It’s easy to do, especially in today’s world of electronic wonders whereby one either has the choice to electronically whiz right past advertising media’s best and brightest creative offerings of the moment, or simply revert to the old school mental technique of “tuning them out”. You remember the catch line or the musical jingle, but you just can’t seem to remember exactly who was advertising exactly what – you know how this goes. In our world of 24/7 media and information barrage, it’s easy to do the same in investment decision making. To the point, do you tune out news and information regarding real estate these days? After all, you’ve been bombarded with residential and commercial RE “information” for years now. There’s a real tendency with repetitive information flow to lose the significance of immediacy, so to speak.
Anyway, it’s time for a very quick check in on some commercial real estate highlights. Important why? Because it just so happens that 2011 will see the largest magnitude of US bank commercial real estate mortgage maturities on record. And this is before 2012, which should be a top tick record setter for bank CRE maturities looking both backward and forward over the half decade ahead at least. Will this be an issue for an industry that has been supporting reported earnings growth in part by reduced loan loss reserves over the recent past? We’ll see. It’s the magnitude of the numbers that tells us it’s probably a good idea not to tune out the commercials ahead.
We know the banks will be sitting on impaired residential real estate assets for years to come. Probably the same will play out with commercial real estate, but CRE reality in the year and years ahead is pictured in the chart below. In 2010, approximately $250 billion in commercial real estate mortgage maturities occurred. In the next three years we have four times that much paper coming due. The result of extend and pretend. Extension time is up, so also is the pretending time? Question for the big dogs in the financial sector this year - can the banks and greater financial sector show continued improved reported earnings as has been the case in the recovery to date with this wall of maturities dead ahead? Moreover, we know full well that the US government has become the de facto key provocateur of the extension of the multi-decade US credit cycle in the current environment as the private sector, necessarily and importantly inclusive of the financial sector, retrenches. This cannot and will not continue indefinitely. Point being, will CRE woes, published or unpublished, further restrain private sector credit creation ahead via the commercial banking conduit?
You know and we know that one of the keys to improved reported bank earnings in the current cycle, and especially over the last year, has been a meaningful reduction in loan loss reserves. Is it the calm before another quiet storm created by CRE loans in the years to come? We’ll find out, but we know vacancy rates remain high for now and we know values have not recovered. LTV ratios have to be incredibly tight (or beyond) for many a bank CRE loan. As mentioned, we crescendo in terms of CRE loan maturities between now and 2013 as is seen below. And as the bottom clip of the above chart shows us the US banking system proper has the bulk of exposure.
Below is a look at the rate of sequential growth in CRE loan delinquencies (middle clip). Bank stocks usually respond bullishly to a quarterly decline in the delinquency growth rate for loans as per total cycle movement. This is what history has to teach us. So looking ahead and knowing the wall of CRE loan maturities to come is very large, is the drop in delinquency growth temporary? We'll find out. Probably the more germane question is whether the regulators will force the large banks to show any increase in loan impairment. Again, given the incredible political clout of the financial sector, I doubt it. But it's an issue to be aware of and monitor, as this could put at least a temporary dent in the macro corporate earnings expansion story given that the reported financial sector operating earnings recovery has been a very big piece macro S&P earnings growth story.
Enough as I know you get the point. We know the very significant central bank liquidity will continue at least through June of next year. For the ECB we may just be getting warmed up. At least as per the rhythm of Fed liquidity injections and equity market direction, liquidity has been the key driver of equity market outcomes since March of 2009. But a key perceptual support to higher prices engendered by this liquidity has been theoretically ever more attractive equity valuations as reported corporate earnings have continued to expand, supporting those valuations. For one of the most restrained and fragile macro US economic recoveries on record, we have experienced one of the most robust corporate profit recoveries on record over the last half century. We know reported financial sector earnings are questionable at best, but the regulators will do absolutely nothing to change that.
Final comment as the story is really told graphically. I continue to believe a small business recovery is crucial to domestic macro economic health. To be honest, a small business recovery may also be integrally important to commercial real estate. Remember, the small business community has been the domestic economy jobs creator historically. The reason we do not have a domestic jobs recovery is that small business optimism just registered its 36th straight month of a recessionary reading (their words, not mine). A jobs recovery = square footage demand in the world of CRE. So in one sense, is it a small business recovery that would indeed help bank solvency issues via helping to heal CRE? The linkage appears clear. Unfortunately everything the US has done to heal the economy over the last three years has been focused completely on the financial sector.
So once again we find ourselves in a period of Fed sponsored asset appreciation. The thought, of course, being that if stock prices levitate so will consumer confidence. Which, according to Mr. Bernanke will lead to increased spending and a virtuous circle of economic growth. Oh really? The final chart below tells us consumer confidence is not driven by higher stock prices, but by job growth.
To be honest, as we’re now in the third year of a Presidential cycle, I think it’s time for some new campaign slogans. How about, “It’s the real economy, stupid. Not the financial economy that attempts to play one on TV”. Somehow, this probably is not going to make it onto anyone’s teleprompter any time soon.
