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Casualties of the Credit Crisis Mount

Scores of smaller banks are projected to collapse as troubled loans take a toll.

More than 150 small and medium-sized U.S. banks are currently failing and expected to close this year as bad commercial real estate loans weigh heavily on their balance sheets.

In all, the nation's 8,390 banks have $13.9 trillion in assets, and $1.9 trillion in commercial real estate loans. However, 90% of the banks are relatively small, with assets of less than $1 billion. More than a third of these smaller banks, 2,562, have disproportionately high concentrations of commercial real estate loans, amounting to at least three times their core capital, a warning sign for regulators.

“Our current outlook is that this downturn for commercial real estate will be worse than in the early 1990s,” says Matt Anderson, partner at Oakland, Calif.-based research firm Foresight Analytics. Rising delinquency rates, lack of credit for refinancing, and over-concentration in commercial loans aggravate the problems.

In addition to the one-third of banks with less than $1 billion in assets that have high concentrations of commercial real estate loans, well over half of the 560 larger banks with $1 billion to $10 billion in assets also have a high share of commercial property loans.

In the first quarter, banks with assets up to $10 billion collectively held $280 billion in commercial real estate loans, says Anderson. “A lot of banks loaded up on construction lending, which in good times was a great source of income but now is a risky place to be.”

Commercial construction loan delinquencies rose from 6.6% in the fourth quarter to 8.9% in the first quarter of 2009, according to Foresight Analytics.

Although the delinquency rate for commercial construction loans was far lower than the 22% delinquency rate for single-family construction loans in the first quarter, the amount of a commercial loan typically is many times greater than a residential loan. That means a delinquency, defined as nonpayment for 30 days, can have a more damaging impact on an institution.

Meanwhile, commercial loan originations fell 70% in the first quarter from the same period last year, the Mortgage Bankers Association reports.

Although all banks are feeling the pressure, small banks are bearing the brunt of the burden.

Non-performing residential loans are a major contributor to the insolvencies afflicting banks, but the rise in commercial loan delinquencies has a significant impact, says Anderson. “We're expecting that commercial real estate will play a larger role in bank distress moving forward.”

The rate of projected bank closures this year is running six times higher than the 25 failures that occurred in 2008, Anderson says. In stark contrast, only three banks failed in 2007.

Foresight Analytics' watch list of troubled institutions includes some 375 banks in the first quarter, up from 276 in the fourth quarter. “Georgia is number one on our list,” with 54 troubled banks, says Anderson.

A projected $264 billion in loan maturities coming due this year poses a big problem for small banks, since refinancing will be difficult, says Sam Chandan, economist and president of New York-based research firm Real Estate Economics LLC.

He expects default rates to soar through 2010. Unlike big banks, the government is not propping up small banks, adds Chandan. “They would be allowed to fail en masse.”

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