Banking recovery? Cross your fingers – Real Estate Matters
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Banking recovery? Cross your fingers

Industry numbers improve, but Commercial Real Estate, weak revenue threaten community banks.

 Many people in the real estate industry have been asking the question; When are banks going take a more active role in providing loans for commercial real estate?  Part of the problem is that until recently there hasn’t been much demand for that kind of lending due to the general decline in the economy and its impact on real estate.  However, now we are starting to see more activity in some areas for commercial real estate and that question is being asked more often.  There are some banks in the area that are making loans for commercial real estate.  These banks are being much more selective about the quality of the borrowers and the real estate being financed but they are actively lending.  Mark Anderson of Finance & Commerce has written an interesting article, which is attached below, about why more banks are not jumping back into the market right away.

Ben CrabtreeArticle by Mark Anderson, Finance & Commerce

The economy has started to turn around. But the shape of that recovery and deep, lingering declines in commercial real estate values will keep community banks on the griddle for a long time to come.

That is the world according to Ben Crabtree, who has been scrutinizing banks for three decades as an equity analyst for Piper Jaffray, Dain Rauscher and a handful of other regional asset managers.

He is focusing his attention on community banks in his current post as a senior adviser to Golden Valley-based Oak Ridge Financial Services Group, and he outlined some sobering realities that small banks face in the January edition of his monthly research piece, Community Banking Monitor (access Crabtree’s “Monitor pieces” at www.oakridgefinancial.com).

Big improvements in retail sales and in debt ratios in 2010 showed that the larger economy started recovering its balance. But the recovery did not climb too far before its trajectory flattened out and economic performance cooled.

Crabtree wrote in his January piece that the 2010 turnaround looked a lot like the halting recovery that followed the 1974 recession, which stalled soon after bouncing off the bottom. “Then, and perhaps now, the economy needed to spend several years working off the excesses of the previous up cycle,” he wrote.

In this cycle, the biggest excesses occurred in the residential and commercial real estate markets, and the huge losses in those sectors mean that neither one will contribute to a recovery by spurring new construction or adding to real estate value.

Income at Minnesota community banks declined to $113 million through the third quarter of 2010, only one-third the earnings posted in the same period in 2007. Those declines were driven by real estate losses.

Real estate development loans still on the books remained a source of trouble last fall – the portion of delinquent development loans in the third quarter was lingering at a level three times as high as in 2007.

In the January edition of their monthly “Compass” report, Bloomington-based Northmarq agreed with Crabtree that there are indications that real estate markets will begin to improve this year, but added that the recovery will be “longer – and bumpier” than in previous cycles.

Economists, investors and President Barack Obama all hope that technology innovations will stand in for real estate as a driver in this recovery, creating products that will prompt spending and investments here and in export markets.

But Crabtree is not comfortable with that speculation.

“I hear technology people talk and it sounds exciting, and I’m willing to assume that will happen. But it’s not going to happen on a dime,” he said in an interview on Thursday. “I can’t figure out where the fuel comes from in the near term to rebuild this economy.”

That feeble recovery pace is bad news for many community banks that need growth and new business loans to offset the devalued commercial real estate they still carry on their books.

Crabtree wrote in his January Monitor that the banking industry’s performance mirrors the uncertain strength the broader economy has shown.

Still, there are improvements: Nonperforming loans have declined and bank earnings are up.

But those numbers are weaker than they appear. Earnings growth occurred mostly at big banks, which boosted income by cutting loan loss provisions and reserves – not from top-line revenue gains, Crabtree wrote.

And the improving nonperforming numbers were also concentrated in big banks, not community banks.

With weak balance sheets and little growth on the horizon, Crabtree said Thursday that community banks are still facing some sober realities and lots of changes.

More banks will consolidate, he says, with the strongest community banks boosting their franchises by culling the weakest.

Banks will keep tightening up on expenses. “You aren’t going to see much revenue growth, so you’re going to have to have diligent cost control.”

And banks will need a focused business plan, he said, “with smart, effective marketing to take customers away from weaker competition.”

Many of the struggling banks built their franchises around real estate construction and development lending, financing that business with high-priced time deposits. “That was a low-value business strategy,” Crabtree says.

“People think now they’ll switch to commercial lending, but that takes time, investment and skilled bankers to make that work,” he said. “What this will all come down to is how good a bank’s management is.”

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