Fed chief Ben Bernanke said he is watching commercial real estate trends.

Are you ready to handle the pending need for commercial loan modifications?

NEW YORK (Fortune) -- Regional banks can no longer ignore the elephant in the room -- their exposure to the commercial real estate bust.
Though housing markets remain weak, analysts expect credit problems over the next year to center on commercial real estate -- mortgages on office and apartment buildings and shopping malls, as well as construction, development and industrial loans.
U.S. banks hold some $1.8 trillion worth of commercial loans, according to Federal Reserve data. Big regional banks, including PNC (PNC, Fortune 500) of Pittsburgh, KeyCorp (KEY, Fortune 500) of Cleveland and BB&T (BBT, Fortune 500) of Richmond, Va., have more than half their loan books in commercial loans.
With financing markets locked up and the economy still mired in recession -- unemployment is at a 26-year high while capacity utilization, a key measure of industrial production, recently hit a record low -- observers fear a wave of loans will go bad in coming quarters.
"The problems facing commercial real estate are severe and will likely take many years to resolve," Deutsche Bank analyst Richard Parkus told the Joint Economic Committee of Congress this month. He said the biggest losses are likely to come from banks' $550 billion of construction loans, such as loans to homebuilders.
Banks are already bracing for impact. Higher credit costs led to second-quarter losses at banks ranging from Atlanta's SunTrust (STI, Fortune 500) to Delaware's Wilmington Trust (WT). Zions Bancorp (ZION), which operates primarily in Utah, California, Texas and Nevada, was among those forecasting deeper losses on problem commercial real estate loans.
"It is still a pretty crummy economy out there and we are seeing deterioration in all of it," Zions Bancorp chief financial officer Doyle Arnold said in a conference call with analysts and investors.
Accordingly, banks have been adding to their reserves for future credit losses. But with more borrowers falling behind on their loans, it's not clear that these so-called reserve builds will be enough.
SunTrust, for instance, added $161 million in the latest quarter to its loan loss reserve, citing continuing housing market deterioration and "increasing economic stress in the commercial market."
But non-performing assets rose even more, jumping to 4.48% of total loans from 2.09% a year earlier. As a result, the bank's loan loss reserve tumbled to 53% of non--performing assets from 70% a year earlier. Investors like to see a number nearer 100%. BB&T, for instance, has 101% coverage.
Thin reserves mean SunTrust "may face material provisions ahead," according to a report from analysts at research firm CreditSights. That could take a toll on profits over the next year.
Similar trends are playing out at Comerica (CMA), whose loan loss reserve has fallen to 78% of non-performing loans from 91% a year ago, and Zions, which fell to 65% from 79%.
The increase in non-performing assets comes as some real estate players complain that banks are sitting on bad loans rather than liquidating them -- a trend they claim is suppressing new lending and compounding the problems in a falling market.
"The rate at which these troubled loans are being resolved has been sluggish," James Helsel, treasurer of the National Association of Realtors, told the Joint Economic Committee July 10. "Over $60 billion in assets have become distressed this year but only $4 billion worth of commercial loans have been resolved so far."
Though the banking industry succeeded in raising tens of billions of dollars in new equity in the second quarter, some expect the financing picture to remain cloudy, adding to price declines.
Office rental rates have fallen 23% in New York and 11% in Washington from their 2008 highs, commercial property manager Jones Lang LaSalle said in its monthly market perspective newsletter this month. Meanwhile, office vacancy rates jumped to 14% in Manhattan and 11% in Washington in the first quarter, reflecting the economic slump.
"Debt will remain constricted as banks continue to adopt the 'delay and pray' approach to their real estate holdings, extending loan terms in the hope that better economic conditions will obviate the need to foreclose," Jones Lang LaSalle said in its report.
For their part, bankers blame the problems on weak loan demand and deny they're kicking the can down the line on troubled credits.
"We are managing these problem loans effectively," Comerica chief executive officer Ralph Babb said in the bank's second quarter earnings statement.
Still, the banks have underestimated their problems before. Comerica forecast in January that this year's credit-related charge-offs, or writedowns of uncollectible loans, would be in line with last year's level of $472 million.
But the bank said last week that charge-offs were $405 million in the first half alone, with even "modest" improvement not expected until the fourth quarter.

The commercial real estate time bomb!

There’s a new main character moving to center stage in the great real estate meltdown. Underwater homeowners vying to refinance or score a loan modification have grabbed much of the headlines (and bailout attention) to date. But now commercial real estate is moving into the spotlight as the next potential body slam for the economy.

Last week The Washington Post reported that the U.S. Treasury department has begun to contemplate what can muck things up for the economy and the recovery beyond what is currently being bailed out. This effort has come to be known as Plan C. As in, “Yikes, Plan B might not do the trick, so what do we need to focus on next?”

