CRE Bubble? Commercial Real Estate Prices Since The Financial Crisis (Apartments Have Largest Run-up, Retail Has Poorest)

Given the advent of on-line shopping, commercial real estate prices are not quite back to where they were at the height of the asset bubble prior to the financial crisis of 2008-2009. Suburban office space is barely above the pre-crisis peak.

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On the other hand, apartment prices are substantially above where they were in 2008-2009, as are CBD (Central Business District) offices.

All with the help of The Federal Reserve’s low interest rate policies. But notice that the growth rate of CRE has slowed (except for apartments).

The good news for CRE investors? The Fed isn’t likely to keep raising their target rate or continue to shrink their balance sheet.

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Speculators Increase Short Treasury Futures Position (But Gold LONG Positions Increase)

Speculators are increasinng Treasury short positions while speculators are favoring long positions in gold futures.
Speculators increased net short positioning throughout the Treasury futures curve in the week ended April 9. The bulk of the moves came from adding short positions in 10-year (TY) Treasury futures contracts. They increased their short position in TY contracts by $56,982. And they added some short risk to their two-year (TU) futures positions, after nearly cutting that position in half the previous week.

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Speculators also increased their short positions in five-year (FV), ultralong (WN) and classic 30-year (US). Speculators still remain short every Treasury futures contract.

How about gold? The net futures have actually increased since December.

 

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Fixing The Holes? G-SIB House Hearing For CEOs Of Citi, Wells, BofA, Goldman, MS, JPMC, Etc. But Where Are Fannie Mae And Freddie Mac?

Today’s hearing in the US House of Representatives Financial Services Committee (where the committee calls Globally-Systemically Important Bank (G-SIB) CEOs to testify and ask them uncomfortable questions).

But today’s hearing should have been extended to mortgage giants Fannie Mae and Freddie Mac that unquestionably qualify as Systemically Important Financial Institutions (SIFIs), both under the statutory and FSOC definitions, and in any objective assessment of their financial importance. Are they G-SIBs? Of course.

Fannie Mae and Freddie Mac are supposed to maintain capital. Congress, in enacting the Safety and Soundness Act in 1992, established minimum capital requirements for the Enterprises and those standards have been in place for the past 25+ years. That Act requires the Enterprises to maintain minimum capital that is greater than or equal to:

  • 2.5 percent of on-balance sheet assets, which include mortgage-backed securities (MBS), mortgage loans, and other investments the Enterprises hold in their respective investment portfolios;
  • 0.45 percent of the unpaid principal balance of outstanding MBS not included in on- balance sheet assets, which include MBS the Enterprises issue and guarantee, but do not own and hold in their investment portfolios; and
  • 0.45 percent of “other off-balance sheet obligations.”

Well, the required capital for Fannie Mae and Freddie Mac clearly did not protect their shareholders from a catastrophic failure in 2008 due to declining home prices and a surge in mortgage delinquencies.

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In fairness, Fannie and Freddie are not depository institutions. But the sheer size of their loan portolios is worrisome.

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Whether you want to call Fannie and Freddie SIFIs or G-SIBs, they should have been called to testify as well.

Regulation of G-SIBs

Under the Dodd-Frank Act, all depository institutions with more than $10 billion in assets, including the U.S. G-SIBs, are supervised by the Consumer Financial Protection Bureau for compliance with consumer financial protection laws and regulations. Furthermore, the Dodd-Frank Act subjects the largest banks, including the U.S. G-SIBs, to heightened oversight and enhanced prudential standards to safeguard the U.S. financial system, which are implemented by the Federal Reserve. These requirements include enhanced capital, liquidity and leverage requirements, as well as regular stress testing to ensure banks hold enough capital to survive a future economic downturn or financial crisis. The G-SIBs are also required to submit resolution plans (also referred to as “living wills”) to ensure their firms can be resolved in an orderly way if they were to fail.

