Which Way Morgan Stanley?

Wall Street Journal

Morgan Stanley may decide to take its final lumps on its unsuccessful $6.5 billion acquisition of Crescent Real Estate Equities Co., the latest of several setbacks for the firm known as one of Wall Street's largest property investors and managers.

Morgan Stanley already has taken about $700 million in write-downs and other losses from Crescent, which owned 54 office buildings, resorts and housing projects at the time of the firm's 2007 top-of-the-market buyout.

Now the investment bank is under pressure to turn the portfolio over to Barclays Capital, which provided a $2 billion loan to help finance the Crescent deal. The debt is due on Nov. 2.

With commercial-property values tumbling and rent rolls declining, Morgan Stanley likely will give up Crescent's properties to the Barclays PLC unit, according to people familiar with the matter.

Capital Infusion?

At the same time, the firm also is considering other options such as putting in more capital to keep the investment afloat, these people said. Negotiations with Barclays could extend beyond the Nov. 2 deadline.

As of the end of the second quarter, Morgan Stanley carried the Crescent properties on its books with a value of $2.8 billion and debt of $2.5 billion, according to a research report by analysts at Citigroup Inc., based on their meeting with Morgan Stanley Chief Finance Officer Colm Kelleher in July.

That would mean the firm's remaining equity in the deal is about $300 million, which would be wiped out should Morgan Stanley opt to turn over the keys to Barclays and walk away from the investment.

Representatives at Morgan Stanley and Barclays declined to comment.

Shareholders of Morgan Stanley will likely get a more detailed picture of the firm's Crescent position when it reports third-quarter earnings Wednesday. In its second-quarter report with the Securities and Exchange Commission, Morgan Stanley said a subsidiary of the firm "is currently in discussions with the lender regarding the orderly transfer of collateral and asset operations and other related matters."

The Crescent deal underscores the problems faced by U.S. financial institutions as a result of their aggressive push into commercial real estate when credit was easy and prices were rising.

The latest third-quarter earnings from U.S. banks show that commercial real estate is becoming a bigger drag on the economy as well as banks' bottom line.

At Bank of America Corp., one of the nation's largest lenders to commercial-property developers and investors, nonperforming commercial real-estate loans reached $6.9 billion in the third quarter, or 9.6% of its total such loans outstanding. That figure more than doubled the level in the year-earlier period.

Mounting Trouble

Commercial real-estate problems began mounting last year as the credit crisis made refinancing debt difficult. But the situation is worsening because thousands of hotels, office buildings, stores and other properties are suffering declining incomes and can no longer pay debt service on the money they borrowed when times were good.

Morgan Stanley may soon have this problem with Crescent, some analysts say. Cash flow from Crescent's office properties, which make up the bulk of the portfolio, will likely fall below the amount required to pay debt service next year, according to an analysis by Matthew Anderson, partner at Foresight Analytics.

At the time of the acquisition, the properties were generating cash flow that was 2.5 times debt service, he said. That "debt-service coverage ratio" has fallen to 1.3 this year and will likely drop to between 0.8 and 0.9 in 2010, he said.

To be sure, Morgan Stanley has been selling Crescent properties to reduce debt since the deal was completed in August 2007. As a result, the kind of buildings in the Crescent portfolio have changed over time, which could have affected the cash flow.

Morgan Stanley's plans for Crescent ran off the track soon after it bought the portfolio from Richard Rainwater, the renowned Texas investor.

Morgan Stanley originally planned to put the properties in one of the real-estate funds it manages for institutions and wealthy individuals. But fund investors balked at buying the buildings at top-of-the-market prices, forcing Morgan Stanley to keep the properties on its own balance sheet.

The Barclays debt originally was due Aug. 3, but the bank agreed to a three-month extension.

When to Buy?

Investment firms without the balance sheets of large investment banks typically don't buy property for real-estate funds until the money has been raised.

The benefit of buying before the money is in place -- as Morgan Stanley did with Crescent -- is that it allows investment banks to move quickly. But they risk losing investor commitments if the property they buy becomes undesirable.

Morgan Stanley has been one of the most active real-estate fund managers.

The firm announced raising at least $14 billion in 2006 and 2007 for its series of real-estate funds known as MSREF, which have taken some big hits as the property market has soured.
Calstrs's Paper Losses

The California State Teachers' Retirement System, for instance, reports its $400 million investment in Morgan Stanley's MSREF VI International LP fund was down 80% as of March 31, and that its $137 million net investment in the MSREF V U.S. LP fund was worth $300,000. Other Calstrs real-estate investments with Morgan Stanley have fared better.

MSREF's bad bets include an investment in North Carolina developer Crescent Resources (unrelated to Crescent Real Estate Equities), which filed for bankruptcy protection in June, and a $3 billion portfolio of German office buildings.

Geithner Says Commercial Real Estate Will NOT Wreck Economy

Wall Street Journal

U.S. Treasury Secretary Timothy Geithner expressed confidence Thursday that the woes of the commercial real-estate sector would not drag the economy back down.

Geithner acknowledged that it was difficult for policymakers to tackle the problem of sliding asset values and write-downs.

However, he said, "I think the economy can handle it" when asked if commercial property could reverse a domestic recovery.

"I think you can say with confidence that the financial system is stable [and that] the economy has stabilized," he told an audience of the Economic Club of Chicago.

His remarks came after GDP data released Thursday showed that the U.S. economy grew by a better-than-expected 3.5% in the third quarter.

Geithner described the first quarter of growth in more than a year as "broad and strong," noting it did not just rely on auto-sector incentives and the broader government stimulus plan.

In front of an audience of the Midwest's business and economic elite, he said that the private sector - and exports in particular - were more central to recovery than in previous downturns.

Amid a pushback from some politicians and lawmakers to the administration's financial reform agenda, Geithner said that a system he has described as "broken" was now "on the path" to resolution.

Capmark Files For Chapter 11

from the Philadelphia Inquirer

Capmark Financial Group Inc.'s weekend bankruptcy filing surprised no one, but it was still a harsh reminder of the hard times ahead in the commercial real estate industry.

"It's not a turning point. The problems are only starting," Dennis Yeskey, a senior adviser at AlixPartners L.L.P., a business-advisory firm in New York, said yesterday.

Yeskey and other experts warned that as long as the economy keeps shedding jobs, the commercial real estate market will be plagued by declining demand and falling property prices.

In its Chapter 11 bankruptcy filing Sunday, the commercial-property lender listed assets of $20.1 billion and debts of $21 billion.

"It's not a turning point.

The problems are only starting,"

Capmark, which has 585 of its 1,000 employees in Horsham, relied heavily on selling loans it had made into the secondary market. When that froze and property values fell, the company got stuck owing more to its own lenders than its loans were worth.

"It's a template that you will see multiply itself many times over over the next three years," said Matthew McManus, chairman of NAI BlueStone Real Estate Capital, a real estate investment bank in Philadelphia.

The problem for the industry is that between now and 2013, more than $2 trillion in commercial mortgages, which typically have a five- to 10-year term, will need to be refinanced, according to a July report by Richard Parkus, head of commercial mortgage-backed securities at Deutsche Bank AG. It is not turmoil in the capital markets that is causing the bottleneck, but rather the fact that properties are not worth enough to retire the old debt in a refinancing, Parkus said.

The value of commercial properties has fallen 40 percent from their peak in October 2007 through August, according the Moodys/REAL Commercial Property Price Index.

