Wednesday, September 16, 2009

Fed Reviewing Banks' CRE Exposure

From CNBC:
The Federal Reserve is involved a broad review of commercial real estate exposures at the nation's largest regional banks, which Fed sources say is both the result of concern in that area but part of the "new normal" for how they will be supervising banks.

People familiar with the examinations say the fed is "getting granular" looking, for example, at the differences in banks' concentration of construction loans vs. multifamily vs. motels and retail.

The effort began after the stress tests earlier this year identified commercial real estate as a major area of concern but recently ramped up in intensity. It principally involves what fed sources call "horizontal reviews" which is looking at the loss rates and concentrations of similar assets across different banks. This is how fed officials have said recently they would be normally reviewing banks.

The government hasn't decided yet whether to actually run stress tests on the information it gathers, that is, to see how these portfolios would perform under adverse economic scenarios.

Tuesday, September 15, 2009

TARP Return On Investment

Opinion piece from Bloomberg:
President Barack Obama did Americans a great service yesterday. He boiled down what’s wrong with his administration’s approach to the financial crisis into a single, symbolic statistic.

Striking a hopeful tone during a speech on the first anniversary of Lehman Brothers Holdings Inc.’s collapse, the president said banks have repaid more than $70 billion of taxpayer money that they had accepted from the government. “And in those cases where the government stakes have been sold completely,” he said, “taxpayers have actually earned a 17% return on their investment.”

This is the kind of math that helped get Lehman into so much trouble. It’s called cherry-picking.

Emphasis added by ENSO (quoting The Who): Meet the new boss....same as the old boss

Let’s be clear: Taxpayers have not earned a 17% return on their investment in companies that have accepted federal bailout money. Real-life investors don’t count only their winners. They count their losers, too, including investments that have declined in value and remain unsold.

A few minutes after that bit of bravado, the president identified the “simple principle” in which all his proposed reforms of the financial regulatory system are rooted: “We ought to set clear rules of the road that promote transparency and accountability.” He’s right. We should. A good place to start would be with the people who crunch numbers for the president’s speeches.

Opportunities Lost

It would be easy to call yesterday’s address by Obama a lost opportunity to champion a crackdown on the banking industry. Yet the best opportunity was lost at the start of his presidency, when his administration decided that no more large financial institutions would be allowed to fail.

Obama said yesterday, “We will not go back to the days of reckless behavior and unchecked excess that was at the heart of this crisis, where too many were motivated only by the appetite for quick kills and bloated bonuses.” Trouble is, with Wall Street’s bonus culture little-changed, we’re well on our way.

“Those on Wall Street,” he said, “cannot resume taking risks without regard for consequences and expect that, next time, American taxpayers will be there to break their fall.” Of course, everyone knows taxpayers will be there to do just that. “History cannot be allowed to repeat itself,” he said. The big worry, though, is we’re already letting it.

Obama said he is calling for “the financial industry to join us in a constructive effort to update the rules and regulatory structure to meet the challenge of this new century.” As he must know, though, the financial-services industry won’t agree to impose strict rules upon itself.

Protections for Banks

Rather than seek to break up banks that already are too big to fail, he has proposed giving them special protections by designating them as “Tier 1 financial holding companies” subject to their own separate oversight council and regulation by the Federal Reserve.

As we have learned, we can’t count on regulators to ensure that too-big-to-fail companies avoid untenable risks. The only way to keep them from threatening the financial system is to break them up before they have the chance. This, however, is something Obama and his advisers are not willing to do.

Obama said his plan “would put the costs of a firm’s failures on those who own its stock and loaned it money.” He had the chance to do this last spring at Citigroup Inc., for instance, and showed no interest. There’s little reason to believe the government would choose a different path the next time around, with or without Obama’s proposed reforms.

Before pushing new regulations, one thing the president could do to restore long-term confidence in the financial system is enforce the rules and laws already on the books. A year after Lehman’s collapse, it remains common knowledge that the asset values of dozens if not hundreds of publicly traded financial companies remain grossly inflated.

Emphasis added by ENSO: Our observation is that in fact there is enforcement of existing rules and laws, it just appears selectively applied. With a few notable exceptions (Corus, Guaranty, BankUnited) most bank failures year to date have been institutions with less than $1 billion in assets. This suggests that regulatory focus is directed at smaller institutions somewhat like an arborist trimming a tree of suckers to try and save rotten limbs.

