The BAN Report: Credit Suisse / 12 Things in Credit / UN Steps In / On Chess Cheating / The 20MM OOCRE Loan Portfolio
Over the weekend, I received multiple texts and emails that Credit Suisse was not going to make it. Back in 2008, we didn’t have Twitter or platforms like it that magnify rumors and create stories out of nonsense. And, after all of that, the stock went up on Monday! So, first off, we now live in an environment where rumors become premature facts. Bloomberg though had a sobering account of what ails Credit Suisse.
Credit Suisse Group AG is in a tight spot, but it isn’t “on the brink,” as the fevered typists of social media imagined over the weekend. The Swiss bank, however, is going through its darkest hours at exactly the worst time, when markets are volatile and everyone is nervous about what’s around the corner. Disappointment is still more likely than disaster.
The terms of trade in financial markets are worsening for all players. This is a new era of higher volatility as policymakers raise interest rates to battle inflation, increasing trading costs and risks. It’s a time when missteps by politicians or central banks can suddenly expose surprising concentrations of risk — just look at last week’s entanglement between the UK government bond market and Britain’s pension funds.
Unfortunately for Credit Suisse, this is going to encourage companies, investors, and savers to do more business at banks with the strongest balance sheets and most stable business models, making speed crucial for Chairman Axel Lehmann to complete the bank’s strategic review and get its restructuring underway. On the one hand, the Swiss lender is just suffering a more exaggerated version of the travails of its peers. But the collapse in its share price and sharp rise in the cost of buying insurance on its bonds are making its turnaround harder. And there’s another three weeks until it’s scheduled to tell investors how it will cut back its investment bank to focus more on wealth management.
As we enter choppier times, regulators are demanding more capital. It’s been said the acronym for the FDIC is “Forever Demanding Increased Capital.” We have had conversations with bank clients in which their regulators are telling them they need more capital when they were just fine back in January. More from Bloomberg:
The biggest global banks have a lot more capital than they did when the last major crisis hit in 2008, and Credit Suisse does indeed stand out. As of June, its leverage ratio — a relatively simple measure of capital as a share of assets — was 6.1%, significantly higher than those of systemically important European peers such as BNP Paribas SA and Deutsche Bank AG.
In the US, levels are likewise much improved since the financial crisis, though they’ve declined somewhat in recent years. For the four largest US banks, the weighted average ratio of tangible equity to tangible assets stood at 6% in June, down from a peak of 8.4% in 2015. (That’s not exactly comparable to European banks, due to differing definitions of assets and capital.)
Problem is, experience and research suggest they’d all need a lot more to survive a severe crisis and still have enough left to inspire confidence. Back in 2009, during the darkest days of the subprime mortgage bust, the International Monetary Fund projected that total losses on loans and securities would amount, on average, to almost 8% in the US and Europe. Some research suggests they’d need about twice that much capital to bring the probability of bailouts down to an acceptable level.
The prescription for policy makers in the US and Europe is simple: Hold the line on capital, and keep pushing for more. The danger of having too little far exceeds that of demanding too much.
Well said – the bar is going up and some banks may need more capital than intended. While this is 20/20 hindsight, a lot of banks could have raised cheap capital last year and didn’t to their regret.
12 Things in Credit
Kroll Bond Rating Agency had a good feature on what to look for in credit today.
1. Wealth effect. It’s real, and it’s been a big part of the consumer’s willingness to spend. Now, it’s falling.
2. The default cycle. We’ll dimension what this upcoming one looks like.
3. Volatility and financial stability. One-offs are creeping in, but contagion figures to remain at bay.
4. Corporate earnings. A spate of Q3 warnings are out, but FedEx’s really makes us think.
5. Fed tightening. The central bank’s new and more realistic projections are an affront to risk.
6. The price of credit. With what we’re facing, does current pricing make sense?
7. The hot CPI print. The likelihood of the Fed overtightening has gone up.
8. The U.S. consumer. Normalization will be a drag on economic growth.
9. Investor risk appetite. A more negative recent turn tells us financial conditions are starting to bite.
10. Credit crunch. How real is it?
11. Growth slowdown. Tightening is starting to bite.
12. Corporate earnings. Estimates have to come down, but what is the risk to credit?
Here’s what they said about the falling wealth effect.
