Echoes Of New Century’s Collapse Amid Sudden Firesale Of Real Estate Loans As One Bank Sees 40% Downside
Those who peaked below the surface of the latest H.8 statement which, as discussed previously, saw the biggest drop on record in bank loans and leases in the last two weeks of March…
… found another, perhaps even bigger surprise. As we detailed over the weekend when breaking down the weekly change in small bank loans and leases by their subcomponents, we found that whereas in the first week after the bank crisis (the one ending March 15) the bulk of the collapse in loans was in the traditionally volatile C&I space, the latest week was a surprise: that’s because while the plunge in C&I loans moderated substantially to just $6.9BN from $25BN the week before, the biggest slide was in one of the anchor pillars of the small bank sector: real estate loans.
In fact, while the biggest drop among small bank loans in the latest week was the $18.7BN decline in real estate loans, this was a continuation of the $19.2BN drop in the previous week. Combining the two weeks adds to a $37.8BN plunge in real estate loans in the second half of March. This number is notable because it is the biggest since the collapse of the country’s then-second largest subprime lender, New Century Financial in March 2007, which as most traders over 40 recall, was the catalyst that ushered in the global financial crisis, and within the year led to the collapse of Bear Stearns and, eventually, Lehman.
Of course, for the past month we have been warning that real estate and especially Commercial Real Estate is the ticking solvency time bomb within both large and small banks, now that the liquidity crisis that crushed several “small” banks has been contained courtesy of nearly half a trillion in reserve injections by the Fed. And while we previously discussed at length the coming multi-trillion CRE maturity wall, (see “New “Big Short” Hits Record Low As Focus Turns To $400 Billion CRE Debt Maturity Wall“)…
… increasingly more are also seemingly starting to notice and, what is far more ominously, are taking a page out of the Margin Call playbook and quietly selling out of their real estate loan exposure: or to quote Kevin Spacey, “this is what the beginning of a firesale looks like.”
To be sure, it’s no longer just us that are focusing on the potential of CRE to be the next market crash catalyst. As Bloomberg wrote over the weekend, “almost $1.5 trillion of US commercial real estate debt comes due for repayment before the end of 2025. The big question facing those borrowers is who’s going to lend to them?”
Well, there is another even bigger question as the video clip above suggests, but we’ll get back to it in a second.
Bloomberg quotes a recent must-read note by Morgan Stanley titled “Scaling Maturity Walls” (available to pro subs in the usual place) in which the bank’s credit strategists write that “refinancing risks are front and center” for owners of properties from office buildings to stores and warehouses, adding that “the maturity wall here is front-loaded. So are the associated risks.”
Looking at the charts below, Morgan Stanley’s James Egan writes that “roughly $400-450bn worth of CRE loans are scheduled to mature in 2023. This is on par with 2022, and both of those years are the largest on record ( Exhibit 12 ). From there it doesn’t get any easier, as maturities climb each year until 2027, reaching over $550bn.” And “while the maturity walls within other asset classes might not be very front loaded, the issue within commercial real estate is happening right now.”
As these maturities come due, Egan warns that he is left many more questions than answers, “chief among them: who is going to be responsible for refinancing these loans as they mature? That story differs depending on property type. The multifamily space has grown very reliant on the GSEs over the years. From 2023 through 2027, 46% of maturities are currently guaranteed by the GSEs. As a reminder, in the GSE space, borrowers will ask lenders for a loan, and if the property meets the eligibility criteria for agency guarantee, then the lender should generally feel comfortable that the loan will be guaranteed by the agency when quoting a rate lock. The agencies will inspect the property at different times depending on the exact program, but given that the majority of agency guaranteed multifamily properties are held by borrowers with multiple properties, there is incentive to continue to work with the agencies.”
But the real punchline is that as these maturities are picking up, the single largest lender in the Commercial Real Estate landscape is the one that is now under the most scrutiny: regional banks, something we have been warning about for months. As Morgan Stanley notes in the next chart, in the years since the GFC, origination volumes and the share of that volume has varied, but since 2014 the trend has clearly been away from CMBS and toward regional banks.
Meanwhile, as we discussed previously, rising rates and worries about defaults have already hurt CMBS deals. Sales of the securities without government backing fell about 80% in the first quarter from a year earlier, according to Bloomberg calculations.
“The role that banks have played in this ecosystem, not only as lenders but also as buyers,” will compound the wave of refinancing coming due, the analysts wrote.
Unfortunately, when apartment blocks are excluded, the scale of the problems facing banks becomes even starker. As much as 70% of the other commercial real estate loans that mature over the next five years are held by banks, according to the Morgan Stanley report.
