As favorable credit conditions, including low interest rates, begin to dissipate, banks could begin to experience more stress from their loan portfolios, including their real estate holdings, according to a report from Kroll Bond Rating Agency.
“Although currently the credit picture regarding bank-owned real estate loans remains quite benign, the image is in many ways too good to be true,” KBRA wrote in its fourth-quarter credit outlook report.
Based on an analysis of Federal Deposit Insurance Corp. data, KBRA argued that the efforts made by the Federal Reserve to influence asset prices may have sown the seeds for future credit problems in the real estate sector.
In particular, KBRA identified loss given default figures as a source of concern. For all real estate loans, loss given default has dropped to 37%, the lowest level recorded since the FDIC began collecting these statistics in the 1980s. For one- to four-family residential loans, loss given default again was below 50%.
“As we’ve noted in previous missives, when banks are reporting negative credit costs on trillions of dollars’ worth of real estate loans, we generally consider that to be a red flag regarding future credit performance of these portfolios,” KBRA wrote.
Overall, net loan losses rose $1.5 billion, or 16.9%, year over year to $10.1 billion, according to the FDIC. The agency also noted, per KBRA, that this is the fourth consecutive quarter with higher net charge-offs.
While charge-offs fell for multifamily and residential real estate loans, bank-owned auto loans displayed higher charge-offs, with the net default rate rise to the highest level since 2011 at 0.75%. Defaults on commercial and industrial and credit card loans also rose.
“As U.S. markets near the release of 4Q 2016 earnings…credit conditions for financial institutions continue to be stable and reflect a benign environment overall,” KBRA wrote. “It is increasingly apparent, however, that the increase in asset prices engineered by the Federal Open Market Committee over the past five years is nearing a conclusion and that bank credit costs are slowly rising — albeit from very low levels.”