Beige book looks blue

The Beige Book report, just released by the Federal Reserve, doesn't tell a very happy tale about the U.S. economy. In fact, I'd call it downright "blue." A few excerpts with my emphasis added:

From the summary of the overall economy ...

"Residential real estate markets declined or were still weak across most of the country. Commercial real estate activity also slowed or remained sluggish in a majority of Districts, although a few Districts noted slight improvement. In banking, loan growth was generally reported to be restrained, with residential real estate lending and consumer lending showing more weakness than commercial lending. Districts reporting on agricultural activity said conditions were mixed, based largely on how June precipitation affected them. Districts reporting on the energy sector said it continued to strengthen.

All reporting Districts characterized overall price pressures as elevated or increasing. Input prices continued to rise, particularly for fuel, other petroleum-based materials, metals, food, and chemicals. Retail price inflation varied across the country, with some Districts reporting increases but others noting some stability, at least for the present."

From a section on consumer spending ...

"Consumer spending was reported as mixed, weak, or slowing in nearly all Districts since the last report, although tax rebate checks boosted sales for some items, especially electronics ... Sales at discount stores were also reported as growing in the Philadelphia, Richmond, St. Louis, Dallas, and San Francisco Districts, and New York reported brisk sales in New York City. However, sales at most other types of stores, especially for discretionary and housing-related items, were typically characterized as weak or falling, and restaurant sales were also reported as slow in the Philadelphia and Minneapolis Districts. The outlook for retail activity was also generally downbeat, with expectations "subdued" among Atlanta District contacts and "grim" among Dallas District contacts.

From a section on commercial real estate ...

"Commercial real estate activity weakened or remained sluggish in a majority of Districts, although Cleveland, Minneapolis, and Kansas City noted some improvement. Boston characterized sentiment in the sector as "decidedly morose," and industrial markets were especially weak in that District. Office market conditions in the Richmond District continued to weaken and were "bleak" in the Washington, DC area. Vacancy rates increased in the Philadelphia and Atlanta Districts, and were up noticeably in both Midtown and Downtown Manhattan, according to contacts in the New York District. Office rents remained steady in the Philadelphia District, and were little changed in the Boston District after taking concessions into account. More positively, contacts in the Minneapolis District noted rent increases and positive absorption in the Minneapolis-St. Paul area office market. Districts reporting on nonresidential construction generally noted sluggishness, which contacts in the Chicago and Kansas City Districts attributed in part to prohibitively high construction costs. Contractors in the Cleveland District were also worried about cuts but reported strong backlogs and a steady flow of inquiries. Contacts in many Districts also cited tightened financing as a constraint. San Francisco noted particularly steep drops in commercial construction in the San Diego area. Retail space was described as overbuilt in the Boston and Chicago Districts."

From a section on loan quality and loan standards ...

"Most Districts reported a further tightening of credit standards, especially for residential real estate and construction loans. Dallas reported that lenders were tightening non-price terms and boosting loan spreads in response to increases in their cost of capital. Tighter standards for construction loans were reported in the Atlanta and Chicago Districts, and San Francisco indicated that credit standards remained quite restrictive for both residential real estate and construction loans. Tighter standards for business loans were reported in three Districts, but banks in the Atlanta District were reported to be competing more intensely for business customers with good credit histories. Kansas City and Boston reported that tightened standards were especially prevalent on commercial real estate loans.

"Among the Districts that commented on bank loan quality, some deterioration was reported, including in the Philadelphia, Richmond and San Francisco Districts. New York reported increased delinquencies on consumer and residential real estate loans, and San Francisco indicated that declines in loan quality were greatest for real estate loans and construction loans. In the Dallas District, contacts had not yet observed a significant decline in loan quality but expected deterioration in coming months, especially for residential real estate and consumer loans."

The immediate impact of the Beige Book's release was a minor downtick in stocks. But we quickly reverted back to the tick-for-tick inverse relationship with crude oil, whereby stocks go up every time oil ticks down.

And you thought RESIDENTIAL real estate was bad...

We all know by now that the residential real estate market has imploded. The forces that inflated the housing bubble are also well-known -- a toxic combination of overbuilding, overspeculating, and ridiculously reckless lending on the part of the residential mortgage industry.

What hasn't garnered as much attention so far is the state of the COMMERCIAL real estate market. Turns out we've had an incredible bout of reckless speculation and -- surprise, surprise -- stupid lending there, too, and it's coming back to haunt the commercial market, according to this New York Times story.

Here's one excerpt (with some choice bits highlighted):

"As often happens in real estate, a once-frothy national cycle is losing steam and the market has turned against many buyers. Mr. Macklowe, with his empire of 15 prime office towers and two development sites in one of the world’s best business districts, is awash in expensive, short-term debt at the very moment that financial backing for megadeals has all but shut down. One of his loans is backed by a $1 billion personal guarantee, and he is already in default on $510 million in development loans for a Park Avenue project.

Mr. Macklowe’s predicament marks the denouement of an unprecedented four-year period in which developers threw gobs of money at real estate as prices for office towers, especially in Manhattan, doubled and tripled almost as fast as sales could be recorded. Investment banks avidly underwrote the binge, often basing loans not on existing rents but on projections of rental income well into the future.

All of this worked swimmingly so long as the economy hummed along and banks could pool the loans and sell them to investors. Now, the economy is showing signs of stress, and Wall Street’s repackaging machine is sputtering.

“In hindsight, everybody should have been more cautious,” said Robert Bach, the chief economist at Grubb & Ellis, the national real estate brokerage firm. “We all knew this wasn’t going to last, but we hoped it would end with a whimper, not a bang.”

Analysts, bankers and developers are not predicting the imminent collapse of the commercial real estate market, a reprise of the early 1990s, when property values dropped by half, vacancies soared and banks were crushed under the weight of soured real estate loans. But developers who jumped in at the top of this market are likely to feel some pain because purchases were built on the assumption that rents would keep escalating and that the value of buildings would keep appreciating."

And here's another:

"The annual rent for the seven Midtown buildings was generally $55 to $59 a square foot, according to William Macklowe, but Deutsche Bank and Fortress underwrote the deal on the assumption that rents would soon rise to $100 a square foot.

"After all, the commercial real estate market was higher than ever. The vacancy rate had fallen to record lows, while high construction costs made new buildings prohibitive. Landlords at prime office buildings were getting more than $100 a square foot annually, while the average rents for first-class Midtown buildings rose to $73.31 by the first quarter of 2007 from $55.21 in the first quarter of 2005, according to Reis Inc., a New York office research company.

