Trepp: Prolonged Commercial Real Estate Recovery Takes Toll on U.S. Banks

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Bank profits will be under pressure in 2012, and the industry’s large exposure to commercial real estate isn’t helping matters. That’s the conclusion of data analytics firm Trepp LLC, which emphasizes that troubled commercial real estate loans have accounted for approximately 80 percent of all U.S. bank failures since 2007.

With $1.5 trillion of commercial real estate debt still on the books of banks, regulatory concerns persist. “That’s about one-fifth of bank lending overall,” said Matt Anderson, managing director of New York-based Trepp. “And it’s a much higher proportion for smaller banks, which are much more dependent on commercial real estate lending.”

Anderson’s comments came during a webinar hosted by Trepp on Thursday that offered a decidedly bearish outlook for the U.S. banking sector. The data analytics firm is forecasting that industry profits will fall 7 percent in 2012, after rising 47 percent in 2011 to an estimated $126 billion.

Reduced net interest margins created by the low interest rate environment and flat yield curve will cut into earnings during the next 12 months, said Anderson. Other factors that will cause bank profits to dip include anemic loan growth and a protracted commercial real estate recovery.

U.S. banks are implementing cost-cutting measures, and that includes layoffs. Anderson said he expects bank employment to contract 0.2 percent in 2012, “perhaps not a disaster but a bit deflating after the rebound of the last two years.” Banks are also looking at ways to grow non-interest income such as transaction-related fees.

Meanwhile, Treppis forecasting that bank failures in 2012 will range between 75 and 100. Ninety-two U.S. banks and thrifts failed in 2011, down from 157 in 2010 and 140 in 2009.

Trepp has identified more than 200 banks that it deems as a high risk of failure. Three states — Georgia, Florida and Illinois — have experienced the highest number of bank failures in the current cycle. Since the financial crisis struck in 2007, at least 73 banks in Georgia have failed and more than 50 banks have been shuttered in Florida.

The positive news is that delinquency rates on commercial real estate loans held by banks have been falling since peaking in the first quarter of 2010. For example, the delinquency rate on commercial and land loans dropped from 19.7 percent in the first quarter of 2010 to 16.3 percent in the third quarter of 2011.src="data:image/svg+xml,%3Csvg%20xmlns=''%20viewBox='0%200%201%201'%3E%3C/svg%3E"

The strongest recovery has been in the multifamily segment, where delinquency rates on bank loans have dropped from 5.9 percent in the first quarter of 2010 to 3.6 percent in the third quarter of 2011. “This is really the one bright segment in commercial real estate, where real estate fundamentals are good and investment demand is very strong,” said Anderson.

Another issue that banks and all commercial real estate lenders are grappling with is the sheer volume of commercial mortgages due to reach maturity. An estimated $360 billion in commercial real estate loans industry-wide will mature in 2012, followed by $370 billion in 2013. The large volume of maturing loans is the result of a boom in the commercial real estate debt market from 2000 to 2007, when commercial real estate debt outstanding doubled.

Anderson expects that the volume of maturing loans held by banks will peak this year at $214 billion, followed by $210 billion in maturing loans in 2013 before declining further.


“It’s a problematic issue for banks in that they are still trying to trim their exposure to commercial real estate. It has become a big regulatory concern,” said Anderson. “There is no obvious exit in the market.”

The commercial mortgage-backed securities (CMBS) market, which historically has been a huge source of debt capital for borrowers, has experienced some setbacks of its own since the financial markets meltdown in 2008.

Annualized loan growth at U.S. commercial banks overall was 0 percent in 2011, according to Trepp. There were some sectors that did expand, however. Commercial and industrial loans, or loans to businesses, expanded by 11 percent. Also, the annual loan growth of multifamily mortgages was 2 percent. But in the construction segment, loans outstanding contracted by 26 percent in 2011.

One response of banks to the low margins has been to shift to higher-yielding, longer-term assets. Long-term assets as a proportion of earning assets reached 24.5 percent in the third quarter of 2011, the highest they’ve been in the past 20 years, according to Anderson.

“The concern that we have is that the banks are taking on additional interest rate risk at a time when rates are so low,” said Anderson. “So, the likelihood that rates will fall is not that great, whereas the likelihood they will increase is much higher.”

— Matt Valley

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