The sharp decline in property values has contributed to a rapid deterioration of the $7.8 billion loan book at the Capmark Bank unit. Most loans were made at the peak of the lending frenzy in 2006-07.

During the five quarters ended June 30, the percentage of loans on the bank's "watch list" for problems soared to 39 percent from 2 percent, according to a presentation posted on the firm's Web site.

Capmark had $340.3 million in loans outstanding in the Philadelphia market, or 4.3 percent of its total, as of Sept. 30. Of those, $35.6 million, or 10.5 percent, were behind on payments, according to the presentation.

Paul Halpern, a partner at Versa Capital Management Inc., of Philadelphia, said a lack of ready financing for commercial real estate had prevented properties from trading at depressed values.

That could help some lenders otherwise facing big write-offs. "By the time financing is available, asset prices will have recovered substantially, though not enough to save everybody," Halpern said.

Existing-Home Sales Reach 2-Year High Mark

From Washington Post

Existing-home sales climbed 9.4 percent in September to their highest level in more than two years, fueled by demand for cheap properties and an $8,000 tax credit for first-time buyers, according to industry data released Friday.

Sales of existing homes, including condos and single-family residences, reached an annual rate of 5.57 million units in September, their highest level since July 2007, according to the National Association of Realtors. The monthly increase was the largest on records that date back to 1999 and was far better than analysts had expected. Sales were up 9.2 percent from the same period a year ago.

This is the latest sign that the housing market has begun to rebound, if only temporarily, as buyers take advantage of record-low mortgage rates and pounce on cheap foreclosed properties, analysts said. Sales have increased five of the last six months and rose throughout the country last month. In the South, which includes the Washington region, sales rose 9 percent last month. Also, the inventory of homes on the market shrank again, though analysts said it needs to come down more. It would take 7.8 months to sell all of the homes on the market at the current rate.

"The supply of used homes for sale is also steadily declining, an encouraging trend," said Mike Larson, a real estate analyst at Weiss Research, a research firm.

But analysts said the market rebound may be temporary. An $8,000 tax credit for first-time home buyers expires Nov. 30, and sales will likely flatten or fall in the following months, analysts said. The tax credit generated temporary demand as buyers who otherwise may have waited to buy a house rushed to cash in before the credit vanished, analysts said.

"The tax credit simply shifted sales from 2010 to 2009," said Patrick Newport, an economist for IHS Global Insight.

Industry lobbyists are pushing Congress to extend the program. Without it, they say, the sales momentum created over the last few months could be derailed before the housing sector can make a substantial recovery.

But the credit would have to be expanded, such as raising the income limits of eligible buyers or increasing the credit's value, for it to have an appreciable impact, Newport said. "If they just extend it, it would not increase the pool that much," he said.

In the meantime, the housing market remains weak and prices continue to decline, analysts said. The national median existing-home price fell to $174,900 in September, down 8.5 percent from the same time last year, according to the Realtors. Sales prices fell the most in the West, 15 percent, but the South saw a 7.6 percent decline.

That is a smaller price drop than in previous months, reinforcing hopes that home prices may be starting to stabilize, said Lawrence Yun, the Realtors' chief economist. "It's a positive momentum, but whether we have a firm stabilization is unclear," he said.

But recent price stabilization in some parts of the country may be temporary, some analysts said. Rising unemployment will push more borrowers into foreclosure and ultimately dump more homes on the market, dragging down prices again, they said.

Watchdog Says FDIC Failed On Commercial Loans

Bloomberg

The Federal Deposit Insurance Corp. failed to enforce its own guidelines to rein in excessive commercial real estate lending by at least 20 banks that later collapsed, reports by the agency’s watchdog show.

The FDIC’s Office of Inspector General analyzed 23 lenders taken over by regulators from August 2008 to March and found that for 20, the agency’s examiners didn’t identify the issue early enough or should have taken stronger supervisory action after recognizing the banks had dangerously high levels of the loans before they failed. The findings are in separate reports posted this year on the inspector general’s Web site.

“It’s often we’ll see in our reports that the FDIC detected problems in the bank in a timely fashion, but in some cases forceful corrective action wasn’t required by the FDIC to be taken quickly enough,” Jon Rymer, the FDIC’s inspector general, said in a telephone interview.

The failure to follow up on the 2006 recommendation, that banks avoid letting commercial real-estate holdings exceed 300 percent of capital, has emerged as FDIC Chairman Sheila Bair steps up her effort to expand the agency’s role in regulating the financial-services industry.

Bair, a 55-year-old appointed by President George W. Bush, is lobbying the Democratic-led Congress to give the FDIC the authority to unwind any failing bank holding companies. The FDIC’s powers are limited to disassembling commercial banks and thrifts, and it lacks authority to unwind Federal Reserve- regulated holding companies such as New York-based Citigroup Inc. and Bank of America Corp. in Charlotte, North Carolina, that have businesses beyond taking deposits and making loans.

‘Stopped It’

“We should ask the prudential regulators why they did not do more to push banks to pay attention to their guidance,” Representative Brad Miller, a Democrat from North Carolina, said in an interview. “If they thought their conduct was unsafe, it’s unsound, they certainly should have stopped it.”

Miller sits on the House Financial Services Committee, which oversees the FDIC and the banking industry.

“We are in process of addressing any existing gaps in supervisory policy with respect to commercial real estate lending,” FDIC spokesman Andrew Gray said in a prepared statement. “The FDIC has also stepped up our off-site surveillance program to assist our examiners in targeting those institutions with elevated risk profiles so that corrective action programs are instituted in a timely and constructive manner.”

Fed, OCC, OTS

The Federal Reserve, Office of the Comptroller of the Currency and Office of Thrift Supervision have been faulted this year by their watchdogs for not reining in commercial real estate lending in reports issued on failed banks they supervised. Inspector generals for the regulators released 12 reports, about half the number completed by the FDIC’s watchdog.

Regulators have closed 99 financial institutions this year, the most since the 179 in 1992 during the savings-and-loan crisis. Matthew Anderson, a partner with Oakland, California- based Foresight Analytics LLC, a real-estate market consulting firm, said the number of failed banks will climb rapidly in part because delinquency rates on commercial real estate mortgages are “rising substantially.”

Defaults on commercial real estate loans totaled $110 billion, or 6 percent of all such loans, in the second quarter. That’s about 11 times the level in the fourth quarter of 2006 when the guidelines were released. Defaults may rise to $170 billion by the fourth quarter of 2010, Foresight Analytics said.

Community Banks

The risks are greater for community banks with assets of $10 billion or less, Anderson said, because commercial real estate loans make up a bigger percentage of their business. Smaller banks don’t have the capital to compete with large banks for mortgages and consumer loans, so they turn to local-market lending, where they have an advantage.

Commercial real estate loans will pose the biggest risk to banks for several quarters, Bair told Congress on Oct. 14.

Declining real-estate values caused by rising vacancies, falling rental rates and weak sales are contributing to losses, Comptroller of the Currency John Dugan, the regulator of national banks, said at the same congressional hearing.

Along with Dugan and the Federal Reserve, the FDIC in 2006 set a threshold -- 300 percent of a bank’s capital -- for safe levels of commercial real estate loans. The guidance was aimed at helping regulators identify banks with high loan concentrations that warranted greater supervisory scrutiny.

At the time, smaller and mid-sized banks opposed the guidelines. Bankers said they feared federal examiners would treat the thresholds as absolute limits, threatening a lucrative business for community lenders.

