Potential for CRE Armageddon Fading

Potential for CRE Armageddon Fading

Weakness, Trouble Remain but Healthy Lenders Could Carry CRE Markets to Better Days

Although first quarter results of U.S. bank holding companies across the country are unmistakably downbeat about the short-term outlook for commercial real estate in general, and their portfolios in particular, they also hint at a growing sense that the problems are working themselves out.

For starters, banks generally reported that troubled loan assets were systematically moving through their books. For example, older construction loans on commercial developments and owner-occupied properties were being shifted to term loans, giving borrowers a chance to work through slow cash flow periods.

Banks were also widely reporting that the inflow of new nonperforming commercial real estate loans was beginning to slow down. At the same time, more of the loans already being labeled as nonperforming were being shifted to the real estate owned (REO) category. From there, it is likely only a matter of time before those assets would be sold back into the marketplace.

In the performing section of their portfolios, banks reported that a substantial portion of those assets have also already been renewed or restructured.

In its April 2010 Global Financial Stability Report, the International Monetary Fund contained a brighter outlook for bank losses in the near term, as expected write-downs on both the loan and securities books of U.S. banks decreased across the board compared to last fall, said Mark Fitzgerald, senior debt analyst for CoStar Group.

“These improved short-term losses are due primarily to two factors. First, signs of an improving economic environment have decreased loss expectations,” Fitzgerald said. “Second, some write-downs have simply been pushed forward, as external factors, including low interest rates, have enabled banks to push off distress into the future.”

In part because of that delay, the IMF report forecasts real estate loan charge-offs are still expected to increase in 2010 and may not peak until 2011.

“What are the implications for commercial real estate investors?” Fitzgerald asked, then answered: “The banks supply approximately 50% of all debt capital to the sector, so lending capital could be constrained for some time. However, there is a bright side. If we continue to follow our current path, and distressed assets bleed slowly into the market over time, then healthy lenders may have enough capacity to meet low transaction volumes (especially with depressed pricing). The large banks that have recently reported healthy earnings (primarily due to their trading and fixed-income operations) are a potential source of capital, and these banks have historically been under allocated to commercial real estate compared to the overall banking sector.”

However, Fitzgerald added: “On the other hand, if an external factor pushed more distress into the marketplace (i.e. major interest rate increases, changes in regulator behavior), this could create significant opportunities for opportunistic investors.”

What follows are recent comments and reports from specific large and medium-sized bank and bankers regarding current commercial real estate portfolio and market conditions and market outlooks. The statements come from first quarter earnings reports, earnings conference calls and monthly banking condition filings with the U.S. Department of Treasury and are believed to be relatively indicative of what most banks reported.

Better To Let a Project Work Out than Foreclose

On the commercial side, CRE non-accrual loan inflows actually declined 27% in the first quarter, but it is typically in everyone’s economic interest, including ours, to write the loan down to continue to have the developer work the project for us rather than foreclose. The process of structuring and executing these solutions can take several quarters to complete, and throughout this process, these loans are closely monitored, collaterals are re-evaluated and if necessary loss content is recognized.

John Stumpf – Chairman, President and CEO of Wells Fargo & Company

Heading in the Right Direction

When you talk about the uptick in commercial real estate charge offs and nonperforming asset inflow, I think it’s important to put it in proper context to remember our overall credit trends. We’ve seen improvement for three quarters now in charge offs, nonperforming asset inflows and past dues and we’ve seen improvement for two quarters now in overall nonperforming assets, provision and the watch list…. We saw that the commercial real estate watch list was down by $100 million in the first quarter and then we analyzed the commercial real estate migration for the last several quarters and all those items supported our belief that the negative migration is receding. That being said, there’s still a lot of work to do on commercial real estate as you can see from the absolute numbers. While we think there may be variability as we certainly saw this quarter, and as we said in prior quarters, we think the overall trend is going in the right direction.

John M. Killian, Chief Credit Officer, Comerica Inc.

REITs Driving New Borrowing

In February, new commercial real estate (CRE) loan commitments totaled $132.4 million, compared with $47.4 million in the previous month. The increase in new commitments was driven by substantial capital raising activities undertaken by some of Citi’s REIT clients, which issued both new equity and longer-term debt to strengthen their balance sheets.

Citigroup in the latest Monthly Treasury Intermediation Snapshot

Short Hold Period for Foreclosed Assets

Excluding $243 million of nonperforming assets (NPAs) in our held-for-sale portfolio, where the loans have already been fully marked, portfolio nonperforming assets totaled $3.1 billion. Portfolio non-performing loans were down over $200 million sequentially, a 7% decline, while other real estate owned (OREO) was up about $100 million largely commercial OREO. That was a really positive move for non-performing loans and as you would expect we are seeing some continued growth in OREO, which represents the combination of treatment strategies on problem loans, with those typically having moved into non-performing status in the year ago timeframe. I would note that only 10% of our OREO has been carried as OREO for more than 12 months.

