The Commercial Loan Nightmare Facing U.S. Banks

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Banks are in for another ugly year in 2010. But this time the problem will be the big batch of deteriorating commercial real estate loans on their books. That’s because the big banks were operating with the same loose standards—and aggressive behavoir—as the investment banks in order to compete in the real estate market during the boom years. (Read our cover story about why this real estate bust is different.) Commercial real estate loans that banks underwrote and held on their books skyrocketed to approximately $190 billion in 2007, up from $11 billion in a single year, a decade earlier. In all, banks hold some $1.8 trillion of commercial real estate debt on their books.

Trouble is, nobody knows just what the values of the loans on bank books’ are since they are not required to mark them to market prices. Since the stress tests conducted by the Feds never looked far enough into the future, the ability to “fully grapple with the prospect of massive future commercial real estate (CRE) loan defaults is uncertain,” admitted Jon D. Greenlee, associate director at the Division of Banking Supervision and Regulation in congressional testimony on July 9 and again on Nov. 2.

Of particular concern, says Greenlee: Almost $500 billion of commercial real estate loans that will mature during each of the next few years. “In addition to losses caused by declining property cash flows and deteriorating conditions for construction loans, losses will also be boosted by the depreciating collateral value underlying those maturing loans. The losses will place continued pressure on banks' earnings, especially those of smaller regional and community banks that have high concentrations of CRE loans,” says Greenlee.

The good news: The Fed is now undertaking a review of commercial real estate loans held by hundreds of small and regional banks. In July, the Fed allowed investors participating in its Term Asset-Backed Securities Loan Facility (TALF) to purchase existing securities backed by loans the government will cover for apartment complexes, office buildings, retail shopping centers and other commercial property.

In the meantime, many banks have been forestalling the day of reckoning. The latest strategy, called “extend and pretend,” appears to be in full swing—a head-in-the-sand approach that provides temporary extensions to troubled borrowers on maturing commercial loans to give them, and the bank, some breathing room.

But surging delinquencies and defaults will eventually catch up with them. So who is most at risk? The biggest exposures are in the regional banks which have much closer ties with their local communities and developers. Some banks, have concentrations of CRE loans equal to several multiples of their capital; many of those loans are in speculative new properties, the Feds say.

Kamal Mustafa, chairman of Invictus Consulting Group and former head of Citigroup's Global M&A and corporate finance departments, says many of these banks will fail as a result. “Right now there are a lot of banks that are showing no charge offs but when the CRE market dives, we’ll see a lot of banks going down.”

KBW Research, a boutique investment bank and research shop in New York, crunched the numbers. Here’s a look at some of the U.S. banks and thrifts they believe have the most commercial real estate exposure based on a percentage of their total loans (from 50% to 71%) as of the second quarter. This doesn't necessariy mean they are buried under bad loans, but just have more exposure to the commercial real estate sector. Keep in mind, that prices in that market have dropped some 40% since the beginning of 2007 through October (more than the housing market) so the value of these assets has most certainly diminished.

Name, Ticker, Percent of Loans in CRE Nara Bancorp, NARA, 71% Center Financial, CLFC, 71% Cass Information Systems, CASS, 69% Hanmi Financial, HAFC, 69% Dearborn Bancorp, DEAR, 66% Wilshire Bancorp, WIBC, 66% Intervest Bancshares, IBCA, 65% MetroCorp Bancshares, MCBI, 64% Unity Bancorp, UNTY, 62% Oak Valley Bancorp, OVLY, 60% PacWest Bancorp, PACW, 59% CommerceFirst Bancorp, CMFB, 59% Jacksonville Bancorp, JAXB, 58% American River Bankshares, AMRB, 58% FPB Bancorp, FPBI, 57% W Holding Company, WHI, 56% Bank Holdings, TBHS, 55% Sussex Bancorp, SBBX, 54% Sun Bancorp, SNBC, 54% Southern Connecticut Bancorp, SSE, 54% Cape Bancorp, CBNJ, 54% Community Central Bank, CCBD, 53% Umpqua Holdings, UMPQ, 53% Parke Bancorp, PKBK, 52% Mackinac Financial, MFNC, 52% Tamalpais Bancorp, TAMB, 51% Mercantile Bank, MBWM, 50% Sterling Bancshares, SBIB, 50% Bank of Marin Bancorp, BMRC, 50% Old Line Bancshares, OLBK, 50%

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