Homebuyers Hit by Commercial Real Estate Slide

Maybe you've considered refinancing your mortgage with a loan from a smaller bank. Well the next time you go to visit, the sign on the bank window may say "closed." That's because many small and regional banks are under serious pressure from the growing troubles in commercial real estate.

Three more banks failed this week alone: TierOne Bank of Lincoln, Neb.; Arcola Homestead Savings Bank of Arcola, Ill.; and First National Bank of Rosedale, Miss. So far, close to 200 banks have gone under since the start of the financial crisis, nearly all of them smaller "community" banks, according to a list kept by the Federal Deposit Insurance Corp.

More than 700 more banks are on the FDIC's confidential "Troubled Bank" list, according to The Associated Press. That's close to one in 10 insured depository institutions, up from fewer than 50 troubled banks just a few years ago.

What's going on? Blame the commercial real estate market.

First, not every small or community bank is in trouble -- 80 percent of community banks have strong ratings from government regulators. But of the banks in trouble, "the reasons cited for these failures have become depressingly similar in an exceptionally large proportion of cases," said John Dugan, the U.S. Treasury's comptroller of the currency.

Reason Number One: "Excessive concentrations in commercial real estate lending, especially construction and
development lending, which produced very large losses," said Dugan. Also, banks raised money in risky ways "to fund rapid growth, especially in commercial real estate lending."

Most of the smaller regional banks didn't have the scale or the cash to play the billion-dollar games played by the largest "money center" banks, such as issuing bonds, or trading in derivatives such as credit default swaps. Instead, many small and regional banks invested heavily in commercial real estate. In particular, commercial banks used to dominate the business of making construction loans to commercial real estate properties and kept most of these loans on their own books.

Commercial real estate is now "bouncing along the bottom" of its long slide, according to the analysts at research company Real Capital Analytics. The default rate for commercial real estate mortgages held by the nation's FDIC-insured depository institutions grew to 4.17 percent in the first quarter of 2010. That's the highest default rate reported since 1992.

About half of these defaulting commercial real estate loans were held by smaller banks with assets of between $100 million to $10 billion. The bad news for these smaller banks is that commercial real estate loans make up a large percentage -- 33.4 percent -- of all the loans on their books, according to Real Capital.

The good news is that, as Real Capital says, commercial real estate seems to be scraping along the bottom. Hopefully commercial real estate -- and local banks -- will recover some of their strength soon.

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