There’s a trio of ticking time bombs in the banking sector that the “green shots” crew just doesn’t want to admit exists. Credit cards, commercial real estate and residential mortgage resets are the equivalent of the bully at school sitting on your car waiting for you. You know he’s there, but you do everything you can to avoid him. Unfortunately, he’s not going away until you take your licks. The U.S. thinks they can skirt the pain and go through a recession where the investors who made bad decisions don’t have to take their losses, but the grim reality is setting in.
Moodys is out with a report showing that commercial real estate is down 21% from its peak in late 2007. Commercial lagged residential into the recession and will likely lag on the way out. With residential prices down over 33% and not done dropping yet it’s safe to assume that the declines in commercial are far from over. The latest sales volumes show 80% declines and Moody’s expects this trend to continue well into the future. Moody’s expects the loss rate on CRE to peak at 7% in optimistic scenarios and 12% in more dire economic scenarios.
“Given where we are in the economic cycle, it is important to point out that there is a marked difference in performance by loan vintage and term. For example, CMBS loans are typically ten year loans, and the current lower delinquency rates encompass performance of those loans originated as early as 2000. These early vintage loans have seasoned and benefit from cash flow and value appreciation over the years.”
Thus, CMBS loans originated earlier in the cycle are likely to help offset higher delinquencies from more recent vintage originations. A similar situation exists for life insurance companies as they hold loans with longer maturities. Bank loans tend to have maturities of five years or less. As a result, bank loan portfolios exhibit greater concentration in years representing the peak of the real estate cycle. They lack seasoned loans on their books to offset the higher delinquency rates expected from this time period.
Bank loans have an additional burden over CMBS at refinance due to their shorter remaining term. The economic downturn is just beginning to have a negative impact on real estate loan performance. As a lagging sector, real estate delinquencies are expected to rise over the next two years. For a bank loan with less than five years remaining, the potential to refinance in a more robust economic period is lower than for a comparable CMBS or life insurance company loan, with more than five years remaining.
A higher level of refinance risk for bank loans should contribute to higher delinquency rates over time.”
The banks haven’t defused the bombs just yet. In fact, the worst of them might be coming in 2010-2012….