The Coming Crisis

The coming crisis in commercial mortgages looks as if it will be a doozy.

James Lockhart, vice chair of WL Ross & Co., New York, told the SourceMedia Buying and Selling Distressed Mortgage Portfolios that while the government is dominant in mortgages, it is commercial banks that dominate commercial real estate-and so are at the most risk in the coming debacle.

While the residential crisis may be bottoming out, Lockhart told the meeting, commercial is just getting underway.

Small commercial banks in particular are sitting on a lot of distressed assets on the commercial side, he said. The Federal Deposit Insurance Corp.'s problem institution list has ballooned to 775 firms, up from just 50 years ago.

Lockhart said that of a total of 8,000 U.S. banks, 250 have been closed and 1,300 have gotten letters from their regulator telling them to reduce concentration of certain loans, many of them CRE.

Many of these will be closed and many will be snapped up by stronger competitors, he said. Delinquency rates on CRE are starting to increase, he said, and may exceed residential delinquencies. Bank construction loan delinquencies are "off the chart," he said.

Smaller banks tend to have higher concentrations of CRE, he said, and "the least ability to handle those assets." One exception he noted has been "a success story" at Fannie Mae and Freddie Mac with multifamily loans.

But the former regulator of Fannie and Freddie didn't have many kind words for his former charges. He said that while they weren't the leader in the residential collapse, "they did participate in the bubble and helped inflate it." Their capital requirements were "incredibly low" with a general leverage of 100-to-1 and an MBS leverage of 200-to-1.

What to do about them? Lockhart advanced three alternatives: nationalizing Fannie, Freddie and Ginnie Mae; going to a public utility model; or putting them into the private sector.

What do they need? A definite mission, a "bright line" demarcation of their public and private roles, underwriting that uses strong insurance principles and strong capital positions, and a "countercyclicality" function to limits the booms and busts. In the meantime, the distressed asset market will continue to grow, Lockhart said, as more CRE assets go bad and banks start to move distressed properties off their books, now that resumed profitability has allowed them to do so.