by Calculated Risk on 1/07/2009 09:51:00 PM

From the WSJ: Commercial Property Loses Shelter

Delinquencies on mortgages for hotels, shopping malls and office buildings were sharply higher in the fourth quarter ... New data from Deutsche Bank show that delinquencies on commercial mortgages packaged and sold as bonds, which represent nearly a third of the commercial real-estate debt market, nearly doubled during the past three months, to about 1.2%. ...

The delinquency rate will likely hit 3% by the end of 2009, its highest point in more than a decade, says Richard Parkus Deutsche Bank's head of research on such bonds, known as commercial-mortgage-backed securities, or CMBS.

This is not only a problem for CMBS, but many banks and thrifts have excessive exposure to CRE loans:

According to research firm Foresight Analytics, soured commercial mortgages on banks' books jumped to 2.2% as of the third quarter of last year, from 1.5% at the end of 2007. The research firm estimates that the rate could rise to 2.6% in the fourth quarter of 2008.
...
Banks and thrifts would suffer in a commercial-real-estate downturn because they own nearly 50% of all commercial mortgages outstanding. ... According to Foresight Analytics, as of Sept. 30, 2008, some 1,400 commercial banks and savings institutions had more than 300% of their Tier 1 capital in commercial mortgages.

Here are some comments from Fed Vice Chairman Donald L. Kohn back in April 2008:

Setting aside the 100 largest banks, the share of commercial real estate loans in bank loan portfolios nearly doubled over the past 10 years and is approaching 50 percent. The portfolio share at these banks of residential mortgage and other consumer loans, which are more readily securitized, fell by 20 percentage points over the same period.

This is a key point that we've been discussing for a few years - most small to mid-sized institutions were not overexposed to the housing bubble because those loans were mostly securitized. Therefore the housing bust led directly to relatively few bank failures over the last couple of years (although some larger banks like WaMu, Wachovia and National City were heavily exposed to residential loans).

However, many small to mid-sized banks have a heavy concentration in commercial real estate (CRE) loans, and also in construction & development (C&D) loans. Now that CRE is weakening - and the C&D loans are coming due - there will probably be a sharp increase in bank failures over the next couple of years.

Concentration risk is another familiar risk that is appearing in a new form. Banks have always had to worry about lending too much to one borrower, one industry, or one geographic region. But as smaller banks hold more of their balance sheet in types of loans that are difficult to securitize, concentration risks can develop. Concentrations of commercial real estate exposures are currently quite high at some smaller banks. This has the potential to make the banking sector much more sensitive to a downturn in the commercial real estate market.

I expect 100s of small bank failures over the next couple of years due to excessive CRE loan concentrations. I predict Bank Failure Fridays will be even busier in 2009 than 2008.