Come Clean

Rather than trying to convince the public that insolvent banks are healthy, through easy-to-pass “stress tests” and other gimmicks, he should direct their officers and directors to come clean about their numbers or else face prosecution. The risk, of course, is that if the bankers fess up, more banks may fail, bringing fear back to the markets.

That is a chance we must be willing to take. Until we start letting companies that deserve to fail actually fail, we will not have transparency and accountability in our markets. Instead, we’ll be setting ourselves up for exponentially larger meltdowns that in time may outstrip the government’s resources to deal with them.

The unfortunate truth is it probably will take a cataclysmic event of such proportions before our leaders stop cooperating with the financial industry and start pressing for substantive changes. Obama must know this, too.

Based on the past eighteen months performance, we at ENSO believe this will be very slow in evolving. In the meantime, regulatory pressure on smaller institutions will increase substantially. We urge our clients to take every possible measure to get their risk management houses in order.

Monday, September 14, 2009

Banking Problems Now Bigger Than Pre-Lehman

From Bloomberg:

Joseph Stiglitz, the Nobel Prize- winning economist, said the U.S. has failed to fix the underlying problems of its banking system after the credit crunch and the collapse of Lehman Brothers Holdings Inc.

“In the U.S. and many other countries, the too-big-to-fail banks have become even bigger,” Stiglitz said in an interview today in Paris. “The problems are worse than they were in 2007 before the crisis.”

Stiglitz’s views echo those of former Federal Reserve Chairman Paul Volcker, who has advised President Barack Obama’s administration to curtail the size of banks, and Bank of Israel Governor Stanley Fischer, who suggested last month that governments may want to discourage financial institutions from growing “excessively.”

A year after the demise of Lehman forced the Treasury Department to spend billions to shore up the financial system, Bank of America Corp.’s assets have grown and Citigroup Inc. remains intact. In the U.K., Lloyds Banking Group Plc, 43 percent owned by the government, has taken over the activities of HBOS Plc, and in France BNP Paribas SA now owns the Belgian and Luxembourg banking assets of insurer Fortis.

While Obama wants to name some banks as “systemically important” and subject them to stricter oversight, his plan wouldn’t force them to shrink or simplify their structure.

Stiglitz said the U.S. government is wary of challenging the financial industry because it is politically difficult, and that he hopes the Group of 20 leaders will cajole the U.S. into tougher action.

“It’s an outrage,” especially “in the U.S. where we poured so much money into the banks,” Stiglitz said. “The administration seems very reluctant to do what is necessary. Yes they’ll do something, the question is: Will they do as much as required?”

Stiglitz, former chief economist at the World Bank and member of the White House Council of Economic Advisers, said the world economy is “far from being out of the woods” even if it has pulled back from the precipice it teetered on after the collapse of Lehman.

“We’re going into an extended period of weak economy, of economic malaise,” Stiglitz said. The U.S. will “grow but not enough to offset the increase in the population,” he said, adding that “if workers do not have income, it’s very hard to see how the U.S. will generate the demand that the world economy needs.”

The Federal Reserve faces a “quandary” in ending its monetary stimulus programs because doing so may drive up the cost of borrowing for the U.S. government, he said.

“The question then is who is going to finance the U.S. government,” Stiglitz said.

Wednesday, September 9, 2009

Small banks seek aid program to avoid insolvency

From MarketWatch:

Big banks have gotten not only the lion's share of the public's attention during the economic crisis, but they have also gotten the lion's share of the government bailout money, leading their smaller counterparts to begin clamoring for their share of the federal largesse.

Experts now predict that as many as 1,000 small banks may fail before the economy recovers, and efforts have intensified to have Treasury launch a program that would direct more funds from the TARP to those troubled smaller institutions.

Lobby groups for small banks are seeking to have Treasury develop a program to provide TARP funds to small stressed banks on the cusp of a default. Under the plan, the aid from the government would be equal to the amount the banks could raise in the private markets. For example, a small bank could be eligible for $10 million in TARP funds from a so-called "matching program" if it could show a commitment of $10 million from private investors.

