Monthly Archives: January 2012

Loan Delinquencies Show Moderation (except for real estate loans)

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Federal Reserve data indicate that the credit health of Americans is improving in several categories. The delinquency rate on consumer loans is falling nicely. Business loan delinquency is declining in a similar fashion.

However, high delinquency rates still burden real estate loans.

First, the good news. Consumer loan delinquency dropped 37 percent in the past year from a peak of $59.8 billion on Jan. 1, 2010, to $37.6 billion in July 2011 (the most recent numbers posted). Another $10 to $15 billion of troubled consumer loans have to be resolved to get back to previous norms, but the trajectory of recovery is fast.

Business loan quality has increased substantially as well in recent months. The cyclical peak of this recession found 4.47 percent of business loans delinquent in July 2009. The rate has fallen every quarter since then to the current level of 1.87 percent.

Notice how the level of delinquency in this recession was noticeably lower than the recession in the early 1990s. Business loan quality looks great. This should encourage banks to expand loans to businesses.

Unfortunately, the health of real estate loans in the portfolio of our American banks still has a long road to recovery. The delinquency rate hit the cyclical peak of 8.76 percent in April 2010 and declined gradually to 6.69 percent at the end of June 2011. The banking system adopted the well-known policy of “extend and pretend” in 2008, and the result is that there are still a lot of troubled commercial real estate loans that will have to ultimately be foreclosed and sold to private investors.

Commercial real estate investors have been waiting for more than three years to purchase distressed real estate loans and properties. Clearly, there are many properties yet to be disgorged from the banking system. The question of “When?” remains unanswerable.

Commercial real estate transaction volume will likely stay muted until this “shadow inventory” of troubled commercial real estate sells to investors. Fortunately, Texas banks are much stronger than the national average and have capacity to make real estate loans.

The following chart explains why bank regulators are still “encouraging” banks to limit real estate lending. Regulators haven’t been able to foreclose and otherwise resolve the backlog of troubled real estate loans, so there is little enthusiasm to increase real estate lending until this backlog is cleared.

Notice how the delinquency rate peaked at 10 percent, well above the 7.5 percent peak in the early 1990s. Banks are making progress in cleaning up their real estate loan portfolios, but the pace is painfully slow for brokers, lenders, lawyers, title companies and moving companies that thrive on commercial real estate transaction volume. At the current pace of disposition, it will be many years before the real estate market credit conditions are back to “normal.”

This final chart is the scariest of the lot. The delinquency rate for residential single-family houses is simply astronomical by historical standards. Failed mortgage modification programs and legal challenges to foreclosure caused the average time to foreclose on a house to explode to 689 days, up from less than 300 days in earlier years.

The single-family mortgage market is the epitome of “extend and pretend.” Banks and mortgage servicers just don’t have enough people to process the massive foreclosure volume. This chart is a great measure to watch the progress of any recovery in residential real estate sales. It shows the shadow inventory of distressed properties that will ultimately come into the market and sell to investors.

We are already three years into the housing bust, and the troubled loans haven’t been addressed in any significant volume. If you make your living selling houses or in the many industries that depend on home sales volume for profitability, you need to root for the government to speed up the foreclosure process and clear this market. Until they do, homebuyers will be fretful that prices could fall farther when these properties ultimately sell.

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Real Implications of Fed’s Policy Announcement

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Wow! I have documented in previous posts how this low-interest-rate environment is crushing retirees and others who have accumulated savings. The Federal Reserve has just announced that they will keep interest rates at “fairy tale” levels until the end of 2014.

That means personal income from interest will not recover for another three years.

What does this mean for real estate?

First, mortgage rates will remain at fantasy levels for another three years. There is no urgency to buy a house now. You don’t have to worry about rising interest rates, so you can postpone buying for a long time. As we say in the business, buyers can now “stay on the fence” for another three years. This is not good news for people who make a living based on transaction volume of residential real estate.

Second, for older Americans there is now little hope that their savings will earn anything for another three years. Americans with savings who have retired already or are considering retiring in the next five years will have to rethink their lifestyle. Treasury bonds have no yield. Inflation-protected Treasury bonds have no yield. Money market accounts have no yield. Certificates of deposit have no yield.

The real estate implications are:

Older people who were planning to buy a second home in Texas may have to revise their plans. This will slow demand for second homes and demand for lakefront and Hill Country properties. This will also affect the demand for properties on golf courses.

