Commercial real estate and commercial banking will cause more trouble to the financial system.

November 4, 2008

Activity in the financial markets continues to contract:

Banks have reported $687 billion of credit losses and writedowns since the start of last year as the worst U.S. housing slump since the Great Depression battered credit markets.

JPMorgan Chase & Co., the largest U.S. bank by market value, will shut down a global proprietary trading desk and shed some of the unit’s employees as the firm braces for a recession, a person familiar with the matter said.

“It’s been a very difficult trading environment,” said Jeffery Harte, a financial analyst at Sandler O’Neill & Partners in Chicago. “In the wake of that, everyone on the street is probably reevaluating capital commitments in regards to trading operations.”

Credit Suisse Group AG, Switzerland’s second-biggest bank, lost 609 million francs ($523 million) from proprietary trading, the firm said Oct. 23. The money-losing trading books will be reduced “significantly,” the firm said. Deutsche Bank AG, Germany’s largest lender, said Oct. 30 it lost 386 million euros betting on equities for the firm’s account.

Swiss Reinsurance Co., the world’s second-biggest reinsurer, posted its first loss in almost six years and suspended a share buyback program after wrong-way bets on credit-default swaps.

The third-quarter loss was 304 million Swiss francs ($259 million) after net income of 1.47 billion francs a year earlier. Swiss Re booked 289 million francs of writedowns on CDS in the third quarter, bringing losses in the past year to 2.81 billion francs.

Today’s writedown is “only the tip of the iceberg,” said Fabrizio Croce, an analyst at Kepler Capital Markets in Zurich who has a “reduce” rating on the stock.

And the contraction in the commercial real estate market is only at its beginning stages. Commercial real estate is a business that is by definition highly leveraged, and there’s no reason to think that the losses here will be less severe than in auto loans, or credit cards. While CRE is not the same as subprime, the very lax lending standards caused errors here too:

New York City commercial real estate transactions plunged 61 percent in 2008 through October as the global credit crisis roiled lending and sidelined buyers.

About $17 billion of transactions have closed so far and the market is headed for its worst year since 2004, according to data from Real Capital Analytics Inc. of New York. Sellers have made 237 deals of $5 million or more, a four-year low in a market that posted a record $51 billion in sales in 2007.

“The banks are not lending, and most of them are saying we’re done for the year,” said Scott Latham, executive vice president for New York investment sales at Cushman & Wakefield Inc., the largest closely held commercial brokerage. “In all likelihood, you will see next to no transactions between now and the end of the year.”

The office market will likely get worse in 2009 and may not improve for at least another year, said Andrew Simon, a managing director for NAI Global, a network of 325 independent commercial property brokerages.

No Rosy Outlook

“I don’t think the first half of 2009 is going to be very rosy,” said Simon. “I believe you’re talking about a year from now before you see more movement toward normalcy.”

Buyers and sellers are looking for a bottom, he said. .

Vornado Realty Trust said today the credit crisis and the slowing economy may lower profit in future quarters, while reducing the volume of real estate sales and reducing property values.

“Our existing real estate portfolio may be affected by tenant bankruptcies, store closures, lower occupancy and effective rents,” which may cut net income, Vornado said. Circuit City Stores Inc., the electronics retailer that announced 155 store closings this week, leases 12 locations from Vornado and pays $8.1 million in annual rent, Vornado said in a regulatory filing.

Global commercial sales fell 57 percent this year through August, Real Capital said in an Oct. 9 report. In the third- quarter, they fell 64 percent from the same period a year ago, according to preliminary data from the company.

In the U.S., sales have declined 72 percent this year through October, the biggest drop since the firm’s recordkeeping began in 2001, Real Capital said. Starting in 2004, property investors, fueled by cheap and abundant debt, began an unprecedented run to $514 billion of U.S. deals in 2007, said Dan Fasulo, Real Capital’s director of market analysis.

“I think it will be a while before we get to that figure again,” Fasulo said. “We’re going to do less than half of that in 2008.”

Sales involving New York real estate investor Harry Macklowe accounted for more than two- fifths of New York’s year-to-date dollar figure through October.

Macklowe paid $6 billion last year for seven Midtown skyscrapers, primarily using short term debt. His lender, Deutsche Bank AG, took control of the towers in February and sold five of them for $2.83 billion. Macklowe also sold the General Motors Building and three other buildings for $3.97 billion to Mortimer Zuckerman’s Boston Properties Inc.

Second-quarter commercial and multifamily mortgage originations tumbled 63 percent in the second quarter from the same period a year earlier, according to the Mortgage Bankers Association in Washington.

Office property loans fell 65 percent, retail property loans fell 63 percent and industrial property loans slid 57 percent, the MBA said. Loans slated for the commercial mortgage- backed securities market declined 98 percent in the second quarter from a year earlier, the group said.

And Commercial real estate activity in New York seems to be especially hard hit:

Financing of deals by so-called portfolio lenders, companies like commercial banks and life insurers that originate loans and keep them on their books, was also down. Loans by banks fell 29 percent and 27 percent for insurers, the MBA said.

