CRE Losses Moderating for U.S. Financial Institutions

27 Sep 2012 4:08 PM
CRE Losses Moderating for U.S. Financial Institutions

Fitch Ratings-Chicago-27 September 2012: Four years after U.S. financial institutions' commercial real estate (CRE) loan portfolios began to come under extreme pressure during the credit crisis, moderate improvements in CRE loan loss performance are supporting steady but slow asset quality recovery for most U.S. financial institutions rated by Fitch. The trend is positive and reflects a view that the recovery in CRE will not be as financially painful as Fitch had previously expected, although the return to normalized levels of performance and growth may be more prolonged.

Trends in net chargeoffs (NCOs) and cumulative postcrisis loan losses for Fitch-rated institutions continued to improve in the first half of 2012, and recent signs of a pickup in parts of the CRE market point to a continuation of improving CRE asset quality trends moving into 2013. Second-quarter NCOs totaled $2.5 billion for all Fitch-rated U.S. banks, compared with $3.8 billion in the second quarter of 2011.

Meanwhile, cumulative CRE loan losses since the crisis have shown signs of leveling off, as fundamentals in pockets of the commercial property markets have improved, lifting valuations in some cases and reducing the size of delinquencies, nonperforming loans, and NCOs from the extremely high levels seen in 2009 and early 2010. As of June 30, the cumulative postcrisis loss figure for Fitch-rated banks stood at $69.6 billion, versus $52.9 billion a year earlier.

Should the pattern of diminishing industry CRE losses continue, the cumulative loss total is likely to remain below our base case assumption of $120 billion-$140 billion that was originally projected in November 2009.

Importantly, recent improvements in asset quality indicators must be viewed in the context of the extreme stress seen in CRE and construction loan portfolios during the crisis. Measures of CRE and construction loan performance for all FDIC-insured banks, for example, have shown improvement since early 2010. Yet, noncurrent loan, NCO, and other real estate owned (OREO) measures all remain well above comparable precrisis numbers from 2005 and 2006. The inflow of new problem assets has slowed, but the primary path for reduction in problem loan levels continues to be chargeoffs. The inventory of problem exposures remains well above historical levels, reflecting the challenges that remain.

For example, FDIC data show that noncurrent construction and CRE loans still represented 10.8% and 3.3%, respectively, of total loans in each category as of June 30. These figures remain well above precrisis comparable rates of 0.7% and 0.6%, respectively, at year-end 2006.

The recovery has been aided in part by the low interest rates made possible by the Fed's monetary policy. However, CRE loss performance could worsen if interest rates spike or if the risk appetite of traditional sources of permanent financing fades.

Commercial real estate markets are continuing to show signs of improvement, with performance varying by property type and location. Fitch's CMBS group expects CRE loan delinquencies to remain relatively flat for the remainder of 2012, with pressure still evident in office properties outside of core markets such as New York. Loan performance for the multifamily and hotel segments continues to improve.

Bank portfolios include construction projects, consisting of both commercial and residential developments. The exposure to this volatile area has been cut in half since the onset of the financial crisis and now represents between 10% and 15% of bank equity capital.

Contact:

Ed Thompson
Senior Director
Financial Institutions

Bill Warlick
Senior Director
Fitch Wire