Real Estate Delinquency Rates Accelerate: Do We Need More Bailout Money?

Currently, there is approximately $3.5 trillion or more of outstanding debt associated with U.S. commercial real estate. The delinquency rate on commercial property loans pooled together into investments is about $750 billion considered under/nonperforming in Q2, 2009. This rate is nearly triple from where it was at the end of last year. The increasing real estate delinquency rate combined with stagnate L-shaped U.S. GDP growth into 2011 and high unemployment leads us to question whether or not some form of additional bailout stimulus is necessary.

To get a true sense for the problem's alarming effects, one has to consider the numbers of banks and life insurance companies, which have approximately $1.7 trillion and roughly $300 billion in commercial loan exposure. Additionally, banks have $1.1 trillion in core commercial real estate loans on their books according to the FDIC, another $590 billion in construction loans, $205 billion in multifamily loans and $63 billion in farm loans. The precise maturity schedule for these loans is not definitive, however bank loans tend to have short-term durations, and the assumption is that all will mature by 2013, exhibiting moderate increases in maturities due to activity pick up over the last 2-3 years.

The Ripple Effect

Today, more than 150 publicly traded U.S. lenders own nonperforming loans that equal 5% or more of their holdings, a level that former regulators say can wipe out a bank’s equity and threaten its survival. The number of banks exceeding the threshold more than doubled in the year through June, according to data compiled by Bloomberg, as real estate and credit-card defaults surged. Almost 300 reported 3% or more of their loans were nonperforming, a term for commercial and consumer debt that has stopped collecting interest or will no longer be paid in full.

For example, the biggest banks with nonperforming loans of at least 5% include Wisconsin’s Marshall & Ilsley Corporation (MI) and Georgia’s Synovus Financial Corporation (SNV). Among those exceeding 10%, the biggest in the 50 U.S. states was Michigan’s Flagstar Bancorp (FBC). In addition, Chicago-based Corus Bankshares Inc. (CORS), Austin-based Guaranty Financial Group Inc. (GFG) and Colonial BancGroup Inc.(CNB) in Montgomery, Alabama, each with ratios of at least 6.5 percent that historically means further toxic loan banking shut downs.

A Snapshot of the Real Estate Market

Commercial construction loans outstanding shrank by 2.2% in 2Q 2009, as compared to a revised 0.3% increase in 1Q 2009. This downward trend will accelerate in the coming quarters as a lack of new starts will sap demand for construction financing, and will represent the first major contraction since the previous cyclical low in 2003.

Construction loans outstanding contracted by 5.5% during the second quarter (vs. 1Q 2009), accelerating from the 4% declines in 1Q 2009 and 4Q 2008. All major construction categories are now declining, including commercial real estate construction.

Delinquency rates for all construction and land loans rose to 16.3% during the Q2 2009, up from 14.5% during 1Q 2009, and more than triple the 5.0% rate in the fourth quarter of 2007. The single family and condo construction sectors are the weakest by a wide margin, with delinquency rates rising to 24.2% and 38.0%, respectively. Despite some indications that residential prices may be bottoming, home prices were weak in 2Q 2009 and the severe cumulative declines in boom-bust markets will cause these delinquency rates to rise further during the second half of 2009.

The Real Estate Market Themes

The refinancing problem thus boils down to two concurrent themes: The first is the altogether entire current shut down in debt capital markets for assets. The government is addressing this first theme through all the recently adopted programs that are meant to facilitate general credit flow especially with regards to lower quality assets.

The second theme is the much more serious and less easily resolved issue of the negative equity deficiency on a per loan basis, which is not a systemic credit freeze problem, but an underwater investment problem. The reason for this focus is that there seems to be an unfortunate misunderstanding in the market that lenders will simply agree to roll the maturities on non-qualifying loans, and that the expected percentage of loans that need special lender treatment is low, roughly 5-10% of total loans. In reality the percentage of underwater loans at maturity is likely to be in the 60-70% range, meaning that refinance extensions could not possibly occur without the incurrence of major losses for lenders.

In order to demonstrate the seriousness of the problem it is important to first present the magnitude of the refinancing problem. To quote data from Deutsche Bank, and focusing on the CMBS product first, there are approximately $685 billion of commercial mortgages in CMBS maturing between now and 2018, split between $640 billion in fixed-rate and $45 billion in floating rate. The figure below demonstrates the maturity profile by origination vintage. As noted previously, vintages originated in the pre-2005 bubble years are likely much less "threatening" as even with the recent drop in commercial real estate values, the loans are still mostly "in the money".

