Commercial Real Estate — the Economy’s Anvil


Commercial Real Estate — the Economys Anvil

Commercial real estate may soon bulldoze the green shoots.

A coming wave of defaults on loans to developers of condominiums,
office buildings and malls could do significant damage to the already
deflating economy. That was the overwhelming concern expressed at a public
hearing of the Congressional Oversight Panel on Thursday that focused on
corporate and commercial real estate lending.

The COP was set up last fall as part of legislation that gave the Treasury
Department permission to spend $700 billion to rescue the nation’s ailing
financial system. The panel, which is headed by Harvard Law professor
Elizabeth Warren, has no legislative or official regulatory powers. It is
supposed to monitor the Treasury’s spending and report back to Congress as
to whether it is being effective in boosting lending and shoring up the
financial sector.

Thursday’s hearing was one of a number of public forums the COP is hosting
on different segments of the lending market. Warren is often criticized for
being too critical of banks and their lending practices. But at the hearing
on commercial real estate, Warren focused on how big a problem future loan
defaults will be and what should be done about them.

She got an earful. Richard Parkus, an analyst at Deutsche Bank, said he
thought two-thirds of all commercial real estate loans due in the next few
years — hundreds of billions of dollars’ worth — could go bust. Jeffrey DeBoer,
president of trade group the Real Estate Roundtable, fretted that problems
in the lending business could cost the nation thousands more construction
and real estate jobs. Next up, Congressman Jerrold Nadler of New York expressed worry
that the country was headed for a lost decade of economic stagnation.

There were not many solutions offered. Nadler said he thought
the government should create new banks, which, unencumbered by souring
loans, would boost lending. Nadler said he thought private investors would be
interested in helping fund the new banks.
A number of the panelists thought the government’s TALF and PPIP programs
meant to boost lending were helpful but not the answer. Parkus said he
thought extending the terms of commercial loans set to default would only delay
the problem and make it worse. As more and more bad loans pile up, he
predicted, it will become progressively harder for any of them to get
refinanced.

What is clear from the hearing is that commercial real estate
could turn out to be a much bigger problem for banks and the economy than
the Treasury Department, the Federal Reserve and other bank regulators seem
to believe. “The question is, What percentage of commercial real estate loans
will have trouble refinancing” Parkus said at the COP hearing. “It is
likely to be a big problem.”

How big In the government’s recent bank stress test, examiners
predicted that commercial real estate loan losses for the 19 largest banks
in the nation would be far less than the value of home loans that go unpaid
in the next two years — $53 billion vs. $185 billion.
But Warren said she thought the two-year horizon of the government stress
test may have understated the size of the banks’ commercial real estate
problem. The government assumed different default rates for each of the 19
banks for commercial real estate and other types of loans. Warren said the
government had not given much information as to what determined the default
rate used for each bank; she plans to release a report on the stress test in
early June.

Parkus concurred that the stress tests probably went too light on potential
losses. He expects that a little over $1 trillion in commercial real
estate loans will be up for refinancing in the next four years. Because of
falling real estate prices and lower rental incomes, he said, as many as
two-thirds of those loans may not be eligible for refinancing and could end
in default.

Kevin Pearson, executive vice president of M&T Bank, said he thinks banks
will be able to avoid many of those loan losses through loan modifications
or “through blocking and tackling,” as he put it.
Parkus, though, said that outlook was too positive. He countered that
banks will have a very tough time refinancing the poor loans they made at
the height of the credit bubble. “There are very large losses embedded in
the system,” he said.

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