No Escape From TARP for U.S. Banks Choking on Real Estate Loans
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By Elizabeth Hester and Linda Shen
Dec. 7 (Bloomberg) -- As the U.S. economy pulls out of a recession and the biggest banks return to profitability, mounting defaults on commercial property may keep regional lenders from repaying bailout funds until at least 2011.
Unpaid loans on malls, hotels, apartments and home developments stood at a 16-year high of 3.4 percent in the third quarter and may reach 5.3 percent in two years, according to Real Estate Econometrics LLC, a property research firm in New York. That’s a bigger threat to regional banks, which are almost four times more concentrated in commercial property loans than the nation’s biggest lenders, according to data compiled by Bloomberg on bailout recipients.
The concentration makes regulators less likely to let regional lenders like Synovus Financial Corp. and Zions Bancorporation leave the Troubled Asset Relief Program, analysts said. Smaller banks would remain stuck in TARP, while bigger lenders, including Bank of America Corp., repay the government and free themselves to set their own policies on executive pay.
“Community and regional banks basically became real estate banks in the past 25 years, and now real estate is on its back,” said Jeff Davis, an analyst at FTN Equity Capital Markets Corp. in Nashville, Tennessee. “The largest banks have other areas where they can make money, be it consumer lending, capital markets and asset management.”
Bank Failures
The stakes for taxpayers include whether they’ll get back $36.6 billion held by 35 of the largest regional lenders that received TARP money. Souring commercial real estate loans pose the biggest threat to the U.S. banking industry, according to October testimony to Congress by Sheila Bair, chairman of the Federal Deposit Insurance Corp., and Comptroller of the Currency John Dugan.
Regulators have shut 130 banks this year, all regional or community lenders, costing the FDIC more than $33 billion. Non- performing commercial property loans caused a majority of the failures, said Chip MacDonald, a partner specializing in financial services at law firm Jones Day.
“Somebody that has a lot of CRE exposure is going to be held to a higher standard” to redeem TARP preferred shares, said Paul Miller, a former bank examiner and now an analyst with FBR Capital Markets in Arlington, Virginia. “You’ve got to be careful they don’t allow these guys to pay back TARP, and then a year goes by and have to give it back to them.”
Commercial real estate loans “absolutely could be a factor” in whether regional banks can repay TARP funds, Bair said in an interview on Dec. 4.
Regional Lenders
Among 35 of the biggest regional lenders that retain TARP funds, commercial real estate and construction loans average 37 percent of total loans, compared with 9.5 percent at Citigroup Inc. and Wells Fargo & Co., the two biggest U.S. banks that haven’t announced plans to repay the government, according to data compiled by Bloomberg. The figures were derived from holdings at regional lenders that still have bailout money whose stocks are listed in either the 24-company KBW Bank Index or the 50-company KBW Regional Bank Index.
Of the 35 firms, 25 hold commercial real estate and construction loans equal to 30 percent or more of their total loans, according to FDIC data; seven have more than half of their loans in commercial property.
Nine of the banks with more than 30 percent of their loans in commercial real estate won’t show a profit for 2010, including Birmingham, Alabama-based Regions Financial Corp., Columbus, Georgia-based Synovus and Zions in Salt Lake City, according to Bloomberg’s survey of analysts.
Paying Back TARP
“To pay back TARP, they need to return to profitability, and for them to return to profitability, credit problems have to start to decline,” said Gerard Cassidy, a banking analyst at RBC Capital Markets in Portland, Maine.
Losses may hamper efforts of regional lenders to compete with bigger banks, such as Bank of America, ranked first by assets and deposits. The Charlotte, North Carolina-based lender, aided by profits from brokerage services and underwriting securities at its Merrill Lynch unit, announced last week that it would pay back the $45 billion it took from the government.
If Bank of America and Wells Fargo join JPMorgan Chase & Co. in redeeming TARP preferred shares, they’ll be free to press their advantage in markets they already dominate and to declare dividends and stock repurchases without seeking government approval. Bank of America and Wells Fargo finance about half of all U.S. home loans, and the four biggest banks -- Bank of America, JPMorgan, Citigroup and Wells Fargo -- account for more than a third of all U.S. deposits.
