BBVA Reignites European Write-Down Fears

BBVA is Spain’s second biggest bank with activities also in the US, Latin America, Asia and China (15% stake in China Citic Bank).

Policy makers have long feared that European banks are failing to face up to their losses. BBVA‘s fourth-quarter results will hardly dispel those concerns. The Spanish banking group reported Wednesday that net income for the three months to December fell to just €31 million ($43.7 million), after taking an unexpected €1.4 billion of new provisions. This follows Societe Generale‘s surprise warning earlier this month that it faced €1.4 billion of fresh write-downs on its structured credit portfolios. As European banks kick off their 2009 reporting season, investors should brace themselves for further surprises. (…)

BBVA’s total nonperforming asset ratio may now be an eye-watering 4.3% — and 5.1% on its Spanish portfolios — but expected losses are now 57% covered by provisions. Meanwhile, BBVA’s capital position looks strong with a core Tier 1 capital ratio of 8%. The bank’s profitable emerging market operations, notably Mexico, provide strong capital generation. And BBVA’s focus on retail banking rather than risky trading activities makes it less vulnerable to new regulatory capital charges.

The higher provisions in the US were tied to commercial real estate loans.

That leaves BBVA still one of the most promising European banks, despite a 5% fall in the shares on the back of the results. A sustainable return on tangible equity of over 20% plus the potential to pay a generous dividend should support a share price in excess of the current twice tangible book value. But investors will now worry about other banks such as Barclays and Deutsche Bank whose balance sheet valuations have been regularly questioned. Policy makers did warn that investors were being too complacent.

Full WSJ article


An Insider’s View of the Real Estate Train Wreck

John Mauldin posted this interview with a successful  insider of the real estate industry. Please read this informative piece, especially if you are positive about housing and commercial real estate, and …banks. (My emphasis).

(…) Back in 2007, however, what most intrigued me about Andy was that he had been almost alone among his peer group in foreseeing the coming end of the real estate bubble, and in liquidating essentially all of his considerable portfolio of projects near the top. There are people that think they know what’s going on, and those who actually know – Andy very much belongs in the latter category.(…)

As you’ll read in the following excerpt from my latest interview with Andy, who now spends considerable time each day helping the nation’s biggest banks cope with growing stacks of problem loans, he remains deeply concerned about the outlook for real estate.

No one has been more right on the housing market in recent years. So, what’s coming next? Some of the housing numbers in the last few months look a little less ugly. Could housing be getting ready to get well?

MILLER: I don’t think so.

For all intents and purposes, the United States home mortgage market has been nationalized without anybody noticing. Last September, reportedly over 95% of all new loans for single-family homes in the U.S. were made with federal assistance, either through Fannie Mae and the implied guarantee, or Freddie Mac, or through the FHA.

If it’s true that most of the financing in the single-family home market is being facilitated by government guarantees, that should make everybody very, very concerned. If government support goes away, and it will go away, where will that leave the home market? It leaves you with a catastrophe, because private lenders for single-family homes are nervous. Lenders that are still lending are reverting to 75% to 80% loan to value. But that doesn’t help a homeowner whose property is worth less than the mortgage. So when the supply of government-facilitated loans dries up, it’s going to put the home market in a very, very bad place.

Why am I so certain that the federal government will have to cut back on its lending? Because most of the financing is done via the bond market, through Ginnie Mae or other government agencies. And the numbers are so big that eventually the bond market is going to gag on the government-sponsored paper.

The public doesn’t have any idea of the scale of the guarantees the government is taking on through Fannie, Freddie, and FHA. It’s huge. If people understood what the federal government has done and subjected the taxpayers to, there would be a public outrage. (…) The government can’t keep doing what it has been doing to support mortgage lending without pushing interest rates way up.

Refinancings of single-family homes are very interest-rate sensitive. Consumers have their backs against the wall. They have too much debt. Refinancing their maturing mortgages or their adjustable-rate mortgages is very problematic if rates go up, but that’s exactly where they’re headed. So anyone who’s comforted by current statistics on single-family homes should look beyond the data and into the dynamics of the market. What they’ll find is very alarming.

On that topic, recent data I saw was that something like 24% of the loans FHA backed in 2007 are now in default, and for those generated in 2008, 20% are in default, and the FHA is out of money.

