[Senate Hearing 112-2]
[From the U.S. Government Publishing Office]



                                                           S. Hrg. 112-2
 
           COMMERCIAL REAL ESTATE'S IMPACT ON BANK STABILITY

=======================================================================

                                HEARING

                               before the

                     CONGRESSIONAL OVERSIGHT PANEL

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               ----------                              

                            FEBRUARY 4, 2011

                               ----------                              

        Printed for the use of the Congressional Oversight Panel


           COMMERCIAL REAL ESTATE'S IMPACT ON BANK STABILITY





                                                          S. Hrg. 112-2

           COMMERCIAL REAL ESTATE'S IMPACT ON BANK STABILITY

=======================================================================

                                HEARING

                               before the

                     CONGRESSIONAL OVERSIGHT PANEL

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                            FEBRUARY 4, 2011

                               __________

        Printed for the use of the Congressional Oversight Panel


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                     CONGRESSIONAL OVERSIGHT PANEL
                             Panel Members
                    The Honorable Ted Kaufman, Chair
                             Kenneth Troske
                           J. Mark McWatters
                           Richard H. Neiman
                             Damon Silvers



                            C O N T E N T S

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                                                                   Page
    Statement of: Opening Statement of Hon. Ted Kaufman, U.S. 
      Senator from Delaware......................................     1
    Statement of J. Mark McWatters, Attorney and Certified Public 
      Accountant.................................................     5
    Statement of Damon Silvers, Director of Policy and Special 
      Counsel, AFL-CIO...........................................     9
    Statement of Kenneth Troske, William B. Sturgill Professor of 
      Economics, University of Kentucky..........................    13
    Statement of Richard Neiman, Superintendent of Banks, New 
      York State Banking Department..............................    19
    Statement of Sandra Thompson, Director, Division of 
      Supervision and Consumer Protection, Federal Deposit 
      Insurance Corporation......................................    23
    Statement of Patrick Parkinson, Director, Division of Banking 
      Supervision and Regulation, Board of Governors of the 
      Federal Reserve............................................    41
    Statement of David Wilson, Deputy Comptroller for Credit and 
      Market Risk, Office of the Comptroller of the Currency.....    54
    Statement of Matthew Anderson, Managing Director, Foresight 
      Analytics, A Division of TREPP.............................    94
    Statement of Richard Parkus, Executive Director, Morgan 
      Stanley Research...........................................   106
    Statement of Jamie Woodwell, Vice President of Commercial 
      Real Estate Research, Mortgage Bankers Association.........   136


      HEARING ON COMMERCIAL REAL ESTATE'S IMPACT ON BANK STABILITY

                              ----------                              


                        FRIDAY, FEBRUARY 4, 2011

                                     U.S. Congress,
                             Congressional Oversight Panel,
                                                    Washington, DC.
    The panel met, pursuant to notice, at 10 a.m. in Room D 
538, Dirksen Senate Office Building, Senator Ted Kaufman, 
chairman of the panel, presiding.
    Present: Senator Ted Kaufman [presiding], Richard H. 
Neiman, Damon Silvers, J. Mark McWatters, and Kenneth R. 
Troske.

   OPENING STATEMENT OF HON. TED KAUFMAN, U.S. SENATOR FROM 
                            DELAWARE

    The Chairman. Good morning. I'm Ted Kaufman, the chairman 
of the Congressional Oversight Panel for the Trouble Asset 
Relief Program.
    And we're here this morning--and I'm--welcome our witnesses 
and visitors--at a pivotal moment in the Nation's economic 
recovery. The financial panic that plagued our country is over. 
The Dow Jones industrial average has exceeded its year-end peak 
from 2007, only a few percentage points below its all-time 
high. Housing prices have begun to recover. Private companies 
are very slowly hiring again, beginning to put our millions of 
unemployed friends and neighbors back to work, although we have 
a long way to go, as everyone knows.
    It's only fitting that, at a crisis past, a government 
should set aside its crisis authorities. And so, Treasury's 
most extraordinary authority, to stabilize our financial 
system, the Troubled Asset Relief Program, has ended. However, 
threats to the banking system and the broader economy remain.
    Our hearing this morning will explore one of those threats 
in detail: the troubled market for commercial real estate 
loans.
    Commercial mortgages are exactly what they sound like, the 
loans taken out by developers to buy, build, and maintain 
commercial properties. Almost everyone who lives in an 
apartment, works in an office building, or shops in a mall has 
spent time in a building that owes its existence to a 
commercial mortgage.
    Most commercial mortgages have terms of 3 to 10 years, but 
the monthly payments are too low and--to fully repay the loan 
in that period. At the end of the term, the entire remaining 
balance comes due, and the borrower must take out a new loan to 
finance its continued ownership of that property. Put another 
way, a commercial borrower must reapply for credit every few 
years. In today's market, where banks remain hesitant to lend 
and the values of commercial properties have fallen by a third, 
many borrowers will be turned down.
    The loans at greatest risk are those made at the peak of 
the real estate bubble, obviously; loans that will come due for 
refinancing in 2011, 2012, and 2013, and beyond. In essence, 
the term of a commercial loan creates a lag between the moment 
the market collapses and the moment that the economic impact is 
felt. The fuse has been lit, but no one knows how much damage 
will occur when it finally burns down.
    The Congress Oversight Panel has been closely monitoring 
the commercial real estate market since its first hearing on 
the subject, in May have 2009. The panel issued a comprehensive 
report in February 2010. Even after almost 2 years, the panel 
remains deeply concerned.
    In fact, just last month, the missed payment rate for 
commercial mortgage-backed securities reached an all time high 
of over 9.3 percent. The commercial real estate market 
encompasses $3.4 trillion in debt. If borrowers default in 
large numbers, commercial properties could face a wave of 
foreclosures. Customers, businesses, and renters in those 
properties could face uncertainty, and even eviction. Small 
banks, in particular, could face insolvency, as nearly 1,300 
banks nationwide are considered by regulators to have 
concentrations in commercial real estate.
    Concerns about commercial real estate also illuminate a 
broader theme of our oversight work, that even in a crisis, 
while authorities must deal with the short-term dangers, they 
must also be vigilant to the longer-term threats. If a small 
bank survived the financial crisis, thanks to the TARP, but 
collapses next year, due to commercial real estate losses, then 
TARP support will have served only to postpone the inevitable.
    Further, more than 500 small banks continue to hold TARP 
money. And the greater the degree of these banks' exposure to 
commercial real estate, the lower is the likelihood that 
taxpayers recover all of our money.
    We are grateful this morning--and I truly mean grateful--to 
be joined by two panels of expert witnesses, who will help us 
to explore these concerns, including government regulators and 
bank analysts. We appreciate your presence and look forward to 
your testimony.
    Let me now turn to Mr. McWatters for his opening remarks.

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 STATEMENT OF J. MARK McWATTERS, ATTORNEY AND CERTIFIED PUBLIC 
                           ACCOUNTANT

    Mr. McWatters. Thank you, Senator Kaufman.
    And welcome to our distinguished witnesses.
    There is little doubt that much uncertainty continues to 
exist within the commercial real estate, or CRE, market. In 
order to suggest a solution to the challenges facing the CRE 
market, it is critical that we thoughtfully identify the 
sources of the underlying difficulties. Without a proper 
diagnosis, it is unlikely that we may craft an inappropriately 
targeted remedy with adverse unintended consequences.
    Broadly speaking, it appears that today the CRE industry is 
faced with both an oversupply of overleveraged CRE facilities 
and an undersupply of respective tenants and purchasers. In my 
view, there has been a remarkable decline in demand for CRE 
property over the past 2 years, and many potential tenants and 
purchasers have withdrawn from the CRE market, not simply 
because rental rates and purchase prices are too high due to 
the excess debt load carried by many CRE properties, but 
because their business operations do not presently require 
additional CRE facilities.
    Over the past few years, while CRE developers have 
constructed new office buildings, hotels, multifamily housing, 
retail facilities, and industrial properties with an excess of 
cheap, short-term credit, the end users of such facilities have 
suffered the worst economic downturn in several generations. 
Any positive solution to the CRE focus--problem that focuses 
only on the oversupply of overleveraged CRE facilities, to the 
exclusion of the economic difficulties facing the end users of 
such facilities, appears less than likely to succeed.
    The challenges confronting the CRE market are not entirely 
unique to the industry, but instead are indicative of the 
systemic uncertainties manifest throughout the entire economy. 
In order to address the oversupply of overleveraged CRE 
facilities, developers and their creditors are currently 
struggling to restructure and refinance their portfolio loans. 
In some instances, creditors are acknowledging economic reality 
and writing the loans down to market value, with perhaps the 
retention of an equity kicker right. In other cases, lenders 
and borrowers are merely kicking the can down the road by 
refinancing problematic credits on a short-term basis at 
favorable rates so as to avoid loss recognition and capital 
impairment for lenders and adverse tax consequences for the 
borrowers.
    While each approach may offer assistance in specifically 
tailored instances, neither addresses the underlying reality of 
too few tenants and purchasers of CRE facilities. Until small 
and large businesses regain the confidence to hire new 
employees and expand their business operations, it is doubtful 
that the CRE market will sustain a meaningful recovery. As long 
as business persons are faced with the challenges of rising 
taxes and increasing regulatory burdens, it is less than likely 
that they will enthusiastically assume the entrepreneurial risk 
necessary for protracted economic expansion and a robust 
recovery of the CRE market.
    It is fundamental to acknowledge that the American economy 
grows one job and one consumer purchase at a time, and that the 
CRE market will recover one lease, one sale, and one financing 
at a time. With the expanding array of less-than-friendly 
rules, regulations, and taxes facing business persons and 
consumers, we should not be surprised that businesses remain 
reluctant to hire new employees, consumers remain cautious 
about spending, and the CRE market continues to struggle.
    The problems presented by today's CRE market would be 
easier to address if they were solely based on the oversupply 
of overleveraged CRE facilities in certain well-delineated 
markets. In such an event, a combination of thoughtful, yet no 
doubt painful, restructurings, refinancings, and foreclosures 
would result in the material deleveraging and repricing of 
troubled CRE properties. Unfortunately, even though CRE 
properties that are appropriately leveraged and priced must 
also assimilate a drop in demand from prospective tenants and 
purchasers who have suffered a reversal in their business 
operations and prospects.
    Although some progress has been made, the Administration 
could further assist the recovery of the CRE market, as well as 
the broader U.S. economy, by sending an unambiguous message to 
the private sector that it will not directly or indirectly 
raise the taxes or increase the regulatory burden of CRE 
participants and other business enterprises. Without such 
action, the recovery of the CRE market will quite possibly 
proceed at a sluggish and costly pace, with further adverse 
consequences for those financial institutions and investors 
that hold CRE loans and commercial mortgage-backed securities.
    Thank you, and I look forward to our discussion.
    The Chairman. Thank you. Damon Silvers.

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  STATEMENT OF DAMON SILVERS, DIRECTOR OF POLICY AND SPECIAL 
                        COUNSEL, AFL-CIO

    Mr. Silvers. Thank you, Mr. Chairman.
    Good morning. This is the third hearing this panel has 
conducted on the interaction of the commercial real estate 
market with the Troubled Asset Relief Program.
    Our earlier hearings looked at this issue through the 
experience of the New York and the Atlanta metropolitan areas. 
And so, this is really the first hearing that is focused on the 
national picture and on the viewpoint and efforts of the bank 
regulators in relation to issues raised by the commercial real 
estate market.
    In our February 2010 report, as my fellow panelists have 
noted, this panel urged the Treasury Department and the bank 
regulators to closely monitor commercial real estate market, 
out of concern that the rapid decline of this market could lead 
to problems for financial institutions with significant 
exposure to commercial real estate loans, and, in particular, 
could affect the small banking sector. We noted that, due to 
the shorter term of most commercial real estate loans compared 
to conventional residential mortgages, the banking system would 
face rollover problems for more than $2 trillion worth of 
commercial real estate loans between 2011 and 2017, loans whose 
collateral seems likely to have fallen in value dramatically 
when the loans become due.
    Today's hearing is an opportunity for us to revisit the 
question of what is going to happen to smaller banks as 
commercial real estate loans become due, and what impact these 
developments will have on efforts to revive commercial lending, 
and on the degree of concentration in our banking system. We do 
this against the backdrop of smaller TARP recipient banks 
having significant concentrations in commercial real estate 
even when compared to non-TARP recipients of the same size, and 
against the backdrop, that we--as we have noted in other 
reports, of the challenges that the Treasury Department faces, 
in terms of constructing an exit from TARP for these smaller 
recipients of TARP assistance.
    But, this hearing is also an opportunity for us to look 
more broadly at the implications of the commercial real estate 
market for oversight of TARP as a whole. Several of our 
witnesses today have pointed out, in their written testimony, 
that commercial real estate loans are concentrated in smaller 
banks, and are not a problem, by and large, that threatens the 
stability of systemically significant institutions. We also 
have a substantial body of testimony today that discusses the 
capacity of banks and other commercial real estate lenders to 
restructure commercial real estate loans, and the difference 
that that capacity and flexibility has made, in terms of 
mitigating the impact of the dramatic fall of commercial real 
estate values.
    Now, neither proposition is a great comfort to me, nor, I 
think, would either proposition be a great comfort to the 
American public if the public understood the implications of 
these statements.
    Every week, the FDIC resolves more failed small banks. 
Those banks are shut down; their stockholders, wiped out; in 
many cases, their employees, laid off; the communities which 
they served, left without important institutions in some cases; 
in other cases, they continue under new names and new 
ownership.
    All the--all those harmed by these actions, unavoidable as 
they certainly are, know that, if they had just been 
systemically significant, they might be well on their way to 
enjoying the fruits of the recent miniboom in finance. And 
then, consider any one of the more than 200,000 American 
families facing the loss of their home each month due to 
residential real estate foreclosures, in substantial part 
because of the lack of flexibility in the approach the bank 
have taken to residential real estate.
    Now, today, rather than dwell too long on these injustices 
that appear, at this point, to be profoundly lodged at the 
heart of our financial policy landscape, I would hope we could 
learn something practical from this hearing as to, one, whether 
we still have cause to be concerned about rollover risk in 
commercial real estate, the risk that this panel has raised in 
prior reports; and, two, What can we learn from the commercial 
real estate experience that might help us in dealing with the 
profoundly troubled residential real estate market?
    So, I look forward to hearing from our witnesses, and 
extend my thanks to all of you for helping us today.
    The Chairman. Thank you, Mr. Silvers.
    Dr. Troske.