"At the same time, average prices for large office buildings in Midtown more than doubled, to $745 a square foot from $357, according to Real Capital Analytics. Investment banks and foreign companies began pouring capital into real estate. Lenders, in turn, took more risks, often providing financing for 90 to even 100 percent of a building’s price. Investors became ever more willing to accept a lower initial rate of return, known as the capitalization rate.

As with the residential market, the money flowed easily because lenders did not keep these risky loans on their balance sheets — as the commercial banks and savings-and-loan associations did to their peril in the early 1990s. Instead, Wall Street repackaged hundreds of billions of dollars of loans as commercial-mortgage-backed securities and sold them to investors.

“Loans with more aggressive terms that weren’t available in ’03 and ’04 became the norm in ’06, when suddenly lenders became very accommodating,” said Mike Kirby, a principal of Green Street Advisors, a research company in Newport Beach, Calif., that specializes in real estate investment trusts. “The attitude was, ‘Gee, we’re not going to own this stuff; we get terrific fees for underwriting these loans, and we can blow it out in a C.M.B.S. deal in three months.’”

I've been concerned about the state of the commercial market for some time. See this piece from back in late 2006 or this one from mid-2007 for more of my thoughts there. You have to wonder what's going to happen to U.S. banks if they get hit with a big surge in commercial mortgage defaults on top of the record surge in losses they're already dealing with on the residential mortgage front. Oh and don't forget all those aggressively leveraged private equity deals that were yet another consequence of the easy money mania. Lenders are having trouble offloading the steaming pile of paper in that market, too.

The New York Times tackles CRE

Yesterday, I put up a post focused on the problems starting to emerge in commercial mortgage backed securities (CMBS) and the commercial real estate (CRE) market. The New York Times picked up the mantle this morning. Some more details from their piece:

"At the end of the second quarter, Deutsche Bank held $25.1 billion worth of commercial loans. Morgan Stanley held $22.1 billion and Citigroup had $19.1 billion.

"Lehman Brothers, which has the largest exposure to this type of security, is shopping about $40 billion worth of commercial real estate assets, as well as its entire commercial real estate business. A large part of its portfolio is a high-risk loan known as bridge equity made with Archstone, a metropolitan apartment developer, and most of the rest are floating-rate loans, which are riskier, according to a person who reviewed the offering.

"Banks are scrambling to dispose of these loans, typically made to hotels, office developers and retail strips, before problems arrive.

"Broader real estate indexes are already showing signs of trouble. Moody’s/REAL Commercial Property Price Index has dropped nearly 12 percent since its peak last October. A more conservative index by the National Council of Real Estate Investment Fiduciaries shows growth slowing to one-half of a percent in the second quarter, from upward of 4 percent a quarter.

"Loans made for commercial real estate are typically among the safest, because a building can be used as collateral and big property developers generate income from the investment, raising the likelihood they will repay their loans.

"But cracks began to emerge late last year, when Morgan Stanley reported write-downs of $400 million in commercial mortgage losses. In the first quarter, Wachovia, which had transformed itself into a leading lender in the nation’s commercial real estate market, said it would take write-downs of more than $1 billion for commercial loans for the second half of 2007. Investors had already begun balking at buying securities backed by these bonds, so banks like Wachovia were stuck with loans of diminished value."

The latest from the Fed; Plus, how commercial real estate is starting to teeter

This morning's speech by Federal Reserve Vice Chairman Donald Kohn has the market all lathered up. Kohn basically opened the door to a rate cut at the FOMC's December 11 meeting by saying "we are going to have to take a look" at the credit market "turbulence."

Why is this such a big deal? Beats me. If you asked a room full of 100 Wall Street bond traders how many actually thought the Fed would stand up to the market and NOT cut rates, you'd probably see one, or maybe two, raise their hands. In other words, a cut was pretty much a given.

But stocks had gotten extremely oversold ... it's that time of year when we tend to get rallies ... and all it took was a spark. So there you go. The question is whether this rally is just like many of those '80s bands -- in other words, a "one hit wonder." After all, we sure saw a heck of a lot of this stuff (big sell-offs, followed by big short-term, short-covering rallies, followed by even bigger sell-offs) in the 2000-2002 bear market. I suppose time will tell.

Meanwhile, in the real world, the Fed just released its latest "Beige Book" report on the economy. It confirmed what I've been saying in a number of venues -- the credit markets are tightening, the housing market (still) stinks, and the overall economy is starting to soften.

Notably, this beige book also references the fact commercial real estate conditions are starting to deteriorate. I haven't talked as much lately about the bubble in commercial mortgage financing, or the ridiculous deals that were done in that part of the R.E. market over the past few years. But I was very vocal about it many months ago. Now, it looks like that part of the real estate market is heading south, too. This Bloomberg story has some interesting facts if you have the time to review.

If there's any good news in the Beige Book, it's that pass-through inflation, outside of food and energy, isn't all that big a deal. Now let's get to some excerpts (with key passages highlighted by me):

ON RETAIL/CONSUMER SPENDING:

"District reports indicated relatively soft retail spending; most retailers said that they were expecting a slow holiday season, with only small gains in sales volumes compared with last year."

and

"Reports on retail spending were downbeat in general, with several significant exceptions. Most Districts characterized sales as weak or indicated that they had softened, with a few reporting that the volume of sales had fallen relative to the preceding survey period or a year earlier."

and

"Among product categories, several Districts noted continued solid growth in sales of consumer electronics, while a few also noted that demand for luxury goods continued to rise at a healthy pace. By contrast, sales of automobiles and light trucks were flat to down, with contacts from several Districts expecting declines going forward."

ON HOUSING:

"Demand for residential real estate remained quite depressed, with only a few tentative and scattered signs of stabilization amidst the ongoing slowdown. Most Districts pointed to further increases in the inventory of available homes, with the earlier tightening of credit conditions for mortgage lending continuing to create barriers for some buyers. Consequently, prices on new and existing homes sold were reported to be down on a short-term or year-earlier basis in most Districts. The pace of homebuilding remained very low in general, and builders continued to shelve projects and lay off workers in many areas; contacts generally do not expect a significant pickup in homebuilding until well into next year at the earliest."

