Jul. 22, 2009 - Bernanke and the Commercial Real Estate Market

The economic downturn is pushing the commercial real estate markets into a difficult period in this deepening recession.  Business bankruptcy are growing, a steady decline in commercial property yields make it difficult for many real estate groups to meet current debt-servicing commitments, creating a major problem for economic recovery. 

Recently Bernanke told the House Financial Services Committee that the commercial real estate borrowers are having difficulty refinancing their loans.  In an effort to shore up the market and the banks balance sheets, Bernanke is urging banks to help creditworthy borrowers refinance, while the central bank is trying to jumpstart the securitization market by accepting new and legacy commercial mortgage-backed bonds as collateral in its Term Asset-Backed Securities Loan Facility, or TALF. 

The banks get to hide their there troubled loans in a maneuver being called in financial circles "extend and pretend".   But do we risk repeating what happened in Japan’s economy which became paralyzed as banks failed to deal with their troubled real estate loans?  It is stunning after Timothy Geitner referred to the Japanese “lost decade” as what we would not do, that the U.S. banks are not cleaning up their books and are hoping real estate values rebound quickly.

Most commercial property loans are structured as balloon notes. Borrowers pay only interest for the first five or 10 years until the loans mature, and then the entire amount must be paid back.  The banks' willingness to extend loan maturities are hoping rental rates and building values return to levels seen during the peak of the real-estate market in 2007.  But what happens to the economy if it doesn’t?

On paper this plan looks like a plus; the bank extends’ the note to the borrower who pays a fee or agrees to pay a higher interest rate, or both, which allows the bank to grab fees and avoids having to foreclose or write down the loans as an impaired asset. They also can keep the loans on their books as if nothing were amiss.

The banks post quarterly results that are misleading, which now has become a different problem because the loans have greater risk than they are disclosing and can pretend things are better than they are.  That is what did happen in Japan during the 1990s.  After their debt-fed real estate bubble burst, Japan slid into the "lost decade", a time of economic and financial malaise.

Despite all the tough talk out of Washington and Wall Street the U.S. seems to be on course to repeat what happened in Japan, granting extensions to commercial real-estate investors, so they don't default. The hidden loans cause banks and especially regional banks to restrict their lending to business to build new facilities, do renovations, or make capital investment which can grow the economy.  What's worrisome is the lack of transparency in the over all system so we are not able to properly evaluate our banking system and make intelligent adjustments.  

So I am left to wonder; what happens in a few years from now if the loans are still under water?  I can only hope Bernanke and Geitner have the skills to maneuver this economic ship through torturous economic waters, to sound economic stability.