Fitch press release ( emphasis added):
Fitch Announces Expanded Review of U.S. Bank Commercial Real Estate Exposure
18 Aug 2009 10:43 AM (EDT) Fitch Ratings-New York-18 August 2009: The performance metrics of commercial real estate (CRE), an area with a significant risk exposure for the majority of Fitch’s U.S. bank universe, continues to deteriorate at an unprecedented pace. While CRE loans, excluding the more problematic construction and development portfolios, represent more than 125% of total equity for the 20 largest banks rated by Fitch, the risk is even higher for banks with less than $20 billion in assets, as average CRE exposure represents more than 200% of total equity for these institutions.
Given the degree of deterioration, and the substantial exposure of many U.S. banking and thrift institutions to CRE, Fitch has recently launched an information survey aimed at obtaining more granular data on the CRE portfolios of the institutions it rates. Fitch intends to use this information to enhance its insight on the size and performance of particular segments of banks’ CRE portfolios. This will allow Fitch to frame areas of specific concern across the industry, conduct various stress tests, and assess if ratings changes are needed to reflect what will likely be continued deterioration in asset quality.
As reported last week by Fitch’s commercial mortgage backed security (CMBS) group, CMBS loan delinquencies surpassed 3% in July and are expected to increase more than 60% by year end to at least 5%. Further, roll rates from 30 to 60 days have increased to over 50% in 2009 and resolutions continue to slow. “The same factors that are placing pressure on CMBS transactions are increasing pressure on the performance of bank and thrift-held CRE portfolios” according to Thomas Abruzzo, Managing Director and co-head of Fitch’s North America Financial Institutions group.
The stress is clearly not confined to CMBS activity. In commenting on the U.S. bank universe, Abruzzo went on to state, “large banking companies have seen levels of early-stage delinquencies, more severe delinquencies and non-accrual loans, as well as charge-offs increase markedly across their CRE and construction and development portfolios. While the 10%+ of construction and development loans in non-accrual is greatly attributed to residential construction activity, the 5% of the CRE book in non-accrual status evidences more widespread problems.”
Fitch currently assigns Negative Outlooks to nearly half of the 20 largest U.S. bank and thrift institutions it rates. As Fitch has indicated in its recent bank rating actions, a major concern contributing to these Negative Outlooks is the potential for further deterioration in the institutions’ loan portfolios with a specific focus on CRE exposures.
“While the relative size of the CRE portfolio is smaller for some of the very large banks Fitch rates, the recent performance trends, expectations for continued economic weakness and the uncertain availability of the CMBS market increases the concern regarding CRE exposure and makes it a likely rating driver as we look out over the next few quarters,” stated James Moss, Managing Director and co-head of Fitch’s North America Financial Institutions group.
As part of Fitch’s expanded analysis it has sent surveys to more than 75 Fitch-rated U.S. bank and thrift institutions requesting additional detail on the institution’s exposure to CRE, covering both the banks’ loan and investment portfolios. Among the uniform information requested is: collateral type, geography, internal risk rating, and performance. Fitch also requested additional detail on each bank’s largest exposures and watch credits. Fitch has asked that this information be provided by the middle of September.
Once in receipt of this information the data will be compiled and Fitch will begin to provide commentary at an industry level on areas of exposure in order to provide investors with a better sense of where the significant risk exposures are. Fitch will conduct various stress tests to gauge a bank’s ability to withstand incremental deterioration. Results of these scenarios will be highlighted in any rating actions Fitch determines to be warranted.
Fitch’s current bank and thrift ratings already incorporate further CRE portfolio stress, and many rating actions in the last couple of years have been driven in part by problematic exposures to CRE, particularly the residential construction sector. Fitch believes current indicators point to the potential for continued deterioration to surpass Fitch’s current expectations. The analysis of the additional data will assist in highlighting which, if any, institution’s portfolios are particularly vulnerable to an extended period of stress.
Contact: James Moss +1-312-368-3213, Chicago; or Thomas Abruzzo +1-212-908-0793 and Christopher Wolfe +1-212-908-0771, New York.
Media Relations: Brian Bertsch, New York, Tel: +1 212-908-0549, Email: brian.bertsch@fitchratings.com.
Fitch’s rating definitions and the terms of use of such ratings are available on the agency’s public site, ‘www.fitchratings.com’. Published ratings, criteria and methodologies are available from this site, at all times. Fitch’s code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the ‘Code of Conduct’ section of this site.
In a new report, Fitch warns investors about CLOs:
“…given the evolution of leveraged loans from a relatively illiquid asset class at the inception of the CLO market to a more actively traded credit product, Fitch questions the practice of accounting for loans at par regardless of the discounted purchase price threshold. There are elements of the current loan market that are not directly addressed through Fitch’s rating criteria, but should not be ignored.”
Remember the recent rush by banks to buy discounted assets on the open market? Although this report was not specifically focused on how banks treat these assets on their balances sheets, if the CLO manager is a bank, it appears possible for the bank to buy-on-the-cheap loans and account for those loans at par rather than the price actually paid. Note that this activity would not be adjusting values due to the recent relaxation of mark to market by the FASB. This shenanigan is separate.
Fitch explains:
Discounted security purchases are generally permitted, but holdings beyond 5% of the portfolio notional balance are generally carried at their purchase price for purposes of overcollateralization (OC) tests.
This structural feature reduces the OC credit given to discounted securities and is intended to protect investors from the following:
• Egregious Par Building: Creating credit enhancement by measuring assets purchased at considerable discount to par at par value rather than their purchase price.• Adverse Selection: Accumulating assets with relatively weaker credit profiles as indicated by lower than average market prices.
While the intention of the discounted security adjustment has merits, Fitch has long identified issues with its practical application.In today’s environment, in contrast to the par loan market several years ago, almost all loans are trading below 85% of par. As such, most of the leveraged loan universe would be considered as discounted securities. Since managers account for discounted securities at their purchase price rather than par, there is a disincentive for a CLO manager to make substitution trades, which may be needed to improve the credit quality of the underlying pool of loans.
Fitch has released its Global 2008 RMBS Transition and Default Study and 2009 Performance Outlook. In its comment, Fitch focuses our attention in a backdoor sort of way on the troubles in the US (we added the emphasis):
“The outlook for the global residential market and RMBS ratings remains negative in 2009 as loan defaults are expected to increase while prepayments will slow considerably. Downgrades will continue to significantly outweigh upgrades in 2009 across all rating categories. However, Fitch Ratings anticipates that, other than the U.S, the majority of rating actions for RMBS will be confined to lower rated tranches and that highly rated ‘AAA’/'AA’ tranches will be able to weather the current downturn.”
The implication of course is that even the ‘AAA’ rated RMBS’s in the US banks will be downgraded significantly over 2009. The residential mortgage and housing price implosion in the US is only half to two thirds done.
“In 2009, residential markets across the US will continue to decline and cause further pressure on ratings. For the subprime and Alt‐A sectors, downgrades have been extensive and further downgrades may not be as widespread as in previous years, thus the Rating Outlook is Stable to Negative. For prime, where downgrades to date have been less prevalent, especially at the senior level, the Rating Outlook is Negative reflecting the poor housing market and wider economy.”
