Magazine article Economic Trends

An Update on Bank Commercial Real Estate Exposure

Magazine article Economic Trends

An Update on Bank Commercial Real Estate Exposure

Article excerpt

01.12.10

Since our summary of banks' commercial real estate (CRE) exposure last August, mortgages backed by commercial property have continued to experience weakness in the form of delinquencies and defaults. A handful of factors are perpetuating the stress on nonfarm-nonresidential mortgages and construction loans, in particular. First, the fragility of the economy itself has led to high rates of unemployment, which necessarily decreases the demand for commercial space.

At the same time, loans made near the peak of the credit boom (especially those related to construction) are deteriorating in quality rapidly, largely because of economic weakness as well as loan terms with low levels of borrower equity. The latter has become a problem as CRE property values have fallen roughly 35 percent overall from their peak in mid-2007. Finally, as noted in the August article, many CRE loans do not pay down principal (amortize) fully over the course of the loan term. As a result, loans that come up for renewal or restructuring often do not have sufficient borrower equity to be refinanced prudently. As a result, borrowers and/ or banks must put up additional capital to ward off default.

As the charts below indicate, banks at the national level are seeing their overall CRE portfolio decline due to a contraction in construction and land-development loans. These loans are typically short in nature and are likely defaulting or not being refinanced because of poor market conditions. Construction loans for new projects would have declined for the same reason.

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Commercial real estate loans that are thirty or more days past due (and still accruing interest) ticked up in the third quarter of last year. A clear majority of problem CRE loans are concentrated in commercial mortgages and construction loans, and about $16 billion and $22 billion, respectively, fall into this thirty-days-and-accruing category. Past-due CRE loans swelled in the last quarter of 2008, and because the volume of problem loans has continued to remain elevated, these loans must be staying delinquent in the months up to default--as opposed to being restructured or becoming current again a[euro]" and/or additional loans must be entering the pool of problem loans. Either way, this figure suggests that CRE delinquencies are worsening or, at best, stabilizing.

Delinquent loan volumes still do not give us a sense of the scale of the problem for bank viability. …

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