The few deals being made usually require sellers to either provide financing or allow buyers to take over their existing loans, said Howard Michaels, chairman of the New York-based Carlton Group LLC, a real estate investment banking firm, which arranged the recapitalization of the GM Building for Macklowe in 2004, and Chicago’s Sears Tower in 2007.

“Most people are waiting to see how 2009 shakes out. Until then, nobody’s putting any buildings on the market unless they have to,” he said. “I don’t think that anybody would voluntarily sell into this market right now.”

Two properties remain on the market five months after they went up for sale. They are Worldwide Plaza on Eighth Avenue, a 1.7 million square-foot tower, and 1540 Broadway in Times Square, the former Bertelsmann Building. The seller of both buildings: Harry Macklowe’s lender, Deutsche Bank.

Meanwhile Fed’s balance sheet continues to grow, as it adds commercial paper to its portfolio of stocks, CMBS, MBS, bonds, and others:

The Fed’s balance sheet may expand to $3 trillion by year’s end, reflecting growth of various liquidity measures supporting banking institutions, Dallas Fed chief Richard Fisher said. As of Oct. 29, the Fed’s balance sheet was $1.97 trillion.

Still, the U.S. faces “an epic challenge,” Fisher said. “We are navigating the mother of all financial storms.” A recovery in the U.S. economy “will take time,” Fisher said in response to an audience question. “I don’t see any economic growth in 2009. None.”

Labor Department figures are expected to show a drop of 200,000 jobs in October, according to a Bloomberg News survey of economists. A report showed Oct. 3 that payrolls fell by 159,000 in September, the biggest drop in five years. The unemployment rate held at 6.1 percent, up from 5 percent as recently as April.

Commercial paper rates are falling, for now, as the Fed’s intervention brings much needed temporary relief to the market:

Interest rates on U.S. commercial paper fell to the lowest in four today. Rates on the highest-ranked 30-day commercial paper fell 0.27 percentage point to 1.74 percent, the lowest since Sept. 22, 2004. Yields on 90-day paper fell 0.06 percentage point to a three-month low of 2.62 percent.

The Fed set the rate it’s willing to accept for 90-day commercial paper at 2.6 percent, down 0.01 percentage point, including a 1 percentage point unsecured credit surcharge. The 90-day secured asset-backed rate was set at 3.6 percent, according to Fed data compiled by Bloomberg. The rates are set under the Fed’s Commercial Paper Funding Facility and are available on CPFF.

The following companies are among those that have registered with the CPFF: American Express Co.; American International Group Inc.; Chrysler Financial Corp.; Ford Motor Credit Corp.; GMAC LLC; General Electric Co.; General Electric Capital Corp.; Harley-Davidson Inc.; Kookmin Bank; Korea Development Bank; Morgan Stanley; Prudential Financial Inc. and Torchmark Corp.

Australia reduced its main rate today, and Libor continues to retreat, although it’s still at phantastically high rates compared with where it was a short time ago:

Tocday  the Libor-OIS spread narrowed 13 basis points to 210 basis points today. That still compares with 87 basis points on Sept. 12, the last working day before Lehman Brothers Holdings Inc. collapsed.

Interbank rates have tumbled worldwide as central banks slashed borrowing costs and governments pledged as much as $3 trillion of emergency funds to kickstart lending.

Australian central bank Governor Glenn Stevens lowered the overnight cash rate target to 5.25 percent from 6 percent in Sydney today, adding to last month’s 1 percentage point reduction. Fifteen of 16 economists in a Bloomberg survey forecast a half-point cut and one expected a quarter-point drop.

The European Central Bank and Bank of England are forecast to cut rates when they meet on Nov. 6.

As bankers see ongoing deleveraging everywhere:

UBS agreed last month to a $59.2 billion aid package from the government and central bank that will split off risky assets. Switzerland’s largest bank is seeking to halt client redemptions, which amounted to 83.6 billion francs at its money-management units in the third quarter.

UBS plans to transfer as much as $60 billion of debt assets to a fund backed by the Swiss National Bank, leaving it with “essentially zero” risk related to U.S. subprime, Alt-A, prime, commercial real estate and mortgage-backed securities, as well as student loan-backed securities and reference-linked notes, CEO Marcel Rohner said last month.

Since the rescue plan was announced, there have been “encouraging signs” for net new money flows, UBS Chief Financial Officer John Cryan told reporters on a conference call today.

Even so, clients may keep removing funds for some time as part of a “general trend of deleveraging,” he said. “That manifests itself in clients effectively selling investments and withdrawing proceeds to pay down debt.”

“It’s too uncertain” to give a long-term profitability outlook for the bank, Cryan said in an interview. “I don’t think any bank can say what its cost of funds is because markets aren’t standalone yet. And in an economic downturn no one knows what the revenue is going to be.”

All the news clips are gathered from Bloomberg.

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One Response to “Commercial real estate and commercial banking will cause more trouble to the financial system.”

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