Banks Turn Blind Eye To Commerical Real Estate Losses

The attitude of banks towards the collapse of commercial real estate seems to be ” ignore it and it will go away”.   Sometimes this strategy works, sometimes it doesn’t.
Right now, this “see no problem” attitude is beginning to raise eyebrows as  losses on commercial real estate loans expand while corresponding loss reserves decline.  Consider Fed Frets About Commercial Real Estate:

Banks in the U.S. “are slow” to take losses on their commercial real-estate loans being battered by slumping property values and rental payments, according to a Federal Reserve presentation to banking regulators last month.

The remarks suggest that banking regulators are girding for a rerun of the housing-related losses now slamming thousands of banks that failed to set aside enough capital during the boom to cushion themselves when the bubble burst. “Banks will be slow to recognize the severity of the loss — just as they were in residential,” according to the Fed presentation, which was reviewed by The Wall Street Journal.

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.

Mr. Conway’s presentation painted a bleak picture of the sliding real-estate values and enormous debt that will need to be refinanced in the next few years. Vacancy rates in the apartment, retail and warehouse sectors already have exceeded those seen during the real-estate collapse of the early 1990s, Mr. Conway noted. His report also predicted that commercial real-estate losses would reach roughly 45% next year. Valuing real estate has always been tricky for banks, and the problem is particularly acute now because sales activity is practically nonexistent.

Commercial real-estate loans are the second-largest loan type after home mortgages. More than half of the $3.4 trillion in outstanding commercial real-estate debt is held by banks.

The strategy of pretending that losses don’t exist while hoping that things get better seems seems to be wearing thinner by the day as defaults and vacancies increase – see
Apartment Glut Deepens.   Meanwhile, the Federal Reserve’s plan to facilitate commercial lending is off to a slow start.

Sept. 17 (Bloomberg) — The U.S. program to kick-start commercial-mortgage lending has failed to produce new debt sales since it began in June, delaying efforts to revive the market for bonds tied to shopping malls, office buildings and apartments.

The fourth monthly deadline under the Federal Reserve’s Term Asset-Backed Securities Loan Facility aimed at commercial real estate is today, and no deals have emerged. The program was expanded to include newly issued commercial mortgage-backed securities to stave off a wave of foreclosures as borrowers are unable to refinance amid a pullback in lending and a 36 percent drop in property prices from their October 2007 peak.

The government has made aiding a recovery in commercial real estate a priority. On Sept. 15, the U.S. Treasury Department adopted rules that will make it easier to extend the maturity of potentially troubled commercial real estate loans as part of its efforts to stem defaults.

As the banking industry continues to struggle with defaults on residential mortgages, they now face another huge challenge on the commercial loan side.   The Fed plan to expand commercial real estate lending may provide some help, but until there is a recovery in jobs and the economy, the banks will face increasing problems dealing with their book of commercial loans.