Reports the WaPo, “The officials in charge of Plan C — named to allude to a last line of defense — face a particular challenge in addressing the breakdown of commercial real estate lending.”

The story line reads like a sequel to the residential debacle: Commercial property owners are sitting on loans that need to be refinanced. The Real Estate Roundtable estimates that about $400 billion a year in commercial loans will need to be refinanced over the next decade.

But with commercial property values way down, vacancies way up, and the recession making it unlikely there will be a demand pick-up anytime soon, banks haven’t been inclined to offer refinancing deals. If they do open the spigot at all, the terms are nowhere near as cheap as what commercial property owners had enjoyed during the boom. Sounds familiar, eh?

Earlier this month, in testimony before the Congressional Joint Economic Committee, Jon D. Greenlee, the Fed’s associate director of banking supervision and regulation, summed up the Plan C worry: “At the end of the first quarter [of 2009],” he testified, “about seven percent of commercial real estate loans on banks’ books were considered delinquent. This was almost double from the level a year earlier.”

Greenlee says there is about $3.5 trillion of outstanding debt associated with commercial real estate, and banks had about $1.8 billion trillion of that tidy sum on their books. That computes to about $126 billion (so far) in delinquent commercial mortgages on the banks’ books.

Now if you’re Goldman Sachs, you might be able to absorb commercial real estate writedowns (reportedly of more than $1 billion) with record trading profits elsewhere. And, to be sure, the vultures are already circling in the hopes of picking up distressed commercial property.

But if the squeeze on commercial real estate is as persistent and pernicious as what we’ve seen in the residential market, it wouldn’t exactly be a shock if the government beefs up its support/bailout. Get your taxpayer dollars ready for Plan C.

Commercial Loan Modification - Keys to Success

Commercial Mortgage Loan Modification: Checklist

Applying for a Commercial Mortgage Loan Modification sometimes requires a lot of paper work. Commercial Mortgage Loan Modification success or failure depends greatly on the current NOI, Borrower Strength and Vacancy rate. You would do well to have your ducks in a row. To simplify the process, we've compiled a list of items you'll need to the lender or broker who is assiting you.

Depending upon your circumstances, you may need to bring additional documents.

• Current rent roll
• Historical Rent Roll (2yrs if you have it)
• Current Income and Expense Report
• Current Mortgage Statement
• Updated PFS (Personal Financial Statement
  
  )
• Tenant profiles describing the larger tenants

Commercial Loan Modification is based on the property type, current cash flow, vacancy rate and borrower strength. For example if you have an apartment building that was 98% occupied in 2007 and 2008 but now is at 89% the modification would be targeted to work within the adjusted NOI (net operating income).

If you had an Office or Retail building those factors plus the strength of the tenants and their leases would be considered. If you had a known tenant (credit tenant) and a few more units to spread the risk with the credit tenant having a longer term lease the Commercial Loan Modification would be easier to negotiate.

In a Commercial Loan Modification negotiation you want to present as strong a case as possible that both you and the property are still a good bet and that helping you weather the current economic conditions

would be a better strategy than letting the loan go al together.

Capital Expands Lending Platform On West Coast

CWCapital, a national lender to the multifamily and healthcare real estate industries, is expanding its national multifamily lending platform via the acquisition of the origination and servicing assets of Sierra Capital Partners.

Sierra Capital Partners was founded in 2003 by Trent Brooks and Bryan Frazier, and over the past 15 years, Brooks and Frazier have been directly involved in providing over $12 billion in multifamily financing, with a focus on conventional and tax-exempt debt financing, throughout California and the West Coast.

Brooks will now serve as managing director and a member of the CWCapital Loan Committee, and will work directly with President and CEO Michael Berman in shaping the strategic vision of the CW multifamily lending business. Frazier will serve as managing director and be directly responsible for the growth and development of CW’s West Coast multifamily lending platform.

With this acquisition, the CW agency lending platform employs 130 professionals in 10 locations across the nation. CW has been steadily growing its agency platform since 2007 through hiring, correspondent arrangements, joint ventures and acquisition.

The company’s commercial mortgage-backed securities (CMBS) special servicer rating has also been upgraded by Fitch Ratings from CSS1- to CSS1. The upgrade is based on the group's highly experienced asset management staff, its robust asset management technology platform and CWCapital's ability to successfully manage substantial portfolio growth, as demonstrated through its timely and thorough interaction with Fitch's CMBS surveillance group, the agency says.

Also considered are the company's proactive surveillance team and CWCapital's low special servicing management and staff turnover in the last two years.

As of March 31, CWCapital's servicing portfolio consisted of 1,108 loans totaling $10.11 billion. As of the same date, the company acted as primary servicer in 40 CMBS transactions, servicing 467 loans totaling $4.8 billion. CWCapital is currently named master servicer on one CMBS transaction totaling $27.47 million.

SOURCES: CWCapital, Fitch Ratings