Commentaries

from Rolfe Winkler:

The CRE disaster

Earlier this week, I was surprised when I read that Moody's put the decline in commercial real estate at 16% over the last TWO MONTHS.  That's a stunning rate of decline that has very negative consequences for banks who are still carrying commercial whole loans on their balance sheet at close to 100¢ on the dollar.

(Click chart to enlarge in new window)

Peak to trough the declines are similar:  Residential is down 33% from its July '06 peak while commercial is down 35% from its October '07 peak.

But note the stunning rate of decline of late for commercial.  28% since September.  Residential is off half as much over that time.

To be sure, comparing these two indices isn't totally fair.  As Dan Alpert of Westwood Capital pointed out to me, there are millions of transactions that go into Robert Shiller's residential index.  It's very granular.  On the CRE side there have been very few actual sales that indicate recent pricing.  So you have to read Moody's/REAL with a grain of salt.

Directionally, however, the index is correct.  Commercial is collapsing very quickly, even as residential looks to be forming a (temporary?) bottom.

What are the implications?  Consider the $1-$1.5 trillion in commercial mortgages being held as whole loans at commercial and savings banks in the U.S.**  Because whole loans are "held to maturity," they are typically carried at full value until the borrower actually defaults.  Never mind that the underlying collateral is now worth far less than the mortgage.

The final straw with Citi

 ”We have and will continue to exit several forms of proprietary risk-taking. Where we continue to take principal risk, we will only do so when we have proven teams and a clear source of advantage.” – Citigroup CEO Vikram Pandit on January 16, 2009.      Don’t be fooled by Vikram Pandit’s playing the part of a prudent banker.

Instead of scaling back risky hedge fund-style trading, Citi is doing just the opposite. And that raises big questions about why the federal government continues to bail out this basket case of a bank, and why Pandit is allowed to remain at Citi’s helm.

Here’s the scoop on this latest bailout outrage: Citi is planning to commit at least an additional $1 billion in capital to a team of stock-focused proprietary traders, say people with knowledge of these strategies — a move seemingly at odds with Pandit’s earlier vow. 

These traders buy, sell and short a wide variety of stocks, including telecom, technology, healthcare and consumer financials. And the profits and losses on those trades all go straight to Citi’s bottom line. 

In all, I’m told that this team of nearly three dozen prop traders and analysts at Citigroup Principal Strategies will get to play with some $2 billion of house money. 

That’s roughly the same sum of Citi capital the group had under its belt before Lehman Brothers melted down last September. Citi sharply scaled back the operation soon afterward. 

By the end of 2008, the Citi Principal Strategies trading group’s committed capital had dwindled to under $800 million. But that was when Citi was fighting for its very survival. Now it appears Pandit has no qualms about ramping up the bank’s prop trading group after getting $350 billion in capital infusions and asset guarantees from U.S. taxpayers. 

from Rolfe Winkler:

Lunchtime Links 7-23

A gap in the output gap (Alphaville)  Tracy Alloway notes a key problem of basing monetary/fiscal policy on the idea that there's "slack" in the economy.  Just because GDP reached a certain high thanks to credit-fueled over-consumption doesn't mean that we can spend and print with impunity until we get back to that level.

usdebtclock.org Brilliant.

Ford posts $2.3 billion profit (WSJ)  One-time items helped a lot.  "Ford Motor Co. returned to profitability in its second-quarter and slowed its cash burn amid speculation that it may issue more equity to reduce its debt."

Wall St. jacks up pay after bailouts (WaPo)  Banker bonuses are on track to beat those received during the height of the bubble.

Mayors, Rabbis arrested in NJ corruption probe (Reuters)

Existing Home Sales Anaylzed, Part 1 and Part 2 (CalculatedRisk)  Nobody in the blogosphere analyzes home sales data better than CR.  Don't think the slight fall in inventories is necessarily positive.  Lots of bank-owned properties are being kept off the market.  And plenty of folks who want to sell are waiting for a better market.  Inventories are going to remain elevated for some time.