ON COMMERCIAL REAL ESTATE:

"A few Districts reported emerging signs of declining demand for commercial space: this included assorted indicators of weaker demand in the major metro areas in the Boston District, reduced leasing activity in Philadelphia, commercial construction activity that was described as "flat to down slightly compared with a year ago" in Atlanta, and reduced transactions and rising vacancy rates in some parts of the San Francisco District. Construction of commercial and public buildings and infrastructure projects remained high in most Districts, however, partly offsetting low residential building activity and helping to limit losses in overall construction employment."

ON LENDING ACTIVITY:

"The glut of available homes continued, keeping downward pressure on prices and construction activity. The demand for commercial real estate remained strong in most areas but showed signs of leveling off in some. Reports from banks and other financial institutions suggested slower growth in overall loan demand, with some Districts noting a reduction in the volume of commercial and industrial lending. "

"Lending standards for construction projects and commercial real estate transactions tightened further in the New York and St. Louis Districts, and they remained tight more generally and reportedly held down the volume of lending for these categories in the Boston District. The reports indicated slight increases in delinquencies on commercial and industrial loans and slightly larger increases for commercial mortgages in many areas."

"Consumer lending was little changed on net, while residential mortgage lending continued its downward slide. More stringent credit conditions remained a constraint for residential mortgage lending in general, with additional tightening during the survey period reported by Chicago, Kansas City, and Dallas; scattered reports suggested slightly stricter standards on consumer loans as well. Mortgage delinquencies increased significantly in many areas, and some Districts pointed to slight deterioration in credit quality for consumer loans."

ON INFLATION:

"Upward pressures on the prices of final goods and services remained modest overall but were significant for products and services that rely heavily on food and energy inputs. Increases in the costs of energy and selected raw materials pushed up production and transportation costs for firms in various manufacturing and services sectors, although this was offset in part by price declines for lumber and transportation equipment. Food prices remained on an upward trajectory. Outside of products and services that rely heavily on energy and food inputs, final prices were reported to be largely stable or down a bit. Wage increases were moderate in general; upward wage pressures eased in a few areas where labor markets loosened slightly, although they remained strong for assorted groups of skilled workers."

General Growth goes broke; largest commercial real estate bankruptcy ever

I highlighted General Growth Properties as a company that was in serious debt trouble a little while back. This morning, GGP filed for bankruptcy protection. The firm is entering Chapter 11 with $27 billion in debt, making this the biggest commercial real estate bankruptcy ever. More from the Wall Street Journal below:

"Mall owner General Growth Properties Inc. sought bankruptcy protection early Thursday in one of the largest real-estate failures in U.S. history, capping a precarious, months-long effort to juggle the crushing $27 billion debt load it shouldered in past acquisition sprees.

"The long-anticipated Chapter 11 filing might wipe out what remains of the Chicago company's stock, but it won't result in mall closures. Many analysts suspect General Growth will survive a lengthy bankruptcy intact, but perhaps smaller after selling properties, without resorting to liquidation. General Growth, which owns and manages more than 200 malls, is the second-largest U.S. mall owner by number of properties behind Simon Property Group Inc.

"General Growth's board opted Wednesday to make the filing in U.S. Bankruptcy Court in New York after efforts to piece together a plan for an out-of-court restructuring with a growing list of creditors failed to gain traction, according to people familiar with the talks. The filing includes General Growth, its Rouse Co. subsidiary and most of its malls. It doesn't include General Growth's management company or joint-venture holdings. All told, the filing covers roughly $24 billion of debt, these people say.

"A General Growth spokesman didn't immediately return messages seeking comment. Trading of the company's stock closed Wednesday at $1.05, down 1 cent, in 4 p.m. composite trading on the New York Stock Exchange. The stock has declined by more than 97% in the past year.

"Finally forcing the bankruptcy filing after months of payment-deadline extensions was General Growth's failure to secure a deal with holders of $2.25 billion of its bonds to abstain from demanding immediate payment while the company tried to restructure its balance sheet outside of bankruptcy. Several holders of past-due bonds notified the company last Monday that they intended to sue for immediate payment. Meanwhile, additional debts came due on an almost weekly basis, making an out-of-court deal more challenging to reach."

The Journal story also highlights a key fact: That we're likely to see even more pressure on commercial property owners and investors in coming quarters thanks to crushing debt loads and falling property values. An excerpt:

"The collapse points to an underlying concern for the commercial real estate industry, too. Developers and property owners that loaded up on debt during the past real-estate boom now face mountains of that debt coming due. But some of those borrowers, like General Growth, lack the cash or the borrowing capacity to refinance or pay those debts. Many lenders are granting cash-strapped borrowers extensions of their payment deadlines, but that only postpones rather than resolves the issue. This year alone, an estimated $248 billion of commercial mortgages will come due, up from $230 billion in 2008, according to real-estate research company Foresight Analytics LLC.

"Meanwhile, commercial-property values have sunk, hampering the ability of owners to refinance or sell their properties. Real estate research company Green Street Advisors predicts a 40% overall decline in U.S. commercial property values in this recession."

Latest Beige Book paints a bleak picture

The Fed's latest Beige Book report on the economy was just released, and it's hard to find anything positive to say about it. It clearly shows the slowdown is radiating out from the housing market into several other sectors of the economy. Some key excerpts (with major passages bolded by me) on ...

The big picture:

"Reports from the twelve Federal Reserve Districts indicate that the pace of economic activity has been slow in most Districts. Many described business conditions as "weak," "soft," or "subdued." Cleveland and St. Louis reported some weakening since their last reports while Boston and New York noted signs of stabilization. Kansas City reported a slight improvement.

"Consumer spending was reported to be slow in most Districts, with purchasing concentrated on necessary items and retrenchment in discretionary spending. Districts reporting on auto sales described them as falling or steady at low levels. Tourism activity was mixed but received support from international visitors in several Districts, and the demand for services eased in most Districts"

Consumer spending:

"Consumer spending was slow in most Districts. Retail sales and other consumer spending was reported as mixed or little changed in Boston, Chicago, St. Louis, and Dallas and weak or declining in Philadelphia, Richmond, Minneapolis, and San Francisco. Sales were described as below expectations in Atlanta but on or close to plan in New York. Cleveland and Kansas City noted some improvement in retail sales since the last report. Several Districts reported that consumers were concentrating on food, staples, and other necessary items while reducing spending on discretionary items. Chicago, Dallas, and San Francisco reported noticeable declines in spending on apparel, electronics, and jewelry. Sales of furniture and household appliances were weak in most Districts. San Francisco described sales of this merchandise as exceptionally poor. A shift of consumer shopping patterns toward discount stores and lower-price brands and away from traditional department and specialty stores was observed in Philadelphia, Chicago, Dallas, and San Francisco. Sales of motor vehicles were reported to be weak or falling in all Districts, especially for larger, less fuel-efficient cars, SUVs, and trucks."

