Monday, March 19, 2007

How Exposed Are Banks to Real Estate?

In my previous post I explained why I think that the quantity of bad mortgages in the US economy may actually be enough to significantly affect the non-performance and write-off rates for the US banking system as a whole. Yesterday, Calculated Risk followed this up with a discussion of why he thinks that the health of commercial real estate loan portfolios may soon suffer the same fate that residential loan portfolios are currently experiencing.

In the comments to both posts there seems to be a lot of confusion about banks' exposure to residential real estate loans. So let me take this chance to provide some data from the Federal Reserve's weekly survey of the assets and liabilities of banks in the US. The following table shows commercial bank assets as of the end of February, 2007, the growth in those assets over the past 12 months, and a comparison of the composition of those assets with the same month ten years ago.

Let me point out a couple of interesting features of this table. First of all, banks have direct exposure to residential real estate loans of close to $2 trillion, plus another $1 trillion in indirect exposure through their holdings of mortgage-backed securities (MBSs). That's not a trivial amount.

Secondly, banks continued to expand their residential real estate lending at an extremely fast pace during 2006, despite the rapidly cooling housing market. This may be worrying (from the banking-sector's point of view), if you think that the loans made most recently are least supported by rising underlying house prices.

Finally, and directly contradicting all of the talk about banks shedding their exposure to real estate, it seems that banks actually have significantly more exposure to real estate loans (both directly and through MBSs) now than they did ten years ago.

It may indeed be the case that banks will dodge any incoming bullets from the growing number of mortgage defaults, as many people argue. But evidence like this tells me that banks have a lot to lose if mortgages go bad.

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