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 STATEMENT OF KENNETH TROSKE, WILLIAM B. STURGILL PROFESSOR OF 
               ECONOMICS, UNIVERSITY OF KENTUCKY

    Dr. Troske. Thank you, Senator Kaufman.
    I would like to start by thanking the witnesses for 
appearing before the panel today. I appreciate you coming here 
to help us with our oversight responsibilities.
    In my opening comments today, I want to touch on a topic 
that, while not the primary subject of today's hearing, is 
certainly related. That is the role of regulation and 
regulatory oversight in the recent financial crisis.
    One common theme in the aftermath of our--the recent crisis 
has been that the crisis could have been prevented by more 
regulation. Of course, in our economic system, there are two 
sources of regulation, that imposed by the market and that 
imposed by the government. Both forms of regulation have their 
strengths and weakness. In my opinion, however, many of the 
calls for increased government regulation fail to recognize 
some of the inherent weaknesses in this type of regulation.
    It is important to start off by recognizing that regulators 
are human beings, not superheroes, and they respond to 
incentives, just like all other normal human beings. Government 
regulators with no skin in the game have little incentive to 
closely monitor the behavior of companies to ensure that they 
protect investors and the economy. In contrast, in a well-
functioning market, shareholders and creditors have a great 
deal of incentive to monitor firm behavior, since they do have 
skin in the game.
    Some government regulators certainly do an exemplary job, 
but there are others, whose efforts will focus on merely 
implementing rules in a way to maintain their positions, and it 
is hardly--hard to know which is which before problems arise. 
As far as I know, no government regulator lost his or her job 
because the firm they regulated failed or received a bailout. 
In fact, many of the regulatory agencies that have received the 
most blame for the financial crisis received additional 
regulatory authority in the recent Dodd-Frank legislation. It 
seems clear that regulators have little financial incentive to 
develop and apply the kind of regulatory procedures that will 
yield maximum benefit, so we are forced to rely on regulators' 
personal motivation for doing the right thing. Hardly a sound 
basis for effective regulation.
    We must also recognize that government regulators operate 
in a political process. When regulators try to regulate large 
companies, the shareholders and executives of these companies 
complain to their elected representatives about the undue 
burden of regulation, and these legislators try to limit the 
efficacy of regulators. We have seen this process play out time 
and time again in a variety of settings. When companies are 
making large profits, as often occurs in a price bubble, it is 
unreasonable to expect government regulators to have the 
political will to defy Members of the Congress and pop the 
bubble. I am not saying that the way the political process 
works is inappropriate, just that this dynamic must be kept in 
mind when thinking about the likely effectiveness of new 
regulation.
    Finally, we need to recognize how executives, shareholders, 
and creditors of financial firms will respond to regulation. 
All businesses, including financial firms, aim to provide the 
products their customers demand. Customers demanded, and 
continue to demand, many of the financial products that 
they're--at the heart of the financial crisis, such as 
collateralized debt obligations and other complicated 
derivatives. Given new government--new government regulation 
will likely push firms to develop more complicated and 
difficult-to-regulate financial products, and move these 
products into an even more shadowy part of the banking sector.
    In addition, with an increase in government--an increase in 
government regulation will decrease shareholders' and 
creditors' efforts at monitoring managers, and allow their 
oversight to be supplanted by government regulation. Given that 
regulation pushes companies to hide risky investments and 
reduces the incentives for shareholders and creditors to 
monitor the behavior of executives, government regulation 
likely leads to a world where there are fewer crises, but those 
crises that do occur will be much harder to spot and much 
larger and more destabilizing. Is this a tradeoff we want to 
make?
    Of course the government's guarantee that systemically 
important financial firms will not be allowed to fail has 
effectively removed any incentive creditors have to monitor the 
behavior of executives and shareholders. It seems to me that a 
much simpler and more efficient solution would simply--would be 
to simply eliminate the government's guarantee, which would 
again provide creditors with the incentives to monitor the 
behavior of firms.
    Claims that government--claims that the lack of regulation 
led to the recent financial crisis are akin to claims that 
someone got sick because they didn't take enough medication. 
Obviously, some medicine can kill you, some may prevent you 
from getting sick, but the correct medication is a complex 
function of the patient's overall health prior to becoming ill, 
his behavior, and the disease he ultimately encounters. So, it 
is virtually impossible to design a regime of medication that 
will prevent someone from ever getting sick. Instead, doctors 
advise us to follow a few basic rules--eat a balanced diet, 
exercise on a regular basis, don't smoke, avoid drinking to 
excess--that are designed to help build resistance to most 
common diseases and minimize the effects if we do become ill. 
However, even following these rules, people still get sick.
    Good regulation would follow a similar course. Establish a 
set of basic rules, to enhance the ability of the natural 
regulators, shareholders, and creditors to oversee the behavior 
of managers. However, even the best government regulation will 
not prevent the occurrence of future financial crises. The best 
it can do is to reduce their frequency, minimize the effects 
when crises occur, and make people aware of the risks so they 
can prepare.
    Responsibility for a firm's failure does not reside with 
government regulators, but instead rests with the managers and 
owners who made poor decisions. We need to keep this in mind 
when trying to design optimal regulation and planning for 
future crises.
    Hopefully, the testimony we hear today will help us better 
understand remaining problems in the market so that political 
leaders can continue to work towards better, more efficient 
regulation to ensure the stability of the financial sector.
    The Chairman. Thank you, Dr. Troske.
    Mr. Neiman.

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STATEMENT OF RICHARD NEIMAN, SUPERINTENDENT OF BANKS, NEW YORK 
                    STATE BANKING DEPARTMENT

    Mr. Neiman. Thank you.
    Good morning. I want to thank our witnesses, particularly 
our senior Federal regulators who are appearing today at our 
Hearing of the Congressional Oversight Panel on Commercial Real 
Estate Lending.
    The panel first explored these issues around commercial 
real estate in our field hearings in New York City in 2009 and 
in Atlanta in January of last year. In the time since then, 
there is reason to remain concerned about mounting pressure in 
the commercial real estate sector. Financial stability overall 
has been returning, but this nascent recovery is still 
vulnerable to shocks. The concern is that the credit risk, and 
particularly the maturity risk embedded in commercial real 
estate loans, could provide such a trigger in the near term.
    It is estimated that hundreds of billions of dollars in 
commercial real estate debt will be maturing through 2014. The 
prospects for refinancing this debt are uncertain, as the 
recession and high levels of unemployment continue to put 
downward pressure on property values and reduce rent rolls. 
This could even jeopardize the viability of loans that were 
properly underwritten. These difficulties may weigh heavily on 
midsized and community banks, which are, comparatively, more 
concentrated in commercial real estate than larger 
institutions.
    But, the future of commercial real estate lending matters 
to more than just a subset of lenders and borrowers. Commercial 
real estate impacts every community, on multiple levels, so 
understanding this sector is an important aspect of stabilizing 
our national economy. We are talking about the office 
buildings, shopping malls, and hotels that shelter jobs. 
Mortgages that help businesses remain open are critical to 
economic recovery.
    Commercial real estate also includes multifamily and 
affordable housing units. For apartment buildings, in 
particular, there is a concern that the properties' condition 
will deteriorate as the owner's cashflow is diverted to making 
debt payments. Further, tenants who pay their rent on time can 
find themselves homeless because their landlord defaulted on 
the underlying commercial mortgage. Workouts for distressed 
loans on multifamily properties should be restructured with 
community preservation goals in mind.
    So, in my questions this morning, I will be exploring this 
connection between the well-being of our society and financial 
stability. There are many open issues, such as: What steps are 
being taken at the national level to protect members, renters, 
and multifamily properties during a foreclosure? Are tightened 
underwriting standards being set at the right level to ensure 
prudent loans, or is credit being artificially restricted? And 
are banks adequately prepared for additional loan losses that 
may be coming?
    I look forward to the witnesses' response on these issues, 
and to hearing your innovative ideas on stabilizing commercial 
real estate. So, thank you, again, for joining us.
    The Chairman. Thank you all.
    I'm pleased to welcome our first witness panel, which 
consists of Federal bank regulators. We're joined by Sandra 
Thompson, director of the Division of Supervision and Consumer 
Protection for the FDIC; Patrick Parkinson, director of the 
Division of Banking Supervision and Regulation for the Federal 
Reserve; and David Wilson, deputy comptroller for Credit and 
Market Risk for the OCC.
    Thank you for coming this morning.
    We ask that you keep your oral testimony to 5 minutes so we 
can have adequate time for questions. Your complete written 
record will be printed in the official record of the hearing.
    And please proceed with your testimony. We'll start with 
Ms. Thompson.

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STATEMENT OF SANDRA THOMPSON, DIRECTOR, DIVISION OF SUPERVISION 
 AND CONSUMER PROTECTION, FEDERAL DEPOSIT INSURANCE CORPORATION

    Ms. Thompson. Good morning. Chairman Kaufman and members of 
the panel, I appreciate the opportunity to testify on behalf of 
the FDIC regarding the condition of the commercial real estate 
market and its relationship to the overall stability of the 
financial system.
    The events surrounding the recent financial crisis have 
taken a heavy toll on economic activity across our Nation. The 
past 3 years have been difficult for many institutions that 
focused on CRE lending, especially in home construction.
    In 2009, there were 140 bank failures. Last year, 157 banks 
failed. And many of those failures were caused by losses on 
construction loans that were made during the boom years before 
the crisis.
    Some community banks with CRE concentrations continue to 
experience elevated losses. Distressed CRE loan exposures take 
time to work out and, in some cases, require restructuring to 
establish more realistic and sustainable repayment programs. 
Some loans may not be able to be modified and must be written 
off. This process of prompt loss recognition and restructuring, 
painful as it may be, is needed to lay the foundation for 
recovery in the CRE market.
    At the same time, it must be recognized that many 
institutions with CRE concentrations have weathered the 
financial crisis. As of the end of the year in 2008, there were 
over 2200 institutions that had CRE concentrations. Many of 
these institutions continue to operate in a safe and sound 
manner and serve the credit needs of their communities.
    It is important to note that capital levels at insured 
institutions are relatively strong. Of the almost 8,000 insured 
depository institutions reporting as of the end of last 
September, some 96 percent are in the well-capitalized 
categories. For banks with CRE concentrations, 87 percent are 
well-capitalized.
    The FDIC and the other Federal banking regulatory agencies 
have taken a number of steps to better understand the nature 
and extent of CRE concentrations. The FDIC has expanded the use 
of supervisory visitations at institutions with CRE 
concentrations. We've broadened our offsite surveillance 
programs to better capture CRE outliers. We receive more 
detailed information on a quarterly basis on owner-occupied CRE 
exposures so that we can better delineate a bank's CRE 
portfolio.
    The FDIC has also joined with the other Federal bank 
regulators in encouraging lenders to continue making prudent 
loans and working with borrowers who are experiencing financial 
difficulties.
    Although a number of financial institutions have reported 
poor results for the past several years, there are emerging 
signs of stabilization. Year-over-year earnings have improved 
for five consecutive quarters through September 30th, and loan-
loss provisions have declined. Additionally, noncurrent loan 
balances have declined, with the largest decline occurring in 
the construction and development lending sector.
    There are other signs pointing to a slow stabilization in 
the residential and commercial property sectors, with 
improvement in prices and vacancy rates. Nonetheless, while 
there are signs of stabilization, the CRE market is distressed 
and it will take some time to work through these issues.
    All banks, community banks in particular, play a critical 
role in helping local businesses fuel economic growth. And we 
support their efforts to make good loans in this challenging 
environment.
    Thank you. And I'll be pleased to answer any questions from 
the panel.
    [The prepared statement of Ms. Thompson follows:]

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    The Chairman. Thank you very much.
    Dr. Parkinson.

 STATEMENT OF PATRICK PARKINSON, DIRECTOR, DIVISION OF BANKING 
 SUPERVISION AND REGULATION, BOARD OF GOVERNORS OF THE FEDERAL 
                            RESERVE

    Dr. Parkinson. Chairman Kaufman, members of the panel, 
thank you for your invitation to discuss the current state of 
commercial real estate and its relationship to the overall 
stability of the financial system.
    Over the past year, the rate of deterioration for CRE 
market and credit conditions has leveled off, and there are 
some early signs of price stabilization in a number of key 
markets. However, weakness in real estate markets, both 
commercial and residential, continues to be a drag on overall 
growth in the economy.
    CRE-related issues also present ongoing problems for the 
banking industry, particularly for community and regional 
banking organizations. Losses associated with CRE, particularly 
residential construction and land development lending, have 
been the dominant reason for the high number of bank failures 
since the beginning of 2008. Credit losses for bank CRE loans 
typically continue well past the trough of recessions, and we 
expect this pattern to continue in this cycle.
    Working through the large volume of troubled CRE loans will 
take time as banks go through the difficult process of loan 
workouts and loan restructurings. However, if done prudently 
and effectively, loan restructuring can reduce the ultimate 
losses to the banking system. In addition, proper restructuring 
can reduce the damage done to businesses and the economy by 
limiting the forced liquidation of properties that would 
further depress prices.
    While we expect significant ongoing CRE-related problems, 
it appears that worst-case scenarios are becoming increasingly 
unlikely. During 2010, delinquency rates on construction and 
development loans began to improve slightly, falling 1 percent. 
Still, even if CRE delinquency metrics continue improving, 
there remains a sufficiently large overhang of distressed CRE 
at commercial banks that loss rates for this portfolio will 
likely stay high for some time to come.
    Approximately one-third of all CRE loans are scheduled to 
mature over the next 2 years. This circumstance represents 
substantial refinancing risk, as CRE loans typically have large 
balloon payments due at maturity. Since the passage of the 
October 2009 supervisory guidance on prudent loan workouts, 
banks have significantly increased the level of restructuring 
of CRE loans. Economic incentives to restructure or refinance 
existing loans are aided by the current low interest rate 
environments. Some banks with properties in healthier markets 
are also beginning to see a pickup in demand for high-quality 
properties with strong tenants.
    Since the beginning of 2008 through the third quarter of 
2010, commercial banks have incurred almost $80 billion of 
losses related to CRE exposure, equating to a little over 5 
percent of the average exposure outstanding during that period. 
Given past historical experience and the recent improvement 
witnessed in the broader economy, it is estimated that banks 
have taken roughly 40 to 50 percent of the CRE losses that they 
will realize over this cycle.
    While we can project potential losses facing banks, losses 
ultimately realized in this cycle will depend on macroeconomic 
and financial factors, especially unemployment rates and 
interest rates. Sensitivity of losses to those factors are 
why--is why we continue to emphasize the importance of stress 
testing as a critical element of managing risks associated with 
CRE concentrations.
    Progress on working through the overhang of distressed CRE 
will take time and it will depend on banks taking strong steps 
to ensure that losses are recognized in a timely manner, that 
loan-loss reserves and capital appropriately reflect risk, that 
loans are modified in a safe and sound manner, and that loans 
continue to be made available to creditworthy borrowers. To 
this end, the Federal Reserve will continue to work with 
lenders to ensure that bank management and supervisors take a 
balanced approach to ensuring safety and soundness in serving 
the credit needs of the community.
    Thank you. And I look forward to your questions.
    [The prepared statement of Mr. Parkinson follows:]

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    The Chairman. Thank you, Dr. Parkinson.
    Mr. Wilson.

 STATEMENT OF DAVID WILSON, DEPUTY COMPTROLLER FOR CREDIT AND 
     MARKET RISK, OFFICE OF THE COMPTROLLER OF THE CURRENCY

    Mr. Wilson. Chairman Kaufman and members of the panel, I 
appreciate the opportunity to discuss the OCC's observations 
about the commercial real estate market and its impact on 
national banks.
    The OCC supervises about 1415 national banks, representing 
about 18 percent of all insured depository institutions, and 
approximately 63 percent of all IDI assets.
    Commercial real estate lending is a prominent business line 
for many national banks and is a sector that the OCC monitors 
very closely. National banks hold approximately 735 billion in 
outstanding CRE loans, which is about 16 and a half percent of 
their aggregate loan balances.
    While there are signs that the commercial real estate 
markets are beginning to stabilize, we are a long way from full 
recovery.
    Vacancy rates across major property types are starting to 
recover, but remain high by historical standards. We expect 
vacancy rates to remain elevated for at least the next 12 
months.
    Capitalization rates, the rate of return demanded by 
investors, have also shown recent signs of stabilization. Cap 
rates fell substantially from 2002 to 2007, to a point where 
they often did not fully reflect the risks associated with the 
properties being financed. Then they increased markedly in 2008 
and 2009, as investors became more risk-averse. Recently, cap 
rates appear to have stabilized, particularly for high-quality 
assets, but the spreads being demanded by investors relative to 
treasuries remains wide.
    A key driver for property values and CRE loan performance 
is the net operating income or cash flows generated by the 
underlying properties. Overall, NOI has continued to decline 
due to soft rental rates. While we expect the rate of decline 
to lessen, only apartments are expected to show meaningful NOI 
growth this year, with other major market segments expected to 
turn positive in 2012.
    Property prices have also shown recent signs of 
stabilization. The Moody's All Property Index recorded an 
increase of 0.6 percent in November 2010, which was the third 
consecutive month of national price gains. While this trend is 
encouraging, we expect the prices to be volatile until 
underwriting market fundamentals improve consistently.
    The trends and performance of CRE loans within national 
banks mirror those in the broader CRE market. While there are 
some signs of stabilization in charge-off rates, nonperforming 
loan levels remain elevated and continue to require significant 
attention by bank management and supervisors.
    The effect of distressed commercial real estate on 
individual national banks varies by size, location, type of CRE 
loan. Because the charge-off rates for construction loans led 
performance problems in the sector, banks with heavier 
concentrations in this segment tended to experience losses at 
an earlier stage. Performance in this segment is expected to 
improve more rapidly as the pool of potentially distressed 
construction loans has diminished. Conversely, banks whose 
lending is more focused on income-producing commercial 
mortgages are continuing to experience increased charge-off 
rates.
    Another factor for many community and midsized banks is 
their CRE concentrations. Although CRE concentrations as a 
percentage of capital has declined recently, they are still 
significant for many midsized and community banks. CRE 
concentrations and problem-loan workouts continue to be areas 
of emphasis and OCC examination activities, and our objectives 
are threefold: ensuring that the banks accurately risk-rate 
their loans, that they work constructively with troubled 
borrowers, and that they maintain adequate loan-loss reserves 
and capital, taking appropriate charge-offs when needed.
    We are also emphasizing the importance of stress testing--
and are assessing whether additional supervisory policies or 
guidance may be needed for examiners and institutions, to more 
effectively deal with the risks that CRE concentrations can 
pose to the industry and the viability of individual financial 
institutions.
    In summary, there are modest signs of improvement, but the 
CRE markets still face significant headwinds. Ultimately, 
stabilization of the CRE markets will require restoring 
equilibrium between supply and demand, and will hinge on 
recovery of the overall economy. This process is not painless, 
and we expect CRE portfolios will continue to be a drag on some 
bank's performance for at least the next 12 to 18 months. 
During this period of adjustment, the OCC will continue to take 
a balanced and measured approach in its supervision.
    [The prepared statement of Mr. Wilson follows:]

