Monday, November 09, 2009

Bank Stresses Mounting; Commercial Real Estate Crisis Looming

As if mounting residential housing defaults weren't enough of a problem, banks are expected to face an even bigger crisis next year: commercial real estate defaults.

Banks hold roughly $1.8 trillion of commercial real estate debt on their books. Many of those loans were made in the same fast and loose manner that home loans were during this decade.

Loans that never should have been issued were ultimately granted under very unrealistic scenarios anticipating endless growth and appreciation.

The parties involved seemed to believe the market could never go down, and loan portfolios expanded rapidly.

Banks underwrote and held $11 billion in commercial real estate loans in 1997; by 2007 that figure had skyrocketed to approximately $190 billion.

The problem is that the $6.4 trillion commercial real estate market is under duress as businesses across the country go under. Stores are closing, mall vacancies are increasing, and office space is all too available.

Between now and 2012, more than $1.4 trillion worth of commercial real estate loans will come due, according to real estate investment firm ING Clarion Partners.

However, the collateral value underlying many of these loans is depreciating. That means many borrowers will have trouble rolling over their loans.

Kenneth P. Riggs Jr., CEO of Real Estate Research, told BusinessWeek that the market won't fully recover until 2020, and in cases where "values were over the top...maybe never."

Commercial real estate prices have dropped 41% from the beginning of 2007 through October. Meanwhile, the housing market has dropped some 31%.

Since banks are not required to mark their loans to market prices, no one knows the values of the loans on their books. But as the commercial real estate market nose dives, many banks will go down with it.

Consider this; $6.4 billion in commercial real estate investments didn't qualify for refinancing in the first ten months of this year.

The tidal wave of defaults will begin next year and banks can hardly take any additional stresses without breaking.

So far, 120 U.S. banks have failed this year, the most since 1992. There were just 25 banks failures last year, which was more than in the previous five years combined. Only three banks failed in 2007.

Things are poised to get much worse.

Currently, there are 2.8 million active interest-only home loans nationwide, worth a combined total of $908 billion. In the next 12 months, $71 billion of interest-only loans will reset. Even after mid-2011, another $400 billion will reset.

That means there will be a massive number of additional defaults over the next two years.

Amherst Securities estimates that 7 million housing units are destined to default, only to be seized by lenders. That number represents well over a year's worth of home sales. When this "shadow inventory" eventually hits the market, home prices will be pushed further downward.

That is truly bad news for already distressed banks.

We can expect bank failures to continually worsen in coming months, and throughout the next two years, at the least.

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