U.S. Treasury Implements Plan C for Banks

I guess it’s Plan C because Plan A and Plan B have already been implemented. The Washington Post reports on the latest attempt to slow down the realization of economic reality — which is that prices are falling — in both residential and commercial real estate [emphasis added]:

Treasury Works on ‘Plan C’ To Fend Off Lingering Threats (Washington Post, July 8, 2009, David Cho and Binyamin Appelbaum)

As the financial system tries to right itself after its near-collapse last fall, the Treasury Department has assembled a team to examine what could yet bring it down and has identified several trouble spots that could threaten the still-fragile lending industry.

Informally known as Plan C, the internal project is focused on vexing problems such as the distressed commercial real estate markets, the high rate of delinquencies among homeowners, and the struggles of community and regional banks, said government sources familiar with the effort.

The problem is not hard to see. Real estate prices have fallen and continue to fall. As we have seen, residential real estate prices have already tumbled in the range of 30-40% in many of the hardest-hit areas such as Florida, California and Nevada. This chart of residential values in major markets tells the tale. The Composite 10 line (blue) covers 10 major U.S. markets for residential real estate and the red line covers 20 markets:

Data: S&P/Case-Shiller Chart: Calculated Risk

Until quite recently, commercial real estate prices had held up well. That does not seem to be the case any longer. I don’t have a similar chart for commercial real estate, but values in that arena are falling very quickly and very hard as these articles attest:

Here is a report from the the San Francisco Business Times about a very nice office building in San Francisco that just sold for 57% off its 2006 price:

A downtown San Francisco office building that sold for $400 a square foot in 2006 has traded for just $172 a square foot, a 57 percent decline that industry experts see as an important milestone in establishing new, recession-era values for financial district property.

A private equity fund controlled by an unidentified “domestic billionaire” has paid $19.9 million for 250 Montgomery St., a 116,000-square-foot building on the corner of Pine Street that Lincoln Property Co. bought for $46 million in 2006. Technically, the buyer bought the note on the building, rather than the property itself. Under the sales agreement the lender on the property, Finance Realty Corp., will deed 250 Montgomery St. to the buyer in lieu of foreclosure. Lincoln Property was in default on the property.

The sale, at a price that represents about 25 percent of replacement cost, represents the first San Francisco office building sale in a year. It is also the first “round trip” transaction where a property went from being sold at the peak of the market to deed in lieu of foreclosure to a new owner. Colliers International Executive Vice President Tony Crossley said the price “gives the market a data point it has been lacking.”…

A data point is all this represents, but it is a frightening data point for owners of commercial buildings and certainly also for lenders. Here is another data point on a commercial building in Manhattan. Bloomberg reports on another more than 50% off sale:

Deutsche Bank AG, Germany’s largest bank, plans to sell Manhattan’s Worldwide Plaza to … RCG Longview and George Comfort & Sons … for about $605 million …

Deutsche Bank is selling the last of seven buildings it seized from developer Harry Macklowe. He paid $1.74 billion for the 1.75 million square-foot property in February 2007, according to Real Capital Analytics Inc. data. Manhattan office building prices have dropped 30 percent to 50 percent since the peak in 2007, according to Woody Heller, head of the capital transactions group at Studley, a New York-based brokerage. Heller wasn’t involved in the transaction…

In both of these cases, the purchaser’s equity was wiped out and the lenders took a huge hit. Assuming these are not just isolated cases, then commercial real estate lenders are going to have a very rough time of it.

The Washington Post article on the Treasury Deparment’s Plan C continues:

…The officials in charge of Plan C — named to allude to a last line of defense — face a particular challenge in addressing the breakdown of commercial real estate lending.

Banks and other firms that provided such loans in the past have sharply curtailed lending.

…Kim Diamond, a managing director at Standard & Poor’s, said the trend is expected to accelerate over the next few years, further depressing prices on some of the nation’s most valuable properties.

“It’s not a degree to which people are willing to lend,” she said. “The question is whether a loan can be made at all.”

The problem affects not just the recipients of the loans but also the institutions that lend, many of them small community banks and regional firms.

Thousands of these institutions wrote billions of dollars in mortgages on strip malls, doctors offices and drive-through restaurants. These commercial loans required a lot of scrutiny and a leap of faith, and, for much of the decade, the smaller banks that leapt were rewarded with outsize profits.

In doing so, many took on bigger and bigger risks. By the beginning of the recession in December 2007, the median midsize bank held commercial real estate loans worth 3.55 times its capital cushion — its reserve against unexpected losses — according to the Federal Deposit Insurance Corp…

Uh no. The problem is not that the banks have stopped lending. They stopped lending because real estate prices are falling and the banks are in work out mode on many properties. You cannot paper over declines in value of 30%, much less 50% or more for commercial properties. The banks and other lenders that made these loans are in trouble and they need to work this out before they will be able to move forward.

If the Treasury officials think the solution is just to pump in billions to get banks lending again, they are going to be sadly disappointed just as they were with the TARP program and other efforts. A bank with a major hole in its balance sheet needs to fix that problem. Also, lending standards and business models have to be updated to address the new, more austere operating environment.

Only when both of those steps have been taken, will lending resume on any kind of normalized basis.

Comments

[Roger Knights:]

"I don’t have a similar chart for commercial real estate, ..."

Here are links to three recent SA articles that contain a chart of Moody's/REAL Commercial Property Price Index (CPPI):

seekingalpha.com/artic...
seekingalpha.com/artic...
seekingalpha.com/artic...

"If the Treasury officials think the solution is just to pump in billions to get banks lending again, they are going to be sadly disappointed ...."

Maybe officials are just SAYING that, but the real purpose is to covertly bulk up banks reserves to allow them to absorb losses.

Jul 09 04:46 AM

[CautiousInv...:]

The author is highlighting an importany story.

I follow home prices more closely than I do CRE prices but my sense is that overall this asset class is down 40% in terms of valuation, making most properties mortgaged in recent years underwater as the original LTV might be around 70%.

This fact, along with the fact that slightly more than $1 trillion of CRE in its many forms will needed to be refinanced between now and 2014, makes this asset class a ticking time bomb. To roll over a commercial loan an owner would have to come to the table with cash equallying 28% of the loan being refinanced.( The original loan was 70%, the value today is 60% and you can borrow today 42% (70% of 60% ) and ( 70%-42%=28%) Ouch.

Recognizing this, the Fed wants to include CMBS in TALF but that ratings agencies are downgrading CMBS so fast that it will all be junk before the Fed gets its act together. And since the Fed is only supposed to hold AAA paper this poses some nasty little administrative problems which I am sure we will be hearing more about as this story unfolds.

Jul 09 05:29 AM

[ain't no fo...:]

This is just another in the endless conga line of trickle-down results that all ultimately feed into the expanding vortex of the massive decline in asset prices.

Insurance companies are traditionally major buyers of a lot of the commercial RE paper that is now underwater, and they are likely to be taking big write downs in the next 18 months. Many of their charts are breaking down, and I would not be a buyer of that particular class of financials here.

I'm reminded of an out of control fire, feeding on itself as it consumes everything in its path.

Jul 09 10:21 AM

[dizzyfingers:]

Quote: an out of control fire, feeding on itself as it consumes everything in its path.

Great analogy, very apt.
Another might be "freight train rolling down hill..." Don't jump in front of it.

Aug 10 05:40 PM