Year: 2023

Unpacking the commercial real estate problem

From Axios:

Data: Moody’s Analytics; Chart: Axios Visuals

If you’re waiting for the commercial real estate apocalypse to hit, it might be a while — maybe forever, Emily writes.

Commercial real estate, particularly the office sector, is slumping — and the regional banks that lend to the space aren’t looking so hot either — leading to concerns about a “doom loop.”

• “There’s definitely been an overreaction in the market about the relationship between banks and CRE [commercial real estate],” said Kevin Fagan, a senior director and head of CRE economic analysis at Moody’s Analytics.

Market watchers were spooked by Federal Reserve data showing that the holders of commercial real estate loans are a highly concentrated group — with small and regional U.S. banks (those not in the top 25) collectively holding 67%.

Stock of outstanding US commercial bank lending by small banks (% of total)

Source: Macrobond, ING

That eye-popping number turns out to be a bit misleading. Under the hood, the situation is more nuanced, as detailed in two reports from the Mortgage Bankers Association and Moody’s Analytics.

• The 67% figure includes loans backed by traditional commercial real estate — apartment complexes, office buildings, retail space — but it also includes construction loans, loans backing farmland, or loans to owner-occupied properties like two-family houses.
• (You can read more in the footnotes to this report from the Fed if you want to nerd out on this.)

The traditional commercial real estate lending market is incredibly diverse. That means borrowers should have options when it comes time to refinance.

• Banks — large and small — account for 39% of outstanding loans, per Moody’s Analytics.
• Regional banks hold just 14% of outstanding loans.
• Fannie Mae and Freddie Mac also make a lot of these loans as do life insurance companies. (The chart above has the breakdown.)

Regardless of the lender mix, there’s sure to be pain in the commercial real estate market in the coming years — likely driven by growing distress in the office building segment.

• Office loans represent about 17% of outstanding commercial real estate debt, as calculated by the MBA.
• Rents aren’t what they used to be, and building values are going to fall.
• With a glut of loans coming due soon, some will surely default. Morgan Stanley estimates that $1.5 trillion in commercial real estate debt is set to mature over the next two years.

“They’re not systemic risks to the overall economy,” says Fagan.

• Lower leverage in the system

Data: Moody’s Analytics; Chart: Axios Visuals

Commercial real estate underwriting standards improved after the global financial crisis — similar to what happened in the residential mortgage market. Loan-to-value (LTV) ratios are much lower now, as the chart above shows.

Borrowers have more equity (and proportionally smaller loans) on their properties.

• That’s going to help when it’s time to refinance these loans. Borrowers may still have a shot at affording new loans, despite lower building values and higher interest rates.
• And when defaults do happen, lower LTVs should mean smaller losses for the lenders.

IMF Says Banking Troubles Create Headwinds for Global Economy International lender sees growth slowing this year, then picking up

Total economic output is projected to increase 2.8% this year, a slowdown from 3.4% last year, as nations continue recovering from slumps caused by the pandemic and the war in Ukraine, the IMF said in its latest World Economic Outlook report. Its new 2023 forecast was little changed—just 0.1 percentage point lower—from its January projection.

The multilateral financial organization also sees global growth accelerating to 3% next year, the report said, citing some encouraging signs.

China’s reopening after its long pandemic lockdowns is injecting vigor into the Asian economy. The U.S. and European economies see their growth supported by resilient consumer demand and strong job markets. Emerging markets are expanding faster than rich countries, and supply-chain crunches seen during the pandemic and following Russia’s invasion of Ukraine are unwinding. 

The eurozone’s economy is forecast to expand by just 0.8% this year, down from 3.5% last year. The U.K.’s economy is projected to shrink by 0.3% in 2023 after expanding by 4% in 2022.

The U.S. economy is expected to grow 1.6% this year, down from 2.1% in 2022, the IMF said.

China’s growth, meanwhile, is seen accelerating to 5.2% this year from 3% last year.

