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Bank Regulators: Real Estate Loans Biggest Concern

Rising losses on commercial real estate loans will continue to hurt U.S. banks in coming months and pose the biggest challenge for many financial institutions and their overseers, regulators said Wednesday.

Real estate loans will continue to be "the most prominent area of risk" for banks over the next several quarters, Federal Deposit Insurance Corp. Chairman Sheila Bair told lawmakers in testimony prepared for a Senate hearing.

With more than 7 million jobs lost in the recession, office space has sat empty and developers have defaulted on their loans. The $6.2 billion in loans backed by commercial properties that banks wrote off as lost in the past two years will likely grow sharply as more loans come due, Bair said.

Bair and U.S. Comptroller of the Currency John Dugan also disputed accusations by some lawmakers and bankers that regulators have been telling banks to restrain lending in the high-risk climate.

"This is not the case," Bair said in her testimony for the hearing by the Senate Banking subcommittee on financial institutions. "The FDIC provides banks with considerable flexibility in dealing with customer relationships and managing loan portfolios. I can assure you that we do not instruct banks to curtail prudently managed lending activities."

Ninety-eight U.S. banks have failed so far this year, many succumbing under the weight of failed real estate loans. The number of banks on the FDIC's confidential "problem list" jumped to 416 at the end of June from 305 in the first quarter. That's the highest number since June 1994 in the wake of the savings and loan crisis. Experts say as many as 400 more banks could fail in the next couple of years.

"The greatest challenge facing many banks and their supervisors is the continued deterioration in commercial real estate loans," Dugan, whose Treasury Department agency oversees some 1,600 nationally chartered banks, said in his prepared testimony.

Commercial real estate loans and lending for construction and development are a significant focus of federal examiners in the field, the regulators said.

Dugan also stressed the importance for national banks of the continued rising losses on credit cards, with loss and delinquency levels reaching records. Some banks have reduced customers' credit lines or raised interest rates on accounts in response to increased delinquencies and the overall economic climate, he added.

Bair and Dugan said their agencies have been taking a "balanced" approach to bank supervision, keeping a vigilant eye on banks' balance sheets and directing them to shore up capital and reserves against losses, while also being flexible and sensitive to economic conditions. In addition, the FDIC has made changes in its strategies for resolving failed banks, such as sharing losses on their soured loans with the banks or investor groups that acquire the banks.

The spate of bank failures has cost the federal deposit insurance fund an estimated $25 billion so far this year and is expected to cost about $100 billion through 2013. The insurance fund has fallen into the red, and the FDIC board recently proposed to have U.S. banks prepay about $45 billion of their insurance premiums _ three years' worth.

The FDIC is backed by the government, and deposits are guaranteed up to $250,000 per account. Also the FDIC stil has tens of billions in loss reserves apart from the insurance fund.

Requiring banks to pay insurance fees in advance is preferable to having the FDIC tap its $500 billion credit line with the Treasury, Bair has said.