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    The Chairman. Thank you, Mr. Wilson.
    We have some questions.
    I'd like to start out talking about--primarily about small 
banks. And I'd like each witness to comment on how much you 
think--you've all talked about the distressed commercial real 
estate market--how much you think that overhang on small banks 
is affecting their recovery.
    And we'll start with Ms. Thompson.
    Ms. Thompson. I think the overhang is impacting their 
recovery. But, when we issued the guidance on CRE loan 
workouts, we started to see a lot of restructurings. And for 
the banks that are in our portfolio, they have a close and good 
relationship with their borrowers. We have about 4,700 
institutions where we are the primary Federal regulator, and 
our employees are located and live in the communities. The 
bankers that service the commercial real estate loans and their 
portfolio have a high touch with their borrowers, and they are 
familiar with the markets, and it would be a win-win for them 
to work out and restructure these loans. We've been encouraging 
them to do so. We've also been encouraging them to acknowledge 
when they can't work these loans out, so that they can take the 
losses right away.
    The Chairman. Dr. Parkinson.
    Dr. Parkinson. I think it is affecting the recovery. As I 
think all of us have been saying, we've really been emphasizing 
the importance of prudent and effective workouts, and certainly 
monitoring what the banks are doing in that area.
    But, even with prudent and effective workouts, many of them 
have large volumes of assets that are extremely troubled, and, 
in the course of working them out, further losses are going to 
be recognized. And, in some cases, that's going to jeopardize 
their ability to pay the economic role that they need to play. 
And I don't think, at this stage, there's much we can do about 
that, other than make sure that they follow the workout 
guidance to mitigate and limit whatever damage their troubled 
condition would otherwise produce.
    The Chairman. Mr. Wilson.
    Mr. Wilson. Yes. I have similar comments. There are a 
number of severely distressed community banks that probably 
won't make it. And, there is no real silver bullet. But, the 
best we can do is make sure that we're fair and consistent with 
our workout guidance, because, in many cases, that's the best 
for the bank, that's the best for the customer, and, as was 
mentioned before, it's also best for the community.
    The Chairman. Many times, when you talk to borrowers,--I 
think it's--many, many borrowers, you have good relationships 
with the banks--the borrowers say the banks tell them they 
can't lend them the money, they can't extend the loan, they 
can't work it out because of the regulators. I've heard this, 
time and time and time again.
    And so, Ms. Thompson, do you have some comments you can 
address to this complaint? Because it is--I mean, the person 
that these borrowers are blaming are not the banks that won't 
lend them the money, it's the--they blame it on the regulators.
    Ms. Thompson. You're absolutely correct. We hear that all 
the time.
    And we really, as regulators, try to take a balanced 
approach to supervision. We want banks to make good, prudent 
loans. We don't want them to create further problems by 
``kicking the can down the road.'' We think it's important that 
there are good underwriting standards. And as long as a bank is 
making good loans, we are encouraging that practice, both for 
small business lending and for residential CRE. The regulators 
are trying to work with institutions so that we can have a safe 
and sound banking system with good loans, because we all know 
what happens when a bad loan is made.
    The Chairman. Dr. Parkinson.
    Dr. Parkinson. Consistent with that, we're certainly aware 
of these reports, and we've been taking a very careful look at 
what our examiners are doing to try to ensure that they follow 
the guidance that we've set out and take an objective and 
balanced approach.
    We try to continue to enforce that through guidance to 
examiners and through training. We're very carefully looking 
and monitoring the examination process, which includes local 
management vettings of exam findings, and reviewing a sample of 
exam reports to see if there are any inconsistencies with the 
guidance.
    Our monitoring, to date, suggests that by and large, the 
examiners are appropriately considering the guidance. And if 
we've made it clear that if a banking organization is concerned 
about supervisory structures imposed by our examiners, they 
should incur contact either the Reserve Bank or contact us, in 
Washington, to discuss and identify the problems.
    The Chairman. Mr. Wilson.
    Mr. Wilson. I agree with that. We do hear that a lot. We 
are very sensitive to it. When we try to solicit specific 
examples of a situation, where we can follow up, as Pat says, 
many times when we do get specific situations, we do believe 
our examiners are working appropriately. But, lots of times 
it's more general, that we can't really track it down.
    The Chairman. I don't have anymore time for questions, 
because--I will not ask--the question I want to ask is, How 
many times do you think the bankers are blaming you for the 
fact that they don't want to make the loan, anyway? But, I 
won't ask that question.
    Mr. McWatters.
    Mr. McWatters. Thank you, Senator.
    Let me start at a 30,000-foot altitude and ask a basic 
question.
    Back at--the last time we had a severe real estate 
depression was '89 through '94, and the answer was the 
Resolution Trust Authority--or Corporation. RTC purchased lots 
of loans, sold them at very cheap prices, although it may not 
have been favorable for the taxpayers, but it did lead to 
immediate price discovery, as to what was a fair market value 
of those assets.
    Given where we are today, is there a need for an RTC?
    Ms. Thompson.
    Ms. Thompson. Well, I worked at the RTC, and I think the 
industry and the regulators can work through this issue. We are 
seeing signs of stabilization. The CMBS market is coming back; 
it's not where it once was, but we saw a lot of transactions in 
the fourth-quarter last year. Vacancy rates are declining. And 
it seems like the workout process just needs time to work 
itself through.
    I'm not sure that an RTC-type entity is necessary at this 
point.
    Mr. McWatters. Okay. Thank you.
    Dr. Parkinson.
    Dr. Parkinson. Just to make an observation that the RTC was 
created to dispose of the assets of failed banks after they had 
failed and come into the FDIC's portfolio.
    Mr. McWatters. Right.
    Dr. Parkinson. If the concern today is about this overhang 
of troubled assets at the banks, until they fail, there really 
wouldn't be a purpose for RTC.
    And, if the notion was that we create a government entity 
to buy troubled assets from commercial banks that were still 
sound, you'd face the same issues they did in trying to get the 
original conception of the TARP program off the ground?. And 
how do you do that in such a way that you aren't creating a 
government subsidy, on the one hand, or not giving a fair price 
to the troubled institution, on the other?
    Mr. McWatters. Oh, okay. Well, let me ask you this 
question. Is there any need for a quasi-TARP structure? I've 
read about government-sponsored REITs, quasi-REITs, where the 
government purchases mortgage, purchases property, holds them 
in this REIT-type entity--it's not a technical REIT, under the 
Internal Revenue Code--holds it, sells interest in it to the 
public, and then ultimately, as the properties recover, 
disposes of the properties, probably with the public investors 
granting back some sort of an equity participation right to the 
government, so the government walks out whole. Is there any 
need for something like that?
    Dr. Parkinson. I haven't given that specific proposal any 
careful thought. But, again, I think the challenges would be 
many. Again, what price would the REIT purchase the assets from 
the institutions? Where within the government would we have the 
capacity to manage a REIT? But, I haven't heard that proposal, 
and therefore----
    Mr. McWatters. Yeah.
    Dr. Parkinson [continuing]. I probably can't give you a 
fully satisfactory answer.
    Mr. McWatters. Yeah. What I'm looking for is not 
necessarily mechanics, but whether or not governmental 
intervention, taxpayer funds, are needed to solve this problem, 
or if this is a problem that can simply be solved by the market 
over the next 2 or 3 years.
    Dr. Parkinson. Well, I think funds have been flowing back 
into real estate REITs, of late. And also, another point I 
think all of us made was that, ultimately, the fate of these 
commercial real estate properties is very much going to be 
driven by developments in the broader economy, whether it's the 
path of interest rates, unemployment.
    So, maybe the best thing we can do is try to support the 
recovery through prudent and appropriate monetary and fiscal 
policies. And that may be the single most effective thing to 
support the value of those CRE assets.
    Mr. McWatters. Okay.
    Mr. Wilson.
    Mr. Wilson. I agree. I think there is a lot of money out 
there. There's private investor money. They're just looking for 
the right price. There is price discovery on some of the most 
distressed assets. But, I think there are many cases where it 
makes more sense for the bank to hang on and work with the 
borrower, if there is a viable source of repayment that can 
eventually pay the loan. So, I think that we probably can work 
through the process, as painful as it would be.
    Mr. McWatters. Okay.
    Ms. Thompson, did you have something else to add?
    Ms. Thompson. Mr. McWatters, I think you're referring to an 
equity trust transaction. This was a type of transaction that 
was used at the Resolution Trust Corporation. Again, that was 
for failed assets, where the assets were sold into a trust--
there were nonperforming and some performing--and the 
government took a percentage share of both the downside and the 
upside. That seems to work well for assets from failed 
institutions.
    I'm not sure that that is necessary right now, because the 
market is starting to open up. Some of the problem banks are 
starting to raise capital. And we are seeing slow signs of 
asset sales. And, as I mentioned earlier, the CMBS market is 
slowly coming back. And, especially in the CMBS market, the 
special services have a lot more flexibility to work out the 
loans, as do banks that have commercial real estate in their 
portfolio.
    The transaction itself has been done before, and I think 
that it's a good mechanism, but I'm not sure it's necessary 
for----
    Mr. McWatters. Okay.
    Ms. Thompson [continuing]. An open market.
    Mr. McWatters. Okay. Fair enough. My time's up.
    But, my takeaway from this is that, from the FDIC, Fed, and 
OCC's perspective, there is not the need--clear need, today, 
for direct governmental intervention of taxpayer funds to solve 
this problem.
    Thank you.
    The Chairman. Thank you, Mr. McWatters.
    Mr. Silvers.
    Mr. Silvers. Thank you, Mr. Chairman.
    I--before I begin my questioning, I just want to observe 
that, in one of the--our work, as a panel, is coming to an end. 
This probably is our second-to-last hearing. And one of the 
great pleasures of having served on this panel is to be able to 
learn from such dedicated public servants as yourselves. And I 
think, particularly when we discuss motivations of folks, it's 
always apparent to me that people such as yourselves have many 
opportunities to make lots of money elsewhere. And I just 
suspect, just from what I know of each of you, that you've 
spent long careers serving the public for far less than you can 
make in the private sector. And the motivations involved in 
that are clearly, perhaps, not dreamed of in economist 
philosophies.
    Now, from that high level to the more mundane. Mr.--Dr. 
Parkinson, in your testimony, you--in your written testimony, 
you observed that the commercial banks have charged off about 
$80 billion of commercial real estate assets. Do I take from 
your testimony that--and this is all--to all three of you, but 
particularly to Dr. Parkinson--that these charge-offs have 
largely been, essentially, driven by--not by refinancing 
failures, but by the failure of the borrowers to be able to 
make the payments? Is that fair? Do I read that right?
    Dr. Parkinson. I think it would be difficult to parse. They 
can't meet the terms of the original loan, or it's in trouble. 
Whether that's because they don't have sufficient cashflow to 
service the debt, outside of an event where the balloon payment 
comes due, or how much that was an inability to make the 
balloon payments, I don't know. I'm guessing that there's some 
of both. And certainly, in many cases, the fundamental problem 
is the lack of cashflow----
    Mr. Silvers. Right.
    Dr. Parkinson [continuing]. And that, in turn, would make 
it very difficult for them to make the balloon payments----
    Mr. Silvers. But, the reason why the chargeoff has 
occurred--Mr. Wilson, you're nodding your head--it seems 
likely, given just the timing of the refinancing issues and the 
balloon payments, that the reason why these 80 billion charge-
offs have occurred is more likely to be in the routine 
cashflows rather than in the balloon payment. Is that----
    Mr. Wilson. Yes, I would agree with that, because 
commercial banks, insurance companies, and really even special 
services and CMBS, you know, have a fair amount of ability to 
work with customers. And if there is cashflow there and the 
loan is matured, that's an issue. But, lots of times they can 
work through those issues if there's a fundamental source for 
repayment still with the loan.
    Mr. Silvers. Ms. Thompson, do you have anything to add to 
this?
    Ms. Thompson. Yeah. I think much of the chargeoffs have 
taken place in the ADC space.
    Mr. Silvers. Yes, I was getting to that.
    Ms. Thompson. Oh.
    Mr. Silvers. Please continue.
    Ms. Thompson. I was just going to say--because there's a 
distinction between the charge-off numbers for ADCs and the 
charge-offs for owner-occupied commercial real estate. And 
you'd notice significant differences in them both, and 
significant----
    Mr. Silvers. What portion of the----
    Ms. Thompson [continuing]. Differences in the----
    Mr. Silvers [continuing]. 80 billion in commercial bank 
charge-offs do you think are ADC--meaning the development loans 
and the like?
    Ms. Thompson. For commercial banks and savings 
institutions, about $64 billion, or 70 percent of all CRE 
charge-offs since year-end 2007, were attributable to ADC.
    Mr. Silvers. All right. Now, in--you know, this hearing has 
sort of already ranged widely, but it seems to me that our 
fundamental concern here, for starters, is that we've got about 
34 billion in TARP assets in banks through CPP, mostly--almost 
entirely smaller banks. They're exposed to the commercial real 
estate market disproportionately. The question is, What happens 
when the balloon payments come due? The--it seems as though--do 
you--tell me if you disagree, but it seems though that question 
really--we haven't really gotten to that question yet, that the 
charge-offs we have seen are predominantly due to cash flow 
issues and disproportionately in development loans, not in, 
sort of, occupied properties. Is that a fair summary of where 
we sit----
    Ms. Thompson. I think----
    Mr. Silvers  [continuing]. Today?
    Ms. Thompson. I think that's fair.
    Mr. Silvers. All right.
    So, our panel's concern, I think--and this is the--like, 
the third hearing and we've done a couple of reports--is, What 
happens when the balloon payments hit?
    Mr. Wilson, you say that there's a lot of flexibility here. 
So, let me ask you this. If I'm a C--if I'm a TARP-recipient 
bank, holding some of the public's money, and I come to one or 
all or more of you, in a year's time, with a bunch of loans 
that have come due, and, they--and the borrowers can't make the 
balloon payments, and they have problems refinancing, because 
the price of property has fallen 40 percent, which is the 
typical--which is what Moody says the market's fallen--so, I'm 
the--I'm a bank, and I come to you and I say, ``I'd like, 
essentially, forbearance. I'd like to be able to rollover this 
loan or redo it, even though the value of the property is now--
can't--the collateral can't support the loan, under normal 
underwriting standards,'' what do you guys say?
    Ms. Thompson. We're telling our examiners not to have banks 
classify loans just because the collateral value has declined. 
We look at the borrower's ability to repay. So, to the extent 
you have a borrower, and they can make a repayment, I think 
that is the fundamental issue.
    Mr. Silvers. But, I'm asking when the--I mean, this is a 
situation where the borrower literally can't make a payment. 
There's a balloon payment due, they can't make it. They--you 
know.
    Ms. Thompson. They may not be able to make that payment, 
but there is a payment that----
    Mr. Silvers. They're making their ongoing payments.
    Ms. Thompson. If they're making their ongoing payments, 
there are flexibilities that the banks are allowed. The CRE 
workout guidance provides some specific examples of those types 
of transactions. They can modify the loan; they can extend the 
loan. We would focus specifically on the borrower's ability to 
repay. We would encourage a modification.
    Mr. Wilson. Yeah, speaking broadly, for construction and 
development loans, if it was a failed project, you really have 
no cashflow; it's a liquidation-type situation. Most of the 
commercial mortgage, income-producing loans, have tenants and 
they have cashflow. It may not be enough cashflow, but there's 
an opportunity to resize the loan, bring additional equity to 
the table. If there is no additional equity, there's the 
ability for the bank to charge it down, but not off, and 
restructure the loan. And so, the loss content's not as high, 
in commercial mortgage, which we see is the bigger issue, going 
forward.
    Mr. Silvers. My time is expired.
    Thank you.
    The Chairman. Dr. Troske.
    Dr. Troske. Thank you.
    I'd like to continue this line of questioning that Mr. 
Silvers has started, because I think it's a very important one. 
And I guess I want to sort of more generally--it seems like--
this is a fairly complicated problem, knowing when you write a 
property down, in a dynamic economy in which prices obviously 
are fluctuating, and that affects the value of the underlying 
property, and things like that. So, I mean, is there--are there 
general rules, that you can sort of provide us with, when you 
think it's appropriate for a bank to write down a property and 
