By Alby Gallun, Dec. 14, 2009
(Crain’s) — Local banks reported a lower percentage of troubled commercial real estate loans in the third quarter, though delinquencies are likely to resume their climb over the next year because of depressed property values and the languishing economy.
The delinquency rate for commercial mortgages at Chicago-area banks fell to 5.9% in the quarter, down from 6.2% in the second quarter, according to Foresight Analytics LLC, an Oakland, Calif.-based research firm. That’s still up sharply from a rate of 3.5% a year earlier.
The third-quarter drop is probably a “statistical anomaly,” not the beginning of a turnaround, says Foresight Partner Matthew Anderson.
With occupancies and rents at many properties continuing to decline, more borrowers will struggle to keep up with their monthly loan payments, especially those who piled on debt when lending was loose.
Other investors will default as loans come due and they struggle to find replacement financing.
Though distress continues to build, regulators are showing flexibility in how banks deal with problem loans, one reason Mr. Anderson expects it could take a lot longer to clean up the financial mess than many observers previously believed.
And many vulture investors could find it harder than expected to scoop up distressed properties on the cheap.
“You’ve got almost all the ingredients for a massive wave of foreclosures or loan sales,” he says. “The part that’s missing is the regulatory pressure.”
Chicago is faring worse than the nation as whole, probably because the job market, a key driver of demand for real estate, is especially bad here, Mr. Anderson says.
Chicago’s third-quarter delinquency rate ranked 14th highest among the 100 biggest U.S. metropolitan areas, and it exceeded the national rate of 4.6%, according to Foresight.
Though he doesn’t offer a forecast for Chicago, Mr. Anderson expects the U.S. delinquency rate to peak at 7.5% to 8.0% near the end of 2010. That would be the highest since 1991, during the last commercial property crash, when the rate hit about 9.5%.
The Foresight data, which is based on bank regulatory filings, does not cover loans packaged and sold off as commercial mortgage-backed securities (CMBS), a segment of the market blamed for some of the biggest lending excess during the boom.
Foresight calculates the delinquency rate by dividing the dollar value of delinquent loans by the value of all outstanding mortgages on operating commercial properties. A loan is classified as delinquent if it’s at least 30 days past due.
Foresight also tracks the delinquency rate for construction and land loans, which hit a new high locally of 24% in the third quarter, up from 21.3% in the second quarter and 13.7% in the year-ago period.
One big source of distress: residential builders who have finished projects but are struggling to sell them out. Others are sitting on undeveloped property that has plunged in value, and they can’t develop it or refinance.
Though banks are required to write off bad loans, federal regulators issued new guidelines in October that could take some of the pressure off. The new rules encourage “loan modifications and restructurings, which will curb defaults associated with the wave of upcoming maturities,” Real Capital Analytics, a New York-research firm, writes in a recent report.
That’s good news for some banks on the edge, but “it could have the unintended consequence of stretching out the whole adjustment process,” Mr. Anderson says. Originally, he expected banks to clear out their bad loans within two years. Now he expects it to take four to five.
In the Chicago area, 398 commercial properties and developments are in various stages of distress, accounting for $5.6 billion in loans, according to Real Capital. The retail sector represents the biggest source of trouble, with $1.3 billion in troubled loans, followed by hotels, at $1.0 billion, and apartments, at $848 million.
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