Fed Frets About Commercial Real Estate
With Banks Slow to Take Losses, Fears of a Residential-Bust Repeat; 'More Pain Likely Lies Ahead'
By LINGLING WEI and MAURICE TAMMAN
Banks in the U.S. "are slow" to take losses on their commercial real-estate loans being battered by slumping property values and rental payments, according to a Federal Reserve presentation to banking regulators last month.
The remarks suggest that banking regulators are girding for a rerun of the housing-related losses now slamming thousands of banks that failed to set aside enough capital during the boom to cushion themselves when the bubble burst. "Banks will be slow to recognize the severity of the loss -- just as they were in residential," according to the Fed presentation, which was reviewed by The Wall Street Journal.
A Fed official confirmed the authenticity of the do ent, prepared by an Atlanta Fed real-estate expert who is part of the central bank's Rapid Response program to spread information about emerging problem areas to federal and state banking examiners throughout the U.S.
While the Sept. 29 presentation by K.C. Conway doesn't represent the central bank's formal opinion, worries about the banking industry's commercial real-estate exposure have been building inside the Fed for months. "More pain likely lies ahead for this sector and for those banks with heavy commercial real estate exposures," New York Fed President Bill Dudley said in a speech Monday.
In another sign that many U.S. financial ins utions are inadequately protected against potential losses on commercial real-estate loans, banks with heavy exposure to such loans set aside just 38 cents in reserves during the second quarter for every $1 in bad loans, according to an analysis of regulatory filings by The Wall Street Journal. That is a sharp decline from $1.58 in reserves for every $1 in bad loans from the beginning of 2007.
The Journal's analysis includes more than 800 banks that reported having more half of their loans tied up in commercial real-estate, ranging from apartments to office buildings to warehouses.
Loan-loss reserves typically rise and fall during any credit cycle, being drawn down as losses mount. Some analysts and investors say the recession combined with inadequate loan-loss provisions when times were good have left banks dangerously vulnerable to the deteriorating commercial real-estate market.
Mr. Conway's presentation painted a bleak picture of the sliding real-estate values and enormous debt that will need to be refinanced in the next few years. Vacancy rates in the apartment, retail and warehouse sectors already have exceeded those seen during the real-estate collapse of the early 1990s, Mr. Conway noted. His report also predicted that commercial real-estate losses would reach roughly 45% next year. Valuing real estate has always been tricky for banks, and the problem is particularly acute now because sales activity is practically nonexistent.
Some of the banks with especially low levels of loan-loss reserves are teetering. Capmark Bank, based in Midvale, Utah, and owned by commercial real-estate finance firm Capmark Financial Group Inc., had 11 cents in reserves for every $1 in bad loans it reported in the quarter ended June 30, the Journal analysis shows.
A Capmark spokeswoman said in a statement that the amount of loans written off by the bank, totaling $357 million as of June 30, "should be taken into account when evaluating possible future losses."
Capmark's parent company, owned by investors led by private-equity firm Kohlberg Kravis Roberts & Co., warned last month that a bankruptcy filing could be imminent and said regulators intend to order Capmark Bank to raise capital and improve its liquidity. Capmark Bank got a $600 million capital infusion from its parent company in late September.
These days, many U.S. banks have adopted a policy of extending loans when they come due even if they wouldn't make those loans now. In some cases, values of the underlying property have fallen below the amount of the loan.
"There's been an extend-and-pretend philosophy by banks to forestall hits to their balance sheets that might occur," says Patrick Phillips, new chief executive of the Urban Land Ins ute, a real-estate industry group. Matthew Anderson, a partner at research firm Foresight Analytics, adds: "It's like taping paper over a hole in the wall."
Last month's Fed presentation supports criticisms that banks have been slow to take losses on bad commercial real-estate loans. The value of commercial real-estate loans as recorded by banks has declined at a much slower rate than property values since 2005. But banks have been slow to absorb losses on their loans partly due to "capital preservation" [insolvency] concerns, the report states.
Bank examiners are stepping up their scrutiny of commercial real-estate portfolios at U.S. banks. Michael Stevens, senior vice president of regulatory affairs at the Conference of State Bank Supervisors, said regulators are reviewing greater volumes of commercial real-estate loans than they did before the financial crisis erupted.
Commercial real-estate loans are the second-largest loan type after home mortgages. More than half of the $3.4 trillion in outstanding commercial real-estate debt is held by banks.
The Fed presentation states that the most "toxic" loans on bank books are so-called interest-only loans, which require borrowers to repay interest but no principal. Those loans "get no benefit from amortization," the report states.
"Today, most of the borrowers are paying because interest rates are so low, but the question is whether the loans will get paid off when they come due," said Michael Straneva, global head of Ernst & Young's transaction real-estate practice.
Regulators are zeroing in on banks that use interest reserves to mask bad construction loans. When such loans are made, banks typically calculate interest that would be paid and set that money aside, basically paying themselves until the loan becomes due or the property generates cash flow. Regulators want to make sure banks don't have a false sense of security only because the interest reserve is paying the loan. Banks need to look at "the sources of repayment" to determine whether the loan will get repaid, says Darryle Rude, supervisor of industrial banks at the Utah Department of Financial Ins utions.
According to Foresight Analytics, more than 40 U.S. banks have been hit so far this year with enforcement actions by regulators that include alleged misuse of interest reserves.