But we all know what’s happened to the consumer’s largest asset, their stock portfolio, in 2022. We estimate stock market losses since year-end have accounted overwhelmingly for the $13 trillion, or 9%, fall in consumer net worth. And now, we are just starting to see softness in consumers’ second largest asset, residential real estate, which was down 0.6% in July from the June level, according to the Federal Housing Finance Agency (FHFA) national home price index. Notably, that is the first negative print since May 2020. We also believe the level of excess savings, estimated to be $2.5 trillion at yearend, is also running down, especially in lower income cohorts.
The point is, when you add it all up, a big drop in equities coupled with cracks in the residential housing market means Americans do not feel as flush as they did at year-end. The absolute downdraft doesn’t feel all that material, at 9%, which should really be viewed as folks giving back just a bit of what had been outsized gains. But sentiment is a function not only of a logical response, but also an emotional one. So, while the logical part suggests Americans continue to have plenty of spending capability, the emotional part will weigh on consumer sentiment and their willingness to spend as we head into the downturn.
While these are all areas to look at, it should be noted that the stress to the system is occurring when companies and individuals have a lot of cash, the job market is still robust, and banks continue to lend. If a severe drop in demand occurs, how quickly can the Fed act so they are not exacerbating a down cycle?
UN Steps In
The United Nations this week warned that the Fed and other central banks could be pushing the global economy into a recession with its interest rate increases. I can’t remember the UN ever intervening in interest rates, so this is certainly a first.
The Federal Reserve and other central banks risk pushing the global economy into recession followed by prolonged stagnation if they keep raising interest rates, a United Nations agency said Monday.
The warning comes amid growing unease about the haste with which the Fed and its counterparts are raising borrowing costs to contain surging inflation. India’s central bank Friday said that the global economy was facing a third major shock after the Covid-19 pandemic and Russia’s invasion of Ukraine, in the form of aggressive rate increases by central banks in rich countries.
In its annual report on the global economic outlook, the United Nations Conference on Trade and Development said the Fed risks causing significant harm to developing countries if it persists with rapid rate rises. The agency estimated that a percentage point rise in the Fed’s key interest rate lowers economic output in other rich countries by 0.5%, and economic output in poor countries by 0.8% over the subsequent three years.
UNCTAD estimated that the Fed’s rate increases so far this year would reduce poor countries’ economic output by $360 billion over three years, and further policy tightening would do additional harm.
The strong US dollar is hurting emerging markets, which is probably what the UN is most worried about.
Compared with other currencies, the U.S. dollar is the strongest it has been in two decades. It is rising because the Federal Reserve has increased interest rates sharply to combat inflation and because America’s economic health is better than most. Together, these factors have attracted investors from all over the world. Sometimes they simply buy dollars, but even if investors buy other assets, like government bonds, they need dollars to do so — in each case pushing up the currency’s value.
That strength has become much of the world’s weakness. The dollar is the de facto currency for global trade, and its steep rise is squeezing dozens of lower-income nations, chiefly those that rely heavily on imports of food and oil and borrow in dollars to fund them.
While the Fed is not going to care too much what the UN thinks, pressure will continue to build on the Fed to soften its approach. And that pressure will only increase next year. While there is a risk that the Fed overcorrects, there is also a risk that we don’t fix the inflation problem and take our foot off the gas too early.
On Chess Cheating
As an avid chess player and someone involved in the chess community, playing in tournaments, and doing some volunteer teaching, everyone has been asking me my opinion on the cheating allegations directed towards Hans Niemann. This week, the WSJ showed that Mr. Niemann has cheated online far more than he previously admitted.
When world chess champion Magnus Carlsen last month suggested that American grandmaster Hans Moke Niemann was a cheater, the 19-year-old Niemann launched an impassioned defense. Niemann said he had cheated, but only at two points in his life, describing them as youthful indiscretions committed when he was 12 and 16 years old.
Now, however, an investigation into Niemann’s play—conducted by Chess.com, an online platform where many top players compete—has found the scope of his cheating to be far wider and longer-lasting than he publicly admitted.
