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December 03, 2009

Jobs and the potential commercial real estate problem: Still keeping us up at night

In the season of good cheer, it is certainly gratifying to know that some in the economic forecasting business are actually feeling cheerier:

Reaffirming last month's call that the Great Recession is over, NABE [National Association for Business Economics] panelists have marked up their predictions for economic growth in 2010 and expect performance to exceed its long-term trend. "While the recovery has been jobless so far, that should soon change. Within the next few months, companies should be adding instead of cutting jobs," said NABE President Lynn Reaser, chief economist at Point Loma Nazarene University.

While we at the Atlanta Fed agree that the recession has likely ended, we wish we could feel as optimistic about the current jobs outlook. We've catalogued those concerns before—here, for example—but we continue to look for reasons to believe that our pessimism is unwarranted.

As was noted in a recent speech by Federal Reserve Chairman Ben Bernanke, weak bank lending remains one potentially significant headwind impeding the jobs recovery:

"… reduced bank lending may well slow the recovery by damping consumer spending, especially on durable goods, and by restricting the ability of some firms to finance their operations."

Among the factors restricting lending, "… with loan losses still high and difficult to predict in the current environment, and with further uncertainty attending how regulatory capital standards may change, banks are being especially conservative in taking on more risk," Chairman Bernanke said.

One area where bank loan losses are potentially high and uncertain is commercial real estate (CRE). As highlighted in a macroblog post from October, if the CRE problem falls disproportionately on financial institutions that also finance small business activity, we will be all the more worried that "the post-recession employment boost [small] firms typically provide may be less robust than in previous recoveries."

In fact, as Atlanta Fed President Lockhart noted in a speech last month, as of mid-2009 the banks with high exposure to CRE (relative to tier 1 capital) accounted for about 40 percent of commercial and industrial (C&I) loans to small businesses.

Underneath that statistic are a couple of additional facts that also have our attention:

  1. Over time, CRE loans have become increasingly concentrated in those banks whose CRE lending activity is high relative to their available capital. As of June 2009, banks with CRE loan books more than three times their Tier 1 capital level accounted for 52 percent of the $1.6 trillion of CRE loans in bank portfolios. Though this is lower than the 2008 peak of 59 percent, it compares to just 17 percent in 1993.

  2. Small businesses that rely on bank loans for credit are much more likely to be affected by a bank's CRE exposure than in the past. In 1993, banks with CRE loan books more than three times their Tier 1 capital accounted for just 11 percent of total small business C&I loans. But this share increased to 42 percent in 2008 and stood at 38 percent in June 2009 (of a total of $281 billion of C&I loans to small businesses).

The following chart summarizes these two observations.

120309

Thus, both commercial real estate loans and small business C&I loans are much more concentrated in banks with relatively lower levels of capital than has been the case in the past. Combined with our previous observation that a relatively high fraction of small business loans sit in banks with significant exposures to commercial real estate, these facts do not strike us as a case for optimism regarding the near-term outlook for growth in small business borrowing.

Perhaps today's job summit will result in additional ideas to counter what we see as a serious drag on job creation in the near term. And, of course, tomorrow's employment report could show signs of improvement in labor markets. That would be good news.

By David Altig, senior vice president and research director, and John Robertson, vice president, both in the Atlanta Fed's research department

December 3, 2009 in Banking, Business Cycles, Labor Markets | Permalink

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Comments

Doesn't this lead you to a rationalization that there needs to be a change in market structures so that institutions are not "too big to fail"? If commercial lending risk is associated with few banks, then isn't there a concentrated time bomb waiting to go off?

It seems as though the Dodd bill, and the Frank bill do nothing to correct this problem. They merely load us up with more bureaucracy and limit the power of the Fed.

Unemployment was slightly better today-but I fear that the seasonal adjustments YOY from last November skewed the number. The situation was pretty dire from November 2008 to March 2009, and I think you can pretty much throw out all stats YOY for comparison.

Posted by: jeff | December 04, 2009 at 01:19 PM

Commercial real estate is poised to default in record numbers by the accounts of many. Many commercial loans are on 3-5 year notes and the notes that are coming due cannot be supported due to a lack of income caused by lower rents and in some cases no rents at all.

Posted by: Boise Real Estate | January 06, 2010 at 09:37 PM

I have to agree with Jeff. Commercial loans could see record defaults in 2010.

Posted by: Roger | January 08, 2010 at 01:48 AM

Yes there probably will be record defaults, but it will probably be no where near as bad as it could have been. Most of the banks started to set up special teams almost a year ago to deal with it. Keep your fingers crossed that it works.

Posted by: Tom | January 26, 2010 at 10:18 PM

Record or near-record defaults are a given in 2010. Worse, that fear is keeping money tight and lenghtening the time required to revive the industry.

Posted by: J. ("The Builder") Prescott | March 11, 2010 at 01:20 PM

I also have to agree with Jeff. Commercial loans could see record defaults in 2010.

Posted by: Wash Park Homes guy | July 14, 2010 at 02:28 PM

commercial real estate loans and small business C&I loans are much more concentrated in banks with relatively lower levels of capital than has been the case in the past.
Most of the banks started to set up special teams almost a year ago to deal with it...very interesting article, i agree with jeff either..

Posted by: How To Build Credit | September 17, 2010 at 07:35 AM

with the current economic situation today there is a need to change the market structure and look for a better resolution for commercial real state loans and unemployment problem.

Posted by: the real estate jobs | October 22, 2010 at 06:18 PM

In CA the standard commission is 10%. I would assume elsewhere it is about the same, but I do not know for sure.

Posted by: Poplar Bluff Real Estate | October 31, 2010 at 11:05 AM

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