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CRE Default a Growing Risk to Banks

Regulators Fret over CRE Concentrations, but Banks Looking to Modify


The recent surge in community bank failures has been widely attributed to small and mid-size lenders’ high concentrations of commercial real estate (CRE) loans. The impact that the sector’s continued deterioration could have on lower-tiered lenders and their local markets has become a growing concern among policymakers and regulators. Elizabeth Warren, head of the Congressional Oversight Panel (COP) charged with overseeing the Troubled Asset Relief Program (TARP), told CNBC this week that by the end of 2010, about half of all commercial real estate mortgages will be underwater, and most of these souring loans are concentrated in regional banks.


We now have 2,988 banks – mostly midsized, that have these dangerous concentrations in commercial real estate lending,” Warren said in the television interview, adding that the economy will face another “very serious problem” as these loans come due that will have to be resolved over the next three years.


Comptroller of the Currency John Dugan echoed Warren’s sentiments when he spoke at the annual convention of the Independent Community Bankers of America (ICBA) earlier this month. He said that experience from the late 1980s and the early 1990s, and from the current period, illustrates that significant concentrations in CRE lending leave banks vulnerable to an economic downturn.


While a healthy economy will mask problems with poor underwriting for a while, Dugan said, the rapid buildup of commercial real estate loans is likely to overwhelm risk management controls, and some concentrations are so large that even the most sophisticated control systems cannot protect the bank from a serious economic downturn.


“We know that significant CRE concentrations in economic downturns can lead to an increase in problem banks, an increase in bank failures, loss of jobs, loss of incomes, loss to communities, loss to the deposit insurance fund, and higher costs for all banks, even those that do not have CRE concentrations,” Dugan said.

As the nation’s top regulators fret over banks’ commercial mortgage concentrations, the head of the Treasury Department says he’s less concerned that it’s a major threat.

“Commercial real estate’s still going to be a problem for the country,” Treasury Secretary Timothy Geithner said in an interview with CNBC. “But we can manage through this process.”


News from the field seems to support Geithner’s assumptions, as lenders appear to be moving more aggressively to modify commercial mortgages and avert another default tsunami. “Commercial lenders throughout the United States are becoming increasingly aware of their need to enter into modification agreements with their borrowers,” according to Kevin Levine, EVP of Strategic Asset Services, an advisory services firm in Woodland Hills, California that provides commercial loss mitigation support.


“When we first began offering commercial loan modification services in early 2009, many lenders were reluctant to recognize the seriousness of their commercial loan problems and modify the loans,” Levine said. “But in the past several months, that recognition has increased dramatically. As a result, we find more and more banks and other lenders welcoming our services on behalf of their borrowers.”


Levine explained that commercial loan values are falling in most markets, and that office, retail, and multi-family properties are losing tenants at a recession-driven pace. As a result, borrowers are experiencing compressed cash flow, and are unable to meet their loan payments. Unless the loan is modified to reduce the payments, the lender inevitably will be forced to commence foreclosure proceedings, but Levine says the balance sheets of banks are only able to absorb a limited number of foreclosed properties, and that limit is quickly being approached by many lenders.


“We saw the same initial reluctance of the residential lenders to work with their borrowers and modify their stressed home loans several years ago,” Levine said. “But just as the residential lenders were forced by declining circumstances to cooperate with the homeowners, so the commercial lenders are now being compelled to negotiate with their borrowers. It is preferable for them to have a paying asset, even at a reduced return, than to go through the expense of foreclosure and incur property management expenses during a two-three year holding period while attempting to sell the property.” 

By: Carrie Bay - DSNews

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