Banking Law

Tonight's post is another guest post by one of my partners at Bank Business Advisors, LLC, John Walker. John's worked up about commercial real estate and its past, present and, most disconcerting, future effects on community banks. He's also not thrilled about either the lack of a plan by the federal government to honestly deal with this train wreck or its lack of transparency in telling us the hard facts about the plan he suspects they might have in mind. But I'll let him tell his story in his own words. John, bank consultant Larry Martin, and banking accounting expert Dan McDonald have a lot more to say about commercial real estate lending, community banks, and related regulatory and accounting issues in their upcoming webinar for Bank Law Stuff.

As I?ve watched the public ?goings-on? over the last 12-18 months with community banks generally, I?m struck by how invisible community banks seem to be to those responsible for stopping the hemorrhaging in our financial system.  You?d think the banks collectively were Burt Campbell (Richard Mulligan?s character) in the long-running tv series Soap, who concluded he was invisible because whenever he?d walk into a room, try to engage in conversation, or otherwise come into contact with other people, no one would acknowledge his presence.

We?ve heard Fed Chairman Ben Bernanke (September 2009) and the President?s top economic advisor Larry Summers (December 2009) announce that the recession?s over.  We?ve heard Treasury Secretary Tim Geithner (September 2009) say that he didn?t think that commercial real estate (CRE) loans would set off a new banking crisis.  We?ve even heard Jamie Dimon say that CRE is a train wreck that?s already happened (January 2010).

But that?s little solace to the community banks.  Deutsche Bank, in it?s quarterly CRE Outlooks published over the last several quarters, provides some perspective about the CRE market that paints a disturbingly different picture for community banks.

• Commercial MBS growth during 2004 ? 2007 came at the expense of banks, particularly regional and community banks, as CMBS offered lower costs and higher leverage for higher quality properties with stable cash flows.

• Unlike residential real estate debt, banks hold the riskiest CRE debt, as banks became more concentrated in riskier CRE loans (e.g., construction, condo development, and land loans) with the better lending opportunities going to CMBS.

• Over $2 trillion in CRE loans mature between now and 2013 and a majority of those lack the equity to qualify for loans sufficient to pay-off the existing debt.

• Of those banks in the Deutsche CRE Outlooks? bank universe that have assets of $25 billion or less (what the Outlooks label smaller regional banks and the community banks - 7,493 of them), they have 27.43% of their aggregate assets in CRE loans, while the larger banks (greater than $25 billion in assets) have only 6.05% of their assets in CRE loans.

• Deutsche Bank expects 1,853 of the smaller regional banks and community banks (collectively with $1.096 trillion in assets) to suffer $72 billion (6.56% of total assets) in CRE loan losses.

• From its total universe of banks in the Outlooks (7,542), Deutsche Bank expects 1,592 banks, collectively holding $1.531 trillion in assets, to lose 50% or more of their Tier 1 capital as a result of CRE loan losses.

Most experienced business executives understand the importance of having a plan with goals or objectives that are clearly communicated, reinforced not only by words but also by deeds daily, and against which all future actions are judged for comparison, particularly when dealing with problems that threaten survival. The plan should incorporate an understanding of the environment in which it?s being implemented and should address the problem, not simply the symptoms.  Commercial real estate loans generally are no better than their collateral, which is not liquid ? notwithstanding the efforts of financial engineers to attempt to dress the illiquid wolf in sheep?s mortgage-backed securities clothing ? and, in an environment where unemployment is greater than 10%, there appears to be general agreement that the greatest generators of jobs are small businesses, small businesses need loans, and politicians are screaming at banks to make loans, it seems fair to ask what?s the plan to save these community banks.

Railing against ?Wall Street banks? with populist fervor isn?t much of a plan to save community banks.  Neither is marching Sherman-like through local communities, wiping out banks? capital based on a regulatory-based drive effectively to mark-to-market illiquid collateral ? especially when value recovery will take time as a number of smart people (including Bill Gross and the McKinsey Global Institute) believe asset value growth in the future will revert back to tracking closely GDP growth as it historically did until the leverage orgy that began in the 1980s.  Issuing updated loan modification guidelines (Fed?s press release) isn?t much of a plan or goal either ? as a road to survivability, it doesn?t even rise to the level of rearranging the deck-chairs on the Titanic; at best, it?s mopping the Titanic?s deck before the chairs are rearranged.  If there is a plan for the community banks, it?s not been clearly communicated and present actions make it appear to be one of surreptitiously effecting a banking industry consolidation.

On the other hand, one might excuse a cynic for thinking that in a job-thirsty environment where credit remains tight and small businesses need credit, and where ?creative? minds have fashioned ?survival? plans that involved shoving aside bankruptcy law precedents for creditor class treatment in order to reorganize forcefully the auto industry, the granting of effective blank-check writing authority to Fannie and Freddie, and the willful granting of huge-dollar special deals to entice favorable votes on legislation, someone could do some unconventional thinking and come up with a plan to cover a defined period of time during which the short-term, capital-threatening pressure of illiquid collateral/assets held by the community banks is alleviated in order to ensure their long-term viability.