when it's--you leave it on the books as is? And what's the cost 
and benefits from taking either action?
    I'll start with you, Ms. Thompson. Could you?
    Ms. Thompson. Well, I think that a borrower's ability to 
repay is a big factor in the consideration of whether you 
modify a loan, or not. And, certainly foreclosures need to take 
place and write-downs need to take place. If banks take a 
really hard look at the borrower's capacity, as opposed to 
collateral value, then they could likely restructure and modify 
a loan that would work for both the borrower and the bank.
    I do think that most institutions, especially the smaller 
institutions, hold these loans in portfolio, and they are very 
much aware of the appraisals and values that are in their 
specific communities. These bankers have a really good 
understanding of what they're supposed to do and when they're 
supposed to do it. We try not to be too prescriptive, but our 
view is, look at the borrower's ability to repay and try to 
restructure the loan. If you can't, then write it off as soon 
as you possibly can.
    Dr. Troske. Okay, thank you.
    Dr. Parkinson, do you have any thoughts?
    Dr. Parkinson. Yes, I generally agree. Well, number one, I 
think you're right, that it is a difficult question. I think 
Sandra is right, that the local bank probably has the best 
information to make a sensible judgment about that difficult 
question, and that the borrower's ability to service even a 
restructured loan is really the critical thing. Or perhaps the 
bank has to ask themself, ``I have two alternatives. I 
foreclose, then I essentially manage the property and try to 
maximize the value. Or, do I leave it in the hands of the 
original borrower? And really, the answer to that question's 
going to depend on my assessment of the borrower and his 
capacity to really manage that property and to maximize its 
value, whether they can do that better than I can.''
    Dr. Troske. Go ahead, Mr. Wilson.
    Mr. Wilson. Fundamentally, when we evaluate a loan, we look 
first to cashflow sources to repay the loan such as the NOI 
from the property, bona fide guarantors that have the ability, 
or other viable sources. And, as long as that's still intact, 
the value of the property is less important. Where the value of 
the property becomes important is when that primary source or 
those sources of cashflow are not there, or they're 
insufficient, then we have to look to the value of the property 
and that's sort of our benchmark for what you charge the loan 
down to. But, we would not do that if there's a source of 
cashflow to pay the loan. The collateral is only a secondary 
source of repayment.
    Dr. Troske. Dr. Parkinson, I want to turn to--sort of 
expand on something that you sort of hinted at that's, I guess, 
sort of a related issue. I mean, one of the things that we have 
noted, as a panel, is the concentration of these--of CRE loans 
in small- and medium-sized banks. Do you have sense of why? Do 
they have a--what is their comparative advantage in making 
these loans? I'm assuming that that's why they're all there. 
And there's also--often been questions about whether it 
should--whether these loans should be with--you know, 
concentrated in these small- and medium-sized banks. I guess 
the alternative is that they would be made by larger banks.
    Give me an overall sense of how we got to this situation, 
where these are the banks holding their loans? And what's their 
advantage in doing this? And, maybe, what's the cost of doing 
it?
    Dr. Parkinson. Well, just stepping back as an economist, I 
think these loans are ones where information asymmetries are 
particularly important. And if I'm a borrower from outside the 
local area, I'm not going to have the knowledge of the 
particular area and the project that the local bank does. And 
that's probably what gives the local bank their competitive 
advantage, compared to other potential lenders of these kinds 
of loans.
    Over the years, one of the reasons smaller institutions 
have become concentrated in CRE is that other kinds of loans 
that they historically made, because of technological changes, 
development of securitization, et cetera, they no longer were 
the most efficient or effective lender, when it came to those 
kinds of products. So, in some sense, their concentration in 
CRE is a result of an adverse selection, where the other things 
that they used to be able to fund, they no longer can do so 
competitively.
    So, it's understandable why they've ended up where they 
are. It does pose risk. Although one of the things that Sandra 
emphasized in her testimony that I think is worth emphasizing 
is that, while lots of banks with CRE concentrations are in 
deep trouble, there are also lots of banks with CRE 
concentrations that are managing those concentrations quite 
well so that--you know, that comes down to the importance, not 
simply of what the percentage of their portfolio is in CRE, but 
their capabilities for managing that portfolio. And that's why 
I think a lot of our guidance has not been specified, in terms 
of, for example, putting arbitrary limit on the concentration, 
but trying to encourage the institutions to manage those 
concentrations effectively.
    Dr. Troske. Okay, thank you.
    My time's up.
    The Chairman. Thank you.
    Mr. Neiman.
    Mr. Neiman. Dr. Troske, in his opening statement, opened 
the door for discussion on the role of government, and 
particularly financial regulators. And I think CRE is, maybe, a 
good example of assessing the role of bank regulators, because, 
you know, regulators typically do review banks at a point in 
time--as well as looking back over bank practices over a prior 
period--assessing the bank's asset quality at a point in time, 
as well as its capital ratios.
    There's a growing consensus that, in addition to this type 
of static assessment, that there should be a forward-looking 
approach to supervision, as well. And I think all of you, in 
your written testimonies, focused on issues around stress 
testing, not only by the regulator, but also in what you're 
expecting from the banks. And when you look at the Dodd-Frank 
reforms, there are additional assessments, going forward, with 
a forward-looking approach, whether it be living wills or the 
role of the FSSA.
    Can you talk about your views on the lessons learned here, 
and how regulatory supervision has changed? And is this a 
concept that is being grasped by regulators?
    Ms. Thompson. Yes. At the FDIC, we do have a forward-
looking supervision program, where we have taken all the 
lessons learned from the bank failures and applied them to our 
supervision process. We looked at institutions that had high 
concentrations of commercial real estate that had volatile 
funding sources, and we have put together a training program, 
for all of our examiners that focuses on, not just the 
financial condition of the institution, but the practices of 
that institution. And we are increasing our offsite 
surveillance for all institutions, so that we know--especially 
for those that have CRE concentrations--what their financial 
condition is at any particular point in time.
    We're very concerned about interest rates. This is a low-
interest-rate environment, and we want our institutions to 
conduct stress testing so that bank management and the FDIC can 
see where the bank will be if an adverse situation takes place. 
We're very concerned about the health and safety and soundness 
of the financial sector, and we have had a good response from 
our bankers with regard to this forward-looking-supervision 
approach.
    Mr. Neiman. Dr. Parkinson, can you comment on in the CRE 
context as to what is expected of institutions in assessing 
portfolios and risk under different economic scenarios, as well 
as utilizing, statistical modeling for loss-reserving?
    Dr. Parkinson. All right. Well, I think that's, again, a 
very important emphasis in the CRE guidance that we put out in 
2006. That's all been reinforced by Dodd-Frank, with respect to 
the larger institution that requires the board to conduct 
annual stress tests and also requires banks to conduct their 
own stress tests on the smaller ones, on a semiannual basis; 10 
to 50 billion, on an annual basis, and to actually publish 
reports on that. And obviously, where they have CRE 
concentrations, the stress testing of the CRE portfolios will 
have to be an important part of that.
    Also an important initiative that I think I mentioned is 
the CRE data-collection project that the agencies have embarked 
upon, where we're collecting loan-level data on CRE loans; 
initially, from the very largest CRE lenders, and that's being 
expanded somewhat. But, I think that loan-level data will give 
us a better insight into asset class, to understand how the 
values of the loans are being driven by the underlying economic 
variables--vacancy rate, rental rates, et cetera--and, from 
that, to be able to figure out better how to stress test their 
existing portfolios. So, I think that is an important recent 
cooperative supervisory initiative among the three agencies.
    Mr. Neiman. Thank you.
    So, the issues around data collection, we've talked often 
about data--better performance data on the residential side; it 
sounds like it's just as important on the commercial side.
    Mr. Wilson, would you like to comment about the 
expectations? What you would like to see in institutions to 
address some of the risks, going forward, on the CRE, as well 
as any changes in examination approach?
    Mr. Wilson. Stress testing is obviously an area of focus at 
all levels of banks. We would size our expectations to the size 
of the bank. And we would also size our expectations to the 
level of concentrations that those banks have. So, if you're a 
community bank without a concentration, don't have a lot of hot 
money, things like that, we would expect a lower level.
    But, we are in the early stages of putting together 
additional guidance. We're working with the Fed and the FDIC on 
that. We do have tools out there now, but we're talking about 
some additional tools that, especially, our community banks can 
use.
    Mr. Neiman. Thank you.
    The Chairman. Thank you.
    And followup on a point raised by Dr. Troske, about the 
concentration of commercial real estate in the smaller banks. 
What impact do you think that's having on the ability of these 
banks--since they have this overhang in commercial real estate, 
the ability to carry out the other things that the bank does? 
Is this--do you think this is limiting their ability to make 
other loans and be--stimulate the economy in other ways?
    And let's start with Mr. Wilson.
    Mr. Wilson. I think, for a small subset of banks, the ones 
that are on the FDIC problem-loan list, for example, that's a 
true concern, because they're focused on working out of 
commercial real estate. But, we have a large number of banks, 
at all sizes, where they're open for business for commercial 
real estate lending as well as other lending. And, you know, I 
think they pull back, we think rightfully so, on some of the 
underwriting standards that, in retrospect, got too liberal. 
And so, it's a little bit of a new world for borrowers. But, we 
believe, there's plenty of credit available for borrowers of 
creditworthy quality.
    The Chairman. Dr. Parkinson.
    Dr. Parkinson. I'm going to build on his points. I think, 
where a lender or bank has a CRE concentration, and that is a 
concentration of loans that weren't very well underwritten and 
that are suffering a lot of losses, which is impairing their 
condition, those banks when you look at loan growth, by the 
CAMEL ratings for the banks, the banks with the lowest CAMEL 
ratings are contracting loans at a must more rapid pace, and 
are recovering more slowly, in terms of their lending activity, 
than the stronger rated banks. So, to the extent that the 
commercial real estate concentration is not managed well and 
the bank gets into trouble, that clearly does have an adverse 
effect on people who rely upon that bank for credit.
    The Chairman. Ms. Thompson.
    Ms. Thompson. I agree with my colleagues. And I've 
mentioned that, during the crisis, the levels of lending for 
the larger institutions decreased, while the levels of lending 
for the smaller community banks, that do have the significant 
concentrations, did increase.
    The Chairman. Ms. Thompson, if the Open Market Committee 
were to prove an increase in the Fed funds rates, would that 
have a result--be a significant shock on the commercial real 
estate market--or do you know where the commercial real estate 
going to--market's going to be?
    Ms. Thompson. I'll defer that an answer to that to my 
colleague at the Federal Reserve.
    The Chairman. Well, he can give us the best estimate of 
whether it'll happen or not----
    [Laughter.]
    The Chairman [continuing]. Which he will not do. And I'm 
more interested in, if it does happen, for the banks you're 
looking at, would this be a significant problem to those banks?
    Ms. Thompson. I hate to----
    The Chairman. Let me put it this way. Without the open 
market--if interest rates start going up, do you----
    Ms. Thompson. This is a really good environment for 
restructuring. It's a really good environment for refinancing, 
modifications, and sales. I think that it might cause an issue 
or two.
    The Chairman. Dr. Parkinson.
    Dr. Parkinson. I think it would depend on why interest 
rates were rising. And the reason interest rates would be 
rising was that the economy was recovering, unemployment was 
coming down, and the Fed was feeling comfortable raising its 
target rate. And I'd be willing to accept the risk and the 
adverse effect of the rising interest rates in that context, 
where it's in the context of economic growth, recovering 
smartly.
    The Chairman. Got it.
    Mr. Wilson.
    Mr. Wilson. I agree totally with that. I think the disaster 
would be if rates went up and the economy doesn't improve 
concurrent with that. But, you know, generally when rates go 
up, it means the economy's getting better. And, hopefully then 
there's more capacity in commercial real estate borrowers.
    The Chairman. Mr. Wilson, you mentioned stress tests; in 
fact, a number of you mentioned stress tests--all of you did, 
in fact--stress tests. Do you think when you do the--when 
stress tests come along, they should concentrate--or, what role 
do you think commercial real estate should play in determining 
stress tests on a financial institution right now?
    Mr. Wilson. Well, I think that the lessons that we just 
went through, and the lessons of the late '80s, early '90s, 
should be applied to commercial real estate portfolios. It has 
been pointed out by my colleagues, that some banks do come 
through even severe downturns and come out the other side, even 
though they have large concentrations. But, what we need to do 
is understand better and size those. For example, it seems like 
construction and development--we may need to pay a lot more 
attention to those than, maybe, the permanent commercial 
mortgage. But, even then, at some level, a concentration is 
just too much. And I think, if you have a good stress test, you 
can show that.
    The Chairman. Dr. Parkinson.
    Dr. Parkinson. We talked about the importance of stress 
testing. I think Dave also observed that, to the extent you 
have a concentration in CRE, it's obviously really important 
that you stress test your CRE portfolio. So, that has to be a 
critical part of it, if that is the profile of your 
institution.
    The Chairman. Ms. Thompson.
    Ms. Thompson. I do think stress testing is important, 
especially for commercial real estate. I also believe that the 
good underwriting underneath the loans is probably the most 
critical.
    The Chairman. Thank you.
    Thank you.
    Mr. McWatters.
    Mr. McWatters. Thank you.
    You know, I don't know of a real estate downturn that has 
not ultimately turned around. There's always a point where 
things were overvalued, there were not enough buyers, there 
were not enough tenants. But, you look forward 5 years, and 
things are a lot different.
    Today, we have the added benefit of very low interest 
rates. Why not just kick the can down the road? Why not 
refinance, short-term basis, assuming interest rates are going 
to be down? Keep that going for 3 or 4 years. Wake up. Realize 
the market has recovered, prices are back up, borrowers are 
willing to pay more for--I mean, purchasers are willing to pay 
more for the property; tenants are willing to pay more in 
rental rates. And you're through this mess without the banks 
recognizing losses, without the banks having impaired capital, 
and without the borrowers representing--recognizing 
cancellation of indebtedness income.
    What's the problem with that?
    Ms. Thompson.
    Ms. Thompson. I just don't think we could ignore the 
problems that exist today. That would be a huge prediction on 
an uncertain outcome. It's important to recognize and have some 
transparency for the financial sector so that people know that 
they have good loans, or they don't. And, it's important to 
take immediate action, whether it's modifying loans or writing 
the loans off, it's either one or the other. ``Kicking the can 
down the road'' just doesn't seem like it's an acceptable 
outcome.
    Mr. McWatters. Dr. Parkinson.
    Dr. Parkinson. I guess, I'd just observe that that strategy 
of kicking it down the road doesn't uniformly deliver success, 
historically. And I think the better approach, again, is to 
look at it loan by loan, borrower by borrower, and make an 
assessment as to whether they really have the capacity to 
service the debt. I think, if you're just kicking it down the 
road, there's a real possibility if the property is in the 
wrong hands, its value is just going to deteriorate, perhaps 
even if there is an economic recovery. So, I guess I would 
agree that we can't count on kicking it down the road producing 
the desired outcome.
    Mr. McWatters. Okay, but that is not being done? I mean, 
that's being done some, but, as a whole, that is not being 
done?
    Dr. Parkinson. Well, in the sense it's simply deferring the 
problem, we hope it's not being done at all. But, in some cases 
a loan may be restructured because that is in the best interest 
of both the bank and the borrower. But, our guidance tries to 
make clear that just doing that automatically or routinely, to 
defer recognition of losses, is not a good strategy.
    Mr. McWatters. Okay.
    Mr. Wilson.
    Mr. Wilson. I would just add that our guidance is also very 
clear that, if you choose to work with your borrower, number 
one, it has to improve the prospects for ultimate repayment; 
and, number two, you need to account for that loan properly. 
