Bair Says CRE Woes Aren’t Confined to Small Banks

For months, analysts and industry experts have assured the markets that the downturn in the commercial real estate (CRE) sector won't be enough to send the financial[IMAGE]system into a second crisis - that it won't be the dreaded ""next shoe to drop"" because exposure is, for the most part, isolated to smaller, community banks.

But at the Commercial Mortgage Securities Association Annual Conference in Washington, D.C. this week, FDIC Chairman Sheila Bair presented some sobering data that paints a very different picture.

""Despite what you may be hearing, CRE credit problems are affecting big and small banks alike,"" Bair said. ""In fact, CRE noncurrent and charge-off rates are higher at banks with over one billion dollars in assets than at community banks.""

Bair laid it out plain and simple: the financial market upheavals of the past few years, and the economic fallout that resulted, have revolved around U.S. real estate markets.

Residential markets fell first. After a decade-long boom that nearly tripled the average price of a home, came a four-year downturn marked by historic declines in housing starts, sales, and prices, and a devastating wave of defaults and foreclosures.

Problems on the commercial side started later. But Bair says by some measures, they have been even more pronounced. Sales of commercial real estate slowed dramatically in 2008 and 2009, as vacancy rates and rental rates declined significantly. And while CRE price

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declines began well after the fall in home values, they have actually been larger on average, she explained, with CRE price indices down by over 40 percent from their peak in fall 2007.

Bair attributes this sharp decline in commercial real estate values to higher rates of return expected by investors and tight credit for commercial real estate financing.

Although investor participation and financing via the secondary market grew dramatically during the last economic expansion, Bair says FDIC-insured banks and thrifts "" both large and small "" still hold the largest share of commercial mortgage debt.

Their dollar exposure to CRE loans stands at a historic high, according to the FDIC's analysis. As of September 2009, CRE loans backed by income-producing properties â€" nonfarm, nonresidential properties or multifamily real estate â€" totaled $1.3 trillion, or nearly 18 percent of total loans and leases. Banks and thrifts also held almost $500 billion in construction and development (C&D) loans.

In the third quarter of last year, institutions' annualized net charge-off rate on C&D loans was 6 percent. Bair says that significantly exceeds the highest rate seen in the last crisis, which was about 4 percent.

Credit performance has also declined for loans on income producing properties. Noncurrent CRE loans on income producing properties have risen by 250 percent over the past year to $44.8 billion, the FDIC's data shows.

While delinquencies on all types of commercial real estate mortgages are expected to go higher still, Bair stressed that lenders of all sizes should be adhering to guidance put out by her agency and other regulators in late 2009. This guidance encourages lenders to implement ""prudent, loan workouts based on an updated picture of the borrower's financial condition,"" and instructs examiners to take a ""balanced"" approach in assessing an institution's risk management practices for workouts.

These principals will facilitate ""responsible "" solid loan workouts"" that are based on the documented financial capacity of the borrower and the long-term prospects of the underlying project, Bair said, and will help to mitigate the impact of the commercial real estate downturn.