REAL ESTATE - Carlini's Comments

COMMERCIAL PROPERTIES, BANK FAILURES & GHOST EQUITY

Filed Wednesday, July 23. 2008

There is a slow-moving, downward vortex starting to pick up speed in some commercial property markets and financial institutions. Several months ago, I posed a question that continues to hit home in the commercial real estate markets nationwide:

Which property owners are sitting on commercial properties that are going to lose value in the vortex of property depreciation?

In New York, the market shows more proof that ghost equity isn’t just in the residential real estate market. Ghost equity – which means you think your property is worth more than what it fetches on the market – has hit the financial and commercial markets, too. That Crain’s New York article states:

Wachovia Corp. and SL Green Realty Corp. have agreed to sell a 21-story garment district office building for a $41 million loss, according to Bloomberg reports.

The bank and brokerage will sell 1372 Broadway to a partnership led by New York developer Lloyd Goldman for $294 million (about $542 per square foot). The 541,800-square-foot building was valued at $335 million [in 2007] when Wachovia bought into the property.

The sale represents a double-digit loss from the building’s value as compared to 2007. Will any executive bonuses at Wachovia be cut due to a bad investment on that building?

Forget the Subprime Mortgage Market Mess

Many of the financial market watchers in New York on CNBC initially said the mortgage crunch would only affect a very small percentage of mortgages that were given out to the subprime residential mortgage market. I remember several saying: “Don’t worry. This is only affecting 1 percent or 2 percent of the total market.”

They said this problem would only affect a very narrow band of mortgage holders and financial institutions. As this financial debacle unfolds, we’re seeing it is a much more encompassing downward vortex that keeps pulling down more and more financial firms and investors.

Construction and development loans along with commercial real estate loans are now becoming tainted.

Look at IndyMac, which is the latest financial casualty. Some analysts are now looking at financial institutions and saying there’s a good chance more will fail. Crain’s New York states:

“The system is not anywhere near the danger that existed in the late 1980s and early 1990s despite all of the whining by public officials,” Richard Bove (an analyst for Ladenberg Thalmann) wrote.
Still, some analysts say as many as 150 of the nation’s 7,500 banks could fail over the next 12 to 18 months. Last week’s whirlwind collapse of IndyMac did little to assuage fears. The FDIC, which maintains a list of “troubled” financial institutions, currently has 90 banks on its list. [This is] up from 76 in the fourth quarter of 2007.
The first-quarter increase marked the sixth-consecutive increase in the number of problem banks, which are up from a low of 47 the third quarter of 2006. The current number is the largest since the third quarter of 2004 but well below the 575 troubled banks listed by the FDIC in 1994.

Wrong Metric to Compare

This isn’t an accurate reflection of the “gravity” of the situation. Crain’s New York doesn’t account for the huge amount of mergers and bank consolidations that happened in the banking industry in the last decade and a half. There were more than 3,500 in just the time period from 1994 to 2003.

It’s a bad comparison for Bove to compare the 150 troubled banks of today to 575 in 1994. It doesn’t account for the amount of total banks in the market today versus 1994. With more than 3,500 consolidations alone, that would shrink the total universe of banks from 10,500 to today’s 7,500. There were probably more than 10,500 back then.

A better measure would be to compare the amount of assets are in trouble. It’s not the number of institutions in trouble as much as it is the total value of their assets. With IndyMac having approximately $17.5 billion in assets and more than 2,000 branches, how many banks would that equate to in 1994 terms before branch banking?

Here’s a good site to review and keep score on all the bank implosions.

So Who Gets Made Whole?

The bailout is for the institutions to get back on their feet, but what about the individual mortgage holder? Some banks like IndyMac aren’t rushing to help the individual. Reuters writes:

The Federal Deposit Insurance Corp. (FDIC) has temporarily halted any foreclosures on the $15 billion of bank-owned mortgage loans found in IndyMac’s portfolio, FDIC Chairman Sheila Bair said on Monday.
Bair has scolded mortgage lenders for being too slow to help distressed borrowers restructure their home loans. She said in an interview on CNBC television: “Modified loans will be worth more than foreclosed loans.”
IndyMac, which the FDIC took over after it failed on Friday, had a $200 billion mortgage servicing portfolio.

How much money does the FDIC have left to bail out all these imploding banks? It can’t keep bailing out multibillion-dollar failures.

The $300 billion bailout package that’s being voted on in Congress really provides a better picture of what this “narrow mortgage market problem” has evolved into. As for predictions from economists or analysts, only time will tell the real impact. When you start comparing many of their predictions to later reality, their predictions have been way off.

Carlinism: Don’t believe early estimates of disasters. At worst, they are always vastly underestimated by “experts” who don’t see the whole picture. At best, they are optimistic from those who don’t want to deal with reality.