Commercial Loans:
Behind the Next Hit

So far most of the losses in the housing crisis have been from homeowners defaulting on their mortgages. But there is another wave of pain about to hit.

Developers increasingly are falling behind on loan payments, especially those who borrowed to finance acquisitions of land and construction of houses and condominiums. This has caused some confusion because regulators and banks typically lump these in with commercial real-estate loans.

Here, then, is a primer.

Question: What is a commercial real-estate loan?

Answer: When the Federal Deposit Insurance Corp. refers to commercial-real-estate loans, it includes the traditional mortgages that a borrower takes on when buying an office building or shopping center. But also under the commercial-real-estate umbrella are construction loans, land development and other land loans even if these involve residential construction.

Thus, a developer's construction loan to build a $300 million office tower is considered a commercial-real-estate loan, but so, too, is a loan to a small home builder. That home builder might borrow from his community bank to buy empty land, to put in new sewer lines in a subdivision or to build a new three-bedroom house -- all categorized as commercial-real-estate loans.

Q: How big is the commercial-real-estate exposure for banks?

A: In a word, huge. The FDIC tallied the total amount of outstanding commercial loans in the first quarter of 2008 at $1.97 trillion.

Q: When regulators say commercial loans could cripple banks, which loans do they mean?

A: Most of the pain -- so far, at least -- is related to residential overbuilding and moribund demand, causing builders to default on construction loans for single-family housing and condominiums. Land once planned for housing has plummeted in value and builders are still completing houses, only to see no buyers.

Consider these numbers: U.S. banks had $264.4 billion in outstanding construction loans for single-family houses at the end of the first quarter of 2008 and an additional $280.8 billion for loans to build commercial properties such as office buildings. Yet, the delinquency rate was for 10.8% for the housing loans, compared with 3.6% to build commercial structures.

Q: Are single-family construction loans the worst-performing such loans?

A: No. Construction loans for condominiums earned that dubious distinction, although they make up a much smaller piece of the pie with $41.3 billion in loans outstanding. Condo loans' rate of delinquency (at least 30 or more days past due) was 13.6% in the first quarter of 2008, according to Foresight Analytics. And experts predict that percentage will rise considerably for the second quarter.

Q: Is there any good news here?

A: Yes, the delinquency rate for nonconstruction mortgages on traditional commercial property -- such as office buildings, hotels and strip centers -- remains near historic lows.