Although the projected surge in commercial loan defaults is expected to be felt largely by regional and community banks, some experts say big banks including Citigroup (C), Bank of America (BAC), and Wells Fargo (WFC) may not be immune to the expected commercial loan collapse in 2010.
Ill-defined or inconsistently applied rules for valuing securities and handling loan modifications has some analysts questioning the health of all banks including large firms who have received federal bailout money.
“The credibility of the banking system could take another step back,” said Paul Miller, an analyst at FBR Capital Markets. “Everyone is expecting we’ve seen the peak in losses, but it’s impossible to know for sure because you can’t get an apples-to-apples comparison.”
Banks are facing a perfect storm in commercial mortgages and construction loans made when prices were much higher and demand for space much stronger. The pace at which U.S. commercial banks are adding to their loan loss reserves has slowed this year, while loans continue to go bad at a brisk pace.
How bad is the problem? According to the Moody’s/REAL commercial property price index, prices on apartment, industrial, office and warehouse properties dropped 33% over the past year. Add to that an estimate from real estate research firm Foresight Analytics that says banks have only booked about one-third should of their projected losses of $110 billion on defaulted commercial real estate and construction loans.
That means the banks could face a backlog of $70 billion or so defaulted but unreserved loans as we head into the teeth of down cycle in commercial real estate — where the bulk of bubble-era loans are due to be repaid or refinanced between 2010 and 2012.
Loans written off as uncollectible hit their highest level on record in the second quarter, according to government data. Loan loss reserves are also at a peak since the government started keeping track in 1984, according to data from the Federal Reserve Bank of St. Louis.
Taking losses on souring loans and troubled assets eats into profits, which tends to drive down share prices and executives’ pay. The losses also erode capital, reducing lendable funds and forcing banks to raise new money by selling stock or businesses.
Accordingly, banks have been eager to stretch their losses across as long a period as possible. Facing a triple-digit bank-failure count and trying to manage hundreds of troubled lenders, regulators are willing to go along, up to a point.
In April, accounting rule makers reversed controversial “mark-to-market” regulations, giving banks more leeway in valuing hard-to-trade securities. But many regulators are now concerned that this has only delayed the inevitable day of reckoning when banks will have to bring some off balance-sheet assets and liabilities back in house.
