Boo!!! Will Halloween Scare the Market into Respecting the Fundamentals?
Oct 31, 2009
I'll admit it to everyone, I am absolutely disgusted with my investment performance over the past two quarters. I came into the second quarter up nearly 500% for the two years running thanks to top notch research across myriad sectors (see Research_Samples 11/17/2008 for examples) and loss about half of that profit fighting the bull rally that I easily saw coming but severely underestimated the length, depth and breadth of. Having switched over to market neutral in the third quarter (see Recent strategy analysis sample available to the public) caused me to simply hover with a few percentage point gains here and there, since by then most of the drastic moves were over, but I was biding my time in mostly cash waiting for the fundamentals to kick back in. You see I am a fundamental investor, and I kill it when 2+2=4, and I do even better when it equals something else. The caveat is when it does equal something else, I have to wait until it starts moving back towards that number 4 for me to realize my meal. This severe boom/bust market is basically custom tailored to my investment style (see "The Great Global Macro Experiment, Revisited", and realize why I call it BoomBustBlog!) just to an aggravated extreme!
Hey, y'all! It appears as if we may be approaching that time where 2+2 may again equal 4.
By now I'm sure we have soaked in the head-fake that was the "better than expected" GDP number. Well, the gross number was only marginally better than expected, and if one bothers to taken even the most cursory glance beneath the surface.... Whoa! Stimulus was quoted as the reason the economy expanded, but this is just not true. Stimulus is something that stimulates. That just didn't happen in this case. The main drivers reported for the GDP pop came from automobiles (the cash for clunkers so-called stimulus plan) and residential investment (the government tax break, more so-called stimulus). This is how I see it. Automobile sales are already down since the clunker plan ended, so there is no speculation as to whether or not this government effort stimulated anything, It didn't. All the government did was to literally "purchase" a few GDP basis points. There was no multiplier effect. There wasn't even a material economic impact that lasted a month after teh plan ended. Basically, the government put $XX billion into car sales to get a $XX billion less slippage and administrative costs purchase of a few GDP points for the months in question. Basically, a waste of money that should have went into guaranteeing ABS for small business loans to take over the hole that CIT is making in entrepreneurial lending - with more realistic underwriting, of course.
How about the housing boost? Well, home sales and home prices have trended downward from what I can see, as soon as the deadline for the first time homebuyer credit approached. Damn near in real time. Again, now real multiplier and no lasting effect. I mean it didn't even last a month into expiration. Again, a waste of money in an attempt to reflate a bursting bubble.
So, what is it that I do see for the economy. Well, from my perch in NYC...
The condo glut will literally devastate rental and owner-occupied buildings in the major metro areas. We have not come close to seeing the worst of the housing price declines. This no exaggeration! Up until this point, most of the attention has been drawn to residential foreclosures due to retail buyers getting themselves in trouble via too much debt, too much building, too little employment and deflating asset values/wealth (the wealth effect is something to behold, see Super Brokers form to push Super Broken products to make those with High Net Worth Super Broke for my take on social mobility, downwards style). Well now, it is the wholesale buyer/builder's turn. In "Who are ya gonna believe, the pundits or your lying eyes?" (for pictures) and "Who are you going to believe, the pundits or your lying eyes, part 2" (for numbers and a very shaky video), I illustrated a trip from Chelsea Piers in Manhattan to Prospect Park in Brooklyn, capturing the rampant supply of residential, office and commercial space that is STILL being put up despite the extreme glut currently in this rapidly declining market. As you look through all of this visual material, remember banks have supplied the capital for building all of these empty edifices, at no less than 10x leverage. And to think that there are some that are actually bullish on the banking sector!!!
