Working through the large volume of troubled commercial real estate loans will take time as banks go through the difficult process of loan workouts and loan restructurings.
Patrick Parkinson, director of banking supervision and regulation at the Federal Reserve Board, delivered that projection during his testimony before a congressional oversight panel Feb. 4. Construction of nonresidential structures continues to lag because of weak fundamentals in the sector, including high vacancy rates and low property values, which are unlikely to change in the near term, he said.
"Credit losses for bank CRE loans typically continue well past the trough of recessions, and we expect this pattern to continue in this cycle," Parkinson said. "Working through the large volume of troubled CRE loans will take time as banks go through the difficult process of loan workouts and loan restructurings."
At the end of third-quarter 2010, approximately $3.2 trillion of outstanding debt was associated with CRE, including loans for multifamily properties, Parkinson said. Of this amount, about one-half, or $1.6 trillion, was held on the balance sheets of commercial banks and thrifts.
Parkinson said approximately one-third of all CRE loans, both bank and nonbank, totaling more than $1 trillion, are scheduled to mature over the next two years. This circumstance represents substantial refinancing risk as CRE loans typically have large balloon payments due at maturity, he noted.
An additional $700 billion represented collateral for commercial mortgage-backed securities, and the remaining balance of $900 billion was held by a variety of investors, including pension funds, mutual funds and life insurance companies, Parkinson said. Outstanding CRE debt has contracted 6% from its peak in 2008, while outstanding CRE loans at banks have contracted by almost 12%. The majority of the decrease in bank loans was associated with reductions in construction and development loan balances, which were largely the result of foreclosures and charge-offs.
Within the credit union industry, foreclosed and repossessed assets grew 8.3% to $1.8 billion in the third quarter of 2010, the highest growth rate of the year, according to NCUA data. As of September, loan modifications accounted for nearly 2% of all loans.
While the pace of loan modifications slowed in the third quarter, growth continues as credit unions work to assist members, the agency said. Many credit unions that provided financing for out-of-state properties had to file foreclosure notices and, in some cases, sue to recover funding. The attempts may drag out in court as property owners filed for bankruptcy, unable to make loan payments.
At the end of third-quarter 2010, almost 10% of CRE loans in bank portfolios were considered delinquent, a three-fold increase since the end of 2007, Parkinson pointed out. Loan performance problems have been most striking for construction and development loans, especially for those that finance residential development. Almost 19% of all construction and development loans were considered delinquent at the end of the third quarter of last year.
Meanwhile, during 2010, delinquency rates on construction and development loans began to improve slightly, falling 1% in the first three quarters of 2010. Additionally, delinquency rates on loans backed by existing nonfarm, nonresidential properties leveled off last year.
"Still, even if CRE delinquency metrics continue improving, there remains a sufficiently large overhang of distressed CRE at commercial banks such that loss rates for this portfolio will likely stay high for some time and many banks with CRE concentrations will remain under stress," Parkinson said.
It has taken a number of approaches from agencies, including the NCUA, to quell the CRE tide. In 2006, interagency guidance on CRE concentrations was developed that outlined expectations that banks and credit unions need to perform, including stress testing and other plans to identify the impact of adverse market conditions on earnings and capital.
The NCUA and other financial regulators have adopted a policy statement that aims to support prudent CRE loan workouts. Among them are that risk management practices for renewing and restructuring member business loans should be appropriate for the complexity and nature of the lending activity and consistent with safe and sound lending practices and regulatory requirements.
Prudent loan workout arrangements should improve the prospects for repayment of principal and interest and should be supported by a comprehensive analysis of the member-borrower's willingness and ability to repay the loan, an evaluation of support provided by guarantors, and a current assessment of the value of the underlying collateral, the NCUA has said.
Parkinson said the Federal Reserve has devoted significant additional resources to assessing the quality of CRE portfolios including monitoring the impact of changing cash flows and collateral values and assessing the extent to which banks have been complying with CRE guidance.
"Examiners have taken a balanced approach to ensuring that banks are recognizing losses in a timely manner, maintaining sufficient loan loss reserves, and monitoring collateral values while being mindful not to discourage healthy banks from making loans available to creditworthy borrowers," Parkinson said.
The Fed is also working with the Office of the Comptroller of the Currency and the FDIC on the collection of CRE data from a number of national and regional banks that will provide information on credit quality and performance.