Residential real estate:

"Residential real estate conditions weakened or remained soft in all Districts, except Kansas City, which reported a modest increase in sales since the last report. Demand for housing was reported to be still moving down in Boston, New York, Chicago, St. Louis, and San Francisco. Residential real estate activity was sluggish in Philadelphia, Cleveland, Richmond, Atlanta, Minneapolis, and Dallas. New York reported low levels of single-family construction but a brisk pace of multi-family construction after an increase in permits in June occasioned by a change in the New York building code effective July 1. Chicago reported a faster rate of decline in residential construction since the last report as well as delays and cancellations in residential building projects. Richmond and Kansas City reported that lower and mid-price houses were selling at a better rate than more expensive houses. Atlanta and Dallas reported that inventories of unsold new houses were edging down."

Commercial real estate:

"Commercial real estate activity moved down or remained weak in all Districts except Dallas. Boston, New York, Philadelphia, Atlanta, and Chicago reported signs of softening demand for commercial real estate, including declining leasing activity, rising vacancies, and decreasing construction. Cleveland, Richmond, St. Louis, Minneapolis, Kansas City, and San Francisco reported that commercial real estate market conditions varied across those Districts but in general were not strong. Dallas reported an increase in office leasing but at a slower pace than in the last report. Chicago and Minneapolis noted drops in demand for retail space. Dallas and San Francisco reported that public projects were buoying construction activity."

Banking/Lending activity:

"All the Districts reporting on loan standards noted tightening. New York, Cleveland, Richmond, and San Francisco reported deterioration in credit quality. Dallas indicated that credit quality was holding up, although bankers in that District expected it to decline. Districts reporting on bank funding noted that competition for deposits remained strong."

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."

Commercial developers lining up at the bailout window

Good Monday morning - I don't know how many people are reading out there, given the fact we're now squarely in the holiday season. But I'm still toiling away and will do my best to keep you abreast of what's going on in the markets. One key news item I can't help but highlight: The story from the Wall Street Journal today entitled "Developers ask U.S. for Bailout as Massive Debt Looms." An excerpt:

"With a record amount of commercial real-estate debt coming due, some of the country's biggest property developers have become the latest to go hat-in-hand to the government for assistance.

"They're warning policymakers that thousands of office complexes, hotels, shopping centers and other commercial buildings are headed into defaults, foreclosures and bankruptcies. The reason: according to research firm Foresight Analytics LCC, $530 billion of commercial mortgages will be coming due for refinancing in the next three years -- with about $160 billion maturing in the next year. Credit, meanwhile, is practically nonexistent and cash flows from commercial property are siphoning off.

"Unlike home loans, which borrowers repay after a set period of time, commercial mortgages usually are underwritten for five, seven or 10 years with big payments due at the end. At that point, they typically need to be refinanced. A borrower's inability to refinance could force it to give up the property to the lender.

"A recent letter sent to Treasury Secretary Henry Paulson, and signed by a dozen real-estate trade groups, painted a bleak scenario: "Right now, we believe there is insufficient systemic capacity to refinance expiring, performing commercial real-estate loans," said the letter. "For many borrowers, [credit] simply is not available," the letter noted.

"To head off some of the impending pain, the industry is asking to be included in a new $200 billion loan program initially created by the government to salvage the market for car loans, student loans and credit-card debt. This money is intended to go directly to help investors finance purchases of securities backed by these assets. If commercial real estate is included, banks might have an incentive to make more loans to developers since they'd be able to repackage and sell them more easily to investors with the assurance of government backing."

I've been saying for months on end that once you open the Pandora's Box of bailouts, you won't be able to shut it again. The government and the Fed are now on the verge of subsidizing everything from the home mortgage market to the credit card business to (potentially) the commercial real estate industry.

This is rapidly becoming a national disgrace. Whatever happened to free markets? The concept of failure for those who rolled the dice and lost? Sure it means the economy would sink into a deeper recession in the shorter-term if we ended up with more bankruptcies and foreclosures. But you know what? That's what happens to economies that binge on too much credit. You have to go through a period of pain to cleanse the bad loans, work off the excesses, and set the stage for a healthy economic rebound. Trying to get in the way of the economic cycle over and over again hasn't exactly worked out well. Witness the gigantic housing bubble we got in the wake of the dot-com bust, partially caused by the Fed's interest rate moves (which were designed to counter the tech-bust-driven recession).

Construction activity slumping further; Keeping an eye on commercial

So we got the latest construction spending figures this morning. In January, overall spending dropped 1.7% -- much worse than the 0.7% decline that was forecast and the biggest decline in any month going back to January 1994. December's monthly change was also revised down to -1.3% from -1.1%.

Now here's where it gets interesting. Residential spending fell 2.9%, exactly what you would expect given what we know about housing. But nonresidential spending also declined for the second month in a row: -0.8% after a -0.5% drop in December. Total PRIVATE non-residential spending fell 1.2%, let by a 3% drop in lodging spending, a 5.6% drop in communication spending, a 2.5% decline in transportation spending and a 4.5% fall in power spending.

The commercial construction and real estate markets continued to prosper after residential began rolling over. But now the commercial market appears to be losing steam, just as I've been expecting it to for some time. The Wall Street Journal dug into the potential ramifications of that unfolding trend this morning:

"After suffering a beating from their exposure to home loans, banks and securities firms are about to take their lumps from office towers, hotels and other commercial real estate. And the losses could last longer than those from the subprime shakeout.

"As the economy wobbles and financing costs rise because of the credit crunch, commercial-real-estate values are starting to slide, with analysts at Goldman Sachs Group Inc. projecting a decline of 21% to 26% in the next two years. That means misery for securities firms with exposure to commercial-real-estate loans and commercial- mortgage-backed securities.

"William Tanona, a Goldman analyst, expects total write-downs of $7.2 billion by Bear Stearns Cos., Citigroup Inc., J.P. Morgan Chase & Co., Lehman Brothers Holdings Inc., Merrill Lynch & Co. and Morgan Stanley in the first quarter. Those firms had combined commercial-real-estate exposure of $141 billion at the end of the fourth quarter."

More losses on commercial R.E. loans looming

The evidence of a second real estate crisis -- this time, focused on the commercial sector -- continues to pile up. According to the following Bloomberg story this morning, the next batch of banking sector earnings reports could be rather ugly ...

