Fitch Announces Expanded Review of US Bank Commercial Real Estate Exposure

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.