U.S. commercial banks are changing some aspects of the way they treat borrowers, especially real estate borrowers. These changes are aimed at improving banks' ability to make profits on loans, or to obtain capital in other ways.

The first thing many banks have done is to raise more capital. From December 2007 through all of 2008 — the major “crash” period — U.S. banks lost a total of $56 billion in equity capital, according to the American Bankers Association. However, for all of 2009 banks boosted their equity capital by $175 billion. In the first quarter of 2010, they gained another $14 billion. Hence, they posted a net gain of $132.7 billion in those 2.25 years.

To put this data in perspective, in December 2009 there were 8,012 U.S. commercial and savings banks insured by the Federal Deposit Insurance Corp. (FDIC), of which 6,839, or 85.4%, were commercial banks. Those commercial banks contained assets of $11.8 trillion, or 90.3% of the assets in all 8,012 institutions. The 10 commercial banks with the largest assets combined held 92.7% of all commercial bank assets. The three largest commercial banks held 53%.

The biggest banks have raised the most capital, while small, regional banks have raised relatively little. The total equity capital held by all 8,012 banks at the end of 2009 was $1.47 trillion. That's 11 times as much as the entire system added to its equity capital from early 2009 through the first quarter of 2010.

Low rates stymie investment

Banks also are borrowing money from the Federal Reserve Bank at the interest charge of only 0.25%, and then lending that money at the prime rate of 3.25% or higher. That prime rate is 13 times as great as what the banks are paying for these funds. That large spread — at taxpayer expense — has been helping banks make money and increase their capital, but it is also keeping interest rates lower than I believe they ought to be to avoid possible future inflation. There is plenty of private investor capital sitting on the sidelines, but low rates of return diminish investors' desire to put it to work right now when the economy needs it.

Many banks are restricting their lending on real estate because they already have so many non-performing real estate loans on their books. These banks are focusing on longtime and large customers whose business they want to retain.

In the fourth quarter of 2009, real estate loans accounted for 61.2%, or $4.46 trillion, of all loans held by the 8,102 lending institutions insured by the FDIC. About 43% of all real estate loans consisted of home mortgages, excluding apartment loans, and 24.5% were commercial property mortgages.

The share of real estate loans in all bank lending rose sharply from 39% in early 2001 to 56% in early 2002 due to a stock market crash. Mortgages have been by far the largest category of loan debt outstanding ever since (see chart).

Tougher collateral requirements

Another tactic employed by many banks is to accept as loan collateral only those assets that produce current cash flows, rather than those with no cash flows but supposedly high market values. For example, vacant land is considered of zero value if it produces no current cash flows, no matter how valuable it seems in markets. This approach made one New York City developer claim that his large, buildable lot in Manhattan was worth nothing. That's because when he included it in a mixed-use project, the bank assigned the lot zero value.

Bankers do not want to receive lending returns for taking what are essentially equity risks in various deals. Hence, some banks are qualifying their interest rates in relation to how closely the borrower's property meets the borrower's own pro forma projections.

If the property's profits fall well below those projected, the bank requires the borrower to pay a higher interest rate because equity returns are supposed to be higher than lending returns.

If you are in real estate and plan on borrowing money from banks, be aware of these behaviors that bankers are likely to exhibit in any deals they offer you.

Tony Downs is a senior fellow at the Brookings Institution. He can be reached at tonydowns3254@gmail.com.