Banks seeking matching funds would need to demonstrate to their state and federal regulators that if they could remove a handful of large bad loans from their balance sheet they would become viable institutions for years to come.

Backers of the proposed program argue it is vital because it would give a much-needed boost to a massive financial sector that is critical to the nation's financial system. Small banks are expected to continue to struggle with large commercial loan losses, a problem that will drive a larger number of small banks into insolvency in the years to come.

The program is important, said ICBA's Cole, because the Treasury hasn't implemented a so-called "Legacy Loan Program," that would use public and private funds to remove toxic mortgages from bank balance sheets. That initiative - which has been stymied by administrative and bureaucratic delays -- would help small institutions more than larger ones because they have more "whole loans" on their books than larger banks.

A recent report by the TARP Congressional Oversight Panel suggests that whole loans are a threat to smaller public banks, with $600 million to $100 billion in assets. Small banks would need to raise significantly more capital, based on pessimistic assumptions the COP considered, as the estimated losses will outstrip the projected revenue and reserves.

The matching program could also complement the TARP capital infusion program, which community bankers argue hasn't helped a sufficient amount of small banks. So far, an estimated 500 community banks have received TARP funds -- about 6% of the 8,000 small U.S. banks.

James Wheeler, a partner in the financial institutions group at Bryan Cave LLP in Washington, said many smaller bank executives have told him that such a program would be vital for their survival. He pointed out that a number of small banks seeking additional TARP money were denied additional funds, while other institutions continued to be rejected. The amount of money involved, is significantly less than the cash infusions provided to larger institutions, he added.

"If you have two bad $1-million loans that are wrecking your balance sheet, a joint funding of $20 million from both the Treasury and private investors could make a big difference," Wheeler said.

The Federal Deposit Insurance Corp., which has a depleted deposit insurance fund, is generally inclined to support such a program, in part, because it could help smaller banks return to viability and escape the kind of failure that requires capital infusion from the agency's drained deposit insurance fund.


However, the program would be controversial because the Treasury would be providing funds to faltering banks from a program that was not initially designed to help troubled institutions. Also, unlike large institutions, a smaller bank failure would not have systemically negative impact on the markets, discouraging the need for such a program, said Dwight Smith, partner at Alston & Bird LLP in Washington.

"They are a source of commercial credit to communities that the big banks may not provide but their failure is not systemically risky to the economy," said Smith.

The program would also face administrative difficulties and be susceptible to allegations of political intervention, in part, because regulators would have a hard time identifying which banks should be eligible for the program and which shouldn't.

"Every congressman that has a bank in his or her district would want to help it out," said Nancy Bush, director of NAB Research Inc. "The major problem is not a philosophical one, but it is an administrative problem about who allocates the money and by what qualifications and who doesn't get it."

Critics also argue there could be other problems at the institution that its managers aren't telling regulators about, or they aren't aware of yet. The concern is that a bank receiving taxpayer funds would simply fail six months later.

"When looking at the bank, there could be other time bombs the problem institution isn't telling you about or doesn't know about yet," said Bert Ely, president of financial advisory firm Ely & Company Inc. "Is the government assistance in any way going to save the bank or merely delay its failure?"

Ely added that problem banks, even with cash infusions, contaminate the local credit marketplace and may still not be positioned to do sound lending.

Another problem is the structure of the matched funds. Ely points out that Treasury would likely seek to provide TARP funds that come as senior preferred shares that would match common shares provided by private capital. However, private investors are skittish about making investments, particularly if they would become common investors that could be wiped out, Ely said.

"Treasury is going to have to make it so that private investors can see a way towards a return on their investments," said Bridges.

Voss, head of the First DuPage Bank in Illinois, said he believes there are a group of community banks in Illinois and the U.S. that would greatly benefit from such a matching program if it could be structured in a way that would encourage private investors to participate.

"This concept of matching funds sounds good but finding the private investments is something that is going to be difficult to happen," said Voss.

A matching program would not be for heavily distressed banks on the FDIC's troubled institution list - only those on the verge of being placed on the list. The bank regulator said last month 416 banks were on its "problem list," up from 305 in June.

Tuesday, September 8, 2009

FDIC Publishes C&D Dissenters

From American Banker:

In its most recent press release listing the banks that received cease-and-desist orders, the Federal Deposit Insurance Corp. included a new section: the dissenters.

