What Happens Next to All This Bad Debt?
Fred Cordova
[thenewnexus.blogspot.com]
DOWNTOWN LOS ANGELES — Fred Cordova is a Senior Vice President with Colliers International. He writes about capital markets and real estate on his blog, The New Nexus.
The recession may be technically over according to Bernanke and Obama, but if you listen to Buffet or any credible economist, this jobless economic “recovery” is likely to be slow and ugly.
We expect the government to allow unemployment to remain high to keep interest rates low so that banks can get healthy quickly by borrowing from the Fed at .25% and charging us 19%+ on our credit cards. Very soon, the OCC (Treasury guys) will start making the banks take the losses they need to take to clear the bad debts so that they can start lending again.
For real estate, this means that Multi-family is now entering the transaction / recapitalization phase, which will bring in new money at much lower prices, but it's still early and will continue for years. This will enable buyers to lower rents and condo prices. Retail and Hotels are getting slammed now. You can stay almost anywhere for $150 a night, including the Ritz. Industrial will soon to follow then office.
The Concerto bankruptcy filing and auction of $5 billion in loan assets by its lender, Corus Bank — which the Feds took over two weeks ago – is the latest close to home example of how banks will deal with nonperforming projects (debt) and how the Feds will deal with the zombie banks.
So what happens next in this ‘food chain” of bad debt? Here is what we are seeing based on meetings with owners, banks, and loan servicers:
The FDIC will close 200-300 banks next year and clear out non-performing assets by first trying to sell notes (debt), then the real estate.
The anticipated "tsunami" of foreclosures is probably an illusion as banks and debt servicers do not want to own property. If a loan is servicing the debt, they will modify it to keep it in place.
Banks will move very slowly as they try to shore up their balance sheets. Ignoring or forestalling the inevitable, often referred to as "kicking the can down the road" or “extend and pretend” buys them time, which helps them get healthy.
Pricing for properties is going to stabilize or rise (based on current bids of 50% to 60% off peak), not fall as aggressive seller financing drives value accretion by 10% to 20%. With interest rates where they are and pricing falling, there is no better time to buy a home or condo.
The equity market is already pricing stocks based on expected future performance. While the opportunity there may have already played out, with the markets up 50% in the last 6 months, there is a lot of money to be made in real estate from the recovery. So assess your situation, map out your journey and get going. It's not too late, but others have already started and are well on their way.
johnnyb on October 07, 2009, at 03:52PM – #1
The idea of the "tsunami of foreclosures" not coming would obviously be good news. Agents have been telling their buyers recently that the inventory is shrinking and the market has turned. In the 90046 zip alone there is already an inventory of 12-14 months worth of unsold homes and 152 REOs( about 12-15 months supply) which will eventually come back on the market. How can increasing inventory not put downward pressure on prices?
Jeremy on October 07, 2009, at 05:41PM – #2
Depends on what market. In Redondo Beach, a single family home in a good area will run you about 5000 PITI, while rent in the same area is under 3000. Manhattan Beach single family homes have only fallen 10% at most, while DT has fallen 50%.
I agree that on a monthly mortgage payment basis (vs equity) this is a great time to buy in a fully corrected market like DTLA or Sacramento.
ImNotPOTUS on October 07, 2009, at 06:33PM – #3
I would like to ask how some salient facts correlate to the opinions expressed above?
"The FDIC will close 200-300 banks next year" in spite of the fact they went broke closing just 129 so far this year. Good thing they are collecting 3 years worth of fees next year in advance, that should be good enough to close 200-300 banks, hopefully. (for some perspective to the 30's, one bank today does not equal one bank in the 30's. The notion of branch banking was not commonplace then. 1 failure today is an order of magnitude larger than in the 30's) How do they plan to fund the closures the year after that? My guess is they will socialize the losses, like they have done up til' now. The PPIP plan has only managed to clear out a pathetic 4.5 billion so far and they have no one asking for more. The risk on capital is less than 3% and no one is taking them up on it? Success for the FDIC might happen, but only on the backs of taxpayers who will finance 97% of the losses.
"If a loan is servicing the debt, they will modify it to keep it in place." This statement makes good theory but banks are only holding on to these homes because they are allowed to mark the value at any price the see fit to choose, as long as they leave them alone. Cure rates for all delinquent loans are less than 1%, 1/2 of the "modifications" do not reduce the monthly payment and almost all of the mods increased the principal and fully half re-defaulted in a matter of months. Once a loan is modified they have to recognize a loss on re-default. So if a mod only results in the recognition of a loss why bother doing it in the first place. If you look at the number of mods and the rate of change, you will see that they are not choosing to mod the loans at any pace close to being effective. The tsunami is only being held at bay by the consent of the government to extend and pretend. This delay can go on until it stops working. Then what? The fire exit is only so big.
No argument with this statement. I think they should call it "if it ain't working, don't fix it."
"not fall as aggressive seller financing drives value accretion by 10% to 20%." Who is this aggressive financier you speak about? If you mean the FHA your accretion is limited to how much cash you can squeeze out of John Q. Public for that 3.5% down payment. And the only participant in the market is the Federal Government at over 100% of this years value of mortgages being purchased by the FED. All of the front door keys to every home sold this year and not ultimately financed by the federal government would not fill a mailbox. The only reason you have bidding wars now is because the enthusiastic "investors" and AGENCY loan qualifiers exceed the supply of non-organic "for sale" properties. I'm not a betting man but I hanker to guess you run out of the former before you run out of the latter.
What is more likely to happen is just #3. The continued expansion of the FED's balance sheet, ZIRP (zero interest rate policy) and the Treasury happily issuing short term debt to all of the addicts trapped into buying more and more of our IOU's, just so they can all kick the can down the road.
Robert on October 07, 2009, at 06:57PM – #4
Jeremy:
DT has fallen 50%? I think you really have to look at the individual buildings. My loft has dropped maybe 10% max in my building and I bought it 3 years ago...and I think I could get close to what I paid for it based on my what I have seen. It really depends on the quality of the building. Loft are selling. It also helps if you have the Mills Act. Downtown is the greatest opportunity for home ownership. Let's hope they extend the first time buyer's tax credit!
Bert Green on October 07, 2009, at 11:39PM – #5
ASKING prices in Downtown have fallen about 50%, but the market is so new that there is not enough history to ground those numbers in reality. I personally think the market is correcting to the right price for condos, not the ridiculous, inflated prices that were never realistic in the first place.
Jeremy r on October 08, 2009, at 10:00PM – #6
Robert, I was making a broad statement. I was merely rebutting the fact that housing prices are the best they have been in decades. MB is a great place to live (for some people) but it is hardly a bargain simply because of low interest rates.