‘Boom Times’

The regulators said the thresholds were not limits and that federal bank examiners would use the guidelines to identify lenders with risky levels of such loans.

“The guidance was put out in boom times,” said Kevin Petrasic, a lawyer at Paul, Hastings, Janofsky & Walker LLP in Washington and former special counsel at the Office of Thrift Supervision. “Profits were very high. There wasn’t a full realization of what we were staring at.”

The FDIC reiterated the importance of strong capital and risk-management practices for banks with high concentrations of commercial real-estate loans in a March 2008 letter.

By September 2008, commercial real-estate loans represented 1,329 percent of total capital at Security Pacific Bank in Los Angeles, a bank that collapsed two months later. The level “far exceeded the capital criteria thresholds for additional supervisory oversight,” according to a review in May by the FDIC inspector general.

The bank’s failure cost the FDIC fund about $210 million.

FirstBank Financial

In December 2007, FirstBank Financial Services of McDonough, Georgia, had concentrations of 645 percent, more than double the recommendation.

The FDIC didn’t take any enforcement action until 2008 “when there were significant and quantifiable losses in the bank’s loan portfolio,” the inspector general found. The bank failed in February, costing the FDIC fund about $111 million.

The FDIC and state regulators were slow resolving banks with other issues. It took almost two years to shut New Frontier Bank, the largest lender in northern Colorado with $2 billion in assets, after agencies identified in mid-2007 a rise in soured loans, increased reliance on volatile funding and weak management. State regulators shut the bank April 10.

Bair, Dugan and Timothy Ward, the Office of Thrift Supervision’s deputy director of examinations, supervision and consumer protection, said last week they are planning to issue guidelines on how to modify troubled commercial real-estate loans to reduce defaults.

$1.8 Trillion

U.S. banks held $1.8 trillion in commercial real-estate loans as of the second quarter, representing 24 percent of outstanding bank loans, according to Foresight Analytics. Commercial real estate loans represent 39 percent of the $4.7 trillion in total real-estate loans.

Of 95 U.S. bank failures before September, 71 were caused by non-performing commercial real-estate loans, said Chip MacDonald, a partner specializing in financial services at Atlanta-based law firm Jones Day.

“The supervisory process has to have more consistency in the good times and not just in the bad times,” said John Bovenzi, a partner at Oliver Wyman, a New York-based management consulting firm, and FDIC chief operating officer until this year. “It’s historically been harder to show effectively that changes need to be made when times are good.”

Deposit Fund

A surge in bank closings pushed the FDIC deposit insurance fund, which pays the cost of unwinding failed institutions, into a deficit, requiring the FDIC to replenish the reserve without overburdening hobbled banks. Last month, it proposed that banks prepay three years of premiums to raise $45 billion.

Bair told a Senate subcommittee on Oct. 14 that bank failures will continue to rise, reaching a peak next year, while costing the fund $100 billion through 2013.

Some analysts are more pessimistic. Christopher Whalen, managing director of Institutional Risk Analytics, a Torrance, California, firm that evaluates banks for investors, said the deposit fund will run a deficit of $300 billion to $400 billion and about 1,000 banks will fail or be merged through 2012.

The FDIC supervised 5,039 banks of the 8,195 commercial banks and savings institutions as of June 30, according to the agency. The FDIC and state regulators share oversight, and each sends examiners to the banks on average every other year.

“We should have been more strict,” Joseph Smith, North Carolina’s bank commissioner and chairman of the Conference of State Bank Supervisors, said in a telephone interview. Two banks have failed in Smith’s state this year.

“Had we required the reduction of CRE lending, it would have been thought of as an intrusion by regulators into the businesses of banks and to the operations of local economies,” Smith said. “Yes, it would have been the right thing to do. It would have caused a firestorm then. That might have been better than a firestorm now.”

Regulators Encouraging Commercial Real Estate Loan Modification

Reuters

U.S. regulators are encouraging banks to restructure commercial real estate loans, which they view as one of the greatest challenges that could compromise the industry's recovery.

Officials are close to finalizing guidance that would encourage banks to recognize potential losses in their commercial real estate portfolios and not simply renew troubled loans to delay loss recognition, regulators told a Senate banking subcommittee.

"While there have been some positive signals of late, the financial system remains fragile and key trouble spots remain," such as commercial real estate, U.S. Federal Reserve Board Governor Daniel Tarullo said.

Other regulators echoed his concerns, including Federal Deposit Insurance Corp. Chairman Sheila Bair and Comptroller of the Currency John Dugan.

Dugan characterized commercial real estate as the "greatest challenge" facing banks while Bair targeted it as a prominent area of risk for the next several quarters.

COMMERCIAL LOSSES SOARING

As of June, commercial real estate loans totaled more than $1 trillion, or 14.2 percent of all loans and leases in the bank industry, Bair said.

Regulators struck a cautious note on the health of the banking system, notwithstanding that JPMorgan Chase & Co, one of the top Wall Street banks, reported on Wednesday that its quarterly profit rocketed to a much-high-than-expected $3.6 billion. [ID:nN13183184]

Tarullo zeroed in on potential losses the banking system faces on soured commercial real estate loans and said some were slow to even acknowledge the weakening sector.

Prices for existing commercial properties have fallen 35 to 40 percent since peaking in 2007 and more declines are anticipated. Rising job losses and high vacancy rates also are weakening demand for commercial property, Tarullo said.

At the end of the second quarter, about 9 percent of commercial real estate loans were delinquent, nearly double the level a year earlier.

Dugan said credit quality is deteriorating across almost all classes of banking assets, in nearly all sizes of banks.

 He said national banks must set aside more capital and reserves to absorb these potential losses, which could cause more small institutions to fail.

Bair said the number of so-called "problem banks" and bank failures will remain high for the next several quarters. So far this year 98 U.S. banks have failed, compared to 25 last year and 3 in all of 2007.

As of the end of the second quarter, 416 banks with about $300 billion in assets were on the problem bank list. The FDIC estimates that bank failures will come with a price tag of $100 billion from 2009 through 2013.

SLOW ECONOMIC RECOVERY

Regulators were wary about celebrating signs of tentative recovery.

Tarullo said the economy appears to have resumed growing but warned that it will take time to rebound from the serious financial crisis it endured and jobs won't come back quickly.

"The unemployment rate has continued to rise, reaching 9.8 percent in September, and is unlikely to improve materially for some time," he said.

U.S. economic activity turned up in the third quarter as investors waded gingerly back into riskier waters and businesses began to restock depleted inventories. U.S. housing prices rose for the third straight month in July, raising hopes the market is stabilizing.

But because of distressed labor markets, consumer spending and credit availability could remain weak.

Bair said the scope of losses in household wealth during the severe downturn over the past two years has been so great that the economy will need time to repair and recover.

"While we are encouraged by recent indications of the beginnings of an economic recovery, growth may still lag behind historical norms," Bair said.

Commercial Real Estate Market Sees Rising Delinquencies

Bloomberg

Yields on bonds backed by hotel, shopping-center and skyscraper loans narrowed relative to benchmarks as U.S. programs help drive demand even as late payments soar on the underlying commercial real estate debt, according to Barclays Capital.

The gap, or spread, on top-ranked commercial-mortgage backed securities tightened 0.15 percentage point relative to benchmark swap rates to 6.25 percentage points for the week ended Oct. 15, Barclays data show. That compares with 10.15 percentage points in March, according to Barclays.