Yet the risks to growth have grown significantly, IMF economists said, alluding to the banking system turmoil that erupted in March. (…) “We are seeing a lot of downside risks going forward.” (…)

The IMF forecasts global inflation to cool, with consumer prices rising 7% this year and 4.9% in 2024, compared with 8.7% in 2022. But the organization projects a slower ebbing of underlying core inflation, which excludes volatile energy and food prices. (…)

The IMF’s longer-term outlook remains dim. The global economy remains weighed down by the effects of the war in Ukraine and the growing rivalry between the U.S. and China. The IMF has cautioned against economic fragmentation, or the breakup of the world trading system into rival blocs comprising either the U.S. and its allies or China, Russia and their allies.

Looking five years ahead, the IMF forecasts global economic growth of 3% in 2028, the lowest such forecast in decades.

• Fed Officials Signal Divide Over Whether to Hike Rates Again New York chief John Williams says one more hike ‘reasonable’
• Fed Official: ‘We Need to Be Cautious’ on Raising Rates After Bank Failures “At moments like this of financial stress, the right monetary approach calls for prudence and patience,” said Chicago Fed President Austan Goolsbee.
• US Small Businesses Face Worst Credit in a Decade After SVB

A net 9% of owners who borrow frequently said financing was harder to get compared to three months earlier, the most since December 2012, according to a survey from the National Federation of Independent Business out Tuesday. The same share expects tougher credit conditions in the next three months, matching the highest level in a decade. (…)

The share of owners who say they believe the next three months will be a good time to expand fell to the lowest since 2009, the report showed. Firms also dialed back capital spending plans.

One in five owners expect to invest in equipment or structures in the next three to six months, the smallest share in two years. Companies scaled back hiring plans and compensation as well.

The survey also showed a net 15% said they expect weaker sales in the next three months, the largest share since August.

  

  

• US bankruptcies increased sharply this year.

Source: S&P Global Market Intelligence (via The Daily Shot)

Online Shopping’s Fast-Delivery Race Is Slowing Down Shoppers are showing more willingness to wait for deliveries as concerns over shipping costs grow.

(…) The dimming attention to speedy delivery comes as the broader boom in online shopping has pulled back, with growth trends now tracking closer to prepandemic levels. E-commerce surged from 11.9% of all U.S. retail sales in the first quarter of 2020 to 16.4% in the second quarter of that year, according to the U.S. Census Bureau. By the fourth quarter of 2022, the share was back down to 14.7%. (…)

Hmmm… This FRED chart using Census Bureau data shows continued rapid growth at nonstore retailers with their market share stabilized around 15-16% and still above trend but recently reaccelerating.

Investors Pull Cash From Oil Despite OPEC+ Cuts as Demand Fears Linger

One oil exchange-traded fund saw its largest one-day outflow in more than three years, a possible sign that some investors remain concerned about the outlook after OPEC+ delivered an unexpected supply cut.

WisdomTree’s Brent Crude Oil ETP — ticker BRNT — had an outflow of $55.7 million on Thursday, the largest one-day fall since late 2019. Another fund, the ProShares Ultra Bloomberg Crude Oil ETF — ticker UCO — saw outflows of $158.5 million last week. That’s its biggest weekly drop since March 2022. (…)

• Chipotle reveals all-electric, wind- and solar-powered restaurant

Chipotle unveiled an all-electric restaurant concept Tuesday that relies entirely on alternative energy to power its stoves, grills, electric car charging ports and more, Axios’ Kelly Tyko reports.

• Most of the restaurants’ energy will come from offsite wind and solar generation.

Chipotle has opened two restaurants with what it’s calling “responsible restaurant design” features so far: one in Gloucester, Virginia, and another in Jacksonville, Florida.

• A third is slated to open in Castle Rock, Colorado.
• Highlights include electric cooking equipment to replace gas-powered variants, rooftop solar panels and heat pump water heaters.

