Stress tests ignored CRE threat – Congress

US banks face hundreds of billions of dollars in losses on commercial real estate loans, a danger that was missed by the Capital Adequacy Program (Cap) stress tests in early 2009.

The Congressional Oversight Panel for the Troubled Asset Relief Program, in a report issued in January, predicted that banks could see up to $300 billion in losses on their commercial real estate portfolios, and warned the threat this poses to the US financial system was completely overlooked by the Cap.

Between now and 2014, “$1.4 trillion in commercial real estate loans will reach the end of their terms. Nearly half are at present underwater”, the report said.

The panel pointed out the bulk of commercial real estate losses would come after the expiry of the Tarp – already being wound down and set to expire on October 3. It warned “the size of the commercial real estate market means that its disruption could also have ripple effects throughout the broader economy, prolonging the financial crisis”.

In addition, although the bulk of the losses will come in 2011 and later, the stress tests only examined banks’ capital adequacy under two stress scenarios up to the end of 2010. Furthermore, the stress tests looked only at 19 major banks; while the heaviest burden of the commercial real estate collapse will fall on small and medium-sized lenders, who have half the total system exposure to commercial real estate, despite having only 15% of total assets.