Mary Tuuk, Chief Risk Officer, Fifth Third Bancorp

Fifth Third continues to monitor the CRE portfolios and continues to suspend lending on new non?owner occupied properties and on new homebuilder and developer projects in order to manage existing portfolio positions. We feel this is prudent given that we do not believe added exposure in those sectors is warranted given our expectation for continued elevated loss trends in the performance of those portfolios.

Fifth Third in the latest Monthly Treasury Intermediation Snapshot

Material Liquidity Coming Back into the Market

I’m not sure that I would necessarily call it seasonality but clearly the quarter started more slowly in January and early February, and there was a real crescendo through March in terms of sales activity… We started seeing some material liquidity coming back into the market in the second half of the first quarter and that’s not seasonal. That is real and it is I think reflective of a recognition that number one, there’s a lot of money out there that’s been looking for somewhat better trends in commercial real estate in particular and are beginning to see it. So we’ve seen a great improvement.

Chuck Hyle, Chief Risk Officer, KeyCorp

KeyCorp’s lending strategies remain focused on serving the needs of existing and new relationship clients while being mindful of risk?reward and strategic capital allocation. There was no change in underwriting standards in February. There was no change in loan demand trends in the CRE segment during February. The CRE market outlook continues to be weak. All new commitments originated in February were attributable to the middle market portfolio. During February, KeyCorp continued to extend and modify existing credits given the lack of liquidity and refinancing options available in the CRE market.

KeyCorp in the latest Monthly Treasury Intermediation Snapshot

A Bifurcated Market

Class A properties are doing well and probably are doing better than anybody might mark them, so actually we’re not in the business of selling those even though we might have taken a mark on them when we took them in. Those properties tend to come back with the economy, and that’s the right thing to do.

The C properties, you just sell. C property rarely comes back so you take very strong marks on those right up front and you just sell them because they always have trouble recovering at all. So we’ve been actively doing that and we’re comfortable with our marks.

The B properties, obviously the majority of the portfolio, but those are the ones you mark down and you have to manage one by one… So that’s a plus, and I think the commercial real estate business over time, if a property loses a tenant, clearly that property has less value as you know. But then they go resign somebody else at a lower lease rate, so the property is worth less, but it’s not like it falls off the planet. There is some cash flow. So I think those B properties, I think will work their way through for the most part.

James Rohr, Chairman & CEO, PNC Financial Services Group Inc.

Ramping Up Owner-Occupied

We continue to produce our concentration of nonowner-occupied commercial real estate. We currently have $1.4 billion in nonowner-occupied commercial real estate and $630 million in owner-occupied commercial real estate. At quarter end, nonowner-occupied commercial real estate is down to approximately 45% of our total loan portfolio.

Based on where we ended the first quarter, we’re now projecting loans to be down approximately 5% to 8% the full-year and are optimistic that we might see some additional lending opportunities in the second half of year that may help us offset some of these decrease.

We have recently implemented an aggressive calling program for our bankers to actively pursue commercial industrial loans, owner-occupied commercial real estate consumer loans and residential mortgage loan opportunities. Despite low loan demands, we still manage the book over $209 million in new loan commitments during the first quarter. Anecdotally, we’re hearing from some of our customers that business had begun to pick up. However, we have not yet seen evidence of that in increased line usage or loan demand.

The sector within commercial real estate, which has experienced the most stress, has been hospitality… Over the last 15 months, the industry has experienced significant declines in occupancy of rates, average daily room rates and revenue per available room. As a result of this deterioration, we charged-off approximately $9 million against the allowance for credit losses associated with this loan portfolio during 2010… We’re in the process of finishing up a thorough review of this entire portfolio.

J. Downey Bridgwater, Chairman, President & CEO, Sterling Bancshares Inc.

Growing Interest in Bank-Owned Properties

While commercial real estate administration and problem loan disposition continue to be quite challenging… we are starting to see increased inquiries and activities in the movement of some troubled commercial real estate. We had a large OREO sale in the first quarter, it was good to see and really the focal point of my comments about being some movement and some activity in the OREO account. As you might imagine, there is a lot of multi-activity there. We have some properties coming in and some properties going out. We are continuing to value those properties each and every month to make sure that we have got an accurate balance based on the market value that we are carrying on our books.

