Feds Frets About Commercial Real Estate

With Banks Slow to Take Losses, Fears of a Residential-Bust Repeat; 'More Pain Likely Lies Ahead'

The Washington Post

By Lingling Wei and Maurice Tamman

Bakns in the U.S. "are slow" to take losses on their commercial real-estate loans being battered by slumping property values and rental payments, according to a Federal Reserve presentation to banking regulators last month.

The remarks suggest that banking regulators are girding for a rerun of the housing-related losses now slamming thousands of banks that failed to set aside enough capital during the boom to cushion themselves when the bubble burst. "Banks will be slow to recognize the severity of the loss - just as they were in residential," according to the Fed presentation, which was reviewed by The Wall Street Journal.

A Fed official confirmed the authenticity of the document, prepared by an Atlantic Fed real-estate expert who is part of the central bank's Rapid Response program to spread information about emerging problem areas to federal and state banking examiners throughout the U.S.

While the Sept. 29 presentation by K.C. Conway doesn't represent the central bank's formal opinion, worries about the banking industry's commercial real-estate exposure have been building inside the Fed for months. "More pain likely lies ahead for this sector and for those banks with heavy commercial real estate composure," New York Fed President Bill Dudley said in a speech Monday.

In another sign that many U.S. financial institutions are inadequately protected against potential losses on commercial real-estate loans, banks with heavy exposure to such loans set aside just 38 cents in reserves during the second quarter for every $1 in bad loans, according to an analysis of regulatory filings by The Wall Street Journal. That is a sharp decline from $1.58 in reserves for every $1 in bad loans from the beginning of 2007.

The Journal's analysis includes more than 800 banks that reported haveing more half of their loans tied up in commercial real-estate, ranging from apartments to office buildings to warehouses.

Loan-loss reserves typically rise and fall during any credic cycle, being drawn down as losses mount. Some analysts and investors say the recession combined with inadequate loan-loss provisions when times were good have left banks dangerously vulnerable to the deteriorating commercial real-estate market.

Mr. Conway's presentation painted a bleak picture of the slideing real-estate vales and enormous debt that will need to be refinanced in the next few years. Vacancy rates in the apartment, retail and warehouse sectors already have exceeded those seen during the real-estate collapse of the early 1990's, Mr. Conway noted. His report also predicted that commercial real-estate losses would reach roughly 45% next year. Valuing real estate has always been tricky for banks, and the problem is particularly acute now because sales activity is practically nonexistent.

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