Midsized regional US banks are being hurt the most by commercial real estate woes and it’s only likely to get worse. According to a study released last week by the International Monetary Fund (IMF), Commercial Real Estate (CRE) exposure represents 50% of the outstanding loans at midsized and smaller regional banks. And at seven banks shut down by the FDIC in the last couple of weeks, CRE represented 80% of the nonperforming loans. That’s a very bleak picture given what we’re about to discuss. While at a national level, CRE exposure makes up only 10% of total bank loans, the impact on regional banks has a major impact on small and midsized businesses that depend on them for capital.
For the first time on record, US real estate lending has declined year-over-year. That’s never happened before and in June, real estate lending at US banks was down 4.7% year-over-year (see chart). The delinquency rate of real estate loans at US commercial banks almost tripled to nearly 9% from the same period only two years ago.
Percentage Change Year-over-Year in Real Estate Lending
Recent data from Capital IQ shows that there were 44 midsized banks (threshold for midsized banks is over $1 billion in assets) that had more than 50% of their loan portfolio in CRE, of which 15 banks had more than 60% in CRE. When you get to smaller banks with less than $1 billion in assets, there are many with even higher proportions of CRE. Even though only a small proportion of these outstanding loans are non-performing (i.e. not paying interest), most of them are underwater and the trouble comes when the loan matures.
Even in stress tests performed on the largest banks in the US, the IMF highlighted 12 banks out of 53 in their study that would need to raise over $14 billion in the next four years, just to maintain minimum regulatory capital ratios. Approximately $1.4 trillion of CRE loans are expected to mature by 2014, and around half of them are underwater or seriously delinquent, according to the report. Of these $1.4 trillion in CRE loans, $245 billion matures in 2010 and the same amount in 2011. That’s when the real fireworks begin. Banks either have to refinance the loan or realize losses and further deteriorate their balance sheet.
It really is a catch twenty-two situation. If you are a bank, you are limited to several unpleasant choices: Option A) write down loans that are underwater today and be forced to raise more capital today to remain compliant with regulatory capital ratios, Option B) sell off loans at a discount today and again realize losses that you can’t afford to, or Option C) delay the inevitable write down until the loan matures and in the meantime raise additional capital, hope that property values increase and manage the most problem outstanding loans in your portfolio.
It is a very difficult situation for all parties and unfortunately there is no simple answer. The full complexity of our current economic situation is unprecedented and as a result would have been very difficult to predict in advance. Increasing bank failures will hurt our entire economy, so hopefully banks are given the time and flexibility to manage their loans without a fire sale situation that could further cripple the capital markets and see lending freeze again.
Again, a thank you to CFO Magazine for their continuing coverage of this situation and their latest article, which contributed material and prompted additional research for this blog.