The reveal comes as Chipotle and other fast-food chains are under enormous pressure to reduce their carbon emissions.

• Several major fast-food and retail chains, including Subway, 7-Eleven and Walmart, have recently announced big pushes into electric vehicle charging as part of broader efforts to go green.

Chipotle aims to use all-electric equipment and at least some elements of its new design at more than 100 locations it plans to open in 2024.

S&P 500 2023 Q1 Earnings Preview: Entering an Earnings Recession

Earnings season kicks off this week and using data from the April 7^th publication of the S&P 500 Earnings Scorecard, 2023 Q1 blended earnings (combining estimates and actuals) are forecasted at $419.1 billion (-5.2% y/y, -4.7% q/q) while revenue is forecasted at $3,558.4 billion (+1.6% y/y, -5.5% q/q).

Q1 is expected to mark the second consecutive quarter of negative y/y earnings growth (third consecutive quarter of negative q/q growth) which meets the criteria of an earnings recession. Furthermore, Q1 aggregate earnings have declined by 11.5% from its high watermark set in 2022 Q2, when the index achieved $473.5 billion in earnings.  Finally, Q1 earnings growth is forecasted to be the lowest y/y growth rate since 2020 Q3.

The prior earnings recession started in 2020 Q2, lasting three quarters from start to finish.  Today’s earnings recession may also last three quarters if analyst expectations turn out to be correct as 2023 Q2 y/y growth is forecasted at -4.0%. (…)

Exhibit 2 highlights the trajectory of Q1 earnings growth, which peaked in April 2022 (+13.7%, +15.2% ex-energy) and has now reset to -5.2% y/y and -6.7% ex-energy.  Interestingly, the majority of Q1 downgrades finished by the beginning of March and has remained stable since (even after the banking collapse), which may indicate that analysts are adopting a ‘wait-and-see’ approach once new information is presented from companies.

Furthermore, ex-energy earnings growth is expected to be negative for the fourth consecutive quarter, surpassing the three quarters of negative ex-energy growth seen in 2020. (…)

When deconstructing the P/E ratio into ‘Price’ and ‘Earnings’, we continue to see one of the largest gaps between the two in recent years.

The S&P 500 forward 12-month P/E ratio is 18.3x, which ranks in the 80^th percentile (since 1985) and a 4.6% premium to its 10-year average (17.5x). For reference, the trough forward P/E during the last four recessions were as followed: 10.1x (Oct 1990), 17.3x (Sept 2001), 8.9x (Nov 2008), and 13.0x (March 2020).

Furthermore, the S&P 500 ‘PEG’ ratio is currently 1.9x which ranks in the 98^th percentile (since 1985) and a 35.7% premium to its 10-year average (1.4x).  The PEG ratio is expensive as the forward P/E continues to rise since the October low, while the long-term EPS growth rate expectations continue to decline. (…)

We also look at earnings growth contribution at a constituent level in Exhibit 3.1 and highlight the top 10 and bottom 10 contributors.  Amazon.com Inc is expected to deliver the lion share of earnings growth for Consumer Discretionary this quarter (1.2 ppt) while the same can be said for JPMorgan Chase & Co for the Financials sector (0.5 ppt).

Within Industrials, all three constituents in the top half of the table are related to the airline industry and are mainly benefitting from easy year-over-year comparisons, which can be considered a lower quality of earnings contribution.

In the bottom half of the table, Semiconductors continue to weigh down Information Technology while many of the large pharmaceutical constituents are expected to post negative earnings growth as it largely benefitted from vaccine sales last year. (…)

S&P 500 23Q1 Earnings Growth Contribution by Constituent

INFLATION WATCH

The U.S. CPI is out tomorrow.

US Online Prices Decline for a Seventh Month on Annual Basis

Online prices in the US dropped 1.7% in March from a year earlier, the seventh-straight decline and the sharpest retreat in four months.