MILLER: Fannie Mae had a $19 billion loss for the third quarter of 2009, and they are now drawing on their facility with the U.S. Treasury. We have all forgotten that Fannie and Freddie are still being operated under a federal conservatorship. On Christmas Eve, the agency announced that they were going to remove all the caps on the agencies.

So what about commercial real estate?

MILLER: When I saw what was happening in the housing market, I liquidated all my multifamily apartments, shopping centers, and office buildings. I liquidated all my loan portfolios, and I’m happy I did.

Then it occurred to me in 2005 and 2006 that the commercial world had to follow suit. Why? Because it’s a normal progression. Obviously, when single-family homes decline in value, multifamily apartments decline in value. And when consumers hit the wall with spending and debt, that’s going to have an impact on retailers that pay for commercial space.

Furthermore, the financing for retail properties had gotten ludicrous. The conduits were making loans that they advertised as 80% of property value when they originated them, but in reality the loan-to-value ratios were well over 100%. And I say that to you with absolute, categorical certainty, because I was a seller and nobody knew the value of the properties that I was selling better than I did. I had operated some of them for 20 years, so I knew exactly what they were bringing in. I knew what the operating expenses were, and I knew what the cap rates were. And, you know, the underwriting on the loan side and the purchasing side of these assets was completely insane. It was ludicrous. It did not reflect at all what the conduits thought they were doing. They were valuing the properties way too aggressively. (…)

Right now there are an awful lot of banks that do an awful lot of commercial real estate lending, and for about a year now you’ve been telling me that you saw the first and second quarter of 2010 as being particularly risky for commercial real estate. Why this year, and what do you see happening with these loans and the banks holding them?

MILLER: It’s an educated guess, and it hasn’t changed. I still think that it’s second quarter 2010.

The current volume of defaults is already alarming. And the volume of commercial real estate defaults is growing every month. That can only keep going for so long, and then you hit a breaking point, which I believe will come sometime in 2010. When you hit that breaking point, unless there’s some alternative in place, it’s going to be a very hideous picture for the bond market and the banking system.

The reason I say second quarter 2010 is a guess is that the Treasury Department, the Federal Reserve, and the FDIC can influence how fast the crisis unfolds. I think they can have an impact on the severity of the crisis as well – not making it less severe but making it more severe. I will get to that in a minute. But they can influence the speed with which it all unfolds, and I’ll give you an example.

In November, the FDIC circulated new guidelines for bank regulators to streamline and standardize the way banks are examined. One standout feature is that as long as a bank has evaluated the borrower and the asset behind a loan, if they are convinced the borrower can repay the loan, even if they go into a workout with the borrower, the bank does not have to reserve for the loan. The bank doesn’t have to take any hit against its capital, so if the collateral all of a sudden sinks to 50% of the loan balance, the bank still does not have to take any sort of write-down. That obviously allows banks to just sit on weak assets instead of liquidating them or trying to raise more capital.

That’s very significant. It means the FDIC and the Treasury Department have decided that rather than see 1,000 or 2,000 banks go under and then create another RTC to sift through all the bad assets, they’ll let the banking system warehouse the bad assets. Their plan is to leave the assets in place, and then, when the market changes, let the banks deal with them. Now, that’s horribly destructive.

Just to be clear on this, let’s say I own an apartment building and I’ve been making my payments, but I’m having trouble and the value of the property has fallen by half. I go to the bank and say, “Look, I’ve got a problem,” and the bank says,
“Okay, let’s work something out, and instead of you paying $10,000 a month, you pay us $5,000 a month and we’ll shake hands and smile.” Then, even though the property’s value has dropped, as long as we keep smiling and I’m still making payments, then the bank won’t have to reserve anything against the risk that I’ll give the building back and it will be worth a whole lot less than the mortgage.

MILLER: I think what you just described is accurate. And it’s exactly a Japanese-style solution. This is what Japan did in ’89 and ’90 because they didn’t want their banking system to implode, so they made it easier for their banks to sit on bad assets without owning up to the losses.

And what’s the result? Well, it leaves the status quo in place. The real problem with this is twofold. One is that it prolongs the problem – if a bank is allowed to sit on bad assets for three to five years, it’s not going to sell them.

Why is that bad? Well, the money tied up in the loans the bank is sitting on is idle. It is not being used for anything productive.

