Are Commercial Mortgage-Backed Securities About To Crumble?

On the ground feedback tells people on a personal level that commercial real estate is in a period of immense stagnation. From deserted strip malls and unoccupied mall stores, to the fall of Sears and K-Mart, commercial real estate has hit a wall, as brick and mortar shops decline in line American aggregate demand.

As Jim Quinn explicates, in Extend & Pretend Coming To An End, the central banker’s manufactured flood of easy money into the market from 2005 until the start of the financial crisis in 2008. Most know that the crash was due to bank’s overexposure to disproportionately irresponsible home loans hedged by investment banks. But the rush of liquidity to mall developers and retail companies looking that have been reaping massive profits for the past few years while their commercial property prices have plunged since the financial crisis. If the economy had been on the path to recovery, the loan extensions made post-crisis would be been fine and in line with returning American demand. But they are the same types of loans that got us into the whole MBS mess in the first place; with nonexistent regulation and given without a fair value assessment on property values (down a whopping 42% since its peak before the Great Recession). And while companies are lining  their pockets with profits, they do not have the equity to pay down those trillions of dollars of commercial loans.

Quinn rightfully calls our attention to the extend & pretend tactics that are keeping commercial and industrial loans north of $1 trillion even after 2008. This push against downward pressure is singularly caused by banks allowance of loans not backed by any property values and banks’ willingness to use accounting voodoo to keep their balance sheets propped up. But the sore fact of the matter is, just like the U.S. housing market, is that the problem is at least a magnitude higher than what the banks are letting on. And the bank’s blind eye conflates the problem as they pretend property values are still high, and extend loans that should never be given, all to keep banker’s bonuses in tact, while institutionalizing moral hazard, a seething risk now priced in to all aspects of the world’s financial system. Quinn points out that the normal commercial real estate loans have a normal maturity 5 to 7 years. So the escalating loans handed out from 2005 to 2008 will start to mature in 2012 and onward.

Quinn quotes an article from the Urban Land Institute:

Ann Hambly, who previously ran the commercial servicing departments at Prudential, Bank of New York, Nomura, and Bank of America said a wave of defaults is coming in commercial mortgage–backed securities (CMBS). And Carl Steck, a principal in MountainSeed Appraisal Management, an Atlanta-based firm that deals in the commercial real estate space, said property values are still falling.

Noting that CMBS investors booked $6 billion in real losses in 2011 and have already taken on $2 billion more in losses so far this year, Hambly told reporters in a private briefing that “it’s going to take a miracle” for many borrowers to refinance their deals when they come due between now and 2017.

Carl Steck said that lenders who are taking over the portfolios of failed institutions are finding that the values of the loans “are coming in a lot lower than they ever thought they would.” And as a result, he thinks a “fire sale” of commercial loans is just over the horizon.

The numbers for the commercial real estate landscape are horrifying;

Office vacancies remain at 17.3%, close to 20 year highs, as 12.3 million square feet of new space came to market in 2011. Vacancies are higher today than they were at the end of the recession in December 2009. The recovery in cash flow has failed to materialize for commercial developers. Strip mall vacancies at 11% remain stuck at 20 year highs. Regional mall vacancies at 9.2% linger near all-time highs. Vacancies remain elevated, with no sign of decreasing. Despite these figures, an additional 4.9 million square feet of new retail space was opened in 2011.

Just like the robo-signing and foreclosure fraud systemic of the U.S. real estate market, so too do banker and mortgage servicer’s morally bankrupt practices extend to the commercial real estate market. Quinn highlights a Harbinger Analytics Group report about fraud for land title underwriting of commercial real estate financing and hits on the coming effects of the crumbling of commercial real estate:

This fraud is accomplished through inaccurate and incomplete filings of statutorily required records (commercial land title surveys detailing physical boundaries, encumbrances, encroachments, etc.) on commercial properties in California, many other western states and possibly throughout most of the United States. In the cases studied by Harbinger, the problems are because banks accepted the work of land surveyors who “have committed actual and/or constructive fraud by knowingly failing to conduct accurate boundary surveys and/or failing to file the statutorily required documentation in public records.

The Wall Street geniuses bundled commercial real estate mortgages and re-sold them as securities around the world. The suckers holding those securities, already staggering from the overabundance of empty office space, will be devastated if it turns out they have no claim to the properties. They will rightly sue the lenders for falsely representing the properties. Mortgage holders in these cases may also turn to their title insurance to cover any losses. It is unknown if the title insurance companies have the wherewithal to withstand enormous claims on costly commercial properties. It looks like that light at the end of the tunnel is bullet train headed our way.

According to Andy Miller, quoted in Quinn’s article, by Thanksgiving of 2011, the underwater commercial property owners started showing up due to an Accounting Standards Update by the Financial Accounting Standards Board. This update, made effective June 15, 2011 on wards, made properties undergoing forbearance, or extending a foreclosure because a loan is underwater, subject to a fair value assessment (mark to market). So the extension habits and moral hazard can no longer be on the books, instead we must know the true extent of the damage the coterie of bankers has inflicted.

Quinn further broaches the future of retailers, taking fault with the BLS’ reported retail sale numbers:

Retail sales in 1992 totaled $2.0 trillion. By 2011 they had grown to $4.7 trillion, a 135% increase in nineteen years. A full 64% of this rise is solely due to inflation, as measured by the BLS. In reality, using the true inflation figures, the entire increase can be attributed to inflation. Over this time span the U.S. population has grown from 255 million to 313 million, a 23% increase. Median household income has grown by a mere 8% over this same time frame. The increase in retail sales was completely reliant upon the American consumers willing to become a debt slaves to the Wall Street bank slave masters. It is obvious we have learned to love our slavery. Credit card debt grew from $265 billion in 1992 to a peak of $972 billion in September of 2008, when the financial system collapsed. The 267% increase in debt allowed Americans to live far above their means and enriched the Wall Street banking cabal. The decline to the current level of $800 billion was exclusively due to write-offs by the banks, fully funded by the American taxpayer.

Lastly, Quinn does a commendable job combating the cable media reports of certain big box retailers who paint rosy pictures whose backing frames have been slowly rotting for some while. This is just the consequence of the protracted real double digit unemployment and its effect on consumer spending levels. Those touting a recovery would be surprised with what Quinn brings to light:

Home Depot was praised for their fantastic 2011 result of $70 billion in sales and $6.7 billion of income. The MSM failed to mention that sales are $7 billion lower than 2007, despite having 18 more stores and profit exceeded $7.2 billion in 2007. Sales per square foot have declined from $335 to $296, a 12% decline in four years.

Widely admired Best Buy has screwed the pooch along with the other foolish retailers that have massively over expanded in the last decade. They have increased their domestic sales from $31 billion to $37 billion, a 19% increase in four years. This increase only required a 444 store expansion, from 873 stores to 1,317 stores.

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