The report, reviewed by The Wall Street Journal, alleges that Niemann likely received illegal assistance in more than 100 online games, as recently as 2020. Those matches included contests in which prize money was on the line. The site uses a variety of cheating-detection tools, including analytics that compare moves to those recommended by chess engines, which are capable of beating even the greatest human players every time.
The report states that Niemann privately confessed to the allegations, and that he was subsequently banned from the site for a period of time.
The 72-page report also flagged what it described as irregularities in Niemann’s rise through the elite ranks of competitive, in-person chess. It highlights “many remarkable signals and unusual patterns in Hans’ path as a player.”
While it says Niemann’s improvement has been “statistically extraordinary,” Chess.com noted that it hasn’t historically been involved with cheat detection for classical over-the-board chess, and it stopped short of any conclusive statements about whether he has cheated in person. Still, it pointed to several of Niemann’s strongest events, which it believes “merit further investigation based on the data.” FIDE, chess’s world governing body, is conducting its own investigation into the Niemann-Carlsen affair.
“Outside his online play, Hans is the fastest rising top player in Classical [over-the-board] chess in modern history,” the report says, while comparing his progress to the game’s brightest rising stars. “Looking purely at rating, Hans should be classified as a member of this group of top young players. While we don’t doubt that Hans is a talented player, we note that his results are statistically extraordinary.”
Initially, I thought the allegations against Niemann were sour grapes from Magnus Carlsen, the world chess champion. But, after reading the chess.com report, it seems more and more likely that Niemann has cheated in other ways.
How does one cheat in chess? It’s quite easy. Any computer engine on a smartphone can beat the best players in the world. If you’re able to somehow transmit the best moves from a smartphone or a laptop to a chess player either constantly or at critical times, it would be an enormous advantage. Before chess cheating became a problem, people used to cheat by leaving a phone in the bathroom and checking it at a critical moment of the game.
At the highest levels though, the moves for the games are transmitted instantly online. During any big event, there is real-time commentary from grandmasters using these powerful chess engines. Someone could be sitting in the audience or somewhere else and they could somehow signal to the player what’s the best move. Most games have a handful of critical moments and assistance from a computer would be decisive.
Nevertheless, there is no smoking gun that Niemann cheated in an over-the-board game. But this is why integrity is so important. If you’re a cheater online, why wouldn’t you try to cheat in a high-stakes tournament? The solution going forward is straightforward. Every player needs to be thoroughly searched before a game and the players must play without the ability to see spectators.
For what its worth, people frequently make accusations about cheating online when they lose. I’ve been told I am using a computer multiple times, and I’ve never used the engine until the game is over.
The 20MM OOCRE Loan Portfolio
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A total outstanding balance of $19,091,941 comprised of 13 loans in ten relationships
86% of the portfolio is comprised of a single performing loan relationship secured by 13 franchise restaurants in multiple states, four of which include 1st mortgages on the real estate
Two all-or-none pools including a Restaurant pool ($16,470,903) and a Midwest pool ($2,545,343)
The Midwest pool is primarily secured by 1st mortgages on commercial real estate, including industrial (21%), car wash (17%), retail (17%), and restaurant (15%)
98% of the portfolio is performing and 2% is sub-performing
The loans have a weighted average coupon of 6.15% and 96% of the loans are variable rate
All loans include full personal recourse
Sale Announcement: Thursday, September 15, 2022
Due Diligence Materials Available Online: Monday, September 19, 2022
Indicative Bid Date: Thursday, October 13, 2022
Closing Date: Thursday, November 3, 2022
Please click here to view the executive summary. The confidentiality agreement is in the upper left hand corner.
The BAN Report: Inflation Update / Housing at 7% / Syndication Losses Likely if Twitter Deal Closes / Watching Football for $550
This morning, the CPI showed a four-decade high in US consumer inflation, excluding energy and food. In response, the ten-year Treasury briefly crossed 4% again this morning.
The Labor Department on Thursday said that the so-called core measure of the consumer price index—which excludes volatile energy and food prices—gained 6.6% in September from a year earlier, up from 6.3% in August. That marked the biggest increase since August 1982.
