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Will the Banks be there for Housing & Neighborhood CRE?

Monday May 10, 2010 University of Connecticut 12 th Annual Housing Conference. Will the Banks be there for Housing & Neighborhood CRE? .

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Will the Banks be there for Housing & Neighborhood CRE?

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  1. Monday May 10, 2010 University of Connecticut 12th Annual Housing Conference Will the Banks be therefor Housing & Neighborhood CRE? The opinions expressed are those of the presenter, and not those of the Federal Reserve Bank of Atlanta or New York, the Federal Reserve or its Board of Governors. The oral comments are critical to context. Without them, this presentation can be misinterpreted.

  2. Destination Recovery - Are we there yet? Event Vs. Recognition The EVENT(value decline) occurred 2007-2009; and now we have the RECOGNITIONof it 2010-2012 (Will capital go to loan losses or lending?)

  3. The EVENT – A steep decline in valuesRRE and CRE price declines 2007-’09 were steeper and more severe than 1990-’92 This CRE value decline “event” has been more severe than anything experienced post WW II. Therefore, the “recognition” will be more challenging as well.

  4. What caused this steep decline? Understanding the WHY is necessary to develop RESPONSE(S) We had a lot of demand being generated from factors not tied to JOBS: i) investors; ii) speculators; iii) subprime mortgages. Population Growth, Baby Boomers, Gen X, Gen Y Securitization, Immigration Loan Servicing Existing Homes Carrying Costs Employment, Income, Finished Inventory Demographic Interest Rates, Alternative Draws on Investments Lending Lines Economic Starts Loan Payoffs Liquidity Construction Supply Demand Owner Cycle Occupied Developed Lots Raw Land Home Sales Affordability Underwriting • Key Concepts: • Demand stopped • Supply continues • Risk is elevated • Values decline • Capital becomes scarce & more expensive Recent Price Appreciation, P&C Insurance, Construction Property Taxes, Loans NINJA Loans (No Income, No Job or Ability to Pay) Cost of Living, Credit Scores, Acquisition Exotic Mortgages, Liar Loans, Loans Second Mortgages NINA Loans We had a lot of Supply ramped up to meet this DEMAND that can’t stop on a dime. Condo Conversions CRE Loans Investors, Federal Reserve Bank of Atlanta – Supervision and Regulation Flippers

  5. Recognition follows the events that cause the value decline.Key Pt #1: CRE “Lag-Effect:” Loan Charge-Offs lag well into periods of recovery. 2.78% 1.26% 09/1992 0.04% 12/05 2-4 yrs

  6. Key Pt #2: The bulk of this CRE debt is in U.S. banks.This level of CRE is problematic – 2007 CRE Concentration Guidance. Total Commercial and Multifamily Mortgage Debt Outstanding Source: Q4 Fed Flow of Funds Update (L-222) Total Commercial and Multifamily Debt Outstanding: $3.383 Trillion Total CRE Outstanding in Commercial Banks: $1.506 Trillion Source: Federal Reserve

  7. Where is the Commercial R.E. debt by type of financial institution?Smaller community & regional banks are more exposed to R.E. percent Source: Reports of Condition and Income 3rd Quarter 2009

  8. Commercial & Multifamily Mortgage Debt Outstanding ($ millions)It more than tripled in a decade… We didn’t build that much new CRE Key Pt #3 This is an “over-leverage” event Vs an “over-building” event. $1 Trillion to $3.5 Trillion in a decade

  9. But, let’s look ahead & ask: Will the banks be there for housing? Key Point #4: Data tends to crisscross in direction near a bottom. Event Vs. Recognition (2007-2009 Vs 2010 - ?)

  10. Key Point #5: Not all areas of R.E. are equally distressed.Q. What is “healthy” Vs. “distressed” R.E.? (2009 CRE Loan Workout Guidance)A.Occupied/“Leased-up” R.E. Vs. “Un-leased,” new R.E. in the banks. Note: Whether it is housing or income producing CRE, capital is more attracted to “occupied” real estate. Why should housing care about CRE? Who wants to buy housing in a neighborhood where all the CRE is vacant or there is an absence of neighborhood retail and services?