"Synovus Financial Corp., Comerica Inc. and Huntington Bancshares Inc. are among regional banks that may face a second wave of real-estate loan losses, this time for shopping centers and residential construction projects.

"Losses in commercial real estate excluding construction are expected to increase tenfold, Deutsche Bank AG analyst Mike Mayo said in a Jan. 5 research note. Moody’s Investors Service said yesterday it’s considering a downgrade of Synovus because of commercial real estate losses.

"Borrowers have fallen behind on payments to regional lenders as the year-old recession shutters retail stores and offices.

"Overdue commercial real estate loans quadrupled from two years earlier in the third quarter to 4.73 percent, according to seasonally adjusted data from the Federal Reserve. That’s the highest level since 1994.

"We’re overbuilt in a lot of areas like shopping malls,” said Bruce McCain, chief investment strategist at Key Private Bank in Cleveland. Apartment developments are also suffering as falling home prices draw people away, he said. “The fundamentals are on the verge of going really, really negative for commercial,” McCain said."

First American: 19.8% of borrowers with mortgages now "upside down" -- Plus, more on CRE

First American CoreLogic is a company that tracks all kinds of mortgage and property data. The firm's latest report on "underwater" or "upside down" borrowers -- those who owe more on their mortgages than their homes are worth -- suggests the problem is getting worse.

More than 8.3 million mortgages exceeded the value of the homes securing them in Q4 2008, up from 7.6 million in Q3 2008. That's a whopping 19.8% of all homes that have mortgages against them. Add in those loans that are near the negative equity threshold, and you get a reading of 25% of all U.S. loans. Some more insight from First American on the meaning of these numbers can be found at this Wall Street Journal link.

Meanwhile, I like this Bloomberg story that details how and why lenders and loan investors are STILL hugely reluctant to cut mortgage principal balances ... and how that could doom the Obama rescue plan to the "dud parade" of federal bailout programs. Good reading.

Finally, it looks like the moronic commercial real estate investments made at the peak of that market are coming back to bite investors in a big way. If you had any doubt that big money managers could make the same stupid mistakes in commercial as casual house flippers did in residential, this story should put that out of your mind:

"In a sign that pension funds and other institutional investors are about to get clobbered by losses in commercial real estate, Morgan Stanley told investors to expect as much as a 60% fourth-quarter write-down on the equity in a marquee $8.8 billion real-estate fund, according to a letter reviewed by The Wall Street Journal.

"Morgan Stanley hailed the commercial-property MSREF VI International fund as "the largest-ever real-estate fund" when it announced its debut in June 2007. The Wall Street firm projected a 22.4% overall average annual return for the vehicle, which made big, highly leveraged investments on commercial properties scattered mostly in Japan, Germany, China and Australia.

"The fourth-quarter losses come on top of a $1 billion shortfall during the first nine months of 2008, which means the fund has lost about two-thirds of its $6.5 billion in invested capital in 18 months. Among the fund's bad bets: a $3 billion acquisition of more than two dozen office buildings in Germany in July 2007 at a very low yield of 3.5%. The fund invested $350 million of equity in the project. As of September, Morgan Stanley valued the equity stake at just $23 million, according to the fund's third-quarter report."

Oops.

Beige Book: The economy stinks ... again

I used that headline before, minus the word "again." I think it's time to dust it off and throw it up here on the blog again. I say that because the latest Fed Beige Book goes on for page after page, talking about how horrid the economy is (in Fed-speak, of course). Here are a few of the more interesting excerpts on ..

The big picture:

"Ten of the twelve reports indicated weaker conditions or declines in economic activity; the exceptions were Philadelphia and Chicago, which reported that their regional economies "remained weak." The deterioration was broad based, with only a few sectors such as basic food production and pharmaceuticals appearing to be exceptions. Looking ahead, contacts from various Districts rate the prospects for near-term improvement in economic conditions as poor, with a significant pickup not expected before late 2009 or early 2010."

Consumer spending:

"Sales of luxury goods such as jewelry, electronic equipment, and other big ticket items were reported to be especially slow in the Philadelphia, Richmond, and Chicago Districts. Demand for furniture, appliances, and other durable household items remained quite depressed, according to Kansas City and San Francisco. Sales of new automobiles and light trucks remained exceptionally sluggish, with Philadelphia, Richmond, and Kansas City reporting further declines from an already slow pace of sales."

Dining out and travelling:

"Travel and tourist activity continued to fall in most areas, as households reduced their vacation travel and corporate travel spending was scaled back. Tourist visits and spending were reported to be slower than in the previous reporting period or down from twelve months earlier for major tourist destinations in the Richmond, Atlanta, Minneapolis, New York, and San Francisco Districts, with the declines in the latter two characterized as "substantial" and "sharp," respectively. Airline traffic fell in the Kansas City, Dallas, and San Francisco Districts. Business at restaurants dropped substantially in some areas, notably in the Kansas City and San Francisco Districts, with extensive layoffs and restaurant closures reported in the latter."

Temporary help and transportation:

"Demand for staffing services weakened considerably. Boston reported that outcomes for providers of temporary staffing services were "dismal," with revenue declines in the range of 20 to 50 percent compared with twelve months earlier. Chicago and Dallas also reported sizable declines in activity by staffing firms, and New York noted that activity by a major employment agency has "virtually ground to a halt."

"Demand for shipping and transportation services fell further. New York, Cleveland, Richmond, and Atlanta reported reduced activity and layoffs among trucking and rail companies, with the decline in activity described as considerable in some cases. Richmond also reported that shipping activity through ports in that District slowed further, as imports and exports both continued on a downward trend."

Manufacturing:

"Manufacturing activity fell on net in all Districts, with very sharp declines recorded for some sectors and only partial offsets provided by the few bright spots. Cleveland reported a drop in overall factory output of about 25 percent compared with twelve months earlier. For most Districts, the drop in activity was especially pronounced for makers of capital goods and construction-related equipment and materials, such as primary metals, wood products, and electrical equipment, along with consumer durables such as autos and furniture. Manufacturers of computers, semiconductors, and other IT products saw further declines in production and orders in the Dallas and San Francisco Districts. Slower export sales were cited as a source of weakness for various manufacturing sectors by the Atlanta, Chicago, and Kansas City Districts."

