Commercial mortgage failures threaten system

Over the next few years, a wave of commercial real-estate loan failures could threaten America’s financial system, and in the worst case scenario, hundreds of additional community and midsize banks could face insolvency, a congressional watchdog group said Thursday.

According to a report by the Congressional Oversight Panel, a watchdog group for a $700 billion bank-bailout package, about $1.4 trillion in commercial real-estate loans will reach the end of their terms between 2010 and 2014, of which nearly half are now under water (that is, the borrower owes more than the underlying property is currently worth).

The report added that losses from commercial loans could range as high as $200 billion to $300 billion.

As a result, it said, banks that suffer from the losses or are discouraged by the economic future could become even more reluctant to lend, which could reduce access to credit for more businesses and families, accelerating a negative economic cycle.

“The Congressional Oversight Panel is deeply concerned that commercial loan losses could jeopardize the stability of many banks, particularly the nation’s midsize and smaller banks, and that as the damage spreads beyond individual banks, that it will contribute to prolonged weakness throughout the economy,” said the report, which was approved unanimously by the five-member COP.

The oversight panel also urged bank regulators to take a more thorough look at which banks they decide to unwind.

“The (COP) is clear that government cannot and should not keep every bank afloat. But neither should it turn a blind eye to the dangers of unnecessary bank failures and their impact on communities,” the report said.

The COP members said that not all banks should be treated the same way when it comes to recognizing losses. The panel contends that banks with weak portfolios across the board should be forced to recognize all losses.

Meanwhile, banks that have financed only the strongest projects and operated prudently, and banks with commercial real-estate portfolios that have weakened but are largely still based on performing loans, should be dealt with more carefully and should not be forced to recognize all potential losses immediately.

Having this group be forced to recognize potential losses immediately could create a “self-fulfilling prophecy,” the report said, as selling commercial real estate at fire-sale prices could depress values of even relatively strong properties.

“Real-estate prices would be driven below actual long-term values, pushing the commercial real-estate sector into what has been termed a negative bubble?not only forcing more banks in a particular region into perhaps unnecessary insolvency, but having ripple effects across the broader markets for commercial real estate,” according to the report.

The report also includes a brief summary of the status of the Treasury’s program to dispose of the warrants it acquired as part of its Troubled Asset Relief Program.

The COP projected the receipts from the sale or auction of the warrants ? those sold or auctioned and those yet to be disposed of ? will total $9.3 billion.

(c) 2010, Inc.?Distributed by McClatchy-Tribune Information Services.