People who retired in the past five years, hoping to live on a golf course and play golf are going to have less income than they thought possible. Those who don’t “play enough golf to make it worth it” will let their memberships expire and play a few rounds at the municipal course instead. Golf course developers will find fewer buyers willing to buy a second home in their project.

Other people who might have wanted a second home to be near the grandkids will have to reconsider as well. When your interest income falls 75 percent, you feel less confident about your financial ability to maintain two homes.

Lower interest rates will increase the value of quality commercial real estate properties. Cap rates are likely to compress even further than they already have. This is part of the Federal Reserve plan to reduce the losses in the banking system from bad real estate loans made in 2005—08. Watch sales prices for “trophy” commercial real estate to move back into bubble territory that we last saw in 2008.

Low interest rates will also create even more feverish demand for agricultural cropland. Prices have increased dramatically in the past two years, and buyer enthusiasm is increasing. Watch quality cropland increase even more. Watch out for bubbles in this sector as well.

Of course, this announcement is likely to cause more investor demand for gold. Gold fever is a natural result of ongoing concerns over a money-printing-happy government.

This is exactly what Japan has done. Their stock market bubble collapsed in 1989. The bubble in commercial real estate collapsed two years later. Banks had catastrophic levels of loan losses. All were deemed “too big to fail.” Unable to recognize the losses, they went into an “extend and pretend” mode for many years. Interest rates in Japan have been negligible for years, and their government goes further and further into debt each year.

Finally, low interest rates enable Congress to spend trillions of dollars that it doesn’t have. In theory, the government could spend a quadrillion dollars this year and fund it with government bonds that have virtually no interest cost. Hence, there is no cost to infinite borrowing. This move by the Fed makes it even easier for Congress to postpone for years any attempt to balance the budget.

One Fed president made this statement about a year ago when asked about the possibility that the U.S. credit rating could be downgraded: “It is no longer prudent to consider the unthinkable improbable.”

Five years ago, nobody would have guessed that their hard-earned savings would earn almost nothing. Up until yesterday, nobody would have guessed that their savings would earn nothing for another three years.

Keep up with the latest Texas real estate news. The Center has several RSS feeds designed to help you make better real estate decisions.

 

Why is Housing Credit Tight?

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Why are banks making it so difficult for borrowers to get a mortgage? The recent letter from the Federal Reserve to Congress with suggestions on how to fix the housing market lays out important reasons why mortgage credit is tight.

The good news is that we can understand the reasons. The bad news is that self-preservation may prevent the problem from being fixed.

The Fed describes the tightness of mortgage credit conditions:

“Other data show, for instance, that less than half of lenders are currently offering mortgages to borrowers with a FICO score above 620 and a down payment of 10 percent – even though these loans are within GSE parameters. This hesitancy on the part of lenders is due in part to concerns about the high cost of servicing in the event of loan delinquency and fear that the GSEs could force the lender to repurchase the loan if the borrower defaults in the future.”

The Fed goes on to say that concerns about the high cost of mortgage servicing stem from:

  • the realization of how expensive it is to resolve a nonperforming loan,
  • uncertainty about what it will cost to comply with new mortgage servicing-related regulations and
  • the potential change in the way Mortgage Servicing Rights (MSRs) are treated for capital requirements under Basel III (new international banking regulations).

National Mortgage News reports that it costs a servicer 75 basis points (.75 percent) or more to service a high-touch loan (a.k.a. defaulted loan) compared with the 25 basis point servicing fee it receives. It is a losing business.

What about the difficulty of getting an FHA loan? Recently the Department of Housing and Urban Development said it would like to see the FHA lenders relax their credit score minimums so that more borrowers could qualify for FHA loans. According to the Asset Securitization Report, “Lenders are telling HUD officials the agency must first change FHA’s lender/monitoring system known as Neighborhood Watch so they aren’t stigmatized for making loans to borrowers with lower credit scores.” A lender that makes loans with higher default rates will have a higher Neighborhood Watch ratio than other lenders, which could lead to audits and indemnification demands. The lenders want HUD to consider borrower credit score when evaluating them and calculating the ratio.

Don’t forget to add the risk of government and private lawsuits and judicial foreclosure proceedings to the list of concerns about making loans that are more likely to default.

If you were a lender facing all these challenges, would you make the loan? Demonization of mortgage lenders and servicers makes for great political theatrics. But it doesn’t make them want to lend more.

