Fitch Expects Residential Loans to Continue Causing Losses for Banks

By: Esther Cho 03/02/2012

Despite recent reports of modest improvement in the health of the housing economy, Fitch expects the real estate sector to continue to depress the performance of banks, according to Fitch Ratings.

Residential real estate is the largest exposure for banks since they make up $2.5 trillion, or roughly one-third of total loans, according to the agency. Home equity represents about 30 percent of this amount, with 1-4 family first lien mortgages making up the balance.

“Most of these loans are on bank balance sheets and are concentrated at the largest institutions,” the Fitch report stated. “As a majority of them are subordinated, performance remains very much leveraged to further home price declines and potential principal reduction initiatives.”

Based on Fitch Rating’s Sustainable Home Price (SHP) model, home prices may continue to decline by 8 to 10 percent over the next several years. According to a recent Case-Shiller report, home prices hit new lows at the end of 2011.

With the decrease in home prices, Fitch believes the declines will continue to pressure homeowners and increase both the likelihood of default and loss severity.

While mortgage delinquency rates showed some recent strides compared to their 2010 peak, the numbers are still elevated compared to levels before the crises. Modifications have also become subdued, but Fitch said in the report that modifications may pick up in 2012 as HAMP 2.0 becomes adopted since the new version removes buyback risks for lenders and aims to qualify more underwater borrowers.

Based on Fitch’s base and stress scenarios, the agency also said that the 20 largest banks can incur losses in excess of $80 billion on home equity and 1-4 family portfolios over the next three years. This estimate represents a loss rate of 5.1 percent on aggregate loans of $1.6 trillion, compared with a loss rate of 8.4 percent since 2008.

Overall, Fitch said in the report that many banks have resolved the most problematic areas of their residential portfolios, which means additional losses are likely to be more moderate compared to previous losses. Still, Fitch said the housing market is likely to remain pressured, and some banks will continue to feel earnings, and possibly capital, pressures as a result.