In the Eye of the Commercial Real-Estate Hurricane By Michael Corkery Wall Street Journal 10-07-2009

In the Eye of the Commercial Real-Estate Hurricane
By Michael Corkery
The Wall Street Journal
October 7, 2009

The Federal Reserve is worried that banks are slow to recognize commercial real-estate losses and is warning that the financial system may be headed for a new wave of painful write downs.

The last time Deal Journal checked with some analysts about the big banks’ real estate exposure they said the situation was improving. Here is Barclays’ takeaway from its banking conference last month. “Following commentary from our financial services conference, we believe commercial real estate prices may have bottomed for the time being, resulting in no meaningful markdown” of assets in the third quarter,’’ wrote Barclays banking analyst Roger Freeman on Sept. 18.

Barclays added that “almost every bank said their CRE portfolio should relatively outperform,’’ in the quarter.

It turns out that the banks may be telling only half truths. That WSJ article linked to above reveals how the banks have a few tricks up their sleeves to prop up their real-estate assets: First, they are extending troubled loans instead of making struggling developers pay them off now. Second, the banks are essentially paying themselves interest from so-called interest reserves that were built into the loans, allowing the borrowers to keep putting off payments.

Lately, the banks may also be able to forestall write-downs because few people are buying office buildings and shopping malls at the moment, so it is difficult to put a value on real-estate assets.

Of course, there is a chance that values may be finding a real floor, as the government steps in to prevent mass liquidation of troubled real-estate assets, such as the fire sales that have befallen the foreclosure ridden housing market. Deals such as the recent government-brokered sale of Corus bank assets, including 112 construction loans, to an investor group, helps prevent a cascade of commercial real-estate fire sales.

But we have seen this movie before. In the early stages of the housing meltdown, in early 2007, banks and home builders reported that the market appeared to be stabilizing and the losses would be limited to subprime mortgages, a relatively small slice of the market. Likewise, the banks third quarter commercial real-estate results may look good, but it could just be the eye of the hurricane.