Many Banks Unprepared for CRE Bust
Anyone catch this scary stat in that WSJ story yesterday on the Fed's concerns about commercial real estate?
In another sign that many U.S. financial institutions are inadequately protected against potential losses on commercial real-estate loans, banks with heavy exposure to such loans set aside just 38 cents in reserves during the second quarter for every $1 in bad loans, according to an analysis of regulatory filings by The Wall Street Journal. That is a sharp decline from $1.58 in reserves for every $1 in bad loans from the beginning of 2007.In other words, lots of banks aren't preparing for the coming deluge related to the ailing commercial property sector. The Journal identified more than 800 banks with more than half their loan portfolios attached to office, hotel and other commercial real estate. Overall, banks have $1.7 trillion in loans classified as CRE loans. This consists of some $1 trillion in "core" CRE loans, $532 billion of construction and land development loans, and $150 billion of multifamily loans.
The problem here is that rising unemployment, especially in the corporate and retail sectors, is causing vacancies to soar and rents to tumble across all major property types -- apartments, office, retail, industrial. As a result, loan delinquencies are taking off, which completes the vicious cycle by squashing a property's value. Commercial property prices fell 5.1 percent in July, and are now nearly 39 percent off their peak in October 2007 (click on chart below to expand).
The eye of the CRE storm is construction loans, according to Deutsche Bank, which expects total losses on these loans to top 25 percent. Those will fall heaviest on smaller banks. As a percentage of their total assets, the four biggest U.S. banks have roughly 12 percent of their loans tied up in commercial property, the investment bank said in a July report. That figure jumps to 24.5 percent for the next 26 largest banks, and nearly 39 percent for the companies rounding out the top 100.
Such institutions often have high concentrations of commercial loans on their books. And while many are trying to raise capital, including tapping the public market, the Journal piece suggests banks aren't moving fast enough to prepare for what's coming.
The damage from souring CRE loans is likely to carry out several years. Many of the loans starting to head south were issued at the top of the real estate bubble between 2005-07, and they won't mature for several years. So the commercial property market may not bottom until 2011 or 2012.
