Just as the housing sector appears to be recovering, gathering problems in the commercial real estate market threaten to become a new drag on the economy.
The collapse in home prices sunk many big banks last year, but this year smaller lenders and community banks are going bust at an alarming rate because of their exposure to souring commercial real estate loans.
At least 115 banks have failed this year, many because of their exposure to deteriorating commercial loans for retail space, office buildings and industrial parks. As of June 30, the Federal Deposit Insurance Corp. was monitoring another 416 institutions as “problem” lenders.
How dire is it? Unable to find enough sound banks to acquire failing banks, the FDIC relaxed its rules earlier this year to allow private-equity funds to bid for troubled lenders.
Banks hold about 50 percent of all outstanding commercial real estate loans, many of them smaller regional players. Another 20 percent of commercial real estate loans have been pooled together by investment banks and sold as commercial mortgage bonds, which also are experiencing high default rates.
The rising rate of delinquency and default in commercial real estate jeopardizes efforts by the Treasury Department and the Federal Reserve to get much-needed lending flowing again.
“When you ask people at the Fed what the biggest worries are, this (commercial real estate) is at the top of their list,” said Laurence Meyer, a Fed governor from 1996 to 2002. “The danger here is not the direct macroeconomic impact but the potential impact on the safety and soundness of the banking system.”
After the political uproar over last year’s $700 billion taxpayer bailout of banks, however, there’s little appetite in Congress for additional taxpayer rescues of financial firms of any size. So regulators late last week attacked the problem another way: They encouraged banks to modify the terms of their commercial real estate, or CRE loans.
“While CRE borrowers may experience deterioration in their financial condition, many continue to be creditworthy customers who have the willingness and capacity to repay their debts,” the joint guidance from bank regulators said.
Regulators also relaxed reporting requirements so that small and mid-sized banks don’t have to value these loans at today’s deflated real estate prices.
“One of the problems was that even performing commercial real estate loans, where the borrower is still making payments, were being forced to be partially written down,” said Paul Merski, the chief economist and senior vice president for the trade group Independent Community Bankers of America.
That group would like to see some of last year’s bailout money given to smaller banks, under less onerous terms, since community banks are suffering from the broad economic downturn, not their own reckless behavior.
“The government has been picking winners and losers, and in many cases the losers have been too small to save,” Merski said. “We’ve been asking for some fairness in that whole process.”
Smaller banks’ problems create problems for small businesses. Small firms depend on local and community banks for loans, so the deteriorating commercial loan environment hurts employment, since small businesses do most of the hiring nationwide.
“If we want to get a broad-based recovery going in this economy, we have to … help small businesses get access to lending again, and commercial real estate is an indirect threat to that,” said Meyer, now a vice chairman of the consultancy Macroeconomic Advisers. “Smaller banks are failing at a high rate and they’re key to what happens to small business. Small business are … basically closed off.”
Problems in commercial real estate have been more anticipated than the unexpected shock the economy took from the collapse in home prices.
“This isn’t nearly as bad as a year ago, but there’s going to be a lot of people that do get hurt, especially small banks,” said Douglas Elliot, a finance expert at the Brookings Institution, a center-left policy research group.
Last year as credit markets seized up, large corporations couldn’t get loans from big banks or even issue short-term debt to fund their daily operations. Amid the so-called credit crunch, groups such as the National Federation of Independent Business boasted that credit hadn’t dried up on Main Street.
Today, the situation is reversed. Small business is struggling to get loans as small and mid-sized regional banks are under severe stress from deteriorating loan portfolios.
In a report Monday, The Real Estate Roundtable, a trade group, said its latest survey of member sentiment found that commercial real estate markets “remain extremely stressed with little prospect for significant near-term improvement.”
FDIC lending data, analyzed by forecaster Moody’s Economy.com, show that as of June 30, 2006, just 0.58 percent of all commercial real estate loans were delinquent. By June 30, 2009, that number had climbed to 2.88 percent.
Related to the problems in commercial real estate, on June 30, 2006, 0.43 percent of all construction and development loans were delinquent. On June 30, 2009, that number stood at 13.45 percent.
Through June 30, the FDIC insured deposits at 8,204 financial institutions whose assets collectively were valued above $1 trillion. About 1,693 of these lenders were considered heavily exposed to commercial real estate, with more than a quarter of their assets tied up in CRE lending.
“We obviously have a world where loans that made perfect sense three years ago make little or no sense today. That’s the kind of dilemma the banks are in,” said Christopher Cornell, an economist specializing in real estate for Moody’s Economy.com in West Chester, Pa.
Commercial mortgages or leases generally span periods of five, seven or 10 years, after which they’re renewed. The economic downturn, however, has rendered many smaller borrowers less creditworthy, and with many firms going out of business, there’s a glut of retail and office space.
“Fewer people want the property. Just follow supply and demand, and the price of property goes down, the net equity on the mortgages on these properties is declining and in many cases is negative,” said Cornell, noting that commercial real estate prices have fallen by at least 40 percent from their peak. “That 40 percent price decline has pretty obvious and easy to trace implications.”
(c) 2009, McClatchy-Tribune Information Services.