Icahn on retention bonuses (Icahn report)  Retention bonuses are "another word for extortion" and Icahn knows all about extortion!

Stock market bulldozes the bears

Yowza is the word that comes to mind when looking at the major stock gauges. The DJIA has burst through 9,000 and the S&P 500, up 2.2%, at 975. Reuters is chalking it up to strong second quarter earnings and a pop in existing home sales. The pace of the rally in recent weeks, however, is starting to send signals that this may be overdone.

David Rosenberg, chief economist over at Gluskin Sheff, notes that that the pop so far in the second quarter is pricing in unrealistic economic growth.

The S&P 500 surged 15% in the second quarter and what we did was go back in the history books to see what happens to the economy the very next quarter typically after such a big bounce and the answer is … just over 3% real GDP growth. So consider that de facto what is being discounted at this time for current quarter growth — it better be a humdinger of an inventory build. Now, for the market to build on such a rapid advance in the current quarter, history again suggests that we would need to see 5½% real GDP growth, which we give near-zero odds of occurring.

The Big Picture points out, that in the Nasdaq at any rate, the gains are also being driven by very few stocks.

In the Nasdaq-100 index, for example, one stock, Apple, accounts for nearly one-fifth of the 11-percent gain. It has also pulled much more than its already hefty weight in the index. Otherwise, just nine stocks are responsible for more than half the move in the technology-laden bellwether.

While that doesn’t mean the rally can’t carry on, it’s another reason to be cautious on reading too much into the advance we’ve seen so far.

from Rolfe Winkler:

Bair on ending “too-big-to-fail”

FDIC Chairwoman Sheila Bair is right now testifying in front of the Senate Banking Committee on "establishing a framework for systemic risk regulation."  This is of course hugely important.  How do we end "too-big-to-fail?"  And how do we resolve failures that are so big they pose a systemic risk?

There's so much valuable stuff in this testimony, readers should really see all of it.  To help you get through all 30 pages, I've highlighted key passages and provided commentary (in pink italics...I didn't choose pink, btw, Scribd just read my formatting that way!).

Bair clearly knows what's wrong with the system, and she articulates it more clearly than any other policymaker in Washington.  She really does want to put the screws to big banks in order to end too-big-to-fail.  She would do so by establishing a Financial Services Oversight Council to, among other things "actively control" leverage. She would also beef up resolution authority so policymakers could wind down bloated behemoths like Citi.

Right now they can't resolve anything.  Regulators' choice is between bankruptcy and taxpayer-funded life support.  Bankruptcies don't work with systemically important institutions.  This we learned from Lehman.  Taxpayer subsidies only allow failed companies to keep operating on the public dime.  Neither is desirable.

My chief worry in what she's proposing is that whoever ends up becoming the systemic risk regulator may not have the same cojones she does.  Who's to say they will actually put the screws to the firms being regulated?

If they don't, its sheer presence may backfire, especially if--as she proposes--there's an "insurance fund" backing its resolution authority.  Private market players will then misinterpret the systemic risk regulator as an implicit government guarantee that protects them from risk.  Exhibit A is OFHEO with Fannie and Freddie.  Exhibit B is FDIC itself and its Deposit Insurance Fund.  Investors and/or depositors in these federally-backed institutions take MORE risk that creates BIGGER systemic problems than if there was a credible possibility they'd eat their own losses.

All of this would be much easier if the Fed just exercised its authority over bank reserve requirements.  Requiring banks to hold significantly more capital in reserve, and preventing them from hiding risk off their balance sheets, would solve just about every problem we face.

Rejected CMBS looks stressed out

More on the CMBS deal rejected by the Fed under its TALF program:

The deal has above-average stress points when compared with those that were accepted. According to Bank of America’s breakdown, 90-day plus delinquencies, for example, were at 3.2% compared with the 1.27% average of those accepted. The highest delinquency rate of those accepted, however, was 4.41%.

Looking at the underlying collateral is where the fun really starts.