Demand for the bonds swelled as rising stocks buoyed investor sentiment and government programs helped further prop up prices of the debt. Rising delinquencies on commercial mortgages provide a “counterpoint to the rally,” Barclays analysts led by Aaron Bryson in New York wrote in an Oct. 16 report.

“The rally in cash CMBS continued,” Bryson wrote. “Better-than-expected earnings reports and strong economic data led to broad-based credit tightening and a further reduction of risk premia.”

Top-rated commercial mortgage-backed debt is trading at a price of about 84.70 cents on the dollar, up from 55.91 cents in mid-March, according to Merrill Lynch & Co. indexes.

Still, “the CMBS delinquency rate is on pace for a large jump,” Bryson wrote.

Commercial mortgages bundled and sold as bonds that are at least 30 days behind on payments rose 30 basis points to 5.42 percent for October, according to Barclays. About 36 percent of the loans hadn’t yet been reported for this month as of the report date. A basis point is 0.01 percentage point.

TALF Fading

The fourth round of the Federal Reserve’s Term Asset-Backed Securities Loan Facility, or TALF, is scheduled for Oct. 21. The Fed began lending against so-called legacy commercial mortgage- backed securities, or those sold before Jan. 1, in July as part of its effort to stimulate lending.

The Fed added newly issued commercial-mortgage backed bonds to TALF in June. No new bonds have been sold through the program.

The impact of TALF has “started to fade” as investors anticipate the start of buying under the U.S. Public Private Investment Partnership, a separate government program that also seeks to attract investors by boosting returns with taxpayer loans, according to Bank of America Corp. analysts.

“Legacy CMBS TALF is still in effect but demand does not seem strong enough, by itself to drive this sector significantly tighter,” the Bank of America analysts led by Roger Lehman in New York said in an Oct. 16 report.

Plunging Values

Unlike the TALF, the PPIP isn’t limited to securities carrying top-ratings and will finance the purchase of a broader swath of securities, including bonds that have had ratings cuts.

Spreads on some lower-ranked bonds have tightened on “at least the perception of PPIP buying,” according to the Bank of America analysts.

TALF loan requests to purchase legacy bonds will likely increase to around $2 billion for October, compared with $1.4 billion last month, according to Barclays. While the fourth round may be stronger than last month’s “disappointing” results, it will fall short of August’s $2.3 billion high, the Bank of America analysts wrote.

The government has made reviving the $700 billion commercial-mortgage bond market a priority as plunging property values and a pullback in lending threaten to derail an economic recovery. U.S. commercial real estate prices are down 40.6 percent from the October 2007 peaks, according to Moody’s Investors Service.

GE Real Estate Holdings Worry Investors

Reuters

General Electric Co's $84 billion real estate portfolio remains a worry for investors, who wonder if the conglomerate will have to take big write-downs to reflect the lower value of real estate debt and equity holdings.

The GE Real Estate unit was the only GE Capital business to post a loss in the latest quarter.

"People are worried about commercial real estate," said Russell Croft, vice president and portfolio manager of Croft-Leominster, which owns 263,000 GE shares.

"I want to hear what they're doing to shrink GE Capital and get more detail on the real estate (holdings)," Croft said. The company has a strong industrial business but "cleaning up GE Capital" was key to extending GE's recent share rally.

Shares of GE, the biggest U.S. conglomerate, fell 5 percent Friday as its quarterly sales disappointed Wall Street even as its profit topped expectations.

GE Real Estate, part of the GE Capital division, posted a loss of $538 million in the quarter, double the loss in the preceding quarter. By comparison, GE Real Estate earned $244 million in last year's third quarter.

NEXT BIG THREAT

The commercial real estate sector has been on the decline for more than a year and represents the next great threat to the financial markets, according to recent government reports.

About $1.4 trillion of commercial real estate debt is expected to mature from 2009 through 2013, with 41 percent of that coming due over the next three years. Much of the maturing debt carries a large balloon payment at the end.

Meanwhile, borrowers are facing lenders who have shut their doors to making any more investments in commercial real estate, and are particularly shying away from large loans. On top of that, properties values have sunk and in many cases aren't worth the debt they carry.

The financing available to roll over a lot of commercial debt coming due in the next few years is limited. Much of GE's commercial real estate equity is not worth what the company paid for it, especially assets bought near the market peak in 2006 and 2007.

"They're still not taking impairments on the commercial real estate portfolio and there's a lot of concern about that," said Jack De Gan, chief investment officer at Harbor Advisory Corp, which owns GE shares in client portfolios.

"They acquired that portfolio very late in the rally for commercial real estate," De Gan said. "There's a lot of concern among investors there are significant write-downs yet to come out of that portfolio."

Standard & Poor's noted on Friday that delinquencies, charge-offs and nonperforming assets remain elevated across GE's major businesses, calling real estate credit performance and asset-value deterioration "particularly severe."

RISKS UNDERSTOOD

GE Real Estate's $84 billion in assets represent about 15 percent of total GE Capital assets of $551 billion.

Impairments in the real estate portfolio are "running above plan," GE Chief Financial Officer Keith Sherin told analysts on the company's earnings conference call. But Sherin added: "the risks are understood and manageable."

GE has taken $467 million in real estate equity impairments so far this year, versus an earlier outlook of less than $300 million. Total credit losses and impairments are $1.5 billion year-to-date, GE said.

Sherin said delinquencies were "right in line" with bank real estate portfolios, and noted GE's asset mix and geographic exposure are different than those of banks.

Delinquencies in the commercial real estate debt portfolio -- a warning sign that precedes defaults -- rose to 4.19 percent from 4.03 percent in the prior quarter. The percentage of non-earning assets rose slightly from the second quarter.

The company, which said it evaluates its debt portfolio twice a year, increased its reserves for potential losses on its debt portfolio, but said it was not clear the losses would materialize.

GE has been working to shrink its huge finance arm, which has been hit hard by the credit crunch, and on Friday stressed the strong performance of many of its infrastructure businesses. But GE CEO Jeff Immelt acknowledged the poor performance of GE Real Estate.

"All the other businesses at GE Capital are profitable except for Real Estate, and that is the one we are really going to have to work through," Immelt said.

Anticipated End To Government Credits Causes Lapse In Homebuilder Confidence

Bloomberg

Confidence among U.S. homebuilders unexpectedly fell in October on mounting concern sales will retrench once government credits expire.

The National Association of Home Builders/Wells Fargo confidence index declined to 18 from a reading of 19 in September that was the highest in more than a year, the Washington-based association said today. Figures less than 50 mean most respondents view conditions as poor.

Builders are fretting as time runs out for purchasers to take advantage of the Obama administration’s $8,000 tax credit for first-time buyers, which expires at the end of November. All three components of the index, including measures of current and future sales and buyer traffic, dropped, signaling the market may take a step back after advancing for five consecutive months.

“Clearly, builders are experiencing the effects of the expiring tax credit on their sales activity, since it would be virtually impossible at this point to complete a new home sale in time to take advantage of that buyer incentive,” David Crowe, the NAHB’s chief economist, said in a statement. Crowe said 85 percent of the members polled thought an extension of the credit would boost sales.

The builder confidence index was forecast to rise to 20 this month, according to the median of 44 estimates of economists surveyed by Bloomberg News. Projections ranged from 18 to 21. The gauge, which was first published in January 1985, averaged 16 last year.

