A reader wrote me complaining about the nonsensical bubble blowing in multi-family properties before the last bubble was even finished bursting. I feel his pain. Let's run through a quick pictorial of how I see the macro climate for real estate as of right now...
I invite all to peruse the mainstream financial media and sell side Wall Street's take on JP Morgan's Q1 earnings before reading through my take. Pray thee tell me, why is there such a distinct difference? Below are excerpts from the our review of JP Morgan's Q1 results, available to paying subscribers (including valuation and scenario analysis): JPM Q1 2011 Review & Analysis.
Here we go...
There's Something Fishy at the House of Morgan
JPMorgan’s Q1 net revenue declined 9% y-o-y ad 3% q-o-q to $25.2bn as non-interest revenues declined 5% y-o-y (down 5% q-o-q) to $13.3bn while net interest income declined 13% y-o-y and (-2% q-o-q) to $12.5bn. However, despite decline in net revenues, noninterest expenses were flat at $16bn. Non-interest expenses as proportion of revenues went was 63% in Q1 2011 compared with 58% a year ago and 61% in Q4 2010. However, due to substantial decline in provision for credit losses which were slashed 83% y-o-y (63% q-o-q) to $1.2bn from $7.0bn, PBT was up 78% y-o-y (15% q-o-q).
Lower reserve for loan losses and consequent decline in Eyles test (an efficacy of ability to absorb credit losses) coupled with higher expected wave of foreclosures which is masked by lengthening foreclosure period and overhang of shadow inventory, advocate a cautionary outlook for banking and financial institutions. As a result of consecutive under-provisioning since the start of 2010, JP Morgan’s Eyles test have turned negative and is the worst since at least the last 17 quarters. The estimated loan losses after exhausting entire loan loss reserves could still eat upto 8% of tangible equity.
As nearly every proclamation and warning that I have given in 2010 has come to pass in 2011, the coming mass restructuring of the European banking system is nigh upon us. Let me make this perfectly clear. Despite what you may have heard, those banks and institutions holding and hoarding EU periphery debt are getting slaughtered. Let's walk through the simply math. I borrow €100 million with €10 million equity and purchase €110 million in bonds from Greece at par. These bonds are now roughly half of what I paid for them. That is a €55 million loss on a €10 million equity investment. A 550% loss! This is not rocket science, yet there are many who are dismissing this concept as sensationalist. Try dismissing it as basic math, first!
Exactly one year ago tomorrow, I went through this scenario in the article "How Greece Killed Its Own Banks!", which my regular readers should be quite familiar with.
Bloomberg has on their front page: Bernanke Briefings May Offset Fed Hawks With Words as New Tool
When Federal Reserve Chairman Ben S. Bernanke convenes his first press conference next week, he may emphasize a point the markets seem to have forgotten: He’s serious about keeping interest rates low for an "extended period."
Shortly thereafter, CNBC runs at the top of their page: S&P Affirms US AAA Ratings While Revising Outlook to Negative (story developing), Futures Sink; S&P: U.S. Outlook to Negative
Broad market futures are currently down 15 points or so. You have heard me warn about the upcoming interest rate storm, potentially ad nauseum. Well, the chickens are coming home to roost.
Reggie Middleton ON CNBC’s Fast Money Discussing Hopium in Real Estate Friday, February 25th, 2011
Of the major economic powers, China is the only economy that is facing true inflation as I see it and China is primed for a hard landing - at best. The US, EU, and UK face stagflation. After the AP excerpt below is a clip from my recent keynote presentation at the ING Real Estate Valuation seminar in Amsterdam on this very timely topic.
LONDON (AP) — Rising inflation around the world weighed on stock markets Friday as investors wondered how fast central banks will raise borrowing costs to counter the threat of rising prices, while the euro was undermined by ongoing worries that Greece will have to restructure its massive debts.
Figures Friday reinforced market expectations that both the European Central Bank and the People's Bank of China will soon be raising interest rates again to counter rising inflation.
In China, figures showed consumer prices rose 5.4 percent in the year to March, up from February's 4.9 percent. The increase was largely driven by surging food costs and represents a setback for the government, which has boosted interest rates four times since October to cool prices.
Analysts expect the People's Bank to enact further measures in the days to come in response to those figures.
Here is a collection of my archived posts on the topic:
- Economic contractions AND rising prices, dare Reggie utter the “I” word – Enter a global phenomenon
- Reggie Middleton’s Take on Investing for Inflation, pt. 1
- Reggie Middleton’s Take on Investing for Inflation, pt. 2
- Reggie Middleton’s Take on Investing for Inflation, pt. 3
- Reggie Middleton’s Take on Investing for Inflation, pt. 4
- Reggie Middleton’s Take on Investing for Inflation, pt. 5
- More on my stagflation rant
- Deflation, Inflation or Stagflation – You Be the Judge!
- Is My Warning of the Risks of a Stagflationary Environment Coming to Fore?