There have been several deregulatory developments and proposals in recent years. For example, S.2155, which was signed into law in May 2018 (Public Law 115-174), reduces the frequency of G-SIB stress tests, and it reduces other capital and leverage requirements. In addition, regulators have been advancing their own proposals. In April 2018, the Federal Reserve issued a set of proposals to simplify its capital rules for G-SIBs and introduced a “stress capital buffer,” or SCB, which would in part integrate the forward-looking stress test results with the Board’s non-stress capital requirements. The Federal Reserve joined the OCC in releasing a second proposal to substantially revise the current enhanced supplementary leverage ratio (eSLR) that applies to G-SIBs. After the proposal was released, former FDIC Chairman Martin Gruenberg said, “Strengthening leverage capital requirements for the largest, most systemically important banks in the United States was among the most important post crisis reforms…the amount of tier 1 capital required under the proposed eSLR standard across the lead IDI subsidiaries would be approximately $121 billion less than what is required under the current eSLR standard to be considered well-capitalized” (emphasis added). In response to a request from Committee staff for more information, the FDIC estimated the eSLR proposal would lower capital requirements for the primary federally-insured bank subsidiary of each G-SIB as follows:

● JPMorgan Chase & Co.: $34.597 billion (20.83% reduction in tier 1 capital) ● Citigroup: $26.978 billion (23.3% reduction)
● Bank of America: $22.838 billion (18.5% reduction)
● Wells Fargo: $20.406 billion (16.9% reduction)
● Bank of New York Mellon: $5.911 billion (33.65% reduction)

● State Street: $5.346 billion (37.5% reduction)
● Morgan Stanley: $2.507 billion (25% reduction)
● Goldman Sachs: $1.93 billion (9.49% reduction)

Despite proposing to reduce capital for the G-SIBs, the Federal Reserve’s own research has indicated current capital requirements are on the lower end of requirements that best balances benefits associated with mitigating systemic risk with a bank’s funding costs. Furthermore, the Federal Reserve has also been working on making stress testing more transparent to banks, potentially undermining the value of the regular exercise. Bank regulators have also proposed reducing enhanced prudential standards and liquidity requirements for banks as large as $700 billion, and there have been reports that regulators may reconsider their proposal on the Volcker Rule and propose further rollbacks of Dodd-Frank reforms.

Finally, while the Dodd-Frank Act and related reforms required additional capital and strengthened oversight of G-SIBs through the creation of the Consumer Bureau, there remain concerns regarding whether some of these institutions are adequately being held accountable for repeated consumer violations, and whether these firms may be too big to manage, as was discussed at the Committee’s hearing on March 12, 2019, with Wells Fargo’s former CEO, Tim Sloan.

Fannie Mae and Freddie Mac’s regulator is proposing that the mortgage-finance giants have a combined capital buffer of as much as $180.9 billion should the companies be released from government control.

I would really like to hear what new-minted FHFA Director Mark Calabria has to say on capital requirements and administrative reform.  And turning Fannie and Freddie loose again in the financial system.

Hopefully Calabria will be fixing the holes in the mortgage system.

 

D.C. Office Market Posts Strong Q1 As Coworking Demand Counteracts Law Firm Consolidation As Mall Vacancies Skyrocket

The topsy turvy world of commercial real estate!

First, vacancy rates are rising fast in US shopping malls. Not surprising given the consumer trend towards on-line shopping.

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Second, coworking demand is leading to a changing face of office spaces. Take Washington DC, for example.

The continued expansion of coworking companies drove strong absorption in D.C.’s office market in the first quarter, counteracting negative forces such as consolidation of law firm footprints and a slowdown in federal government leasing. 

Of course, San Francisco leads the US is most coworking spaces, followed by Miami, Atlanta and Washington DC.

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Speaking of commercial real estate and CMBS. the five largest loan losses in the CMBS space were reported by Trepp. Not surprising, the leader in March 2019 is a shopping center.

