Community banks taking major hit as U.S. Commercial Real Estate value drops
By: Eran D. Grossman, Esq.
More problems are on the horizon between government regulators and local U.S. banks (smaller, regional and/or community banks) over how to handle falling commercial property values. Currently, banks are holding roughly $1.9 billion in commercial real estate loans, which equals about a quarter of all outstanding loans, according to Moody’s. The values of such loans have plummeted about 50% since their peak in 2007.
Why is this a problem?
This drastic reduction in value country-wide is disproportionally hurting the smaller bank since they tend to have a larger concentration of capital invested in commercial real estate loans. These smaller institutions compose the majority of banks in the U.S. as they hold a majority of outstanding commercial real estate debt. These smaller banks are less equipped to handle sharp and steady decreases in commercial property values than their larger institutional bank counterparts. As a result, since many of these loans are underperforming and in default, smaller bank failure may be right around the corner as banks struggle to stay afloat. Therefore, there is now mounting pressure from government regulators over how to handle falling commercial property value and to keep these smaller institutions buoyant and lending.
One contentious problem is what constitutes a performing loan. Banks argue that so long as the borrower is making interest payments only, the loan should be rendered performing. Regulators argue that banks should be more realistic in their assessments as to whether a loan will remain performing, given the decreases in value in the marketplace. Further, regulators indicated that a loan should not be reclassified simply because the value of the property has dropped. However, bankers have stated this is exactly what is happening.
Due to this overwhelming problem- banks suffocating on the bad loans they originated- they have less desire to continue lending. In fact, Moody’s has estimated that many smaller banks will not be participating in the Obama Administration’s $30 billion initiative to encourage small business lending because of insufficient capital.
Solutions? Regulators want these banks to writedown the troubled loans. A writedown is when a banks recognizes the reduced value of an impaired asset (an asset’s current market value is less than the market value at the time of loan origination), also commonly known as an underwater asset. The problem for the bank is that a writeoff will leave the asset with a lower value, thus lowering the value of the banks overall assets. This also poses a problem for bank investors. If investors realize that this will become a common bank practice, they will be less inclined to invest, thus resulting in banks being less inclined to lend. Stay tuned as this problem will only get worse before it gets any better…
