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Fri, Jan 08, 2010 - Page 10 News List

Commercial property is biggest risk: bank examiners

BLOOMBERG

Losses on commercial real estate loans pose the biggest risk to US banks this year, troubling smaller lenders but unlikely to threaten the entire financial system, US bank examiners concluded during a review.

“Losses from commercial real estate will be quite high by historic standards,” said Eugene Ludwig, former comptroller of the US currency who is now chairman of Promontory Financial Group, a Washington-based consulting firm to financial institutions. “Hundreds of banks will fail or will be resolved over the course of the cycle.”

The failure of loans backing malls, hotels and apartments may impede the US recovery as small and medium-sized banks reduce lending and conserve capital to absorb losses, analysts said.

Tight credit could slow the cycle of investment and hiring that is critical for sustained growth, they said.

Total loans and leases by banks in the US fell to US$6.79 trillion in November from US$7.23 trillion in the same month a year earlier, US Federal Reserve data showed.

The default rate on commercial mortgages held by US banks more than doubled to 3.4 percent in the third quarter, said Real Estate Econometrics LLC, a property research company in New York.

Default rates in the first three quarters of last year have been the highest since 1993, the firm said.

Losses on the debt will “place continued pressure on banks’ earnings” because collateral values have fallen, Jon Greenlee, associate director of the Fed’s bank supervision division, said in Nov. 2 testimony to the domestic policy subcommittee of the US House Committee on Oversight and Government Reform.

Banks and investors held about US$3.5 trillion in commercial real estate debt in June, with about US$1.7 trillion of that total on the books of banks and thrifts, Fed data showed.

About US$500 billion of the loans will mature each year over the next few years, Fed officials say.

Regional banks are almost four times more concentrated in commercial property loans than the nation’s biggest lenders, data compiled by Bloomberg on bailout recipients showed.

Investors have recognized the comparative vulnerability of smaller banks. The KBW Regional Banking Index, which includes shares of Old National Bancorp of Evansville, Indiana, and Glacier Bancorp Inc of Kalispell, Montana, fell 24 percent last year compared with a 3.6 percent decline for the KBW Bank Index, which includes shares of JPMorgan Chase & Co and Citigroup Inc.

“The strong get stronger and the weak get weaker,” said Joel Conn, president of Lakeshore Capital LLC in Birmingham, Alabama, which specializes in financial stocks. “It is very difficult to come up with a scenario where earnings get anywhere back to normal for small banks with large commercial real estate exposures.”

Fed officials stepped up reviews of commercial real estate loans at banks last year. The Fed is focusing on banks smaller than the 19 largest lenders examined in May. Those institutions held assets exceeding US$100 billion.

Defaults among prime borrowers for residential mortgages will probably accelerate this year, said Robert Shiller and Karl Case, the economists who created the S&P/Case-Shiller Home Price Index.

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