Commercial Real Estate

Sen. Dodd: CRE Problems Require 'Prompt and Robust' Action By Regulators
Banking Committee Chairman Asks Regulators for Updates On 'Prudent CRE Workouts' And Other Efforts to Address Mounting Troubled Debt Problems In the Industry

By Randyl Drummer

February 24, 2010

Concern continues to mount in Congress about the potential impact of weak commercial real estate markets on the economic recovery, even as major legislation overhauling regulations for the nation's banking and financial system move closer to the Senate floor. Senate Banking Committee Chairman Chris Dodd this week asked bank regulators to redouble their efforts to stabilize commercial property capital markets and provide Congress with an update on those and future steps.

The government has been sounding alarms about weakness in CRE for months, starting with the Federal Reserve Board's warnings about maturing debt last summer, followed by additional warnings and new guidance for lenders from the Federal Deposit Insurance Corporation (FDIC) and other regulators, reports and testimony before the Congressional Oversight Panel, and most recently, the call for action by Dodd's powerful banking committee.

"I believe weakness in the CRE market requires prompt and robust responses from the regulators to guard against harmful effects on financial institutions and the economy," Dodd said, citing recent reports and testimony by bank examiners that the credit performance of loans on income-producing property has deteriorated sharply in bank portfolios, with delinquencies on the rise and borrowers are "underwater" on nearly half of the $1.4 billion in mortgage debt slated to come due by 2014.

Commercial real estate, a lagging indicator, continues to struggle despite signs of recovery in the broader economy, Dodd noted. More evidence of flagging fundamentals surfaced on Tuesday, with the National Association of Realtors (NAR) forecasting no significant improvement until 2011.

"Because of the lingering impact from the deep recession over the past two years, vacancy rates will trend higher and many commercial property owners will need to make rent concessions," NAR Chief Economist Lawrence Yun said. "With the job market expected to turn for the better later this year, we’ll see rising demand for office and warehouse space, but that isn’t likely before 2011."

Dodd urged regulators "to redouble your efforts to provide appropriate oversight of this vital component of our economy" in the letter to Federal Reserve Chairman Ben Bernanke, which was also sent to FDIC Chairman Sheila Bair, Office of Thrift Supervision Acting Director John E. Bowman, Comptroller of the Currency John C. Dugan and National Credit Union Administration Chairman Debbie Matz.

Efforts to stabilize and improve oversight of CRE capital markets are gaining steam as the broader financial industry reform bill moves closer to being unveiled after nearly a year of debate. Dodd of Connecticut and committee colleague Sen. Bob Corker, R-TN, next week are expected to introduce a bipartisan reform proposal in an effort to avoid a repeat of the financial crisis of late 2008 and 2009.

The FDIC and other member agencies of the Federal Financial Institutions Examination Council last fall adopted a policy statement urging banks and thrifts to conduct "prudent CRE loan workouts" to extend or restructure such loans for credit-worthy borrowers. Dodd this week asked the agencies for an update "on how that guidance is helping to stabilize the CRE market," and requested specific details on how they're addressing commercial property issues and what additional steps they intend to take.

Dodd noted that delinquency rates for commercial mortgages climbed from 4% at the end of the third quarter of 2009 to more than 6% in January 2010, with more than $500 billion of commercial loans slated to mature each year over the next few years.

The agencies had not specifically responded to Dodd's request at Advisor's press time. FDIC Chairman Bair told reporters Tuesday during the agency's unveiling of its Quarterly Bank Profile that "resolving these credit market dislocations will take time." For related CoStar coverage, see "Distressed CRE Assets Jump 15% at Nation's Banks"
The number of problem banks and the amount of distressed real estate on banks books rose sharply in the fourth quarter, according to the quarterly report. (See related CoStar coverage)

"Small- and mid-sized institutions who tend to make business loans secured by residential and commercial properties are dealing with the effects of large declines in real estate value," Bair said. "Lower values reduce the collateral coverage of existing loans and make it more difficult for households and small businesses to qualify for credit.

"One thing that can help is a balanced approach toward lending as outlined in the recent interagency policy statements on prudent CRE loan workouts and meeting the credit needs of small business borrowers," Bair added. "Institutions must effectively manage concentration risk in their portfolios, however, they should neither over-rely on models to manage concentration risk nor automatically refuse credit because of a borrowers' particular industry or geographic location."

"Obviously, these policy statements alone won't make the problem go away, but they do get to the root of the matter by giving lenders a roadmap for working out problems and making new credit available to qualified consumers and businesses," Bair said.

Bair and other FDIC staff said distressed CRE loans would take longer to work through the system because some borrowers may have cash reserves to continue to make payments or because tenants may have longer-term leases that have yet to expire and renew at lower market rate rents. Accordingly, charge-offs and delinquencies will continue to cause problems -- especially for community and regional banks -- "for the next couple of years," the FDIC said.

Although many of the smaller banks are capital constrained, disproportionately affecting the borrowing power of small businesses, Bair said the nation's largest banks have driven most of the loan and credit line cutbacks. Large banks have tightened underwriting and increased the money that they hold in reserve against unexpected losses.

"I do think the large banks do need to do a better job of stepping up to the plate here," Bair said.