Keep up with the latest Texas real estate news. The Center has several RSS feeds designed to help you make better real estate decisions.

 

Here Comes ‘Wall Street’ Fed

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What is the Federal Reserve’s end game by suggesting ways to fix the housing market? A recent letter from the Fed to Congress suggests ways to buoy home prices and by doing so to fix the housing market.

The Fed wants to increase home values so homeowners feel wealthy and spend more and help the economy recover. Is this the foundation for economic recovery we need?

Move over Wall Street banks, here comes the “Wall Street” Fed. How did we get into this mess in the first place? During the bubble, home values rose, so households felt wealthier. The way they increased consumption was by taking out loans against increasing home values. Wall Street banks, motivated to help households take on more debt, made it happen.

In retrospect, we learned that the debt-fueled consumption bubble was not sustainable. The growth in debt could not be supported for the long term by household income. Yet now we have a Federal Reserve that wants to take its turn at making you feel wealthy so you will consume more.

The Fed wrote in its letter to Congress:

“Obstacles limiting access to mortgage credit even among creditworthy borrowers contribute to weakness in housing demand, and barriers to refinancing blunt the transmission of monetary policy to the household sector.”

Yet here’s what Richmond Fed President Jeffery Lacker had to say about monetary policy in a recent CNBC interview:

“We’ve known this for decades, that monetary policy has an effect on real growth that is transitory. It definitely has an effect on inflation. So to the extent we can get some traction it’s going to show up as inflation, maybe as an increase in growth but only temporarily.”

Have you noticed that the most important economic recovery policies of the Federal Reserve and the Obama Administration are designed around getting households to take on more debt? Read my recent Tierra Grande article “Dialing Down Debt” to see how far household debt is out of whack compared with the historical norm.

When will this country realize that the only path to long-term economic recovery is to increase consumption by increasing real household income? We must regroup and retrain our nation’s population to invent and manufacture real products that the world wants to buy.

Our leaders must improve domestic regulatory and tax policy while standing up forcefully to unfair foreign trade practices so that American producers are competitive in the global economy. We must create jobs through fully developing our natural resources for domestic consumption.

Engaging in monetary policy that produces short-term wealth effects and inflation won’t fix the problem. The solution lies with Congress and the American work ethic of households.

Keep up with the latest Texas real estate news. The Center has several RSS feeds designed to help you make better real estate decisions.

 

Zero-Interest Rate Policy Crushing Household Income

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The Federal Reserve has dropped interest rates to near zero for short-term investments. They have done this in an attempt to spur job growth and reduce the unemployment rate in America. Recently, they announced Operation Twist designed to bring down interest rates on longer-term bonds as well. Consequently, the ten-year Treasury now offers less than 2 percent interest, and the 30-year Treasury offers 3 percent.

The hoped-for positive consequence of this is to stimulate borrowing by businesses to expand and hire and to encourage households to buy houses, cars, boats and clothes. Unfortunately, the lower interest rates haven’t spurred an increase in home sales. The allure of low interest rates hasn’t been enough to offset the business uncertainty created by Congress. As a consequence, the low interest rate policy hasn’t been sufficient to bring about economic growth.

The negative consequences of the zero-rate policy are being felt all over the country. These negative consequences include:

Low rates reduce the incentive to save money

Why should you save when you can’t earn any money on your savings? Actually, this is part of the Fed policy to encourage Americans to borrow and spend rather than to save.

Low interest rates cause savers to “chase yield” by investing in riskier assets

Americans who would prefer to own low-risk bonds are tempted to invest in “high-yield” bonds or stocks. They are forced to take more risk than they are comfortable with. This is also part of the Fed strategy to get Americans to drive up stock prices by forcing investors out of money market accounts and short-term bonds.

Low interest rates create impression among Americans that runaway inflation is just around the corner

Recurring threats of more “quantitative easing” sends gold prices higher. This causes many people to buy gold to hedge against the threat of the Fed “turning on the printing presses and never shutting them off.” This fear of a debauched dollar has driven investors to speculate in commodities like gold and silver. Commodity speculation is one of the riskiest “investment” decisions you can make.

Low rates distort investment market by creating bubbles

I used to have confidence in Treasury Inflation-Protected Securities (TIPS) as a protection against inflation. For a decade, you could expect to get 1.5 to 2 percent interest, PLUS inflation on these bonds. Alas, those were the good old days. Now Fed policies have scared investors enough to the point that five-year TIPS actually offer a negative yield.

