by Calculated Risk on 11/02/2009 02:12:00 PM

Testimony of Jon D. Greenlee, Associate Director, Division of Banking Supervision and Regulation on Residential and commercial real estate

[T]he condition of the banking system is far from robust. Two years into a substantial economic downturn, loan quality is poor across many asset classes and, as noted earlier, continues to deteriorate as weakness in housing markets affects the performance of residential mortgages and construction loans. Higher loan losses are depleting loan loss reserves at many banking organizations, necessitating large new provisions that are producing net losses or low earnings. In addition, although capital ratios are considerably higher than they were at the start of the crisis for many banking organizations, poor loan quality, subpar earnings, and uncertainty about future conditions raise questions about capital adequacy for some institutions. Diminished loan demand, more-conservative underwriting standards in the wake of the crisis, recessionary economic conditions, and a focus on working out problem loans have also limited the degree to which banks have added high-quality loans to their portfolios, an essential step to expanding profitable assets and thus restoring earnings performance.
emphasis added

On Commercial Real Estate (CRE):

Prices of existing commercial properties have already declined substantially from the peak in 2007 and will likely decline further. As job losses have accelerated, demand for commercial property has declined and vacancy rates have increased. The higher vacancy levels and significant decline in the value of existing properties have placed particularly heavy pressure on construction and development projects that do not generate income until after completion. ...

As a result, Federal Reserve examiners are reporting a sharp deterioration in the credit performance of loans in banks’ portfolios and loans in commercial mortgage-backed securities (CMBS). At the end of the second quarter of 2009, approximately $3.5 trillion of outstanding debt was associated with CRE, including loans for multifamily housing developments. Of this, $1.7 trillion was held on the books of banks and thrifts, and an additional $900 billion represented collateral for CMBS, with other investors holding the remaining balance of $900 billion. Also at the end of the second quarter, about 9 percent of CRE loans in bank portfolios were considered delinquent, almost double the level of a year earlier. Loan performance problems were the most striking for construction and development loans, especially for those that financed residential development. More than 16 percent of all construction and development loans were considered delinquent at the end of the second quarter.

Of particular concern, almost $500 billion of CRE loans will mature during each of the next few years. In addition to losses caused by declining property cash flows and deteriorating conditions for construction loans, losses will also be boosted by the depreciating collateral value underlying those maturing loans. The losses will place continued pressure on banks' earnings, especially those of smaller regional and community banks that have high concentrations of CRE loans.

The current fundamental weakness in CRE markets is exacerbated by the fact that the CMBS market, which previously had financed about 30 percent of originations and completed construction projects, has remained closed since the start of the crisis. Delinquencies of mortgages backing CMBS have increased markedly in recent months. Market participants anticipate these rates will climb higher by the end of this year, driven not only by negative fundamentals but also by borrowers’ difficulty in rolling over maturing debt. In addition, the decline in CMBS prices has generated significant stresses on the balance sheets of financial institutions that must mark these securities to market, further limiting their appetite for taking on new CRE exposure.

Higher vacancy rates, sharply lower rents, reduced leverage and much higher cap rates - back in July, Brian called this the "neutron bomb for RE equity"; destroys CRE investors and banks, but leaves the buildings still standing.

by Calculated Risk on 11/02/2009 12:32:00 PM

There was some good news on employment in the ISM Manufacturing survey report this morning:

ISM's Employment Index registered 53.1 percent in October, which is 6.9 percentage points higher than the 46.2 percent reported in September. This is the first month of growth in manufacturing employment following 14 consecutive months of decline. An Employment Index above 49.7 percent, over time, is generally consistent with an increase in the Bureau of Labor Statistics (BLS) data on manufacturing employment.

That calls out for a graph!

The following graph shows the ISM Manufacturing Employment Index vs. the BLS reported monthly change in manufacturing employment (as a percent of manufacturing employment).

The graph includes data from 1948 through 2009. The earlier period (1948 - 1988) is in red, and the last 20 years is in green.

Click on graph for larger image in new window.

Sure enough the ISM employment index is related to changes in BLS employment.

According to the BLS, manufacturing employment has declined by about 50 thousand per month for the last 3 months. The ISM survey suggests that manufacturing employment might have increased in October. The equation suggests an increase of about 4,000 manufacturing jobs in October (with significant variation) - not much, but that is far better than losing 50,000 jobs per month.

by Calculated Risk on 11/02/2009 10:26:00 AM

We started the year looking for two key construction spending stories: a likely bottom for residential construction spending, and the collapse in private non-residential construction.

It appears residential construction spending may have bottomed, although any growth in spending will probably be sluggish until the large overhang of existing inventory is reduced.

And the collapse in non-residential construction spending has started, and there will be further declines to come as projects are completed.