At the time the deal was put together in March 2007, Moody’s Investors Service noted that 79% of the loans in the pool backing this class and others had loan-to-value ratios over 100%. Talk about easy lending! Additionally, 78% of the loans pay only interest for the entirety of the loan, leaving a big balloon payment at the end.

The loans, 229 in all, were originated in the previous 12 months, so essentially at the peak of crazy lending standards.

The face value of the bond is $688.9 million, so I’m guessing its market value is much, much less since the total loan applications were only for $669 million. Sure there’s the Fed’s haircut, but still.

On the Fed haircuts:

Wiedeking Porsche exit paves way for VW

Porsche’s chief executive Wendelin Wiedeking may have been persuaded to leave in order to ease a merger with Volkswagen, but there are still major hurdles to overcome before the sports car maker finally emerges from the pits.

Wiedeking is paying the price for his disastrous plan to take over the far larger carmaker, which left Porsche with a majority stake in VW but saddled with debts of 10 billion euros ($14 billion). His departure marks a crucial turning point in a bitter power struggle between VW Chairman Ferdinand Piech and his cousin Wolfgang Porsche, chairman of the family firm.

    Wiedeking’s exit ultimately paves the way for Piech to install his own lieutenant to run the sports car maker instead of Wolfgang Porsche’s golden boy Wiedeking, who brought it back from the brink of bankruptcy in 1992.

    But before that happens, the two companies still need to agree on a structure which will allow them to make Porsche’s sports car unit VW’s 10th brand. A merger between the two companies rather than VW buying the Porsche sports car brand from the Porsche family holding company is being touted as the way forward. But although the various parts are gradually being assembled, a deal could still be some way off.

    As to be expected in this family feud, mixed messages from the Porsche and VW camps continue. The precise role of Qatar is still unclear, some insiders are insisting Porsche can go it alone with a financial boost from Qatar, while VW executives are confidently predicting  that Porsche will be absorbed into the larger company.

    Lower Saxony premier Christian Wulff says the German state will retain its 20 percent stake in VW, with Qatar to take a 17 percent stake — this would roughly fit with the Qataris taking Porsche’s VW options off its hands. But the crucial question of how much the Porsche and Piech families would own of a combined VW/Porsche has yet to be nailed down.

    VW Chief Executive Martin Winterkorn — Piech’s loyal lieutenant — says a decision on Qatar taking a stake will be taken on August 13 by the VW supervisory board. Presumably the Qataris will want a better idea by then of who they will be sharing the company with.

GM dumps Chinese in Opel race, standoff looms

Two things Opel junkies need to know in today’s news.

1) General Motors has dumped Chinese state-owned carmaker BAIC’s long-shot bid to take over GM’s main European arm. That leaves a two-horse race between Canadian-Austrian car parts maker Magna and Belgium-based financial investor RHJ, loosely associated with U.S. private equity firm Ripplewood.

2) The two trustees appointed by the German authorities to a board overseeing Opel in its transition to new ownership are refusing to toe Berlin’s line that Magna’s bid is the only game in town (according to an intriguing Reuters sources story).

This strengthens the prospect of a deadlock between Detroit and Berlin, which in theory would be arbitrated by the five-member Opel Treuhand (trustee) board. The panel comprises two GM appointees, one nominee of the German federal government, one representative of the four German states which have Opel plants on their territory, and a chairman — the president of the American Chambers of Commerce in Germany – who does not have a casting vote.

Chancellor Angela Merkel made crystal clear on Wednesday, before GM and German officials had held their first talks on the final offers, that the German authorities (both her national ”grand coalition” and all four regions) are backing the Magna solution, which she called “sustainable in all respects”.  The Opel workforce and the  co-governing Social Democrats strongly back Magna because it proposes fewer job losses and no plant closures, whereas RHJ would mothball the politically symbolic Eisenach factory in eastern Germany. 

Yet according to Reuters sources, both German trustees are defying their masters (and mistress). The Berlin government’s man is said to favour the offer by RHJ, which would downsize Opel and give GM a chance to buy back control in a few years. The regions’ representative is said to be leaning towards a managed insolvency, under which Opel would go into administration and viable bits would be auctioned off.

