The Wall Street Journal-20080201-Politics - Economics- Regulators Urge Fast Action By Lenders on Risky Loans

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Politics & Economics: Regulators Urge Fast Action By Lenders on Risky Loans

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WASHINGTON -- Two federal regulators urged lenders to take quick action to avoid a surge in losses tied to the weakening credit cycle, with one forecasting an increase in bank failures.

Comptroller of the Currency John Dugan said the federal government planned to ramp up its scrutiny of commercial-real-estate loans, while Federal Deposit Insurance Corp. Chairman Sheila Bair said lenders must act to slow foreclosures on residential borrowers with interest-only and other nontraditional mortgages.

Congress and others have criticized the regulators for not doing enough sooner to prevent the current credit-market turmoil.

Commercial banks and thrifts wrote off $524 million in construction and development loans in the third quarter of 2007, almost nine times the amount of the third quarter of 2006, according to the FDIC. It was also the highest quarterly charge off since 1993, and the numbers are expected to worsen. Construction and development loans are used to build a wide variety of real-estate projects, from golf courses to office complexes to condominium buildings.

Mr. Dugan, whose agency is a division of the Treasury Department that regulates national banks, said in a speech to the Florida Bankers Association that lenders in stressed areas would likely have to order new appraisals on their loans, downgrade more assets, increase loan- loss reserves, and potentially hold more capital to protect against losses.

Commercial-real-estate loans are extremely popular with small and medium-size banks, with many holding high concentrations of these loans.

"As the result of a prolonged period of exceptionally benign credit conditions, many community bankers had become a little too complacent regarding the potential for significant stresses in these markets," Mr. Dugan said, according to prepared text.

Commercial-real-estate lending can be riskier than residential- mortgage lending because many properties aren't occupied by the owners of the buildings. Stressed economic periods can lead to higher vacancies, which can quickly lead to high concentrations of defaults.

Mr. Dugan said more than 60% of Florida banks had commercial-real- estate loans worth more than 300% of their capital, a level that automatically attracts more attention from examiners. He also said the appraisals on file at banks are often outdated, which makes it difficult to determine the "true credit quality" of loans on a bank's books.

"The potential for rapid deterioration in this business is simply too great not to conduct . . . testing on an ongoing basis," he said, predicting an increase in the rate of bank failures.

Separately, Ms. Bair told the Senate Banking Committee that loan servicers should quickly formulate a plan to deal with the 1.7 million outstanding nontraditional mortgages, such as interest-only loans, many of which are expected to reset into new interest rates next year. These mortgages aren't included in the industry-led plan to modify the terms of subprime adjustable-rate loans, which frequently reset into higher monthly requirements after the first two or three years.

"Waiting to confront the next reset problem will once again create the risk of falling behind a fast-moving trend," she said.

The Bush administration faced criticism at the Senate hearing over a plan it helped broker with lenders and investors to allow some borrowers with subprime adjustable-rate loans to freeze their initial interest rates for as long as five years. Democrats criticized the plan and said it wasn't helping enough struggling homeowners, while a top Treasury Department official urged more patience.

"The hour is getting very late here," Senate Banking Committee Chairman Christopher Dodd (D., Conn.), said. "The listening period, in my view, ought to be over . . . I'm very uneasy about the likelihood that you are going to produce the kinds of results we're looking for."