Financial Update (Third Quarter 2004)


 New Check 21
 Products for Banks

 Fed Responds to
 Declining Check

 Bank Regulators
 Watch Real
 Estate Market

 Call Reports

 Regulating Fannie
 and Freddie

 New Report on
 Banking Industry

 Fair Credit Act


 Data Bank

 Circular Letters



Bank Regulators Watch
Real Estate Market Closely

Although few real estate–related problems exist for banks today, regulators with bank supervision responsibilities in the Sixth Federal Reserve District are keeping a close eye on the possible effects that rising interest rates might have on the real estate sector.

Increasing exposure
Over the past 20 years, real estate loans at banks have increased considerably as a proportion of assets. Sixth District banks’ exposures are higher and have grown faster than those of U.S. banks generally (see the chart). As the Southeast’s economy and population have grown, banks have expanded their financing of traditional commercial development and increased their focus on loans for home mortgages and home equity loans.

Commercial real estate
For the past three years, commercial property fundamentals such as vacancy rates and rents in most markets have been extremely weak. The lowest interest rates in a generation may have masked these problems at weak properties by allowing borrowers to service their debt. Higher interest rates may expose such problems if occupancy rates and rents don’t rise correspondingly. Higher rates could also mean lower commercial property values, especially for properties unable to raise rents or reduce vacancies.

FDIC’s assessment of commercial real estate portfolios
OCC’s real estate and construction lending handbook
OCC’s residential real estate lending handbook

Residential real estate
The strength of the housing market in the face of the rising unemployment rate during the recent recession was unusual compared with trends during previous recessions. Most analysts agree that low mortgage rates were the driving factor behind the robust housing market.

Declining interest rates have also resulted in higher debt loads for many consumers who have refinanced their homes to cash out equity that came from appreciation. Home equity loan programs have become more generous, often allowing customers to borrow more than their property is worth. New loan programs using more aggressive or alternative underwriting techniques have been very successful at producing volume but are unproven in down markets.

Another trend based on recent evidence is more borrowers choosing adjustable rate mortgages to qualify for larger loan balances just as rates have begun to rise. In an environment of rising mortgage rates, borrowers may see higher prices generally, and programs such as zero-percent auto financing probably will disappear. How debt-laden consumers perform in this unfamiliar and challenging environment will affect banks’ real estate portfolios.

Real Estate Loans as a Percent of Total Assets
Source: Bank call reports

Homebuilders and developers
Home construction is a significant industry in the Southeast, given the region’s in-migration and record of income growth. Not surprisingly, financing homebuilders is a major business line for many banks in the region. Traditionally, home building has been highly sensitive to changes in mortgage rates, but many economists believe that a revived economy and favorable demographic trends outweigh the effects of rising rates and that homebuilding will remain strong for several more years.

Planning for a downturn
If historical relationships prevail, a decline in home sales and prices could occur in markets where building has been extremely strong. One example is the condominium markets of south Florida and the Florida Panhandle, where many purchasers are investors hoping to sell the properties for a short-term profit.

Given the recent uptick in interest rates, now is an important time for real estate lenders to monitor concentrations, borrower behaviors, and supply/demand balances. Bankers will need to have strategies to contain portfolio risks if conditions deteriorate.

This article was written by Bill Chalker, a senior financial analyst in the Atlanta Fed’s Supervision and Regulation Department.