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Now That the Impairments Are Starting, Will Anyone Bother to Look into How Realistic They Are?
In Straight Talk From the Homebuilder CFO: The tricks builders use to disguise the true losses on their,
the impairment game was discussed as a method of hiding losses on
builders' balance sheets by taking impairments on what could be
considered exaggerated book values. The exaggeration may not be that
hard considering how far, how fast, and potentially how long property
and land values can continue to fall.
Again, I refer to the
comparative chart that shows the appreciation rate of Japan's major
city real property values as their GDP started to ramp up and out of a
major recession:
This
brings me to mind of what is actually going on in the CRE space now. As
my regular readers know, I tend to actually analyze the portfolio of
REITs by hand, which acts as a check and balance against overzealous
reporting of book values that may or may not run in line with realistic
market values. Upon performing this exercise with General Growth
Properties, solvency issues became quite obvious during a time when
most of the street still had a buy on this company ( see my work with GGP).
Well,
I'm back to taking the forensic microscope to various companies'
portfolios and it is interesting what can be found. Here, an
institutional real estate owner describes a voluntary impairment of its
asset in a recent 8K filing:
The Board’s decision considered that The Pier’s current cash flows, as well as estimates of future cash flows, are insufficient to cover debt service
and operating costs due to economic conditions, tenant sales
performance, high capital requirements to complete the property’s
lease-up, high operating costs, and the anticipated refinancing shortfall at the loan’s maturity in May 2017.
After recognizing the noncash impairment charge, representing the
excess of book value of the investment over its estimated fair value,
the consolidated joint venture’s remaining book value of the investment
will be approximately $52 million. A default on this loan will not
trigger any cross defaults on the Company’s lines of credit or any
other indebtedness. The Company’s cash investment in The Pier is
approximately $35 million.The Company has concluded
that the investment in Regency Square is also impaired based on current
estimates of future cash flows and the expected holding period. After
recognizing a non-cash charge in the range of approximately $55 million
to $58 million, representing the excess of book value of the investment
over its estimated fair value, the remaining book value of this
investment is expected to be approximately $30 million. At the current
level of cash flow, Regency Square intends to continue to service its non-recourse mortgage loan. This loan has a current principal balance of $74.5 million, with
$71.6
million due on this amortizing loan at its maturity in November 2011.
On September 22, 2009, the Company issued a press release announcing
the write down of the book value of The Pier and Regency Square to fair
value.
This company has seen its
share price rise despite these negative evens, and further analysis
reveals that this is probably going to be necessary another 3 to 6
times over the coming quarters (or potentially 25% or so of their
portfolio) - all on top of a rising share prices and what I see as a
further deteriorating macro environment. The big question is, "Who is
there to call this, or any other REIT, out on valuation issues?" The
sell side has strong buys on the company and not one that I know of has
bothered to seriously address the valuation of the portfolio. This
is/was the case with GGP, and all of the other REITs that I have
covered or are anticipating covering.
The underlined phrases
above are instrumental in determining true value in the REIT portfolio.
100 LTV+ loans (in reality, any loan over 85 LTV in the CRE space),
negative cash flows and excessive vacancies are the banes of this
industry of the next 12 or so quarters. Many loans that are underwater
from a valuation perspective will be able to continue debt service,
with the blessing of many (or most) banks making the ability to truly
identify distress in these situations a bit more befuddled due to the
government endorsed "extend and pretend" rules now in place. We have
government complicity in the purposeful opacity of the values of
mortgage assets (see the FDIC "Prudent Commercial Real Estate Loan Workouts" guidance issued Oct 30th, as reported by the WSJ: Banks Hasten to Adopt New Loan Rules and the new FDIC guidance
that states performing loans "made to creditworthy borrowers" will not
require write downs "solely because the value of the underlying
collateral declined").
Now, keep in mind that although banks
may not be calling these under water loans in, they are essentially
under collateralized, or in some cases literally uncollateralized loans
(any mezzanine level loans should be considered worthless in many of
these deals). This changes the risk profile immensely, and if the graph
above depicting the Japanese land values bears any semblence to what is
to come in the US, the pretending stance of the banks will simply lead
to defaults with minimal or zero, if not negative recovery values. This
may increasingly be the case in non-recourse situations when the
borrower has tough decisions to make. Very much like the residential
home owner and jingle mail, certain REITs may simply throw in the
towel, which will leave the banks in a lurch, particularly since they
decided to ignore prudent lending practices by pretending the loan that
shouldn't have been written now doesn't need to be called in when there
is some value left in the term recovery value.
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I envision a National Lottery....buy tickets to win CRE, weekly drawings. Sell enough tickets and we are home free and some lucky sap will have a vacant building to call his own, and pay taxes on.
The way that will work, based on the administration's past programs, is that to buy a lottery ticket you need to be a "Qualified Buyer" The criteria will coincidentally only qualify GS and JPM and PIMCO.
Qualified buyers get to buy the lottery tickets for a couple of bucks each and win property worth tens of millions.
In order to preserve the stability of the financial system and promote prosperity for the American people, the banks that would have to take losses on these properties being distributed for a dollar each, will be given interest free loans by the Fed for the full amount of the loan they've had to write off, with a payment schedule of "whenever you feel like and there's enough left over after you've ramped your bonus pool to size of the GDP of a midsized nation."
when to short the reits?
If one was watching the GGP drama unfold as I was the clear message was that in order for a loan to be considered in default a REIT needs to pinch a loaf on the bondholder's doorstep in leau of a cupon payment.
GGP said in press releases they were not going to pay their bondholders several MONTHS before BK. Even before things got to that point there were several near nonpayments that were resolved by restructuring the issues in question.
So to your question of when it will be a good time to short the REITS, it would take CRE prices falling uniformly with such visciousness and velocity that no sentient being could possibly deny the collateral for these loans are garbage. And even then there would be a massive Fed intervention and several rounds of extend and pretend.
If REITs learned anything from GGP it is that when you are about to default on a loan, tell your creditors that you're in such bad shape that unless they extend the loan 40 years then they're not going to see a dime on their senior secured. Threatening one's creditors is surely one of the great financial innovations of the past couple decades.
it started with asswipe donald stump....i mean
trump
Looking under the covers, .
They MUST gamble on inflation. Deflation "Japan Style" dooms them.
Our government will have to choose, us or them.
I don't think it's the deflation that will get them. Today smells a lot like a Comex default brewing. Inflation/deflation doesn't mean sh!t if the dollar collapses. I like my paper lightly salted with tungsten, but not my gold.
Us or them? Oh, I suspect that decision has already been made based on the few data points out there. ;-)