MaxedOutMama
Friday, April 27, 2007
GDP - WHOA!!
This is the big test for the Dow. Not only are P/E ratios way out of whack considering the norm, but this morning advance GDP (it will be revised for months to come) was released at 1.3%. That is very bad no matter how you look at it. Worse yet:
This release will be revised substantially. Fourth quarter was revised up and then down and then up again to get the final of 2.5%.
The last four quarters of GDP growth:
Regarding unsustainability, let us proceed to Table 4, which is preceded by earnest warnings about not using the data in it. Naturally, it is one of the most usable and informative tables in the GDP release. Table 4 gives price indexes for various components (change from preceding period), and note the incredible changes from Q4 2006:
As the Beige Book and Yellen noted, wage increases are concentrated in certain sectors. This may make inflation fanatics cheer up, but for the individual who is experiencing a real drop in buying power it is hardly good news. At the bottom of Table 10 you can find real disposable personal income:
The reason why I am so certain that we are headed into a recession (if we have not already landed in one) is that the broad mass of individual consumers have been financing a lot of spending from wealth increase rather than income. However, in the last year the wealth increase has shifted from real estate to the stock market. Only about 20% of the population really has much in the stock market, though, whereas home ownership reaches nearly 70% of the population. The result is that a Dow bubble has much less impact on the spending patterns of Americans than the real estate bubble.
I am still not sure whether we are actually in a recession or not. If we are not, we are close to it. If we are (remember, a quarter is quite a long time) in a recession, we are in the early stages and at this time it is mild. Either way, the disturbing aspect is that none of the factors that seem to have initiated this downturn, however you characterize it, seem to be ameliorating. The housing market is not recovering, and prices certainly will not recover until after 2010. Business investment still seems weak. Inflation is putting a further crimp in consumer spending on top of the MEW contraction.
IMO we seem to be at the beginning of a new cycle rather than at the end of one, as the Fed and most Street economists claim. Perhaps I am wrong. Perhaps I am right. Remember, my job is to try to help banks cope with conditions coming up in the future; I am strongly focused on conditions 3 and 4 quarters down the road. We cannot change the past but it is necessary to try to adapt to the future, so I really don't care about .5% here and there in current numbers. I care about conditions on the ground in their service area.
Based on recent economic information, and adjusted for the area income and industry components, I am warning bankers that they can expect to see much higher defaults on car, credit card and personal loans to lower income persons, will have to adjust their adjustable rate loans with high margins to prevent high default ratios, and that they will need to step up their collections and loss mitigation efforts. Money spent there will pay them back two or three-fold, because the early bird gets the disposable income.
Going forward, FICOs will mean much less than Debt-To-Income ratios. FNMA originations (which many of my banks do) will soar. Money spent on developing any sort of government guaranteed lending will have a high payback. Net interest margins will continue to be pressured; everyone is chasing the same relatively small group of consumers.
Debt consolidation and refinancing non-GSE mortgages and credit lines into GSE loans will be a big source of income for many of my banks going forward. They do this well. All of them will have problems with their CRA programs; they need to offload onto FNMA until FNMA tightens. They should do this quickly, because FNMA is going to have to tighten up on those >60% DTI MyCommunity loans.
For commercial lending, the dangers are mounting. Dealerships selling mid-level discretionary items to consumers (RVs, smaller boats, cars) are going to be under pressure. Many stock ag loans are going to be in trouble if not backed by some sort of government insurance program. Needless to say, builder and commercial construction loans must be vetted very carefully, and it is time to call in some chips there and be very careful about participation loans.
I cannot believe that I am all that different than many other persons in the same line of work, so I would say that these stats would amount to an inevitable credit tightening going forward. This is not a positive for the economy, and we seem to have a long way to go before debt loads, shoe sole inflation and employment trends are likely to shift for the better.
Regionally, Texas = Good, Florida = Bad, California and Oregon = Bad. Most rural states are slumping and mixed states such as PA will continue to generally slide a bit. Some recovery in housing markets in the NE. Good recovery for lower-bracket homes in lower central region.
Jumbo Alt-A mortgages = disaster across most of the nation.