So, if there's risk in that loan, there needs to be appropriate 
reserves, there needs to be appropriate accrual on the loan, 
chargeoff, as necessary. For the bank, it's not kicking the can 
down the road, it's that the ultimate repayment is impaired.
    Mr. McWatters. So, the best approach is to recognize 
economic reality, write it down, recognize losses, take the hit 
to capital, and, in effect, have price discovery based upon 
that. Is that a fair assessment?
    Ms. Thompson. Yes.
    Mr. McWatters. Okay.
    And that ties back to my first question, about RTC-type 
structures, bailout-type structures--is that that might not be 
the answer if the financial institutions that were holding the 
CRE were in such perilous shape they could not absorb the 
losses, they could have not absorbed the hits to capital, and 
that the borrowers could not absorb the tax hits. Is that a 
fair statement?
    Ms. Thompson. I think so.
    Mr. McWatters. Okay.
    That's it.
    The Chairman. Thank you.
    Mr. Silvers.
    Mr. Silvers. Just to pick up where I left off in the last 
round. So, we have a whole bunch of small banks that still have 
TARP money, in the form of CPP, disproportionally exposed to 
commercial real estate--to the commercial real estate sector. 
Do any of you have thoughts on what is--if our policy goal--and 
it certainly--it would be, if I was the policymaker--is to 
avoid further concentration in our banking sector--if that's 
our policy goal, which means that we would like a robust small 
bank sector, any particular advice to Treasury, in terms of the 
management of TARP's investments in small banks over this 
period when these refinancings are coming due in commercial 
real estate?
    Ms. Thompson. Many of the smaller institutions that have 
TARP CPP funds are managing their portfolios adequately. The 
Treasury has a provision, to the extent that TARP recipients 
miss dividends, that the Treasury can add someone to oversee 
the bank's board of directors. So, I think the measures are 
there. There are several institutions that have concentrations, 
and they're working their way through the crisis adequately.
    Mr. Silvers. Any more--any further thoughts on this 
subject?
    Mr. Wilson.
    Mr. Wilson. No.
    Mr. Silvers. Or----
    Mr. Wilson. Yeah, I'm not real close to the TARP program. 
But, I would say that pursuant to our 2009 guidance, we have 
laid out how we would like to see these problem loans managed. 
And I think that applies whether the bank has TARP or not. If 
the bank needs to be resolved, I think it still needs to be 
resolved.
    Mr. Silvers. My--I don't know, it seems sort of intuitive 
to me, and I wonder if you all agree, that, if our goal is to 
try to keep the small bank sector healthy, that--during this 
period when small banks that have CRE exposure are going to 
have to manage through the rollover of these loans, that it 
might not be a good idea to try to compel them to pay back 
the--to pay the Treasury's money back during that period. But, 
I'm--this is not an ideological observation, it's a practical 
one. Is that right? Or would it be better to try to get them, 
during that period, to have--be subjected to the discipline of 
raising that capital privately?
    Dr. Parkinson. Well, I don't think we've been trying to 
force them to repay the TARP----
    Mr. Silvers. No, I'm----
    Dr. Parkinson. We have----
    Mr. Silvers [continuing]. Wasn't suggesting----
    Dr. Parkinson [continuing]. We have----
    Mr. Silvers [continuing]. You had been.
    Dr. Parkinson [continuing]. Lots of institutions that want 
to repay their TARP, but absent a substantial raise of private 
capital, we don't think that they wouldn't be safe and sound, 
having done that. I think that really is the issue. We look at 
each one of these TARP repayments, one by one, and want to 
satisfy ourselves that, either given the amount of capital they 
currently have or the amount of capital they can raise in the 
market post-TARP repayment, they will still have adequate 
capital to bear the risks that are present in their portfolio, 
including any risks that may be as a result of troubled CRE 
assets. But, at least the banks themselves feel that the sooner 
they can repay their TARP, the better. So, they're quite 
anxious to repay.
    Mr. Silvers. I see. That's very helpful.
    If part of our mandate is to sort of look at these very 
practical aspects of TARP that I've just been asking about, if 
the other part of our mandate, I believe, is to--is that 
Congress wanted this rather extraordinary intervention in the 
financial markets; that is, TARP to be done fairly. This may be 
asking too much of the three of you, but I would ask you to 
comment on, What do we say to the executive or the employee or 
the investor in a small bank that is being resolved by the 
FDIC, against the backdrop of what we did, you know, in terms 
of forbearance to institutions, like Citigroup and Bank of 
America--how do we justify--how, in any respect, is that fair? 
And what do we say to the person who's on the losing end of the 
unfairness?
    [No response.]
    Mr. Silvers. I guess we say nothing. Is that really so? 
It's kind of sad.
    [No response.]
    Mr. Silvers. Well, perhaps it's unfair to----
    Dr. Parkinson. I'll just say two things. One, obviously the 
reason for the extraordinary interventions was a belief that, 
if the banks had failed in a disorderly manner, that the 
economy, the financial system might have been much more worse 
off, including those small institutions that didn't benefit 
directly from that assistance.
    I think also the too-big-too-fail problem is a very real 
problem. The Dodd-Frank Act has various provisions designed to 
address that. I think we're still working through the 
implementation of those. So, ultimately, how effective they 
will be, the jury is still out, but we're working very hard to 
ensure that, particularly, the so-called systemically important 
institutions are held to much tougher standards than other 
institutions.
    And, very importantly in terms of the market discipline 
side, with the new orderly resolution authority there's no 
longer any authority to do open bank assistance, so there's not 
going to be any benefit to the shareholders. I think all the 
agencies agree that any holder of a capital instrument should 
not benefit in any way from extraordinary assistance. And even 
the FDIC has proposed that holders of longer-term debt, that 
assistance payments for that class of creditors will be ruled 
out, in which case, I think all of those should do quite a bit 
to reinvigorate market discipline.
    Ms. Thompson. I think you're right. What took place really 
helped everyone in the economy. And I think the Dodd-Frank Act 
did a lot to level the playing field between larger and smaller 
institutions. It took away some of the competitive inequities 
between the largest and the very smallest institutions. And, 
most importantly, it did remove ``too big to fail.'' So, I 
think that the steps that were taken were necessary. And the 
steps that we're taking now, in terms of the orderly 
liquidation authority and implementation of other provisions of 
the Dodd-Frank Act, will go a long way toward having that 
conversation.
    Mr. Silvers. Well, my time is long expired.
    Thank you.
    The Chairman. Dr. Troske.
    Dr. Troske. Thank you.
    I guess I want to--one comment I'll make about my opening 
statement. I was hoping to get the point across, that I think 
regulators were far too much blamed for the financial crisis 
than was warranted. I think it was primarily a result of the 
managers and owners of firms.
    Dr. Parkinson, I wanted to start with you, because I wanted 
to ask a question sort of specific about the Fed. I was looking 
at the data yesterday, and I believe the levels of bank 
reserves at the Fed have grown back to $1.1 trillion, after 
dropping below 1.1 trillion for a while. We could discuss why 
that is. But, there seems to be--and most of that is excess 
reserves. So, banks seem to have a ample supply of capital 
sitting, certainly, at the Federal Reserve. Is that--does that 
give you some comfort, when thinking about the CRE situation? 
Do you have a sense of how much of this capital and excess 
reserves held at the Fed are held by these small- and medium-
sized banks, thereby giving them a cushion if there are any 
additional problems in this market?
    Dr. Parkinson. I don't know the answer to that question. 
But, I would have approached it a different way, if the concern 
is about the availability of lendable funds to meet the needs 
of creditworthy borrowers. The fact that the banking system as 
a whole, is holding so much in excess reserves at the Fed that 
pays so very little, I think they have ample motive to go out 
and find creditworthy borrowers that they can make loans to, to 
make much higher returns than they're making on those excess 
reserves. And I think we are starting to see some signs that 
the tightening of credit conditions, that's been going on since 
the crisis emerged, is coming to an end, and that they are 
looking very actively for creditworthy borrowers to put that 
money to work.
    Dr. Troske. And----
    Dr. Parkinson. But, I don't know the answer to your 
specific question. I suspect that a disproportionate amount is 
at the large institutions, but I don't know the facts.
    Dr. Troske. I suspect the same. And I did ask our staff to 
find out, yesterday, and they were unsuccessful, as well. So--I 
wasn't surprised they were unsuccessful, since I suspected they 
weren't going to be.
    I want to build on that last statement that you made, or 
the statements that you made, about just overall lending, and 
ask, I guess, the three of you. It is clear that lending is 
down by most banks. And there's a question--and I'm not sure 
we're going to resolve it today--about whether that reflects a 
lack of demand or a lack of supply. From your regulatory 
standpoint, can you give me a sense of whether you think--what 
it--it's a lack of demand or supply?
    And we'll start with you, Ms. Thompson.
    Ms. Thompson. I think it's both. Actually, I think there's 
three things. I think there's a lack of demand. I believe that 
there are borrowers that lack confidence. I think that there's 
a lack of supply. I think bank capital is concentrated. And, 
the biggest issue is the collateral values, because they've 
declined so precipitously.
    I think that there is plenty of capital in the system. 
People have to start showing confidence in the financial 
institutions, and that is a slow process. I think there's a 
tentative rebuilding. We're working our way towards whatever 
this new norm is. And when people get comfortable, they'll go 
to institutions, apply for loans, and receive credit. But, I 
think there is a tentative nature out there right now. People 
are cautiously optimistic, because we're not out of the woods 
yet.
    Dr. Troske. Okay.
    Dr. Parkinson.
    Dr. Parkinson. Well, I think it is elements of both demand 
and supply. On the demand side when you talk to the banks, 
where they have binding lending commitments outstanding, the 
utilization rates of those lines is, sort of, at historic lows. 
And I think that's a pretty good indicator, at least for those 
borrowers, they just don't have the demand.
    On the supply side, I think there are signs that for 
stronger borrowers, there's ample credit out there. But, 
obviously there's been a real change since the crisis, in terms 
of the access to credit by weaker borrowers. Now, we don't want 
to go back to the availability of credit that we had in 2006 
and 2007. We want to go to some new normal, where there are 
more prudent underwriting standards. But, that does mean that 
lots of people that could get credit formerly probably are not 
going to be able to get it on the same terms today. And that 
must be constraining their spending.
    But, again, we have ask, ``What's the alternative?''
    Dr. Troske. Mr. Wilson, do you have anything to add?
    Mr. Wilson. I agree with that.
    I guess I would also point out, on both the demand and the 
supply side, the Federal Reserves' quarterly survey shows that 
banks are saying that they're not tightening standards beyond 
what they were. And also, they're seeing loan demand starting 
to pick up.
    But, in our conversations with banks, they said, ``Yeah, we 
don't like the rate that the Federal Reserve pays on the 
reserves, and we would like to lend the money.'' So, I think 
there is a willingness, on the part of our banks, to put those 
out--back into good quality loans.
    Dr. Troske. Thank you.
    The Chairman. Thank you.
    Superintendent Neiman.
    Mr. Neiman. Yeah. I'd like to follow up on the issues 
around supply and demand, and really focus on underwriting 
criteria. Ms. Thompson mentioned that underwriting criteria is 
so critical.
    The reference to the Federal Reserve senior loan officer 
survey does show that standards remain largely unchanged in the 
fourth quarter. Certainly, they are higher than the average 
level over the last decade. And the majority of respondents 
indicated that lending standards, would not expect to return to 
long-run norms until after 2012, and, as a result, will remain 
tighter, for the foreseeable future.
    Is this a good thing? Were underwriting standards too lax, 
or is this some evidence of an overreaction?
    Ms. Thompson.
    Ms. Thompson. Well, I think underwriting standards were 
lax. And, the return to the basic fundamentals of lending is 
critical: making sure the borrowers have the ability to repay, 
not focusing on collateral values as the primary source of 
repayment, and looking at other ways to generate income to 
repay the loans. I think that's critical.
    Mr. Neiman. Where regulators are sometimes criticized for 
extending--going too far to one extreme, have banks, in 
tightening and correcting those lax standards, gone too far? Is 
there any evidence of that in your reviews?
    Ms. Thompson. Regulators are criticized, generally. In 
looking at the crisis, there were things that we could have 
done more quickly. And I do believe that there were some steps 
that we could have taken to help deal with this issue. I think 
that the lending and underwriting standards that we have worked 
collectively on through our guidance is good guidance, it's 
prudent, and it certainly will be sustainable in good times as 
well as bad.
    Mr. Neiman. Dr. Parkinson, what are you seeing in your 
assessment of the underwriting standards being used by lenders?
    Dr. Parkinson. Well, again, I think you had it right, that 
there was a long period of tightening. But, that proceeded from 
a base period, where standards were too lax. And now, we see 
some signs that that's abating.
    But almost more important than the specific standards, when 
you're assessing whether someone's a creditworthy borrower, 
that depends, in part, on your economic outlook, and how 
supportive you think the economic environment will be.
    And I think confidence, both by the borrowers and by the 
lenders, has been slow to recover. I guess there are hopeful 
signs that the economy, in the last couple of months, has been 
picking up steam. And I think, once people are convinced that 
that higher path of growth is sustainable and is the most 
likely path, you'll get a rebound in confidence. And that's 
probably the most important thing, both to work on increasing 
the demand and increasing the supply of credit.
    Mr. Neiman. Great.
    Mr. Wilson, you mentioned taking supply and demand into 
consideration has an impact on lending levels. And you 
indicated that it has a varying degree, depending on the size 
of the institution or the type of the asset. Can you elaborate 
so we can get a better sense of loan levels, whether they be 
from big or small banks or a variety of type of loans?
    Mr. Wilson. Well, I think that, for example, in the 
community banks that do have big concentrations of commercial 
real estate, what we're going through right now, brought to 
bear the risks, and they're more sensitive of those risks. So, 
they probably are tighter than they would have normally been if 
they didn't have the concentration.
    Yeah, underwriting standards in almost any asset class in 
2006, early 2007, were too liberal. The pendulum usually swings 
too far the other way as banks try to recover from problem 
loans. But, we're seeing evidence that, you know, they're 
coming back into balance pretty quickly, especially in certain 
markets, like leveraged loans. There are stories out there that 
the recap deals, number one, are very prevalent these days. 
Pricing is getting tighter. And, even in commercial real 
estate, pricing has tightened dramatically in the last couple 
of months. So, we do feel like those supply/demand factors are 
coming back into balance.
    Mr. Neiman. And taking into consideration, in addition to 
the tightening of underwriting standards, how much is 
preservation of capital playing into that same issue of supply?
    Mr. Wilson. And obviously that's a big problem with 
community banks that are under stress. It's, to some extent, an 
issue for all banks, because of the Basel 3 initiatives. But, 
Basel 3 was very sensitive to that. And that's why the 
committee has a phase-in that goes out through 2018, to be 
sensitive to that issue, to not constrain lending because of 
capital requirements.
    Mr. Neiman. Thank you.
    The Chairman. Thank you, Superintendent Neiman.
    And thank the board. First, I want to thank you for being 
here today. But, even longer, I want to thank you for your 
public service. I continue to be incredibly impressed with the 
overall quality, intelligence, and competence of the people 
that serve in the Federal Government. And I think anyone here 
watching you today would be proud of the fact that you are 
representing all Americans near here, and doing a competent, 
thorough, and intelligent job at everything you do. So, I 
really want to thank you especially for that.
    Thank you.
    And if the second panel would come forward--the second 
panel, come forward.
    Mr. Silvers is going to have to leave. It's nothing 
personal. [Laughter.]
    But, he has to be somewhere else. He's necessarily absent.
    [Pause.]
    The Chairman. Welcome. Thank you for being here. Thank you 
for helping us work through these rather thorny complicated 
issues.
    I'm really pleased to welcome our panel: Matthew Anderson, 
managing director at Foresight Analytics, a division of Trepp; 
Richard Parkus, executive director at Morgan Stanley Research; 
and Jamie Woodwell, vice president, commercial real estate 
research at the Mortgage Bankers Association.
    And thank you for coming. Please keep your testimony to 5 
minutes so we'll have time for questions. Your complete written 
statement will be printed in the record.
    And we will begin with Mr. Anderson.

