by Doug Marshall, CCIM
Market Assessment

It is not often that I agree with an editorial written by The Oregonian Editorial Board. And it’s even less often when I just quote an article (it’s been shortened a bit) without comment. But this article is spot on and needs no comments by me. Please read this insightful opinion piece regarding the current commercial real estate banking crisis.

The Oregonian
March 7, 2010
“A wave of commercial real estate loan failures could threaten America’s already-weakened financial system,” begins a Feb. 10 report by the Congressional Oversight Panel, which gloomily predicts that losses at banks alone could reach $300 billion as more than $1.4 trillion in commercial real estate loans become due over the next five years.

This is leading to a massive recalibration of the commercial real estate market, and is likely going to spell a wave of foreclosures or distressed sales of commercial buildings. It also has the potential to undermine a swath of small and mid-size banks that made commercial real estate loans.

As the oversight panel put it, “their widespread failure could disrupt local communities, undermine the economic recovery and extend an already painful recession.”

What to do?

The choices range, roughly, from writing down all the values to reflect current market conditions, which would likely spell the failure of many independent banks, to some sort of coordinated, TARP-like intervention by the federal government in the small-bank sector. Neither direction is promising or desirable.

A middle course would be to encourage lenders to work out with borrowers the terms of loans that have sunk underwater. This is precisely the course mapped out by a set of financial regulators last fall, but it doesn’t seem to be happening in any consistent way.

A policy statement issued by a coalition of regulatory agencies in October encouraged examiners to make it easier for banks and borrowers to work out under performing loans.

Yet independent bankers in Oregon complain that examiners haven’t relented on their demands that banks purge their balance sheets of underwater loans, or raise more capital in reserve. This has the effect of taking out of circulation money that would otherwise be lent to credit-worthy borrowers.

What’s best for the economy is that credit keep flowing, because it is the lubricant that makes it possible for businesses to hire people and buy equipment. We’re just coming out of a period when they were doing neither: we want to avoid driving ourselves into another recession.

There’s a growing tension between the forces of rigorous regulation and those who want to buy time to let lenders and borrowers work their loans, while hoping for a market rebound.

Washington Gov. Chris Gregoire, Rep. Barney Frank D-Mass., Sen. Chris Dodd, D-Conn., and others have expressed alarm about inflexible bank examiners, but market purists call that “extend and pretend,” and say it’s imprudent to allow banks to keep bad loans on the books without taking action.

A lot of loans shouldn’t have been made and deserve to be written down. But a massive, economy-wide write down will be destructive. It’s OK that some buildings will be sold at a loss and that some banks will be closed.

But the guiding principle for regulators, from senators to bank examiners, should be to keep credit flowing and follow no rule over a cliff, especially since valuation is an inexact science.

The bias should be toward survival. Close the banks that made too many imprudent loans, but don’t close the ones that deserve to survive, as angry shareholders of the wrongly seized Ben Franklin Savings and Loan would remind us.

Nobody wants to make a bad situation worse.

Banks in Path of Commercial Real Estate Crash, The Oregonian, March 7, 2010.