The increase in real GDP in the first quarter primarily reflected positive contributions from personal consumption expenditures (PCE) and state and local government spending that were partly offset by negative contributions from residential fixed investment, private inventory investment, and federal government spending. Imports, which are a subtraction in the calculation of GDP, increased.Decliners on various exchanges have been outweighing the overachievers that make up the headline, so this is a crucial test of the run-up. Lately, no matter how bad the economic news has been stocks have gone up. We'll see if this can be sustained in light of the news above - a GDP that is extremely weak and making it only on state and local government spending plus consumer spending, both of which cannot be sustained:
The deceleration in real GDP growth in the first quarter primarily reflected a downturn in exports, an upturn in imports, a deceleration in PCE for nondurable goods, and a downturn in federal government spending that were partly offset by a smaller decrease in private inventory investment, an upturn in equipment and software, a smaller decrease in residential fixed investment, and an acceleration in PCE for durable goods.
Final sales of computers contributed 0.04 percentage point to the first-quarter growth in real GDP after contributing 0.22 percentage point to the fourth-quarter growth. Motor vehicle output contributed 0.09 percentage point to the first-quarter growth in real GDP after subtracting 1.18 percentage points from the fourth-quarter growth.
The price index for gross domestic purchases, which measures prices paid by U.S. residents, increased 3.6 percent in the first quarter....I have deep doubts about the accuracy of the price index, meaning that real PCE could be overstated. One perturbing matter is that although the dollar is dropping, exports are dropping:
...
Real personal consumption expenditures increased 3.8 percent in the first quarter, compared with an increase of 4.2 percent in the fourth.
Real exports of goods and services decreased 1.2 percent in the first quarter, in contrast to an increase of 10.6 percent in the fourth.One would have hoped to see the opposite. Imports also rose after having fallen in the fourth quarter.
This release will be revised substantially. Fourth quarter was revised up and then down and then up again to get the final of 2.5%.
The last four quarters of GDP growth:
Q206: 2.6 Q306: 2.0 Q406: 2.5 Q107: 1.3There is a trend.
Regarding unsustainability, let us proceed to Table 4, which is preceded by earnest warnings about not using the data in it. Naturally, it is one of the most usable and informative tables in the GDP release. Table 4 gives price indexes for various components (change from preceding period), and note the incredible changes from Q4 2006:
GDP; Q4 1.7; Q1 4.0The bottom line is that prices of consumer goods switched from favorable to consumption to broadly unfavorable over the two quarters, with the exception of durable goods. So if you have money it is a good time to buy the car or boat, but for those who are just trying to get along on needs expenses, the environment is tough. This is why personal consumption is not going to be sustainable. Recent releases show an acceleration of price increases for needs items (food, fuel, utilities), which means more than half of the population is getting it in the face this year.
Personal Consumption (PCE); Q4 -1.0; Q1 3.4
Components of PCE:
Durable Goods; Q4 -2.7; Q1 -1.8
Nondurables; Q4 -7.7; Q1 5.1
Services; Q4 2.9; Q1 3.5
As the Beige Book and Yellen noted, wage increases are concentrated in certain sectors. This may make inflation fanatics cheer up, but for the individual who is experiencing a real drop in buying power it is hardly good news. At the bottom of Table 10 you can find real disposable personal income:
Q406: 8,419.7This is personal income adjusted by the implicit price deflator expressed in chained 2000 dollars. On the face of it this number might look okay, but there are two caveats. First, inflation for "needs" goods - food and fuel - is skyrocketing, so lower income people who spend a much higher percentage of their incomes on such items are hurting. Second, the distribution of increased income is extremely unequal, so wages for lower income individuals are actually dropping in some areas (due largely to manufacturing and construction declines). In most cases, personal income is not keeping pace with inflation for the bottom 40%; in many cases, personal income is lagging inflation for the 41%-70% brackets.
Q107: 8,512.8
The reason why I am so certain that we are headed into a recession (if we have not already landed in one) is that the broad mass of individual consumers have been financing a lot of spending from wealth increase rather than income. However, in the last year the wealth increase has shifted from real estate to the stock market. Only about 20% of the population really has much in the stock market, though, whereas home ownership reaches nearly 70% of the population. The result is that a Dow bubble has much less impact on the spending patterns of Americans than the real estate bubble.