Before I delve into those past posts, let's take a look at a recent article from Crain's NY:
There are 601 condo buildings in just six neighborhoods across New York City that have either a substantial amount of vacant units or stalled construction activity, according to survey data from the New York chapter of the grassroots community organization Right to the City. This number is well above the 454 buildings originally reported by the Department of Buildings for the entire city. The survey, which will be released next Tuesday at a rally in Downtown Brooklyn, found the highest concentration of troubled developments in Downtown Brooklyn, where 126 buildings are currently maintaining very high vacancies. It was not immediately clear how the organization defined a substantial amount of vacant units. The 246-unit Be@Schermerhorn condo building, at 189 Schermerhorn Street, has a 93 percent vacancy rate, and the 108-unit Forté condo, at 230 Ashland Place, has a vacancy rate of more than 60 percent, according to the survey. The report will also include data on troubled developments in the South Bronx, Bushwick, Harlem, the Lower East Side and the West Village. "We want to show the city how big the problem is," David Dodge, a member of Right to the City's New York chapter, said. "The problem is larger than people knew and the city took count of." [Crain's]
Now those of you who are not familiar with lower Manhattan or Downtown Brooklyn may not realize the extent of the highly leveraged monies wasted here. That is why created the pictorials linked above. Let's pull some content from them, shall we?
This is the Forte' Condos from various angles, many of which can be seen through empty lots (buildings that were razed to make room for more condos and higher density office space, funded by banks at 10 to 60 times leverage):
For those who don't know NYC, this is not grasslands. This space in the 5 or so pics above abutts the 2nd largest transportation hub in all of NYC (Flatbush and Atlantic Avenues- with access to LIRR, and at least a dozen subway lines, the largest hub is Grand Central Station in Midtown Manhattan) and is walking distance from Manhattan.
More gigantic, empty condo towers, empty lots that are paid for with bank money and will try to be condos, and more condos. Here's an interesting view of the Forte' Condos, as seen through a space that was a building that has since been torn down to maximize the air rights to make an even bigger office/retail/residential space. I gues they ran out of money... To the right is vacant retail and office space, and you can guess what's to the left.
And off that very same corner, the historically significant Williamsburg Bank and Clock Tower, bought by some smart speculators to convert into... I'll let you fill in the blanks. If you do, you'll be more successful than they are in filling all of those expensively built (with bank money) blank condo units. There are a lot, this is a BIG building (the tallest in the borough of Brooklyn), surrounded by many other BIG condo units, interspersed between many condo towers under BIG construction. By now, I would assume that you're recognizing a pattern here.
The Forte' Condo is literally right around the corner from what you see here. If they are only 47% occupied after years of trying to sell, how do you think these guys are going to fair in a 10% unemployment environment? The 246 unit Schemerhorn building that is over 90% vacant is walking distance from this bunch. Check out the next block over toward Manhattan...
Massive construction of what was supposed to be condos, now rentals, next store to apartments for rent, next store to a lot slated for apartment building construction! By the way, these are directly across the street from newly built condos that are already in disrepair. Not to worry, because about 30 seconds down Flatbush Ave and over the Manhattan bridge are 4 more super condo towers, freshly built that are not in disrepair yet.
I strongly suggest you go through my pictorial links if you haven't already, then see the video so you can get a true feel of the amount of pain the banks will feel from these endeavors. Remember, banks fund the construction loans, mezzanine, permanent, and the retail mortgages of the end buyers. This ugliness is just getting started. Here ya' go again: "Who are ya gonna believe, the pundits or your lying eyes?" (for pictures) and "Who are you going to believe, the pundits or your lying eyes, part 2" (for numbers and a very shaky video), I will be expanding my coverage of the commercial side next week as I start to unveil the first of several REITs that will not have the cash to rollover their debts (at least as of now they don't) to subscribers. We are also still waiting for that plus four number from some existing guys, February REIT Actionable Intelligence Note Update -check out the video here.
This is the most recent CS condo pricing index report:
As you can see, it does not appear that the index believes NYC prices are going anywhere significant. The macro scene of unsustainable and government suppressed mortgage rate levels, rampant unemployment expected to increase for at least another year, and the potential end to government housing subsidies really don't seem to bode well for prices either. Oh well, what the hell do I know?
Of course, what good is a solid investment thesis without a juicy government conspiracy thrown in...
Check out this breaking story from the Journal...
Federal bank regulators issued guidelines allowing banks to keep loans on their books as "performing" even if the value of the underlying properties have fallen below the loan amount.
