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Construction and Development Loan Exposure Continues to Plague Community Banks

NEW YORK (TheStreet) -- The number of FDIC-insured financial institutions continues to decline and at the end of the third quarter the total is down to 7,181 from 7,245 sequentially. Among the total are 1,131 publicly-traded money center banks, regional banks and community banks including savings and loan associations.

Today I focus on 24 regional and community banks and their exposures to commercial real estate loans, which include construction and development loans. But first, here's a review of the regulatory guidelines for risk exposures for these types of real estate loans.

In the fall of 2005, the Federal Reserve, U.S.Treasury and the Federal Deposit Insurance Corporation realized that community banks were loaning funds to the housing and real estate markets at a pace above what these regulators thought as prudent. Guidelines were set and monitored via quarterly filings to the FDIC. These guidelines were formalized by the end of 2006. They included the following stipulations:

The guidelines for exposure to construction and development states that if loans for construction, land development, and other land are 100% or more of total risk capital, the institution is considered to have loans concentrations above prudent risk levels, and should have heightened risk management practices.

The guidelines for exposure to construction and development loans plus loans secured by multifamily and commercial properties are 300% or more of total risk capital, the institution would be considered to have CRE concentrations above prudent levels, and should employ heightened risk management practices.

In my opinion, one of the reasons for the great credit crunch was that the three regulators ignored these regulatory guidelines. Today 1,784 FDIC-insured financial institutions or 24.8% of the banking system remain overexposed to CRE loans.

Another measure of risk is the CRE loan pipeline. The industry considers a pipeline where 60% of loan commitments are funded as healthy. When real estate loans are paid down, new loan commitments can be made. Today 2,472 banks (34.4%) have 80% to 100% of their CRE loans fully funded, which is a reason that community banks are reluctant to lend to developers and home builders. This remains a sign that the great credit crunch continues. Banks can't issue new loan commitments until the old ones are paid off.

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