For the first time in the nearly 20 years that enforcement actions have been made public, the FDIC released a notice of charges against the banks that refused to consent to the proposed orders.

This will become routine, but given the graphic nature of the notices — they include exam data and details of alleged wrongdoing — industry insiders and observers say such disclosure could harm banks. Some also contend that the change is meant to dissuade banks from contesting regulatory orders, just as more are starting to do so.

"This seems like a ploy to beat bankers into submission," said Joseph D. McKean Jr., the chairman and owner of the $720 million-asset Frontier State Bank in Oklahoma City, which went to court this summer over an FDIC order and is awaiting a decision on the case. "It is not a well-thought-out tactic. Anything the FDIC posts in this regard is likely to hurt a bank."

According to the FDIC, the change is not meant to harm or bully the dissenting banks; rather, it is intended to make the enforcement process more visible.

All formal regulatory orders became public in 1990, under the Financial Institutions Reform, Recovery and Enforcement Act.

But before its Aug. 28 press release, the FDIC had not been so publicly outing the banks that dispute such orders. The notice of charges could be obtained by making a request under the Freedom of Information Act. The charges also would be aired at a public hearing, if the squabble went that far.

David Barr, an FDIC spokesman, could not specify what triggered a change now, after nearly 20 years. But he said the goal is simply to make the information accessible.

The notices will be included in a press release of regulatory orders each month, he said. "Since the notices are part of the enforcement process, we decided to make them available when they are imposed."

While the Aug. 28 press release specifies a notice is a proposed enforcement action, not a final decision or order, observers said that the charges can come across as damning, and that the wording is harsh.

"This is just another way of putting additional pressure on community banks to consent to these orders, even if they think it is not in the best interest of the bank," said Jeffrey C. Gerrish, a partner at the law firm Gerrish McCreary Smith PC in Memphis. "The inflammatory nature of these charges could certainly do damage to a community bank."

A cease-and-desist order typically includes boilerplate language, and without identifying what rules a bank broke, gives directives on how it must improve. The notice of charges is far more explicit.

Barr dismissed the idea that the disclosure could hurt banks, saying the charges against dissenters come out during public hearings anyway.

"If a bank isn't going to stipulate, a lot of information is going to be made public. That is part of the process," Barr said. "There is the notice, motions, testimony, so all of that information is going to be made available at some point."

That's accurate, but disingenuous, according to several banking lawyers. Few banks ever take a dispute with regulators to the point of a hearing. More often, a bank contests an order to buy more negotiating time, in the hopes of getting a lighter enforcement action.

Regardless of whether the FDIC changed its longstanding practice to gain leverage, banking lawyers said that the details included in a notice could damage a bank.

"I don't think the FDIC is trying to do anything bad to the bank, but this still might have a bad effect," said Chip MacDonald, a partner at the law firm Jones Day. "It is not going to put you in a very good light. A lot more information is going to come out than if you consented."

Rusty Cloutier, the president and CEO of the $1 billion-asset MidSouth Bancorp Inc. in Lafayette, La., agreed that this change might be harmful, but strongly advised against battling regulators in the first place.

"I would tell you that being on the opposite side of the regulator is the worst mistake that can be made, period. They carry enormous power," said Cloutier, who negotiated a memorandum of understanding — a decidedly softer enforcement action — with regulators in the 1980s. He credits his bank's survival to a proactive approach and a willingness to work with regulators. He still keeps the document in his desk as a reminder to stay proactive.
Emphasis added by ENSO: Could not agree more strongly
Ken Thomas, an independent banking consultant in Miami, said that while the banks may feel as if the details in the notices are unsubstantiated or incorrect, the information should be made public. "False or misleading reports, manipulated and misstated and inflated capital accounts … why shouldn't this be public?" Thomas said. "I am of the school of the more disclosure the better."

Walter G. Moeling 4th, a partner at the law firm Bryan Cave LLP, said regulators are under increasing pressure to be more forthcoming about their dealings with banks, and the Office of the Inspector General is repeatedly complaining that regulators did not act fast enough with troubled banks. So the FDIC's decision to disclose the notices more quickly and more publicly than in the past could just be about improving transparency.