  11. Q.What State(s) have most CMBS delinquency? (competing inventory for banks)A: AZ is the worst @14% & NV, MI, FL,TN, GA ,TX are worse than U.S. avg. US Avg. AZ FL GA TX CT CA Source: Moody’s CMBS Delinquency Tracker Q1 2010 report

  12. Key Pt #6 CMBS Defaults are rising & expected to breach 11%.

  13. CMBS leading indicator to monitor: Loans moving to Special Servicing SSLT up to 9.26% DQT near 6% 15% DLT & SLT Source: Moody’s CMBS Delinquency Tracker Q1 2010 report (SSLT: Loans transferred to Special Servicing)

  14. So where are we with respect to conditions? Let’s start with housing…

  15. Home Foreclosures: What are the numbers? Have we peaked? Sources: Equifax, Moody’s.com, Mark Zandi (Jan 2010)

  16. 14.6% of mortgages are NOT current. Prime Mtgs. are now the delinquency problem. Why? 50%+ of all Loan Mods re-default after 9 months. HELOCs and ALLL

  17. The noncurrent loan rate (delinquencies + foreclosures) has risen above 13%31%of loans 6-mosdelinquent have notentered foreclosure 23%of loans 12-mosdelinquent have notentered foreclosure What is the implication for HELOC losses?

  18. Capital consequences to the banks…How does it impact future lending?

  19. Connecticut compares favorably to the US with respect to Mortgage Delinquency Key Note: Except for Windham 30-59 Past Due category, the major CT markets have mortgage delinquency rates for all mortgages that are less than the US average. Windham is also the smallest market with total mortgages just 10%+ the volume as Hartford or New Haven.

  20. Negative Home Equity by State – The housing indicator of most concern. NV #1 65% Now >70% US avg. 22% Now 24%

  21. Negative Home Equity by MSA:CT has one market that ranks among Top-50: Hartford US avg. 24%

  22. But…This type performance decline did not occur in Sr. Housing?Q. So why isn’t capital differentiating and lending to Sr. Housing? Can banks differentiate “healthy “ CRE from “distressed CRE? Even if they can differentiate, will they have the capital to lend?

  23. CRE Construction: 2005-07 Constr. In US is winding down.(Condos underway, though, are still tracking the same as 2009 completions) Source: Dodge pipeline

  24. Construction/CLD Loans?What is the value of partial construction in a distressed market? LGD / Loss Given a Default will likely be greater in banks Vs CMBS due to this wrinkle. Question: What are the characteristics of a “PASS” construction credit?

  25. What is the value of this “completed” CRE?Remember the “Event” Vs. “Recognition” comment on Slide 2? Construction “mis-Management” Actual photos from 2009 UPDATE appraisals by banks with “Impaired CRE” projects. The appraiser “assumed away” the construction defects (Hypothetical Vs. Extraordinary Assumption), and the Bank: i) had a “lax” construction management process; ii) a weak “Administrative” appraisal review program; and iii) had not inspected the collateral in a year. 1. 2. 3. 4. Will the banks be there to lend with this kind of construction oversight?

  26. Appraisals & Constr. Oversight …Investors have to believe in the value.

  27. MF: National Occupancy @ 91.6% Vs. Change in Occupancy/Vacancy by Property Type Mid-’09 to Q1 2010 Retail: National Vacancy @ 12.4% Vs. 92% Q3 ‘09 93% Q2 ‘09 12% Q3 ’09 10% Q2 ‘09 Warehouse: National Vacancy @ 14.1% Vs. Office: National Vacancy @ 15.9% Vs. 15.7% Q3 ’09 12.9% Q2 ‘09 13.8% Q3 ’09 10.6% Q2 ‘09 Source: REIS

  28. Where are things the worst for CRE? TX & CA markets are experiencing “worse decline.” Source: KC Conway, MAI, CRE – Atlanta FRB

  29. MF/Apts: Good news – “new supply” ending, concessions abate, but… MF/Apt Constr Q3 ‘07 to Q4’09 Source: Dodge Pipeline / Atlanta FRB Note: New for-rent MF construction is declining; and rent concessions are starting to abate; but …condos

  30. MF/Apts: Good news – Concessions ( a leading indicator) are abating. Note: Even with Corus Bank condos reverting to rentals.