More than half of the 18 categories tracked by Adobe Digital Price Index showed annual price declines, data released Monday showed. Compared to the prior month, online prices were flat in March. (…)

Meanwhile, grocery prices remain a tough spot for household budgets. While price gains have moderated over the past six months, they were up 10.3% in March from a year ago. Online grocery prices track the food category in the government’s consumer price index. (…)

More than 85% of the top 100 US Internet retailers are tracked by Adobe.

Goods deflation is back and is about to show up in official YoY stats.

• Manheim used car auction prices increased 1.3% to 40% above the pre-pandemic level in March (after adjusting for depreciation) and are now down just 11% from their peak (vs. a trough of 18% below their peak and consumer prices now 12% below their peak). We expect Wednesday’s CPI report to show that used car prices for consumers increased by 0.5% month-over-month in March. (GS)

But the main concern is with services with much hope on rent, still rising 8.8% YoY.:

This chart from Tricon Residential which rents 36,000 single family homes in the U.S. Sun Belt says that rent growth on new leases has indeed slowed from 16-20% during the pandemic to 9-11% since last fall. But renewals are still done at +6-7%, up from +4-5% pre-pandemic.

Tumbling Money Supply Alarms Economists Who Foresaw Inflation

Britain’s money-supply economists, who emerged from obscurity in the pandemic by correctly anticipating sky-high inflation before anyone else, are sounding the alarm again.

Money supply growth is collapsing in the UK, eurozone and US, and they read that as a warning of recession and deflation. Central bankers have raised interest rates too far and, if the so-called monetarists are proved right again, they say there should be a “clear out” of officials.

(…) for monetarists, growth and inflation are a function of the quantity of money in circulation and its velocity — the number of times it changes hands. Those measures are now pointing to a slump. (…)

Today, money supply is plummeting. In the eurozone, the six month rate of change of M3 broad money, which measures deposits and cash equivalents of up to three year maturities, is the weakest since the aftermath of the financial crisis in 2010. M1 narrow money, cash and overnight deposits, is negative for the first time since the currency bloc’s birth in 1999, RBC Capital Markets strategists said. (…)

“Annual broad money growth rates in the UK and Eurozone are well below their 2010s averages – associated with below-target inflation,” Ward said by email. “This is extremely worrying and suggests recession, disinflation and deflation.” (…)

Trends are more concerning in the US, it added, where deposits are “exiting the banking system” and putting “liquidity pressures” on the banks. (…)

What matters? Quantity or flow? Growth (flow) has slowed, but only because the quantity of money has stabilized at a very high level.

Here’s M2 per unit of nominal GDP (the inverse of velocity). Post GFC, the quantity of money rose rapidly, and exploded during the pandemic:

Yet, real GDP growth slowed since 2010 and is now 15% below trend. But the S&P 500 Index is 110% above trend (charts from Advisor Perspectives). That’s where money inflation went.

• BofA’s Regime Indicator suggests that the economy has entered a downturn. (The Daily Shot)

In Europe:

Bank lending survey: banks tightening of lending conditions not seen since 2009.

Macrobond (via The Market Ear)

Yesterday, I had these charts relating to the U.S.:

New loan program expected to put homeownership within reach for more Californians

(…) Cal HFA has been providing down payment assistance for low- and moderate-income first-time home buyers for years. But now, a new program is set to supercharge their ability to help. It’s called the California Dream For All Shared Appreciation Loan program.

“It’s available to low- and moderate-income. So the upper income limit is $211,000,” Martin said.

The loans pay for a down payment and closing costs. (…)

“The state of California can give up to 20% for a down payment and closing costs. It’s a 0% interest rate. The payments are deferred for the entire life of the loan,” explained Evans.

Evans said the new loan program has a shared equity program.