I am still not sure whether we are actually in a recession or not. If we are not, we are close to it. If we are (remember, a quarter is quite a long time) in a recession, we are in the early stages and at this time it is mild. Either way, the disturbing aspect is that none of the factors that seem to have initiated this downturn, however you characterize it, seem to be ameliorating. The housing market is not recovering, and prices certainly will not recover until after 2010. Business investment still seems weak. Inflation is putting a further crimp in consumer spending on top of the MEW contraction.
IMO we seem to be at the beginning of a new cycle rather than at the end of one, as the Fed and most Street economists claim. Perhaps I am wrong. Perhaps I am right. Remember, my job is to try to help banks cope with conditions coming up in the future; I am strongly focused on conditions 3 and 4 quarters down the road. We cannot change the past but it is necessary to try to adapt to the future, so I really don't care about .5% here and there in current numbers. I care about conditions on the ground in their service area.
Based on recent economic information, and adjusted for the area income and industry components, I am warning bankers that they can expect to see much higher defaults on car, credit card and personal loans to lower income persons, will have to adjust their adjustable rate loans with high margins to prevent high default ratios, and that they will need to step up their collections and loss mitigation efforts. Money spent there will pay them back two or three-fold, because the early bird gets the disposable income.
Going forward, FICOs will mean much less than Debt-To-Income ratios. FNMA originations (which many of my banks do) will soar. Money spent on developing any sort of government guaranteed lending will have a high payback. Net interest margins will continue to be pressured; everyone is chasing the same relatively small group of consumers.
Debt consolidation and refinancing non-GSE mortgages and credit lines into GSE loans will be a big source of income for many of my banks going forward. They do this well. All of them will have problems with their CRA programs; they need to offload onto FNMA until FNMA tightens. They should do this quickly, because FNMA is going to have to tighten up on those >60% DTI MyCommunity loans.
For commercial lending, the dangers are mounting. Dealerships selling mid-level discretionary items to consumers (RVs, smaller boats, cars) are going to be under pressure. Many stock ag loans are going to be in trouble if not backed by some sort of government insurance program. Needless to say, builder and commercial construction loans must be vetted very carefully, and it is time to call in some chips there and be very careful about participation loans.
I cannot believe that I am all that different than many other persons in the same line of work, so I would say that these stats would amount to an inevitable credit tightening going forward. This is not a positive for the economy, and we seem to have a long way to go before debt loads, shoe sole inflation and employment trends are likely to shift for the better.
Regionally, Texas = Good, Florida = Bad, California and Oregon = Bad. Most rural states are slumping and mixed states such as PA will continue to generally slide a bit. Some recovery in housing markets in the NE. Good recovery for lower-bracket homes in lower central region.
Jumbo Alt-A mortgages = disaster across most of the nation.
Comments:
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MaMa,
This seems to be a contradiction:
In the comments section of your “When all else fails” posting, you wrote:
“According to my numbers, building really hasn't slowed much.”
Now in this posting you write:
“The housing market is not recovering, and prices certainly will not recover until after 2010.”
“Building hasn’t slowed much” vs. “housing market not recovering.”
Isn’t ‘housing’ part of ‘building’?
This seems to be a contradiction:
In the comments section of your “When all else fails” posting, you wrote:
“According to my numbers, building really hasn't slowed much.”
Now in this posting you write:
“The housing market is not recovering, and prices certainly will not recover until after 2010.”
“Building hasn’t slowed much” vs. “housing market not recovering.”
Isn’t ‘housing’ part of ‘building’?
# posted by 
: 5:13 PM
: 5:13 PM
Anon - more later. Sorry, the vacancy rate increase, especially in metro areas, threw me into deep dismay. A 4% vacancy rate in metro areas coming into the season in most of the country is a staggering number. At best, one would expect 8% metro turnover this year, and 4% metro vacancies implies that at least half of all homes sold this year will be vacant, which puts homeowners who need to sell in real jeopardy.