"The public very much has a need-to-know philosophy," Moeling said. "So perhaps the FDIC just wants to spell out what they are doing in full."

Still, Moeling said the small pool of banks willing to rebut charges is likely to shrink further.

"This change may influence their decision to consent or run the risk of having the strong rhetoric that exists in the order out there," Moeling said. "The press coverage of a C&D is bad enough."

Saturday, September 5, 2009

Construction Loans Get Worse

From the NYT:

Even as the economy may be starting to recover, banks across the country are confronting a worsening outlook for their construction loans, an area that boomed for much of the decade.

Reports filed by banks with the Federal Deposit Insurance Corporation indicate that at the end of June about one-sixth of all construction loans were in trouble. With more than half a trillion dollars in such loans outstanding, that represents a source of major losses for banks.

Construction loans were highly attractive in recent years for many banks, particularly smaller ones without a national presence. One reason was that other types of loans were not easy to make. A handful of big banks came to dominate credit card loans, for example, and corporate loans were often turned into securities.

Construction loans, however, needed local expertise and were not easy to standardize. In a booming real estate market, there were few losses on such loans.

The problems now extend well beyond loans for the construction of single-family homes, where banks have been taking losses and cutting back their commitments for a couple of years. At the end of June, $173 billion in construction loans related to single-family homes was outstanding, barely more than half the peak level reached in the fall of 2006, when the housing market was booming.

It is in commercial real estate construction — be it stores or office buildings — that the pain seems likely to rise. At the end of June, $291 billion in such loans was outstanding, down only a few billion from the peak reached earlier this year.

“On the commercial side,” said Matthew Anderson, a partner in Foresight Analytics, a research firm based in Oakland, Calif., “I think we are fairly early in the down cycle.”

Foresight estimates that 10.4 percent of commercial construction loans are troubled, but expects that to increase as the year goes on.

The definition of troubled loans used in the accompanying charts includes loans that are at least 30 days past due, as well as those on which the bank identified problems that led it to stop assuming that interest on the loans would be paid.

It is possible that some of the rapid rise in problem loans represents pressure from regulators to admit problems, rather than new problems. The number of newly delinquent loans seems to have declined in the second quarter, although it is hard to know if that is a trend that can continue. But the number of loans that the banks do not expect will be fully repaid has soared.

The reports that banks file with the F.D.I.C. do not include details on all types of construction loans, nor on where the construction is. That information is estimated by Foresight, based in part on where each bank operates and on disclosures in other company reports.

Foresight estimates the biggest problems are in loans for condominium construction, with 38% of all construction loans troubled. Mr. Anderson says even that might be an understatement. He pointed to Corus Bank, a Chicago institution that specialized in condo loans. Its latest report shows that its capital is gone and that it expects losses on two-thirds of its construction loans.

Foresight’s estimates of the proportion of problem construction loans in the 20 largest metropolitan areas has one surprise: the one with the largest proportion of troubled loans is Seattle, where the recession has started to pinch. But it is also notable that just one of the 20 areas has less than 10% of construction loans in trouble. A year earlier, most of them were below that level.

Wednesday, September 2, 2009

CRE - The "Other Real Estate Issue"


Below is the three decade-plus history of quarterly returns for the NCREIF property index. Get the picture as to current trends?

Of course you do. We’re currently looking at the most significant period of consecutive quarterly drops in value in what admittedly is the short history of the data (going back to 1978). Although we do not detail the quantitative numbers in the chart, over the last four quarters (3Q 2008-2Q 2009) the index has recorded a 22.5% contraction in value. And just what does this infer about bank holdings of CRE loan paper? Thanks to the current Administration’s financial sector “don’t ask, don’t tell” policy for bank assets, we’re not going to really know any time soon. Good thing the US banks can simply move forward reporting record earnings and ignore the current inconvenient truth of declining CRE values, no? We only see some glimpse of the truth in asset values every Friday when we see that week's US bank failures. Did you catch how BB&T wrote down Colonial Bank asset values by 37% after Colonial's essential failure and melding into BB&T? The write down never happened until Colonial hit the tarmac nose first, yet asset values had vaporized long ago. And this is the "transparency" we've been promised?

