Jeff Harding
The Daily Capitalist
Tue, 06 Oct 2009 07:53 CDT

My company has been looking for real estate deals and we have been frustrated finding deals we can live with. We have researched the Southern California market with which we are familiar and find either banks are holding on to bad deals or that , once they foreclose, they are asking more than we believe the property is worth. This isn’t a local phenomenon, but, as our connections tell us, is nationwide.
Many investors are sitting around waiting for the big commercial real estate crash, and they won’t be disappointed. As any property owner will tell you now, it’s a scramble to keep and find tenants. Rents are declining, buildings are starting to empty, and there is very little financing available. Everyone knows the debt refi burden that won’t peak until 2013.
We are patient.
This Wall Street Journal article speaks to that issue and reveals, which we knew in practice, that banks aren’t being realistic in valuing or writing down their loans. It’s a good article and you may wish to read the entire thing other than these excerpts:

Banks in the U.S. "are slow" to take losses on their commercial real-estate loans being battered by slumping property values and rental payments, according to a Federal Reserve presentation to banking regulators last month.
The remarks suggest that banking regulators are girding for a rerun of the housing-related losses now slamming thousands of banks that failed to set aside enough capital during the boom to cushion themselves when the bubble burst. "Banks will be slow to recognize the severity of the loss – just as they were in residential," according to the Fed presentation, which was reviewed by The Wall Street Journal. …
In another sign that many U.S. financial institutions are inadequately protected against potential losses on commercial real-estate loans, banks with heavy exposure to such loans set aside just 38 cents in reserves during the second quarter for every $1 in bad loans, according to an analysis of regulatory filings by The Wall Street Journal. That is a sharp decline from $1.58 in reserves for every $1 in bad loans from the beginning of 2007.
The Journal’s analysis includes more than 800 banks that reported having more half of their loans tied up in commercial real-estate, ranging from apartments to office buildings to warehouses. …
Mr. Conway’s presentation painted a bleak picture of the sliding real-estate values and enormous debt that will need to be refinanced in the next few years. Vacancy rates in the apartment, retail and warehouse sectors already have exceeded those seen during the real-estate collapse of the early 1990s, Mr. Conway noted. His report also predicted that commercial real-estate losses would reach roughly 45% next year. Valuing real estate has always been tricky for banks, and the problem is particularly acute now because sales activity is practically nonexistent. …
These days, many U.S. banks have adopted a policy of extending loans when they come due even if they wouldn’t make those loans now. In some cases, values of the underlying property have fallen below the amount of the loan.
"There’s been an extend-and-pretend philosophy by banks to forestall hits to their balance sheets that might occur," says Patrick Phillips, new chief executive of the Urban Land Institute, a real-estate industry group.
Matthew Anderson, a partner at research firm Foresight Analytics, adds: "It’s like taping paper over a hole in the wall."
Last month’s Fed presentation supports criticisms that banks have been slow to take losses on bad commercial real-estate loans. The value of commercial real-estate loans as recorded by banks has declined at a much slower rate than property values since 2005. But banks have been slow to absorb losses on their loans partly due to "capital preservation" concerns, the report states.
Bank examiners are stepping up their scrutiny of commercial real-estate portfolios at U.S. banks. Michael Stevens, senior vice president of regulatory affairs at the Conference of State Bank Supervisors, said regulators are reviewing greater volumes of commercial real-estate loans than they did before the financial crisis erupted.
Commercial real-estate loans are the second-largest loan type after home mortgages. More than half of the $3.4 trillion in outstanding commercial real-estate debt is held by banks.
"Today, most of the borrowers are paying because interest rates are so low, but the question is whether the loans will get paid off when they come due," said Michael Straneva, global head of Ernst & Young’s transaction real-estate practice.
Regulators are zeroing in on banks that use interest reserves to mask bad construction loans. When such loans are made, banks typically calculate interest that would be paid and set that money aside, basically paying themselves until the loan becomes due or the property generates cash flow.
Regulators want to make sure banks don’t have a false sense of security only because the interest reserve is paying the loan. Banks need to look at "the sources of repayment" to determine whether the loan will get repaid, says Darryle Rude, supervisor of industrial banks at the Utah Department of Financial Institutions.

We all know that the Fed is not surprised by this. It’s been talked about for over a year now, including many times in The Daily Capitalist. Investors ask, "What is the Fed going to do about it?" The correct question is: "What can they do about it?" Nothing. The best thing that can happen is that banks quit waiting for more bailouts and write down/off this debt now. By waiting they’ll just drag this re/depression longer than it has to be.

http://theruthlesstruth.com/wordpress/2009/11/25/fed-says-cre-loan-losses-to-be-45-in-2010/