A loss rate that high means that U.S. banks and thrifts, which hold $1.8 trillion of commercial real estate on their books, could incur $216 billion in losses by the end of 2010. With that loss rate, "you're talking about a depression in the U.S. economy and a major crisis in the banking system," Richard Bove of Rochdale Securities told The Wall Street Journal.
As property values plummet and defaults surge, credit rating firms imposed downgrades on collateralized debt obligations filled with commercial real estate debt. Moody's downgraded $52.9 billion of the $83.1 billion in CDOs. The FDIC has sold about $1.16 billion of distressed real estate debt and other types of commercial loans from failed banks for about 59 cents on the dollar between January 2008 and the end of February, according to industry data.
Nearly 3,000 banks and thrifts are estimated to have commercial real estate loan portfolios that exceed 300 percent of their total risk-based capital, according to Foresight Analytics. Regulators consider 300 percent a red flag, but it doesn't mean all the banks at that threshold will fail.
While failure of small banks is unlikely to cause systemic damage, they could still have a big impact as the government tries to get a grip on the crisis. Just to give you an idea of the scope of the problem. Banks with commercial real estate loan portfolios exceeding 300 percent of their total risk-based capital have total assets of about $2 trillion, compared with $2.3 trillion in assets at Bank of America (BOA).
The large banks that are part of the stress tests that are thought to have a problem with commercial real estate loans include Regions Financial (RF), BB&T Corp. (BBT), Fifth Third Bancorp (FITB) and KeyCorp (KEY). Jeffrey Weeden of KeyCorp told the Journal, "We remain well capitalized by any regulatory measure."
The entire problem can be avoided if things don't get to the worst case scenario used in the stress tests. Since late 2007, 58 banks and savings institutions failed with assets totaling $400 billion. Only about 12 of these banks failed because of unusually high commercial mortgage exposure, according to Foresight.
So far banks have been reluctant to sell their commercial property loans in trouble because they would be insolvent if they sell the assets at the current bargain basement prices. Regulators could put pressure on these banks to clean up their books. The ones in the worse shape could be seized by regulators and put under conservatorship or receivership.
Lita Epstein has written more than 25 books, including Reading Financial Reports for Dummies.