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— Analysis —
In all, about $1.5 trillion in commercial real estate loans are coming due within two to three years, and every vacant property represents another lost source of money needed to pay off those obligations. Make no mistake about it: We are in an asset quality recession. About 60% of these assets exist on the books of commercial banks. Add a few high-profile foreclosure auctions, such as the St. Regis Monarch Beach Resort -- site of American International Group Inc.'s luxury retreat shortly after last fall's emergency bailout of the once great insurer -- and commercial lenders are beginning to see plenty to worry about on the horizon.
Bankers, take heart, and take action. We last saw something like this, though on a smaller scale, in the 1990s. You can and should put lessons learned then to good use immediately. There is still time to mitigate the consequences of a meltdown of the commercial real estate lending system, should it come to that. If you are affiliated with an institution that has significant exposure to commercial real estate, the lesson from the recent phase is this: Prepare for every possible outcome. More than ever, you must closely and carefully monitor your commercial real estate loan portfolio and prepare yourself and all stakeholders to take decisive action. Once the regulators step in during an examination, significant write-downs can result if you have not prepared properly. The unthinkable may even occur -- closure of an entire bank. Of course, it takes time to unwind a portfolio, especially in such a difficult economy. Get ahead of bigger problems later by starting with these action steps right now: Thoroughly review and revalue your portfolio. Pay special attention to any concentration in commercial real estate, including retail, hotels, office space, strip malls, etc. You need to know exactly how badly your portfolio values have deteriorated. Don't waste time trying to justify unreasonable valuations. Get realistic, impartial outside opinions if colleagues balk about write-downs required on the balance sheet. You need a sober evaluation of your holdings to understand the extent of the damage and how much new capital you are going to need. Do your research on appraisal requirements and troubled debt restructuring. Take write-downs now. It will only get worse the longer you wait. It is better to take a 50% hit today than lose 100% a year from now. Start talking to potential merger partners and investors. It may be time to face the facts: Are you willing to accept deep discounts on some or all of these assets? If your goal is to recapitalize the intitution, you need to manage through the crisis to emerge stronger. Also, be ready to acquire another institution or assets if you're in a position to do so. Practice good preventive risk management. Once you've jettisoned bad assets, revalued your institution or found sources of new equity, you must still guard against becoming overconcentrated by asset class or geography. Create and implement enterprise risk management and a "compliance culture." If anyone needs evidence that strong risk management is just a cost center, please review the banks that have been closed or merged and the ever-expanding Federal Deposit Insurance Corp. list of problem banks. Take a good look at some of the notable breakdowns such as Washington Mutual Inc. and Countrywide Financial Corp. Many of their problems would have been foreseeable using proper risk management. According to some industry insiders, we will not see the worst of the commercial real estate crisis until 2011. If true, there is some danger that executives will become complacent and believe that the economy will turn around and their portfolios will recover. Don't be lulled into assuming that time will heal financial wounds: We've seen formerly highly rated banks become candidates for forced sale in less than a year. Use this window of opportunity to apply lessons learned. Take a good, hard and, most importantly, objective look. The combination of skyrocketing vacancies, increasing interest rates and plummeting property values provides the powder that awaits only a spark. Walter J. Mix III is a Los Angeles-based managing director of the financial services sector of Comments |
Empty strip malls and abandoned auto dealerships are becoming familiar signposts on the road to the next logical phase of the global economic crisis in the U.S. 
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This is, of course, excellent advice. The hardest to follow will be the admonishment to not: “…waste time trying to justify unreasonable valuations.”
The problem is many bankers don’t believe they are wasting time when they rationalize their valuations. They don’t think the valuations are unreasonable, on-the-contrary, they think your unreasonable when you tell them the paper they paid $1.00 for is worth ¢0.45.
Until people get their heads around the magnitude of the losses they will continue to be unable to deal with them.