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Commercial Borrowers Look Better than Homeowners

The delinquency rate on commercial real estate has been cut nearly in half compared to nine quarters ago, when it was in the double digits. In most recently reported figures, during the second quarter, it was 5.28 percent among U.S. commercial banks, according to SNL Financial.

Meanwhile, delinquency rates for people with 1-to-4-unit residential loans stood at a whopping 12.66 percent in the second quarter, down from a peak of slightly above 14 percent at the end of 2009.

One could almost assume that commercial real estate borrowers are faring far better than homeowners. But not so fast.

The disparity exists because banks have been moving bad commercial loans to the foreclosure category much quicker than residential loans, say regulators and industry observers.

Big banks hold most of the residential mortgages in this country, and they haven’t been under the gun to dispose of bad residential loans, says Matthew Anderson, a managing director with Trepp LLC, a research firm based in New York.

In fact, the government has several programs designed to keep people in their homes when they are struggling to pay. One could debate the success or failure of programs such as the U.S. Treasury’s Making Home Affordable, but the reality remains that no such efforts exist for commercial borrowers who are in default.

Community banks, in contrast, are under a good deal of pressure to foreclose on bad loans, and many of them have high percentages of their holdings in commercial real estate, as opposed to the big banks, which don’t, says Anderson of Trepp.

His firm’s data seems to prove his point. Big banks, or those with more than $10 billion in assets, had a residential loan delinquency rate of 14.3 percent in the second quarter. Banks with less than $10 billion in assets had a residential loan delinquency rate of 5.1 percent on average, defined as loans 30 days or more past due or on nonaccrual status. So smaller banks either are better at picking good residential borrowers, or they foreclose on them faster, or both.

As for the strength in the commercial real estate market, there isn’t much. Bert Otto, deputy director for the Office of the Comptroller of the Currency in Chicago, says there has been a slight improvement but “we are nowhere out of the woods right now when it comes to commercial real estate.”

-Naomi Snyder

Basel III Nightmare Unfolds

The heads of Washington regulatory agencies have been promising for months not to apply a one-size-fits-all approach to banking regulation if it doesn’t make sense for community banks.

So community bankers are shocked and enraged at the prospect of the global banking capital standards in Basel III applying to them. Some of them are going to every TV outlet they can find to complain about Basel III, or for that matter, any TV outlet that doesn’t balk at a story that sounds like it came from a Roman herb garden.

This is a story about the Federal Deposit Insurance Corp. (FDIC), the Office of the Comptroller of the Currency, and the Federal Reserve jointly proposing in June to apply Basel III to all U.S. banks, including tiny, one-branch operations in North of Nowhere, Nevada. Comments on the proposals were due Oct. 22.

The published regulatory explanation emphasizes that better capital and more capital will make the entire financial system safer and stronger. After all, the last two rounds of global capital standards (called Basel I and Basel II) didn’t seem to do a whole lot to keep the global financial system from the brink of disaster, hence we are now on version three.

Critics say the new rules will lead to less lending, as community banks that end up having a hard time raising capital will shrink their balance sheets instead.

Among those hitting the airwaves to fight the proposals was Frank Sorrentino III, the chairman and chief executive officer of North Jersey Community Bank, an $822-million asset bank in New Jersey.

“You’re going to tell me the same capital rules that apply to the largest financial institutions in the world should apply to community banks?” he asks. “I don’t think so.”

His argument is that politicians might have justified taxpayer bailouts of the big banks as a way to protect the world’s economies, but community banks are a different matter. They can and do fail without huge consequences. Their depositors are protected by the FDIC.

“If our bank failed, five other banks in our market would take our business,” Sorrentino says. “Why is that such a problem for our economy?”

Cam Fine, president and chief executive officer of the Independent Community Bankers of America, has argued that “credit would dry up” under the new standards and hurt lending to small businesses. “You could have [the hypothetical] First National Bank of Peoria having to adhere to the same capital guidelines as HSBC,” he told Fox News. “It’s just insane.”

William Loving, president and chief executive officer of Pendleton Community Bank in Franklin, West Virginia, which has five offices and $261 million in assets, says his bank may have to raise more capital sometime in the future.

“If Basel III goes into place, capital may not be an issue [for our bank] today but it may be an issue tomorrow,” he says. “We have a different business model. We are relationship bankers. I’m not sure the same risk applies as it would for a larger institution.”

Others are trying to make the case against applying Basel III to all banks by submitting formal comment letters and quantifying impacts to regulators.

New York-based Sandler O’Neill + Partners L.P. filed a 33-page comment letter that dissects many aspects of the proposals. Perhaps of most concern to the investment bank is a provision to require banks and thrifts to adjust their capital based on unrealized gains and losses on available-for-sale securities.

If the current market value of bonds falls as interest rates rise, that could hit regulatory capital ratios, even though no actual loss was triggered.

There are many changes under the proposals impacting the residential mortgage market, including provisions requiring that more capital be held for mortgage loans sold to U.S. agencies with representations and warranties, and there is a new deduction of investment in mortgage servicing rights. Sandler O’Neill calculated that the “add-back” of mortgage loans sold with representations and warranties alone could require the industry raise an additional $7 billion in capital.

Among other significant aspects of the new rules: Regulators have created a new “capital conservation buffer,” or additional capital needed before you can pay bonuses to executives or dividends to shareholders. They have redefined what is allowed and not allowed as regulatory capital. Trust Preferred Securities, for example, would be phased out as Tier 1 capital and become Tier 2 capital.

While the formal comment process may soften some of the requirements, Basel III capital ratios and the Dodd-Frank Act in combination represent “the most significant changes in banking regulation since the Great Depression,” says Thomas W. Killian, a principal at Sandler O’Neill.

-Naomi Snyder

Regulation Number One Concern of Bankers

Even the smallest banks are beefing up their risk management capabilities in the midst of a worsening outlook on the economy and deep concerns about the regulatory burden, according to a survey of bank chief executive officers, chief financial officers and audit committee members by Bank Director magazine and audit, tax and advisory firm Grant Thornton LLP.

More than 170 bank executives and directors completed the e-mailed survey in June and July.

Only 13 percent of respondents expect the U.S. economy to improve in the coming months, compared to 39 percent in last year’s survey. This year, 68 percent expect the U.S. economy will remain the same, neither getting much worse or much better.

The number one concern in the Bank Executive Survey this year was the regulatory burden-which worries 94 percent of respondents compared to 91 percent last year.

Banks seem to be responding proactively to the regulatory burden and concerns about the economy. A full 78 percent of respondents say they perform stress testing, and 8 percent expect to start this year. That compares to 70 percent last year who said they performed stress testing. Sixty-eight percent say they have strengthened their loan review procedures during the last 24 months and 59 percent now have an enterprise risk management structure. Roughly one-third have a separate risk committee of the board and 21 percent have a chief risk officer.

Only 5 percent of respondents say they haven’t begun planning for increased compliance with regulations.

“We haven’t seen exactly how [the Dodd-Frank Act] is going to play out in entirety, but I do know this, we have already expanded our personnel roster in terms of compliance officers and we are not done,” says Jack Barrett, the president and chief executive officer of First Citrus Bank in Tampa, Florida. “They are in high demand and there is a short supply of consumer loan compliance officers. We are turning over stones.”

Given their concerns about regulation, it is perhaps not too surprising that the presidential candidate who has promised to roll back Dodd-Frank, Mitt Romney, has more support from bank executives and directors, 78 percent support versus 8 percent for President Barack Obama, according to the survey.

-Naomi Snyder and Robert Phelps

Bank Director Staff Writer

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