Stress Test Results Bode Ill for Real Estate Finance

Capitol Hill

WASHINGTON, DC-The Treasury Department is getting ready to release the so-called stress test results it has been putting banks through for the last several weeks. These will be the final grades for the 19 top banks that were the first to jump through Treasury’s hoops – the final grades that is, for the assets that they are holding and how well they can perform in a severe economic downturn. After that, Treasury will begin the process of stress testing some 8,000 regional and commercial banks.

The real estate community is becoming more nervous as the day of reckoning approaches. Leaks and obscure comments by governments have led many to the conclusion that the stress tests will result in banks having to dispose of non-performing assets – many of which are real estate. The end result, it is feared, is that banks will be so spooked by the results that what little lending they are providing to real estate will cease.

“Many banks that are profitable today are getting increasingly nervous,” says an executive from a consulting firm that assists banks with the stress tests. If an otherwise healthy bank is found to have inadequate capital for its assets, it may be forced to take government assistance – along with the government strictures on executive compensation.

Many banks will become too nervous to lend in this scenario, this person tells GlobeSt.com. “The only financing that will be available will be loans that have a clear-cut exit strategy that is well defined.”

Furthermore, the results expected for the top 19 banks will not necessarily be a guide for how Treasury will evaluate second tier banks. “I don't think the government will be as charitable as it works its way down the ladder. The government can’t afford to have the top 19 banks go out of business so it will be easier on their assets. But smaller banks will not be as lucky.”

The coming results do not bode well for banks or real estate lending, Walter J. Mix III, managing director
of the Los Angeles-based consulting firm LECG, agrees. 


“For all but a few banks it is difficult to raise capital in this market -- some would even say that the capital markets are closed down for many of the banks,” he tells GlobeSt.com. “The next step in that analysis is if a bank already has a weak capital base and is required to mark down loans, one can see how for many of the banks that would mean a decreased capacity to originate new loans.”

Not everyone agrees with this grim view of the future.

“As someone who is working closely with regional and community banks I can tell you that stress tests are in part motivating banks to dispose of certain questionable assets on their balance sheets which they otherwise would have worked to keep,” David Schechtman, senior director of Eastern Consolidated’s Loan Sales and Turnaround Group, tells GlobeSt.com. But, he says, the ultimate conclusion to that process is not necessarily a complete pull back in real estate lending.

“They will sell the assets and raise more equity. And when they have more equity they will make more loans.”

Of course banks haven’t been lending very much in recent months; Schechtman, however, thinks that is going to change.

He recently attended a Mortgage Bankers Association event in New York and found that many of the attendees – loan orginators – are underwriting new deals.

“They are working to put more money out. At the very least they are willing to look and are issuing quotes.” It’s not a return to 2007, though. “Everybody remains very realistic. People are lending on assets that have existing income. Projected income [lending] is still off limits.”

The worst impact of the stress tests will be more psychological, he says.

The leaks and rumors coming out now about the stress test results contradict other signals sent by Washington – namely relaxing the accounting mark to market standard several weeks ago. “Think how this looks from a bank’s perspective: they were told they were no longer required to mark to market various assets – and while many of these regulations do not apply to banks, some of these do.”

On one hand Washington is helping banks out by allowing them to keep troubled assets on their books. Then weeks later it says these ‘good loans’ are problems, Schechtman says. “It does not raise the confidence level in the government.”

It is ironic because there is a sizable contingency in the analyst community that does not believe the stress tests will have that much practical impact on the financial system, other than the volatility the release of the results will surely cause.

“I never thought that the stress tests by themselves would be important in the near term,” Leo Tilman, former Bear Stearns & BlackRock strategist, now president of the strategic advisory firm L.M.Tilman & Co., and author of the book “Financial Darwinism” tells GlobeSt.com. “In the long term they send an important message, which is regulatory capital is meaningless when talking about capital adequacy.”

Source: GlobeSt.com