Some banks with unusually low levels of loan-loss reserves based on the Journal analysis said those figures reflect their decision to aggressively write off hopeless loans. "We've tried to both build up our charge-offs and reserves," says David Shearrow, chief risk officer of United Community Banks Inc. About 80% of the Blairsville, Ga., bank's problem loans have been charged down to a level where the bank thinks it can sell them.
Dozens of mid/small banks that were given TARP funds but were "healthy", are so healthy that they have fallen behind in repaying TARP funds.
conclusion: Fed lied about them being healthy.
Green shoots of a recovery, my ass. Only Wall St and super-wealthy are doing well, but they are detached from the real economy and real people.
"Just when we thought it was over, it was only getting started."
and now the other shoe drops.
Who is "we"?
FHA news:
October 9, 2009
Concerns Growing Over Another Mortgage Giant
By LOUISE STORY
WASHINGTON — First it was Fannie Mae and Freddie Mac. Now concern is growing that another government mortgage giant might teeter, just as the nation’s housing market is stabilizing.
A year after Fannie and Freddie were effectively nationalized, problems at the Federal Housing Administration are raising worries among industry executives and Washington policy makers.
In testimony before a House subcommittee on Thursday, the F.H.A. commissioner, David H. Stevens, assured lawmakers that his agency would not need a bailout and that it was taking steps to manage its risks.
“I’ve already begun to improve portfolio analysis and risk management,” Mr. Stevens said. “We’ve made more significant credit policy changes in my first two months here than F.H.A.’s made in decades.”
But he acknowledged that some 20 percent of F.H.A. loans insured last year — and as many as 24 percent of those from 2007 — faced serious problems including foreclosure, offering a preview of a forthcoming audit of the agency’s finances.
Mr. Stevens said that the F.H.A., which insures mortgages with low down payments, holds more than $30 billion of cash in reserve to cushion against potential losses, and the average credit score of borrowers is about 9 percent higher now than two years ago.
“Let me simply state at the outset that based on current projections, absent any catastrophic home price decline, F.H.A. will not need to ask Congress and the American taxpayer for extraordinary assistance — we will not need a bailout,” Mr. Stevens said in his testimony.
The issue of F.H.A.’s financial health took on new urgency as skeptical lawmakers and critics focus on its reserve levels. In prepared remarks, a former Fannie Mae executive predicted that losses might soon overwhelm the F.H.A, prompting a government bailout.
Since the bottom fell out of the subprime mortgage market, the F.H.A. has filled the void left by banks and assumed a growing role in the nation’s housing market. Created in 1934 to help lower-income and first-time buyers purchase homes, the agency now insures roughly 5.3 million mortgages, with a combined value of $652 billion, on single-family homes.
To critics, among them Republican lawmakers, the agency’s rapid growth recalls the ill-fated expansion of Fannie Mae and Freddie Mac during the housing boom. They worry that the F.H.A., like Fannie Mae and Freddie Mac, might need to be rescued by the government.
“It appears destined for a taxpayer bailout in the next 24 to 36 months,” the former Fannie Mae executive, Edward Pinto, said in testimony prepared for the hearing. Mr. Pinto, who was the chief credit officer from 1987 to 1989 for Fannie Mae, predicted losses on its mortgage insurance would more than wipe out the agency’s reserves.
Much is at stake. In addition, principal and interest on mortgage-backed securities containing F.H.A.-insured loans are guaranteed through the Government National Mortgage Association, known as Ginnie Mae. That means the taxpayer is responsible if the mortgages underlying those securities fail.
Jack Healy contributed reporting from New York.
Copyright 2009 The New York Times Company
The US during the Great Depression.
To understand reserve requirements of banks, let's look at something really simplified:
Acme Bank
Assets (loans to other people, cash, etc.)
$100
Liabilities (depositors accounts, bonds issued, etc.)
$90
Equity
$100-$90= $10
This is the "magic" solvency reserve and represents the cushion for the bank should things go wrong.
If somehow, the assets of the bank suddenly are worth less than they were before (say a large number of loans default), the bank can absorb some losses.
Say out of their $100, 9% of that goes bad...
100-9=91
New equity would be
$91-90= $1
So you can see that the bank can afford anything up to 10% write-offs in their loans.
Now let's say the bank wants to grow a lot, so they borrow heavily, but have no constriction on the proportion of their reserves relative to assets, i.e. (assets-liabilies)/assets
The bank borrows, say $400 and loans that cash out immediately.
Assets
$500
Liabilities
$490
Equity/surplus/reserve
$10
Note the final reserve is unchanged, although the bank itself has gotten 5 times larger in terms of assets.
Now take away 9% of the assets and you get... 500-45=465
Assets
$465
Liabilities
$490
Equity
-$25
Oops.
The same asset swing that left the old bank solvent, completely sunk the new "bigger, better" bank.
The new bank takes only a 2.1% drop in asset valuation to go under, as opposed to 10.1% for the older, more conservative bank.
This is how "leverage" can bite you in the butt. Sure the income on $500 looks good to shareholders when times are good, but...
http://www.economist.com/research/ar...ry_id=14587120
Interesting article on how people are trying to analyse the winners/losers to figure out what saved some and sunk others.
Not really flattering to upper management at any bank.
How big is TOO big to effectively manage? I think a LOT of financial ins utions are over this line.
Large financial en ies are very complex and I doubt ANYBODY really could get a handle on them.
"I doubt ANYBODY really could get a handle on them."
They don't want to be handled or down-sized or regulated, and so they won't be.
They get whatever they want by buying Congress.
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