Click on graph for larger image in new window.

The first graph shows private residential and nonresidential construction spending since 1993. Note: nominal dollars, not inflation adjusted.

Residential construction spending increased in September, and nonresidential spending continued to decline.

Private residential construction spending is now 62.2% below the peak of early 2006.

Private non-residential construction spending is still only 16.0% below the peak of last September.

The second graph shows the year-over-year change for private residential and nonresidential construction spending.

Nonresidential spending is off 15.4% on a year-over-year basis.

Residential construction spending is still off significantly from a year ago, although the negative YoY change will get smaller going forward.

Here is the report from the Census Bureau: September 2009 Construction at $940.3 Billion Annual Rate

by Calculated Risk on 11/02/2009 10:00:00 AM

PMI at 55.7% in October up from 52.6% September.

From the Institute for Supply Management: October 2009 Manufacturing ISM Report On Business®

Economic activity in the manufacturing sector expanded in October for the third consecutive month, and the overall economy grew for the sixth consecutive month, say the nation's supply executives in the latest Manufacturing ISM Report On Business®.

The report was issued today by Norbert J. Ore, CPSM, C.P.M., chair of the Institute for Supply Management™ Manufacturing Business Survey Committee. "The manufacturing sector grew for the third consecutive month in October, and the rate of growth is the highest since April 2006 when the PMI registered 56 percent. The jump in the index was driven by production and employment, with both registering significant gains. Production appears to be benefiting from the continuing strength in new orders, while the improvement in employment is due to some callbacks and opportunities for temporary workers. Overall, it appears that inventories are balanced and that manufacturing is in a sustainable recovery mode."
...
The recovery in manufacturing strengthened in October as the PMI registered 55.7 percent, which is 3.1 percentage points higher than the 52.6 percent reported in September, and the highest reading for the index since April 2006 (56 percent). A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting.
emphasis added

As noted, any reading above 50 shows expansion.

Also, from the NAR: Pending Home Sales Rise for Record Eight Straight Months

The Pending Home Sales Index,* a forward-looking indicator based on contracts signed in September, rose 6.1 percent to 110.1 from a reading of 103.8 in August, and is 21.2 percent higher than September 2008 when it stood at 90.9.

by Calculated Risk on 11/02/2009 08:56:00 AM

From the Independent: Darling prepares to unveil bank shake-up

Chancellor Alistair Darling will this week unveil his proposed overhaul of the UK banking system which includes breaking up Lloyds and Royal Bank of Scotland and bringing "at least" three new banks to the high street.
...
The two banks "will be divesting some of the holdings they have at the moment. What you really want to do is have substantial divestment of branches, or particular institutions they own, made available to other people," Mr Darling said. This follows pressure from the European competition commissioner, Neelie Kroes, who has demanded that RBS and Lloyds sell operations under the EU's state aid rules.
...
Banking giants Barclays, HSBC and possibly Spain's Banco Santander, which owns Abbey, Alliance & Leicester and branches of Bradford & Bingley, are likely to be blocked from bidding as the Government is "determined" to see more competition in the wake of its £1.2 trillion bailout of the sector.

Breaking up the big banks to lower the risk and increase competition. It makes me think of BofA and Citi ...

by Calculated Risk on 11/01/2009 11:15:00 PM

From Crain's New York: Not much life left in the party

The severity of the recession may have caught some companies by surprise in 2008, but this year reality has sunk in ... The lavish celebrations of years past are not making a comeback this year in the city—or anywhere else in the country.

Just 62% of companies nationwide are planning holiday parties this year, down from 77% last year and 90% in 2007, according to a survey by outplacement firm Challenger Gray & Christmas.
...
Restaurants and hotels that count on this lucrative business say their private party business is off by about 20% this year, compared with a dismal season in 2008.

Just more bad news for restaurants and hotels ...

by Calculated Risk on 11/01/2009 07:08:00 PM

The WSJ has an article on landlords cutting effective rents: Landlords Offer Incentives to Stay Put

... Equity Residential said new tenants in the third quarter paid 9% to 10% less rent than the previous residents. ... Denver-based UDR is offering renewing tenants a flat-screen TV, new carpet, kitchen upgrade or, $300 in cash. ... Some landlords have also become more open-minded about tenants with credit issues involving home foreclosures.

Rents are falling because vacancies are at record levels. Reis recently reported that the apartment vacancy rate in cities hit a 23 year high of 7.8 percent in the third quarter, and Reis expects the vacancy rate to reach a record 8 percent soon.

Click on graph for larger image in new window.

Last week the Census Bureau reported the overall rental vacancy rate hit a record 11.1 percent in Q3 2009.

