As Wave of CRE Defaults Builds, CUs Take Stock in Conservative Loans
There's just no comparison between a foreclosure or walk-away from a $5.4 billion Manhattan 56-building complex and a defaulted loan on a small retail space in a strip mall.
That's one way to look at how mega banks and other lenders are grappling with the commercial real estate downturn compared to the business that credit unions do on a much denser scale. For the past year, economists and mortgage trade groups have been watching the CRE sector, predicting that while its losses may not be on the same level as the residential housing bust, the shortfall could further hamper efforts toward a recovery.
Earlier this year, all 12 of the Federal Reserve districts, which include major cities such as Atlanta, New York and San Francisco, reported a continued decline in commercial and industrial space bogged down by rising vacancy rates and falling rents. Around the same time of the Fed report, a real estate development company walked away from what is considered to be the biggest deal in U.S. history. According to published reports, Tishman Speyer Properties turned over a 56-building, 11,232-unit apartment complex in Manhattan to its lenders after defaulting on nearly $4.4 billion in debt. The property was purchased in 2006 for $5.4 billion and is now underwater by about $1.8 billion.
It's safe to say that for credit unions, those numbers are unattainable and probably with good reason. With a few exceptions-and those CRE deals tend to fall in the multimillion dollar range-the industry has a reputation for closing much smaller loans. As a result, they may not be bracing for the wave of CRE loans expected to come due this year in an environment rife with growing foreclosures and lately, less of a stigma to simply walk away from underwater properties.
"The credit union industry is buffered by the fact that we have typically smaller, more conservative, plain-vanilla type of deals," said Larry Middleman, president/CEO of CU Business Group, a business lending CUSO in Portland, Ore. "The things that are making headlines are the Silicon Valley high rises that are vacant or almost vacant. For the most part, credit unions are not going to be in on these kinds of deals."
Of the 325 credit unions that CUBG works with, most have properties such as office complexes and single-purpose spaces like bowling alleys. A small building with eight tenants, for instance, is much more of a typical CU loan, Middleman said. If one of those tenants leaves, there's still some room for renegotiation rather than worrying about whether the entire space will go into default.
Still, the predicted CRE collapse is so dire that last November bank regulators concerned about the nonstop drop in rental and occupancy rates issued new guidelines for loan workouts. According to the FDIC, CRE loans represented 14% of all loans and leases for a total of $1.1 trillion as of June 2009.
One piece of good news for credit unions is they still have low delinquency and charge-off rates on business loans compared to banks. According to NCUA data compiled by CUBG, 50% of delinquencies were concentrated in 18 of the 698 credit unions that hold 95% of all MBL dollars as of June 30, 2009. Nearly 230 of these CUs had zero delinquencies. A similar trend rings true for MBL charge-offs, with only 23 CUs having greater than $1 million in MBL charge-offs. The business lending CUSO also found that $83 million or 91% of all charge-offs is concentrated in the portfolios of just 100 CUs.
The low-hanging fruit for cooperatives tends to be in investment real estate, said Kent Moon, president/CEO of Member Business Lending LLC in South Jordan, Utah. He said it's an "overinvestment" that may show early signs that a bubble could burst as foreclosures mount.
"As the market deteriorates, the lending community has to continue to mark down their recovery potential," Moon explained.
This recession is significantly different from the one in the early 1980s when, after the oil embargo, stagflation set in, Moon said. The current downturn was created when certain regulatory issues went unaddressed, he added. The real estate collapse had more to do with mark to market, an accounting concept that requires a lending institution to downgrade capital based on the ability to recover pledged assets on loans. Moon said he believes the answer is new regulation of accounting principles and practices.
"They have to be corrected so that we have a system that doesn't drive down capital," Moon said. "Because mark to market continues to erode a lender's ability lend, real estate owners are not able to recapitalize. It's a vicious cycle."
Meanwhile, credit unions, which have been very effective in weathering the recession, have to maintain a philosophy of sticking with long-term resolutions, Moon said. That may mean being very proactive, watching for danger signals and moving in quickly to do evaluations of things like cash flows to come up with a solution that will help both the member and the credit union. Deferments and interest rate and payment reductions and weekly monitoring also help. Small businesses are divided into early, middle and large phases. It's usually in the early stage when a business will tend to lease space. This is where many of the defaults have occurred, Moon said.
Some of Member Business Lending's clients have been on resolutions plans for the past 24 months and are now in a healthy condition, Moon said. The CUSO's delinquency rate has gone up from 2.7% to 5%, Moon noted. However, its loss rate "has always been sustained at only half of the national average." He said "it shows the resolution approach does work." Just as important is keeping up the psychological and mental health of members, Moon said.
"Don't move in with an adversarial approach. What we find is that members are deeply grateful and nearly all have returned to healthy conditions. In the end, it helps members, it helps credit unions and the nation as a whole."