Source data: Q209 data from FDIC, FFIEC.  Note that for the sake of brevity and ease of understanding, I refer to loans classified as “Secured by non-farm, non-residential real estate” in the FFIEC call report as simply “commercial real estate loans”.  I start with a look at all non-performing loans, then zoom into loans likely to impact the real estate market, then take a closer look at commercial real estate loans.  Note if we are talking about non-performing loans, we are talking about a leading indicator that should tell us about future market direction as in most cases it takes the bank time to foreclose and dispose through an REO sale.  I’ll update this post when the Q3 numbers are available.

The following graph shows the growth in non-performing loans for FDIC insured active institutions.  The graph doesn’t exactly represent the whole non-performing loan pie because as institutions are closed (it happens, look it up), the banks are pulled out of the active list and don’t show up in the data anymore.  You can see from the graph that non-performing loans flattened out in the 3rd quarter of 2008, the same approximate time that several of the larger bank closures took place.  It’s also worth noting that the graph line shows a steady upward march despite the fact that the line is based on book value and banks should be writing down the book value of their loans.  The numbers are in 000’s, so you are reading that right.  Over $330 billion in non-performing loans at the end of Q209.

Not all loan types are going to impact the real estate market.  As an example, credit card debt, home equity lines, and junior liens are all types of loans that could be underperforming, but they have less impact on the real estate market than those types of loans that will lead directly to increasing supply in the vulture market.  Construction loans, commercial real estate, multi-family , and single family 1st liens do however lead to more supply in the vulture market.  Based on the Q2 data the classes of loans that I would call related to the real estate market accounted for 84% of the non-performing loans, or $282 billion in book value.

Below is a pie chart showing a further breakdown by classes of loans and excluding the types of loans not likely to impact the vulture market (home equity, 2nd liens, credit card, etc).  Again, numbers in 000’s.

Single family mortgages are still the key component among non-performing loans, accounting for 54% of the book value of loans shown in the graph.  Land development and SFR construction loans accounted for $81.5 billion in book value.  Loans on commercial real estate are a smaller part of the pie, but are growing.  The following graph shows that non-performing loans secured by commercial real estate doubled in the previous four quarters reported.  Numbers are in 000’s, so there were over $41 billion in loans non-performing at the end of Q2.

However, I suspect that buyers or brokers waiting for a real vulture market to materialize in the commercial market will have to wait.  The following graph shows the percentage of loans non-performing for construction loans compared with commercial real estate loans.  The vulture market in construction loans and land development loans has been on fire this year because banks have become willing sellers at prices that buyers will accept.  The deteriorating quality of construction loans goes a long way towards explaining why banks have become such willing sellers.

Based on the Q2 data, over 16% of all construction loans, if measured by book value, are non-performing.  As is obvious to anybody that has been paying attention, loan quality has been battered by falling prices for the fully developed product like single family housing, or commercial real estate.  However, loans secured by commercial real estate are performing at a higher rate and aren’t seeing the same rapid deterioration in the quality of all loans.  Because of the current bid-ask gap in the commercial market, as well as the fact that banks typically have to be beat over the head with the problem loans before they get aggressive in selling, we could be waiting for some time before the real commercial vulture market materializes.  This is backed up by anecdotal accounts as well.  Talk to anybody in commercial real estate and they’ll tell you deal flow is at a trickle and the bid-ask gap continues to widen.

Every market contains opportunities and challenges.  If anybody has any interesting insights related to these numbers, or guesses as to where they tell us the market is likely to go, I would be really interested to hear them in the comments.

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