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Banks Affected By Increased Loan Defaults
Warnings about the looming problems in the commercial real estate loan market have started to reach a shrill pitch in the media, accelerated by recent data that showed default rates hitting new highs.
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The Stats
The latest report from Real Estate Econometrics said that 2.88% of all commercial real estate loans were in default in the quarter ending June 30, 2009. This percentage was up sequentially from the 2.25% in the previous quarter, and more than double the 1.18% in the same quarter in 2008.
These statistics refer to loans still held on bank balance sheets, and not on the smaller commercial mortgage-backed securities (CMBS) market. Banks hold $1.1 trillion of these loans on balance sheets. Sheila Bair, the chairman of the Federal Deposit Insurance Corporation (FDIC), also weighed in on the issue, and said that future bank failures would be driven mostly by commercial default rates.
Bank Optimism
If there is a storm coming, the nation's major banks don't seem all that worried, with two announcing that they would repay investments received from the government. Wells Fargo (NYSE:WFC) just announced that it would redeem the $25 billion in preferred stock held by the U.S. government as part of the Troubled Asset Relief Plan (TARP). The bank said it would not raise additional capital to replace the funds.
Bank of America (NYSE:BAC) made a similar announcement last week, and said it would pay back $20 billion of the $45 billion it received in TARP funds. This portion was received to help support the purchase of Merrill Lynch in 2008.
The Bad News
Other banks reported further weakness in this loan category during second-quarter earnings season. Huntington Bancshares (Nasdaq:HBAN) reported a $221 million increase in non-accruals in the second quarter, which "reflected the continued decline in the housing market and stress on retail sales." PNC Financial Services Group (NYSE:PNC) has a $25 billion commercial real estate portfolio, which is approximately 14% of its overall loans. The bank said that it was monitoring its exposure to lending to retail strip shopping centers and lodging areas, due to its leverage to consumer spending.
The Bottom Line
One problem is that default statistics are often taken out of context, and analyzed in isolation. The more important statistic is not the default rate, but how much the banks have reserved to cover those losses. Capital reserves to cover those losses is also important.
The default rates on commercial real estate loans are hitting new highs, and are projected to go higher, but the banking industry doesn't seem worried, with several large institutions handing back capital to the government. (For more, see The Risks Of Mortgage Backed Securities.)
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IN PICTURES: 7 Tips On Buying A Home In A Down Market
The Stats
The latest report from Real Estate Econometrics said that 2.88% of all commercial real estate loans were in default in the quarter ending June 30, 2009. This percentage was up sequentially from the 2.25% in the previous quarter, and more than double the 1.18% in the same quarter in 2008.
These statistics refer to loans still held on bank balance sheets, and not on the smaller commercial mortgage-backed securities (CMBS) market. Banks hold $1.1 trillion of these loans on balance sheets. Sheila Bair, the chairman of the Federal Deposit Insurance Corporation (FDIC), also weighed in on the issue, and said that future bank failures would be driven mostly by commercial default rates.
Bank Optimism
If there is a storm coming, the nation's major banks don't seem all that worried, with two announcing that they would repay investments received from the government. Wells Fargo (NYSE:WFC) just announced that it would redeem the $25 billion in preferred stock held by the U.S. government as part of the Troubled Asset Relief Plan (TARP). The bank said it would not raise additional capital to replace the funds.
Bank of America (NYSE:BAC) made a similar announcement last week, and said it would pay back $20 billion of the $45 billion it received in TARP funds. This portion was received to help support the purchase of Merrill Lynch in 2008.
Other banks reported further weakness in this loan category during second-quarter earnings season. Huntington Bancshares (Nasdaq:HBAN) reported a $221 million increase in non-accruals in the second quarter, which "reflected the continued decline in the housing market and stress on retail sales." PNC Financial Services Group (NYSE:PNC) has a $25 billion commercial real estate portfolio, which is approximately 14% of its overall loans. The bank said that it was monitoring its exposure to lending to retail strip shopping centers and lodging areas, due to its leverage to consumer spending.
The Bottom Line
One problem is that default statistics are often taken out of context, and analyzed in isolation. The more important statistic is not the default rate, but how much the banks have reserved to cover those losses. Capital reserves to cover those losses is also important.
The default rates on commercial real estate loans are hitting new highs, and are projected to go higher, but the banking industry doesn't seem worried, with several large institutions handing back capital to the government. (For more, see The Risks Of Mortgage Backed Securities.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
by
Eric Fox
Eric J. Fox, CFA, is a freelance financial writer and has previous experience working in the asset management industry as an equity analyst and portfolio manager on the buy side. His favorite area to write on is the energy sector and he keeps current on the industry by reading Haynesville Shale, Permian Oil and Gas and various other blogs.
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