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Real Estate Market Commentary - February 2010
by Peter L. Zachary, MAI, MRICS

On February 10, 2010, the Los Angeles Times Business section had an article "Bailout Oversight Panel Warns of Wave of Commercial Real Estate Foreclosures".

The article stated: "The special panel set up by Congress to monitor the $700- billion bailout fund is raising new warnings about the economic impact of a wave of expected commercial real estate foreclosures.

In its monthly report, to be released Thursday, the Congressional Oversight Panel for the Troubled Asset Relief Program predicted those failures could threaten a still-struggling financial system. The panel is not alone in sounding the alarm about commercial real estate troubles. But in its job as overseer of the bailout fund, the panel urged the Treasury Department and banking regulators to develop a plan to address the problem before it hits full-force starting next year.

"The government cannot and should not rescue every bad loan or keep every bank afloat, but neither can it turn a blind eye to bank failures and their impact on communities," the panel's chairwoman, Elizabeth Warren, told reporters ahead of the report's release. "The report is designed in part to wave a red flag to signal there is a serious problem coming and it will hit an already weakened financial system."

The report noted that between 2010 and 2014, about $1.4 trillion in commercial real estate loans will come to the end of their terms. Almost half of those are now under water, the result of a drop of more than 40% in commercial property values since 2007.

Losses from those loans could hit $300 billion, and would severely affect many community banks. Regulators have identified nearly 3,000 small banks -- about 37% of all U.S. financial institutions, as having high concentrations of commercial real estate loans on their books.

The oversight panel warned that without a coordinated government response, many of those banks could fail.

"If hundreds more community banks go under, the effect could be to dump sand in the gears of our economic recovery," Warren said.

The panel suggests several ways to address the problem, including injecting more TARP money into some of those banks, a government program to buy up some of the bad assets or creation of a guarantee fund to absorb losses from the loans.

The important point, Warren said, is for government officials to start working on a solution now before a crisis develops.

"Never again should America be in a position where the Secretary of the Treasury comes in to Congress and says "Give me $700 billion or the economy will disappear by Monday," she said."

And apparently Elizabeth's Warren's warning is a result of what the Wall Street Journal reported on its website on 10/31/09 "Banks Get New Rules on Property"

The article states: "Federal bank regulators issued guidelines allowing banks to keep loans on their books as "performing" even if the value of the underlying properties have fallen below the loan amount.

The volume of troubled commercial real-estate loans is skyrocketing. Regulators said that the rules were designed to encourage banks to restructure problem commercial mortgages with borrowers rather than foreclose on them. But the move has prompted criticism that regulators are simply prolonging the financial crisis by not forcing borrowers and lenders to confront, rather than delay, inevitable problems.

The guidelines, released on Friday by agencies including the Federal Deposit Insurance Corp., the Federal Reserve and the Office of the Comptroller of the Currency, provide guidance for bank examiners and financial institutions working with commercial property owners who are "experiencing diminished operating cash flows, depreciated collateral values, or prolonged delays in selling or renting commercial properties." Restructurings are often in the best interest of both lenders and borrowers, the guidelines point out.

The new rules don't reverse existing rules. Rather they are more explicit than regulators have been in the past about how banks should deal with restructuring issues. Banks in recent months have been peppering agencies with questions about this as the number of problem loans has soared.

Regulators have been expressing increasing concern that problems in commercial real estate could unglue the nascent economic recovery by slamming financial institutions with billions of dollars in new losses. FDIC Chairmen Sheila Bair told a Senate subcommittee earlier this month that reworking the terms of these loans could help banks to avoid larger losses. She likened it to the push regulators made last year for banks to rework troubled residential mortgages.

About $770 billion of the $1.4 trillion commercial mortgages that will mature in the next five years are currently underwater, according to Foresight Analytics. As of last week, 106 banks had failed this year, the most since 1992 - the peak of the savings-and-loan crisis. Regional and community banks especially have been paying dearly for their aggressive push into commercial real-estate lending during the boom years.

The new guidelines are targeted primarily at the hundreds of billions of dollars worth of loans that are coming due that can't be refinanced largely because the value of the properties have fallen below the loan amount. In many of these situations, the properties are still generating enough income to pay debt service.

Banks have generally been keeping a lid on commercial real-estate losses by extending these mortgages upon maturity. However, that practice, billed by many industry observers as "extending and pretending," has come under criticism by some analysts and investors as it promises to put off the pains into the future.

Now federal regulators are essentially sanctioning the practice as long as banks restructure loans prudently. The federal guidelines note that banks that conduct "prudent" loan workouts after looking at the borrowers financial condition "will not be subject to criticism (by regulators) for engaging in these efforts." In addition, loans to creditworthy borrowers that have been restructured and are current won't be reclassified as "high risk" by regulators solely because the collateral backing them has declined to an amount less than the loan balance, the new guidelines slate.

Critics say the new rules are yet another example of a head-in-the-sand approach by regulators, pointing to the relaxed accounting standards last year that enabled banks to avoid marking the value of the loans down. This is doing long-terms damage to the economy, they say, because it ties bank capital, preventing them from resuming lending.

Critics say a wiser approach would be for regulators and banks to deal with problems quickly like the Resolution Trust Corp. did in the early 1990s during the last commercial real estate crash. Back then, the RTC helped purge the financial system of toxic mortgages.

The new guidance "gives people a long time to figure out they're not going to pay it back," said Douglas Durst, a leading New York City developer. "We are in a period where nothing is happening," he said adding that banks are "not making any new loans because they have this bad debt on their books and not writing it down and getting rid of it."

I could not agree with Douglas Durst more, I am sorry to say that our government has forsaken the American tax payer to the "fat cats" of Wall Street and the banking system in general. Instead of helping the American tax payer, the government has once again shown their scorn to the hand that feeds them. If the government had let free market forces work, as eventually they are doing with the rash of home foreclosures, many banks would have foreclosed on commercial real estate and sold them at current market value to investors who still have money. Commercial real estate brokers tell me there are many buyers but no sellers because the banks have not foreclosed on their "under water" real estate.

The American tax payer voted with their felt for the election of Senator Scott Brown in Massachusetts. Hopefully, health care reform will die and banks will start foreclosing on commercial real estate.

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