Community banks’ CRE loans are starting to show cracks

"Problems with commercial real estate (CRE) loans bubbled to the surface for community banks in the third quarter and are expected to continue to plague them through much of the year, bankers and analysts say.

Though construction and land loans — usually earmarked for home developers — are in default in higher percentages, CRE is now the primary driver of new nonperforming loans. The transition took place in the third quarter.

An examination of all U.S. banks with between $1 billion and $20 billion in assets by investment firm Boenning & Scattergood found that in the second quarter, CRE accounted for 33 percent of new nonperforming loans. That number shot up to 45 percent in the third quarter. Conversely, construction and land loans made up 36 percent of new nonperformers in the second quarter and only 28 percent in the third quarter.

Among the region’s 37 publicly traded community banks, which typically loan only to local projects, CRE made up 21 percent of all nonperforming loans in their portfolios during the third quarter, according to data provided by Charlottesville, Va.-based business intelligence firm SNL Financial. Nonperforming loans for new construction and development, which felt the downturn earlier than commercial real estate, were 44 percent of all nonperforming loans.

The first large local community bank to report fourth quarter earnings was Fulton Financial, and its numbers reflect the national trend of rising CRE problems. The bank indicated that its commercial real estate nonperforming loans increased 11 percent, offsetting an 11 percent decrease in nonperforming construction loans.

Extremely large projects are typically financed primarily by big national banks, insurance companies or pension funds, with community banks sometimes sharing in the loans with several other lenders. Data on local nonperforming loans held by national lenders was unavailable.

Boenning analyst Jason O’Donnell said commercial real estate is a lagging economic indicator and the Philadelphia region has been hit with problems later than more high-growth areas such as Florida, Arizona, California and Nevada.

“We’ve been later to the party than other regions, but it will be the major problem in portfolios over the next three quarters,” O’Donnell said. “If the economy continues to improve, CRE problems should moderate in the second half of the year. But if unemployment continues to stay high, it could go on longer.”

With the holiday season in the rearview mirror, many struggling retailers will now decide whether to discontinue operations or to scale back locations. That puts pressure on landlords, which in turn puts pressure on banks.

David Pioch, regional manager for commercial real estate at Wachovia Bank, said there has already been a fair amount of shakeout among retailers and store closings. Retailers are signing few new leases and asking for concessions on existing leases, he said.

Similarly, businesses forced to scale back personnel have asked landlords to renegotiate leases for smaller space at cheaper terms.

Joseph Walker, executive vice president for commercial real estate lending at National Penn Bank, said layoffs at businesses will cause immediate problems while retailer problems take time to manifest.

“An office building in which a tenant employs 300 people and cuts jobs, they can renegotiate the lease terms for less space,” Walker said. “Landlords will negotiate the new lease terms because they don’t want to lose the tenant all together.”

National Penn’s Scott Gruber, group executive vice president for corporate banking, said the bank likes to have diversity within the commercial real estate portfolio — $154 million in office buildings, $215 million in retail, $168 million in residential subdivision and $280 million in multifamily projects as of the third quarter.

Dominic DeSimone, co-partner in charge of Ballard Spahr’s distressed real estate initiative, said the largest CRE projects are financed by large banks. He said each big bank has a different philosophy — some will put up $200 million for a whole project and others instead split the risk with other lenders, including community banks.

Though community banks aren’t often involved in the largest of projects, Boenning’s O’Donnell and DeSimone each said community banks often have disproportionate percentages of CRE loans partly because their lending opportunities lead them to real estate and their portfolios are less diverse.

The competitive landscape for commercial real estate changed when the commercial mortgage-backed securities market, which took hold about 15 years ago and eventually reached more than 20 percent of the $3.5 trillion national CRE lending market, crashed in late 2007.

Pioch said Wachovia, which is still one of the region’s largest CRE lenders after being acquired last year by Wells Fargo & Co., competes with a select group of lenders for larger projects. And with the CMBS market challenged, the competition has become even thinner."