Interest Rate Roundup

Friday, August 01, 2008

Credit crunch spreads in auto, CRE sectors

The reason this credit crunch/crisis has been so durable, persistent, and severe is that so many lenders did so many dumb things in so many sectors. Aggressive mortgage lending. Aggressive commercial real estate lending. Aggressive auto lending. It was a free-for-all because money was cheap and plentiful. The ultimate funders of these loans (the bond buyers, hedge funds, pension funds and so on who purchase asset-backed securities, mortgage-backed securities, finance company bonds, and other debt instruments) were willing to pay up big-time for anything yielding more than plain-vanilla U.S. Treasuries.

Now, that entire process is playing out in reverse. Losses are rising on foolish loans and bonds that entitle holders to the cash flows from them, causing the funders/enablers in the secondary market to run away screaming. That is causing primary lenders to tighten standards and raise rates on some loan programs, while eliminating others entirely. And that, in turn, is causing the economic slump to deepen and widen well beyond residential real estate.

Case in point: The auto sector. Just look at the July sales numbers out of Ford, GM, and the other majors today. Ford sales dropped 15% year-over-year. Toyota sales were down 12%. Chrysler sales dropped 29% and GM sales plunged 32%. High gas prices are to blame for a large chunk of the decline in demand for gas-guzzling SUVs. But tighter credit conditions is a contributing factor as well, and it will probably become a bigger one going forward. After all, you have the captive finance companies cutting back on leasing -- which accounts for about 20% of auto sales -- across the board.

UPDATE: The July auto sales rate looks like it will come in at 12.5 million, the weakest level since April 1992.

As for commercial real estate, construction spending is still growing. We learned this morning that private, nonresidential construction spending gained 0.8% in June even as private residential spending shrunk 1.8%. But given the state of the credit markets and the deteriorating economy, that strength just can't last in my view. Evidence of a weakening market is already out there if you know where to look.

Just consider what General Growth Property, the second-largest operator of shopping malls, had to say earlier this week (via Reuters, my emphasis added):

"Mall and land owner General Growth Properties Inc on Wednesday reported lower-than-expected quarterly results and cut its forecast and postponed some development, citing the weak U.S. economy.

"General Growth said that, after conferring with some of its retail tenants, it would postpone the opening of some shopping centers and defer $500 million of development spending over the next 18 months.

It also lowered its 2008 forecast for core funds from operations to $3.42 per share from a range of $3.52 to $3.58."

Or what about Boyd Gaming? It's halting construction of a Las Vegas casino in the middle of the project (via Reuters, my emphasis added):

"Boyd Gaming Corp said on Friday that it would delay construction of its partially built Echelon casino project on the Las Vegas Strip, and investors concerned about a glut of new resorts in the city sent the company's shares up as much as 30 percent.

"The construction delay overshadowed news that Boyd was suspending its quarterly dividend.

"The company, whose shares had been falling for nearly a year, also announced a $100 million share repurchase program and posted lower second-quarter profit as the U.S. economic slowdown reduced gambling revenue.

"Las Vegas-based Boyd said it had decided to delay the construction of the $4.8 billion Echelon, already built to around eight stories, because of the challenging economy. It plans to resume construction in three or four quarters, assuming credit market conditions and the economic outlook improves."

Isolated examples? I don't think so. Leasing activity, construction, and sales all appear to be already decelerating (or on the verge of doing so). Just look at the news on the commercial real estate front that mega-brokers CB Richard Ellis Group and Jones Lang LaSalle released this week. Here's an excerpt from a Bloomberg story, with my emphasis added:

"The credit crisis, which began a year ago in the U.S., has impacted virtually all financial centers and economies,'' Jones Lang LaSalle Chief Executive Officer Colin Dyer said in a conference call. "For commercial real estate, the major impact continues to be declining capital market activity and much stricter debt financing.''

"Financial firms have raised borrowing rates and curtailed lending amid $476 billion in mortgage-related losses and asset writedowns and announced 100,000 job cuts. Together, the figures mean it's harder for would-be commercial real estate buyers to borrow and the financial firms brokers count on to rent space need less of it.

"What we have, in this marketplace at least, in this industry, is a classic stagflation market,'' CB Richard Ellis Chief Executive Officer Brett White said in a separate conference call. A strong economy with tight credit would have bolstered broker profits from leasing, while a weak economy with low borrowing costs would have fueled property sales, White said."


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