America’s large banks have already warned about the threat to their balance sheets posed by their commercial real estate exposure, but it may well be the smaller regional banks that are most at risk.
In an interview with the FT in 2008, Comptroller of the Currency John Dugan said he was particularly worried about lending by smaller banks to commercial real estate developers for condominiums and other projects. As the FT reported at the time:
More than a third of smaller community banks have made commercial property loans that exceed 300 per cent of their capital, the OCC says. By comparison, in 1987, when hundreds of banks failed amid a commercial property collapse, such banks had commercial property loans equal to 175 per cent of their capital.
Mr Dugan said he did not expect failures to rise as high as during the late 1980s and early 1990s – when 534 banks failed in 1989 alone – because banks are better capitalised, have better underwriting standards and did less speculative lending.
“Banks are better capitalised going into this…but the flip side is they are more concentrated,” he said. “Part of it depends on the depth of the downturn and duration of the downturn.”
As it happens, the downturn has been lengthy and acute, which bodes ill for the 1,700 institutions regulated by the OCC. And as the New York Times reported on Saturday, the FDIC is approaching the “grim milestone” of having 100 failures among lenders it regulates:
Burdened by worsening commercial real estate loans, many small banks’ troubles are just beginning. Many analysts say that the now-toxic loans could sink hundreds of small lenders over the next few years and place a significant drag on the economy.
…
Regulators expect closures to ripple through hundreds of small banks over the next couple of years, especially in the Midwest and Southeast, where lenders have been hard hit by the recession.
These banks loaded their balance sheets with loans to home builders and other property developers to make up for lost business in credit card and mortgage lending that bigger competitors wrested away. They eased their lending standards during the boom years and made big bets on new housing developments, strip malls and office projects. Now, many of those deals are falling apart, and the lenders are scrambling to raise capital to cushion the losses.
“These banks were big enough that they could do loans that were fairly sizable,” said John R. Chrin, a former investment banker who is now an executive in residence at Lehigh University. “If they go bad, they are toast.”
According to an analysis by research firm Foresight Analytics, about half of the industry’s $1,800bn commercial real estate loans are held by small and medium-sized banks, the NY Times said:
In fact, applying only the commercial real estate loss assumptions that federal regulators used during the stress tests for the big banks last spring, Foresight analysts estimated that as many as 581 small banks were at risk of collapse by 2011.
By contrast, commercial real estate losses put none of the nation’s 19 biggest banks, and only about 5 of the next 100 largest lenders, in jeopardy.
As the newspaper put it, these banks might just be “too small to save”.
Related links:
A CRE news summary – Calculated Risk
Banks not worried enough about commercial real estate, Fed says – FT Alphaville
The end of Corus bank, enabler of the condo boom – FT Alphaville
Corus: Cash for Clunkers of Commercial Real Estate – WSJ Deal Journal