Strain of Distress Eases Up for Banks

NEW YORK CITY-The default rate for commercial mortgages other than multifamily loans rose in the second quarter, but at a slower pace than it has in nearly three years, says Dr. Sam Chandan, global chief economist and EVP at Real Capital Analytics. This suggests that the strain on lenders is easing, although the FDIC said Tuesday that 54 financial institutions nationwide were added to the list of problem banks during Q2.

Chandan’s analysis of data from quarterly bank filings as well as the FDIC shows that the Q2 default rate for commercial, non-multifamily mortgages ticked up just nine basis points to 4.28% from Q1. It marks the smallest quarterly increase since Q3 2007; Chandan says the increase in the default rate has been steadily slowing over the past year. Still, he points out that the default rate is at its highest level since the 4.55% rate reached during the RTC era 18 years ago.

“The new data suggests that the strain on banks from new distress is moderating,” Chandan says. “Further easing will likely depend upon economic and labor market conditions supporting an improvement in credit and stabilization of property fundamentals.”

That stabilization isn’t likely to occur for awhile, though. Chandan says the incremental increase in commercial default rates reflects both immediate challenges in refinancing loans at maturity and property owners’ “difficulties in meeting recurring principal and interest obligations during the life of the loan.”

Mortgages in the multifamily sector saw a 47-basis point drop in the default rate from Q1, which declined to 4.16% during Q2. It’s still 103 bps higher than it was a year ago, but that compares to a 139-bps rise in the commercial mortgage default rate.

The improved result in multifamily defaults coincides with recent reports showing improvements in apartment fundamentals, says Chandan. In its July report, Axiometrics reported that national apartment effective rent growth improved from 0.43% to 0.56%, while annual effective rent growth improved from 1.12% to 1.8% during the same period.

The improvements seen in default rates were not uniform across the spectrum of lenders, Chandan points out. For banks with more than $10 billion in assets, both the commercial and multifamily default rates declined, to 4.98% and 4.21%, respectively. Yet at smaller institutions with $1 billion to $10 billion in assets, default rates rose during the quarter, with a 39-bps jump in commercial default rates to 3.96% and a 40-bps rise in multifamily defaults to 4.56%.

Adding to this, the concentration of commercial and multifamily loans increased at smaller institutions from 33.2% of net loans and leases to 33.7%. Overall, Chandan says, banks reduced their commercial real estate balance sheet by just under 1%—$9.6 billion—during the quarter.

As the ranks of loans and assets in distress have swelled in the past two years, the FDIC has cited commercial real estate exposure as a sore point for lenders incurring heavy losses.  The FDIC’s list of “problem banks” now totals 829, up by 127 since the end of 2009 and the highest tally since the early 1990s.

However, the FDIC said on Tuesday that banks turned a $21.6-billion profit in Q2, compared with a $4.4-billion quarterly loss the year prior. “Without question, the industry still faces challenges,” FDIC chairman Sheila Bair says in a release. “Earnings remain low by historical standards, and the numbers of unprofitable institutions, problem banks and failures remain high. But the banking sector is gaining strength. Earnings have grown, and most asset quality indicators are moving in the right direction."