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September 16th, 2009

Commercial Real Estate: Credit Crisis #2?

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Towards the end of 2008, the meltdown in the financial and mortgage markets led to a credit crisis that froze lending nationwide. For a while now analysts have been forecasting another looming credit crisis — this time it has to do with the commercial real estate market. Finance and economic blogger Calculated Risk predicted declines back in December 2008.

However, what makes this “latest” threat to U.S. lending institutions particularly dangerous, is that several Federal entities — from the Federal Reserve, to the Treasury, to the FDIC — are financially stretched to their limits, and may be unable or unwilling to provide adequate support to lenders if or when the time arises.

With the nation’s banks still in recovery from the first credit crisis, are they stable enough to withstand another? If the commercial real estate market does collapse and banks begin to collapse at great speed, will the struggling FDIC even be able to support the banks’ customers?

The Cause for Concern

Remember back in June when we argued that, in terms of the residential real estate recovery, home prices were the statistic that mattered most? Well, the same could be said for commercial real estate. Furthermore, it seems as though many of the same factors that contributed to the first real estate collapse, are triggering the second — falling property prices, unemployment, vacancies, underwater loans, etc. What’s particularly disconcerting about these factors is that, just like residential mortgage loans, they can make refinancing impossible.

The losses sustained by big banks during the residential mortgage meltdown were so severe and far-reaching, Washington created a $700 billion “bailout” to save them. According to HSH VP Keith Gumbinger, this will affect small and mid-size banks disproportionally. While TARP has allowed those large banks to quickly bounce back to business (the top four residential mortgage originators in the second quarter of 2009 were TARP banks), there is no “bailout” or support system in place to save the smaller lenders that may go under because of commercial loans.

Structure of Commercial Loans

The way commercial loans are structured is very different from residential loans. The more you hear about commercial real estate and it’s potential threats to our economic recovery, the more you will hear the phrase “coming due”.

The makeup of a commercial loan is that after a given period of time (say 10 years), the loan is intended to be refinanced, or, they loan is “coming due”. Again, like residential, if the loan is underwater, if the property is vacant, if the owner is underemployed, or if the property has lost significant value, there’s a slim chance the lender will be willing to refinance the loan.

Rapid Failure

Currently, the commercial real estate market is valued at $3.5 trillion dollars. The industry has experienced a 39% decline from its peak reached just two years ago, according to the MIT Center for Real Estate. What’s keeping market observers up at night is that the decline far outweighs the 27% drop the industry experienced during the economically-devastating ’savings and loan crisis’ of the late 1980s, early 1990s.

From the AJC:

The problem is that without immediate changes in bank regulations and laws governing Real Estate Mortgage Investment Conduits (REMICs), this next wave of the credit crisis will sabotage economic recovery — driving up bank failures and bailouts by the FDIC. The recession could become a depression.

It’s important to note that, unlike residential loan failures, the growing defaults of commercial loans are largely recession related and the defaults aren’t a result of subprime lending or exotic products, but the result of ongoing economic troubles.

Readers: Thanks to commercial failures, are small and mid-size banks next in line for a “bailout”? If so, do they deserve it?

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9 Responses to “Commercial Real Estate: Credit Crisis #2?”

  1. donmcclain (Don McClain) Says: September 17th, 2009 at 11:37 am

    Commercial Real Estate: Credit Crisis #2? – http://blog.hsh.com/?p=5828

  2. Lucia Says: September 17th, 2009 at 6:09 pm

    I think small and midsized banks are the backbone of small and midsized communities. Their investment in commercial properties is based on meeting community retail needs and failure of commercial property owners to refinance their loans appears directly related to recessionary pressures. However, I don’t believe any “bailout” for these banks can be based on whether or not they “deserve it”, but whether or not the FDIC or the taxpayer can afford it. If recessionary pressures cause the banks to fail, then the same pressures could cause the taxpayer to fail to bail out their banks or the FDIC.

  3. Tim Manni Says: September 18th, 2009 at 11:44 am

    Lucia,

    Great additions as usual. We agree, many small and mid-size banks are the backbone of many communities and the bizs that make them run. For the most part, the small and mid-size banks played by the rules and were less risky than their larger counterparts. As we said, the failure of commercial real estate is recessionary based.

    “However, I don’t believe any “bailout” for these banks can be based on whether or not they “deserve it”, but whether or not the FDIC or the taxpayer can afford it.” — But will taxpayers accept this? Can taxpayers handle another bailout???

    Thanks,
    Tim

  4. Lucia Says: September 18th, 2009 at 1:08 pm

    It seems the FDIC is borrowing from the Treasury again to refill their reserves. Does this save the taxpayer?

  5. Tim Manni Says: September 18th, 2009 at 1:23 pm

    Hey Lucia,

    Well, if the FDIC is receiving a loan from the Treasury, then they will have to pay it back (they have had to do this before). To generate those repayment costs, the FDIC raises the fees they charge to the banks. Banks then offset those higher fees by raising the fees they charge to consumers. Everything runs downhill.

    It may save the taxpayer if their bank collapses and the FDIC is there to pick up the pieces, but it also may result in higher costs for taxpayers along the way.

    Good question,
    Tim

  6. Mona Says: October 4th, 2009 at 7:51 pm

    Tim, I agree that we can’t decide to bailout banks on grounds on wether they deserve it or not. But we can’t either use the basis if the “tax payers can afford it or not”. We can’t! We have already spend way to much money on bailing out banks. But the sad sitaution is that we don’t have much choice – letting financial institutions go bankrupt would have such serious effects on the economy that it would harm us all severly. Just look at what happend with the World Ecobomy when Lehman Brothers were let go.

    What we should focus on though, is securing assets in the banks that can be sold later on, for the government to retrieve it’s money.

  7. Tim Manni Says: October 5th, 2009 at 11:14 am

    Mona,

    I think you hit the nail on the head here Mona. There’s no denying that a serious crisis is brewing in the commercial real estate industry. However, any type of assistance is going to be a tough, if not impossible, sell to consumers. How many more bailouts can we fund??? However, this sentiment that Washington has stirred in the consumer is dangerous to a degree…we can’t afford another real estate crisis.

    There is some activity in the banking industry regarding the interest of private money, which is a good sign that we can again operate without govt. assistance. Again, I like your point that the govt needs to focus on getting taxpayers repaid for loans it has already lent. That’s taxpayer money and we deserve to know when we’re getting it back.

    Great comment, please visit us again soon.

    Thanks,
    Tim

  8. The Commercial Real Estate Market Remains Distressed | Portfolio Real Estate Observer Says: December 17th, 2009 at 8:19 pm

    [...] Commercial Real Estate: Credit Crisis #2? (hsh.com) [...]

  9. David Leeman Says: September 8th, 2010 at 1:17 am

    Well, I forgot to address your question about the FDIC and REMIC revisions. I don’t think the FDIC revisions will affect loan liquidation lags; my understanding is that they relaxed qualification of what CRE loans is considered impaired, so that banks didn’t need to reserve capital against them.

    Perhaps 2010 will finally be the watershed year. Here is another good stat: In 2009, the FDIC alone sold about 3,500 CRE loans with a book value of more than $6.1 billion. That compares to CRE loans sales in 2008 of just $153 million. Its good news to buy a home for you for you now.

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About the HSH Blog

HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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