Goldman rules are not for small lenders

July 15, 2009

Goldman Sachs’ second-quarter earnings, as jawdropping as the numbers were, did come with a few warning signs of trouble ahead. Most notably, the $1.2 billion in losses and write-downs the investment bank absorbed on commercial real estate loans, securities and related investments may be a harbinger of bad news to come from other financial firms.

Now it’s easy for a firm like Goldman, which generated blowout gains from trading stocks, bonds, currencies and commodities, to sweep its commercial real estate losses under the rug. But that’s not possible for small regional lenders stuck with loans to operators of half-empty strip-malls or quarter-filled offices.

That’s why short sellers are betting against shares of banks in the western United States that were big lenders to commercial property developers and landlords in California, Las Vegas, Oregon and Arizona. Those are all places where the recession is hitting the commercial real estate market hard.

For instance, Brad Golding, a portfolio manager with Christofferson, Robb & Co. who did well two years ago shorting small banks that loaded up on subprime home loans, says his fund has been shorting shares of Beverly Hills, California-based City National Corp., a bank with an affluent clientele and $4.7 billion in commercial loans.

Another favorite short is CVB Financial, a tiny lender with big exposure to some of the California counties that have been hardest hit by the recession.

So far this year, shares of CVB have been nearly cut in half, but City National’s stock has fared much better — falling 25 percent. Both banks have received funds under the
government’s Troubled Assets Relief Program (TARP).

The thing is, short sellers and other skeptics have been predicting a collapse in commercial real estate for quite a while now. But up until now, the losses at the banks have not come anywhere close to approaching the pain coming from the housing sector.

Don’t kid yourself: the worst is still to come from commercial real estate. Many banks have simply taken advantage of accounting rules to delay the inevitable pain. A bank has a lot of discretion about when it must mark down the value of a commercial or residential loan — discretion it doesn’t have with a real-estate-backed security that must be marked to market.

Goldman, which says it has marked down its $6.4 billion commercial loan book by roughly 50 percent, can afford to take a big hit now because it’s making so much money in other places.

Many other banks, however, can’t afford to be as aggressive as Goldman. So most lenders have only taken modest hits to the value of their commercial loan books. But if Goldman is right, it’s only a matter of time before other banks will have to fess up — especially as commercial borrowers start to default.

The trouble is most of those smaller banks can’t count on the federal government to bail them out. Nor can any of those banks wish away their problems by taking the kind of trading risks Goldman does, because none of them have been deemed to big to fail.
(Editing by Martin Langfield)

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