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Thursday, January 31, 2008


regional bank concentration in commercial lending

for the surrogate memory...

calculated risk passes on his observations:

As I noted last week, with the failure of Douglass National Bank in Kansas City, the housing bust hasn't hurt most small banks and institutions because the banks didn't hold many of the residential mortgages they originated. Instead the small to mid-sized institutions focused on commercial real estate (CRE) and construction and development (C&D) loans, so rising CRE and C&D defaults will impact community banks much more than rising residential mortgage defaults.

though s&p's forthcoming downgrades will attack regional and local banks who have not marked to market in their residential portfolios, commercial real estate and C&D lending is where a recession and increased corporate defaults could really injure banks like M&I.

Credit ratings agency Moody's Investors Service said Friday it has placed a negative outlook on regional bank holding company Marshall & Ilsley LLC and the lead subsidiary despite affirming some investment-grade ratings.

Moody's said the negative outlook reflects the company's large commercial real estate exposures, which the ratings firm has long cited as a credit weakness. Yet, Marshall & Ilsley has a very strong capital position offsetting that weakness, the firm said.

There's also a potential for increased debt because property markets continue to be volatile, Moody's said. The firm also said if the bank's capital strength falls significantly, "further negative rating pressure could emerge and could result in a downgrade."

However, Moody's said fundamentals for Marshall & Ilsley's parent company are sound.

one can take a look at M&I with the FDIC's reporting interface and note that, while carrying 16.6% of its balance sheet in 1-4 family residential mortgages, the bank is also 12.1% into commercial real estate, 4.0% into multifamily residential, and 18.1% into construction and land development. furthermore, 19.8% of assets are commerical and industrial loans. this totals over two-thirds of the bank's assets.

with a tier 1 capital ratio of 7.08%, it wold not take much in the way of losses to put M&I in some peril -- though that is, by the measure of its competition, a reasonable ratio. (the FDIC's idea of adequately-capitalized is 4%, well-capitalized 6%.)

nonetheless, goldman sachs is calling for 25% price declines in commercial real estate -- and just as home price declines haven't been exclusive to california and florida, CRE disappointments will be felt in the midwest. and the scale of the problem is such that comptroller dugan is giving explicit warnings of bank failures.

“We’re entering a stage of the commercial real-estate credit cycle where problems have started to surface and losses have started to increase,’’ Mr Dugan said in a speech in Florida.

The crisis in the US housing market has had a knock-on effect on commercial property, he said.

Mr Dugan expected a rise in bank failures, since many community institutions had significant exposure to this now-declining market and would face rising delinquencies and loan defaults. “CRE concentrations [have risen] significantly in many banks, even as the quality of risk management practices lagged,” he said.

Mr Dugan said that many banks had failed to adjust their lending practices and risk management procedures, despite previous warnings from regulators.

“Even more significant than this overall industry statistic is the number of individual banks that have especially large concentrations,” Mr. Dugan added. “Over a third of the nation’s community banks have commercial real estate concentrations exceeding 300 percent of their capital, and almost 30 percent have construction and development loans exceeding 100 percent of capital.”

His department would adopt an extremely “pro-active” approach in dealing with deficiencies. “There will be more frequent interaction between supervisors and banks with concentrations in CRE loans that are declining in quality,” he said. “There will be more criticised assets; increases to loan loss reserves; and more problem banks. And yes, there will be an increase in bank failures.”

dugan is referring to CRE concentrations as defined on page 74585 of this document. for the record, as of september 30, 2007, M&I carried $9.5bn in construction and development loans over $4.9bn in equity capital, or 190% of capital -- and a CRE concentration as defined by guidance of $18.1bn, or 370% of capital. perhaps notably, M&I had seen the sum of past due and non-accruing assets in C&D rise from $146mm a year ago to $410mm (180% rise to 8.3% of C&D loans), and in all real estate loans (including C&D) from $371mm to $711mm (92%).

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