On a monthly basis, the core CPI rose 0.6% in September, the same as in August, and up from 0.3% in July. Investors and policy makers follow core inflation closely as a reflection of broad, underlying inflation and as a predictor of future inflation.
The overall CPI increased 8.2% in September from the same month a year ago, down from 8.3% in August. That was also lower than annual increases of 8.5% in July and 9.1% in June, which was the highest inflation rate in four decades. The CPI measures what consumers pay for goods and services.
The retreat of overall inflation from the June high came as gasoline prices cooled. But prices for housing, medical care, food, and other items have continued to increase, threatening to keep inflation higher for longer.
Housing costs rose by the most since the early 1980s, as a strong labor market continues to push up rental rates. Housing makes up the largest share of the overall and core indexes.
Prices for used cars and apparel cooled in September, offering limited relief to consumers from high inflation.
“Inflation has built up a lot of momentum over the last year,” said Bill Adams, chief economist at Comerica Bank. “That’s going to keep inflation higher than the Federal Reserve wants it for at least a couple more months—if not a couple more quarters.”
The resilience of the American economy, a source of great pride back in 2020, is now presenting problems. This report makes a 75-basis point hike in rates next month a near certainty.
Housing at 7%
Bloomberg wondered what happens to the housing market with 7% rates by interviewing Morgan Stanley housing strategist Jim Egan. The short answer – significantly less activity.
The structure of the mortgage market itself is very different today than when we compare it to 2004 to 2007. If I were to just take one specific aspect of it, it's the overwhelming percentage of mortgages that are fixed rate. We think that over 90% of the outstanding mortgage market is fixed rate. We were much more heavily skewed towards adjustable rate mortgages in the early 2000s. And so as mortgage rates went higher, the monthly payment for current homeowners was resetting higher as well. This time around, especially when you consider the record amount of mortgage origination volumes in 2020, the fact that we broke that in 2021 for a new record amount of mortgage originations, most of these homeowners were able to either buy their home or refinanced their mortgage at historically low rates. Their affordability is locked-in for 30 years. They're not seeing affordability deteriorate. This deterioration is coming for first time home buyers, prospective home buyers. That's where this sits.
And it's something we refer to as the lock-in effect. They're kind of locked-in to their current homes at these lower rates. And we mentioned housing activity versus home prices earlier. We do think this is going to lead to a different evolution of those two kind of paths of the housing market. Current homeowners, in order to sell their home in a lot of instances would have to take out a mortgage that might be 200, 250, 300 basis points higher than their current mortgage. That becomes prohibitively expensive when you combine it with how much equity they have in their homes. They're just not going to be willing to sell their home at the lower price point that might be more affordable for the first time home buyer.
Those who own homes likely have a fixed rate in the 3s or 2s. So, while a decline in home prices is certainly likely, inventory may stay low enough to keep the bottom from falling off. The markets seeing the biggest declines now have seen the biggest increases. According to Realtor.com, ten smaller cities are seeing high single digit declines right now. Take Austin for example:
Austin became the poster child for torrid housing market growth during the pandemic. Prices, sales, and incoming residents all skyrocketed. The city has become a tech hub in recent years, and the overall relative affordability of Texas has drawn newcomers from both coasts.
But, as the saying goes, what goes up must come down. After historic low inventories, more homes are now for sale. Prices dropped more than 10% in just the past three months, almost wiping out the gains seen over the past year. Austin is still up 2.2% year over year, but that’s the lowest remaining gain on the list.
In reviewing this list, which also includes Phoenix, AZ, Palm Bay, FL, Charleston, SC, Ogden, UT, Denver, CO, Las Vegas, NV, Stockton, CA, Durham, NC, and Spokane, WA, the COVID boomtowns seem to be seeing the most stress in the housing market. There are certainly employees that relocated to smaller cities, and now they may be under some pressure to go back to offices in larger cities.
So much here is unprecedented that predicting the direction of the housing market is virtually impossible. It does seem highly likely though that transaction volume goes way down, which has negative implications for title companies, real estate brokers, mortgage lenders, contractors, etc.
