As noted in CoStar's Watch List article, banks are becoming cash strapped to cover loan losses - especially from Commercial Real Estate which means that any liquidity banks were expected to lend to the real estate investment market will not materialize and will choke any new lending and, therefore, any recovery. As I noted last summer, the extend and pretend program will be a Phyrric Victory - and will cause the pain and devastation currently being felt on Main Street to also be extended into the future. I still believe that banks will not shed toxic assets faster than their capital account and loan loss reserve will allow them....which will restrict their ability to loan new money for good new deals...did anyone say Catch 22? With more than 10% of all CMBS loans in special servicing - and growing monthly, the commercial real estate liquidity crisis is the next shoe to fall - and it has the potential of throwing the whole economy down with it - WE NEED TO ACT NOW to provide liquidity to the marketplace with a new CMBS market.....
Thinning Loan Loss Coffers May Restrict CRE Lending
Efforts To Squirrel Away More Cash Keeping the Lid on Commercial Real Estate Lending
By Mark Heschmeyer
March 10, 2010
In addition to keeping an eye on declining property values, falling rents and rising vacancy rate numbers, the commercial real estate community is also concerned over ominous signs in banking industry numbers.
One big area of concern is the fact that banks are stowing away more money to cover problem loans. The amount being set aside is rising rapidly and is now higher than it has been for a quarter of century. Meanwhile, the amount of problem loans is rising at even more than twice that rate.
The implications of the increased loan loss coverage for the commercial real estate industry is that it will likely further limit the amount of money available for borrowings. Those numbers also signify that this will continue to encourage "extend and pretend" policy that some lenders have pursued, and it may further encourage lenders to be optimistic about their recovery rates to avoid taking further losses/writedowns. And at the same time, lenders won't hesitate in demanding more money out of borrowers' pockets.
Mark Fitzgerald, senior debt analyst at Property and Portfolio Research (PPR), a CoStar Group subsidiary, keeps track of the rising levels of loan loss reserves and problem assets and the ratio between the two. Similar to what happened in the early 1990s, bad loans are piling up so fast, banks can't increase reserves fast enough without showing huge negative earnings, he said.
"It looks like the loan loss allowance to noncurrent loan ratio began declining in second half of 2006," Fitzgerald noted. "Noncurrent loans and leases began increasing in second half of 2006, whereas loan loss allowances began increasing in second half of 2007. The average from 1992-2009 is 1.33, compared to 0.58 today."
Put in dollars, that means that for the past 15 years or more, banks kept aside an average $1.33 for every dollar in bad debt they were carrying on their books. Today, banks have only 58 cents set aside.
"The biggest takeaway from those numbers is that banks will continue to need to carefully manage their way out of this --- timing of earnings, reserves, and write-offs are all critical to keeping capital ratios intact," Fitzgerald said. "As delinquencies continue to rise, reserves will need to be kept at high levels, and new lending could be restricted for some time." (See related CoStar Group coverage of recent analysts' takes on CRE mortgages and other capital markets trends.)
Patrick Fitzgerald (no relation to Mark), CCIM, vice president, REO Property at KeyBank Asset Recovery Group, has been on one of the major front-lines fighting the effects of the recession: Florida.
"There is pro-cyclicality in the reserves such that in good economic times the reserves get built up a bit as they are sparsely used and in bad they are tapped to cover losses. It's not surprising to see the coverage ratio decline," Patrick Fitzgerald said.
"During 2009, most line employees in banks spent the majority of time going through loan portfolios and figuring out exactly what they had, how much underlying collateral values had changed, and aggressively marking-down distressed and non-performing loans to reflect new recovery assumptions," Patrick Fitzgerald said. "Thus, a lot of reserves were used in 2009 as loans were charged-off (partially or in full) to essentially mark-to-market the loan book.
" In addition, KeyBank's Fitzgerald noted that federal banking regulators -- in Washington, at least - have shown banks a willingness to allocate less reserves as a percentage of non-performing loans.
This should be a bullish signal to the market, Patrick Fitzgerald said. "At a minimum it says that the belief is that things are getting less bad. We've gotten our arms around our loan book and although non-performing loans may still grow a bit, we believe the biggest write-downs are in the rearview mirror. And if this isn't the case, God help us all."
Indeed, year-end balance sheet numbers for banks do show some hope. The amount of some noncurrent loans decreased in the past quarter for the first time in years. For example, the total amount of noncurrent construction and development loans fell for the first time in four years. In addition, the average net charge-off ratio also improved after peaking in third quarter, and early stage delinquency trends showed promise.
Despite these signs of stability, the bad news is that the increase in overall noncurrent loans last quarter was driven largely by real estate. The amount of real estate loans secured by nonfarm nonresidential real estate properties that were noncurrent rose by $4.5 billion (12.2%). And such exposure will likely necessitate considerable more reserves this year. So while some forms of lending seem to be coming out of the woods, banks will still be trying to clear a path through the commercial real estate thicket.
"Loan delinquencies and defaults continue to rise as expected, but they still fail to capture the enormity of distress in the commercial real estate market, as most properties are still producing enough cash flow to adequately meet debt payments," writes Josh Scoville, Director, US Equity Research at PPR in PPR's Daily Update for March 10. "However, given the massive correction in property values, it is increasingly likely that assets with debt are upside down - i.e., the property value has fallen below the principal left on the loan. This may be all fine and dandy in our extend-and-pretend world as long as two things occur: 1) the cash flow remains high enough to continue to meet debt service, and 2) there are no major capital events required to maintain the asset. With market cash flows falling, the first requirement is under growing pressure, and this distress is directly reflected in the rising delinquency and default rates. However, the latter requirement may be an even bigger issue, as debt maturities continue to force capital events."
