Jeffrey Bernstein

Jeffrey Bernstein
Contributor since: 2008
Company: Guild Partners, LLC
I have never been so disconnected intellectually from the market trend. But the 200 day MAs say there is a trend and it is up. You can no longer call this a bear market rally. That is not to say the market can never revisit the lows, but a period of distribution will have to take place, breaking down the support of the moving averages, we aren't just going straight back down, which often happens in bear market rallies. That's really my only point here. I hate the dollar, I hate the economy, I hate the long-trem outlook for our nation (unless something changes in a big way) I am still long some gold and have lots of cash on the sidelines.
For the most part retail REITs have reported year-to-year FFO declines in the single digits for Q1, not exactly life threatening. The biggest issue here are maturity defaults, which are being addressed by equity issuance....stinky as those dilutive deals may be. Public REITs have the option of equity financing and will be much better off than other commercial real estate borrowers, many of whom will succumb to maturity defaults whether or not they have resilient NOIs and reasonable debt service coverage ratios. The real call is long REITs (whose stocks already reflect much higher market cap rates) and short non-REIT commercial real estate, where valuations have to come down and there is no equity option. If only there was a good way to play this trend.....long select REITs (like FRT which has already refi'd all its pending maturities for the next few years) and short regional bank stocks is probably the nearest approximation.
Since when it is it a crime to have debt maturing? Only since the financial system imploded. REITs for the most part are at little risk of defaulting on their loans because their cash flows don't cover debt payments. Of course investors are willing to pony up more equity even at the risk of diluting themselves, rather than have a total loss on an asset that can actually support its debt load. Even in bankruptcy the equity might have value as the maturities would be pushed out...liquidating these entities makes no sense. The maturity default thing has been beaten to death. Yes we could have hyperinflation and an implosion of the world economic systems in the next few years.....if we do there will be much better shorts from here than the REITs.
The rally quality was an A. The market indices are now overbought. How investors react to the inevitable pullback, coupled with the inevitable additional bad news on loan losses will say a lot about the next assault on the indices 200 day moving averages and the inception of a bull market on that definitional basis.
All of this is widely known and the street has had negative positions in REITs reflecting this. The surprise is that REIT stocks in some cases are already reflecting cap rates lower than where CRE is headed. If they are able to refinance and/or raise equity and don't default on their long-term debt at maturity some of these stocks are going to run hard.
You fail to discuss one topic. REIT valuations versus underlying commercial real estate prices. There is a significant discount embedded in REIT prices....partially to reflect maturity default risk. However, part of the discount is also a discounting of future weakness in CRE prices....which is being driven by to a great degree by over-leverage and both maturity default risk as well as cash flow risk, not significant over-building of CRE. So maturity default risk is being baked in twice. This is why some large investors like Equity One are now looking at buying REITs as a way to buy commercial real estate at or near bottom dollar valuations. Yes we all know Wall Street has an excess of back scratching and that it looks even more excessive now that there are only a couple of backs to scratch, but their is a fundamental story here based REIT's discounted valuations vs. underlying CRE. I'm not sure I'm a believer in it, but one must acknowledge it.
Losses in the North Fork portfolio have not yet begun to bite. COF for me...OK COF again.....I think you may be coming down with something.
The question of unintended impacts is undoubtedly a good one regarding all these new programs. But to gain a little insight into what is to come with whole loan sales, just look at the federal reserve data on bank loans. Residential real estate loan delinquencies have blown through the highs of the early 90s and are on a ballistic trajectory. These are loans where the owner has stopped paying interest and principal. (Charge-off rates are also following suit and much more rapidly than in the 1990 period, probably due to less equity in properties and the economic slowdown, keeping borrowers from recovering and banks being quicker to charge off the loans) Where should delinquent loans be valued? If they were traditional 80% LTV loans, in the absence of plunging real estate prices somewhere in the 90 cents + on the dollar range would be a reasonable start (statistically, some of these borrowers will start paying again and eventually pay off their loans and penalties, while those resolved through foreclosure have high frictional costs of dealing with a foreclosure sale). However, with real estate prices down 10 to 40% nationally and a large overhang of supply, one must be much more sanguine about "severity" of losses. My guess is the whole loans that have gone delinquent should be valued at somewhere in the mid 70 cents per dollar or less, for an investor to take them through the foreclosure process and get their money back plus a return. Now maybe there are a bunch of "legacy loans" that aren't delinquent yet, but banks are worried about, that they would like to get off their books. How do you value those? My guess is with the trajectory of delinquency as sharp as it is buyers will look at individual "worrisome" loans as delinquent loans - what other rational approach is there. You could buy a large portfolio of these still performing "worrisome loans" and factor in a big margin for future delinquencies above current levels to diversify your risk. But the bottom line is there is huge pain to come which the banks can't afford to take and in most cases the debt needs to be expunged through foreclosure so a buyer can buy the asset from the bank or debt holder at a haircut that truly makes sense, because delinquencies are soaring, and delinquent loans will not become current again in large numbers. We are not talking about corporate debt, bought for a discount where the borrower recovers eventually. We are talking about delinquent loans that need to be liquidated, or loans that look questionable in a world of soaring delinquencies, that have some high percentage chance of being liquidated.
