Friday, July 10, 2009

Green Shoot Fatigue

It's tough fighting against the tide. For several months the popular (i.e. loudest) media spoke of the signs of the rebound. Truthfully, having a more defensive portfolio position started to look a little spooky. The chief strategist for Schwab called being out of the market now, "a career killer." Yeah, I grimaced as she seemed to be looking directly at me.

Anyone who says they know exactly what happens next is either lying or too old to be considered anything but suffering dementia. We have not seen this set of circumstances in our lifetime. It is not a recession in the usual sense of the word. Since World War II, the time period for most historical comparison there has never been a credit based recession. They have been manufacturing recessions for which inventory adjustment and interest rate policy would soon put the ship of state back on course.

This is driven by a lack of available credit. As I see some perfectly reasonably qualified individuals be rejected time and time again for credit one has to consider looking more deeply at the reasons. Based on the anecdotal information it would seem less a question of risk analysis by the banks an inability to lend within the regulatory capital requirements of the lenders.

Anticipation of commercial loan impairment is the fly in the ointment. The $3.5 trillion commercial real estate market could dwarf the residential real estate problems of the recent past. In the next year, about $700 billion will need to be refinanced or significant bankruptcies of shopping centers, hotels and other real estate holdings loom with the subsequent losses and effect on banks.

The argument for end of the recession in a traditional inventory readjustment shows signs of approaching---if only that were the problem. In a cyclical economic environment, we are near a bottom. Currently North American automobile sales are running at a rate of 7.0 million units per year. Production is at a 3.9 million units per year pace. Obviously production of automobiles will have to increase simply to slow the destocking process. The knock on effect to the manufacturing economy should bring some benefit.

The sea anchor to this positive cyclical process is credit system impairment. As long as severe credit headwinds exist, the traditional recession ebb and flow will not play out as we are used to. Despite the popular refusal to say it, we are in an economic depression not a mere recession. It is not the severity that defines this, it is the process of deflationary pressure unseen since the 1930's.

John Barnyak

Our view of CRE exposure has not changed at all, namely that the loss rates in that asset class will be multiples of the record loss rates on residential or RES exposures. Why on earth is the Obama Administration still listening to Tim Geithner and Ben Bernanke on the latest PPIP proposal to buy CMBS at current prices when the cash flows are falling every month? If you look at the yields on bank CRE and then extrapolate to the securitization market where much of the CRE exposure resides, there is no way that the pricing assumptions in the PPIP make sense. Guess we have to wait for T-Day for Obama & Co to wake up and smell the bird burning.

One of the questions I ask my clients is this: How do you think prices for exisiting homes and commercial both will react when the RES and CRE properties now in foreclosure work their way through the courts and come popping out onto the secondary market around Thanksgiving? My firm entered a JV with a very experienced asset management and disposal group earlier this year. The view from the disposal channel is ugly.

Excerpt of article below:

Commercial Real Estate Is a ‘Time Bomb,’ Maloney Says (Update2)

(Adds comments on rebound in third, fifth paragraphs.)

By Dawn Kopecki

July 9 (Bloomberg) — The $3.5 trillion commercial real estate market is a ticking ”time bomb” that may lead to a second wave of losses at large U.S. banks, congressional Joint Economic Committee Chairwoman Carolyn Maloney said.

About $700 billion in commercial mortgages will need to be refinanced before the end of 2010 and ”doing nothing is not an option,” Maloney, a New York Democrat, said at a committee hearing today. This ”looming crisis” may lead to significant losses for banks, force shopping center and hotel owners into bankruptcy, and impede economic recovery, she said.

The response by banks to this ”growing threat has been slow and inadequate,” said James Helsel, a partner at RSR Realtors in Harrisburg, Pennsylvania, and treasurer for the National Association of Realtors. ”The lack of liquidity and banks’ reluctance to extend lending are also becoming apparent in the increasing level of delinquent properties.”