Residential and commercial real estate:

"Residential real estate markets remained in the doldrums in most areas, with only scattered, very tentative signs of stabilization reported. The pace of sales remained very low in most areas and declined further in some; most Districts reported small declines, but New York cited a sales drop of 60 to 65 percent in Manhattan compared with twelve months earlier. By contrast, Cleveland, Richmond, Dallas, and San Francisco each reported a rising or better-than-expected sales pace for existing or new homes in some areas, attributed largely to falling prices and improved financing terms for some types of home mortgages. House prices continued to decline, reportedly at double-digit paces in some areas, with little or no signs of a deceleration evident. Builders in various Districts generally remain pessimistic regarding recovery prospects this year, and consequently the pace of new home construction declined further in most areas.

"Demand for commercial, industrial, and retail space fell further during the reporting period, with some evidence of more rapid deterioration than in preceding periods. Vacancy rates rose and lease rates declined on a widespread basis; New York noted that commercial real estate markets "weakened noticeably," while Atlanta described reports on commercial real estate that were "decidedly more negative" than in previous periods. Construction activity has declined commensurately, and assorted reports suggest that market participants expect this weakness to continue at least through the end of 2009. Cleveland noted that public works projects have shown stability of late, although they declined in the San Francisco District as a result of the budgetary struggles of some state and local governments there. Credit constraints and uncertainty were reported to be a drag on commercial construction and leasing activity in the Philadelphia, Chicago, Dallas, and San Francisco Districts."

Banking risks rising: FDIC

The FDIC just released its latest regional and state-by-state bank performance report. Some key statements from the release announcing the report can be found below (with areas of particular interest bolded by me)

"Moderate to strong job growth across much of the nation is helping to support loan growth and credit quality at federally insured banks and thrifts," said FDIC Chief Economist Richard A. Brown. "However, heavy dependence on mortgage and construction lending is making some banks more vulnerable to regional downturns in real estate activity."

In today's report, FDIC analysts noted that while average U.S. home prices increased at a double-digit rate for the second consecutive year, rising inventories and slowing sales point to possible moderation in housing activity for the remainder of 2006. Analysts also noted rapid growth in commercial real estate (CRE) and construction and development (C&D) lending and higher concentrations of these loan types as a percent of capital.

The bottom line is this: The nation's banks are loaded to the gills with real estate loans -- both residential and commercial. Right now, bank stock investors don't seem to care. They're paying attention to every little word out of the Fed, waiting for someone to say, in effect, "We're done tightening. You can go ahead and buy everything in sight." But with the housing market already going over a cliff, and commercial real estate valuations stretched to the max, the risk of real credit problems down the road is building.

The "key" to losing a lot of money? Making too many real estate loans

That seems to be the lesson from this after the bell news out of KeyCorp. The super-regional bank (the nation's 24th largest by assets as of Q2, per American Banker) announced wide-ranging losses related to its real estate lending exposure, as well as several changes to its business plans ...

* Key has a $3.7 billion portfolio of residential property commercial real estate development loans (meaning loans to developers to build homes and condos, as opposed to individual mortgages to home buyers). It said it will no longer make such loans to many home builders outside of its regional banking "footprint." It will also transfer roughly $1.1 billion of its loans to builders -- and $800 million of its condominium construction loans -- to a special asset management group. Recall that Wells Fargo recently did something similar with a portfolio of consumer home equity loans.

* Key also noted that residential real estate development loan conditions are deteriorating in places like Florida and California. That will result in net loan charge-offs of $110 million to $120 million. in Q4 Nonperforming assets are going to surge by 34% in the quarter ($195 million) from Q3 levels.

* Credit market turmoil is also hurting the valuation of commercial mortgage loans in its held for sale portfolio, and impacting the valuation of certain real estate investments. Total additional losses: $55 million to $65 million.

* The company said it would get out of the national home improvement lending business. It makes dealer-originated loans to fund improvement projects, with a portfolio of $1.4 billion.

* All told, Key plans to cut 740 jobs as a result of these actions, and leave 300 other open positions unfilled. The company's bottom-line Q4 forecast? A per-share loss of 5 cents, versus expectations for a profit of 66 cents.

Dissecting the Oct. jobs report ...

So overall nonfarm payrolls rose in October (92,000), but less than expected. Where was the weakness? Where was the strength?

Sectors with notable gains:
mining (+4,600)
clothing/accessories stores (+6,000)
transportation/warehousing (+6,800)
Publishing (+3,700)
Finance and insurance (+6,400)
Management and technical consulting (+11,700)
Administrative and waste services (+24,000)
Health care and social assistance (+27,600)
Food service and drinking places (26,700)
Local government (+39,000) -- big teacher hiring

Sectors with notable losses:
Construction of buildings (-6,100)
Specialty trade contractors (-22,000) -- residential contractors took a huge hit, while nonresidential was up several thousand
Durable goods manufacturing (-19,000) -- autos, furniture, fabricated metal, and wood products particularly bad
Nondurable goods manufacturing (-20,000) -- plastics and rubber worst off, but lots of categories saw little hits
Real estate/rental/leasing (-4,800)

This isn't a complete list of all categories, but some trends are clear: Residential real estate and sectors related to it are in big trouble ... commercial real estate is still okay ... and food service/health care/entertainment/local government sectors are where the biggest job growth can be found right now.

Whether that holds up, though, depends on the broader economy. I have my suspicions about retail and commercial real estate -- both could get whacked if consumer spending continues to show signs of slowing and/or if hiring doesn't pick up. Those factors would hurt retail hiring, demand for mall and office space, etc.

No avoiding the CRE elephant in the room

While there have been some "green shoots" emerging in the residential real estate market in select areas, there is nothing of the sort happening in the commercial real estate (CRE) market. Commercial lags residential during declines and recoveries, and I believe we are still deeply mired in a CRE cesspool. Of course, some of us were warning well in advance that this debacle was coming (see here, here, and here) so this shouldn't come as a surprise.

More from the New York Times today ...

"Though it came as no surprise to investors, the collapse of General Growth Properties, the nation’s second-largest mall owner, has stirred new fears about a coming debacle in commercial real estate, The New York Times’s Terry Pristin writes. The company, which owns 200 shopping centers encompassing 200 million square feet and 24,000 tenants, filed for bankruptcy protection last week.

"With the credit markets virtually shut down, General Growth said it was unable to refinance the $3.3 billion in debt that had already matured or would be due this year. These included loans totaling $900 million on two malls in Las Vegas — Fashion Show and the Shoppes at the Palazzo — that were due to be repaid in November. An additional $6.4 billion in debt matures next year.