Wouldn’t banks know that ultimately the piper must be paid, and so they’d be trying to build cash – trying to build capital to deal with the problem when it comes home to roost?

MILLER: The more intelligent banks are doing exactly that, hoping they can weather the storm by building enough reserves, so when they do ultimately have to take the loss, it’s digestible. But in commercial real estate generally, the longer you delay realizing a loss, the more severe it’s going to be. I can tell you that because I’m out there servicing real estate all day long. Not facing the problems, and not writing down the values, and not allowing purchasers to come in and take these assets at discounted prices – all the foot-dragging allows the fundamental problem to get worse.

In the apartment business, people are under water, particularly if they got their loan through a conduit. When maintenance is required, a borrower with a property worth less than the loan is very reluctant to reach into his pocket. If you have a $10 million loan on a property now worth $5 million, you’re clearly not making any cash flow. So what do you do when you need new roofs? Are you going to dig into your pocket and spend $600,000 on roofing? Not likely. Why would you do that?

Or a borrower who is sitting on a suburban office property – he’s got two years left on the loan. He knows he has a loan-to-value problem. Well, a new tenant wants to lease from him, but it would cost $30 a square foot to put the tenant in. Is the borrower going to put the tenant in? I don’t think so. So the problems get bigger.

Why would the owner bother going through a workout with the bank if he knows he’s so deep underwater he’s below snorkel depth?

MILLER: It’s always in your interest to delay an inevitable default. For example, the minute you give the property back to the bank, you trigger a huge taxable gain. All of a sudden the forgiveness of debt on your loan becomes taxable income to you. Another reason is that many of these loans are either full recourse or part recourse. If you’re a borrower who’s guaranteed a loan, why would you want to hasten the call on your guarantee? You want to delay as long as possible because there’s always a little hope that values will turn around. So there is no reason to hurry into a default. None.

So that’s from the borrower’s standpoint. But wouldn’t the banks want to clear these loans off their balance sheets?

MILLER: No. The banks have a lot of incentive to delay the realization of the problem because if they liquidate the asset and the loss is realized, then they have to reserve the loss against their capital immediately. If they keep extending the loan under the rules present today, then they can delay a write-down and hope for better days. Remember, you suffer if the bank succumbs and turns around and liquidates that asset, then you really do have to take a write-down because then your capital is gone.

So here we are, we’ve got the federal government again, through its agencies and the FDIC, ready to support the commercial real estate market. They’ve taken one step, in allowing banks to use a very loose standard for loss reserves. What else can they do?

MILLER: Well, obviously nobody knows, but I can guess at what’s coming by extrapolating from what the federal government has already done. I believe that the Treasury and the Federal Reserve now see that commercial real estate is a huge problem.

I think they’re going to contrive something to help assist commercial real estate so that it doesn’t hurt the banks that lent on commercial real estate. It’ll resemble what they did with housing.

They created a nearly perfect political formula in dealing with housing, and they are going to follow that formula. The entire U.S. residential mortgage market has in effect been nationalized, but there wasn’t any act of Congress, no screaming and shouting, no headlines in the Wall Street Journal or the New York Times about “Should we nationalize the home loan market in America.” No. It happened right under our noses and with no hue and cry. That’s a template for what they could do with the commercial loan market.

And how can they do that? By using federal guarantees much in the way they used federal guarantees for the FHA. FHA issues Ginnie Mae securities, which are sold to the public. Those proceeds are used to make the loans.

But it won’t really be a solution. In fact, it will make the problems much more intense.

Don’t these properties have to be allowed to go to their intrinsic value before the market can start working again?

MILLER: Yes. Of course, very few people agree with that, because if you let it all go today, there would be enormous losses and a tremendous amount of pain. We’re going to have some really terrible, terrible years ahead of us because letting it all go is the only way to be done with the problem.

Do you think the U.S. will come out of this crisis? I mean, do you think the country, the institutions, the government, or the banking sector are going to look anything like they do today when this thing is over?

MILLER: I know this is going to make you laugh, but I’m actually an optimist about this. I’m not optimistic about the short run, and I’m not optimistic about the severity of the problem, but I’m totally optimistic as it relates to the United States of America.

This is a very resilient place. We have very resilient people. There is nothing like the American spirit. There is nothing like American ingenuity anywhere on Planet Earth, and while I certainly believe that we are headed for a catastrophe and a crisis, I also believe that ultimately we are going to come out better.

