Pretty much everyone agrees the year ahead will be grim for banks with big commercial real estate loan books. The question is, will the medicine coming out of Washington cause more harm than good?
According to SNL Financial, delinquency rates on CRE loans, including construction and development, were running at 9.09 percent through the second quarter. Deutsche Bank Securities analyst Richard Parkus estimates that banks have $534 billion in C&D loans on their balance sheets, $220 billion in multifamily loans and another $1.1 trillion of "core" CRE loans, tied to seasoned office, hotel, retail and other properties. With vacancy rates rising and cash flow from commercial properties shrinking, he predicts C&D losses will surpass 25 percent, or at least $140 billion, while losses on the rest of the bunch could reach as high as 15 percent or another $150 billion. "Let's not minimize this: $300 billion in losses is a huge problem," Parkus says.
That's triggering alarm bells across Washington. Lawmakers, fearful that CRE problems could derail the nascent economic recovery and leave the government saddled with more bills, have held hearing after hearing on the topic. Regulators, tired of being called on the carpet for failures by their political masters, are ratcheting up the intensity of exams. Examiners have cited CRE lending in 15 percent of cease-and-desist orders so far this year, according to FinCri Advisor in Maryland, and the numbers are expected to rise. The Federal Reserve is reportedly set to launch another series of "stress tests" - this time aimed squarely at some 800 regional and community banks it has tabbed as big CRE lenders. And as many as 2,000 institutions with non-owner-occupied CRE loans above supervisory thresholds of 300 percent of capital, or development loans above the 100 percent-of-capital levels, can expect a grueling exam season. "If a bank is not below those levels, it's looking at an administrative action of some sort," says Peter Weinstock, a financial institutions partner at Hunton & Williams in Dallas.
Authorities are expected to employ both real estate and peer-group data to assess how well individual institutions have kept tabs on collateral values and provisioned for potential CRE losses. Examiners are often ordering new CRE appraisals, which aren't cheap. Those deemed to be doing a poor job will likely be required to boost reserves to recognize the bulk of their losses - and, if needed, raise additional capital - following that one exam. "We're already hearing from bankers who have never had problems in the past, and are surprised by how stringent the exams are," says Ann Grochala, a vice president at the Independent Community Bankers of America.
Weinstock is among the critics who argue that cracking down on struggling CRE lenders at this juncture will suck lending liquidity from the market, prevent refinancing activity at more reasonable collateral values and lead to more failures. Many bankers "are trying to ride out the storm over several quarters, but the regulators aren't going to let them do that," he says.
Getting a bad asset-quality or management review "can impact your deposits and liquidity, your FDIC assessments, your ability to retain customers," Weinstock adds. "It can set off a slow-motion train wreck that ends in a bank's failure."
ICBA is lobbying for more of a go-slow, case-by-case approach. "There are signs that the economy is turning around," Grochala says. "We'd like to see [examiners] not assuming the worst, and not treating all lenders in a particular region the same way."
Unlike the residential mortgage crisis, regional and community banks are more in the crosshairs on this one. "There's not going to be a financial institution in America that doesn't suffer some problems with commercial real estate," says Ray Davis, CEO of Umpqua Holdings Corp. in Portland, Ore. About 55 percent of Umpqua's loans are tied to CRE. Davis says he has stress-tested the portfolio "a variety of times," and believes that aside from the occasional "one-off," conservative underwriting, based on debt ratios, the $8 billion-asset company has little to fear. "If you were a loan-to-value underwriter, you're going to have problems," Davis says.
In total, 38 banks and thrifts with more than $10 billion in assets have at least 25 percent of their portfolios in CRE loans, according to SNL figures; 16 of those have double-digit CRE delinquency rates. Among the most exposed: The $12.8 billion-asset UCBH Holdings in San Francisco, where CRE accounts for nearly 60 percent of the loan book and delinquencies are running at a 14.4 percent clip; and Sterling Financial Corp. in Spokane, Wash., which has half of its $8 billion of loans in CRE loans, more than 15 percent of which are delinquent.
Weinstock suggests that banks get a jump on examiners by closely reviewing their loan portfolios and capital levels, and making adjustments before they arrive. "It's easier to raise capital before the regulators have a gun to your head," he says. "An adequate allowance is much more important than a profitable quarter."