Syndication Losses Likely if Twitter Deal Closes
If the Elon Musk acquisition of Twitter closes, many banks are looking at losses if they look to unload the debt, due to the higher interest rates and tighter credit standards demanded by buyers of syndicated loans.
Banks that agreed to fund Elon Musk’s takeover of Twitter Inc. are facing the possibility of big losses now that the billionaire has shifted course and indicated a willingness to follow through with the deal, in the latest sign of trouble for debt markets that are crucial for funding takeovers.
The $44 billion deal, which Mr. Musk had been trying to walk away from, would be paid for in part with some $13 billion of debt seven banks including Morgan Stanley, Bank of America Corp. and Barclays BCS PLC agreed to provide when the takeover was sealed in April.
As is typical in leveraged buyouts, the banks planned to unload the debt rather than hold it on their books, but a decline in markets since April means that if they did so now they would be on the hook for losses that could run into the hundreds of millions, according to people familiar with the matter.
Banks are presently looking at an estimated $500 million in losses if they tried to unload all the debt to third-party investors, according to 9fin, a leveraged-finance analytics firm.
The debt package includes $6.5 billion in term loans, a $500 million revolving line of credit, $3 billion in secured bonds and $3 billion in unsecured bonds, according to public disclosures.
People familiar with Twitter’s debt-financing package said the banks built “flex” into the deal, which can help them reduce their losses. It enables them to raise the interest rates on the debt, meaning the company would be on the hook for higher interest costs, to try to attract more investors to buy it.
However, that flex is usually capped, and if investors still aren’t interested in the debt at higher interest rates, banks could eventually have to sell at a discount and absorb losses, or choose to hold the borrowings on their books.
The banks will have to either sell these loans at a loss or keep them and absorb the mark-to-market hit. It illustrates the risks of doing syndicated loans in a rapidly rising interest rate environment.
Watching Football for $550
It’s always fascinating in which something that used to be free can now be expensive. In Vegas, if you want to watch the NFL games at the casino with your friends, you may need to pay up.
Seats at the massive areas called sportsbooks, where guests can watch and bet on major sporting events, can now cost as much as—and sometimes more than—seeing one in person.
Football, a big draw for Las Vegas visitors from fantasy draft parties through the Super Bowl, has fast become a luxury proposition in the gambling and entertainment mecca. Casinos are banking on a souped-up experience to pull in fans who can bet on sports in many parts of the U.S. now.
When I entered the Caesars Palace sportsbook early this past Sunday morning, the host put a bright yellow bracelet on my wrist and ushered me to my reserved seat on a temporary riser more than 30 yards from the early Packers-Giants game airing from London.
I was in the cheap seats, relatively speaking. My spot in the cordoned-off “bleacher” section, nine rows of movie-theater style seats with cupholders, cost $92, with two tickets for less-than-top-shelf beer, wine or well drinks included. For a lounge chair in the heart of the sportsbook, Caesars was asking $280 for a seat that also came with a few free drinks. For $550, fans got unlimited drinks in a VIP section.
Plenty of Las Vegas destinations are asking similar prices, and filling those seats. The Cosmopolitan of Las Vegas required a $400 minimum spend on food and drinks to reserve a tiny high-top table for four in its sportsbook on college football Saturday and $600 on NFL Sunday. The spots sold out both days. Mirage was selling VIP seats for $258 on Saturday and $323 on Sunday, open bar included.
Top sportsbooks use sophisticated reservation systems to maximize revenue, much as they do with nightclubs and pools. Prices change based on demand and, in some cases, time of purchase.
People start lining up at 4 AM on weekends to watch the games at Circa, which has an outdoor pool with ten TV screens. That sounds both incredible and understandable at the same time. It’s basically the combination of nightclub bottle-service and a sports bar.
The BAN Report: Strong Bank Earnings / Liz Truss Resigns / College Enrollment Drops / Algos Boost Rents / Productivity Paranoia
Strong Bank Earnings
US Banks have posted strong earnings so far, and there are little signs of a weakening of credit so far. Take Bank of America, for example.