"The banks are trying desperately to survive the current crises without facing up to massive losses," said Robert D. Domini, MBA, MAI, president of Continental Valuations Inc. Perrysburg, OH. "With delinquencies mounting, loan loss reserves are definitely falling behind. How long [banks] can hold off will depend on how bad the commercial real estate crisis gets. Vacant, deteriorating buildings in default can't be papered over for long."
Cash Is King
Jeffrey Rogers, president and COO of Integra Realty Resources, the largest independent commercial real estate valuation and consulting firm in North America, said the banking numbers show that they may be out of the "crisis phase" but still have a lot of clearing out to do.
"We still have a long way to go before we have a normal banking system again," Rogers said. "We are still in a period of deteriorating assets and loan losses to work through. This will take some time. 140 banks were shut down by the FDIC last year. This year, we will have more than twice that. The weak banks must be cleared out of the system and it is a process. Notwithstanding, we are through the crisis phase of the cycle and the top thirty banks are healthier than they were a year ago today."
"No institution wants to sell an asset at the bottom of the market unless it has to. As long as the asset does not deteriorate significantly during the hold period and the asset will likely increase in value in a normal market, there is a bias to hold," Rogers said. "Moreover, when banks were at their weakest point, taking big losses on assets would have been even more perilous. Banks need time to earn their way out of this recession. They will be able to absorb losses better after recapitalization and positive operating metrics."
"In a recession and in the midst of a banking crisis, lending standards tighten significantly," Rogers said. "Nothing becomes more important than cash. There is still a lot of uncertainty in the capital markets and no one has the appetite for risk. Those with the cash will come out on top." And when it comes to getting cash, there still remains a great deal of uncertainty, Rogers said. The following are additional comments from industry observers on the state of the banking credit markets.
Stymied
Banks are willing to take a wait and see attitude, forbearance has come into play as well as blend and extend. There is an unreal expectation that values of these non or spotty performing assets is higher than what the market would pay. It is a Catch 21, wanting the assets off the books but expecting pricing to be at unusual levels. This leaves the banks with assets that require more coverage dollars than may be necessary. Taking the loss, on the heels of previous loss write downs keeps the holes from being further dug, or filled in. I think there is a stymie right now and more and greater losses on the horizon. Trish Walden, Broker-Associate, Advisor, Sperry Van Ness Florida Commercial Real Estate Advisors, Lake Mary, FL
Trying To Cope
Everybody is trying to spread the manure out, hoping that there isn't so much it just burns the plants. Folks knew in their heart of hearts that the music would stop. The party would be over, but now that it is, they're just trying to cope day by day. Charles B. Warren, MRICS ASA-Urban Real Property, Pleasant Hill, CA
Trying to Dollar Cost Down
Waiting for a real estate and economic rebound to take place before shedding "non-performing loans and assets" in an economy that is de-leveraging itself is a mistake. These large financial institutions should start taking the "hits" on these loans and troubled real estate assets now in order to raise "cash" and preserve their liquidity. There is plenty of private equity money around that would surely jump at the idea of buying loans and assets at a "discount." The amount of refinancing that will need to take place especially in 2012 with rollover of 2002 (10-year) and 2007 (5-year) money will be rather significant. Keeping borrowers on extended "life-support" with short term "workouts" is like trying to "dollar cost down" rather than "cutting your loss" and get out from a bad situation that may worsen further (i.e. The value of the asset versus the loan balance continues to shrink). Howard Applebaum, President, Corporate America Realty & Advisors, Rutherford, NJ
Hoping Time Will Heal All Wounds
I specifically know of a certain case with a local community bank (I'm assuming this is pretty "normal") where they are pushing appraisers for high values so they can minimize reserve requirements, avoid having to re-classify or foreclose the property and will just continue to extend and pretend instead of taking the adequate reserve or taking the 30% loss that they would have to take if they foreclosed and re-sold the property. They are obviously hoping that time will heal and/or that they can spread out their reserves over time. I believe that the regulators are basically OK with this because they don't have the manpower to take over the number of banks who would need to be closed if true values were recognized today. David Blain, Principal, Pacific Southwest Realty Services, Irvine, CA
Wild West
Clearly the banks are not prepared to take on any more REO property. The way they have handled the residential problem is deplorable. They clearly saw what was coming and did nothing I can see to be ready for the take backs. The short sale process is like the Wild West and we are now getting ready to try it in commercial. The only difference is that there will be fewer deals (in number) and banks and borrowers are used to creative deal structuring with commercial deals. My concern is the bank mentality and the bank bureaucracy will make the process more painful than necessary. We may have casualties we don't need to have. Let the loan originators (the production folks) who have the flair to do creative deal structuring do the workouts, not the underwriters. Set up parameters but give folks who "get it" the authority to get it done. Cindy S. Chandler, Principal, The Chandler Group, Charlotte, NC
Whamo!
After living through the many bank missteps of at least six major recessions in my 55 years of real estate experience in dealing with troubled bank assets, the Feds have neither the dough or the staff or the will to shut down the many, many troubled banks; some say at least 1,000 or more are on the watch list. This time around, banks are holding, with Fed approval, assets at appraised value or loan amount, whichever is the higher number, unlike, for example, the '80s when while doing work outs at Senior George H. Bush's son's bank, Silverado in Denver, the minute a loan was 60 days overdue, Whamo, the Feds were at my door forcing a write down to a new appraised value which discounted a projected holding period for the asset, etc., etc. Does history repeat itself, you betcha, only this time around the Feds are in deeper trouble than ever given the reluctance of Washington to admit defeat on this issue, i.e., the banking system is in a world of hurt. David C. Nilges, President, Managing Broker, Nilges Commercial*Realtors Inc., Centennial, CO
Subscribe to:
Post Comments (Atom)
No comments:
Post a Comment