BID® Daily Newsletter
Jan 23, 2008

BID® Daily Newsletter

Jan 23, 2008

COMMUNITY BANK LOAN PERFORMANCE FOR DEC


For those of you using our Loan Pricing Model, you already have access to the latest December information. For everyone else, we provide an update on community bank loan performance. On average, default probabilities rose 6.5% for the month of December, one of the largest jumps for the year (a 78% annualized increase). To put this in perspective, banks will suffer about a 2% decrease in risk-adjusted return on equity, as a result of higher default rates. On the opposite side of the coin, to compensate for this risk, (given the average structure of loans for December) banks would have to increase pricing 26bp to maintain the same ROE (which incidentally was 14.3%). The riskiest loan a community bank could make in December - a 2nd TD HELOC (at a 3.81% probability of default).
Other notable changes include a 50% month-over-month jump in default expectations for hospitality lending and manufactured housing. Mixed use, multifamily, office, retail and self storage all rose 20% from last month. Office and retail continue to track each other and now show a 1% probability of default. The increases in defaults in these sectors are a result of a healthy amount of new supply coming on the market, combined with a decrease in demand. Our forward-looking model shows rents will decrease in about 75% of the 170 markets that we cover. Southern CA, southern FL, Las Vegas, Salt Lake City and San Bernardino/Riverside are all projected to have some of the largest deterioration of bank loan credit quality as a result of lower resets (exacerbated by lease terms that have shortened on community bank collateral over 2007). Nationwide, the retail vacancy rate hit 7.5%, its highest level since June of 1996.
The bright spot at this point is loans on agriculture farm land, which dropped 33% from last month. As we have been saying for years, while agricultural loans have higher default rates, they are counter-cyclical and can offset construction risk nicely. Another bright spot is loans on senior housing. After some higher probabilities of default over the last several months, December saw lower risk (as it looks like many properties lowered rates and increased occupancy, resulting in better DSCRs). Construction risk abated slightly, due to lower cost of construction inputs (causing less reported price overruns on projects). In addition, lower employment has caused many firms to increase manpower on projects. The combination of more available workers and lower construction inputs (wood, steel, gypsum, concrete, etc.) has overwhelmed the risk from slower lease up times. As a result, for the short-term at least, the probabilities of default on both residential and commercial construction have been reduced an average of 8% for the month.
On a statewide basis, some significant changes last month include default probabilities going down 4% in PA and 6% in RI. Meanwhile, probabilities went up 6% in NH and 5% in MN. The worst states for loan performance for community banks include: TX, OK, TN, MI and VT.
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