The company was the latest on Wall Street to offer a largely rosy assessment of the US consumer. Spending on BofA’s credit cards jumped 13% in the third quarter from a year earlier as consumers spent more on traveling and entertainment. Less-affluent consumers are still sitting on savings five times what they were before the pandemic. And the number of cars the bank repossesses in any given month has been cut in half.
Investors have been on edge while waiting to see how US consumers are holding up against surging prices and the Federal Reserve’s aggressive interest-rate hikes to fight inflation. While accounting rules did force the biggest US banks to set aside more in reserves for potential loan losses, putting a crimp on profits, executives are adamant they’re not seeing signs of stress from customers.
“These numbers are so low, we’re squinting to see a change here,” Chief Financial Officer Alastair Borthwick said on a conference call with analysts Monday, noting that delinquencies are at their second-lowest level of all time at Bank of America.
BofA’s results mirrored those reported last week by rivals JPMorgan Chase & Co. and Wells Fargo & Co. All three banks saw net charge-off rates in their credit-card portfolios decline from the second quarter even as spending on the firms’ cards soared.
“We are in an environment where it is kind of odd,” JPMorgan Chief Executive Officer Jamie Dimon told analysts on a conference call Friday. “Consumers are in very good shape, companies are in very good shape.”
Citigroup Inc. Chief Executive Officer Jane Fraser said her firm now believes the US economy will enter a mild recession by the end of next year as the Fed’s efforts to tame inflation weigh on economic growth. Still, she said, US consumers should be able to withstand it.
The US economy “remains relatively resilient,” Fraser said Friday. “So while we are seeing signs of economic slowing, consumers and corporates remain healthy, as our very low net credit losses demonstrate.”
Indeed, it’s not just consumers who seem to be holding up: Bank of America saw more upgrades for companies it lends to than downgrades, CEO Brian Moynihan said. The firm’s so-called commercial reservable criticized utilized exposure -- a measure of worsening corporate-credit quality -- dropped 27% to $17.7 billion in the quarter.
In a somewhat surprising turn, inflation has been lucrative for banks this year. Prices have risen just fast enough that shoppers are spending more, boosting the fees banks collect from merchants when cards are used at checkout, but the increases aren’t steep enough to keep consumers from traveling or making discretionary purchases. That spending, along with higher interest rates, has boosted the profits banks earn from credit-card lending.
In Hemingway’s, The Sun Also Rises, when asked how he went bankrupt, Mike replied, “Two ways. Gradually, then suddenly.” Of course, we are not seeing any deterioration at this point. While we are experiencing the most dramatic increase in rates since the early 80s, it will be a while before certain businesses and consumers buckle. The housing market appears to be in a recession, but the rest of the economy is humming along.
The consumer appears to still have plenty of gas. Take leisure travel for example. It appeared that there might be a travel slowdown this fall given inflation and a summer of revenge travel, but it hasn’t happened yet. For example, last Sunday, TSA screened 2.49 million air passengers – the highest number since February 2020.
Banks are certainly worried about credit. We are fielding calls from banks that are concerned about possible deterioration in their loan portfolios, but it’s hard to say it has occurred yet. Meanwhile, we are seeing no evidence of any pricing deterioration in the loan sale market, on both distressed and performing portfolios.
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Liz Truss Resigns
In a sign of political instability throughout the west, Prime Minister Liz Truss resigned today after only 44 days in office. How did this happen?
By the end of her tenure, according to a YouGov poll, Truss’s net favorability stood at minus-70 percent. If that figure had continued its downward slide, she would have been on track to overtake Russian President Vladimir Putin, who has a net favorability rating of minus-84 percent among members of the British public.
Truss became prime minister on Sept. 6 after being elected by members of the Conservative Party to replace Boris Johnson as their leader. Her first two weeks included the death of Queen Elizabeth II and were politically muted while the country entered a period of mourning.
But on Sept. 23, her finance minister, Kwasi Kwarteng, made a fatal misstep: Without any warning, he unveiled a significant shift in the country’s economic strategy, promising to slash taxes for the highest earners and biggest corporations — with no plans to pay for it.
Almost immediately, the British pound’s valuation tanked, the United Kingdom’s central bank was forced to hike interest rates, and the cost of taking out mortgages soared. Inflation — already at record highs — raised the cost of living further, shredding the Conservative Party’s reputation for fiscal responsibility. Some working-class voters who were drawn to Conservatives by their embrace of Brexit were turned off by a renewed sense that the party represented only the interests of financial elites.