- China’s Most Expensive Export: Price Inflation
Attention subscribers: related content is available for download: BoomBustBlog Complimentary FX Index model
I’m fresh back from my trip to Amsterdam where I lectured ING institutional clients and staff on the potential of a European banking collapse. Below are a few clips from the first of two lectures.
Now that the mainstream media has been reporting what BoomBustBloggers knew as fact as far back as two years ago. Today, the FT printed an article titled “Greek debt hit by restructuring fears“, whose pertinent points are as follows:
The euro tumbled on Thursday and premiums charged on Greek debt over Germany’s hit euro-era highs after the countries’ respective finance ministers talked of Greece needing more time and raised the prospect of debt restructuring.
In an interview with the Financial Times, George Papaconstantinou said Greece needed more time to convince international investors of its commitment to reform its finances.
Separately, Wolfgang Schauble, Germany’s finance minister, told Die Welt newspaper that, if a study already under way showed Greece’s debt levels were unsustainable, “further measures” would have to be taken.
When asked what those could be, he ruled out any involuntary restructuring before 2013, but warned investors could face losses after that point… Yields on Greek two-year bonds jumped nearly a full percentage point to 17.884 per cent.
… “Greek bonds are getting crushed today due to the comments from the German finance minister and the Greek equivalent,” said Gary Jenkins, head of fixed income at Evolution Securities. “The European Stability Mechanism allows a roadmap towards restructuring, indeed it insists upon it if debt cannot be restored to a sustainable path.”
Investors… flight left yields on equivalent Greek debt 24bp higher at 13.162 per cent while Portuguese 10-year notes yielded 8.88 per cent, up 14bp. Mr Jenkins said investors expected that any restructuring would start with Greece trying to extend repayment deadlines on existing debt, or asking investors to “forgive” interest on the loans. But he warned it could take more than that. “Ultimately we believe that if the idea is to get the debt back to a sustainable level then the target will be the Maastricht treaty limit of debt-to-GDP of 60 per cent. In order to reach that level bonds will have to take a haircut of some 62 per cent,” he said.
Online Spreadsheets (professional and institutional subscribers only)
Professional and institutional subscribers should feel free to look at a variety of haircut scenarios via out proprietary sensitivity analysis for the Greek head grooming. If you remember last year when illustrated How Greece Killed Its Own Banks!, you realize the main reason why the EU has been using the kids gloves with the Greeks. To make a long story short, let’s employ the old adage “A picture is worth a 1,000 words”…
Insolvency! The gorging on quickly to be devalued debt was the absolutely last thing the Greek banks needed as they were suffering from a classic run on the bank due to deposits being pulled out at a record pace. So assuming the aforementioned drain on liquidity from a bank run (mitigated in part or in full by support from the ECB), imagine what happens when a very significant portion of your bond portfolio performs as follows (please note that these numbers were drawn before the bond market route of the 27th)…
The same hypothetical leveraged positions expressed as a percentage gain or loss…
When I first started writing this post this morning, the only other bond markets getting hit were Portugal’s. After the aforementioned downgraded, I would assume we can expect significantly more activity. As you can, those holding these bonds on a leveraged basis (basically any bank that holds the bonds) has gotten literally toasted. We have discovered several entities that are flushed with sovereign debt and I am turning significantly more bearish against them. Subscribers, please reference the following:
- Leveraged European Entities from a Sovereign Risk Perspective – retail
- Leveraged European Entities from a Sovereign Risk Perspective – professional
If you think those charts look painful, imagine if the Maastricht treaty was actually respected. Our models haven’t pushed passed 80% debt to GDP, but if you were to put the treaty’s debt ceiling in you would see the very definition of contagion. The following chart represents the first order consequences of a 62% haircut on Greek debt…
From ZeroHedge: Greek 10 Year-Bund spreads just passed 1,000 for the first time ever and were last trading north. Following this statement from Germany's Hoyer, it seems all hell is about to break loose for peripheral spreads.
- *GERMANY WOULD BACK VOLUNTARY GREEK RESTRUCTURING, HOYER SAYS
- *GREEK DEFICIT CUTTING MAY NOT BE ENOUGH, HOYER SAYS
- *GERMANY ‘WORRIED’ ABOUT GREEK FISCAL DEVELOPMENTS, HOYER SAYS
- *GREEK DEBT RESTRUCTURING `WOULD NOT BE A DISASTER,' HOYER SAYS
- *GERMAN EUROPE MINISTER HOYER SPEAKS IN INTERVIEW IN BERLIN
As anticipated last October, reality is catching p with the banking industry and JP Morgan in particular. From CNBC:
U.S. banks such as JP Morgan Chase & Co. and Bank of America Corp. may report weak revenue for the first quarter after lending by the industry dropped in almost every category.