Survey Components

Builder shares fell for a third consecutive day. The Standard & Poor’s homebuilder supercomposite index closed down 1.4 percent at 265.7 in New York. The broader market rallied, sending the S&P 500 Index up 0.9 percent to 1,097.91, a one- year high, on better- than-anticipated earnings.

“I would regard today’s numbers as a temporary blip,” said Michelle Meyer, an economist at Barclays Capital Inc. in New York. “Once we smooth through that volatility, home sales will continue to improve. The tax credit isn’t the only thing that’s helping sales.” The drop in prices, which has made buying more affordable, and a general improvement in the economy are among the factors that will contribute to a rebound, she said.

The builder survey asks builders to characterize current sales as “good,” “fair” or “poor” and to gauge prospective buyers’ traffic. The survey also asks participants to gauge the outlook for the next six months.

Broad Decline

All three measures dropped for the first time since November. The builders group’s index of current single-family home sales fell to 17 this month from 18 in September. The gauge of buyer traffic dropped to 14 from 17, and a measure of sales expectations for the next six months decreased to 27 from 29.

Confidence decreased in three of four regions, led by a four-point slump in the West. The Northeast was the only region to register a gain.

The Mortgage Bankers Association, National Association of Home Builders and the National Association of Realtors today sent a letter to Treasury Secretary Tim Geithner, White House economic adviser Lawrence Summers and Housing and Urban Development Secretary Shaun Donovan requesting an extension of the credit for at least a year after it expires on Nov. 30.

The three groups urged Congress to expand the initiative to include all, not just first-time, buyers of primary residences, increase the amount of the credit and make the funds available for closing. The Realtors’ association estimated the program generated about 355,000 more home sales than would have been the case.

Sales Gains

Sales of new homes dropped to a four-decade-low 329,000 annual pace in January. Purchases climbed in six of the next seven months, reaching a 429,000 pace in August. Commerce Department figures on September sales are due next week.

If Congress extends the credit and credit begins to flow again “we can turn this thing around by the middle of next year,” NAHB President Jerry Howard, said in an interview on Bloomberg Television. If lawmakers don’t act quickly, “then the housing industry is in jeopardy.

The group projects an extension for another year will create 350,000 jobs, generate $28.2 billion in wages and business income and $11.6 billion in additional tax revenue.

Preparing for Rebound

D.R. Horton Inc., the largest U.S. homebuilder by revenue, is among companies projecting the recent improvement will be sustained. The Fort Worth, Texas-based company said last month it is buying finished lots, rather than building on undeveloped land it already owns, to boost its construction pipeline in anticipation of a housing revival.

“There have been some small encouraging signs in our sales and our average sales prices,” Bill W. Wheat, D.R. Horton’s chief financial officer, said on a Sept. 30 call with investors.

Stabilization in residential construction is among the reasons economists project the U.S. began to grow again last quarter. The world’s largest economy probably expanded at a 3.2 percent annual pace from July through September, according to the median estimate of economists surveyed earlier this month.

CMBS Delinquency Rising Rapidly

Story from the Wall Street Journal

Delinquencies among U.S. commercial mortgage-backed securities surged to by a record amount in September, according to Moody's Investors Service, highlighing the ongoing woes on the commercial real-estate market.

Occupancy rates and rents are falling, which, coupled with an inability to refinance debt, is resulting in an acceleration of woes for property owners. "After tapering off for two months, the delinquency tracker appears to have resumed an upward trend as expected," said managing director Nick Levidy. "The delinquency rate is likely to continue moving higher over the next several months as troubles compound in the commercial real estate sector."

September's delinquency rate of 3.64% compares with 0.54% a year earlier.

The commercial real estate market had held up better than the residential real estate market until it began to deteriorate quickly at the end of 2008 as the U.S. recession deepened. Retail and hotel properties have been hit especially hard.

The hotel industry posted the largest increase in September, rising to 4.97% from 4.18% in August. Multifamily delinquency rates continued to go up, climbing to 6.09% from 5.51%, the highest of any property type. The delinquency rate for loans on retail properties rose one-third of a point to 3.76%.

Moody's said delinquency rates continued to be highest in the South at 5.14%, up from August's 4.66%. The East was the only region with the delinquencies below the national average - with a rate of 2.14%, up from 1.84% a month earlier.

Arizona, Michigan and Nevada all have delinquency rates nearly three percentage points higher than any other state, with rates of 9.32%, 9.29% and 9.14%, respectively. Ohio was the next highest, at 6.22%.

Swig Co. and Capmark Acquire Arbors at Warner Center

From San Francisco Business Times

A joint venture between an affiliate of the San Francisco-based Swig Co. and an institutional real estate investment fund managed by Capmark Investments LP has acquired the 250-unit Arbors at Warner Center multifamily residential community located in the Warner Center area of Woodland Hills.

The property was purchased for approximately $33 million dollars — about $132,000 per unit. Mitch Thurston and Andy Ahlers of Capmark Finance Inc.’s San Francisco office originated a new first mortgage for the acquisition through Freddie Mac’s CME multifamily loan program. Investors Property Services headquartered in Foothill Ranch will handle the day-to-day property management of the Arbors.

“We are very excited to have completed another venture with Capmark Investments to acquire a good institutional-quality residential community at a basis that should minimize our downside exposure and allow for great cash flow and potential upside as the economy and the local market recovers,” said Swig Co. Chief Investment Officer Ken Perry.

The Swig Co. and Capmark are also partners in the $200 million Kaiser Center project on Lake Merritt in downtown Oakland.

“This one-off investment in a multifamily residential property is clearly a departure from our business plan goal of acquiring additional urban office buildings,” Perry said. “However, in addition to being a great buy, this investment creates additional product-type and geographical diversity to our portfolio.”

The Arbors represents the Swig Co.’s second major real estate holding in Southern California along with the Arco Center office complex in Long Beach.

Prediction: Commercial Properties To Push U.S. Banks Into The Abyss

Reuters

The next big headache for banks is likely to be commercial real estate and analysts expect big losses and another wave of bank failures to result.

Banks held about $1.7 trillion in commercial real estate loans at the end of September, according to Federal Reserve data, or about 15 percent of their total assets. But to the extent these loans weaken, small banks are likely to be hit the hardest because larger banks are better diversified.

The banks that analysts say could risk big losses include Salt Lake City's Zions Bancorp, Columbus, Georgia- based Synovus Financial Corp and Dallas-based Comerica Inc.

But it is not just earnings that are at stake -- bank failures could surge in the coming quarters.

"The serenity of the quiet closure of two to three banks per week is soon going to come to an end," said George Ball, chairman of Sanders Morris Harris Group, an investment bank and investment adviser, in Houston.

Banking regulator the Federal Deposit Insurance Corporation had 416 banks on its watch list of problem banks at the end of the second quarter and veteran analyst Dick Bove at Rochdale Securities expects another few hundred will fail in the next few quarters.

The FDIC closed Chicago-based Corus Bank on Sept. 11, following losses on commercial real estate and condominium developments in Arizona, California, Florida and Nevada.

At Warren Bank in Michigan -- closed on Oct. 2 by the FDIC -- almost 40 percent of its $395 million in total loans were in commercial real estate.

"Real estate lending has long been the specialty of Warren Bank," the company still claims on its website.

Analysts are worried banks such as Corus and Warren Bank may be just the first of a coming wave of bank failures due to commercial mortgages.