Great article, it raises an interesting conundrum. here is the answer, the problem is not that bank credit is frozen (as evidenced by recent FDIC numbers showing bank loans off marginally y-y in 2008)'s that it's about to be. The securitization markets are what are frozen. You don't show numbers for commercial real estate (CMBS) or credit card or auto loan (ABS). These declines are what are inhibiting consumers (beyond a normal propensity to save returning) on the one hand, and the commercial real estate business on the other. The tanking economy is causing borrowers in the business world and segment of the commercial real estate world who borrowed from banks, not securitization markets to feel extreme pain from the economic contraction and reduction in asset values, but their banks have not started to foreclose on them.....yet. Reports are rampant of banks extending loan maturities and renegotiating terms in order to forestall pulling the plug on clients. Meanwhile banks are building reserves to beat the band (held as excess reserves at the Treasury, which have gone ballistico). Act II the refinancing/bank loan calling crisis will unfold in the second half, if current efforts to unclog the system and get the economic contraction to stop are not successful.
Thanks for the positive feedback. HMorgan - I think that ABS securities where the originator traditionally had a good amount of skin in the game, like credit card receivables, should get a boost from TALF. Commercial real estate (CMBS) which is in the process of imploding, will not come back until the bear market in real estate ends and the securitization process is re-engineered to make buyers feel a lot more comfortable with the quality of the product. Commercial real estate and C&I loans are going to be a big hit to banks balance sheets in the coming quarters, after which banks may begin to see the light of day again.

I and my firm have no positions in individual stocks long or short.
On Feb 16 01:31 PM User 349063 wrote:
> You state that you have no position in NYB. Does Guild Partners
> have a short position in NYB?
All of the fears you outlined above and more have resulted in the market downturn we have experienced. You will need new bad news to catalyze a lower low in the markets and financials. I personally had been a believer in a lower low and a more rapid decline in the economy. The Bear Stearns bailout may have forestalled this. The massive money creation by the fed may be propping up the economy. Don't fight the tape. negative moving averages argue for a long period of basing in the market, but a lower low is unlikely without some new heretofore unexpected calamity - 9/11 and the Enron, Worldwom scandals were arguably those type of events in the 2000 - 2003 bear market - hard to bet on.
This is not a new phenomenon in blighted markets. Newburgh, New York being an example I am familiar with, where banks sometimes in the past just walked away and the city ended up owning significant numbers of properties. In the case of Newburgh, the city has finally cleaned up its inventory of property after nearly two decades. Business Week carried an article a couple of months ago about Buffalo and some other Northern industrial cities where legislation is being enacted to force banks not to allow re-possesed properties to become blighted. In many cases even REO properties are allowed to sit with maintenance issues and prices are not reduced enough to entice buyers.
I just wrote a very similar article on entitled the Mother of All Margin Calls....and it is pretty scary. Hold onto your hat.
Vern: As an institutional investor in Commerce Bank I salute you. It was a pleasure to be an investor in a company that revolutionized the business model of it's industry and flattened or enlightened avery competitor whose path it crossed. I still tell people about my due diligence trip to southern New Jersey where I saw an old Mellon Branch with a lightbulb driven digital clock on top, half of whose bulbs where out. It was so quite there was tumbleweed rolling across the empty parking lot. Across the street there was a brand new gleaming Commerce Branch, with 4 drive through lanes......every one of them packed in addition to the line out the front door of the bank. You served financial services to them their way! Always a winning strategy.