In the next chart we’ve taken CRE individual asset class quarterly returns from the NCREIF data and produced a compound rate of return series for each asset class since the beginning of the current decade. Please be aware that the NCREIF rate of return data includes two components - an income return and capital price change. Although we will not drag you through the specific quantitative data mud, you’ll just have to trust us in telling you that income returns have been positive each and every year. That means the capital return (price change) both primarily drives the direction of the data in the chart below plus is a bit worse than the actual numbers in the chart show due to the positive influence of the income flows.

In short, we are looking at some very substantial price declines to produce these compound annual rate of return trends for each property type. In the table below we delineate the NCREIF pure prior four quarter rate of return by property type for the period ending 2Q 2009. Again, it is the true reality of actual property price appraisals that is driving these numbers. C'mon, can't we allow the pension funds to simply make up "fair value" numbers like the banks do? It just doesn't seem fair they should have to take these types of asset value hits, right? They can't convert to bank holding companies, can they?

CRE Property Class

NCREIF Prior Four Quarter Rate Of Return











Certainly the numbers you see above are breathtaking, especially given that they only cover the prior four quarters through 2Q of this year. And to be totally honest, value declines in the third quarter of last year for all property types were less than 1%. Meaning that 95% of the price damage you see in the table above has occurred since September month end of last year to the present. Just how meaningful is this historically? How does the present CRE down cycle compare to historical cycles? We only wish we had the very long term data. But what we do have is a copy of a presentation done by Ken Riggs, President and CEO of Real Estate Research Corp. (RERC) given at the summer 2009 conference of the very same NCREIF. The following is some data Mr. Riggs presented to the NCREIF crowd literally seven weeks ago in terms of prior CRE cycle character.

Periods Of Commercial Real Estate Downturns

Quarters Of Duration

Price Adjustment For Each Period

1Q'90 - 4Q'95

24 quarters


3Q'01 - 1Q'03

7 quarters


2Q'08 - Present

4 quarters so far


As you can see, his numbers for current magnitude of decline are not too far off what the NCREIF property index tells us. As we look at the data above, what is most striking is that it has only now taken really three quarters in the current cycle to produce 41% of the decline seen in the 24 quarter down cycle of the early 1990’s. And of course the early 1990’s CRE collapse was in good part driven by the vaporization of the S&L industry. Seven quarters of CRE decline early this decade produced a “rounding error” of price decline magnitude relative to the present cycle. And unfortunately, as we see it, we’re still in the first few innings of the current CRE cycle reconciliation game for now. And as far as the banks and their CRE assets are concerned, the national anthem has not yet even been played. We’ll just have to see how it all unfolds from here.

Final chart from the good folks at the NCREIF. As is often the case in any asset class where a very meaningful decline in values takes place over a very short period of time, activity simply dries up. You may remember our personal near and dear mantra courtesy of Ray DeVoe - “Liquidity is a coward. There’s always too much when it’s needed the least and it’s never around when it’s needed the most.” Please be aware that the 2009 number in the chart below has indeed been annualized. Quite the collapse in activity, right? In no way will this help "price", quite the opposite.

It’s a shame all the buyers have vanished, because as you may remember close to $300 billion-plus of CRE mortgage loans are up for renewal or reset this year. And as of now the asset backed market for commercial real estate loans is contracting as opposed to expanding. Much like the residential asset backed markets, the commercial asset backed markets are no longer open 24/7.

That really leaves the banks as the potential saviors for commercial real estate finance. But here unfortunately again, the banks are nursing their CRE wounds in the privacy and blackness of their non-mark to market balance sheets. What we do know is that per the most recent bank loan officers survey, over 65% of banks were still tightening standards for commercial real estate loans when these folks last answered the phone (a quarterly survey).

So just where does that leave CRE owners who need to refinance this year or early next? In trouble, that’s where. And if this were not enough, we can tell you from first hand knowledge that bank regulators have been crisscrossing the country examining bank CRE loans intently. They do not want another mortgage debacle as was residential real estate on their current watch. Like they have a choice, right? In many cases current CRE appraisals are being conducted against existing bank property loans and capital calls are going out to CRE owners who have always been model credits and have never missed a payment in their lives. And CRE values will improve in this type of a regulatory and available capital environment? Quite the opposite, as you already know.