Banks have been slow to recognize losses from commercial mortgages to forestall posting big losses, preferring to alter loan terms in the hope an improving economy will keep the loans from heading south, a phenomenon widely known as "extend and pretend."

"It takes a long time for an actively rented commercial real estate space to get to a point where a bank can't be flexible in terms of conditions and has to start writing it down," said Tom Mitchell, analyst at Miller Tabak & Co.

Banks may set aside larger amounts of money to cover losses in the fourth quarter, when banks consult with auditors over their results, Mitchell said.

When commercial real estate makes up a large portion of a bank's balance sheet, the bank is at risk of being forced to set aside much more money for losses.

At Zions, commercial real estate accounted for almost 35 percent of its $41.6 billion in loans at the end of the second quarter, while Synovus had almost 28 percent of its $28 billion loan portfolio in commercial real estate. Comerica's commercial real estate loans made up about 22 percent of its loan portfolio.

But while regulators stepped in to prop up large banks suffering from residential mortgage losses, they are not expected to help out small regional banks suffering commercial real estate losses since these are not seen as a threat to the wider financial system.

"The system will survive but with more cuts and bruises. We're going to see quite a lot of consolidation," said Marshall Front, chairman of Front Barnett Associates in Chicago.

"It's not pretty and there's not a lot of relief out there for these banks."

Many Are Struggling - Even After Mortgage Modification

Story from USA Today

WASHINGTON — Lenders are ramping up efforts to avoid home foreclosures, but a report by bank regulators says more than half of borrowers who get help fall behind again.

More than 50% of homeowners with loans modified in the first half of last year had missed at least two months of payments a year later, the federal Office of the Comptroller of the Currency and the Office of Thrift Supervision said Wednesday.

But the results were better among those who saw their payments drop substantially.

About one in three borrowers whose monthly payments were reduced 20% or more had fallen behind again within a year. That compares with more than 60% for borrowers whose loan payments were left unchanged or increased.

The report highlights a significant challenge for the Obama administration's plan to tackle the foreclosure crisis, backed by $50 billion in money from the financial industry bailout fund.

High rates of redefault have typically plagued loan modification programs, and critics argue that there is little point to modify loans that will fall into trouble again.

Officials in the Obama administration, however, counter that their plan requires the lending industry to make far more substantive changes — for example, reducing a borrower's interest rate to as low as 2% — than was common in the past.

The administration's effort got off to a slow start, but has picked up speed in recent months. As of last month, about 360,000 borrowers, or 12% of those eligible, have signed up for three-month trial modifications. They are supposed to be extended for five years if the homeowners make their payments on time. There is currently no data on redefaults within the plan.

Traditionally, most lenders have offered payment plans that allowed borrowers to catch up on missed payments. But those modifications often do not involve an interest rate reduction and result in a higher monthly payment.

But the bank regulators' quarterly report shows that lenders were shifting their focus to modifications that reduced borrowers payments. They made up nearly 80% of new modifications in the April-June quarter, up from about half in the first three months of the year.

The report covers 34 million loans, representing more than 60% of primary home mortgages. Consistent with other reports, it showed borrowers are continuing to fall behind as job losses mount. More than 11% of borrowers covered by the report had missed at least one payment as of June 30, up from 10% in April.

It also highlighted mounting problems with an especially troubling category of loans — "pick-a-payment" or option ARM loans, which allowed borrowers to defer some of their interest payments and add them to the principal. At the end of June, 10% of these loans were in foreclosure, more than triple the rate for all mortgages in the survey.

Detroit To Sell The Lions' Den

Story from Detroit Free Press

Time is running out to buy Michigan's largest vacant home.

The Pontiac Silverdome, home of the Detroit Lions from 1975 until 2002, will be sold next month to the highest bidder, no matter the bid, as the cash-strapped city looks to offload the $1.5-million annual upkeep costs at the empty facility.

Tulsa, Okla.-based Williams & Williams is conducting the auction and accepting sealed bids through 4 p.m. Nov. 12. After that, the city has the option of inviting the top five bidders back for a live auction Nov. 16. Would-be bidders can tour the facility by appointment and they must pony up a $250,000 deposit -- to show they are serious -- but there is no minimum bid.

"We are excited about the upcoming sale of the Silverdome and finding a new owner who will become a key member of our community," said Pontiac Emergency Financial Manager Fred Leeb, adding that the auction "illustrates our commitment to sell the stadium this year and convert an expense into a vibrant future development."

A $17.5-million plan to turn the Silverdome, which sits on

127 acres, into a racetrack, hotel and conference

center fell through last year.

The facility, which stands on 127 acres, has been used sporadically since 2002 when the Lions moved to Ford Field in downtown Detroit. Several efforts to redevelop it have fallen through.

A $17.5-million plan to turn the stadium into a horse racetrack, hotel and conference center fell through last year and it's unclear whether that option remains on the table.

"I just don't know," said Bloomfield Hills attorney H. Wallace Parker, who spearheaded that effort.

The iconic building dominates the skyline of Pontiac, visible for several miles. Its namesake roof is made of fiberglass and suspended by positive air pressure in the building. With more than 80,000 seats, the building hosted a Super Bowl, an NBA All-Star game, a papal mass and Wrestlemania III.

"It's a very important piece of property for Pontiac, but I think it's important for Oakland County as well," said Doug Smith, the county's director of economic development. "It sits right out there at the intersection of M-59 and I-75."

Battered by auto retrenchment and declining home values, Pontiac's finances are so weak that Gov. Jennifer Granholm appointed Leeb to fix them. Leeb approved the auction after the county and Mayor Clarence Phillips couldn't agree on what to do with it.

Real Estate Business Still Jumping At The Cemetery

If a customer has something that's worth $3,000, that could pay for utility bills and living expenses... They're not thinking of the future. They have something they're able to sell and get money for now.

Story from the Wall Street Journal

For nearly 20 years, John Dotson planned to spend eternity at Block 29L, Lot 58, Site 1DD at Parklawn Memorial Park in Rockville, Md.

Heaven will have to wait. Plagued by a series of misfortunes at home, from job loss to multiple illnesses, Mr. Dotson has decided to put the double plot he had bought for himself and his wife up for sale. "Things got really tight," he says, and his wife has come around to the idea of cremation.

He purchased the plot in 1990 for about $1,500, and though the cemetery now values it at $4,555, Mr. Dotson says he would gladly unload it for around $2,800.

As if the recession hasn't ruined enough people's plans in this life, it now seems to be disrupting the hereafter as well. Cemeteries and funeral-property Web sites report a burgeoning marketplace for the sale of burial plots by individuals, many of which have been in families for years. As times get tough, they are now being liquidated to make ends meet.

In Orlando, Fla., Greenwood Cemetery has seen a record number of customers coming in to sell their plots back to the municipal-owned facility. Don Price, the cemetery's sexton, or manager, has had 44 "buybacks" in the first six months of this year, compared with 42 in all of last year and only 11 five years ago. Greenwood considers what a customer paid for the plot, and will offer as much as $1,500 if someone wishes to sell it back to the cemetery, which can then resell it on the open market.

In Dayton, Ohio, David's Cemetery reports that in the past year it has seen roughly double the number of clients coming in to sell their spaces back to the cemetery.

Web sites such as Grave Solutions and Plot Brokers, which advertise spaces and broker sales of cemetery properties, have also seen an uptick in postings. Caskets-N-More, a Glendora, Calif.-based business that sells funeral products and brokers sales of cemetery properties, reports a doubling of people wanting to sell their plots, to about 20 new postings a month from 10 a year ago.