Tom, a recovery of the housing market would involve a stabilization in prices and inventory. Part of my total dismay over the vacancy rate is because such high vacancies seem to indicate that we can expect no recovery whatsoever for quite a while. In terms of pricing, almost everyone I respect would not expect a return to real price increases until after 2010, but in terms of home building, most people expected some resurgence beginning in 2008 after a further decline in 2007. The vacancy rate seems to put that expectation in question.
However, building involves non-residential such as commercial (including roadwork) and public. The increases in commercial and public have overall tended to balance out the drop in housing construction, although this does seem now to be tailing off. From the point of view of a construction worker, working on a government project or a commercial building is fine as long as they get paid. The increase in government and commercial construction has greatly lessened the impact of the downturn in homebuilding on the general economy.
Also, high metro vacancies are more of a concern because that is where the jobs are. There is no doubt that we are in at least a period of poor economic growth, and one would expect more rural areas to get hit hardest. But with such good employment figures, one would expect metro demand to remain relatively high. Today's vacancy report explained some discrepancies in data that have been puzzling me, but also threw a huge spanner in my overall gears. I have to rework my thinking in light of this. Unless that report is totally wrong, and I doubt that, I have been overoptimistic.
Tom, a recovery of the housing market would involve a stabilization in prices and inventory. Part of my total dismay over the vacancy rate is because such high vacancies seem to indicate that we can expect no recovery whatsoever for quite a while. In terms of pricing, almost everyone I respect would not expect a return to real price increases until after 2010, but in terms of home building, most people expected some resurgence beginning in 2008 after a further decline in 2007. The vacancy rate seems to put that expectation in question.
However, building involves non-residential such as commercial (including roadwork) and public. The increases in commercial and public have overall tended to balance out the drop in housing construction, although this does seem now to be tailing off. From the point of view of a construction worker, working on a government project or a commercial building is fine as long as they get paid. The increase in government and commercial construction has greatly lessened the impact of the downturn in homebuilding on the general economy.
Also, high metro vacancies are more of a concern because that is where the jobs are. There is no doubt that we are in at least a period of poor economic growth, and one would expect more rural areas to get hit hardest. But with such good employment figures, one would expect metro demand to remain relatively high. Today's vacancy report explained some discrepancies in data that have been puzzling me, but also threw a huge spanner in my overall gears. I have to rework my thinking in light of this. Unless that report is totally wrong, and I doubt that, I have been overoptimistic.
Mama writes:
“The increases in commercial and public have overall tended to balance out the drop in housing construction… From the point of view of a construction worker, working on a government project or a commercial building is fine as long as they get paid.”
This 'seems' to be based on the assumption that construction workers can move ‘freely’ from housing into commercial and government projects. When analyzing labor it is important to keep in mind the distinction between union and non-union workers and their respective construction areas. Housing is based, on my experience – not economic statistics, a non-union work force; whereas, commercial and government is union. Workers do not move easily –if at all - from one type of job site to the other. This is to say: a given % drop in housing offset by the same % increase in commercial/gov’t construction spending does not necessarily imply that the corresponding drop in housing labor will be offset by an equal increase in commercial/gov’t labor.
“The increases in commercial and public have overall tended to balance out the drop in housing construction… From the point of view of a construction worker, working on a government project or a commercial building is fine as long as they get paid.”
This 'seems' to be based on the assumption that construction workers can move ‘freely’ from housing into commercial and government projects. When analyzing labor it is important to keep in mind the distinction between union and non-union workers and their respective construction areas. Housing is based, on my experience – not economic statistics, a non-union work force; whereas, commercial and government is union. Workers do not move easily –if at all - from one type of job site to the other. This is to say: a given % drop in housing offset by the same % increase in commercial/gov’t construction spending does not necessarily imply that the corresponding drop in housing labor will be offset by an equal increase in commercial/gov’t labor.
# posted by : 4:32 AM
: 4:32 AM
Tom - that's a good point, but it varies widely. There is a law about paying prevailing wages for some projects, but in states like GA, unions can't require membership and don't control much. Every road crew I've seen in GA for the last two years has been mostly those short brown people with confused looks on their faces. That's all government. As soon as you put contracts out to bid without the requirement that all workers belong to a union, inevitably the non-union bids will win those contracts.