Taking The Lead?...So just where does all of this lead us with CRE ahead? When will we begin to get some “green shoots” or signs of “stabilization” in CRE values? We wish we had the answer. But we do have yet another data point from an industry source we hope can help in terms of timing ahead. The wonderful folks at the National Association of Realtors have put together what they call the Commercial Leading Indicator (CLI). The Commercial Leading Indicator for Brokerage Activity is a tool to assess market behavior in the major commercial real estate sectors. The index incorporates 13 variables the NAR believes reflect future commercial real estate activity. The index is designed to provide early signals of turning points between expansions and slowdowns in commercial real estate. We like it in that it is comprised of the NCREIF price index, the NAREIT price index, industrial production, labor market data, retail sales, personal income and capital spending data factors. As much as we distrust most data or comments from the NAR, the CLI appears a very reasonable indicator. In fact, this is what it is telling us right now.

Admittedly it’s not looking too wonderful, especially as a “leading indicator”. Sorry for the small print in the chart above. It covers the 1990 to present period and, of course, it’s the direction that’s most important. Directly from their latest report comes these comments.

“The sharp fall in the CLI implies that commercial activity, as measured by net absorption and the completion of new commercial buildings, will likely contract quite severely over the next six to nine months. Commercial real estate construction spending (i.e., non-residential structural investment) had held on relatively well in the current economic recession, but is anticipated to tumble in commercial real estate building construction in upcoming quarters. Commercial practitioners can also anticipate a much weaker net absorption in the office and industrial sectors later in the year and a far fewer number of new commercial buildings reaching the market.”

“We now expect office vacancy rates to rise very sharply, surpassing 20 percent in 2010. Office rents will fall 7 percent in 2009 and further fall an additional 1 percent in 2010. Industrial and retail sectors will face deteriorating conditions as well. Only the multifamily sector looks to squeeze out positive rent growth, though at a slower rate of increase than in the past.”

Comforting, right? Sure it is. One final comment in terms of the commercial real estate cycle and how that cycle relates to residential real estate. The following is simply an update of a chart we have shown you the past. Directly from the GDP data, we are looking at the year over year change in residential fixed investment (residential real estate) set against the same year over year change in non-residential fixed investment (a loose proxy for CRE).

Important point being that at least as per the historical message of past cycles, the rate of change in the residential markets turns up before the rate of change in non-residential activity does. And at least as of yet, residential construction/investment activity is not turning up. As we said a few minutes ago, the CRE down cycle is unfortunately still young. We hope we can anticipate the eventual turn when we see the NAR CLI reverse up and the annual rate of change in residential fixed investment bottom and begin to move higher.

That Vacant LookAnd we’ll close with a bit more data from the super folks at the National Association of realtors. In conjunction with the production of their Commercial Leading Brokerage indicator, they also project forward vacancy rates for office, industrial and retail property types. Here’s what they think is coming down the pike for the remainder of this year and looking into next. Maybe we're colorblind, but it seems even the NAR can't find any "green shoots"? We never thought we'd see the day. The numbers for this year and next are certainly sobering.

Property Type And Data Points






Vacancy Rate





Net Absorption (000 sq ft)





Rent Growth






Vacancy Rate





Net Absorption (000 sq ft)





Rent Growth






Vacancy Rate





Net Absorption (000 sq ft)





Rent Growth





There you have it. We suggested in February of this year that CRE would be an important issue before the current year had run its course. The numbers, analysis and industry commentary tidbits suggest the down cycle is far from complete. The ultimate impact on the financial sector remains an open question mark at this point. Will banks simply ignore the issue, as they continue to do with many a residential real estate foreclosure situation by simply not sending out notices of default? Will the Fed/Treasury/Administration devise yet another taxpayer funded bailout scheme for their very close friends at the banks and in the US financial sector at large? Without question, the regional and community banks are most at risk with current and to come CRE issues. We do not expect death and destruction as excesses in CRE lending were NEVER as egregious as what we witnessed in residential lending. But these folks will need time to heal. They will need time to earn their way out of their current and to come CRE problems. This simply tells us their will be less aggregate systemic risk taking and credit availability from this crowd of regional and community bankers ahead. It can be no other way. And yet equity investors continue to attempt to discount a “V” economic recovery, as is implicit by the recent vertical action in equities? They certainly know something we do not. They do know something, don’t they?