The REO Independence Mall asset accounted for 66% of the total realized losses for the month with a write-off of $149.7 million. That loss ate into 74.9% of the $200 million face amount tied to the asset, and is the largest loss ever incurred by a retail CMBS loan. Located in suburban Kansas City, Missouri, Independence Center is a 1 million-square-foot superregional mall and 398,000 square feet of that space served as collateral. The mall was sold to California-based International Growth Properties for $63.3 million last month, which marked a significant discount from its most recent valuation of $104.5 million. Following a maturity default in May 2017, special servicer commentary revealed that increased competition and economic challenges made it difficult for tenants to increase sales at the property. The loan represented 52.4% of the remaining collateral behind the WBCMT 2007-C33 deal. That deal has now lost 11.5% of its original balance to disposals.

Whoomp. There it is!

 

Trump Announces Fannie And Freddie “Cap And Release” Plan

Fannie Mae and Freddie Mac’s stay in regulatory purgatory may be coming to an end.

President Trump announced his plan to recapitalize the GSEs Fannie Mae and Freddie Mac and release them into the wild.

The memorandum is short, both in length and details.

The President is directing the Secretary of the Treasury and the Secretary of Housing and Urban Development to craft administrative and legislative options for housing finance reform.

  1. Treasury will prepare a reform plan for Fannie Mae and Freddie Mac
  2. HUD will prepare a reform plan for the housing finance agencies it oversees.

What is left out of the memo is … whether Fannie and Freddie will carry a Federal guarantee or not. And where their capital will come from.

So, rather than shutting them down, Trump is “catching and releasing” like undersized lobsters. But these are not undersized (or “chicken” lobsters, but extremely large financial institutions.

For example, Fannie Mae has a loan book of 3.26 trillion …

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while Freddie Mac’s loan book is $1.93 trillion.

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This compares with Bank of America’s loan book of almost a trillion dollars.

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Wells Fargo has a similar loan book to BofA.

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So, how much capital will Fannie and Freddie have to raise to get released given their YUGE book of loans, given their interest rate exposure?

Its almost Supernatural that Fannie and Freddie are escaping purgatory.

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An Occurrence At The Federal Reserve: Increased SMART Money & Equity Volatility, Crushed Bond Volatility

Ambrose Bierce wrote a short story about a man being hanged during the American Civil War and what went through his mind in his final moments. It is called “An Occurrence At Owl Creek Bridge.” Hauntingly similar to today’s plight: overoptimistic expectations before being hung, then …. snap.

In summary., Ben Bernanke and The Federal Reserve entered the markets in 2008 in force. The Fed Funds Target rate was raised once during President Obama’s two terms as President, but eight times since President Trump’s election as President. Plus, The Fed’s Quantitative Tightening (in terms of its balance sheet) begin in earnest in 2019.

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Once The Fed hurled its monetary weight at the economy in 2008, the stock market had an amazing run. but since The Fed started to raise rates and began their balance sheet unwind, the S&P 500 index has increased in volatility as has the SMART Money Flow Index.

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The bond market volatility indices have gotten crushed by central banks.

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On the real estate front, equity REITs, like the small cap Russell equity indices, seemed to be benefit greatly from The Fed’s Zero Interest Rate Policy and QE. Mortgage REITs, on the other hand, kind of died with the financial crisis and never recovered. The RCA CPPI commercial real estate index too off like a missile.

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Like in the Ambrose Bierce short story “An Occurrence At Owl Creek Bridge,” The Fed and other central banks are quitting any attempts at rate normalization (for fear that they might hear that dreaded “snap” at the end of the monetary rope].

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Did The Federal Reserve Kill Off 10-Year Swaption Volatility? (Lowest Since 2005)

10-year Swaption volatility has sunk to the lowest level since 2005. Did The Federal Reserve provide too much liquidity for too long, effectively drowning bond volatility?

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The Fed’s lingering Target Rate near zero and its three rounds of asset purchases helped kill of bond volatiilty. And with rising Fed Target rate and balance sheet unwind (removing liquidity from markets) has pushed bond volatility to 2006-2007 levels.

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So, the answer is … YES!

(Vol has been) shot through the heart and The Fed’s to blame! The Fed gives central banks a.bad name.

Wipeout! US Department Store Sales Hit A New Record Low Since 1992 (Retail REIT And CMBS Alert!)