“When you sell the property or refinance the loan, they take up to 20% of the appreciation. The homeowner gets to keep 80%,” he said. (…)

The state only has $300 million in the program and with thousands of Californians expected to apply, that money is expected to go fast.

A blueprint for other states?

China Consumer Price Growth Eases, Reflecting Caution on the Economy Inflation in China eased for the second straight month in March despite signs of a pickup in the economy.

Consumer prices rose just 0.7% in March from a year earlier, China’s National Bureau of Statistics said Tuesday, the lowest annual rate of inflation since September 2021.

March’s reading was weaker than the 1.0% annual rate recorded in February and the 0.9% rate expected by economists polled by The Wall Street Journal. (…)

Unemployment in China is stubbornly high—especially among young people—with just over 18% of those aged 16 to 24 out of work in February. (…)

While signals from business surveys, cinema box-office receipts and traffic and public transit data suggest China’s economy bounced back in the first quarter of the year as consumers flocked back to stores and restaurants, other data imply consumers are wary about spending on cars and other big-ticket items while continuing to sock away cash rather than run down savings. (…)

Tuesday’s data showed the slowdown in inflation was driven by weaker food-price inflation, with prices for vegetables tumbling 11.1% from a year earlier. Nonfood inflation also slowed.

Prices charged by producers at the factory gate, meantime, fell 2.5% from a year earlier, another sign that inflationary pressures in China are weak. That was a steeper fall than the 1.4% decline recorded in February.

(Bloomberg)

China Auto Parts Makers Join Apple in Offshore Factory Push

Chinese car parts makers are facing growing pressure from overseas customers to set up factories outside the country as mounting trade tensions and three years of Covid lockdowns make them wary of relying too heavily on China.

Carmakers from Europe and elsewhere are making direct overtures to manufacturers of everything from cooling components to brake systems and auto charging parts, pressing them establish plants in places like Vietnam and Indonesia so they can still benefit from their expertise and long-held relationships but avoid the risks China poses right now, according to a number of suppliers interviewed by Bloomberg News. (…)

It’s not just auto parts makers feeling the pressure of what has come to be known as China+1: the push to establish at least one factory outside the home base of China. Most notably, Apple Inc. and its suppliers are moving production out of the country. Foxconn Technology Group plans to invest about $700 million on a new plant to make iPhone components in India, while AirPods maker GoerTek Inc. is plowing an initial $280 million into a new Vietnam facility and considering expanding in India. 

“Firms are moving away from a cost-driven strategy to a resilience-driven strategy,” said Ben Simpfendorfer, a partner at Hong Kong-based consultancy Oliver Wyman. “The resilience is by adding an extra factory or more in a different part of the world,” he said, adding that the pandemic and trade tensions have brought into sharper focus the fragility of global supply chains. (…)

For the first time in about 25 years, China isn’t a top three investment priority for a majority of US firms, an American Chamber of Commerce in China survey showed. The survey also found the proportion of companies moving supply chains elsewhere, or considering doing so, had almost doubled from a year ago. (…)

A survey it [the European Chamber of Commerce in China] conducted last year showed that 23% respondents were considering shifting their current or planned investments out of China, the highest on record. (…)

New Bank of Japan Chief Says He Will Maintain Easy Money Kazuo Ueda said he would maintain monetary easing and negative interest rates despite expectations for an early policy change.

“We will continue the monetary easing adopted by the previous leadership,” Mr. Ueda said at a news conference Monday night after finishing his first weekday on the job. He became governor on Sunday, succeeding Haruhiko Kuroda.

Mr. Ueda said that achieving sustainable and stable 2% inflation was “the project of many years” and he wanted to finish it. It is also “not an easy goal,” he said. (…)

Inflation reached 4% late last year mainly because of higher costs of imported energy and food, but it slowed to 3.3% in February, and the central bank forecasts that the rate will fall below 2% later this year. (…)

“There are also positive signs in wages. This could continue and lead to achieving stable and sustainable 2% trend inflation.” (…)