As we have noted many times, exposure to commercial real estate loans has been among the biggest problems for small banks in the US.
Losses and potential losses on CRE loans, combined with regulatory capital requirements, have constrained the balance sheets of these banks and restricted their ability to lend.
With that in mind, Moody’s has just published some new findings on the sector that contain mixed news. First, the Moody’s/REAL All Property Type Aggregate Index declined by 4% in June (via Research Recap):
Moody’s writes:
The index currently stands at 112.51, which is a slight decrease since the beginning of the year. In the first half of 2010 the CPPI is down 0.9%. Commercial property prices are 41.4% below the peak that was recorded in October 2007, but still 4.2% above the recession low from October 2009.
We expect property prices to remain choppy for some time as commercial real estate markets and the broader economy continue their slow recovery from the recession. Sovereign debt problems, lingering unemployment in the United States, and heightened concern about a double dip recession and even deflation, operate as a drag on investment activity, notwithstanding historically low interest rates.
But even the recession low from October 2009 is above the price level from before the boom started in 2002 — so choppiness or not, there is still room for a continued decline.
As for what this decline since the peak means for short-term loans originated before the crisis (and for CMBS) Moody’s writes in a separate report:
An analysis of five-year loans bundled in conduit/fusion commercial mortgage-backed securities that have matured to date in 2010 shows a roughly 70% / 30% split between favorable and negative resolutions. The findings, in a new report from Moody’s Investors Service, provide insight into what will happen to similar loans over the balance of 2010 and 2011.
This doesn’t sound so promising. But the report then points out that these loans are a small percentage of outstanding CMBS:
Taking into account the size of the loans relative to their respective deals, as well as the stress factors already applied to ratings on those transactions, Moody’s expects few if any ratings ramifications for CMBS holding these loans.
In other words, it’s not good news that 30% of these loans will continue to have “negative resolutions”, but the problem was anticipated. And even with its pessimistic forecast for the performance of these 5-year loans, Moody’s expects the CMBS they back to perform mostly in line with expectations.
Moody’s writes (emphasis ours):
With this gloomy outlook for five-year maturing loans, how will this impact existing ratings? When we look at the size of the loans in question as a share of their respective deals, a relatively benign picture emerges. Figure 6 shows that just over three-quarters (77% by count) of the five-year loans maturing through 2011 with a DSCR less than 1.0X constitute less than 1% of their respective CMBS deal. A full 96% are less than 4% of their deal and only 1% of these loans comprise more than 7% of their deal by balance. This suggests that deal exposure to individual low coverage maturities is relatively minor with few outliers. We can expect little if any ratings ramifications since our surveillance process already stresses the performance of near-term maturities.
DSCR stands for debt service coverage ratio. A DSCR of greater than 1 indicates, roughly, that the borrower has enough money to cover the required debt and principal payments. And as you can see in the aforementioned Figure 6, the short-term maturing loans with a DSCR of less than one make up a small percentage of their CMBS deals.
It must be said that this outlook is rosier than we described in February, when a Congressional Oversight Panel (COP) report said that “the most serious wave of commercial real estate difficulties is just now beginning.”
Those fears have not come to pass, but it’s not as if the economy has markedly improved since then. So just let’s hope Moody’s is right about this, and the COP wrong.
Related links:
US commercial real estate prices down 4% in June – Research Recap
The commercial real estate-failed bank nexus – FT Alphaville
‘The most serious wave of commercial real estate difficulties is just now beginning’ – FT Alphaville