Most of the skilled labor (electricians, plumbing, ac) that I know of around here bid widely on commercial, government and fill-in residential jobs.
I can't guess the relative percentages. Overall, the least building occurs in areas like the NE.
There's a sharp distinction between the highly skilled and licensed trades and the relatively unskilled workers anyway. My guess is that many of the skilled workers will keep their jobs but get much less work.
Most of the skilled labor (electricians, plumbing, ac) that I know of around here bid widely on commercial, government and fill-in residential jobs.
I can't guess the relative percentages. Overall, the least building occurs in areas like the NE.
There's a sharp distinction between the highly skilled and licensed trades and the relatively unskilled workers anyway. My guess is that many of the skilled workers will keep their jobs but get much less work.
MoM,
I listened to a bunch of 1q calls from California (inland emprire), Nevada and Arizona up-to-their-necks-in-CRE lenders (cbon, wal, pfb, others). Universally they are claiming to see zero stress in their CRE loans, and even in their construction loans.
My question is, how can CRE lag so far behind residential in those states? I would have thought that just the existence of vacant housing developments would pressure strip malls and even some office complexes (which these days are wall-to-wall mortgage brokers, appraisers and escrow agents). Add to that impairments on the homebuilder side and you would think that the banks would be seeing some stress ahead.
How long a lag do you think there will be in those states for the community banks, or are they just in deep denial?
Even auto and c.c. should be seeing more stress given the degree of MEW decline, and yet we see nothing. As you point out, most of the people that are early defaulters do not benefit from cap gains, and so their real wages/incomes are probably trending down.
David Pearson
I listened to a bunch of 1q calls from California (inland emprire), Nevada and Arizona up-to-their-necks-in-CRE lenders (cbon, wal, pfb, others). Universally they are claiming to see zero stress in their CRE loans, and even in their construction loans.
My question is, how can CRE lag so far behind residential in those states? I would have thought that just the existence of vacant housing developments would pressure strip malls and even some office complexes (which these days are wall-to-wall mortgage brokers, appraisers and escrow agents). Add to that impairments on the homebuilder side and you would think that the banks would be seeing some stress ahead.
How long a lag do you think there will be in those states for the community banks, or are they just in deep denial?
Even auto and c.c. should be seeing more stress given the degree of MEW decline, and yet we see nothing. As you point out, most of the people that are early defaulters do not benefit from cap gains, and so their real wages/incomes are probably trending down.
David Pearson
# posted by : 3:27 PM
: 3:27 PM
David - in my experience community banks usually are much more cautious in their lending than the larger banks. Obviously this is not a hard and fast rule, as Coast Bank alone will prove.
Also, my statements are targeted forward considerably. Otherwise, they are no use at all.
In places like Irvine, somebody, somewhere is going to be taking a hit on those buildings that were built and are now empty. But I would expect it to play out over quarters, not months. Securitization of commercial mortgages seems to me to have followed a pattern similar to non-prime loans, so a lot of junk has been offloaded to bondholders.
In the smaller banks, I expect most of their losses to come from their loan portfolios of auto loans, HELOC's, and small commercial loans to tradespeople/small businesses as this thing begins to lock up.
I believe it is the bigger banks and the bondholders that will take more of a hit on the larger commercial loans. Usually it seems to happen much like the Coast Bank implosion - things look fine on the surface and then there's a sudden implosion over 3-6 months.
Take all this with a big question mark - I have run across bad lenders in small banks. But community banks that have been in business for a while usually have some cautious, experienced people at the helm. They do not have much margin for error and they know it, and if they are careful and good at what they do they will build a customer base that is pretty durable by originating for FNMA and serving small businesses.
Risk factors to look for:
1) Balance sheet - are defaults/writeoffs rising while loan reserves are falling?
2) Management - have there been recent retirements?
3) Are they paying abnormally high interest rates on deposits? Usually this is a real danger sign.
4) Recent startups (>1999) in bubbly areas. Unfortunately, De Novos have been concentrated in CA and FL. Many of the ones under good management have already sold.