The largest CMBS refinance threat occurs in the 2010-2013 period when 2005-2007 vintage loans mature. These loans, originated at the top of the market have experienced 40-50% declines in underlying collateral values, and the majority will have material negative equity at maturity (if they don't in fact default long before their scheduled maturity). Of these loans, only a small percentage will qualify for refinancing at maturity.

At this point cynical if all CMBS loans are unable to be rolled, it is at most $700 billion in incremental defaults. Is that a big deal - after all that's what the government prints in crisp, brand new, sequentially-numbered dollar bills every 24 hours (give or take). Well, the truth is that CMBS is only the proverbial tip of the $3.5 trillion CRE iceberg.

Conclusion

The ripple effect of the commercial real estate problem has a significant likely hood of requiring new bailout stimulus to attempt to contain the problem from bleeding over into other sectors. The multi-trillion pending commercial real estate meltdown is simply too massive to be manipulated. It’s much too large to be simply swept under the carpet or handed down to the next generation on top of the increased taxes, trillions of debt and spiraling healthcare costs. It is inevitable that we must address this financial issue head on, and the sooner it happens, the less the eventual destruction of individual assets, accelerating more potential job losses. Delaying the inevitable at this point is not a viable option.

As poor economic conditions persist into 2011, supported by the latest 298,000 job losses reported for August 2009, according ADP National Employment Report. Beware of the accelerating epic drops in commercial real estate values and rising real estate loan delinquency rates that will infect other market sectors requiring upwards of $800 Billion in allocated bailout money.

Disclosure: NONE

Comments

[User 480228:]

Mr. President why are the banking,and loan company not making loans as you promised they would do for the american people we are all hurting and not getting any help. Time for them to answer to you for not helping us the little people that keep them in business, maybe we should boycott their business. Check www.obamamortgagerelie.../.

Sep 04 05:54 AM

[Mad Hedge F...:]

dfhh. Don’t kid yourself into thinking that the real estate collapse is over. Yes, you can be forgiven for thinking so with July new home sales up 10%, the Case-Shiller home price index up two consecutive months, and homebuilder stocks like Toll Brothers (TOL), D.R. Horton (DHI), and Lennar (LEN) through the roof. Nationally, home prices have fallen back to their historic average of 3.2 times earnings. The problem with all of this is that crashes don’t end at the averages, they overshoot. Some cities like Los Angeles, New York, and Washington DC are still historically expensive. Take away the life support of ultra low interest rates, the $8,000 first time buyer tax credit, the $6,000 California tax credit, $1 trillion in Fed purchases of securitized debt, and toss in another five million expected new foreclosures, and that might give you your final bottom. But that isn’t happening this year. Rent, don’t buy.

Sep 04 09:40 AM

[AndrewBaker:]

The commercial real estate collapse has just begun. If you think the sub-prime residential fall was big; just wait 'til you see what's gonna happen in commercial!

Prime borrowers are failing to pay their mortgage now in residential whilst in commercial, prime and sub-prime are in trouble. Buildings are being sold for less than the cost of putting them up.

If you've derived comfort from soundbites suggesting it's getting better, enjoy it for the time it lasts: and it won't be very long.

Sep 04 02:26 PM

[AndrewBaker:]

The best market now for commercial real estate is the UK: London and the south and south-east prime properties are undervalued and have sunk too much in price in the past two years, and can be let at 7% to 10% return; and prime borrowers can borrow money at 2% in the UK. It doesn't take much math to see that there's money to be made, and profits to be extracted even whilst waiting for any capital gain. And most UK leases are upwards only on rent reviews. This is one market that will soon be frothing, with currency gains in time as well, possibly.

Sep 04 02:30 PM

[billddrummer:]

CORS suggested that 75% of its loans were nonperforming in a filing with the SEC explaining why the 10-Q was filed late.

www.corusbank.com/acro...

The comment is in paragraph 8 on page 3.

Sep 04 04:21 PM

[relaplan1:]

43% of US households spend more than their income. Making loans to those people is what caused this mess. And, in doing so Banks did not maintain adequate reserves. Hopefully Banks learned. The best thing "little people" can do is get out of debt, not borrow more money.


On Sep 04 05:54 AM User 480228 wrote:

> Mr. President why are the banking,and loan company not making loans
> as you promised they would do for the american people we are all
> hurting and not getting any help. Time for them to answer to you
> for not helping us the little people that keep them in business,
> maybe we should boycott their business. Check www.obamamortgagerelie.../.

Sep 05 10:42 AM

[greedcanbgood:]

Do We Need More Bailout Money? No.

Sep 09 10:23 AM

[B.Truszkowski:]

Flagstar Stock s been going up for the la 2 days. Why is it going up?? What do you think about the future??

Sep 22 10:07 PM