Truss made so few public appearances in the ensuing days that one of her ministers, standing in for her during a parliamentary grilling, told lawmakers that the prime minister was “not under a desk” hiding — a reassurance that succeeded solely in prompting people to picture her doing just that.
Talk about a short honeymoon! The next shortest Prime Minister term excluding death was the Viscount Goderich, who lasted 144 days. The poor rollout of the tax plan was the culprit, especially since tax cuts are often popular. But, it shows how unpopular most world leaders are today. According to Morning Consult, 15 of the 22 countries surveyed had net negative approval ratings, including all seven G7 countries, including US (-10), Canada, (-8), France (-33), Germany (-40), Italy (-16), Japan (-38) and UK (-68). Unpopular leaders have a tough time getting anything done, let alone anything that may be politically unpopular.
College Enrollment Drops
Undergraduate enrollment continues to decline, although the rate of decline has slowed.
Total undergraduate and graduate enrollment combined declined 1.1% over last fall, leading to a total two-year decline of 3.2% since 2020. The total rate of decline has slowed by almost half since last year when it dropped 2.1% and a third since fall 2020’s 3.4% loss.
This preliminary fall data is based on 10.3 million undergraduate and graduate students, as reported by 63% of Title IV degree-granting institutions that are participating in the Clearinghouse as of September 29, 2022.
Undergraduate enrollment declines this fall are evident across all sectors especially among four-year institutions, with a drop of 1.6% at public four-years; 0.9% at private nonprofits; and 2.5% at private for-profits. Declines at community colleges have slowed, with only a 0.4% enrollment loss compared to fall 2021, driven by an 11.5% jump in dual-enrolled high school students.
“After two straight years of historically large losses, it is particularly troubling that numbers are still falling, especially among freshmen,” said Doug Shapiro, Executive Director, National Student Clearinghouse Research Center. “Although the decline has slowed and there are some bright spots, a path back to pre-pandemic enrollment levels is growing further out of reach.”
Also, the 18- to 20-year-old age group grew at community colleges by 1.4%, with an increase in traditional-age freshmen making up about one-third of the climb. Total freshman enrollment at community colleges appears to have stabilized for the first time since the start of the pandemic.
However, freshmen enrollment declined by 1.5% overall. Freshmen numbers declined in all four-year sectors, led by private nonprofits dropping 3.1%, publics declining 2.4%, and private for-profits losing 0.9%. Highly selective institutions saw the largest freshmen declines this fall of 5.6% compared to a 10.7% gain in fall 2021. Meanwhile, community colleges saw a 0.9% increase this fall, driving an upward trend of 1% freshmen growth at community colleges since fall 2020.
Furthermore, graduate enrollment declined 1%, which reverses last year’s 2.7% gain. This may signal the end of the pandemic-related influxes of post-baccalaureate students. However, graduate enrollment is still above pre-pandemic levels, with a total two-year change of 1.6% from fall 2020.
There seems to be a few factors at play. For one, expensive private colleges, especially those that are not as prestigious, are seeing weaker demand from budget-conscious students. Enrollment at community colleges continues to rise. Two, while foreign student enrollment has returned to pre-pandemic levels, the explosive growth from the prior decades has plateaued. Moreover, US universities are losing ground as they only have 34 of the top-100 universities, versus 34 in 2018.
Algos Boost Rents
Yield management software, popularized by American Airlines decades earlier, has taken over the property management industry and is fueling a strong increase in apartment rents.
“Never before have we seen these numbers,” said Jay Parsons, a vice president of RealPage, as conventiongoers wandered by. Apartment rents had recently shot up by as much as 14.5%, he said in a video touting the company’s services. Turning to his colleague, Parsons asked: What role had the software played?
I think it’s driving it, quite honestly,” answered Andrew Bowen, another RealPage executive. “As a property manager, very few of us would be willing to actually raise rents double digits within a single month by doing it manually.”
