Concerns over community banks

In a report to be released today, the Congressional Oversight Panel, which is responsible for reviewing the Treasury’s $700 billion bailout program, states that it is “deeply concerned that commercial loan losses could jeopardize the stability of many banks, particularly the nation’s midsize and smaller banks, and that as the damage spreads beyond individual banks that it will contribute to prolonged weakness throughout the economy.’’

The panel’s chairwoman, Elizabeth Warren, has been pressing the Treasury to compel thousands of banks to undergo stress tests like the ones that the Federal Reserve required of 19 of the country’s biggest financial institutions early last year. Treasury Secretary Timothy Geithner has called that idea impractical.

He acknowledged, however, that many community banks had greater exposure than the largest banks to a downturn in commercial real estate.

From 2010 to 2014, about $1.4 trillion in commercial real estate loans will reach the end of their terms, according to the report, which the panel provided.

Commercial property values have fallen more than 40 percent since the start of 2007, and nearly half of the loans coming due are underwater, meaning the borrower owes more than the property is worth, according to the report. Vacancy rates are as varied as 8 percent for multifamily housing to 18 percent for office buildings, and rents have fallen 40 percent for office space and 33 percent for retail space, the report states.

Commercial real estate loans are structured differently from home mortgages. Typically, the loans have a term of 3 to 10 years, but the principal is not fully repaid by the end of that period. Instead, the entire remaining balance comes due at the end of the initial term, and the developer has to take out a new loan to finance continued ownership. If the borrower cannot make monthly payments or cannot obtain refinancing, default and foreclosure can result.