Why would anyone want to buy a five-year bond priced to lose money over a five-year investment horizon? Buying ten-year and 30-year Treasury bonds also are treacherous investments at this time. If our economy ever recovers and interest rates go back to more normal levels, these Treasury bonds will fall in value. Farmland in America is also in a bubble because of the Fed policy. The same reason that some people buy gold is also causing others to pay record prices for farm land.

Low rates reduced Americans’ personal income by $1.5 trillion a year since 2008

American households get their income from several sources, including wages and salaries, interest on bonds and mortgages they own, dividends from stocks, rent from properties they own and government transfer payments like Social Security, Medicaid and unemployment benefits. For older Americans who have saved money for their retirement years, this is a catastrophe. One-thousand five-hundred billion dollars of spendable income has just evaporated.

Is this zero-interest policy really worth it? Who is really benefitting?

Keep up with the latest Texas real estate news. The Center has several RSS feeds designed to help you make better real estate decisions.

 

 

 

Current Commercial Thinking

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I recently gave a speech at a two-day conference in Dallas. The event was the Texas Bank and Financial Institutions Special Asset Executive Conference on Real Estate Workouts. The central focus of the event was how banks and CMBS (commercial mortgage-backed securities) servicers are handling the disposition of troubled real estate loans.

This topic is of keen interest to many who are trying to find distressed real estate to purchase. I sat in on the conference produced by the International Marketing Network for the full two days because the panels were full of global caliber speakers (except of course for me). Their comments provide a snapshot of the current sentiment of the top professionals that are daily making decisions whether to continue to “extend and pretend” or move forward with foreclosure. Here are my notes.

  • Buying houses from Fannie Mae is very difficult. They offer no due diligence, no title insurance. It costs a lot of money to do due diligence. Then you make an offer they accept and then they get an offer from a family and then turn the investor away. Then the family cannot get a loan, and FNMA goes back to the investor who then lowers their bid.
  • Small commercial real estate deals (less than $10 million to $20 million) are hard to finance. The buyers have limited equity. After they buy two to four deals, they may run out of equity, when they have to put 30-40 percent down. Also, banks have a limit as to how much they can loan to one borrower.
  • National Commercial Auctioneers sold 140+ single-family houses from the Houston Housing Authority that decided it did not want to be a property manager anymore. The properties sold at about 60 percent of the appraisal district’s value.
  • Special servicers are not anticipating any significant recovery in rents and values in 2012, so they are reducing their net present value assets of their nonperforming properties.
  • The bank regulatory environment is still intense. They are coming in and classifying lots of loans.
  • Banks are starting to be aware of shadow inventory, when a business is paying rent but not using some space. When the lease renews, they won’t be renting as much space.
  • A lot of borrowers are real estate operators where part of their stated income is from property dispositions. Without the income from property sales, their loans become classified.
  • Haven’t seen a lot of bulk REO sales, just one at a time.
  • New CRE originators have skyrocketed recently on a percentage basis. But the total volume is still small, except for life insurance companies. Selling property in Illinois takes a long time. They now hold bank as “owner” and make them clean up code violations.
  • A bank foreclosed on a property and found a $400,000 lien filed for unpaid water bills.
  • Another bank foreclosed on a marina that had lost its lease for the water two years ago and had EPA storage tank problems. Banks don’t like to take title; they prefer to sell at foreclosure auction. Banks can also sell the note and avoid taking ownership.
  • Volume of distressed asset sales is increasing. It’s largely difficult properties that can lose value. Properties that deteriorate or need significant management are being sold.
  • Bigger, higher quality properties are getting loans resolved. Unique properties and those in second and tier markets are coming through the workout system.
  • Volume of distressed sales was up substantially in 2011 and is likely to increase further in 2012.
  • Don’t expect bank closings to increase much in 2012.
  • Bankers not seeing any improvement in the market next year. “If we can package troubled loans and sell them in bulk, we will. You’ve got to know when to hold and when to fold.”
  • There is an estimated $350 billion in real estate loans in CMBS maturing in 2012. There is a sense that CRE is about to fall over a cliff and that properties are going to get repriced. Many properties are going to all-cash buyers at steep discounts.
  • 2012 is going to be the year when troubled real estate comes to market. Now is the time to sell.
  • $1.4 T CRE debt matures by 2014. There will be a lot of investor equity and debt financing needed to purchase these properties or renew the loans.
  • 2013 could be an ugly year for CRE if this troubled property can’t refinance.
  • Apartments are red hot. A 90-year-old apartment building in D.C. recently sold for a 4 percent cap rate.
  • Regulatory pressures will force banks and life insurance companies to stop the extend and pretend policy.
  • Investors are having a difficult time finding deals that make sense. Trophy properties are selling for low cap rates. But these are only about 10 percent of the market. The other 90 percent of the commercial market is still dysfunctional.
  • Rental markets for office and industrial are flat at best and sometimes still declining. The reason we may see a flood of deals come into the market is that owners are realizing rents may not get better in the next year or two, and it would be better to sell now.
  • The big banks are starting to be competitive on loan rates, making it hard for small community banks to compete for loans.
  • The idea of a “new normal” is starting to set in. The decision will be “how long are we going to wait to take our medicine.” Maybe it’s time to sell properties with distressed loans.
  • Some banks are now in a position to make real estate loans. Could see some growth in C/I (commercial and industrial) loans that are collateralized by real estate. C/I loans are not viewed as a real estate loan, even when a building and land are purchased.
  • Owner/operators will be most likely buyer for real estate because C/I loan can have real estate as collateral. Investors will continue to have a hard time finding financing in 2012.
  • 2012 will be a year of more confidence for special servicers. They have been unsure whether they should sell a property and take the loss or keep the property. Now it’s clear things aren’t going to get better soon, so it’s time to sell.
  • Some banks are restructuring a troubled real estate loan into an A note and a B note. The A note is a lower amount that is underwritten with conservative assumptions. The B note is a hope note, expected to be charged off the bank’s books. The idea is to get the A piece to performing status and write off the B piece. The bank would keep the A note and sell the B piece and be in good shape with the A loan. The A piece must be at a market rate of interest.