“Commercial real estate needs to re-price and alternative ways to refinance the debt are needed,” the analysts said.
To be sure it’s not all doom and gloom, and as Bloomberg notes, there are some slivers of good news. Conservative lending standards in the wake of the financial crisis provide borrowers, and in turn their lenders, with some degree of protection from falling values. Additionally, sentiment toward multifamily housing also remains much more positive as rents continue to rise, one reason why Blackstone Real Estate Income Trust had a positive return in February even as rising numbers of investors lodge withdrawal requests. The availability of agency-backed loans will help owners of those properties when they need to refinance.
Alas, with regional banks now undergoing cardiac arrest, and unlikely to reboot their lending activity as long as deposit flight continues – which as discussed last week has slowed modestly but remains an existential risk to the regional banks and which is unlikely to be resolved as long as the Fed refuses to cut rates and remove depositors’ preference from shifting funds from banks to safer, and higher yielding money markets (see “JPM Asks If The Fed Will Restrict Reverse Repo Use To Short Circuit $1.5 Trillion Bank Run“)…
…. it doesn’t take rocket science to realize that, just like in March 2007 when the collapse of New Century finally shocked everyone into a state of brutal realization that the party was over, it’s about to get a whole lot worse.
How much worse? Well, according to Morgan Stanley office and retail property valuations could fall as much as 40% from peak to trough, creating a feedback loop of liquidations, bank failures, defaults and from there even more liquidations:
US securitized credit – CRE: $1.35-1.46 trillion (30-32%) of CRE debt matures by YE 2025 and banks hold ~42-56% of maturing debt. Recent attention on US CRE is understandable as the asset class faces a trifecta of risks:
- (1) Maturity walls are front loaded. Acknowledging the variance in the numbers reported by different sources, we estimate that nearly $566-615 billion (22-24%) of the outstanding $2.6 trillion core CRE debt (excluding multifamily) matures by year-end 2024 and another $275-340 billion (11-13%) is due in 2025.
- (2) Bank dependence is high – both as direct lenders to the asset and also as buyers of both agency and non-agency CMBS. Banks hold 36-64% of debt maturing each year and account for nearly half the agency CMBS and 10-15% of the non-agency CMBS investor base.
- (3) Valuation concerns have increased in specific sectors such as office and retail.
Our equity colleagues expect a 30-40% peak to trough correction in both asset classes.
We are glad that one month after we called CRE the “BIg Short 3.0”, one of the largest and most respected US banks agrees. We are not glad that if, or rather when we are proven right that with trillions in loan maturities which nobody wants to roll CRE is about to become the next Subprime, the US financial system will suffer another existential shock, or as some call it “credit event.”
Morgan Stanley’s conclusion: “commercial real estate needs to re-price and alternative ways to refinance the debt are needed.”
And while it may not have been Morgan Stanley’s intention, yelling “re-pricing” in a burning theater can be even worse than yelling fire: it’s the green light for everyone else to start selling… something the collapse in real estate loans suggest may have already started.
Much more in the must-read MS notes (here and here) available to pro subs.This post was originally published at Zero Hedge
Jamie Dimon Warns QT Will Lead To More Bank Failures
At the start of May we explained that it’s not just the Fed’s rate hikes that are behind the nascent regional bank crisis(because with Fed Funds rate at 5.25% and both T-Bills and money market funds offering similar yields, there is no way small banks can compete with these returns, prompting a bank jog (which periodically turns to a sprint) and deposit flight from both checking and saving accounts).
We said that the Fed’s ongoing QT is a just as pernicious threat to the viability of small/regional banks because with every dollar drained from the system as part of the Fed’s quantitative tightening, a matching deposit dollar is also destroyed, to wit:
Under an ample reserves framework, virtually all deposits are created by the Fed.
That’s why banks were forced to load up on low-yielding securities during 2000-2001 and are now getting crushed as yields soar and fixed income/loan prices plunge.
It also means that under QT as Fed reserves shrink, deposits must follow: as such deposits are either forced to shift into Bills/TSYs or are destroyed (bank failures).
Thus, the bank crisis is an inevitable side effect of Fed tightening.
Now, by now everyone knows that when it comes to banks failing (and capitalizing on it) few are as experienced as JP Morgan, aka JP Mega…
… aka JP More-gain, which now has more than 13% of the nation’s deposits and 21% of all credit card spending: in other words, there has never been a bank that is more systematically important than JPMore-gain… and with every small bank failure, Jamie Dimon’s goliath is only getting bigger. Which is why we found it curious that none other than Jamie Dimon confirmed what we said three weeks ago during JPM’s Investor Day on Monday.
