CRE “extend and pretend” reaching breaking point

For 2011, 10 of the 11 banks that have closed so far showed bad commercial real estate loans taking the lion’s share of the distressed loan book. In six of those cases, losses on bad construction loans made up more than half of the bank’s nonperfoming loans. According to Trepp Analytics, CRE loans comprised $600 million, or 82% of the $732 million in nonperforming loans. For the past two years, lenders followed a trend of refinancing the terms of the loan, in a strategy called “extend and pretend.” Losses on those loans leading to bank failures show a distinct end to that practice, at least in markets where commercial real estate is struggling. Standard & Poor’s recently added that they still expect modifications to remain high in 2011, although liquidations are projected “to increase as a percentage of total resolutions as market conditions improve,” according to S&P credit analyst Louis Cicerchia. “For awhile commercial real estate servicers were happy to clunk along and extend the terms of loans,” said Dan Gorczycki at real estate banking firm Savills. “But now as they are facing their own reserve challenges they want to see who’s putting fresh equity in the game.” Trepp’s Foresight Analytics researcher Matt Anderson said the locations of some of the banks put them at added risk. Other locales caught Trepp somewhat off guard. “Several of the failures occurred in boom-bust areas such as Florida, Georgia and Arizona,” the research note states. “But several also occurred in areas that were sparsely represented on our watch list until recently. These areas included Colorado, North Carolina and South Carolina.” Gorczycki said that in any market where the properties are underwater, lenders will need to see that investors are serious about keeping up with their investments. “If a borrower, say in a Las Vegas investment, is looking for a free ride in the form of an extension, then banks will be more likely to look to foreclose,” he said. “Banks in less strong markets will go under as their exposure to commercial real estate continues to drain reserves until there’s nothing left.” Construction loans made up more than half of the total, at $391 million, while commercial mortgages contributed $209 million, or 29% of the total nonperforming pool. Bad residential loans, by way of comparison, made up $90 million in nonperforming loans. Write to Jacob Gaffney. Follow him on Twitter @JacobGaffney.