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 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 7th 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 80th 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 98th 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