John Mauldin can be reached at


U.S. Strip mall vacancy hits 18-year high

Vacancies at U.S. strip malls hit an 18-year high in the fourth quarter and the vacancy rate for large regional malls reached the highest in at least 10 years, according to real estate research firm Reis Inc.

Strip malls had a vacancy rate of 10.6 percent in the fourth quarter, surpassing the high set in 1991.(…)

Reis said that continuing high unemployment and inconsistent consumer spending will weigh heavily on retail properties for at least another 18 to 24 months.

It expects the vacancy rate at neighborhood and community centers to keep rising, and rents to continue falling through 2011.(…)

Asking rent at U.S. strip malls fell 0.5 percent from the third quarter to $19.12 per square foot in the fourth quarter, or down 2.05 percent for the year. Factoring in months of free rent and the landlord’s portion of the cost for interiors, effective rent fell 0.8 percent to $16.75 per square foot, wiping out rent gains over the past nearly four years.

For the first time in Reis’ 29 years of tracking the fundamentals of strip malls, effective rent in all of the 77 markets it covers declined.(…)

The vacancy rate at large regional malls rose to 8.8 percent from 8.6 percent the third quarter. It was the highest vacancy rate for U.S. malls since Reis began tracking mall performance. Asking rent fell 0.4 percent to $39.03 per square foot, the lowest since the second quarter 2006.(…)

Full Reuters article



Private-equity groups are becoming active in the commercial real estate market, the WSJ reports today.

(…) Both Blackstone and the partnership of CIM and Mr. Macklowe are using a strategy that is expected to become increasingly popular this year: going after distressed commercial-property assets by buying debt or paying off creditors at a steep discount.(…)

The deals come as pressure builds in the commercial real-estate market with landlords struggling with rising vacancies, falling rents and heavy debt loads. According to Real Capital Analytics, a New York real-estate research firm, more than $160 billion of commercial properties in the U.S. are now in default, foreclosure or bankruptcy.

During most of 2009, opportunistic investors accumulated cash to go after distressed assets but there was very little deal activity primarily because lenders were unwilling to unload debt at distressed prices. But this year, more lenders are expected to take hits as the financing drought continues and rents and occupancy rates keep falling.

The amount of debt available for sale is skyrocketing. Many banks remain reluctant to sell at prices investors are demanding. But the government and servicers responsible for handling defaulted commercial mortgages that were packaged into bonds, known as commercial mortgage-backed securities, or CMBS, are emerging as big sellers.

Currently, the Federal Deposit Insurance Corp. has about $30 billion in real-estate debt that had been held by the scores of banks that have failed since the economic downturn, according to the agency. CMBS servicers also are emerging as sellers because, unlike banks, they have limited flexibility to extend or restructure troubled loans. (…)

“This is the first inning in a nine-inning game,” said Keith Barket, head of the real-estate business at Angelo, Gordon & Co., a New York-based private-equity firm specializing in distressed investments. (…)

See also D.C. Deal Flashes Foreign Capital


UK commercial property recovery to hold up

The recovery in the UK commercial property market is expected to be sustained into 2010, according to leading forecasters, in spite of the unexpected strong bounce in the sector that caught out many investors this year.

UK commercial property values rose 2.4 per cent in November, the largest monthly growth in 15 years, according to the IPD index. Capital growth in the year to date was -8.4 per cent, but total returns stood at -1.4 per cent and were heading for a positive finish to the year. This bounce in values would have been unthinkable just six months earlier in a sector that was reeling from the sharpest falls on record.(…)

However, while few expect prices to rise at the same pace, many predict that next year will be positive for returns from property. The consensus view is broadly that capital values will plateau, with total returns settling at 6 to 10 per cent for the next two years. There is a range of other opinion, however.(…)

Full FT article



(…)  Property values in the U.K. are down 8.4% since January, according to IPD, the London-based property-research group. But since August, U.K. commercial-property values have risen 5.4%. (…) There is still a lot of money chasing very few property assets—a big support for property pricing this year, especially in the U.K.(…)

Some analysts say that the demand for space from the financial industry, the anchor for London offices, is on the rise. But actual leasings fell 30% in Europe this year, according to CBRE. And while there are some signs that rent is rising or at least stable in some central London buildings, David Hutchings, head of European research at Cushman & Wakefield, predicts that rent levels across Europe will fall 5% to 10% in the first half of next year.(…)