The US Commerce Department reported that Department stores are a “wipeout.”

E-commerce is wiping out brick and mortar stores are a rapid rate.

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At the same time, e-commerce sales are rising rapidly.

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It’s not the end of the world for bricks and mortar shopping. Consumers still eat at out at restaurants, use fitness clubs, bars, etc. But it does cause a rethinking of retail REIT and CMBS valuation and growth projections.

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The Land Of Oz! Northern Virginia Office Vacancies Continue To Rise Faster Than The National Rate (Office Glut Begat Governor’s “Opportunity Zones”)

Oh we have trouble, right here in Potomac state, with a capital T that rhymes with G and that stands for … glut.

Yes, the suburban office developers in Northern Virginia have unleashed a tsunami of office construction that has resulted in a glut of office space. And the office developers will continue to develop as long as lenders continue to fund their developments.

As of December 2018, Northern Virginia office vacancy rate has hit 20.3% compared to the national office vacancy rate of 16.7%. It is interesting to note that the national office vacancy rate has remained above 16% since 2009 while northern Virginia’s office vacancy rate has over-DOUBLED since 2007.

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The glut of office space begat Virginia Governor Northam’s (in conjunction with the US  Department of Treasury) “Opportunity Zones.” This allows companies like Amazon to build its east coast headquarters in Crystal City (just outside of Reagan National Airport). Amazon will create thousand of jobs in Northern Virginia, and a boondoggle for office developers.  Of course, home builders will benefit as well.

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The recently passed Tax Reform Act included a potential tax break for investors. Through this program, an investor may defer capital gains taxes on the sale of any asset by investing those gains through a Qualified Opportunity Fund. These original taxes can potentially be deferred until 2026, or upon the sale of the new investment (whichever is earlier). Alongside the deferral, this original capital gains tax is reduced by up to 15% over time. In addition to those benefits, when held long enough, appreciation from the new investment can be realized tax free.

 

 

 

Deja Vu? Bankers Get Creative to Offload CLO Risk in U.S. and Europe (Here We Are Again!)

Bankers dumping business loans and corporate debt in the forms of Collateralized Loan Obligations off on investors in the US and Europe? As New York Yankee legend Yogi Berra once said, “It’s déjà vu all over again.”

(Bloomberg Quint) — Arrangers of collateralized loan obligations are innovating their way through a tough market as they try to shift a stockpile of warehoused assets from their balance sheets.

The year’s first batch of new CLO issues to price in the U.S. includes two transactions with short maturities and one static deal, where the underlying pool of loans remains the same throughout its lifetime. These non-typical features are offered to draw in investors some of who have grown more cautious after leveraged-loan prices dropped and CLO funding costs rose at the end of last year.

Investors say similar structures are being touted in Europe as well. And it’s not the first time that more creative structures have appeared: short-dated deals emerged in 2015 and 2016 when market conditions deteriorated during the oil and gas crisis and liability spreads ballooned.   

Issuance of CLOs — bonds whose cashflows are provided by an underlying pool of loans — soared last year as investors wanted exposure to higher-yielding, floating-rate debt. The market stalled toward year end amid the broader market volatility and weaker sentiment. CLO managers are now trying to navigate the slow recovery in the market.

*Pine Bridge Capital has a nice “CLOs for Dummies” article.

Although CLOs are primarily bank and corporate loans, they can degrade quickly like the “subprime” loans in 2008/2009 (as discussed in The Big Short somewhat accurately).

CLO for dummies

And like the period of time discussed in The Big Short (and other lated books and movies), the “A” rated tranches are looking good in terms of impairment rates, but the “killler Bs” are looking stressed.

CLO impairment rate

The CLOs 2.0 average structures (aka, “Cov Lite” loans) have higher risk.

CLO 1 vs 2

While this is NOT a chart of CLOs, it does show the growth of corporate debt since the financial crisis, particularly at the A and BBB ratings.

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Makes one ponder holding a protective asset like … gold.

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Here we are again!

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