S&P Lowers Insurers Ratings, What About Banks' $400B CMBS Losses?

On Thursday, Standard and Poor's lowered the counter party credit risk ratings of 10 insurers. The downgrades were the result of a previously announced review of the industry and commercial real estate loans, particularly CMBS. S&P indicated that the current economic weakness was the prime culprit for the new “stress” tests. From the report:

Given these difficult economic conditions, we believe that life insurer’s bond holdings, commercial mortgages, and commercial mortgage-backed securities (CMBS) could experience unprecedented stress in the next 12-18 months.

In a previous post, I wrote that the commercial banks are actually the largest holders of commercial mortgages and CMBS. The following chart shows the percentage of commercial mortgage loans held by Commercial Banks, Life Insurance companies, CMBS issuers, Savings Institutions, and GSEs.

click to enlarge

The chart illustrates that commercial banks have not only been the largest holders of commercial mortgages, but they have been increasing their exposure even during the economic crisis. The largest commercial banks have the following exposure to the credit markets:

click to enlarge

During the savings and loan crisis, the delinquency rate on commercial real estate reached highs of 12%. According to the Federal Reserve, delinquency rates on commercial real estate are running about 5%. If S&P is correct, then it is reasonable to assume that delinquencies will reach at least 12%. Commercial banks hold roughly $1.4 trillion in commercial mortgages, which means that there are likely $100 billion more in losses to be recognized. If “unprecedented” levels mean delinquency rates approach the 30% level seen by sub-prime loans, then there could be as much as $373 billion in losses yet to be recognized. I suppose we will just add that to our tab…

Disclosure: I am long SRS.

Comments

[Rocknbob:]

Mr. Kelly,
Correct me if Im wrong , your first graph shows almost constant CMBS ownership/distribution from Q107 thru Q308. If thats true, then you're assuming the net # of CMBS issued increased during the time.

your statement "The chart illustrates that commercial banks have not only been the largest holders of commercial mortgages, but they have been increasing their exposure even during the economic crisis." indicates this.

Maybe you could indicate whether the absolute amount of CMBS issued increased.

Feb 27 07:01 AM

[Brian Kelly:]

Rocknbob,

CMBS issuance did not increase during this period, it declined. In fact it has totally seized up. I suspect this is the reason commercial banks still hold so many commercial mortgages - there is no securitization market to sell the mortgages into.


On Feb 27 07:01 AM Rocknbob wrote:

> Mr. Kelly,
> Correct me if Im wrong , your first graph shows almost constant CMBS
> ownership/distribution from Q107 thru Q308. If thats true, then you're
> assuming the net # of CMBS issued increased during the time.
>
> your statement "The chart illustrates that commercial banks have
> not only been the largest holders of commercial mortgages, but they
> have been increasing their exposure even during the economic crisis."
> indicates this.
>
> Maybe you could indicate whether the absolute amount of CMBS issued
> increased.

Feb 27 09:29 AM

[the ilster:]

yup its a ticking time bomb I am short IYR myself. Too bad its such a crowed trade. Do you have any other ideas on how to profit from this?

Feb 27 10:02 AM

[REITBull:]

I could be wrong on this, but I believe a large portion of that 5% delinquency rate is tied to residential construction/developme... loans. It's still bad news for the banks, but it may not be an effective indicator of future CRE loan performance. As you can tell I am taking the contrarian bet on CRE and I am long URE, but I do enjoy your articles.

Mar 01 02:45 PM