  31. MF/Apts: Conditions not improving where condo constr. was elevated 10 Worst – 2009 Completions Chicago # 1 NY # 2 Wash DC # 3 Orlando # 4 Miami # 5 Tampa # 6 Atlanta # 7 Phoenix # 8 LA # 9 Seattle #10 Orlando &Las Vegas The impact of timeshares too. Source: Dodge Pipeline /CBRE Econometric Advisors

  32. How lending policy changes can make a big difference in housing… Discuss expiration of the home buyer tax credit April 30th.

  33. Retail CRE: Construction has slowed, and Sales have improved, but…700 msf was added 2007-2009 & Co-tenancy not yet recognized by banks. The crisscross data points: + Supply is ending + Sales have improved - 700 msf was completed 2007-’09 - 50% of new retail is not leased up - Co-tenancy clauses have yet to be recognized.

  34. Key Pt # 7 Co-Tenancy & Impact on Retail CRE.

  35. Office CRE: New Supply + Sublet + Office Job Loss = Rising VacancyRecognition is masked by “Sublet” vacancy. On a year-ago basis, office-using employment sank for the seventh consecutive quarter, contracting by a near record 5.8 percent or by 1.69 million jobs .

  36. Warehouse CRE: The net negative absorption and rising vacancy data call into question forecasts regarding an “inventory rebuild.” The “Inventory Rebuild” recovery? Where is the “inventory rebuild” with this kind of “net negative absorption;” and Key “inland” distribution markets seeing higher warehouse vacancy rates? P Inld Inld P Net Warehouse Absorption: What we are seeing is “less loss.” We are not yet seeing positive absorption and leasing activity - which should accompany the rebuilding of inventory. P Inld Inld

  37. How does Hotel NOI in this down-cycle compare to1937, 1982, 2001? • Overall NOI decline was approximately 35% in 2009 and a cumulative 50% in the past 24 months Source: PKF Research

  38. While all “segments” have been impacted, “Luxury” has been hit hardest. • Hotels with higher price points have been more affected • In 2009, the luxury segment was the hardest hit segment, showing a RevPAR decline of approximately 23.6%, in comparison to 2008 • However, all segments have posted decreases of at least 14.8% in 2009 Source: Smith Travel Research

  39. Let’s wrap up with a few notes on Cap Rates…and Capital… What is a historical perspective on Cap Rates? The nearly 6% avg Cap Rate (NCREIF), and sub 6% Cap Rates (CMBS and Banks) were historically unprecedented and unsustainable.

  40. Life Co, REIT, Fund money in. LTVs rising from 50%-60% to 60%-70% Equity IRRs now dipping below 20%.

  41. Final Key Point: The “ReFi Gap” is the challenge 2010-2012. Recognition of 300 bp rise in Cap Rates & 20% decline in cash-flow on Value

  42. KEY “Take-away” Points: • Recognition of CRE losses will keep a focus on bank’s capital planning processes. • The largest portion of CRE debt to be refinanced is located in the banks. • This CRE crisis is an “over-leverage” event Vs. “over-building” event like the 1980s • Data tends to crisscross in direction when we are near a bottom. • This CRE event has been more severe than any since WW II. • Not all CRE is distressed. • 2005-2007 CRE construction is winding down – condos are the exception. • MF is fairing the best – concessions (leading indicator) are abating. • “Less Loss” is best way to characterize the other CRE property types. Co-tenancy is the issue with respect to retail CRE. “Less loss” translates into higher defaults – need jobs! • The “ReFi Gap” is the 2010-12 challenge. It is RECOGNITION of the value decline event.

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