By CJ Follini

The figures were released this week by the Federal Deposit Insurance Corporation, as it announced that the number of banks in trouble had risen sharply, and forecast that the rate of bank failures would increase. The report served as a stark reminder that the banking system remained in perilous health, despite large bailouts of major financial institutions. Many smaller banks are especially exposed to commercial real estate loans, where problems are growing. Senator Chris Dodd, Chairman of the Senate Committee on Banking, Housing and Urban Affairs, noted that delinquency rates for commercial mortgages climbed from 4% at the end of the third quarter of 2009 to more than 6% in January 2010, with more than $500 billion of commercial loans slated to mature each year over the next few years.

“I believe weakness in the CRE market requires prompt and robust responses from the regulators to guard against harmful effects on financial institutions and the economy,” Dodd said, citing recent reports and testimony by bank examiners that the credit performance of loans on income-producing property has deteriorated sharply in bank portfolios, with delinquencies on the rise and borrowers are “underwater” on nearly half of the $1.4 billion in mortgage debt slated to come due by 2014.

FDIC Chairman Bair told reporters Tuesday during the agency’s unveiling of its Quarterly Bank Profile that “resolving these credit market dislocations will take time.”

“Small- and mid-sized institutions who tend to make business loans secured by residential and commercial properties are dealing with the effects of large declines in real estate value,” Bair said. “Lower values reduce the collateral coverage of existing loans and make it more difficult for households and small businesses to qualify for credit.

“One thing that can help is a balanced approach toward lending as outlined in the recent interagency policy statements on prudent CRE loan workouts and meeting the credit needs of small business borrowers,” Bair added. “Institutions must effectively manage concentration risk in their portfolios, however, they should neither over-rely on models to manage concentration risk nor automatically refuse credit because of a borrowers’ particular industry or geographic location.”

“Obviously, these policy statements alone won’t make the problem go away, but they do get to the root of the matter by giving lenders a roadmap for working out problems and making new credit available to qualified consumers and businesses,” Bair said.

Bair and other FDIC staff said distressed CRE loans would take longer to work through the system because some borrowers may have cash reserves to continue to make payments or because tenants may have longer-term leases that have yet to expire and renew at lower market rate rents. Accordingly, charge-offs and delinquencies will continue to cause problems — especially for community and regional banks — “for the next couple of years,” the FDIC said. The amount of distressed commercial real estate assets on the books of the nation’s banks and thrifts approached $60 billion as of year-end 2009. That is up from $52 billion just three months earlier, a 15% increase.

As the CRE distress numbers went up, so did the number of troubled institutions on the FDIC’s “Problem List.” At the end of December, there were 702 insured institutions on the Problem List, up from 552 on Sept. 30. In addition, the total assets of “problem” institutions increased during the quarter from $345.9 billion to $402.8 billion. Forty-five institutions failed during the fourth quarter, bringing the total number of failures for the year to 140, the highest annual total since 1992.

As can be seen in the chart below, banks’ net charge-off rate rose to 2.9%, up from 1.95% a year earlier and 2.72% in the third quarter of 2009. The F.D.I.C. said that was the highest rate since the agency was formed in 1934. Banks charged off 0.77% of their loans on nonresidential income-producing properties, up from 0.62% in the previous quarter. In addition, 5.4 percent of all loans were at least 90 days behind, and another 1.9 percent were more than 30 days overdue.

Commercial real estate loans are widely viewed to be an area of coming problems, in part because such loans are normally made for periods of seven to 10 years, in anticipation that they will then be rolled over into new loans. Many properties are no longer worth anything close to the amount owed, making such rollovers doubtful. Still, many such loans require payments of interest only, or of only minimal amounts of principal, so it is possible for borrowers to stay current until the loans mature.

At the end of 2009, 6.3 percent of such loans were either behind in payments or were being classified by banks as doubtful for repayment. That figure may be held down by a regulatory change. A bank owed, say, $4 million on a property now worth $3 million would previously have had to classify the entire loan as troubled. Now it can do that to the $1 million difference only.

Just how rapidly that becomes worse may depend on how many banks choose to “pretend and extend,” renewing the loan and hoping property values will recover. Loans on nonresidential income-producing properties that had been foreclosed on increased from $5.84 billion to $7.05 billion – a 21% increase. Reserves for loan and lease losses increased by only $7 billion (3.2%) in the fourth quarter 2009, as institutions added $8.1 billion more in loss provisions to their reserves than they took out in net charge-offs.

The average coverage ratio of reserves to non-current loans and leases fell from 60.1% to 58.1%, ending the year at the lowest level since midyear 1991. In contrast, the industry’s ratio of reserves to total loans and leases rose from 2.97% to 3.12% during the quarter, and is now at its highest level since the creation of the FDIC.


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  1. Social comments and analytics for this post…

    This post was mentioned on Twitter by MEInvestors: FDIC UNVEILS QUARTERLY BANK PROFILE: SMALL BANKS VULNERABLE TO COMMERCIAL REAL … http://bit.ly/9mljR4

    by uberVU - social comments
    on 01. Mar, 2010

  2. This article is so true! Our company is at the street level with more than 20 Community and Regional banks and they’re indeed hurting. It is these smaller institutions who put credit out to the every day consumers in our local communities and until they get their balance sheets cleaned up, no real “consumer” lead recovery will ever take place….
    We help them with dispositions of assets and most just don’t have the loan loss budgets to consider selling at even modest discounts and they’re adding 15% over each quarter in NP inventory and still no real solutions with getting product “marked to market”…. We will be dealing with this desperate situation for many years to come I assure you and end up with 40% less banks in our country as well….

    Kyle Johnson
    Asset Procurement Group, LLC

    by Kyle Johnson
    on 03. Mar, 2010

  3. On one hand the banking industry is in desparate need of fresh capital, and on the other the regulatory bodies overseeing the banks is a significant impediment to private equity entering the space. Some of that private equity is willing to invest in banks without taxpayer supported loss share agreements. Yet, the government would rather work with other banks to shore up failed institutions and provide generous taxpayer backed incentives to have those banks take on the troubled assets.

    by Douglas Thompson, CFA
    on 15. Mar, 2010

  4. I can see that you are putting a lots of efforts into your blog. Keep posting the good work.Some really helpful information in there. Bookmarked. Nice to see your site. Thanks!

    by Real Estate
    on 15. Jul, 2010

  5. From my review of the latest FDIC Call Reports, bank capital for small to mid-sized banks is significantly overstated, becuase of over-inflated carrying values for CRE, and C&L lonas. You can find my report on my website http://www.recounsel.net, in the Research & Articles area.

    by Douglas Thompson, CFA
    on 28. Jul, 2010

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