"If a customer has something that's worth $3,000, that could pay for utility bills and living expenses," says Caskets-N-More owner Olga Fernandez. "They're not thinking of the future. They have something they're able to sell and get money for now."

Grave Decisions

The apparent increase in sellers of cemetery plots has to do with more than just economic necessity. Changes in how people live and wish to be buried also play a role. Increased mobility means individuals may no longer live near a family plot and would rather sell off unused spaces. And growing acceptance of cremation as an alternative to burial means people realize they may have no need for previously purchased in-ground plots.

But while many plots are sold that are no longer needed, other families are reluctantly giving up their plans of being buried near their loved ones.

"I've had widowers sell back spots next to their spouses, and only because they needed to pay rent," says Mr. Price, Greenwood's sexton. In such cases, the cemetery will pay for the space, but hold off on putting it on the market for a month, in case the seller is able to come up with the money to buy it back.

The Los Angeles-based Web site Plot Brokers is representing a family that wants to sell a multiplot area worth about $350,000—and is in the process of moving someone already buried there in order to sell. In recent months, Baron Chu, who runs Plot Brokers, has noticed a big increase in people willing to sell high-end plots—an indication of how desperate some people are for funds. "Usually people that already have money aren't the ones looking for money," says Mr. Chu.

The crypt above screen siren Marilyn Monroe in Westwood Village Memorial Park in Los Angeles was posted for sale on eBay on Aug. 14 with a starting bid of $500,000. By Aug. 24, bidding topped out at $4,602,100, though the offer, from Japan, was later rescinded. The plot hasn't yet sold, and eBay is currently working with the seller in hopes of having her relist it, says a company spokesman.

Plots sell quickest and cost the most in places where people tend to retire—such as Florida, Arizona, Texas and Southern California—according to Ken Brant, who runs the Grave Solutions Web site.

For example, there are over 500 plots for sale on Grave Solutions for Restland Cemetery in Dallas, a 375-plus-acre facility owned by Jefferson, La.-based Stewart Enterprises Inc. The listings reveal some potential bargains—as well as sellers in a hurry: "REDUCED," reads one listing for a single plot in the Masonic section where the seller is asking $2,200. Another listing invites buyers to "make an offer" for two burial plots in the Garden of the Cross. Another seller is asking $4,500 each for his three plots in the Garden of Gospel—or $12,000 if the buyer buys all of them.

One posting for Restland's desirable Whispering Waters section says $40,000 will buy you two "packages," complete with services, caskets (choice of copper tone or silver tone) and bronze memorial.

With so much inventory on the market, it could be a great time for a consumer to buy. Generally, sellers post plots for about half of what a comparable one would retail for at the cemetery. These days, because there is so much inventory, "people are much more willing to negotiate," says Jeff LaGrone, a Charlotte, N.C.-based cemetery-plot broker who helps run a Web site called American Cemetery Property.

Precautionary Measures

Before buying property on the secondary market, you need to take some precautionary measures. First, make sure the seller is the owner of record with the cemetery. If he inherited the property from someone else, but neglected to alert the cemetery, for example, he likely can't transfer ownership until the books are straightened out.

When selling property, check with the cemetery first to see what the rules are. For the most part, cemeteries will allow plot owners to sell their space on the secondary market—though it's worth checking first to see if the cemetery itself will buy it back. (Most don't, says Robert Fells, general counsel for the International Cemetery, Cremation and Funeral Association, since cemeteries generally aren't lacking for spaces to sell.)

When shopping, be sure to ask what's included in the price. Some properties include ancillary costs, such as the burial and headstone. Others include only the plot itself. Check with both the seller and cemetery about what exactly you are paying for. Mr. Dotson, for instance, is selling only for the rights to the land. The buyer would eventually need to pay for the two in-ground crypts, which together would cost an additional $2,340, as well as other fees.

Another option: a so-called pre-need purchase, in which you purchase funeral arrangements, which may include cemetery space and funeral services, in advance of your death, before your survivors are grieving and easily fleeced by salesmen. But it also might not be a bad place to park your money, given how rapidly burial costs are escalating. Average funeral prices in the past decade have increased by about a third, to $6,199 (not including the cemetery plot), according to the Springfield, Ill.-based Federated Funeral Directors of America, which tracks costs annually.

Time-Share, Luxury Development Sales Drop At Record Pace

Story from Bloomberg

Sept. 29 (Bloomberg) -- U.S. vacation timeshare sales may fall the most this year since the industry gained popularity in the 1970s as consumers forgo spending to ride out the recession.

Sales may drop 30 percent this year from 2008, said Howard Nusbaum, president and chief executive officer of the American Resort Development Association, a Washington-based trade group. The market “will be a challenge for at least the next 18 months,” Patrick Scholes, senior equity research analyst at FBR Capital Markets & Co. said this month.

“Timeshares are just very, very discretionary items,” said Chris Woronka, an analyst at Deutsche Bank Securities in New York. “It’s the perpetual vacation. I am prepaying for the ability to take a vacation every year. Under the current circumstances, people are more reluctant to pay for that.”

U.S. timeshare sales dropped 8.5 percent last year to $9.7 billion from a peak of $10.6 billion in 2007, excluding the luxury fractional business and private residence clubs, according to an Ernst & Young LLP study prepared for ARDA. The decline was the industry’s first since 1975 and is being driven by tighter credit, a higher personal savings rate and the loss of 6.9 million jobs since the recession started in December 2007.

Marriott’s Charge

Marriott International Inc., the largest U.S. hotel chain, said last week it will take a third-quarter pretax charge of $760 million in its timeshare business. The company will cut prices, halt development at some residential resorts and at some luxury fractional ownership properties, and sell some undeveloped land.

“We have enough inventory to last a few years,” Laura Paugh, senior vice president of investor relations at Marriott, said in a telephone interview. “Prices are not likely to turn around in the near term. Given the development risk, we plan to complete the inventory we have under way, but not develop any more.”

Wyndham Worldwide Corp., the largest seller of timeshare vacation units, in December said it would cut 40 percent of those sales in 2009.

Timeshares give owners the right to use a property for a set period of time each year, typically a week. Fractional ownership plans usually offer longer stays at a property and tend to include more services and amenities, according to ARDA.

For hotel companies, the businesses can build customer loyalty, Marriott’s Paugh said.

‘Buy the Hotel’

Timeshares first emerged in the 1960s, according to Group RCI, Wyndham’s vacation rental and timeshare unit. According to RCI’s Web site, a hotelier in the French Alps marketed the world’s first timeshare development with the slogan, “No need to rent the room, buy the hotel -- it’s cheaper!” The concept moved to the U.S. in the 1970s, initially in Florida, the state with the most timeshare resorts, according to RCI.

“The main obstacle for the industry is that there will be a semi-permanent reduction in demand because developers would sell to people with relatively low credit scores,” said Deutsche Bank’s Woronka. “That won’t be possible anymore. Your pool of buyers will be much smaller from now on.”

Starwood Hotels & Resorts Worldwide Inc., the third-largest U.S. lodging company, may also have to “recognize significant timeshare impairments” since it has more high-end timeshares than Marriott, David Loeb, an analyst at Robert W. Baird & Co., said in a note this month.

Demand Drops

Starwood’s fourth-quarter timeshare sales fell 48 percent, the company said in January. It closed nine sales centers and cut 900 employees from the division since the start of 2008.

