Dandelions in the Weeds: Real Estate

By Jeff Harding

Home Sales

Existing-home sales rose a second month in a row during May, but prices again fell sharply, threatening a delay to a housing sector recovery.

Home resales increased by 2.4% to a 4.77 million annual rate from 4.66 million in April, the National Association of Realtors said Tuesday. The NAR originally reported April sales rose 2.9% to 4.68 million.

Of the 4.77 million homes actually sold in May, about 33% were foreclosures and short sales. While elevated, that figure is lower than the 45%-to-50% range earlier this year.

Distressed property sales have pushed prices lower, year over year. The median price for an existing home last month was $173,000, down 16.8% from $207,900 in May 2008.

Of course we still have a lot of other debt generated from the boom phase that is liquidating as well: auto loans, credit card loans, student loans, and commercial real estate loans.

This is more good news. As home prices decline from increased foreclosures and short sales, the market is starting to find a bottom. The fact that sales are up means buyers are coming back into the market looking for deals. That’s how market bottoms are found. The implications of this statistic is that the main asset driver of the boom phase, the one asset that almost all the debt of the cycle was based on, is starting to stabilize. Once housing stabilizes, all the mortgage debt based on housing, including subprime mortgages, and all the derivatives based the mortgages will also stabilize, and the holders of these assets will finally be able to determine the value of these so-called “toxic assets.” And then they will repair their balance sheets and the economy will go forward.

Commercial Real Estate

I read that my local bank, Pacific Capital Bancorp (PCBC) is in some trouble. In order to boost their Tier 1 capital per OCC requirements, they suspended their dividend which included interest on TARP money they took:

Pacific Capital Bancorp, a Santa Barbara, Calif., lender that got $180.6 million from the Treasury Department in November, has since posted net losses of $49.7 million. Pacific Capital said Monday that it suspended dividend payments on its common and preferred stock as part of a wider effort to save about $8 million per quarter. A bank spokeswoman confirmed that the U.S.’s preferred shares are included in the dividend freeze.

I looked up their Q1 09 quarterly statements and their nonperforming loans went up from $161 million to $261 million over Q1 08. Their reserves for loan losses went up to $155.7 million from $48.4 million in a year. So, roughly they have about a $100 million gain in problem loans in a year. Almost all of the nonperforming loans were real estate related, most of it from residential construction loans.

It doesn’t appear that they have substantially increased their loan book which is what I’d expect from a bank sitting on potential loan losses. This is what is happening to credit in America.

These guys were among the more conservative of lenders. I find this interesting in that their troubles have come to them late. While we have Goldman and JP Morgan pulling out of their hole, the small, local banks are still dealing with massive problems. From my own experience I have found that the local banks work with their borrowers as long as they can to keep the loans current so they don’t have to accrue reserves for a bad loan. At some point they get pressured by the regulators to put these loan in the nonperforming category. And then the loan losses add up, they accrue capital for their reserves, and credit shrinks.

So, another way to look at this is that these banks are finally dealing with their bad loans and are cleaning up their books. It hurts, but it’s necessary for a recovery.