  STATEMENT OF MATTHEW ANDERSON, MANAGING DIRECTOR, FORESIGHT 
                 ANALYTICS, A DIVISION OF TREPP

    Mr. Anderson. Chairman Kaufman and members of the 
Congressional Oversight Panel, thank you for the opportunity to 
discuss commercial real estate and bank stability.
    My testimony today will include a discussion of real estate 
value declines, the growth in the size of the debt market and 
resulting mortgage maturities, bank commercial real estate 
exposure and distress, and finally, some aspects of our outlook 
for the economy, real estate, and commercial real estate debt 
market, in particular.
    I should add, the views expressed today are my own and not 
necessarily those of my employer, Trepp LLC.
    One of the most important features of the current real 
estate cycle is the dramatic decline in property values. The 
most recent figures indicate that commercial property values 
have fallen by approximately 42 percent since speaking in late 
2007. That's larger than the decline in the earlier 1990s, when 
commercial real estate values fell by nearly one-third, and on 
par with our estimates of the decline during the Depression.
    A rise in volume of mortgage--maturing mortgages has put 
pressure on the commercial real estate debt market, and will 
continue to do so for several years. By our estimates, annual 
maturities reached $200 billion in 2006, and surpassed $300 
billion in 2009. We further estimate that commercial real 
estate debt maturities will climb to approximately $350 billion 
per year between 2011 and 2013.
    The combination of lower property values and rising volumes 
of maturing mortgages has resulted in a large amount of 
maturing loans that are underwater. We estimate that as much as 
half of the loans maturing in 2011 to 2015 are currently 
underwater, and that $251 billion is underwater by 20 percent 
or more.
    Many banks entered the financial crisis with substantial 
exposures to commercial real estate. As of the first quarter of 
2007, more than 2700 banks and thrifts, or 32 percent of the 
total bank count, had a commercial real estate, or CRE, 
concentration. The greatest concentrations were among banks 
with $1 to $10 billion in assets and banks with $100 million to 
$1 billion in assets, where 56 percent and 43 percent of banks 
in those groups, respectively, had CRE concentrations.
    The number and proportion of banks with commercial real 
estate concentrations has fallen significantly since 2007. As 
of the third quarter of 2010, just under 1300 banks and thrifts 
had a CRE concentration, a decline of more than 1400 from the 
first quarter of 2007. Part of this reduction is the result of 
reduced amounts of debt outstanding. Approximately $300 billion 
of CRE loan exposure has been trimmed from banks' balance 
sheets over the last 2 years.
    Banks that received CPP funds from TARP are more likely to 
have commercial real estate concentrations than non-CPP 
recipients. We've tabulated commercial real estate 
concentration figures for bank and thrift subsidiaries of firms 
that received CPP investments, including banks that have repaid 
the CPP funds, with the result that, as of the third quarter of 
2010, 32 percent of the CPP-recipient subsidiaries had CRE 
concentrations, compared with 15 percent for non-CPP 
recipients.
    Delinquency rates for construction loans and commercial 
mortgages have been declining, but remain high relative to the 
pre-crisis levels. Our early estimates for the fourth quarter 
of 2010 indicate that construction delinquency rates stand at 
18 percent and commercial mortgage delinquencies at 5.3 
percent, compared with 1-percent delinquency rates prior to the 
onset of the downturn.
    We maintain a watch list of banks that appear to be at 
elevated risk of failure. This list has proven quite accurate, 
capturing 96 percent of failed banks since the beginning of the 
current cycle in 2007. Nonperforming commercial real estate 
loans have been the largest problem loan type for banks on this 
watch list. For more than 80 percent of the banks on our watch 
list, nonperforming commercial real estate loans are the main 
problem loan type.
    Economic and real estate market conditions are improving, 
albeit slowly. The job market is gradually turning around. And 
in the commercial real estate market, occupancy rates and rents 
are stabilizing, but net operating income has been reduced by 
15 percent, or more, from pre-recession levels.
    Liquidity has also been returning to the commercial real 
estate market. This has been most notable in the CMBS segment, 
where $11.6 billion of new issuance occurred in 2010. Our 
parent company, Trepp LLC, expects this trend to continue, with 
$50 billion of new issuance during 2011.
    We believe the recovery will be a prolonged one, with slow 
improvement in the broader economy translating into gradually 
increasing demand for commercial real estate. Delinquency rates 
will improve, as well, as lenders continue to reduce 
nonperforming loan balances, but this process looks likely to 
last several more quarters. We remain concerned about the 
volume of underwater mortgages that will mature over the next 
several years, and the broader issue of mortgage maturities 
overall.
    Continued high demand for refinancing for loans originated 
during the commercial real estate debt boom of the 2000s will 
constrain real or inflation-adjusted growth in the commercial 
mortgage market over the next decade. We believe growth in the 
market will more closely resemble the 1990s, when annual growth 
was 0.8 percent in real terms, rather than 2000 to 2008, when 
annual real growth was 9.4 percent.
    Mr. Chairman, I thank you and the other members of the 
panel. This statement constitutes my formal testimony. And I 
look forward to any questions you might have.
    [The prepared statement of Mr. Anderson follows:] 

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    The Chairman. Thank you very much.
    Mr. Parkus.

STATEMENT OF RICHARD PARKUS, EXECUTIVE DIRECTOR, MORGAN STANLEY 
                            RESEARCH

    Mr. Parkus. Chairman Kaufman and members of the 
Congressional Oversight Panel, my name is Richard Parkus, and 
I'm head of commercial real estate debt research at Morgan 
Stanley, and chair of the research committee at the Commercial 
Real Estate Finance Council.
    I would like to thank the panel for taking--for giving me 
the opportunity to discuss the current state of commercial real 
estate financing markets and their potential impact on banks.
    I would like to emphasize that the opinions I share today 
are strictly my own and do not represent those of Morgan 
Stanley or the Commercial Real Estate Finance Council.
    The question of whether commercial real estate will be the 
next shoe to drop is often heard. In my view, this shoe dropped 
2 years ago. Since late 2008, commercial real estate has gone 
through the most severe downturn since the early 1990s. In many 
respects, the downturn has been even more severe than the early 
1990s. Vacancy rates have soared to greater heights. Rents have 
experienced larger declines. And the drop in property prices 
has been much larger than during the previous episode.
    With respect to commercial real estate loans, most analysts 
expect that the loss rates for CMBS loans, originated during 
the bubbled years of 2005 through 2008, will exceed the 9- to 
10-percent losses experienced in the early 1990s, possibly by 
as much as 4 to 5 percent.
    The credit crisis had a particularly severe impact on 
commercial real estate financing markets. During the depths of 
the crisis, financing for large, high quality properties, so-
called trophy properties, virtually disappeared. The 
availability of financing was severely impacted for small 
properties, as well, although it never completely dried up. 
Some regional and community banks continued to lend, albeit at 
reduced levels.
    As TARP brought calm to financial markets in mid 2009, the 
flow of capital began to return quickly to the trophy property 
segment. The trickle of new capital has since grown into a 
flood, and today financing markets for trophy assets has fully 
recovered. Financing is widely available, and at very favorable 
rates.
    Unfortunately, this story is not as positive in the 
financing markets for smaller properties. Here the market 
remains highly dislocated and has seen little improvement since 
the depth of the crisis. The vast amount of capital that has 
targeted the trophy property segment has not made its way into 
the market for smaller properties.
    In summary, there's a growing bifurcation in the recovery 
of financing markets for trophy assets and smaller nontrophy 
assets, on the other hand. This is reflected in the large 
difference in property price appreciation between the two 
segments. Trophy property prices declined 39 percent between 
the 2007 market peak and the 2009 market trough, but have 
increased 17 percent since that trough. For the market as a 
whole, and smaller properties in particular, prices were down 
44 percent, peak to trough, and have been effectively unchanged 
since that time.
    Improving the availability of financing is a critical step 
in the price recovery process for smaller properties. One of 
the main sources of financing for this segment is banks, both 
regional and community, many of which continue to struggle with 
problem commercial real estate loan portfolios. Taking steps to 
improve the availability of financing for small properties 
would undoubtedly improve the ability of these banks to work 
through their problem loan books.
    To date, core commercial real estate loans and bank 
portfolios are exhibiting delinquency rates in the 5-and-a-
half-percent range, significantly below the 9-plus-percent 
delinquency rates for loans in CMBS. At least part of the 
reason for this differential relates to the fact that a 
significant portion of bank loans are floating-rate. As short-
term interest rates plunged from 5 and a half percent in 2007 
to a quarter of a percent in 2009, required monthly mortgage 
payments on floating-rate loans declined by as much as 60 to 70 
percent, or more.
    Without such enormous debt relief, we believe that 
delinquency rates on bank commercial real estate loans would be 
far higher, comparable at least to those of fixed-rate loans in 
CMBS, which did not receive the benefit of debt payment relief. 
However, this sword cuts both ways. If short-term interest 
rates rise significantly over the next several years, this 
could have a significantly negative impact on the performance 
of floating-rate loans and commercial real estate loans in bank 
portfolios. Not only would higher interest rates raise required 
mortgage payments, they could also lead to declining property 
prices, exacerbating the already significant maturity--maturing 
debt problem that lies ahead.
    Without question, the biggest uncertainty and potential 
problem facing commercial real estate debt markets today is the 
wall of near-term maturing debt. We estimate that approximately 
a trillion dollars of core commercial real estate debt will 
mature through the end of 2013, more than 600 billion of that 
coming from banks. Adding to this the $375 billion of 
construction loans in bank portfolios that mature over the same 
period brings the total to almost 1.4 trillion over the next 3 
years.
    Many maturing CMBS loans are already receiving maturity 
extensions. And we speculate that the same is true in banks. 
Nevertheless, simply extending problem loans does not represent 
a comprehensive solution to the problem as a whole. While 
maturity extensions will undoubtedly help some borrowers, many 
loans are far too underwater--are too far underwater to be 
saved by this approach.
    A critical ingredient for managing smoothly through the 
mountain of commercial real estate debt maturities that lie 
ahead is a well-functioning financing market. This is 
particularly important for smaller properties, since they make 
up the bulk of the maturities. In my view, a reformed and 
revitalizes CMBS market, one that is quickly reemerging now, 
has the potential to play a key role in helping to improve the 
availability of financing, particularly to smaller properties; 
and thus, to reduce the degree of stress as we work our way 
though this massive deleveraging process.
    I thank you for the opportunity to share my views on these 
important issues and would be happy to answer any questions you 
may have.
    [The prepared statement of Mr. Parkus follows:]

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    The Chairman. Thank you very much.
    Mr. Woodwell.

STATEMENT OF JAMIE WOODWELL, VICE PRESIDENT OF COMMERCIAL REAL 
         ESTATE RESEARCH, MORTGAGE BANKERS ASSOCIATION

    Mr. Woodwell. Thank you for the opportunity to discuss the 
Mortgage Bankers Association's research on conditions and 
trends in commercial real estate and commercial real estate 
finance.
    In my testimony, I'd like to cover three general areas. The 
first is to correct some myths that have taken hold in 
discussions about commercial real estate. The second is to 
highlight current conditions and trends in commercial real 
estate markets. And the third is to note some key factors that 
will affect commercial real estate markets, going forward.
    An important point of clarification is to ensure that we're 
speaking of the same thing when we say ``commercial real 
estate.'' When industry professionals speak about commercial 
real estate and commercial mortgages, they're speaking about 
office buildings, apartment buildings, shopping malls, 
warehouses, and other properties that lease out space in 
exchange for rental payments.
    This income-producing property market is generally distinct 
from two other markets that are sometimes folded into 
conversations, particularly in discussing bank lending: owner-
occupied commercial real estate and construction loans. Neither 
owner-occupied commercial properties nor single-family 
construction lending are closely tied to the core commercial 
real estate markets. The many recent discussions and 
conclusions have grouped them. These distinctions are a key 
reason for some of the confusion about commercial real estate 
and how commercial mortgages have been forming in recent 
quarters.
    Before discussing the state of commercial real estate 
markets, I think it's important to clear up a few myths that 
have taken hold in discussions about commercial real estate. 
The first is that banks are being excessively weighed down by 
their commercial mortgages or their mortgages on commercial and 
multifamily properties. The second is that there's been a 
looming wave of loan maturities threatening the system.
    As of the third quarter, bank and thrift delinquency rates 
for commercial and multifamily mortgages remained lower than 
the average for their overall books of business. And commercial 
and multifamily mortgages continued to have the lowest 
chargeoff rates among any major loan type.
    To put these numbers in context: Since 2006, banks and 
thrifts have charged off $132 billion of single-family 
mortgages, $127 billion of credit card loans, $72 billion of 
commercial and industrial loans, $66 billion of construction 
loans, and $53 billion of other loans to individuals, but just 
$27 billion of commercial and multifamily mortgages.
    A second myth I'd like to address is that there's been a 
looming wave of commercial and multifamily loan maturities 
weighing on the market. On Monday, MBA will release its third 
annual study detailing the scheduled loan maturities of $1.4 
trillion of commercial and multifamily mortgages held by 
nonbank lenders. What these studies have shown is that, with a 
typical loan term of 10 years, most investor groups' commercial 
and multifamily mortgage maturities are spread over a 
relatively long period. This is in direct contrast to other 
forms of credit, such as credit card debt, in which the entire 
outstanding balance rolls every month, and commercial paper, in 
which nearly the entire market matures every 80 days or less.
    Let me now turn briefly to current commercial real estate 
conditions and trends which continue to exhibit the influences 
of the broader economy. During the third quarter, the economy 
began to show modest growth, and the absorption of commercial 
space picked up in the face of little new space coming online. 
The impact has been marginal declines in vacancy rates and a 
firming of asking rents. Property sales and origination volumes 
have picked up, but have not been high enough to keep up with 
the mortgage debt that investors have seen paying off and 
paying down.
    Looking ahead, the most significant factor in the 
performance of commercial real estate markets will be the 
performance of the broader economy. Vacancy rates at commercial 
properties rose as jobs were lost, as consumers pulled back in 
spending, and as household growth contracted. Economic growth 
is needed to reverse this trend.
    Commercial real estate finance markets will be driven by 
property incomes, values, and interest rates, and where the 
markets are when loans come due, relative to where they were 
when loans were made. To the degree future incomes, values, and 
rates support refinancing existing debt, loans will mature and 
roll over. To the degree they do not, the existing equity, 
mezzanine debt, and, as a last resort, first-lien mortgages, 
will be resized to fit the future capital stack.
    The Great Recession has strained commercial real estate 
markets, as it's strained nearly every part of the U.S. 
economy. The long-term nature of the market, in the form of 
relatively long leases and borrowing terms, however, has helped 
moderate the recession's impact.
    Thank you for the opportunity to discuss these issues with 
you today.
    [The prepared statement of Mr. Woodwell follows:]

