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Wednesday, March 4, 2009

Geithner not really wowing ‘em; Bernanke pitches shorting commercial reits

Treasury Secretary Timothy Geithner emerged from his bunker to testify before congress on the merits of the new budget plan.  Congress seemed upset that their blank checks aren’t helping the stock market and Geithner was catching blame for things like AIG, which happened under the prior administration and while he was on watch at the New York Federal Reserve.  Recall the day Obama selected Geithner as Treasury Secretary, the market rallied 10%.  He has certainly had a quick fall from grace.

The administration continues to try to provide financing to consumers, unveiling a 200 billion dollar program to buy consumer-related debt such as those backed by student loans, car loans and credit card accounts.  It is likely this program will expand to cover heavy machinery and agriculture in its next stage, according to officials.  At some point this will benefit Caterpillar and John Deere, who rely on a rollover market to sell receivables to perpetuate working capital.

Bernanke also testified yesterday before the Senate Budget Committee.  He had this to say:

"There's a looming crisis in commercial real estate whereby owners of shopping malls, hotels, rental properties and many other types of buildings are unable to refinance or to pay for new construction because the (commercial) securitization market is completely shut down," Bernanke said during an appearance before the Senate Budget Committee.

Is Bernanke the new David Einhorn and announcing his favorite short picks in front of congress?   That would be AWESOME, but no, that’s probably not happening.  The more likely scenario is the Fed has identified commercial real estate as a nuclear zone on bank balance sheets and is trying to float the issue before congress so they’re not blindsided by it when he suggests solutions to the problem later.  As congress likes to accuse officials of missing the ball, he’s telling them in no uncertain terms that there will be an issue here and he’s aware of it.  Almost all of the damage control from the Fed has been after the fact – AIG and Citigroup received bridge loans because they would fail if they didn’t.  Bernanke is highlighting a problem that hasn’t gotten to the podium yet and by doing so, is calling attention to what is likely to blow up next.

Rents are getting slammed as occupancy rates fall and sub-leased space is hitting the market in droves.  Current square footage rates are likely to be reset significantly lower as leases come up for renewal.

Reits have grown aggressively through leverage under the assumption that pricing remains somewhat constant and that real estate prices always go up over time.  In fact, analysts value these stocks based upon their “funds from operations”, or FFO.  FFO is net income excluding gains/losses and depreciation expense.  It’s the depreciation expense removal that utterly distorts results.  Depreciation should be accelerated and included in FFO in a down real estate market, not ignored.  The assets are depreciating in value, why would you exclude that when looking at their operations?  It’s a ridiculous convention, like looking at internet stocks on price to sales in 2001.  Don’t bother, it’s over.

The problem is these businesses have been extended significant credit under those very optimistic assumptions.  When it comes to refinancing in a down market, there’s likely to be a very different evaluation criteria and one that many reits will not pass.  Don’t forget, banks are being told not to take risks.  Why loan to the over-levered?  They won’t.  The precedent has clearly been set by the many other crises of the last year.  It’s not up to banks to make bad loans to over-extended borrowers -- anymore.  It’s the Fed’s self-chosen mandate to make all the bad loans now.

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