The celebratory remarks were more than swagger. For years, RealPage has sold software that uses data analytics to suggest daily prices for open units. Property managers across the United States have gushed about how the company’s algorithm boosts profits.
“The beauty of YieldStar is that it pushes you to go places that you wouldn’t have gone if you weren’t using it,” said Kortney Balas, director of revenue management at JVM Realty, referring to RealPage’s software in a testimonial video on the company’s website.
The nation’s largest property management firm, Greystar, found that even in one downturn, its buildings using YieldStar “outperformed their markets by 4.8%,” a significant premium above competitors, RealPage said in materials on its website. Greystar uses RealPage’s software to price tens of thousands of apartments.
RealPage became the nation’s dominant provider of such rent-setting software after federal regulators approved a controversial merger in 2017, a ProPublica investigation found, greatly expanding the company’s influence over apartment prices. The move helped the Texas-based company push the client base for its array of real estate tech services past 31,700 customers.
The impact is stark in some markets.
In one neighborhood in Seattle, ProPublica found, 70% of apartments were overseen by just 10 property managers, every single one of which used pricing software sold by RealPage.
To arrive at a recommended rent, the software deploys an algorithm — a set of mathematical rules — to analyze a trove of data RealPage gathers from clients, including private information on what nearby competitors charge.
For tenants, the system upends the practice of negotiating with apartment building staff. RealPage discourages bargaining with renters and has even recommended that landlords in some cases accept a lower occupancy rate in order to raise rents and make more money.
One of the algorithm’s developers told ProPublica that leasing agents had “too much empathy” compared to computer generated pricing.
Apartment managers can reject the software’s suggestions, but as many as 90% are adopted, according to former RealPage employees.
As multi-family properties are increasingly owned and managed by fewer and larger operators, properties are becoming far more efficient. Before this software became popular, landlords would often keep rent increases minimal for longstanding tenants, in order to reduce vacancy and keep stable tenants.
“Productivity paranoia,” coined by Microsoft chief Satya Nadella, is the new term to describe the not-so-new concern that workers aren’t as effective (or honest) at home, and it appears to be intensifying amid recession forecasts. Some 85% of leaders in a recent survey by the software company said hybrid arrangements make it hard for them to know how productive employees really are.
The mistrust goes beyond doubts about effort and output, and follows two years of high employee turnover. In some places, it begins before hiring.
In online meetings, it can be difficult to tell who’s paying attention to Zoom and who’s cruising Zillow.
And those email and Slack time stamps? They don’t necessarily show when someone is working. Anyone can compose a bunch of messages in the morning, schedule them to be delivered later, and take the afternoon off.
Measuring the frequency of such shenanigans is tough, and work-from-anywhere evangelists preach that managers ought to stop fretting about how and when stuff gets done—as long as it gets done.
Still, a few horror stories can reinforce bosses’ feelings that workers are out of hand when they’re out of the office. In a Fiverr Business survey of 1,000 U.S. managers published this month, a third said they want employees to return full time because people are more motivated when superiors have eyes on them.
“The real crux of things is a lack of control,” says Jerome Hardaway, who runs a nonprofit, Vets Who Code, that helps military veterans learn programming skills and get hired.
He notes that even in the tech sector, where a number of big players such as Twitter and Airbnb have made remote work a permanent option, many companies are leaning harder on employees to show up in person.
Some, channeling Tesla Inc., and SpaceX CEO Elon Musk, are stressing in-person collaboration. Businesses that invested in swanky buildings or expanded to new cities (hello, Austin) before the pandemic want those locations to be used.
Calling people into offices is also a strategy to ward off poachers, Mr. Hardaway says. Interviewing with other companies during the workday is easier to pull off when you’re remote. In the office, bosses and co-workers can peek over your shoulder or notice that extra-long lunch break.
Remote and hybrid work is here to stay on some level, but companies are gradually trying to get employees back into the offices they spend money to rent. But there is no research that suggests that remote workers are less productive – in fact, many suggest the opposite. As of June 2022, 15% of full-time employees are fully remote, 55% are full-time on site, and 30% are in a hybrid arrangement according to WFH Research, a collaboration between Itam, Stanford University, and the University yof Chicago.
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.
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.
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