Commercial Real Estate: The Next Problem For Financial Services Industy?

Implications: Many of the larger financial services firms have been hurt by the subprime mortgage downturn, with most of the damage resulteding from the loss of confidence in the credit markets for MBS, CDOs and other instruments that would be tainted by subprime collateral.  However, the industry is also heavily exposed to commercial real estate (CRE), and the percentage of capital tied up in CRE loans is greatest for smaller banks.  If the market turns south, as now seems a real possibility, there will be big problems for community banks.

Analysis: The financial services industry is reeling from problems caused by subprime mortgages, but not because the banks hold these loans.  Rather, the problem for the banks is that they hold, or are managing funds that hold securities that may be tainted by subprime assets.  This is a problem for the big banks. 

For years, regional and smaller banks have been aggressively making commercial real estate loans.  The concentration of commercial real estate loans in smaller institutions grew so large that the banking agencies issued guidance in December of 2006 warning of the risks in this asset class.  Now we are getting the first indications that the CRE market may go south, and if this comes to fruition, the pain will be felt especially by regional and smaller banks.  The California market may be the bell weather, but I would also look carefully at Florida and Nevada.  Iff the economy slides into a recession, the CRE turmoil could be just as drastic as the subprime mess. M