K.C. Kavanagh, a Starwood spokesman, declined to comment.

“Our sense is that the timeshare industry is less optimistic about any near-term recovery than is the hotel industry, as the timeshare industry’s hands are tied by the availability -- or lack -- of financing,” Scholes said in a note this month.

On Sellatimeshare.com, a one-bedroom, one-week timeshare at the Marriott Aruba Surf Club is being offered for $25,900.

The Web site includes the testimonial of a client who sold her unit at the Renaissance Aruba Beach Resort and Casino for $5,000.

On Timeshareadventures.com, a two bedroom, two-bath one- week timeshare at Marriott’s Canyon Villas at Desert Ridge in Arizona was for sale for $25,000. The annual maintenance fees and taxes are $900. The property includes a golf course, tennis courts and spa.

Plenty of Ads

A one-week, every-other-year unit at Marriott’s Ko Olina Beach Club timeshare resort in Oahu, Hawaii, is advertised for $15,999. The annual maintenance and taxes on the two bedroom, two bath are $728.

Mark Massarelli, who runs Dynasty Limousine in Boston, has been trying to sell one of two timeshares in Hollywood, Florida, that he and his sister inherited from their mother. He has been advertising a one-bedroom, one-bath unit on Craigslist.org for six months. It’s at a full-service oceanfront property with access to an 18-hole golf course.

Massarelli, 46, hasn’t received any inquiries even after cutting the price twice.

“I am offering it at $3,995 but its value right now is probably around $8,000,” Massarelli said in a telephone interview. “I tried to sell it a couple of times for a higher price but nobody bit. The maintenance and taxes on the unit are getting expensive. So I cut the price to attract more buyers, but nothing so far.”

Hotel Deals

The average sales price for timeshares in the U.S. climbed to $20,152 in 2008 from $15,790 in 2004. Occupancy remained little changed from 2005 to 2008 at about 82 percent, according to Ernst & Young. Average maintenance fees increased to $646 from $471 from 2005 through 2008.

“This year in particular, timeshare sales are down because hotel deals have been so good,” said Woronka. “Owners may think ‘I could have stayed at a luxury hotel for $150 a night and I am paying much more for this timeshare.’”

The luxury timeshare segment, where units can sell from $100,000 to more than $1 million, also is being hit, according FBR’s Scholes.

Demand for such rooms “was soft in 2008 and weakened further in 2009,” Arne Sorenson, Marriott’s president and chief operating officer, said on Sept. 23.

“I don’t think timeshares are out of style,” said Marriott’s Paugh. “Customers really do like it. But the returns we currently receive on our investment are disappointing. For us it’s probably not the place we want to put our money.”

Banks Begin Writing Off Principal

Story from the Wall Street Journal

Banks and loan investors are starting to bite the bullet and lower the principal due on home mortgages for some struggling borrowers, a new report from bank regulators shows.

That's good news for some homeowners, but may portend more write-offs over the next few years for banks and other lenders now wading through hundreds of thousands of applications for loan modifications. The tradeoff for banks is that by taking the hit now they can boost their chances of being repaid.

Banks and loan servicers modify loans primarily by reducing interest rates or extending the term of the mortgage. These methods can temporarily help borrowers struggling to make payments without requiring lenders to lower the principal owed. Now, in a small but growing number of cases, banks are going further and writing off some of the loan altogether.

Part of this is due to prodding from the Obama administration, which has made saving homeowners from foreclosure a cornerstone of its economic-rescue strategy. The administration in March announced plans aimed at helping as many as nine million households struggling with mortgage debt through loan modifications or refinancings. The plans include financial incentives for mortgage-servicing firms that modify loans.

At the same time, banks now have more flexibility to modify loans because of their success in stabilizing their balance sheets and, in some cases, raising fresh capital. Banks can afford "to take the pain up front," said Kevin Fitzsimmons an analyst at Sandler O'Neill & Partners LP in New York. "If they want a legitimate chance of salvaging something out of the loans, they are better off taking the loss now."

The portion of loan modifications in the second quarter that involved reducing the principal jumped to 10% from 3.1% in the first quarter, according to the report released Wednesday by the Office of the Comptroller of the Currency, or OCC, which regulates national banks.

Alejandro Estrella, a mail carrier in Riverside, Calif., said he was surprised when his lender, the Wachovia unit of Wells Fargo & Co., agreed recently to reduce the principal he owed on two mortgages on his home by 18% to about $237,000. That will lower his monthly payments to less than $1,500 from about $2,100. "I wasn't expecting it," said Mr. Estrella, who started out seeking just a reduction in his interest rate and got counseling from Springboard Nonprofit Consumer Credit Management.

Principal reductions are still the exception, though. Tom Kelly, a spokesman for J.P. Morgan Chase & Co., said the lender first tries to make loans affordable by lowering the interest rate for borrowers who qualify for modifications. If that doesn't result in a low enough payment, the bank may extend the term of the loan or defer repayments on part of the principal. That deferred principal would come due if the home is sold or refinanced.

But banks and loan servicers are recognizing that modifications don't always work if the borrowers aren't given a big enough break. Of loans modified in this year's first quarter, 28% were in default again within three months, the OCC said. Among those modified in last year's second quarter, 56% were in default again a year later.

Although the Obama administration programs for averting foreclosures got off to a slow start, they are starting to result in larger numbers of modified loans. The OCC report tallied 439,574 agreements to help troubled borrowers, including loan modifications and other repayment plans, in the second quarter. That was up 75% from a year earlier. Of that total, 142,362 of the agreements were classified as loan modifications, and 10% of those involved reducing the principal.

Beyond Housing, a nonprofit in St. Louis that counsels distressed borrowers, recently won a principal reduction for Evone Lester, a prison employee who had fallen behind on her payments and faced foreclosure. The loan was being serviced by Wells Fargo & Co. but was owned by an investor, Beyond Housing said. The investor agreed to reduce the loan balance to about $48,800 from $72,000, said Chris Krehmeyer, chief executive of Beyond Housing. That helped cut the monthly payment to $761 from $1,039.

In spite of these efforts, foreclosures continue to rise. In a report last week, Amherst Securities Group, a New York research firm, estimated that about seven million homes -- representing 12% of U.S. homes with mortgages -- will end up changing hands in foreclosures or related transactions over the next few years. The company said it doesn't expect that loan-modification efforts will ease the problem significantly, largely because so many people default again.

The OCC's report, which covers about 64% of all U.S. home mortgages outstanding, found that 11.4% of those mortgage loans were at least 30 days overdue or in foreclosure at the end of the second quarter, up from 10.2% three months earlier and 7.4% a year before.

The OCC isn't requiring banks to reduce principal, said Joseph Evers, a deputy controller at the regulatory agency. But, he said, the OCC has told banks they need to make sure modifications are "more sustainable," giving borrowers a real chance to keep up with the new payments.

Separately, the Federal Reserve Board Wednesday released a report on mortgage data from more than 8,000 lenders under the Home Mortgage Disclosure Act, known as HMDA. The report showed that blacks and Hispanic whites were far more likely to be denied last year for refinancing conventional mortgages, those that aren't insured by the federal government.

The denial rate for blacks was 61%, compared with 51% for Hispanic whites and 32% for non-Hispanic whites. That may partly reflect the larger proportion of minority borrowers who got subprime loans during the housing boom and ended up in homes whose values have crashed.