Then you look at service area characteristics, type of loan portfolio, stability factors (originating and retaining servicing is one), and loan portfolio composition.
Reading their balance sheets helps me, but it helps me more to look at their product lineup and rates. I also am very leery about smaller community banks that work through brokers. That can be very, very dangerous.
In this environment, percentages of HELOCS and seconds is a very important factor. Non-amortizing loans are a danger sign. Overweight on construction loans to small builders is a bad sign.
For both commercial real estate and small commercial lending, I think the bottom may be in 2009. That's a best GUESS, but whenever it comes it certainly will be after third quarter 2007.
Also, my statements are targeted forward considerably. Otherwise, they are no use at all.
In places like Irvine, somebody, somewhere is going to be taking a hit on those buildings that were built and are now empty. But I would expect it to play out over quarters, not months. Securitization of commercial mortgages seems to me to have followed a pattern similar to non-prime loans, so a lot of junk has been offloaded to bondholders.
In the smaller banks, I expect most of their losses to come from their loan portfolios of auto loans, HELOC's, and small commercial loans to tradespeople/small businesses as this thing begins to lock up.
I believe it is the bigger banks and the bondholders that will take more of a hit on the larger commercial loans. Usually it seems to happen much like the Coast Bank implosion - things look fine on the surface and then there's a sudden implosion over 3-6 months.
Take all this with a big question mark - I have run across bad lenders in small banks. But community banks that have been in business for a while usually have some cautious, experienced people at the helm. They do not have much margin for error and they know it, and if they are careful and good at what they do they will build a customer base that is pretty durable by originating for FNMA and serving small businesses.
Risk factors to look for:
1) Balance sheet - are defaults/writeoffs rising while loan reserves are falling?
2) Management - have there been recent retirements?
3) Are they paying abnormally high interest rates on deposits? Usually this is a real danger sign.
4) Recent startups (>1999) in bubbly areas. Unfortunately, De Novos have been concentrated in CA and FL. Many of the ones under good management have already sold.
Then you look at service area characteristics, type of loan portfolio, stability factors (originating and retaining servicing is one), and loan portfolio composition.
Reading their balance sheets helps me, but it helps me more to look at their product lineup and rates. I also am very leery about smaller community banks that work through brokers. That can be very, very dangerous.
In this environment, percentages of HELOCS and seconds is a very important factor. Non-amortizing loans are a danger sign. Overweight on construction loans to small builders is a bad sign.
For both commercial real estate and small commercial lending, I think the bottom may be in 2009. That's a best GUESS, but whenever it comes it certainly will be after third quarter 2007.
Oh, and David, don't forget that a lot of that MEW money is still with us. There was a big wave of refis last year after rates dropped. There was another surge right before nonprime mortgage guidelines really tightened down. It takes at least six months after refi for most borrowers to begin to get in the hole again. While inflation is certainly beginning to cut into things, that's a slow erosion rather than a crushing blow. My guess is that the average family would take 3-6 months before accumulating too much damage.
As the next wave of resets and recasts hits this summer, I am thinking we'll start to see a more rapid degeneration.
As the next wave of resets and recasts hits this summer, I am thinking we'll start to see a more rapid degeneration.
David - in my experience community banks usually are much more cautious in their lending than the larger banks. Obviously this is not a hard and fast rule, as Coast Bank alone will prove.
Also, my statements are targeted forward considerably. Otherwise, they are no use at all.
In places like Irvine, somebody, somewhere is going to be taking a hit on those buildings that were built and are now empty. But I would expect it to play out over quarters, not months. Securitization of commercial mortgages seems to me to have followed a pattern similar to non-prime loans, so a lot of junk has been offloaded to bondholders.
In the smaller banks, I expect most of their losses to come from their loan portfolios of auto loans, HELOC's, and small commercial loans to tradespeople/small businesses as this thing begins to lock up.
I believe it is the bigger banks and the bondholders that will take more of a hit on the larger commercial loans. Usually it seems to happen much like the Coast Bank implosion - things look fine on the surface and then there's a sudden implosion over 3-6 months.
