus call off Option One deal

... H&R Block Inc. said Tuesday it ... will close all remaining origination activities of Option One and has stopped accepting new loan applications.

H&R Block said the move will result in 620 staff cuts, the closure of three offices and a pretax restructuring charge of about $75 million. The company said it continues to pursue the sale of its loan-servicing activities.
...
H&R Block Inc. said ... it has agreed to terminate a previous agreement under which an affiliate of Cerberus Capital Management would have acquired ... Option One.

No surprise.

by Calculated Risk on 12/04/2007 12:01:00 AM

From the WSJ: SIV Exposure Seen at Some Money Funds

Funds recently holding some of the SIVs include some from Barclays PLC's Barclays Global Investors; UBS AG; Charles Schwab Corp.; Deutsche Bank AG; BNY Hamilton Funds and Morgan Stanley.
...
The funds range in asset size from $2 billion to $36 billion, and hold about 1% to 2% of their investments in some of the SIVs.
...
Among funds holding SIVs is the $29 billion Western Asset Money Market Fund, run by a unit of Legg Mason Inc. The fund holds a SIV called Orion Finance, which was on Friday downgraded by Moody's. Orion represents about 0.5% of the fund.

A Legg Mason spokeswoman said in an email that the company is confident in the stability of the fund's net asset value. "By and large, SIVs are paying on time, and Legg Mason's money funds' exposure to SIVs continues to come down as paper matures and pays."

It is extremely unlikely that any of these funds will "break the buck". However the last comment is important for the SIVs: everyone wants to reduce their exposure to SIVs as the paper matures.