UPDATE 1-Fed's Tarullo warns on commercial real estate

Thu Oct 15, 2009 12:08am IST

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WASHINGTON Oct 14 (Reuters) - The financial system remains fragile and bank exposures to a deteriorating commercial real estate sector present a trouble spot, U.S. Federal Reserve Board Governor Daniel Tarullo said on Wednesday.

"While there have been some positive signals of late, the financial system remains fragile and key trouble spots remain," such as commercial real estate, he told a Senate Banking subcommittee.

"Prices for both existing commercial properties and for land ... have declined sharply in the first half of this year, suggesting that banks are vulnerable to significant further deterioration in their CRE loans," Tarullo said.

He said the economy appears to have resumed growing but warned that it will take time to rebound from the serious financial crisis it endured and jobs won't come back quickly.

"The unemployment rate has continued to rise, reaching 9.8 percent in September, and is unlikely to improve materially for some time," he said.

Tarullo zeroed in on potential losses the banking system faces on soured commercial real estate loans and said some were slow to even acknowledge the weakening sector.

Prices for existing commercial properties have fallen 35 to 40 percent since peaking in 2007 and more declines are anticipated. Rising job losses and high vacancy rates also are weakening demand for commercial property, Tarullo said.

"The negative fundamentals in the commercial real estate property markets have caused a sharp deterioration in the credit performance of loans in banks' portfolios and loans in commercial mortgage-backed securities," he said.

At the end of the second quarter, about 9 percent of commercial real estate loans were delinquent, nearly double the level a year earlier.

Tarullo said the Fed -- the U.S. central bank -- was developing guidelines to encourage banks to restructure commercial real estate loans and offer "workouts" for troubled borrowers.

In the meantime, he said, Fed examiners are seeing instances where banks are slow to acknowledge declines in cash flows from commercial real estate properties and it wants to find ways to encourage banks to offer "prudent" workouts to creditworthy customers. (Reporting by Glenn Somerville; Editing by James Dalgleish)

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