The volume of troubled commercial real-estate loans is skyrocketing. Regulators said that the rules were designed to encourage banks to restructure problem commercial mortgages with borrowers rather than foreclose on them. But the move has prompted criticism that regulators are simply prolonging the financial crisis by not forcing borrowers and lenders to confront, rather than delay, inevitable problems.
The guidelines, released on Friday by agencies including the Federal Deposit Insurance Corp., the Federal Reserve and the Office of the Comptroller of the Currency, provide guidance for bank examiners and financial institutions working with commercial property owners who are "experiencing diminished operating cash flows, depreciated collateral values, or prolonged delays in selling or renting commercial properties." Restructurings are often in the best interest of both lenders and borrowers, the guidelines point out.
The new rules don't reverse existing rules. Rather they are more explicit than regulators have been in the past about how banks should deal with restructuring issues. Banks in recent months have been peppering agencies with questions about this as the number of problem loans has soared.
About $770 billion of the $1.4 trillion commercial mortgages that will mature in the next five years are currently underwater, according to Foresight Analytics. As of last week, 106 banks had failed this year, the most since 1992 -- the peak of the savings-and-loan crisis. Regional and community banks especially have been paying dearly for their aggressive push into commercial real-estate lending during the boom years.
The new guidelines are targeted primarily at the hundreds of billions of dollars worth of loans that are coming due that can't be refinanced largely because the value of the properties have fallen below the loan amount. In many of these situations, the properties are still generating enough income to pay debt service.
Banks have generally been keeping a lid on commercial real-estate losses by extending these mortgages upon maturity. However, that practice, billed by many industry observers as "extending and pretending," has come under criticism by some analysts and investors as it promises to put off the pains into the future. [More to the point, the longer you wait to foreclose, the less the collateral will be worth. Those silly, dilly, nillies who are waiting for property values and rents to go back to where they came from better have a few Snickers bars available, for it ain't going back to the credit bubble highs until, well,,, we have another credit bubble! Once the banks realize this, those that can take the immediate losses without being rendered immediately insolvent, not many of them but there are a few out there, will actually race to the bottom of the valuation ladder since it is bascially first come first serve for distressed properties in a rapidly deflating market. I better get mine before you get yours since there is less and less for either of us to get the longer we wait. And when you do wait... Well that is how Japan was able to fit 19 years of deflation into what many who can't count call the lost decade!!!]
Now federal regulators are essentially sanctioning the practice as long as banks restructure loans prudently. The federal guidelines note that banks that conduct "prudent" loan workouts after looking at the borrower's financial condition "will not be subject to criticism (by regulators) for engaging in these efforts." In addition, loans to creditworthy borrowers that have been restructured and are current won't be reclassified as "high risk" by regulators solely because the collateral backing them has declined to an amount less than the loan balance, the new guidelines state.
Critics say the new rules are yet another example of a head-in-the-sand approach by regulators, pointing to the relaxed accounting standards last year that enabled banks to avoid marking the value of the loans down. This is doing long-term damage to the economy, they say, because it ties up bank capital, preventing them from resuming lending.
Critics say a wiser approach would be for regulators and banks to deal with problems quickly like the Resolution Trust Corp. did in the early 1990s during the last commercial real-estate crash. Back then, the RTC helped purge the financial system of toxic mortgages.
The new guidance "gives people a long time to figure out they're not going to pay it back," said Douglas Durst, a leading New York City developer. "We are in a period where nothing is happening," he said, adding that banks are "not making any new loans because they have this bad debt on their books and not writing it down and getting rid of it.
Let's not forget the intertwined relationship between these buildings and individual residential mortages. Those who are in sparsely populated condo buildings tend to default at a higher than average rate, due to a varierty of factors, maintenance being one of them (see lyin' eyes part 2 for the math on this topic) - US Home Vacancies Rise to 18.8 Million on Defaults.
So, taking this WSJ article into perspective, who among the big and small banks are lying about thier commercial loan portfolio? Take a gander at the numbers in question from just one bank.
I strongly urge professional subscribers to go through the balance sheet sections of the extended reports available from the downloads section to see what your favorite bank is holding. If you have any questions, you can post them in the public comments and if they are germaine to specific subscription content, I will have my analysts address them in the professional subscribers' discussion forums.