Many investors are starting to become worried about looming problems within commercial real estate lending, as the credit cycle continues its tortuous path through the American landscape. Is it possible that this will be round two of the bailout of the U.S. financial system?

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This is not a new issue, and many have written on this area previously, but Federal Reserve Chairman Ben Bernanke may have focused renewed interest on with his testimony before Congress earlier this week. (Learn about the tools the Fed has at its disposal in The Federal Reserve's Fight Against Recession.)

Bernanke testified before the Senate Banking Committee, and told the Senators that a potential wave of defaults in this lending category was a concern, and might even require some type of government assistance to help the banking sector cope. He noted that no specific plan was currently being contemplated at the Federal Reserve. He made similar comments to the equivalent committee in the House of Representatives a day earlier.

This concern is well supported by recent data from Moody's Corp (NYSE:MCO), which reported that prices for the all properties national index was down 7.6% for May. The index is now down a staggering 34% from its peak in 2007.

One fact that might serve to mitigate the commercial real estate problem scenario is that these properties have cash flow to help support them, unlike the residential area, where foreclosed properties can just sit empty for months.

Earnings reports and management commentary on conference calls also indicate a growing problem for some banks.

Dowd Ritter, the CEO of Regions Financial (NYSE:RF) said during the second quarter conference call that the majority of the Commercial Real Estate portfolio was performing "relatively well," but that the bank was starting to see "signs of weakness in income producing commercial real estate lending." Ritter noted in particular that retail and multifamily properties were a concern.

SunTrust Banks Inc. (NYSE:STI), another large regional lender, noted during its earnings call that it was seeing "increased strain in certain economically sensitive industries" within its commercial real estate portfolio. The bank said that the majority of its portfolio was owner occupied commercial real estate, which afforded a degree of credit protection.

Key Corp (NYSE:KEY) saw an increase in non-performing assets in the quarter, due partly to its commercial real estate portfolio. Chuck Kyle, the chief risk officer said, "I think it is very fair to say that fundamentals in the business are still not very good and show no particular signs of improving."

The U.S. financial system may need another bailout if the worst-case scenario on commercial real estate lending becomes fact. Investors who are assessing the likelihood of this should remember that the same banks that were responsible for aggressive and irresponsible residential mortgage lending are the same banks in the commercial real estate lending business. (For additional reading on commercial real estate, take a look at The Risks Of Real Estate Sector Funds and 7 Steps To A Hot Commercial Real Estate Deal.)

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Tickers in this Article: STI, RF, KEY, MCO

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