This is what the billionaire CEO said:
We haven’t been through Quantitative Tightening. So we really don’t know what’s going to happen to deposits at all [ZH; actually we do: deposits will shrink dollar for dollar alongside reserves]. And that’s why I’ve been quite concerned about that. I’m probably more concerned about quantitative tightening with anybody in this room.
We’ve never had QT before. It just started, okay? And you see huge distortions in the marketplace already. We’ve never had the Fed in the market like this with that RRP program that Jeremy mentioned ever. They have $2.3 trillion basically lent out to money funds. And I don’t know the full effect of that. And obviously, that’s a direct deduction from deposits are rolling out it made sense to do.
So I think people should build into their mindset that they may have to move deposit beta more than they think and manage that. So I mean, if I was any bank or any company, I’d be saying, can you handle higher interest rates and surprise in deposits, etc?
And this is how JPM itself shows the impact of the shrinking Fed balance sheet and TGA/RRP liquidity drains soak up commercial bank deposits.
By the way, “deposit beta”, as Jamie calls it, for those unfamilliar is a polite way of saying bank run, which is a less polite way of saying bank failure. As for Dimon’s rhetorical last question, the answer is a resounding no, or so JPM’s shareholders would like because for the second time in a month, JPM hiked its Net Interest Margin forecast, this time courtesy of the bank’s FDIC/taxpayer-funded gift in the form of First Republic Bank.
According to a slide in the bank’s Investor Day presentation, JPMorgan will gain an even bigger benefit from rising interest rates because of its “purchase” of First Republic Bank. We put purchase in quotes because in reality it was a gift by the FDIC, which gave JPM all the good parts of the collapsed California bank, while taxpayers were left holding the nuclear waste.
The biggest US bank raised its guidance for net interest income this year to $84 billion up from a previous forecast of $81 billion, according to an Investor Day presentation. The reason: the failure of First Republic which directly boosted JPM’s top line by billions!
In other words, as other banks fail, JPM prospers: here is a history of JPM’s Net Interest Income courtesy of Bloomberg. It will only keep rising…
… as more banks fail.
It is no surprise then that it is Jamie’s sincerest wish for rates to keep rising…
… after all that’s the surest way for John Pierpont’s bank – which still pays 0.01% interest on most of its deposits – to once again become bigger than the US and to finally fulfill the reason behind creation of the Federal Reserves.This post was originally published at Zero Hedge
Debt Ceiling Negotiations Crumble, McCarthy And Biden To Hold Sunday Call As Impasse Intensifies
Negotiations in Washington DC over the debt ceiling have taken a big step back over the weekend, as the White House and House Republicans continue to point fingers at each other.
“It seems as though he wants default more than he wants a deal,” House Speaker Kevin McCarthy (R-CA) told Fox News on Sunday. “We have got 11 days to go,” McCarthy continued, urging Biden and the Democrats to be “sensible about this.”
Republicans have been pushing for substantial, longer-term spending reductions, arguing that Congress needs to roll the nation’s deficit spending back to 2022 levels, while restricting the growth of government spending. The White House, on the other hand, wants to achieve policy goals via taxation.
McCarthy said there’s some talk of extending the debt ceiling until 2025, but he said he’s demanding cuts to federal spending in exchange for GOP votes to do so. Biden, he said, is resisting.
“The president keeps changing positions every time Bernie Sanders has a press conference,” he said.
McCarthy said Biden is demanding tax increases after earlier agreeing to keep them off the table. He also said Republicans have made compromises but didn’t specify them. –Bloomberg
Meanwhile, Biden – speaking at a press conference held after the Group of Seven (G-7) summit in Hiroshima, said that he would speak with McCarthy shortly, though he added that the Republican plan was unacceptable.
“The speaker and I’ll be talking later on the plane as we head back,” said Biden. “And our teams are going to continue working.”
“I’m willing to cut spending, and I proposed cuts in spending of over a trillion dollars,” he continued. “But I believe we have to also look at the tax revenues,” adding that the Republican proposal to cut $2 trillion in taxes would hurt the economy.
“Now it’s time for the other side to move from their extreme positions, because much of what they’ve already proposed is simply, quite frankly, unacceptable,” Biden told reporters. “And it’s time for Republicans to accept that there is no bipartisan deal to be made solely on their partisan terms.”
He also rambled a lot.
Biden’s comments came after McCarthy on Saturday accused the White House of backtracking during negotiations, and told reporters that there would be no progress made until Biden returns from the trip.
