If I were the head of commercial real estate lending at a community bank in Massachusetts, I would believe in Santa Claus.

I’d be looking ahead to December, to the orgiastic frenzy when most retailers make all their profit, and I’d be begging Santa Claus to bring me a really, really good holiday buying season. Because if that happens, maybe all those little strip shopping centers in my loan portfolio will stop being lumps of coal.

Everyone’s trying to feel really good about the economy slowly, slowly crawling out of the well it fell into a few years ago. In many respects, we’ve made progress in the Bay State. Unemployment is dropping, home sales are increasing. But these are slippery handholds, and while we’re no longer at the bottom, we’re also nowhere close to the top.

And one of the areas continuing to be a problem for many banks is local commercial real estate loans. It’s not that the loans are yet soured. It’s that there’s a strong likelihood they will be, within a period counted in months. And the biggest area of concern is retail commercial real estate.

Stripped To The Bone

Drive around most developed communities in the commonwealth, and you’ll spot at least one, more probably several, of these mini-malls. They’re small strips with space for a half dozen storefronts and a carpet of asphalt in front for easy parking. Count the vacant retail spaces, and that will translate into the number of heart palpitations that the banker with the loan on the building is having.

“I’m worried,” said Donato Maisano, president of Real Estate Lending Services. Maisano is a longtime appraiser in the region, and a former director of the Appraisal Institute. “These are the strips that have a 7-Eleven in them, and probably not much else these days. Whatever tenants are left are pressuring the owner to reduce the rent. Meanwhile, the bank is pressuring the owner to pay more. This isn’t a good situation.”

Maisano spends a lot of time doing these kinds of commercial appraisals, and he’s concerned that we’re about to go into another spiral of degrading assets at community banks. Of course, this isn’t something that the banks have much control over. What they need is people spending money at retail stores, to encourage more shopkeepers to open in their vacant strip malls.

They’re probably going to be waiting a good long while.

The numbers are telling a cautionary tale. When the National Federation of Retailers (NFR) released its latest forecasts, it could hardly be called whooping. The NFR was pleased that its index of sales in July was up .08 percent over July 2011. But that minimal increase followed three months of declining retail performance. For the first seven months of 2012, the retailers association says sales are up an unimpressive 1.2 percent.

The U.S. Commerce Department’s measure of retail activity shows sales up nearly 4 percent for the year, which is still anemic. But Commerce’s measurement includes non-general merchandise sales, such as automobiles. So while it’s good that consumers are buying something, it’s unlikely anyone’s going to open a car dealership next to the Hair Port and Billy Jones Insurance Agency.

In Massachusetts, retailers are skittish to say they see any improvement. The Federal Reserve Bank of Boston reports that retailers have no clue about what’s happening in the market, with reports hitting just about every mark possible.

“Retail contacts offer a very mixed take on economic conditions in the region,” the Boston Fed said in its latest economic indicators report. “Demand remains strong for adult clothing, but spending on durable items such as furniture and electronics continues to be lower than earlier in the year. Some companies cite disappointing sales during the last six weeks, while others report some upside surprises. Sales results range from low single-digit declines to high single-digit increases compared with a year earlier. Some contacts say that consumer sentiment has become more negative, while others observe that consumers are ‘coming back.’ Retailers note wholesale prices remain flat so they are holding selling prices steady. Respondents still express uncertainty about the direction of the U.S. economy and say they expect little improvement over the next six to eight months.”

I would hate to be a bank’s chief risk officer trying to make a portfolio prediction based on that.

Market Corrections

Greater Boston, of course, is its own market. Commercial real estate here seems to be improving at a stronger pace than elsewhere. But these strip shopping centers are creatures of their community. Locations in Wellesley might be fully rented, while many in Roxbury are empty and sad – and are likely to stay that way for a while.
Meanwhile, it’s pretty easy to find lots of these potential problems across Massachusetts. You see them in Hadley, in Auburn, in Swampscott. These are small local deals, most backed by local community banks – staffed with increasingly worried bankers. And the only thing that’s going to fix these shopping strips is more consumers going to more stores.

But consumers are still holding back in many ways. Credit card spending is up only nominally, and there’s a lot less home equity around to fuel wanton spending sprees. And every day that situation continues, it’s another day closer to an asset that’s going to get marked “non-performing,” either by the bank or by bank regulators.
Unless, that is, Santa Claus comes to the rescue. It’s a big job, and he’s a long way away. But I’ve already got my cookies and milk ready.

I’m pretty sure a bunch of commercial real estate loan officers are doing the same thing.