Investor's Business Daily
Concern Grows About Bank Failures And Their Impact
Wednesday July 2, 6:08 pm ET
Joe Gose
The last thing U.S. real estate needs is for a bunch of lending banks to collapse. But that worry is the latest cliffhanger bearing on commercial and residential property markets.
Regulators fear more small banks will fail under the weight of bad loans as real estate values keep falling. That would pull a rug out from under some commercial property owners. Stuck without loans, they could be forced into distress sales.
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The Federal Deposit Insurance Corp. anticipates as many as 150 bank failures in the next few years, largely due to bad real estate loans.
Bank analyst Mark Fitzgibbon, with investment banker Sandler O'Neill & Partners in New York, suggests that problem loans will plague small banks for another 18 months.
More Than Mortgages
"So far, the worst-performing loan segments have been residential mortgage and construction lending," he said. "But my guess is that commercial real estate will be impaired by the softening economy, too. So the problem is likely to get worse before it gets better."
Smaller community and regional banks largely escaped scrutiny after last year's subprime debt implosion as regulators and politicians focused mainly on big Wall Street institutions. But now regulators have grown worried that small-bank lending portfolios are overexposed to commercial real estate loans.
They include mortgages on existing shopping centers, office buildings, warehouses and other commercial properties. They also include residential and commercial construction/development lending.
These loans have been getting late and raising the specter of foreclosures ahead, FDIC data show. Construction/development loans more than 90 days past due rose 47.2%, or $9.5 billion, from the last quarter of 2007 to the first quarter of 2008.
"Commercial real estate loan concentrations at banks have increased significantly in recent years," said FDIC Chairman Sheila Bair, testifying in June before the U.S. Senate Committee on Banking, Housing and Urban Affairs. "The (construction and development) segment of the lending category stands out as the most important short-term credit quality issue for the institutions supervised by the FDIC."
The FDIC keeps a list of problem banks and this year through March added 14, bringing its count to 90. They have assets of $26.3 billion, and most banks added to the list in 2008 hold construction/development or commercial real estate concentrations. This year the FDIC has closed four banks. It closed three in 2007 and none the two prior years.
Small bank woes should provide opportunities for vulture investors, who buy assets at a discount. But while some distressed loan trading is occurring, in many cases buyers and sellers can't agree on price.
Buyers Wait It Out
"The whole loan market is kind of locked up right now," Fitzgibbon said. "Sellers are unwilling to part with loans at distressed prices, and the buyers think the longer they wait, the cheaper things will get."
DebtX, a Boston online marketplace for commercial debt, has sold more than $650 million in nonperforming and performing commercial and residential loans this year. But a large number of deals continue to fail in the broader secondary market for distressed commercial real estate debt, says DebtX Chief Executive Kingsley Greenland.
"Someone comes out with an offering ... the seller is out of touch with where the market thinks it should be priced," he said. "Therefore the loans don't sell."
Over the past 20 years, banks have raised exposure to real estate loans, which on average now account for more than 50% of their portfolio, according to data from the Federal Reserve System and Sandler O'Neill.
That trend accelerated at small banks in recent years as they lost credit card, car loan and other business to big institutions, says David Grenier, president of Cutler Capital Management in Worcester, Mass.
Community and regional banks still battled for local commercial real estate loan business, he says, but faced shareholder pressure to grow as property values were rising.
"Local bankers were being challenged across the U.S. in the same way for commercial real estate loans, so the banks had to decide whether they were going to reduce the price (of loans) or accept higher loan-to-value ratios," Grenier said. "The question is ... what kind of position did they put themselves in?"
Banks where residential building boomed and values skyrocketed -- California, Phoenix, Las Vegas and Florida -- are under significant pressure, Fitzgibbon says. But small and regional banks in Midwest manufacturing cities are being hit hard, too.
Flint, Mich.-based Citizens Republic Bancorp (NasdaqGS:CRBC - News) suspended a dividend after first-quarter net income fell 60% from the prior quarter to $11.1 million. In June, the bank raised $200 million in stock offerings to strengthen its balance sheet, but took goodwill impairment of $180 million related to commercial real estate business and a $47.1 million write-down tied to commercial and residential loans.
Banks Coming To Terms?
Other small banks are raising capital and restructuring terms to forestall dealing with bad loans, say Grenier and Fitzgibbon. But at some point 13any must decide to sell problem loans at a discount or foreclose.
"There will be a period of time until the banks realize that there's only a certain number of distressed loans or foreclosed properties they can handle," Grenier said. "Gradually it will seep in, they'll accept discounts and they'll move on."
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