But during the first quarter I am very pleased, we saw a number of, besides that large sale, we saw a number of sales to small properties throughout the quarter both on some commercial properties, some residential properties, amounts that made us approach that comment there about the activity in the marketplace, and there continues to be some offers and some interest heading into the second quarter. Whereas six months ago, nine months ago, a year ago, there was not a whole lot of interest in bank owned properties, we are starting to see some activity and some movement there as I indicated.

Bob Kaminski, Executive Vice President & Chief Operating Officer, Mercantile Bank Corp.

Dealing with Construction Loans

The increase in the term commercial real estate loans is only partially a result of the decrease in the construction loans. We do have some construction loans that are moving to term loan because the properties are leasing up and they are qualifying. We have fairly strict standards for moving a loan from construction to term. They basically need to qualify as though they were being originally underwritten as a term loan before we move them into that category.

Doyle Arnold, Chief Financial Officer, Zions Bancorporation

CMBS Failures Contribute to Rising Bank Failures

An article over at National Real Estate Investor relates that the delinquency rate for commercial mortgage-backed securities rose sharply in March to more than 7%.

Troubled commercial real estate and construction loans are contributing to higher bank failure rates, Trepp reports. The researcher projects that 200 banks will fail in 2010.

Many of the failures to date have occurred in Florida, Georgia and California, as well as in the rust belt markets of Illinois, Wisconsin, Minnesota and Michigan.

The banks are already feeling the effects of the highest delinquency rate in CMBS history at 7.61%. The percentage of loans 30 or more days delinquent, in foreclosure or REO, jumped 89 basis points, according to the new report.

Read the full report.

Is The United States Headed For A Commercial Real Estate Crash Of Unprecedented Magnitude?

Will commercial real estate be the next shoe to drop in the ongoing U.S. financial crisis?  While most eyes are on the continuing residential real estate disaster, the reality is that the state of the commercial real estate market in America could soon be even worse.  Very few financial pundits are talking about this looming disaster but they should be.  The truth is that U.S. commercial property values are down approximately 40 percent since the peak in 2007 and currently approximately 18 percent of all office space in the United States is now sitting vacant.  That qualifies as a complete and total mess, but the reality is that the commercial real estate crisis is just starting.

Continue reading “Is The United States Headed For A Commercial Real Estate Crash Of Unprecedented Magnitude?”

Loan Loss Reserves Restrict Banks From Making Commercial Real Estate Loans

In addition to keeping an eye on declining property values, falling rents and rising vacancy rate numbers, the commercial real estate community is also concerned over ominous signs in banking industry numbers.

One big area of concern is the fact that banks are stowing away more money to cover problem loans. The amount being set aside is rising rapidly and is now higher than it has been for a quarter of century. Meanwhile, the amount of problem loans is rising at even more than twice that rate.

The implications of the increased loan loss coverage for the commercial real estate industry is that it will likely further limit the amount of money available for borrowings. Those numbers also signify that this will continue to encourage “extend and pretend” policy that some lenders have pursued, and it may further encourage lenders to be optimistic about their recovery rates to avoid taking further losses/writedowns. And at the same time, lenders won’t hesitate in demanding more money out of borrowers’ pockets. Continue reading “Loan Loss Reserves Restrict Banks From Making Commercial Real Estate Loans”

The Coming Great Recession of 2011 – 2012

The American Spectator published an article written by James Srodes titled, “The Great Recession of 2011-2012”

Mr. Srodes hits the nail on the head.  He explains why, despite the rosy projections you read in the morning newspaper, we are headed for worse times in the next couple of years.  I don’t want to be a doomsayer, or create a sense of pessimism.  I just think the old adage that to be forewarned is to be forearmed is a good one.

I am not going to summarize the article here.  It is a very well-written and logically presented.  It is important to read it in its entirety.  I suggest you go here and do just that.  And then arrange your finances so that you will still be standing when we hit 2013.

While he writes about all the reasons 2011 and 2012 will be very difficult years financially for most Americans, he doesn’t mention one other factor that will contribute to the downturn.  There are billions of dollars of commercial mortgages that will mature in the next 18 months.  The borrowers will not be able to refinance those loans without contributing substantial cash equity.  As a hypothetical example, a borrower who borrowed $21 Million (70%) on a shopping center that was valued at $30 Million in 2006, will likely now find that he can only refinance 60% of a revalued asset now worth $25 Million.  That means he will only be able to get a new loan of $15 million to pay off a $21 Million loan.  He will either have to come up with $6 Million in additional equity, or run the risk of losing his property.  That bubble is still ahead of us and will make the bursting of the home mortgage bubble seem like a minor glitch.

All the signs are there.  You just have to read them.

Go to the American Spectator and read the whole article.