Burning Out The Bottom Of The Pot
This weekend I finished winterizing the homestead. In a flurry of activity, I turned off the irrigation and drained the pipes, hauled myself up onto the roof to clean out the chimney and service the swamp cooler, tucked some extra insulation into the chicken coop where a brood of seasonally-confused chicks is fledging. Then I harvested the last of my pumpkins and tomatoes, and left some little strychnine treats for the gophers who are trying to set up a new household under my artichokes. It all felt so tidy when I had finished that I couldn’t help congratulating myself. I may not be set to weather the financial storms of this coming winter, but at least I’m reasonably certain of getting through the next few months without starving or freezing to death.
I was enjoying a cozy fire and a glass of cabernet when I got a call from my buddy Arla. Several years ago Arla’s husband died and left her a nice life insurance policy and a stack of hospital bills. She jokes that his untimely demise was the most productive thing he’d done in his working life, because after probate she sold their large Bakersfield home at the top of the market, moved into a rented condo, and invested the proceeds in a small strip mall—which quickly filled with tenants. Anchored by a franchise take-out, the rents made her, if not a wealthy woman, at long-last a fairly comfortable one.
But now there’s trouble brewing. Despite her seven-figure down payment, the interest-only loan that financed the place is resetting in March and a balloon payment of nearly a million more is looming. Two of her five tenants have given notice as of December 31, and a third is a month behind on their lease. Knowing I was “somewhat bearish,” as she put it, on the whole real-estate-as-investment thing, she called to tell me that in spite of her 50% equity position in the property, (good,) the lender (first the defunct GMAC, now the soon-to-be-defunct Capmark,) has refused to either refinance or re-negotiate the loan (bad,) and is demanding payment in full when the note comes due after next quarter (very bad.)
Although she’s tried to short sell, no one else seems to want to touch her little empire because of the location, (Bakersfield, one of the underwater capitals of the world,) and the fact that its future occupancy is now in question. The gift shop and the salon will soon stand empty, and the clothing boutique is obviously on its last legs. The food joint is hanging on, but doesn’t have the cash flow to justify taking over the loan. Apparently a medical supply concern expressed interest in leasing one of the spots, but because of her uncertain financial status the partners decided to pass on the location.
She owns no other substantial property she can use to secure the loan, so it’s not looking cheery for her on that end either. Even the city council has turned their backs on her, and she’s thinking about withholding the first installation of her ’09-’10 property tax unless they grant her some relief –even temporarily.
Alva confessed to me that she’s seriously considering a walk-away. On a million dollar investment—her only hope for retiring with more than her survivor’s social security stipend to keep her going. So, what did I think?
Well, I think she’s not alone. According to Moody’s Investors Service, commercial real estate prices have fallen 41% in the last two years alone, and American banks are now on the hook for nearly 1.7T in US loans secured by these properties. It is estimated that in the next three years, $1.5T in loans are coming due, and if Arla’s story is any indication, a lot of these loans are going to default.
Which begs the question. Is a bailout likely for the lending banks holding commercial real estate as collateral?
Let’s ask our old friend, the Fed.
In a policy announcement released 10.30.09, the Fed got downright cagey, even coy.
Of particular interest is the following:
“…(we will)…support prudent and pragmatic credit and business decision making within the framework of financial accuracy, transparency, and timely loss recognition…(emphasis mine.)”
“Timely loss recognition,” eh? That’s a good start. Then it goes on to say,
“…Financial institutions that implement prudent loan workout arrangements …will not be subject to criticism for engaging in these efforts, even if the restructured loans have weaknesses that result in adverse credit classifications…”
“Prudent loan workout arrangements,” eh? “Will not be subject to criticism?” This is staggering stuff. It would appear that the Fedsters are both acknowledging that there is big trouble looming for banks with CRE holdings, and is telling them that they’ll “not be subject to criticism” (!) for write-downs; in essence handing them the legalese version of “you’re on your own, suckers.”
As Arla has discovered in her search for refinancing, there is no Fannie Mae or Freddie Mac equivalent for strip malls. And without a GSE conservatorship for commercial real estate, it would appear that the government largesse that residential loan-owners have come to rely upon will not be forthcoming for holders of CRE-backed loans.