The main buyers in the market are German open-ended funds, sovereign-wealth funds and institutional investors. What these investors have in common is that they have been willing to do deals with little or no debt. Debt financing remains hard to get.(…)

The strongest recovery in commercial-property markets was seen in the U.K., particularly in London markets with high-quality buildings or shopping centers with solid tenants, long leases and no need for additional capital to make improvements. Yields on these properties have declined to 6.5% in the second quarter of 2009 from 6.75% in the fourth quarter of 2008, according to Jones Lang LaSalle, a sign of rising prices.(…)

“We have an investment market that is bottoming out and an occupational market that is still struggling,” says Paul Guest, head of European research at Jones Lang LaSalle in London. “At best, it’s going to be a bumpy year.”

Full WSJ article



Good FT article on CRE. Much like in residential housing (see US HOUSING: ECONOMIC MAGIC OR ILLUSION?) , banks are sweeping the problems under the carpet in the hope that time will bal them out. But the carpet hump just keeps  growing.

(…) The scale of lending across the world – with an estimated £3,000bn ($4,940bn, €3,300bn) of property debt outstanding in the US and Europe (…)

HSBC estimates that 85 per cent of UK loans made in the past five years are in breach of lending agreements. But banks are ignoring such problems. (…)

“Let me not pretend that it is not something that we are looking at closely. It represents a risk. We recognise that loans with LTVs of over 100 per cent will not be refinanced,” says Andrew Haldane, director for financial stability at the Bank of England. “The hope would be that new sources of finance will come to the market before the refinancing dates.”(…)

“Banks may overlook a breach of loan-to-values but they will take action if the interest is not paid. Loans then become impaired and banks will have to account for [them] in a different manner. ”(…)

About $1,600bn of commercial mortgage debt is estimated to mature in the next five years in the US and a further €366bn in Europe. This represents a massive equity call on the property sector.(…)

Those in the group estimate that £100bn could be needed to recapitalise the UK property sector, taking it to a sustainable LTV ratio, which means the industry could be in negative equity until 2017. (…)

Refinancing has not been more of a problem before because banks have been able to roll loans over, even when in breach. In fact, banks can make good money in bad times by boosting margins and fees. (…)

imageAnd yet, Goldman Sachs’ Financial Stress Index is at its lowest level since 1990. !!!

Related posts:



David Rosenberg today reports on a Moody’s release on CRE prices which shows that CRE prices continue to decline. Unfortunately, David does not mention that Moody’s index is appraisal based and thus not an exact reflection of the reality. Below, I add the MIT CRE index which is a transaction-based CRE index. Much like the Case-Shiller house price index, the TBI is a better gauge of what is happening in the real world. Given David’s bearishness, some may think that the positive slant of the MIT index was not as newsworthy as Moody’s. I prefer to think that the MIT release was simply missed by his staff.

Moody’s real estate commercial price index fell 3.9% MoM in September and down 37% on a year-on-year basis. The peak-to-trough slide is now 43%, which is worse than the 35% slide we saw in home values, and down to their lowest level in seven years.

Monthly National All Properties Index

In the coming months, Moody’s expects values to fall by as much as 55% from the peak before rebounding.

After hitting bottom, property values are expected to bounce back, but not as high as 2007 levels. More likely, the values will settle at 30% to 40% below the market high as the economy rights itself and investors reenter the marketplace.

Cash flows for commercial real estate of all property types have been depressed by about 10% from their high point in early 2008. Cash flows will continue to decline over the next several quarters (see chart), Moody’s analysts project.

Full NRE Investor article

However, the above NPI index is an appraisal-based index based on appraisal estimates rather than actual prices of actual transactions. MIT has developed a TBI index for CRE which, much like the Case-Shiller house price index, tracks actual transacted price changes of the same properties within the database.

The MIT TBI price index shows

4.4% increase in prices compared to the previous quarter for properties sold from the NCREIF database, placing the price index 36.5% below its 2007Q2 peak. The demand-side index rose by 11.8% (second highest in index history), to 41.9% below its 2007Q2 peak. The supply-side of the market recorded a continued modest drop of of -2.5%, taking that index to 31.8% below its 1Q08 peak.

Click to view chart

Click Image to Close

Full MIT press release