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For Banks, More Trouble Just Around the Bend

By Philip Van Doorn from

Commercial real estate and construction loan default rates are on the rise, presenting a new problem area for an already reeling banking sector.

This is the first of a two-part look at banks that could suffer from their exposure to nonperforming commercial real estate and construction loans. Part II looked at smaller banks.

Commercial real estate and construction loan default rates are on the rise, presenting a new problem area for an already reeling banking sector.

Delinquencies in commercial real estate loans are still historically low, but are rapidly increasing, according to a recent JPMorgan Chase report on commercial mortgage-backed securities (CMBS). Analyst Alan Todd said that retail delinquencies of 60 days or more were 0.40% in October, increasing from a low of 0.08% in July 2007. Over the same time period, office delinquencies increased to 1.29% from 0.47% and multifamily delinquencies increased to 0.28% from 0.11%. The report also noted commercial property prices had only fallen 11% from their peak, and were expected to fall 30% to 40% "over the next few years."

The JPMorgan report encompassed the entire CMBS market, and commercial loans that are securitized tend to be underwritten to tighter standards. If we narrow our focus to loans that haven't been securitized but are still held by banks, the numbers are more alarming.

According to preliminary third-quarter bank call report data provided by Highline Financial on Dec. 3, nonperforming commercial real estate (CRE) and commercial construction loans (CCL) comprised 2.56% of total CRE and CCL, up from 2.17% in June and 0.95% in September 2007.

"Nonperforming" loans are past due 90 days or more, or placed in nonaccrual status since the banks don't expect full repayment of principal. Looking at loans delinquent 30 to 89 days but still considered "performing," there were another 1.11% in problem CRE and CCL as of Sept. 30.

Since bank call reports don't break down delinquent loans precisely enough to isolate commercial construction loans, we used reported numbers for nonfarm, non-residential real estate loans and "all other" construction loans, which exclude one- to four-family residential construction loans. Our figures for commercial real estate and construction delinquencies include some multifamily construction loans (which are usually for condominium projects) and large residential development loans.

For savings and loans, the data problem is even worse. The Thrift Financial Report lumps all delinquent construction loans together. Since this figure is dominated by one- to four-family residential loans, we have excluded the entire group from our data.

The table below ranks banks with over $10 billion in assets as of Sept. 30, by the ratio of domestic nonperforming nonfarm, non-residential real estate loans and "all other construction loans" (that is, those that aren't for one- to four-family residences) to total assets:

Banks with > $10
Billion in Assets

Highest Asset Concentration in Nonperforming CRE & CCL
Click here for larger image.

All the banks on the list were considered well-capitalized per regulatory guidelines, with leverage ratios above 5% and risk-based capital ratios above 10%.

Westernbank Puerto Rico

Westernbank Puerto Rico, the main subsidiary of W Holding Company , led the list with a ratio of nonperforming CRE and CCL to total assets of 5.07% as of Sept. 30. The institution's total nonperforming assets ratio was 9.44%.

Despite the high level of problem assets, Westernbank's year-to-date ratio of net charge-offs to average loans was just 0.77%. With loan loss reserves covering 3.33% of total loans, the bank would appear well-positioned to handle this level of charge-off activity going forward. However, Westernbank lost $12.1 million during the third quarter and with nonperforming assets doubling from last quarter, the bank appears to need additional capital in a hurry, despite the low rate of charge-offs so far.

Since nonperforming loans factor in the risk-based capital ratio, Westernbank was the closest on the list to slipping below the 10% required to be considered well-capitalized under regulatory guidelines.

On Dec. 2, W Holding Company conducted a reverse stock split, with a ratio of one share for every 50. This will prevent the stock's delisting on the New York Stock Exchange, which threatened to do just that after the company's shares sold for less than $1 for 30 consecutive days. The closing share price Tuesday after the split was $8.98, down from the open of $12.20.

Much more troubling is that the holding company has not filed a 10-Q or 10-K report since July 2007, when it reported first quarter 2007 results. In a Nov. 11 filing, the company announced it wouldn't be able to file its third quarter 10-Q report on time, and that financial statements from 2005, 2006 and 2007 could no longer "be relied upon" and would be restated. This all sprang from the company's June 2007 announcement of a "collateral deficiency" it discovered in one of its largest asset-backed loans, to the tune of $80 million.

W Holding Company declined to comment about any capital raising activity, as the company was in the midst of preparing its financial restatement. It expects to have the filing completed by year-end.

Fifth Third Bank of Grand Rapids

Fifth Third Bank of Grand Rapids, Mich. came in second on the list, with a ratio of nonperforming CRE and CCL to total assets of 2.15%. The bank, with $54 billion in total assets as of Sept. 30, and Fifth Third of Cincinnati, Ohio, with total assets of $67 billion, are the two main commercial bank charters held by Fifth Third Bancorp .

Fifth Third of Grand Rapids' total nonperforming assets ratio of 3.92% was by far the highest among U.S. banks with at least $50 billion in total assets, reflecting its concentration in the troubled Michigan market. The next highest was National City Bank of Cleveland (held by National City Corp. , soon to be acquired by PNC Financial Services ), which had 3.22% nonperforming assets as of Sept. 30, and didn't make the above list because most of its bad loans were residential mortgages.

Loan loss reserves covered 2.71% of total loans, keeping ahead of the annualized ratio of year-to-date net charge-offs to average loans, which was 2.17%. However, the pace of charge-offs for just the third quarter was 2.93%. This means the elevated pace of provisioning for loan loss reserves is likely to continue, along with further net losses.

One bright spot for Fifth Third of Grand Rapids was that even after losing $191 million during the third quarter, the institution had a leverage ratio of 10.04%, the highest for the banks on the list. This gives the institution strength to weather more losses as it beefs up reserves. Even with the large third quarter loss, the bank's annualized return on equity was a negative 11.99%, showing that it can withstand this level of stress for quite some time.

Fifth Third Bancorp has received preliminary approval to receive a $3.45 billion preferred equity investment from the Treasury's Troubled Assets Relief Program, but it's too early to say how the holding company will allocate the money to its main banking charters.

Colonial Bank

Colonial Bank of Montgomery, Alabama (held by Colonial BancGroup was next, with a ratio of nonperforming CRE and CCL to total assets of 1.56% as of Sept. 30.

Despite reporting net charge-offs of $121 million during the third quarter, the $26 billion institution's total nonperforming assets ratio increased to 2.75% as of Sept. 30, from 1.69% in June. Colonial's net loss of $61.5 million for the quarter reflected the institution's $159 million provision for loan losses during the quarter. While the provision for the quarter exceeded the net charge-offs, the institution still appeared under-reserved as of Sept. 30, since the annualized ratio of year-to-date net charge-offs to average loans was 1.71%, while the ratio of reserves to total loans was 1.65%.

With similar loan quality performance over the coming quarters, provisions will continue to be elevated and the net losses will continue.

On Nov. 13, the holding company released a statement saying its application to receive TARP money was still pending. Morgan Keegan analyst Robert Patten upgraded the stock to outperform the next day, saying that even if Colonial BancGroup didn't receive a capital infusion via TARP, the company could still be sold at a price close to $4.50.

On Tuesday, the company announced preliminary approval for $550 in TARP money, and shares closed at $3.08, a gain of 54% on the day. has the best rates.

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