The implications here are pretty clear. It the FED is unwilling to quantitatively ease commercial real estate exposure, as it has for residential mortgages, the economy is in for a bumpy ride. Those banks that have not used the ongoing rally to dump their commercial mortgage backed securities or CRE holdings might want to do so as quickly as possible and as quietly as possible if they intend to remain solvent.
No bailouts for commercial real estate implies no bailouts for commercial real estate builders either. The upside of this for the likes of us is that maybe at long last Washington will get the idea that housing prices are going to fall eventually—their best intentions to stave off the carnage notwithstanding. And those of us who have so patiently bided our time waiting for this to happen may now have some real hope of it occurring within our lifetimes.
It makes sense from a political standpoint, of course. While individual homemoaners can vote, (and there are millions of homes in foreclosure right now, with many more expected before the 2010 elections.) Builders (and their in-house lending arms) can only lobby and give money– and builders are running out of money these days. And they’re giving their unfinished projects back to the lenders. Who in turn give them back to the banks that the Fed says it isn’t going to bail out of their gone-bad portfolios. Who sell them to the hedge funds that…aHA!
So what happens to all the actual commercial property secured by these non-performing loans?
It would seem that vulture hedge funds are “snapping them up”—with a little help from the FED, as evidenced by the aforementioned policy announcement. Why not buy defaulted commercial property at pennies on the dollar when the government is not only encouraging you to do so, but de facto financing the whole operation by infusing investment banks with TARP funds to facilitate the deal?
Indeed such a seemingly far-fetched assumption would tend to be supported by recent announcements like this one, brought to our attention by Ben Jones:
“…SunCal Cos. bought 1,072 finished and partially finished residential lots spread across 11 Kimball Hill Homes’ communities throughout Las Vegas and Henderson for $20 million, or an average of $18,727 (emphasis mine,) per lot, from KHI Post Consummation Trust. It was an all-cash deal financed through D.E. Shaw Group….”
(D.E. Shaw Group, by the way, is the firm Larry Summers managed between his dismissal, er, resignation as president of Harvard and his appointment as Director of Obama’s National Economic Council.)
Taking it a step further, what happens when these closely-aligned-with-PPIP equity firms own a substantial portion of America’s commercial real estate a few years hence? Do they turn it over to the government to pay back the taxpayers who funded TARP? If Chris Dodd’s 1000-page giveaway to hedge funds like D. E. Shaw is enacted, it’s not likely. Check out this excerpt from page 438 of this Senate discussion draft. (Warning: PDF)
‘‘(ii) EXEMPTION.—The Financial In stitutions Regulatory Administration by rule or order, as FIRA deems necessary or appropriate in the public interest, may conditionally or unconditionally exempt a swap dealer or major swap participant (emphasis mine,) for which FIRA is the primary financial regu latory agency from the requirements of this subsection and the rules issued under this subsection with regard to any swap in which 1 of the counterparties is—”
So, all those CRE-backed CDO’s and credit swaps are going to be exempted from regulation and oversight in the “public interest?” How very convenient.
Is Professor Bear’s “Megabank, Inc.” destined to become commercial American real estate’s Fannie Mae and Freddie Mac? That’s a lot of unoccupied commercial property to landlord and manage; they can’t just let it sit around gathering termites and amassing delinquent property tax bills. At some point, someone is going to have to collateralize it, or sell it or lease it, and not incidentally, make someone—presumably someone aligned with Megabank, Inc.,—a whole lot of money. My bet it isn’t going to be Arla.
In the coming weeks it will be interesting to watch the turf war between Sheila Bair’s FDIC and the more populist Elizabeth Warren’s Congressional Oversight Committee as they battle it out for consolidation and regulatory reform of America’s financial services industry. Whether we end up with a post-Soviet style giveaway to favored cronies, or a marginally more equitable and democratic redistribution of these properties remains to be seen, but unless Congress declares a jubilee, or passes a 0% interest, 99-year repayment plan for small business owners seeking to refinance their interest-only loans, the whole economic stew may soon be burning out the bottom of the pot. And guess who gets to scrub up the mess?
by ahansen