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    The Chairman. Can you--I'd like to start my first question 
to all three of you, starting with Mr. Anderson. Has the 
commercial real estate market, do you think, hit bottom?
    Mr. Anderson. From a value standpoint, yeah, I think so. I 
think the value indicators would--or price indicators would 
seem to indicate that we've hit bottom, we've bounced along 
bottom for roughly a year, for the broad market. As Mr. Parkus 
mentioned, for trophy properties, prices have picked up, and 
that's gained a lot of attention. So, I think we have, more or 
less, hit bottom. But we also haven't seen very much in the way 
of very strong price growth, at least for the broader market.
    The Chairman. Mr. Parkus.
    Mr. Parkus. I also do believe that the commercial real 
estate market--in terms of fundamentals, we have to be careful 
about what we're talking here about. In terms of the rents and 
vacancies, those dramatic declines that we've seen in the 
performance of actual properties, I believe is approaching a 
bottom. And we will probably be at a bottom sometime in 2011 or 
2012 for most property sectors. So, yes, I do believe that that 
has--we are at a bottom.
    I think the bigger question is, ``How long do we bump along 
the bottom?'' as Mr. Anderson was saying.
    In terms of price improvements, we have seen dramatic 
improvements for a relatively small proportion of the 
commercial real estate universe which focuses really on trophy 
assets and higher-quality institutional-quality assets, and 
relatively little improvement for smaller assets.
    The Chairman. Mr. Woodwell.
    Mr. Woodwell. Echoing some comments that were made, I think 
there are many aspects to the commercial real estate markets. 
One can look at prices, one can look at the property 
performance, one can look at a whole range of different things. 
And they move in relation to one another, but not necessarily--
--
    The Chairman. Right.
    Mr. Woodwell [continuing]. In lockstep.
    Prices probably are the leading indicator. They were one of 
the leading indicators of the decline, and now they're probably 
one of the leading indicators of a return. We have seen some 
greater strength there in the last quarter or so.
    I think it also is interesting to look at the different 
types of markets. So, a primary market, with more institutional 
investors, is probably more driven by investor yields and what 
competitive investor yields are. Whereas, the tertiary markets 
are probably more driven by the fundamental economics of what's 
happening in that market, the job growth, and how those are 
supporting individual commercial properties.
    The Chairman. Great.
    And back to your question, Mr. Parkus. How long can we bump 
along the bottom?
    Mr. Parkus. Well, you know, the--it's a difficult question. 
But, our best estimate is that it will take several years for 
individual properties--the cashflow, the net operating income 
at individual properties to begin to improve substantially.
    We think that vacancy rates will begin to come down 
gradually, probably sometime in 2000--late 2011 or 2012. But, 
those improvements will tend to be offset by the sort of delay 
or lagged impact of declining rents. Declining rents don't flow 
through into property revenues until space changes. And, as 
space changes, it will change those rents in the properties. 
Even as rents are rising--begin to rise, space will be rolling, 
in many cases, into lower and lower rents. So, that will drag 
the recovery out several years, we believe.
    So, property-level improvements are probably a late 2012 or 
maybe even 2013 phenomena. I should say, robust, very 
significant improvements, which we do believe will ultimately 
come.
    The Chairman. Mr. Anderson.
    Mr. Anderson. I would generally agree.
    I think you have to look sector by sector. And, really, in 
the multifamily sector there's already some improvement. The 
lodging sector has shown some improvement, as well. Lodging 
tends to be very volatile and very correlated--highly 
correlated with the economy. So, with an improving economy, the 
lodging sector is one of the early beneficiaries. The office 
sector is probably one that we're the most concerned about. 
Office jobs are off by almost 2 million jobs from the peak in 
2007. And it'll really take quite a while to build those jobs 
back up again. So, I think we're looking at a multiyear impact 
in the office market.
    The Chairman. Mr. Woodwell.
    Mr. Woodwell. Echoing that last point, I think by sector is 
very important. If you look at the different lease terms, of 
different types of commercial properties, you can think of a 
hotel having, essentially, a nightly lease; self-storage having 
a monthly lease; apartment buildings, generally, a year-long 
lease. The longer the lease term, the more muted the impact of 
the downturn in the recession, but also, then, the more muted 
the impact in the upturn. So, as a result, hotels and 
multifamily, which saw the impacts most immediately, are also 
seeing the positive impacts most immediately.
    The Chairman. Thank you.
    Mr. McWatters.
    Mr. McWatters. Thank you, Senator.
    Following up on Senator Kaufman's comments, it doesn't 
sound like any of you see a double dip--a serious double dip in 
CRE within the next few years.
    Mr. Anderson.
    Mr. Anderson. No, that's not a big feature of our outlook. 
It's always possible.
    Mr. McWatters. Okay.
    Mr. Anderson. And, you know, external events can drive the 
economy back into recession, as we've seen with the debt crisis 
in Europe. But, that's not a major part of our outlook.
    Mr. McWatters. Okay.
    Mr. Parkus.
    Mr. Parkus. No, I don't see anything like that. It would 
have to be driven, again, by some extraordinary surprise on the 
downside, which is economywide.
    Mr. McWatters. Okay.
    Mr. Woodwell.
    Mr. Woodwell. And, again, I think the market's being driven 
very much, now, by the economy. Where the economy goes, so will 
the return of the commercial real estate markets.
    Mr. McWatters. Okay.
    What about a spike in interest rates over the next year or 
so? How would that affect your outlook?
    Mr. Anderson. An outright spike would definitely have an 
impact on real estate, especially bank lending in real estate. 
There's a large amount of floating-rate debt. On the 
construction side, it's pretty much all floating-rate. So, the 
low interest rates have definitely benefited borrowers and 
lenders, from the standpoint of avoiding some of the distress 
that could crop up in that segment. And also, in the broader 
commercial mortgage market, I think. For banks, about half is 
floating-rate and half is fixed-rate; it depends on the bank. 
But, those are probably pretty good rough figures. So, a surge 
in interest rates could have a negative impact on borrowers' 
ability to pay.
    Mr. McWatters. Okay. Okay.
    Mr. Parkus.
    Mr. Parkus. I agree with Mr. Anderson. I think that rising 
interest rates do pose a nontrivial threat to commercial real 
estate, especially if the rate increases are significant.
    I'd also say that it depends on what drives the interest-
rate increase. As someone on the previous panel made the very 
good point, if rate increases largely reflect a buoyant 
economic condition, where the Fed is trying to sort of rein in, 
you know, surging economic activity, that would be one 
scenario. And I think the--that type of rising interest rate 
would be less problematic. On the other hand, today there's a 
lot of concern about future inflation through commodity price 
inflation. And I think that fear can get embedded as--in 
interest rates, as well, as it--we--it appears to be in long-
term interest rates, already.
    So, it really depends on whether the interest rates are--at 
the short end or the long end are rising, and what the source 
of the push upward is.
    Mr. McWatters. Okay, fair enough.
    Mr. Woodwell.
    Mr. Woodwell. One additional point is, it sort of is 
relative to the interest rates that are in place. So, if you 
think of the different cohorts of loans, loans that were made 
in the--2001/2002 that might be coming due now, they were made 
at points with relatively higher interest rates than we're 
experiencing right now. So, they've got a bit of a cushion. As 
you get to 2004, say, the interest-rate environment there was 
much lower. So, loans that'll be maturing--10-year loans 
maturing from 2004, say, in 2014, they'll have much less of a 
cushion for current interest rates, and, as a result, future 
higher rates would have more of an impact on them.
    Mr. McWatters. Okay. So, it sounds like the three of you 
anticipate a slow recovery of the CRE market over the next few 
years. May I assume from that, that you do not see the basis, 
the need for a TARP-2, an RC--RTT--RTC-type structure or any 
other government source funds to bail out these financial 
institutions or CMBS holders?
    Mr. Anderson.
    Mr. Anderson. I don't know about the outright need. It 
would certainly have an impact. If there were--if there was an 
RTC established all over again, it would help clear the market 
of troubled debt that much more rapidly. But, it would also 
have a cost and an impact.
    You know, part of the corollary would be a significant 
increase in the rate of bank closures; whereas, what we've been 
seeing is a high rate, but a--really a process of working 
through problem banks. And so, I--it would have an impact on 
the market. You'd have a sharp drop in prices, and it would 
come at a great cost. But, you would have--what we had in the 
early '90s was a market that cleared and then, actually, rapid 
growth after that, in the later half of the 1990s.
    So, absent an RTC, our outlook is for pretty much more of 
the same as what we've been experiencing for the last couple of 
years, just really stretched out over quite a long period.
    Mr. McWatters. Okay.
    My time's up. I will continue with this next time.
    The Chairman. Thank you.
    Superintendent Neiman.
    Mr. Neiman. Thank you.
    During my opening remarks, I referenced the multifamily 
housing as a category of CRE; the impact that properties may 
deteriorate as rental income is diverted from maintenance to 
debt service, with the impact of renters possibly losing their 
homes. How do you all assess the impact of the CRE situation on 
multifamily housing?
    Mr. Anderson. Well, I'm--for us, we focus on bank loan 
performance very closely. And, probably simply put, the 
delinquency rates on bank multifamily loans have been highly 
correlated with the delinquencies on commercial mortgages. So, 
if the question is, ``Do we see multifamily as a commercial 
real estate type?'' I'd say, yes. The correlation is very high 
there.
    Mr. Neiman. Mr. Woodwell.
    Mr. Woodwell. It's interesting, if you look at what's been 
happening with the homeownership rate, every percentage-point 
drop in the homeownership rate means, essentially, a 3-percent 
increase in demand for rental housing. So, with the drop in the 
homeownership rate, we've actually seen a large surge, 
essentially, in demand for rental housing. A lot of that is for 
single-family housing--rental housing, but also a fair amount 
going into the apartment sector, as well.
    So, notwithstanding the fact that the apartments do have 
those annual leases that turn, and turned over the course of 
the recession, the multifamily sector, the apartment sector, 
has been among the better-performing of the different 
commercial real estate sectors, in terms of fundamentals. And 
that has sort of rolled over to generally good performance in 
many of the different investor groups that lend money for 
multifamily mortgages. The one exception there is, in the CMBS 
market, the multifamily mortgages do have a delinquency rate 
that's well above many of the other property types.
    Mr. Neiman. Well, as a result, and with increased demand 
for rentals due to the mortgage crisis, do we face a shortfall 
in available rental properties?
    Mr. Woodwell. A lot of folks have studied that. We've 
looked into some of those numbers, as well. It does appear 
that, with--the vacancy rates are still at relatively high 
levels. So, even with that demand, the vacancy rates remain 
high. We'll see, as those start to get burned through, how much 
of a demand is there.
    Mr. Neiman. Are there ways that bankers and borrowers are 
working together, possibly with local or state housing finance 
authorities, to ensure that tenants and living conditions are 
not negatively impacted by the CRE crisis?
    Mr. Woodwell. I guess I would just put out there that the 
servicer and the lender, themselves, often have some of the 
greatest stake in making sure that that property maintains its 
ongoing operations and value. So, they're working very closely, 
in those situations, to keep those properties operating well.
    Mr. Neiman. Mr. Parkus, are there any unique issues that 
should be highlighted in distinguishing multifamily properties 
from other CRE?
    Mr. Parkus. Well, I think there are. You know, our outlook 
for multifamily is dramatically better than for other sectors, 
in the near term. As some of my colleagues have mentioned here, 
the state--the restricted state of credit for the single-family 
housing sector has redirected much of the new family formation 
process to multifamily. And we've seen dramatic improvements in 
vacancy rents--vacancy rates, dramatic improvements in rents, 
over the last just 3 to 6 months. We think that that will 
continue, that the medium-term demographics look very good.
    In terms of the very stressed operating environment that 
we've just come through, and the impact on residents in these 
properties, I would also very much agree that the absolute most 
important objective of special servicers is to make sure the 
properties do not deteriorate, to the extent that they have any 
control over that. And they do, generally. Keeping enough 
cashflow to keep up maintenance and other property expenditures 
is very, very high; otherwise, the value of the property 
deteriorates.
    Mr. Neiman. So, your confidence in servicers of commercial 
property mortgages, as opposed to residential mortgages, you--
--
    Mr. Parkus. I'm not familiar----
    Mr. Neiman [continuing]. Think--oh. But, you did indicate a 
level of confidence, with respect----
    Mr. Parkus. I do believe----
    Mr. Neiman [continuing]. To the ability----
    Mr. Parkus [continuing]. That that is a very high priority, 
yeah.
    Mr. Neiman. Okay. Appreciate it.
    The Chairman. Thank you.
    Dr. Troske.
    Dr. Troske. Thank you.
    I guess I want to sort of look back and ask some--a 
somewhat more philosophical question about price movements and 
what occurred in the commercial real estate market over the 
early part of the decade. You know, it's often been 
characterized that there was a bubble in the commercial real 
estate market. As many economists, I sort of struggle to know 
what that means, because--something that I can look back and 
name is not a particularly useful concept. I like to be able to 
know what it is before it occurs.
    Recently, economist Casey Mulligan, in his New York Times 
column, has presented data suggesting that, relative to 2000, 
investing in commercial real estate actually fell, in real 
terms, which is not what you'd expect in a bubble, and then 
much of the price increase was being driven by sort of a 
competition for resources that were flowing into residential 
markets and driving up the price of land and the price of labor 
and the price of other inputs into--in the production.
    I'd like the three of you to comment. I mean, do you--would 
you characterize it as a bubble? Is it--was it--were changes in 
prices reflecting what was going on in the housing market? Or 
was there just some overly optimistic investors in commercial 
real estate that's--that were driving all of this?
    And we'll start with--actually, we're going to start with 
Mr. Woodwell, since--you know, we'll start at the other end----
    [Laughter.]
    Dr. Troske [continuing]. Just to be fair.
    Mr. Woodwell. It's a great question. And trying to 
understand that, I think, is really important to trying to 
understand what the commercial real estate markets and other 
markets have been going through.
    If--one thing--the--we include in our written testimony is 
looking at commercial real estate prices, relative to the Dow-
Jones industrial average. And the same type of increase. If you 
look, during that period, you saw increases in a whole variety 
of different investment forms and a variety of different 
commodities, et cetera, during that runup period. Absolutely, 
construction costs were high during that period, and rising.
    When one looks at the property performance, property 
performance was very strong. When one looks at the mortgage 
performance, the mortgage performance was very strong in that 
preceding period. So, I think that it did lead to a lot of 
optimism that folks probably wish that they could rewind a 
little bit right now.
    Dr. Troske. Mr. Parkus.
    Mr. Parkus. I would say that there was a bubble. And I 
would say--you know, I can't define a bubble, or I can't do it 
here--but I would say that there was--you know, what we saw in 
the early part of this decade--and let's not forget, commercial 
real estate went through a sort of mini downturn in 2001/2002, 
and really didn't come out of that until sometime in 2000--late 
2003 or 2004. And, because of that, we saw relatively little 
overbuilding in this time around. Now, overbuilding was 
beginning to show its sort of ugly face in 2006 and 2007, but 
was cut off very quickly in 2008. So, we owe the previous 
downturn, you know, a just drove of thanks to keeping the 
overbuilding away this time.
    However, what we did have, in coming out of the last 
downturn, was extraordinarily low interest rates, as we have 
right now. And extraordinary low interest rates drove many 
investors to demand into riskier and riskier products. We also 
had a tremendous increase in the size of the--of pools of so-
called ``hot money'' in international financial markets, 
seeking yields wherever.
    All of that--and all of those conditions, I think, came 
together to create bubble-like conditions, not only in 
commercial real estate, but across the spectrum, in terms of 
leveraged loans, in terms of--across all credit products, in 
terms of corporate bonds. We saw a loosening of lending 
standards, driven by a loosening--really driven by a loosening 
in what investors would accept. The demand for yield was 
dramatic and was driving--really drove the decline in lending 
standards. In normal conditions, investors don't put up with 
that. But, in those in kinds of condition, with extraordinarily 
low interest rates, investors were amenable to almost anything.
    Dr. Troske. Mr. Anderson.
    Mr. Anderson. Yeah, that--although--quite a few comments.
    I think it was a bubble. In terms of a definition of a 
``bubble,'' it's probably--maybe one definition would be a 
rapid rise that's really unsustainable. Now, whether you would 
know that it was unsustainable at the time, or not, may be 
something else. But, certainly one feature of the price 
increase that occurred during that period was that it was 
almost all based on pricing, as opposed to income. The way real 
estate is generally--real estate prices are generally thought 
of is--in terms of an income stream that's capitalized. That 
has--and capitalization rates came way down during that period, 
and that drove almost all of the increase. So, really, net 
operating income grew a little bit, but not really that much. 
And it was almost all from declining capitalization rates, or 
cap rates.
    How did the cap rates come down? Well, a big part of it was 
the availability of financing. So, very liquid debt markets 
very much contributed to declining cap rates. If you had to pay 
all cash for a property, you'd have a very different standard 
for what sort of price you would pay. Whereas, if you can 
borrow ever greater amounts, which borrowers could heading into 
the boom, you know, you can pay ever higher prices and still 
hit a return, as long as you can add more debt.
    And, you know, one other feature factoring into the 
availability of debt was that--it was sort of self-
perpetuating, but the great liquidity in the market and good 
cashflow performance helped keep delinquency rates very low. 
So, it appeared--from a lender standpoint, it appeared to be a 
very safe, you know, low-risk area to be lending in. And so, I 
think those factors really played together.
    One item I was going to add is, I remember vividly, in 
2006, seeing an investor presentation, a very credible argument 
for why cap rates could be 5 percent, or even lower, and that 
that was very--that was sustainable. And I went in as a 
disbeliever, and came out not exactly being a believer, but 
having been impressed, anyhow, by the argument. So, in 
hindsight, certainly we know that it was a bubble. At the time, 
there were some very credible players that had good arguments 
as to why pricing could remain where it was at.
    Dr. Troske. Thank you.
    The Chairman. Thank you.
    I'd like each of you to comment on when you expect to see 
the majority of losses from defaults.
