Commercial Real Estate Loans May Be The Next Shoe to Drop

Proshares Ultrashort Real-Estate ETF (SRS) is on a nice entry point.

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Commercial Real Estate Loans May Be Next Shoe to Drop

By Research Recap, An SA Author.


Residential mortgages have gotten most of the attention during the current credit crisis, but a heavy concentration of commercial real estate [CRE] loans may be a better metric for gauging which banks are most at risk for failure in the coming months, according to Standard & Poor’s.

Eleven banks failed in the first half of 2008 and not surprisingly, S & P’s RatingsXpress Credit Research is predicting more this year and in 2009, due to continued deterioration in capital ratios, liquidity and in CRE, land development and construction loans.

Since construction loans are bullet loans with interest reserves accruing until a project is completed, we expect that problem construction loans will continue to rise in coming quarters. We also expect that loss severities among defaulted construction loans will be materially higher during this economic downturn compared with earlier downturns given sharp price declines among homes and condominium projects.

The rating agency also said most of the failures would be concentrated in small banks, especially those with a high degree of exposure to commercial real estate.

Among banks that have already failed this year, CRE loans accounted for an average 60 percent of loan portfolios. In contrast, in the three bank failures of 2007 more than 70 percent of the loan portfolios were concentrated in residential loans.

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Banks with significant exposure to real estate in California, Nevada, Florida, Arizona, Michigan and Georgia are suffering the biggest downturns in credit quality, and S & P said it expects further home price declines and economic weakness to continue pressuring banks active in those markets.

S&P said while it’s hard to predict the number of bank failures, it does not believe failures will reach the levels seen during the savings and loan crisis of the late 1980s and early 1990s.

For details, see “U.S. Bank Failures Expected to Rise.”

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