Take all this with a big question mark - I have run across bad lenders in small banks. But community banks that have been in business for a while usually have some cautious, experienced people at the helm. They do not have much margin for error and they know it, and if they are careful and good at what they do they will build a customer base that is pretty durable by originating for FNMA and serving small businesses.
Risk factors to look for:
1) Balance sheet - are defaults/writeoffs rising while loan reserves are falling?
2) Management - have there been recent retirements?
3) Are they paying abnormally high interest rates on deposits? Usually this is a real danger sign.
4) Recent startups (>1999) in bubbly areas. Unfortunately, De Novos have been concentrated in CA and FL. Many of the ones under good management have already sold.
Then you look at service area characteristics, type of loan portfolio, stability factors (originating and retaining servicing is one), and loan portfolio composition.
Reading their balance sheets helps me, but it helps me more to look at their product lineup and rates. I also am very leery about smaller community banks that work through brokers. That can be very, very dangerous.
In this environment, percentages of HELOCS and seconds is a very important factor. Non-amortizing loans are a danger sign. Overweight on construction loans to small builders is a bad sign.
For both commercial real estate and small commercial lending, I think the bottom may be in 2009. That's a best GUESS, but whenever it comes it certainly will be after third quarter 2007.
Also, my statements are targeted forward considerably. Otherwise, they are no use at all.
In places like Irvine, somebody, somewhere is going to be taking a hit on those buildings that were built and are now empty. But I would expect it to play out over quarters, not months. Securitization of commercial mortgages seems to me to have followed a pattern similar to non-prime loans, so a lot of junk has been offloaded to bondholders.
In the smaller banks, I expect most of their losses to come from their loan portfolios of auto loans, HELOC's, and small commercial loans to tradespeople/small businesses as this thing begins to lock up.
I believe it is the bigger banks and the bondholders that will take more of a hit on the larger commercial loans. Usually it seems to happen much like the Coast Bank implosion - things look fine on the surface and then there's a sudden implosion over 3-6 months.
Take all this with a big question mark - I have run across bad lenders in small banks. But community banks that have been in business for a while usually have some cautious, experienced people at the helm. They do not have much margin for error and they know it, and if they are careful and good at what they do they will build a customer base that is pretty durable by originating for FNMA and serving small businesses.
Risk factors to look for:
1) Balance sheet - are defaults/writeoffs rising while loan reserves are falling?
2) Management - have there been recent retirements?
3) Are they paying abnormally high interest rates on deposits? Usually this is a real danger sign.
4) Recent startups (>1999) in bubbly areas. Unfortunately, De Novos have been concentrated in CA and FL. Many of the ones under good management have already sold.
Then you look at service area characteristics, type of loan portfolio, stability factors (originating and retaining servicing is one), and loan portfolio composition.
Reading their balance sheets helps me, but it helps me more to look at their product lineup and rates. I also am very leery about smaller community banks that work through brokers. That can be very, very dangerous.
In this environment, percentages of HELOCS and seconds is a very important factor. Non-amortizing loans are a danger sign. Overweight on construction loans to small builders is a bad sign.
For both commercial real estate and small commercial lending, I think the bottom may be in 2009. That's a best GUESS, but whenever it comes it certainly will be after third quarter 2007.
For anyone reading this who is not immersed in banking, take a look at FRB delinquencies and chargeoffs here.
Look at rates for Q42006 for the 100 largest vs others, and you'll see what I mean.
Look at rates for Q42006 for the 100 largest vs others, and you'll see what I mean.
MoM,
Thanks for that link! I do see the difference b/t the two.
One of the things I look at is just the combo of asset growth and CRE exposure vs. capital. The community banks seemed to have gone whole-hog the past 3-4 years if you look at the changes in both. This tells me they may be relatively more prudent than the big guys, but also that they took some pretty big sips of the kool-aid themselves. When I hear their commentary on the conference calls, it strikes me they may be managerially unprepared for what's coming down the pike.
David Pearson
Thanks for that link! I do see the difference b/t the two.