The higher vacancy rate is pushing down rents and the value of rental units. This is good news for renters, but this will also lead to more apartment defaults, higher default rates for apartment CMBS, and more losses for small and regional banks.

And falling rents are already pushing down owners' equivalent rent (OER). OER just turned negative for the first time 1992. From the BLS:

The increase [in CPI] occurred despite declines in the indexes for rent and owners' equivalent rent, the first decreases in those indexes since 1992.

Since OER is the largest component of CPI, this will apply downward pressure on CPI for some time. And lower rents will also put pressure on house prices, since renting is a competing product.

Note: REIT BRE reports tomorrow and their CEO always some interesting comments.

"I think it is shaping up there is another leg down in terms of market rents and effective rents and that will be somewhere late this year or early [next] year where I think all the operators will move their rents down to basically handle the late stage of this recession."
BRE CEO, Aug 5, 2009

by Calculated Risk on 11/01/2009 03:53:00 PM

Press Release: CIT Board of Directors Approves Proceeding with Prepackaged Plan of Reorganization with Overwhelming Support of Debtholders

And from the NY Times Dealbook: CIT Files for Bankruptcy

On Sunday afternoon, the company filed for Chapter 11 — but under a so-called prepackaged bankruptcy plan that will enable it to emerge from court protection by the end of the year.

Sunday’s filing, made in a Manhattan federal court, caps months of efforts by CIT to stay alive.

And from the WSJ:

One loser from a bankruptcy would be the U.S. Treasury. Late last year it injected $2.3 billion of funds from the Troubled Asset Relief Program ... The government investment is likely to be wiped out ...

Even if CIT emerges intact, its lending capacity could drop to less than 20% of what it was two years ago, according to an estimate by Brian Charles, a debt analyst at R.W. Pressprich & Co.

CIT provides financing for about one million small businesses, so the key question is how will this impact the ability of many small businesses to obtain financing.

by Calculated Risk on 11/01/2009 12:41:00 PM

Another busy week ahead starting with construction spending, the ISM reports, vehicle sales, the Fed meeting (little change in wording expected), and ending with the employment report. Did the unemployment rate hit 10% in October?

Here is a summary of data released in October and the updated Unofficial Problem Bank List.

October Economic Summary in Graphs

Unofficial Problem Bank List Grows to 500

A guest post from albert:

On a New York bankruptcy case in the news: In re Olga: of Bankruptcy and Foreclosure

****************************
On the GDP report:

From Rex Nutting at MarketWatch: U.S. GDP rises 3.5% as stimulus kicks in

From Paul Krugman: What recovery should look like

From Jim Hamilton at Econbrowser: A welcome GDP report

And from me: Random Thoughts on the Q3 GDP Report

Click on cartoon for larger image in new window. Cartoon from Eric G. Lewis www.EricGLewis.com (site coming soon)

****************************
A few stories on the collapse of WaMu:

From Kirsten Grind at the Puget Sound Business Journal: The downfall of Washington Mutual

From Drew DeSilver at the Seattle Times: Part one | Reckless strategies doomed WaMu

From David Heath at the Seattle Times: Part two | WaMu: Hometown bank turned predatory

****************************
And on the Home buyer tax credit:

From Bloomberg: Senate Said to Revise Plan to Extend, Expand Homebuyer Credit

The details:
- Income eligibility for home buyers increases to $125,000 for individuals and $225,000 for couples.
- The tax credit for first-time home buyers (anyone who has not owned in the last 3 years) will be the lesser of $8,000 or 10% of the purchase price.
- For move-up buyers - "who have lived in their current home for at least five years" - the credit would be limited to $6,500.
- The credit runs from Dec. 1, 2009 to April 30, 2010, with an additional 60 day period to close escrow. (So end of April to sign contract, end of June to close escrow)

Cartoon from Eric G. Lewis www.EricGLewis.com (site coming soon)

by Calculated Risk on 11/01/2009 09:03:00 AM

From Greg Gordon at McClatchy Newspapers: How Goldman secretly bet on the U.S. housing crash

In 2006 and 2007, Goldman Sachs Group peddled more than $40 billion in securities backed by at least 200,000 risky home mortgages, but never told the buyers it was secretly betting that a sharp drop in U.S. housing prices would send the value of those securities plummeting.
...
A Goldman spokesman, Michael DuVally, said that the firm decided in December 2006 to reduce its mortgage risks and did so by selling off subprime-related securities and making myriad insurance-like bets, called credit-default swaps, to "hedge" against a housing downturn.

DuVally told McClatchy that Goldman "had no obligation to disclose how it was managing its risk, nor would investors have expected us to do so ... other market participants had access to the same information we did."

The last section of the article "I've got a secret" discusses the selling of Goldman's MBS and the disclosure rules.