"The global credit crisis, weakening retail demand and rising unemployment have taken a toll on commercial property around the world. At least $153 billion worth of property is already in distress, according to Real Capital Analytics, a New York research company. Of this, $87.1 billion represents defaulted mortgages, while the rest is outstanding debt from about 40 commercial-property and investment companies that have failed, most of them outside the United States."

FDIC QBP: Earnings down, "problem" institutions up, charge-off rate at 17-year high and more

The FDIC just released its latest Quarterly Banking Profile (PDF link), or QBP report. This is a comprehensive report that provides a wealth of data about the health of the banking industry. Some highlights (or lowlights, as the case may be; emphasis added by m):

* Insured commercial banks and savings institutions reported net income of $5.0 billion for the second quarter of 2008. This is the second-lowest quarterly total since 1991 and is $31.8 billion (86.5 percent) less than the industry earned in the second quarter of 2007. Higher loan-loss provisions were the most significant factor in the earnings decline.

* Loss provisions totaled $50.2 billion, more than four times the $11.4 billion quarterly total of a year ago. Second-quarter provisions absorbed almost one-third (31.9 percent) of the industry’s net operating revenue (net interest income plus total noninterest income), the highest proportion since the third quarter of 1989.

* Loan losses registered a sizable jump in the second quarter, as loss rates on real estate loans increased sharply at many large lenders. Net charge-offs of loans and leases totaled $26.4 billion in the second quarter, almost triple the $8.9 billion that was charged off in the second quarter of 2007. The annualized net charge-off rate in the second quarter was 1.32 percent, compared to 0.49 percent a year earlier. This is the highest quarterly charge-off rate for the industry since the fourth quarter of 1991.

* Net chargeoffs increased year-over-year for all major loan categories in the second quarter. Charge-offs of 1-4 family residential mortgage loans increased by $5.8 billion (821.9 percent), while charge-offs of real estate construction and land development loans rose by $3.2 billion (1,226.6 percent). Net charge-offs of home equity loans were $2.8 billion (632.7 percent) higher than a year earlier, charge-offs of loans to commercial and industrial (C&I) borrowers were up by $1.8 billion (127.5 percent), credit card charge-offs increased by $1.7 billion (47.4 percent), and charge-offs of other loans to individuals grew by $1.4 billion (70.3 percent).

* The amount of loans and leases that were noncurrent (90 days or more past due or in nonaccrual status) rose for a ninth consecutive quarter, increasing by $26.7 billion (19.6 percent). This is the second-largest quarterly increase in noncurrent loans during the nine-quarter streak, after the $27.0-billion increase in the fourth quarter of 2007 when quarterly net charge-offs were $10 billion lower.

* All major loan categories registered increased levels of noncurrent loans in the second quarter. The amount of 1-4 family residential real estate loans that were noncurrent increased by $11.7 billion (21.2 percent) during the quarter, while noncurrent real estate construction and land development loans rose by $8.2 billion (27.2 percent). Large increases were also reported in loans secured by nonfarm nonresidential real estate properties (up $2.0 billion, or 19.6 percent), C&I loans (up $1.8 billion, or 15.0 percent), and home equity loans (up $1.7 billion, or 25.5 percent). At the end of June, the percentage of the industry’s total loans and leases that were noncurrent stood at 2.04 percent, the highest level since the third quarter of 1993.

* For the third consecutive quarter, insured institutions added almost twice as much in loan-loss provisions to their reserves for losses as they charged-off for bad loans. Provisions exceeded charge-offs by $23.8 billion in the second quarter, and industry reserves rose by $23.1 billion (19.1 percent). The industry’s ratio of reserves to total loans and leases increased from 1.52 percent to 1.80 percent, its highest level since the middle of 1996. However, for the ninth consecutive quarter, increases in noncurrent loans surpassed growth in reserves, and the industry’s “coverage ratio” fell very slightly, from 88.9 cents in reserves for every $1.00 in noncurrent loans, to 88.5 cents, a 15-year low for the ratio.

* A majority of institutions (60.0 percent) reported declines in their total risk-based capital ratios during the quarter. More than half (50.9 percent) of the 4,056 institutions that paid dividends in the second quarter of 2007 reported smaller dividend payments in the second quarter of 2008, including 673 institutions that paid no quarterly dividend. Dividend payments in the second quarter totaled $17.7 billion, less than half the $40.9 billion insured institutions paid a year earlier. Even with reduced dividend payments, fewer than half of all institutions (45.5 percent) reported higher levels of retained earnings compared to a year ago.

* Two insured institutions failed during the quarter, bringing the total for the first six months of 2008 to four failures. Three mutually owned savings banks, with combined assets of $1.1 billion, converted to stock ownership in the second quarter. The number of institutions on the FDIC’s “Problem List” increased from 90 to 117 during the quarter. Assets of “problem” institutions increased from $26.3 billion to $78.3 billion.

* The Deposit Insurance Fund (DIF) decreased by 11.7 percent ($7.6 billion) during the second quarter to $45,217 million (unaudited). Accrued assessment income added $640 million to the DIF during the second quarter. The fund received $1.6 billion from unrealized gains on available for sale securities and took in $395 million from interest on securities and other revenue, net of operating expenses. The reduction in DIF came primarily from $10.2 billion in additional provisions for insurance losses. These included provisions for failures that have occurred so far in the third quarter.

The DIF’s reserve ratio equaled 1.01 percent on June 30, 2008, 18 basis points lower than the previous quarter and 20 basis points lower than June 30 of last year. This was the lowest reserve ratio since March 31, 1995, when the reserve ratio for a combined BIF and SAIF stood at 0.98 percent.

Beige Book shows broad economic stability. Nothing more. Nothing less.

The latest Beige Book report on the state of the economy was just released by the Fed. The summary suggests we're seeing more stability and/or gradual improvement in the economy:

"Reports from the twelve Federal Reserve Districts indicate that economic conditions have generally improved modestly since the last report. Eight Districts indicated some pickup in activity or improvement in conditions, while the remaining four--Philadelphia, Cleveland, Richmond, and Atlanta--reported that conditions were little changed and/or mixed."

On housing, the report confirms my prediction months ago that the market was slowly but surely finding its footing. But the outlook for commercial real estate remains pretty awful. A brief excerpt:

"Residential real estate conditions were somewhat improved from very low levels, on balance, led by the lower end of the market. Most Districts reported some pickup in home sales, though prices were generally said to be flat or declining modestly; residential construction was characterized as weak, but some Districts did note some pickup in activity. Commercial real estate markets and construction activity were depicted as very weak and, in many cases, deteriorating."