“The White House is moving backward in negotiations,” McCarthy tweeted Saturday afternoon. “Unfortunately, the socialist wing of the Democrat Party appears to be in control—especially with President Biden out of the country.”
“President Biden doesn’t think there is a single dollar of savings to be found in the federal government’s budget,” McCarthy tweeted in the evening. “He’d rather be the first president in history to default on the debt than to risk upsetting the radical socialists who are calling the shots for Democrats right now.”
One of McCarthy’s top deputies, House Financial Services Chair Patrick McHenry (R-NC) on Sunday said he’s ‘pessimistic’ about the current state of negotiations, and that there is no plans for DC-based negotiations to continue at this time.
In response to McCarthy’s comments, White House Press Secretary Karine Jean-Pierre issued a statement from Hiroshima, reiterating Biden’s c all for a “reasonable bipartisan budget agreement.”
“Last night in D.C., the Speaker’s team put on the table an offer that was a big step back and contained a set of extreme partisan demands that could never pass both Houses of Congress,” she said.
Meanwhile, Treasury Secretary Janet Yellen underscored the urgency of the situation, telling NBC that the likelihood the US would be able to pay its bills by mid-June is “quite low.”
“Well, there’s always uncertainty about tax receipts and spending,” Yellen told “Meet the Press” on Sunday. “And so it’s hard to be absolutely certain about this, but my assessment is that the odds of reaching June 15 while being able to pay all of our bills is quite low.”
“Deficits can be addressed both through changes in spending and also through changes in revenue — and Republicans have taken that off the table,” Yellen continued.
In short, drama right up to the finish line. Did you expect anything less?This post was originally published at Zero Hedge
Buffett Turns Gloomy: The “Incredible Period” For The US Economy Is Coming To An End
While Warren Buffett’s insights on the economy are traditionally cheerful and uplifting – usually hitting at time of peak pessimism in the form of self-serving NYT op-eds or CNBC vignettes (and usually around the time the Omaha billionaire knows that the government will backstop his TBTF investments, unlike those of pretty much anyone else), on Saturday the head of Berkshire Hathaway had a far more downbeat and gloomy prediction for his own businesses – and the broader economy in general – the good times may be over.
Speaking at Berkshire’s annual general meeting in Omaha, Nebraska, the billionaire investor said he expects earnings at the majority of the conglomerate’s operations to fall this year as the coming economic downturn slows corporate activity further. He made his pessimistic comments even as Berkshire posted an almost 13% gain in operating earnings to $8.07 billion for the first quarter, up from $7.04 billion a year ago.
“The majority of our businesses will report lower earnings this year than last year,” Buffett, 92, said, before crowds of thousands at the event on Saturday according to Bloomberg. During the last six months or so, the “incredible period” for the US economy has been coming to an end, he said.
As Bloomberg notes Berkshire is often viewed as a proxy for economic health owing to the expansive nature of its businesses ranging from railroad to electric utilities and retail. Buffett himself has said Berkshire owes its success to the incredible growth of the US economy over the decades, but his prediction for a slowdown at his firms comes as upheaval at regional banks threatens to curtail lending as inflation and higher rates continue to bite.
Buffett’s long-time business partner Charlie Munger, 99, who joined him on stage, said the more-difficult economic environment will also make it harder for value investors, who typically buy stocks that look cheap compared to the intrinsic value of the businesses.
“Get used to making less,” Munger said.
Despite the broader pessimism, Buffett said he expects earnings at its insurance underwriting operations — which are less correlated to business activity — to improve this year. Berkshire already reported higher earnings at those businesses including auto-insurer Geico, which swung to profitability following six quarters of losses.
Geico posted $703 million in earnings as higher average premiums and lower advertising spending contributed to the gain even as claim frequencies fell, Berkshire said in a statement reporting its earnings Saturday. That revival follows a difficult period for the underwriting business as inflation took its toll on the cost of materials and labor.
Geico has been facing particular pressure from rivals including Progressive, which Buffett has called “well-run,” and Allstate which had long used telematics programs to track drivers and encourage better behavior before Geico introduced the offering. Geico’s profit also helped Berkshire’s insurance underwriting businesses deliver $911 million in profit compared with $167 million a year earlier.
Berkshire previously said it expected Geico to return to operating profitability in 2023, after securing premium rate increases. Still, Geico remains an issue for Berkshire, with top line growth in the quarter of less than 1% that “significantly lags peers,” CFRA analyst Cathy Seifert said.
“I suspect rate hikes being put through to offset claim cost inflation is being met with policy cancellations,” she said. “While the loss of unprofitable policies is not always a bad thing- that’s not usually the policies — and policyholders — that leave.”
