THIS WEEK'S 
REPORT:

The BAN Report: GDP Turns Positive / How Higher Rates Impact CRE / Tech Woes / Credit Suisse Recapitalizes / The 10MM SNF Relationship

 

 

GDP Turns Positive

What recession? Today, the GDP showed strong 3rd quarter growth of 2.6%, exceeding expectations and ending the two consecutive quarters of negative GDP growth. 

The U.S. economy posted its first period of positive growth for 2022 in the third quarter, at least temporarily easing recession fears, the Bureau of Economic Analysis reported Thursday.

GDP, a sum of all the goods and services produced from July through September, increased at a 2.6% annualized pace for the period, according to the advance estimate. That was above against the Dow Jones forecast for 2.3%.

That reading follows consecutive negative quarters to start the year, meeting a commonly accepted definition of recession, though the National Bureau of Economic Research is generally considered the arbiter of downturns and expansions.

The growth came in large part due to a narrowing trade deficit, which economists expected and consider to be a one-off occurrence that won’t be repeated in future quarters.

GDP gains also came from increases in consumer spending, nonresidential fixed investment, and government spending. The report reflected an ongoing shift to services spending over goods, with spending on the former increasing 2.8% while goods spending dropped 1.2%.

Declines in residential fixed investment and private inventories offset the gains, the BEA said.

“Overall, while the 2.6% rebound in the third quarter more than reversed the decline in the first half of the year, we don’t expect this strength to be sustained,” wrote Paul Ashworth, chief North America economist at Capital Economics. “Exports will soon fade and domestic demand is getting crushed under the weight of higher interest rates. We expect the economy to enter a mild recession in the first half of next year.”

Surprisingly, the consumer is still spending strong, albeit on services and experiences, as opposed to goods. It remains to be seen how the economy holds up while the real estate industry is in a recession, and higher rates continue to circulate through economy.

How Higher Rates Impact CRE

 

HP Sori of TD Bank sent this out on LinkedIn last week. I thought this was a great example on how higher rates impact DSCR, property valuation, and the need for more equity. In the example above, it assumes NOI stays the same. For certain properties with long-term leases, rent bumps tend to be in the 1-3% range, so there is limited ability to benefit from higher inflation. For properties like apartments, hotels, industrial buildings with shorter term leases, the ability to raise rents may mitigate the higher debt costs.

We think that the short-term impact is a slowdown of transactions. Owners of buildings may be enjoying low-fixed rates on their properties and may not be under any pressure to sell. Just like residential housing sale activity has been drying up, commercial property sales seem to be seeing similar activity. Until sellers capitulate, many buyers will just wait on the sidelines for the deals they expect to see later.

According to the NAIOP CRE Sentiment Index, which is at the lowest level since September 2020,

“Respondents expect higher interest rates, higher cap rates, and a decrease in the supply of equity and debt over the next year. Respondents predict a sharper increase in cap rates and greater contraction in the supply of equity and debt than in any previous survey.”

 

The above chart from the National Association of Realtors shows the vacancy rate and 12-month rent growth by sector. Multi-family and Industrial properties have low vacancy rates, so they have the ability to raise rents to keep up with higher expenses. Office and retail properties are seeing rent growth below the inflation rate.

Tech Woes

After an extraordinary run, tech companies are being challenged by higher rates and inflation. 

 

Google this week reported a steep decline in profits. Social media companies such as Meta said that advertising sales — the heart of their businesses — have rapidly cooled off. And Microsoft, perhaps the tech industry’s most reliable performer, predicted a slowdown through at least the end of the year.

Tech companies led the way for the U.S. economy over the past decade and buoyed the stock market during the worst days of the coronavirus pandemic. Now, amid stubborn inflation and rising interest rates, even the biggest giants of Silicon Valley are signaling that tough days may be ahead.

The companies are navigating the same problems as the rest of the economy. Pumped up by aggressive consumer spending during the pandemic, they invested to keep up with demand. Now, as that spending is slowing, they’re trying to adjust. It hasn’t been easy.

Amazon, which had 798,000 employees at the beginning of 2020, is reining in expansion of its warehousing operations, mothballing buildings, pulling out of leases, and delaying plans to open facilities. The company employed 1.52 million people in the second quarter, almost 100,000 fewer than at the end of March.

But their sudden slowdown is exposing a weakness. The big tech companies haven’t really found a new, very profitable idea in years. Despite years of investment in new businesses, Google and Meta still rely mostly on ad sales. The iPhone, 15 years after it upended the industry, still drives Apple’s profits.

Tech companies are just not growing like they used to. In fact, some of them are not growing at all. Meta Platforms actually showed declining revenue in the last quarter. The challenges in tech are somewhat surprising as most large tech companies have hardly any debt. For example, Meta has no long-term debt and has more interest income than expense. Meta is investing in growth, but it’s not paid off yet as its Reality Labs unit for the metaverse has lost $9.4 billion so far in 2022 and revenue fell by 50%.  

Credit Suisse Recapitalizes

Credit Suisse today announced a plan to raise capital and cut costs.

Credit Suisse Group AG opted to tap investors for a painful multibillion-dollar capital raise to shore up confidence and fund a years-long reshaping that will carve out its investment bank and slash its headcount by 9,000. 

The stock dropped as much as 16% on the firm’s plans to raise 4 billion francs ($4.1 billion) through a rights issue and selling shares to investors including the Saudi National Bank. It’s effectively breaking up the investment bank, separating the advisory and capital markets unit and selling the majority of a trading business to a group led by Apollo Global Management Inc.

The moves mark an urgent attempt to restore credibility at Credit Suisse after a succession of big losses and management chaos shattered its status as one of Europe’s most prestigious lenders. Chief Executive Officer Ulrich Koerner and Chairman Axel Lehmann are already facing questions over whether the biggest overhaul in the bank’s recent history is radical enough and offers sufficient payoff for suffering shareholders. 

“The new Credit Suisse will definitely be profitable from 2024 onwards,” Koerner said in an interview with Bloomberg Television’s Francine Lacqua. “We do not want to overpromise and underdeliver, we want to do it the other way around.”

While the capital raise was difficult and caused a double-digit drop in its stock price, it does show that repeats of 2008 are not likely. A few weeks ago, the internet was flooded with false rumors of the firm, and pressure was building to act fast to protect wealthy depositors from fleeing the bank. They are hoping to get back a 6% return on tangible equity in 2025, which was slammed by analysts for its lack of ambition.

The 10MM SNF Relationship

Clark Street Capital’s Bank Asset Network (“BAN”) proudly presents: “The 10MM SNF Relationship” This exclusively offered portfolio is offered for sale by one institution (“Seller”). Highlights include:

  • A total payoff balance of $9,991,378.50 comprised of seven loans

  • The loans are secured by first mortgages on three properties, including two Skilled Nursing Facilities located in Ohio

  • The portfolio has a weighted average coupon of 7.87%

  • All loans are matured, but borrower continues to make payments based on an expired forbearance agreement

  • All loans include personal guarantees and are cross-defaulted and cross-collateralized

Files are scanned and available in a secure deal room and organized by credit, collateral, legal, and correspondence with an Asset Summary Report, financial statements, and collateral information. Based on the information presented, a buyer should be able to complete the vast majority of their due diligence remotely. 

Timeline:

  • Sale Announcement: Thursday, October 27, 2022

  • Due Diligence Materials Available Online: Monday, October 31, 2022

  • Indicative Bid Date: Thursday, November 17, 2022

  • Closing Date: Thursday, December 1, 2022

Please click here for more information on the portfolio. You will be able to execute the confidentiality agreement electronically.