One of the things I look at is just the combo of asset growth and CRE exposure vs. capital. The community banks seemed to have gone whole-hog the past 3-4 years if you look at the changes in both. This tells me they may be relatively more prudent than the big guys, but also that they took some pretty big sips of the kool-aid themselves. When I hear their commentary on the conference calls, it strikes me they may be managerially unprepared for what's coming down the pike.
David Pearson
# posted by : 8:43 AM
: 8:43 AM
A lot of them, yes. And some of them who were relatively conservative may get caught in the backwash in certain areas. If you look at any bank's balance sheet there's a lot to be concerned about if the area gets particularly weak, and some of these areas that were recently built up will get seriously hit.
I see nothing to be complacent about. I do believe that there is some substantial denial going on. Some of that denial, IMO, is going on in the regulatory agencies themselves. I found the last ALLL guidance extraordinarily interesting. I know that for several years banks were being hit for making loss allowances and that the boards were just taking it out of one bucket per the examiner's writeup, but putting it back in another bucket. A lot of smaller banks with experienced mgmt know exactly what's coming.
There's some stuff that wants badly to roll off my tongue, but I need to shut up because of confidentiality issues. At this point, everyone's gone too far IMO. Even FNMA is writing some loans I wouldn't touch. As this unwinds, it will not be pretty.
The truth is that a huge amount of small business financing is really dependent on home values. I don't think anyone's faced up to this. Inflation is making a bad situation much worse, and we're all going to have to sit tight and be very careful for a couple of years.
Parts of the Fremont C&D could have been written about a huge number of institutions. The agencies face a situation in which they have no authority over a big chunk of the market. By 2005, both FNMA and many banks were in a situation in which they were losing market share to largely unregulated credit markets that had abandoned all reason. I do not blame the Fed nor the agencies all that much. If they had enforced strong safety and soundness guidelines, they would have been aggravating a bad situation for the whole financial system and the economy in general.
I see nothing to be complacent about. I do believe that there is some substantial denial going on. Some of that denial, IMO, is going on in the regulatory agencies themselves. I found the last ALLL guidance extraordinarily interesting. I know that for several years banks were being hit for making loss allowances and that the boards were just taking it out of one bucket per the examiner's writeup, but putting it back in another bucket. A lot of smaller banks with experienced mgmt know exactly what's coming.
There's some stuff that wants badly to roll off my tongue, but I need to shut up because of confidentiality issues. At this point, everyone's gone too far IMO. Even FNMA is writing some loans I wouldn't touch. As this unwinds, it will not be pretty.
The truth is that a huge amount of small business financing is really dependent on home values. I don't think anyone's faced up to this. Inflation is making a bad situation much worse, and we're all going to have to sit tight and be very careful for a couple of years.
Parts of the Fremont C&D could have been written about a huge number of institutions. The agencies face a situation in which they have no authority over a big chunk of the market. By 2005, both FNMA and many banks were in a situation in which they were losing market share to largely unregulated credit markets that had abandoned all reason. I do not blame the Fed nor the agencies all that much. If they had enforced strong safety and soundness guidelines, they would have been aggravating a bad situation for the whole financial system and the economy in general.
In places like Irvine, somebody, somewhere is going to be taking a hit on those buildings that were built and are now empty. But I would expect it to play out over quarters, not months.
During the last SoCal real estate boom, we ended up with a lot of "see-through" (completely-empty) high-rises near the OC airport (Costa Mesa, just SW of Irvine). The local city council had to step in and stop the new Highrise Office projects being announced because the existing buildings were all sitting empty.
They remained empty through the RE slump, but filled up when things recovered in a couple years.
In SoCal, this sort of thing happens on a 10- to 12-year cycle, and it's been 12 years since the last crash.
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During the last SoCal real estate boom, we ended up with a lot of "see-through" (completely-empty) high-rises near the OC airport (Costa Mesa, just SW of Irvine). The local city council had to step in and stop the new Highrise Office projects being announced because the existing buildings were all sitting empty.
They remained empty through the RE slump, but filled up when things recovered in a couple years.
In SoCal, this sort of thing happens on a 10- to 12-year cycle, and it's been 12 years since the last crash.
# posted by : 4:28 PM
: 4:28 PM << Home