Other parts of the conglomerate took a bigger hit, with after-tax earnings from Berkshire Hathaway Energy falling 46.3% from the same time last year amid “lower earnings from the US regulated utilities, other energy businesses and real estate brokerage businesses.” Railroad results were also weaker than expected due to a fall in freight volumes and higher operating expenses, according to Edward Jones analyst Jim Shanahan.
But at one of Berkshire’s best known businesses, Brooks Running Co., Chief Executive Officer Jim Weber was skeptical of a steep consumer downturn.
“With unemployment being so low, it’s hard to be believing we’re going to fall off a cliff into a recession at the consumer level,” Weber said in an interview on Friday ahead of the meeting. “I wonder if this is going to be an asset-value recession.”
Among other topics discussed on Saturday were Buffett’s succession, the banking crisis, the US debt ceiling crisis, the company’s investment in Occidental, Chna’s upcoming invasion of Taiwan and more:
- Succession planning: Buffett named Greg Abel, 60, as heir apparent in 2021, and the vice chair for non-insurance operations has had a more pronounced presence ever since. On Saturday, Buffett reaffirmed he was “100% comfortable” with the decision and even indicated a largely business-as-usual transition, for whenever that could be. “Greg understands capital allocation as well as I do. That’s lucky for us,” Buffett said at the meeting in Omaha, Nebraska. “He will make those decisions, I think, very much in the same framework as I would make them. We have laid out that framework now for 30 years.”
- Occidental control: One analyst called it the biggest announcement of the day: Berkshire won’t make an offer for full control of Occidental Petroleum Corp., the energy firm it has spent months boosting its wagers on. The comment by Buffett likely helped temper speculation that Berkshire is seeking to own Occidental after winning approval from US regulators last year to acquire as much as 50% of the firm. Buffett didn’t rule out buying more stock of the Houston-based firm, adding it may — or may not — seek further purchases.
- Banking Turmoil: Buffett and Munger were so sure they’d be questions about the recent banking turmoil that they jokily brought placards bearing the accounting classifications spotlighted during the upheaval. One was labeled “available for sale,” while the other read “held to maturity.” Striking a more serious note, Buffett faulted the executives in charge of the failed banks, arguing they should be held accountable for mistakes that were hiding in “plain sight.” He also called out “messed up” incentives in banking regulation, as well as poor messaging by regulators, politicians and the press to the American public about the upheaval. Buffett pointed to First Republic Bank, the insolvent bank which last weekend was acquired by JPMorgan after it collapsed after offering jumbo, non-government-backed mortgages at fixed rates that were interest-only for 10 years in some cases — which Buffett called “a crazy proposition.”… “It was doing it in plain sight and the world ignored it ‘til it blew up,” Buffett said.
- Debt Ceiling: As lawmakers race to resolve a standoff around the US debt ceiling, Buffett said he couldn’t see how Washington would allow the US to default on its debt, an outcome that would tip the financial system into turmoil. Investors and politicians are zeroing in on whether or not the US government can avoid crashing into its statutory debt ceiling and a potentially catastrophic technical default that could follow. Despite the impasse, Buffett reiterated his belief in America as an “incredible society” with “everything going for us.” Given the choice, he would still want to be born in the US, he said.
- Geopolitics, Taiwan: In Q4 Buffett slashed his holding of Taiwan Semi just months after disclosing a major stake in a quick reversal that spooked investors. Buffett said Saturday the company was one of the best managed and most important in the world, but that he didn’t like the location — a reference to Taiwan amid rising tensions between the island and China. Buffett and Munger emphasized the need for smooth relations between the US and China and urged increased trade. While the two will be competitive, they will always need to judge “how far you can push the other guy without them reacting wrong,” Buffett said.
Separately, Berkshire topped up its cash pile, ending the quarter with $130.6 billion, a $2 billion increase from the $128.6 billion at the end of the year. This means that Berkshire stands to make a bonanza from interest income as the Fed keeps hiking rates: “Our investment income is going to be a lot larger this year than last year, and that’s built in,” Buffett said at the annual meeting.
The company was also a net seller of equities for the second quarter in a row, pocketing $10.4 billion in net stock sales ($13.3 billion gross) after deducting purchases of $2.9 billion.
Finally, Berkshire bought back $4.4 billion of stock, an increase from the same period last year, as Bekrshire confronted turbulent markets that offered fewer of the blockbuster deals he’s renowned for. Berkshire has turned toward buybacks more often as valuations in public markets had made it more challenging for Buffett to identify promising acquisitions.