Regional, community banks face pressure

By Edgar Ortiz

For the AJC

There is a growing concern that a wave of loan defaults in the commercial real estate sector will hit the economy contributing to the insolvency of hundreds of small regional and community banks, curtailing access to credit to the local business community and prolonging the economic recovery.

A recently published report from the Congressional Oversight Panel created to oversee the Treasury's $ 700 billion TARP bailout program highlights a serious threat to the economy from the weakening financial fundamentals in the commercial real estate sector.

Similar to the recent collapse of the residential market, Elizabeth Warren, chair of the panel said, ". . . there's been an enormous bubble in commercial real estate, and it has to come down."

The panel also warned that of the approximately 8,100 U.S. banks, nearly 36 percent of them are small regional and community banks with problematic exposure to commercial real estate.

Although profitable during the building boom, this disproportionately high allocation of capital into commercial real estate poses a serious threat to the survival of small and regional community banks, as they continue to experience:

Growing delinquencies

High number of vacancies in strip malls, office buildings, hotels, apartments and shopping centers.

Reductions in property values as nearly half of all outstanding commercial loans today are "underwater."

The Congressional Oversight Panel also warned almost 3,000 small banks could be forced to curtail their lending because of growing losses in their commercial real estate portfolios.

This reduction in lending can severely jeopardize the economic recovery as these banks account for nearly 50 percent of loans to small businesses.

Not to miss the opportunity, Wall Street brokerage firms got into the action and began marketing them as profitable, but low risk investments.

Banks liked them because of their hybrid characteristic of debt and equity. If issued by a bank holding company (BHC), up to 25 percent of a bank's Tier 1 capital could originate from funds raised through trust-preferred security offerings in the market.

When the economy went into recession and the commercial real estate market faltered with decreasing property values and growing loan losses, a growing number of small banks, issuers of these securities could no longer meet their financial obligations.

Holding these securities continues to be problematic for the large number of small banks that bought them, because trust-preferred securities were subordinated to all of the issuing Banc Holding Company's other debt.

Any loss in the value of these securities reduces their capital ratios and curtails their lending capacity to small businesses, the engine of growth of the economy.

Although viewed as an attractive option for a BHC to bolster its regulatory capital during profitable periods, these securities turned out to be problematic when financial conditions deteriorated causing them to write down the securities to their market value, absorbing huge losses, weakening their capital cushions and lowering their capital ratios.

Small regional and community banks now face one of the most challenging market conditions since the 1980s and may bear the brunt of losses in the commercial real estate sector.

Jobs are the key to move the economy out of its current slump.

Most jobs are created by small businesses. It is fundamental; therefore, that we ensure the financial stability of our small regional and community banks as they are the major source of financing to small businesses who ultimately create over 70 percent of new jobs.

Edgar Ortiz is president and CEO of Strategic Analytic Solutions, an Atlanta-based management consulting firm that provides strategic planning, predictive analytics and credit risk management advisory services to small and midsize businesses. He can be reached at ortiz@strategic
analyticsolutions.com.