New distressed debt numbers from the banking sector have recently been published, so it is time again to take a look at the 181 banks that make up our local lending landscape. There is a lot of talk about a very serious forthcoming correction in commercial real estate and the effects that this will have on our financial institutions. New numbers indicate, however, that Massachusetts lenders may be set to dodge this bullet… at least to some degree.

Overall, Massachusetts banks saw an increase in their distressed real estate balances of only about 5% Q2-Q3 2009. I don’t know if this sounds like a lot or a little to you, but compared to the US totals at 11% its not too bad. Still, distress totals are up 72% over the last four quarters, not a confidence-inspiring figure.

This quarter is the first quarter that two Massachusetts banks are reporting capital adequacy numbers below those deemed healthy. In lay terms, capital adequacy has to do with the ratio of what you’ve got in the vault to what you’ve got on the street. Tier 1 + Tier 2 capital to risk weight adjusted assets should be no lower than 8%. One of these banks, Mt Washington Bank, recently announced a merger with East Boston Savings Bank, which, while reporting a little less than $20 Million in non-accrual loans and a little more than $2.5MM in (mostly construction) REO, is well capitalized reporting a ratio of 14% compared to Mt Washington’s 6%.

The other bank of note is Butler Bank. Butler reported capital adequacy ratios at 2% and 3%, a far cry from the 4% and 8% that regulators like to see. Butler’s construction portfolio has gone south at a rate of almost 40% (39.59%) and is by every measure the main source of their ills. It has been reported Boston Business Journal that the bank is being closely monitored by the FDIC.

Overall, Massachusetts banks saw the following changes from Q2 to Q3.

• 15% increase in residential distress, largely driven by REO
• 3.26% increase in distressed multifamily
• Unchanged (virtually) commercial real estate distress
• Unchanged (less than 1%) construction distress

The distressed real estate totals are calculated by adding a bank’s 90+day late loans, non-accrual loans, and REO (bank-owned property). It appears that we may be getting over the hump with construction loans, both locally and nationally, but that doesn’t mean that banks have dealt with the construction problems at hand only that most of the problems are already in the system. For example, while non-performing construction loans with Mass. banks fell by 2% to $222M construction REO (bank-owned) grew from $75.7M to $84M.

There are strong indicators that many, if not most, banks (with problems) are postponing inevitable losses as they move paper around internally. At some point, that will have to stop, and distressed properties will have to be sold. Today, Massachusetts-based banks are holding about $1.33 billion in distressed real estate loans and property. About two-thirds of that is residential, construction, and multifamily, while the balance is commercial. It’s important to remember that the numbers I’m giving you do not represent the whole of the distressed real estate market in Massachusetts. But only the numbers held at Massachusetts-based banks. That means Bank of America, Citi, Deutsche Bank, and all of the largest lenders’ numbers, as well as mortgage-backed securities are  unrepresented.

While the recession enders cheer positive signs in the stock market hailing the return of the bulls, everyone else seems to be wondering where the jobs are, and real estate industry folks are pointing at the long shadow being cast by the coming wave of commercial real estate problems. While there are no answers to the employment numbers or the stock market, there may be a real estate crystal ball.

It is all about the banks. Banks not only control the reigns to capital and reasonable debt, at a time like this when debt positions are the only positions left in real estate, banks control a whole lot more. In fact recent bank data suggests that institutions are in control of hundreds of billions in real estate. How they handle it will affect us deeply. In this installment we’ll look at the 180 (more or less) local lenders are dealing with in terms of real estate and what to expect next.

Massachusetts’ banks are generally fairing better than the those nationally when it comes to real estate loans. Approximately 2.2% of all the banks in the US are headquartered in MA, while our banks only hold about .44% of the real estate problems. This is a good start. The most recent consolidated bank reports available show that MA banks hold only about $1.27B in problems. A drop in the bucket compared to the $290B+ in whole loan and REO problems with lenders nationally.

It’s not all peaches and cream though. Many things are tracked, but 3 of those things fall into the distressed real estate pipeline, including 90 day late loans, nonaccrual loans, and REO. For each of these three columns we track residential, commercial, construction, and multifamily problems. In nearly all cases, and in almost every category, distressed real estate balances are growing nationally and locally.

Dollar Volume of Distressed Assets at MA Banks

Massachusetts based banks are reporting increased real estate problems.

Number of Massachusetts Banks with Distressed Assets

More Massachusetts based banks are reporting problems.

Do you notice a pattern?

Let’s ignore the first column for now because 90-Day-Lates are not as good a forecasting tool as non-accrual or non-performing loans. In nearly every category problems are mounting, not just with individual banks but across a greater number of banks.  If a crystal ball exists though, here it is in the numbers.

The hunch is on continued problems across the real estate spectrum, more struggling banks, more struggling property owners and certainly more great deals for those with capital. The next 18-24 months should prove to be very exciting for those prepared.