Will Bad Commercial Loans Torpedo The Economy?

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(The following story is the first in a two-part series discussing the Congressional Oversight Panel's report on banks at risk from high concentrations in commercial real estate loans.)

NEW YORK (TheStreet) -- The U.S. financial system, torpedoed by subprime loans and the stock-market crash, faces another threat, this time from commercial real estate loans that have soured, according to the Congressional Oversight Panel. But the government group exaggerates the number of banks in trouble.

A total of 2,988 of the country's 8,100 banks and thrifts had "problematic exposure" to commercial real estate (CRE) loans, said the report, "Commercial Real Estate Losses and the Risk to Financial Stability." The "CRE-concentrated" banks and thrifts have loans for construction, land, commercial real estate and multifamily residences exceeding 300% of total capital, or construction loans exceeding 100% of total capital.

Hundreds of banks will be in a pickle as an estimated $1.4 trillion in commercial real estate loans mature between 2010 and 2014. The committee estimates that half of those loans are "underwater," with property values having dropped so much that borrowers won't be able to renew loans without pledging more collateral or cash, which most won't have. It's not hard to imagine regulatory forbearance allowing lenders to renew many of the loans anyway by lowering underwriting standards.

Many lenders with high concentrations in commercial real estate loans had underwriting standards that kept loan-to-value ratios low enough to absorb a significant decline in property values. Others are in areas less affected by the boom-to-bust real-estate bubble, and some specialize in property loans in which the collateral already has a track record of strong cash flow from rental income.

Of the 10 largest banks that are held by publicly traded companies and meet the committee's criteria, there are five that remained profitable through 2009 despite a high concentration in CRE, construction or multifamily mortgages. They are:

Manufacturers & Traders Trust Co.

Manufacturers & Traders Trust Co. of Buffalo, N.Y., is the biggest of the five, with $68 billion in total assets as of Dec. 31 and a 306% ratio of CRE, multifamily and construction loans to total risk-based capital. The bank is the main subsidiary of M&T Bank Corp.(MTB Quote), with Allied Irish Banks PLC(AIB Quote) holding 23% of M&T's common shares as of Oct. 1, according to Bloomberg.

M&T Bank still owes the government $600 million in Troubled Asset Relief Program, or TARP, money. The bank's ratio of nonperforming assets to total assets was 2.37% as of Dec. 31, up from 1.46% a year earlier. Nonperforming assets include repossessed real estate, nonaccrual loans and accruing loans past due 90 or more days, included to provide a meaningful comparison to the national aggregate noncurrent assets ratio provided by the Federal Deposit Insurance Corp., which was 3.07% as of Sept. 30.

M&T Bank's ratio of net charge-offs (actual loan losses) to average loans for 2009 was a moderate 1.01%, which compared with an annualized national aggregate of 2.38% for the first three quarters.

The company earned $380 million during 2009, or $2.89 a share, down from $556 million or $5.01, in 2008, as elevated loan-loss provisions and expenses related to the acquisitions of Provident Bankshares and Bradford Bank took their toll. The fourth quarter was the strongest of the year, and M&T's net interest margin continued to improve, to 3.71% from 3.41% a year earlier.

The shares closed at $72.40 on Thursday, up 8% this year. The company has weathered the storm quite well so far, but paying off TARP is a headwind for the stock. While regulatory capital ratios for Dec. 31 weren't yet available, the company's tangible common equity ratio of 5.13% wasn't considered excessive, and FBR Capital analyst Bob Ramsey told TheStreet.com's Laurie Kulikowski last week that M&T had "thin capital," meaning it may need a dilutive secondary offering to raise enough money to repay TARP.

New York Community Bank

New York Community Bank would be termed a "CRE-concentrated" institution, according to the committee because of its focus on multifamily mortgages, most of which are apartment buildings in New York City that feature rent-controlled units. This has been a remarkably stable business for the main subsidiary of New York Community Bancorp.

New York Community's strong performance was recently discussed as part of TheStreet.com's series on bank stocks paying high dividends, with the shares rising 8% this year and 27% since Dec. 4, when the company acquired the failed AmTrust Bank.

Valley National Bank

Valley National Bank of Wayne, N.J., is held by Valley National Bancorp, which repaid TARP in December after raising $135 million in capital by issuing additional common shares during 2009.

Valley National's loan quality has remained strong, with a nonperforming assets ratio of 0.86% as of Dec. 31.

The shares closed at $13.68 on Thursday, down 3% this year.

First Niagara Bank

First Niagara Bank of Buffalo, N.Y., is the main subsidiary of First Niagara Financial, which was recently profiled as part of TheStreet.com's Best in Class series.

First Niagara has exited TARP and has maintained very strong loan quality, with a nonperforming assets ratio of 0.52% as of Dec. 31, and a net charge-off ratio of 0.50% for 2009. The shares closed at $13.58 on Thursday, down 1% this year. The stock has an attractive dividend yield of 4.12%.

BancorpSouth Bank

BancorpSouth Bank of Tupelo, Miss., is held by Bancorp South, which didn't participate in TARP.

This is another stable bank that has been able to maintain decent asset quality and low charge-offs so far through the crisis, despite its focus on commercial real estate and construction lending. The nonperforming assets ratio for the holding company was 1.58% as of Dec. 31, and the net charge-off ratio for 2009 was 0.69%.

Earnings for 2009 declined to $104.3 million, or $1.25 a share, from $120.4 million, or $1.45, in 2008, but were sufficient, along with a slight decline in total assets to $13.2 billion, to allow the company to boost its capital ratios. The tier 1 leverage ratio was 9.11% and the total risk-based capital was 12.81% as of Dec. 31, comfortably exceeding the 5% and 10% that most banks need to maintain to be considered well-capitalized.

The shares closed at $22.04 on Thursday, down 6% this year, with a dividend yield of 3.99%.

(In part 2, TheStreet.com will discuss the remaining five banks that meet the committee's criteria).

-- Reported by Philip van Doorn in Jupiter, Fla.

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