If positions do not change, the trustees ought logically to back GM and vote for RHJ. That would leave German authorities with a straight choice between agreeing, however reluctantly, to give state credit guarantees to RHJ, or refusing, at the risk of plunging Opel into insolvency. 

Credit Suisse pulls ahead of UBS

UBS has always looked down its nose at its cross-town rival, but Credit Suisse under Brady Dougan has turned the tables on the blue-bloods. As UBS remains mired in a potentially catastrophic legal tussle with America’s tax collectors, CS is winning market share across the board.

With its second quarter results, Dougan has shown that the storming first quarter was no flash-in-the pan. Stripping out various one-offs (including a counter-intuitive 1.1 billion Swiss franc loss thanks to an improvement in the value of its own debt), Credit Suisse’s net income increased 62 percent on the first quarter, to 2.5 billion Swiss francs. That is equivalent to a boom-like 27 percent-plus return on equity.

Dougan can point to some long-term strengths underpinning this result. The bank has increased its tier 1 capital ratio to a market-leading15.5 percent. And it has managed to attract funds to the private bank, despite the collateral damage inflicted on all Swiss banks by UBS.

As Dougan puts it euphemistically, “We have continued to prepare our Wealth Management business for the new environment by expanding our international footprint and building an efficient, global platform that complies with applicable laws and regulations.” In other words, CS is not going to repeat UBS’s mistakes, and is going to diversify away from an America whose sympathy for Swiss bank secrecy is disappearing fast.

However, despite Dougan’s talk of an integrated bank, CS’s results are dominated by the investment bank.  Asset management has only just turned a profit. Clients are continuing to withdraw their money, and at a faster rate than in the first quarter. Moreover, respectable results from private banking were helped by investment banking revenue booked from clients of the private bank. While this arguably shows the success of the “integrated bank” strategy, it masked a fall in recurring margins over the quarter.

So, investment banking dominates CS’s results even more than ever,  accounting for some 70 percent of net revenues, compared to less than 60 percent in 2005 . The bank has grabbed  share in equities, fixed income and some areas of investment banking. Dougan seems to think that CS is well-positioned whatever happens. If markets remain buoyant, CS will continue to grow share; if things turn down, there will be a flight to its well-capitalised quality.

However, the crisis is still fresh in the memory. Much of today’s investment banking profits across the industry result from a huge implicit subsidy via low central bank rates. Dougan will have to continue to engage in “close dialog with regulators around the world” if he wants to protect the bank from a taxpayer backlash.

The CMBS, re-Remic muddle

FT’s Alphaville has a great post on re-Remics and the push to make them respectable, at least in the eyes of the Federal Reserve and its TALF program.

If the Fed were to accept repackaged CMBS in its TALF program, it would go a long way in feeding the securitization machine that Wall Street banks are eager to jump start. But is that a good thing? The re-Remics are essentially repacking problem CMBS bond deals so they can create a “bullet-proof” AAA slice for investors who don’t want to have to worry about downgrades. If you’re thinking you’ve seen this movie before, you’re not alone.

There’s also the little problem of finding investors who want to take the riskier, or junior, tranches that are created by the re-REMIC. Like a CDO, the risk doesn’t go away, it’s just shifted around.

Re-Remics started popping up last month after S&P warned it would downgrade a huge swath of CMBS bond deals.  Wall Street responded by slicing and dicing the AAA portion to create a top slice within the top slice,  a super, super-duper portion if you will.

This is all coming at a time when the Fed’s TALF program is still trying to find investors who want to participate. Last week, loan applications using legacy CMBS as collateral didn’t even break the $1 billion mark, and even then, not all the collateral was accepted.

The Fed said late Wednesday that it rejected one bond, CUSIP # 46630JAK5, for one of two reasons: it didn’t qualify under the programs terms, or it didn’t pass the bank’s stress test.

The S&P snafu this week has muddied the waters even more, with some CMBS deals qualifying for TALF one day, not the next, and then qualifying again a week later.