Keep up with the latest Texas real estate news. The Center has several RSS feeds designed to help you make better real estate decisions.

 

Voices from the Past

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Banking and financial crises are a regular part of American history. We have weathered them successfully many times since the Civil War. Somehow, our government has become convinced that America is no longer strong enough to overcome a banking crisis. All we hear is that some companies are “too big to fail” and create “systemic risk” that would result in some unimaginable failure of life as we know it.

One person in a recent audience sent me a letter his great-grandfather wrote in 1907 to his daughter. He was a banker in East Texas at the time, and his daughter was concerned that she couldn’t withdraw more than $35 from her bank. Here is the banker’s description of the 1907 situation.

My Sweet Kittie Baby:

You ask why only $35 can be drawn out of the Fort Worth banks. It is the same way all over the country now. However, we are fortunate here. No limit has been fixed by our home banks, but they are cautious, and the least little run on any one of them would make them adopt the same rule.

The reason is that the whole United States has been on the very verge of a panic for some time, beginning in New York. The ostensible beginning was the failure of the Knickerbocker Trust Company of New York, a very large banking concern. This caused depositors to want their money deposited in other banks; so many calling for their money at the same time is what we call a “run” on the bank.

So now to protect all depositors alike, banks have adopted a rule to let their depositors have only a small amount each day until this nervous feeling is over. The U.S. government is also now issuing $50 million of bonds to sell to get money to deposit in banks to help.

Conditions are improving every day, and hopes are entertained that the worst is already over. These financial panics occur about every decade; the last one was in 1893. The one before that was in 1886 and so on.

Reckless speculation and inflated values bring them on, and it takes skillful management and good “financiering” to prevent disastrous results.

Well Baby, this is enough of finances for one time. This same pressure has caused our loan companies to hold up funds from us, and we cannot get money to make loans. We are doing very little business now. I do hope things will soon change up so we can get money to make loans.

Bushels of LOVE,

Father

As you can see, there is nothing new under the sun. We have been down this path many times in our history. America is strong enough to overcome heavy adversity.

I don’t know about you, but I’m getting tired of hearing how every company on earth is too big to fail. If they are truly too big to fail, then they should be dismantled until they aren’t.

If we need to have a “bank holiday,” then let’s have it. There are thousands of strong banks in this country. Let’s find out who the zombies are, and put them out of their misery.

The healthy banks can pick up the pieces and lead our country to growth and prosperity.

Keep up with the latest Texas real estate news. The Center has several RSS feeds designed to help you make better real estate decisions.