Other nuggets of information: Retail sales have a better tenor. The job market still stinks, but is not getting worse. Lean inventories will likely need to be rebuilt. Lending conditions remain tight, while demand for new credit is anemic.

All in all, it's a "blah" report -- not so hot, not so cold.

Better get a bigger container

The "well-contained" credit problems keep growing. Now there are signs of trouble ...

At Credit Suisse (from the Wall Street Journal):

"Swiss bank Credit Suisse Group, until now relatively unscathed by the credit crisis, Tuesday said first-quarter earnings will be reduced by $1 billion from mismarkings and pricing errors by traders which led to the reduction in the value of some asset-backed securities by $2.85 billion.

"The news came only a week after the company reported robust fourth-quarter profits largely free of any impact from subprime-credit exposure. The Zurich-based bank said it is reviewing whether the change in value of the securities will impact last year's earnings as well.

"In the first quarter to date, we estimate we remain profitable after giving effect to these reductions," the bank said."

At Lehman Brothers (also from the WSJ):

"Many investors have been surprised at the ability of Lehman Brothers Holdings Inc. to navigate the credit crunch, given the size of its exposure to potential land mines.

"But there are growing signs that the New York investment bank's latest quarter will be the rockiest since the mortgage crisis began. Behind the worry: Lehman is sitting on a big pile of commercial real-estate loans, and that market is deteriorating, potentially causing bigger-than-expected write-downs.

"In recent weeks, credit markets have worsened, and Lehman believes it is now facing a write-down in the $1.3 billion range, according to people familiar with the matter. That has risen from a recent estimate of $800 million to $1 billion, and from a $830 million write-down in the fourth quarter."

At Bank of Montreal (from Bloomberg):

"Bank of Montreal, Canada's fourth- largest bank, said it will report costs of about C$325 million ($323.9 million) for trading and investment writedowns in the first quarter.

"The Toronto-based bank also said in a statement today it named Thomas Flynn as Chief Risk Officer, replacing Robert McGlashan."

And in the leveraged loan market (once more from the WSJ):

"U.S. and European banks, already reeling from persistent losses on mortgage investments, are facing a new hit as the global financial crisis spreads to deteriorating corporate debt.

"UBS AG and Credit Suisse Group last week announced the write-down of a combined $400 million in the value of leveraged loans as part of their fourth-quarter earnings reports. That signals more misery right around the corner for banks that barreled into these low-rated corporate loans, which typically are issued by banks and sold to investors like junk bonds, and are stuck holding them. Leveraged loans served as buyout-related debt that fueled a merger boom until the credit slowdown.

"Credit Suisse, Switzerland's second-largest bank in stock-market value, valued its leveraged-finance portfolio of loans and bonds at a 6.3% discount as of Dec. 31. That suggests the loans and bonds have an average value of 93.7 cents on the dollar. Meanwhile, two corporate-loan credit-derivative indexes have fallen sharply in the past two weeks, indicating negative sentiment and falling demand.

"If the trend holds, analysts and investors are bracing for as much as $15 billion in leveraged-loan-related write-downs at commercial and investment banks in the first quarter, further depleting capital levels already sapped by the mortgage mess. Estimates of the markdowns range from 2% to 10%."

Indeed, U.S. banks are in such bad shape, they're tapping the Federal Reserve for massive amounts of money. Per the FT ...

"US banks have been quietly borrowing massive amounts of money from the Federal Reserve in recent weeks by using a new measure the Fed introduced two months ago to help ease the credit crunch.

"The use of the Fed’s Term Auction Facility, which allows banks to borrow at relatively attractive rates against a wider range of their assets than previously permitted, saw borrowing of nearly $50bn of one-month funds from the Fed by mid-February.

"US officials say the trend shows that financial authorities have become far more adept at channelling liquidity into the banking system to alleviate financial stress, after failing to calm money markets last year.

"However, the move has sparked unease among some analysts about the stress developing in opaque corners of the US banking system and the banks’ growing reliance on indirect forms of government support.

"The TAF ... allows the banks to borrow money against all sort of dodgy collateral,” says Christopher Wood, analyst at CLSA. “The banks are increasingly giving the Fed the garbage collateral nobody else wants to take ... [this] suggests a perilous condition for America’s banking system.”

I'm just going to go back to a long-standing message of mine -- This was NEVER just a residential mortgage problem. Lenders played fast and loose with credit in several markets, from residential real estate to commercial real estate to LBO-land. Now, they're paying the price.

Some interesting news on the CMBS market

For the past several months, this is what you've heard from the financial industry about the scope of the credit crisis:

"It's just subprime mortgages."

Then ...

"No, it's just Alt-A and subprime."

Then ...

"Okay, you're right. Prime doesn't look so hot anymore either. But clearly, it's just residential mortgages.

Then ...

"Those auto loans? Alright. You caught me there too. But that's it. I swear."

But time and again, I have made the point that this credit crunch was never the result of just reckless subprime residential mortgage originations. It's the result of stupid LBO lending ... stupid commercial mortgage lending ... high-risk Alt-A and prime mortgage lending ... risky auto lending ... and so on. While the residential mortgage lenders were the worst offenders, banks and nonbank lenders went overboard extending other forms of credit. Now they're paying the price.

In fact, it's no surprise whatsoever that I'm now reading stories like this one from Bloomberg. It talks about how spreads on commercial mortgage backed securities, or CMBS, are blowing out due to deterioration in the underlying commercial real estate market. An excerpt (with a key quote highlighted by me):

"Yields on commercial real estate securities relative to benchmarks rose to near record highs on concern that Riverton Apartments, a high-rise complex in Manhattan's Harlem neighborhood, will default on a loan.

"AAA rated commercial mortgage-backed bonds widened about 37 basis points to 305.57 basis points more than 10-year swap rates during the week ended yesterday according to data from Bank of America Corp. A basis point is 0.01 percentage point.

"The gap, or spread, jumped after a trustee report showed payments wouldn't be made by Rockpoint Group LLC and Stellar Management in September on a $225 million loan on the 1,230-unit Riverton. The property was refinanced in December 2006 using optimistic assumptions for anticipated income, a practice that became common as prices reached their peak, said Alan Todd, head of commercial-mortgage backed securities research at JPMorgan Chase & Co.

"It is indicative of the type of loans that were allowed to get securitized during this time,'' Todd, who is based in New York, said yesterday in a telephone interview."