    Mr. Woodwell? In the commercial real estate market.
    Mr. Woodwell. We don't have any models that would predict 
that. I do think, based on the loan maturity survey that 
we're----
    The Chairman. Right, that's what I was----
    Mr. Woodwell [continuing]. Looking at there, as folks have 
discussed, there is, sort of, the income perspective on things, 
and then the maturity perspective, and which will be driving 
those. The different investor groups have very different 
maturity profiles so that, if there is a maturity issue facing 
mortgages, different investor groups will see them at different 
times. The multifamily investors, some of those loans--FHA, for 
instance, have a 40-year maturity. You work back, life 
insurance companies, 10-year, typically; CMBS, 5, 7, 10; and 
then, credit companies, banks would have a shorter term.
    So, to the degree one's focused on maturity, one would look 
at those----
    The Chairman. Right.
    Mr. Woodwell [continuing]. Those schedules. To the degree 
one's focused then on income-driven, then we're probably back 
to the discussions of different property types having very 
different situations, where, for instance, hotel and 
multifamily--those are shorter-lease terms--have probably seen 
the bulk to the hit to their NOI and are starting to see a 
rebuilding of those. Whereas, the longer-lease-term properties 
weren't as dramatically hit by the downturn, in terms of their 
bottom lines, but then, likewise, won't see quite as quick of a 
rebound.
    The Chairman. Mr. Parkus.
    Mr. Parkus. I think it depends on the location or the 
investor base. In CMBS, we are beginning to see losses ramp up 
very quickly now. It depends on the investor base, because it 
depends, really, on whether--the extent to which problem loans 
are pushed out, extended, and how long that process lasts. In 
CMBS, there will be a combination of loan extensions and 
foreclosure and liquidations. Losses are already ramping up 
very quickly now. We expect losses to remain high for this year 
and through next year. The difference is, is that the sources 
of losses in the nearer term are from term defaults--what we 
refer to as term defaults, where properties simply can't make 
the mortgage payments and are foreclosed and liquidated. And 
sometime in 2012/2013, that will come more from maturity-
related defaults.
    On the bank side, it really is a question about, I believe, 
when banks seriously begin to deal with the problem loan 
portfolios. It's----
    The Chairman. And, when----
    Mr. Parkus [continuing]. Hard to say.
    The Chairman [continuing]. Do you think that will be? Yes. 
I mean, no one knows. I'm----
    Mr. Parkus. I think, within a couple of years. I think that 
the regulators that we heard from today are right, that as soon 
as banks have the wherewithal--individual banks have the 
financial wherewithal to deal with these problems, they are 
being forced to deal with them. But, it will also be dragged 
out, because many banks do not have that wherewithal today.
    The Chairman. Mr. Anderson.
    Mr. Anderson. Actually, yeah, we do model it for banks. And 
we've done quite a few calculations, ourselves, to try to 
estimate what the ultimate losses will be for banks, and how 
far along they are through the charge-off process. By our 
estimates, banks, in aggregate, including large and small 
banks, are through 50 to 60 percent of the charge-offs on 
commercial real estate loans--on defaulted commercial real 
estate loans. So, you know, we're past the halfway point, but 
there's still quite a bit more to come, we think.
    The earlier panel noted that banks have been provisioning 
less over the last few quarters. You can kind of take that as 
a--two different ways. You could take it--the glass-half-full 
interpretation would be that banks see the light at the end of 
the tunnel and feel less of a need to add to loss allowances. 
The converse would be that--and I do think there is something 
to that--but, the converse would also be that, I think, there's 
intense pressure in the--among--in the bank sector, to maintain 
capital. And so, the--to the extent that you can stretch your 
losses out, you certainly boost your capital in the near term. 
And I think that's another feature of what's going on.
    So, there's certainly an incentive to work through the 
problems, but banks have been doing it for the last 2 or 3 
years, and, you know, and given that they're past the halfway 
point, I think, we'll be at it for at least another couple of 
years, probably.
    The Chairman. Thank you very much.
    Mr. McWatters.
    Mr. McWatters. Thank you.
    Let's continue with the TARP-type structure, TARP-2. Mr. 
Parkus, do you think it would be critical that Congress provide 
more money to bail out financial institutions, due to their CRE 
loans?
    Mr. Parkus. That gets to an area, really, outside of my 
domain. I guess I don't feel that I have--you know, that I 
should be speaking to a question about--sort of really 
addressing how to deal with banks. My expertise is in 
commercial real estate. If I understand your question.
    Mr. McWatters. Okay. Fair enough.
    Mr. Woodwell.
    Mr. Woodwell. And, I apologize, I don't think I have the 
adequate knowledge to address that adequately.
    Mr. McWatters. Okay. Well, I mean, my question is, Can 
these banks work through CRE problems by themselves, or do they 
need assistance--the small banks and the large banks, both?
    It sounds like, when I heard the answer to your first 
questions, is that, you know, given a few years, things will 
turn out okay. It's going to be rocky for a while, but it's 
going to turn out okay. And that would lead me to believe, as 
the regulators said, there's really not a need for an RTC, a 
TARP-2, or something along those lines.
    Mr. Woodwell. I----
    Mr. McWatters. Does that help?
    Mr. Woodwell. I guess I--I think I do understand what 
you're getting at. I think that an RTC, traditionally, is for 
the liquidation of loans out of banks, in receivership.
    Mr. McWatters. Yes.
    Mr. Woodwell. Now, does it make sense for regulators, the 
FDIC, to consider an RTC solution for the large number of loans 
that they are taking in from failed banks? They should 
certainly consider it. It's another form of securitization. 
And, quite frankly, that is what gave rise to the CMBS market 
in the first place, in the early 1990s.
    On the other hand, you simply have to look at the cost-
benefit analysis, according to how much they can get by 
liquidating loans in the way that they are currently doing. 
And, I--it's difficult for me to know--to make that cost-
benefit analysis. I would certainly think that it's--it is a 
potential outlet. Whether or not it is more cost-effective than 
the current disposal methods, I don't know.
    Mr. McWatters. Okay. Okay.
    Help me understand, since you--all three of you think the 
market will turn around in the next few years, taking the 
approach of simply extending loans, today, at favorable rates--
we have low interest rates, on a short-term basis--and rolling 
those, versus a full-tilt restructuring, refinancing, 
writedown, impairment of capital, recognition of tax 
cancellation indebtedness income, and the like. When is that 
appropriate to use one of those approaches, and when is it 
appropriate to use the other approach?
    Mr. Anderson.
    Mr. Anderson. Well, I--in one sense, I think you have to 
look at it loan by loan, borrower by borrower, property by 
property.
    You know, for the lender, the ultimate metric probably has 
to be what sort of loss they expect to take. So, whether it 
would be better to--if they need to take a loss now versus 
potentially taking a loss down the line. And, you know, if 
lenders are of the general view that the markets are gradually 
improving, then, at least in cases where they think that the 
borrower ultimately will get right-side-up again and be able 
to, ultimately--or keep current on payments and ultimately 
repay the loan, then that's a sound strategy, as long as it 
works out.
    In cases where the bank doesn't really think that that's 
too likely, then it wouldn't really be appropriate, and 
especially if they think that there's, for whatever reason, the 
likelihood that the value recovered a year or 2 or 3 from now 
would be lower than it might be now, then certainly it makes 
more sense to put the pressure on now and try to deal with the 
loan--deal with that problem sooner.
    In terms of modifications and charge-offs, again, that has 
to do with whether or not the bank, after their analysis, deems 
that to be a better outcome than outright foreclosure or 
rolling the loan over. I should add also that, you know, per 
the guidance in 2009, banks can't just roll over a loan if it's 
not otherwise performing. So----
    Mr. McWatters. Right.
    Mr. Anderson [continuing]. So the borrower does have to be 
current in order to even quality for that.
    Mr. McWatters. Right. And there could be some incentive to 
do that, not so much because that loan, in 2 or 3 years, is 
going to be in the money, but that the institution itself may 
be stronger in 2 or 3 years, and able to absorb a loss in 2 or 
3 years.
    So, Mr. Parkus.
    Mr. Parkus. Well, you know, I basically agree with that. I 
would add that, you know, if you have a borrower, with a loan 
that is, let's say, an 85 LTV in the market--in order to 
refinance, the current market is a 70 or 75 LTV sort of maximum 
LTV--that certainly makes sense, as long as you believe the 
borrower is--has good intentions, as long as the property is 
liked--likely to improve, as opposed to deteriorate. There are 
many cases where we think extensions make a lot of sense.
    But, there are many cases where we think that extensions 
clearly do not make a lot of sense. There are many loans out 
there that are not 85 LTV in today's environment; they're 120 
or 130 LTV. These loans will not be viable in the future under 
any reasonable scenario. And there are many out there like 
that, many that were overlevered to that degree. When you--
that's what happens when you have a 40- or 50-percent price 
decline and the original LTV on the loan was not 70, but was 90 
or 95, you get into those situations. So, in those cases, we 
think that that is not a good approach.
    Mr. McWatters. Okay. That's helpful.
    I'm way over my time. Sorry.
    The Chairman. Superintendent Neiman.
    Mr. Neiman. Thank you.
    I find interesting, and hopefully constructive, to make 
some comparisons between the CRE crisis, as well to the 
residential mortgage crisis. And when you hear about the 
factors that contributed to it--investors seeking higher yield, 
weak underwriting, low equity, over-leveraging, too much focus 
on collateral--lots of similarities, until you get down to the 
comparison, that on the residential side, a high evidence of 
borrowers who clearly did not understand the product they were 
getting into, less sophisticated in efforts by either brokers 
or lenders to take advantage of those borrowers. This, I don't 
see on the commercial real estate side. We have some of the 
most sophisticated developers in the country.
    Can you speak to this issue and are there lessons to be 
learned in making comparisons or contrasting differences?
    Mr. Parkus. Well, yeah. I would say that, for the most 
part, on the commercial real estate side, apart from really 
small loans--say, owner-occupied loans, in bank portfolios--
certainly what we see in CMBS, we deal with borrowers, for the 
most part, that are fairly sophisticated.
    And the transparency. One of the huge differences, I think, 
between residential and commercial, is the--simply the degree 
of fraud that was out there. There was a lot of opacity in the 
residential side, and there was a lot of outright fraud. I 
would say, in CMBS, it was not a case of outright fraud, for 
the most part. There's--you'll always be able to find, you 
know, a small number of loans that had questionable this or 
that. But, we are not here because borrowers did not 
understand--or, I should say, investors did not understand the 
nature of the loans that were being made. I think we were all 
guilty, in the sense that very bad loans, clearly that should 
not have been made, were made.
    Mr. Neiman. So, is the same euphoria, that real estate 
prices, whether residential or commercial property, will always 
go up----
    Mr. Parkus. Yes. Yes, certainly that was that case. I think 
it had been so long since we had seen--I think the idea that 
rising prices just validates--rising price--the idea that 
prices will always rise just gets built into a mentality. And 
when you need--when you're--when you have--as an investor, you 
need to reach certain debt hurdles, you're willing to cut 
corners, you're willing to believe that, ``Well, I--maybe this 
will perform, maybe this clearly inadequate loan''--and then 
the next time, ``Maybe this even worse-quality loan will 
perform.'' And it's sort of a--you get swept away along those 
lines.
    Mr. Neiman. Mr. Woodwell, your organization sees this from 
both the commercial and the residential side.
    Mr. Woodwell. I might draw a greater distinction between 
the motivations for purchasing a home and for investing in an 
income-producing property, that an investor, someone purchasing 
an office building, a shopping center, is looking for that--
looking at that as an investment, as something that's going to 
both throw off income and, essentially, get dividends through 
those income payments in the degree to which the income exceeds 
any mortgage payments; and then also is looking for a capital 
gain. And the degree to which an investor is driven more by a 
capital gain and, sort of, heightened expectations there, 
versus the income of the property, that can lead to those 
prices exceeding the growth of the incomes, which is probably 
something that we saw during the '05, '06, '07 period.
    But, that being said, I do think that one needs to be 
careful that there are very different motivations between those 
who are purchasing homes and those who are purchasing 
commercial real estate.
    Mr. Neiman. Mr. Anderson----
    Mr. Anderson. Yeah, I got a couple comments that--I'd 
agree, I don't think there was a subprime element of--in the 
commercial real estate market. And, as you pointed out, they 
are generally sophisticated borrowers that understand, you 
know, the terms of what they're agreeing to.
    Mr. Neiman. Are they so sophisticated that they took 
advantage of the system with little equity?
    Mr. Anderson. There might have been some of that going on, 
sure. You know, if you're looking at it, thinking, ``Gosh, I 
can squeeze some more dollars out of this by adding more 
leverage,'' you can understand how people might get into that. 
The irony is that, with ever higher prices, the sense of risk 
was diminished. So, the pricing of risk went way down, and yet, 
actually, that was when risk was the highest. So, the higher 
the prices went, the greater the real risk, but the lower risk 
pricing actually went.
    Mr. Neiman. Well, thank you.
    The Chairman. Dr. Troske.
    Dr. Troske. Thank you.
    A number of you have made a distinction between sectors of 
the commercial real estate market, in a number of your 
comments. And I guess I wanted to explore that a little more.
    I'll start with you, Mr. Parkus. You made a big distinction 
between financing trophy properties and other smaller 
properties, or the difference in performance of financing, 
going back into commercial properties. And, I guess, what are 
some of the--you know, what are the differences that are 
producing this--in these two types of markets, that are 
producing these different performances?
    Mr. Parkus. Well, I think the big difference is in the 
price performance. We're seeing trophy properties and 
institutional-quality properties appreciate at a much more 
significant rate than smaller properties. And I think that that 
is, you know, largely the result of, you know, institutional 
investors. When institutional investors come in and look for 
higher-quality properties.
    There's been a tremendous interest, from institutional 
investors all over the world, in the U.S.--high-quality U.S. 
commercial real estate properties. Smaller properties are 
typically outside of their purview. They don't invest in small 
multifamily--for the most part, small multifamily properties, 
in Dallas, say. They invest in large office properties in 
gateway cities.
    So, there is--what my point was, is that there is a very 
significant bifurcation going on between the haves, the very 
best, and, kind of, the have-nots, which is more the--a very 
large portion of the commercial real estate sector is.
    Dr. Troske. And listening to your comment, it does seem 
like you indicated that the difference was reflecting the fact 
that these trophy properties were seeing a greater appreciation 
in price. So, there should--a reason for why they have an 
easier time getting financing, not just some dream of owning a 
office building in Manhattan.
    Mr. Parkus. They have an easier time getting financing, 
because there is, intrinsically, greater demand for those types 
of assets, from large, well-capitalized investors. If there 
is--if you have an asset for which there is a lot of interest, 
lenders will be very interested, as well.
    Dr. Troske. Mr. Anderson, you've sort of commented on that, 
as well.
    Mr. Anderson. Yeah. Well, I'd pick up on the demand-for-
trophy-properties argument. I think that's true. What you tend 
to see in a market downturn with lower rents is occupants--
occupiers of space being able to move up the quality of space 
at roughly the same rent that they were paying. So, they may 
move from what's called B space in the--B-quality space in the 
office sector, up to A space, with little or no increase in 
rent. So, they take advantage of those price declines--or rent 
declines.
    The way that works--and so, how that benefits the trophy 
properties is that they tend to remain full; whereas, the B 
properties and then C properties experience even greater 
vacancies as people move out of those spaces and into higher-
quality properties.
    Dr. Troske. Mr. Woodwell--and you focused primarily on the 
difference between, sort of like, commercial properties and 
development--construction. And so, give me a little--I mean, 
and that seems to be much of the difference between your 
point--your view of the market and some of the other views 
we've heard. And so, can you, sort of, maybe, expand on that a 
little?
    Mr. Woodwell. Sure. And I think the--first, it sounds like 
everyone is peeling off the construction activity, particularly 
that that had to do with single-family construction activity 
that's driving a lot of the numbers that we've seen, in terms 
of chargeoff rates, delinquencies, in that broader CRE 
category.
    In terms of, then, the distinction between, sort of, 
primary, secondary, tertiary market, I think what you have 
there sort of makes sense. If you think about it as primary 
markets, you'll have hundred-million-dollar investments; 
tertiary markets, you'll have $500,000 investments. And that 
the large institutional investors who are drawn to those 
hundred--hundred-million-dollar investments, it would take a 
whole lot of tertiary market investments to get to one of those 
major market investments. So, that there--there is a natural 
break, with more local investors playing in those smaller 
primary--or secondary and tertiary markets; more of the large 
international institutional players playing in those primary 
markets.
    I think also, if you think about the course of the credit 
crunch in the recession, the credit crunch probably had more of 
an impact--which came first--probably had more of an impact on 
those large international institutional investors. And then the 
recession probably had much more of an impact on those local. 
So, slightly different impact, slightly different forces at 
play amongst those different players.
    Dr. Troske. You wanted to----
    Mr. Parkus. There's one additional factor, I think, that we 
could mention here. And that is the--sort of, emphasize the 
demand from lenders. The ultimate lenders, in many cases, are 
not the banks, but investors in CMBS. And investors in CMBS 
have a strong preference for high-quality assets, when you can 
get them. So, that tends to drive--you ask, ``Why would lending 
focus on trophy assets versus smaller assets?'' I think that 
that is--and large banks, as well.
    Dr. Troske. Thank you.
    The Chairman. Well, that concludes our meeting.
    I want to thank you for your--for being here today and for 
your excellent testimony and dealing with our questions.
    Also want to take a moment to thank a member of our 
professional staff. We've had 27 hearings, and every one of 
them has been organized by Patrick McGreevy, including nine 
field hearings.
    Patrick, we appreciate all your terrific work, on behalf of 
the panel. And I want to thank you, for the panel, for your 
good work.
    We'll leave that hearing record open for 1 week, in case 
there are any questions. This is not our last hearing. So, 
until the next time, which will be our last hearing, this 
hearing is adjourned.
    [Whereupon, at 12:40 p.m., the hearing was adjourned.]
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