I discussed the inevitability of this occurrence on CNBC's Squawk on the Street - 10/19/2010
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JP Morgan's share price has increased, and they have been authorized to reinstitute their dividends, despite the following minor issues:
- Residential housing, where the vast majority of JPM's loans reside, has not only resumed its downward slide in terms of price but has also exacerbated it - In Case You Didn’t Get The Memo, The US Is In a Real Estate Depression That Is About To Get Much Worse and The Latest Case Shiller Index – Housing Continues Freefall In Aggressive Search For Equilibrium
- JPM's lawsuits and aggregate legal exposure has literally ballooned - see JP Morgan Purposely Downplayed Litigation Risk That Spiked 5,000% Last Year & Is Still Severely Under Reserved By Over $4 Billion!!! Shareholder Lawyers Should Be Scrambling Now and Less Than 24 Hours After My Warning Of Extensive Legal Risk In The Banking Industry, The Massachusetts Supreme Court Drops THE BOMB!
- Shadow inventory in the states is being compounded by the foreclosure issues, of which JPM is at the forefront - The 3rd Quarter in Review, and More Importantly How the Shadow Inventory System in the US is Disguising the Equivalent of a Dozen Ambac Bankruptcies!
- Despite a materially worsening housing market wherein JPM is a major lender, legal issues up the whazoo, and a spike in prospective shadow inventory, JP Morgan as reduced its risk reserves - An Unbiased Review of JP Morgan’s Q1 2010 Results Yields Less Roses Than the Maintream Media Presents“…
More on the topic:
Posting will be sparse until Thursday, as I cater to business out of town. In the meantime, I think readers may benefit from more of my dated writings on inflation.
As stated in part one of my inflation series of blog posts, I am not sure if we will have rampant inflation in the near to medium term (and I believe anyone who thinks they can accurately forecast such is in la-la land), but it is evident that interest rates and energy prices are going up while the effective affordability of major consumer items are going down. For instance, mortgage rates, 10 year treasuries, oil and gasoline have all spiked up recently. Home affordability, contrary to many reports in the popular media, is actually down. Without employment (or the promise of continued employment), it is harder to buy a home. Down payments are now a considerable barrier to many when it was not before. Now let it be known that I am far from an economist. I am a mere investor, but since most economists had no idea this malaise was coming and I saw it clearly, I am more than comfortable in issuing my 24 cents (it was my two cents, but I levered up 12x!).
For anybody who didn't catch the hint, another banking crisis the continuation of the banking crisis is inevitable. I've said it before, Is Another Banking Crisis Inevitable? This is the current landscape, undoubtedly fudged over by optimistic marks.
Banks NPAs to total loans
Source: IMF, Boombust research and analytics
Euro banks remain weak as compared to their US counterparts
Health of European banks is weaker when compared to US banks. European banks are highly leveraged compared to their US counterparts (11.1x versus 4.1x) and are undercapitalized with core capital ratio of 6.5x vs. 8.5x. Also, the profitability of European banks is lower with net interest margin of 1.2% compared with 3.3%. However, non-performing loans-to-total loans for European banks are slightly better off when compared to US with NPL/loans at 4.9% vs. 5.6%. Nonetheless, considering the backdrop of high exposure to sovereign debt in Euro peripheral countries, we could see substantial write-downs for Euro banks AFS and HTM portfolio, which would more than offsets the relative strength of loan portfolio.
I really do mean substantial!
Credit rating agency Moody's cut Portugal's sovereign debt by one notch on Tuesday, saying it believed an incoming government would need to seek financing support from the European Union as a matter of urgency.Moody's cut its rating on Portugal's long-term government bonds to BAA1 from A3 and said the country's debt was still under negative review, with further downgrades dependent on Lisbon's ability to secure medium-term funding.
..."...Moody's believes that the government's current cost of funding is nearing a level that is unsustainable, even in the short-term," the ratings agency said on a statement.
...Portugal's president dissolved parliament last week and set June 5 as the date for the next polls, meaning the country is effectively in limbo for two more months.
...While Portugal can probably go on funding itself for the next eight weeks - it has to refinance 4.3 billion euros ($6.1 billion) of debt in April and 4.9 billion in June - the cost of doing so is likely to go on being punitively high.
Events are unfolding precisely as paying subscribers should anticipate. A quick recap:
- Portugal Is On The Verge Of Tapping Out, UFC Style – You Knew It Was Coming, Here’s The Analysis! Thursday, March 31st, 2011
- ECB Swallows Massive Portuguese Bond Losses As It Is Clear That The Third State Will Soon Join The Bailout Brigade – Haircuts, Here We Come!!! Friday, February 18th, 2011
- The Coming Interest Rate Volatility, Sovereign Contagion, Geo-political Unrest & Double-Dip Recessions: Here’s The Answer To Valuing Global Real Estate Through This Mess Tuesday, February 15th, 2011
If one were to dig deeper into link number 1, above, you will see the impetus (with specificity) behind this next headline: CNBC - Portugal Banks Threaten to Shun Bonds: Report