Diversified banks are also better able to capitalize on close-to-zero borrowing costs to make money by trading currencies, commodities and other assets.
Bank Stocks
Stocks of regional banks have taken a bigger hit than their larger peers. The KBW Regional Bank Index is down 28 percent this year. Bank of America and JPMorgan have posted gains this year, while Wells Fargo has dropped 9 percent.
There are more than 8,000 banks in the U.S., most of them community and regional lenders. Regional banks typically operate in several communities or states while lacking national or international operations.
Property owners and their bankers are facing losses because the recession cut into employment and consumer spending, pushing up vacancies at office buildings, shopping centers and hotels and bringing down asset values. Commercial real estate prices may drop as much as 55 percent from their October 2007 peak, Moody’s Investors Service said last month. Office vacancy rates may approach 20 percent in 2010, according to brokers at Jones Lang LaSalle Inc. and Grubb & Ellis Co.
‘Out of Whack’
Synovus, with $968 million in TARP money and two-thirds of its loans in commercial property and construction loans -- the highest of any TARP-holding bank in the KBW Bank Index -- posted five straight quarterly losses and is projected to lose money for all of 2010.
The bank’s failures include a $220 million loan to Sea Island Co., a Georgia real estate development firm, which it renegotiated and declared non-performing in April. Last month, co-lender Wells Fargo took over the deed to Sea Island’s 3,000- acre Frederica community on St. Simons Island that features a course favored by professional golfer Davis Love III.
“We got out of whack in the last four, five years, where we were pushing for growth, trying to keep up with the herd,” said Kevin Howard, Synovus’s chief credit officer. “Real estate, in the Southeast, is where you can get the growth. We let our percentages get higher than we normally have. We are fine, really, with moving it back.”
Zions Losses
Zions, Utah’s biggest lender and recipient of $1.4 billion from TARP, has posted four straight quarterly losses, and analysts are predicting the bank won’t return to profitability next year, according to Bloomberg data. Commercial property loans make up 57 percent of Zions’ portfolio, second-highest among banks in the KBW Index that haven’t repaid the government.
Collateral values are “stabilizing,” and while losses are expected to “increase somewhat,” they will be “extremely manageable” when compared with earnings, bank spokesman James Abbott said in an e-mail.
Other regional banks have seen defaults on projects ranging from a condominium-conversion project in Racine, Wisconsin, that was foreclosed on by Milwaukee-based Marshall & Ilsley Corp., the state’s biggest bank, to a subdivision in Oregon inspired by J.R.R. Tolkien’s “The Lord of the Rings.”
The Shire
Umpqua Holdings Corp., the Portland, Oregon-based bank that has 66 percent of its loans tied up in commercial property, sank $3.4 million into the Shire, a development in Bend, Oregon, with homes that have artificial thatched roofs modeled on the hobbit community in Tolkien’s trilogy. The developer defaulted in July, according to Oregon’s Bend Bulletin newspaper.
Umpqua CEO Raymond Davis said that while the bank did not experience a “significant loss” on the Shire, its real estate portfolio was “showing signs of weakness.” The bank has the highest commercial-property loan ratio of any lender in the regional bank index still holding TARP funds.
Davis said that Umpqua has set aside cash to repay the $214 million in TARP funds that it took from the government last year and is waiting for the economy to show further signs of stabilization before returning the money.
The worst may still be ahead for regional banks, according to Moody’s, which calculated that the non-performing loan ratio for commercial mortgages is higher than for residential ones.
“The commercial real estate problem is looming, and a bit like the rat going through the snake,” said William Bartmann, CEO of Bartmann Enterprises in Tulsa, Oklahoma, and former chairman of Commercial Financial Services, which was among the first companies to purchase assets from regulators during the savings and loan crisis. “We can see that it’s coming, it just hasn’t shown up yet.”
To contact the reporters on this story: Elizabeth Hester in New York at ehester@bloomberg.net; Linda Shen in New York at lshen21@bloomberg.net.
Last Updated: December 6, 2009 20:00 EST
