Published: Dec. 5, 2023 at 5:24 p.m. ET
Shares of Federal Realty Investment Trust FRT sank 0.13% to $99.77 Tuesday, on what proved to be an all-around rough trading session for the stock market, with the S&P 500 Index SPX falling 0.06% to 4,567.18 and Dow Jones Industrial Average DJIA falling 0.22% to 36,124.56.
The stock’s fall snapped an eight-day winning streak.
Federal Realty…
Shares of Federal Realty Investment Trust
FRT
sank 0.13% to $99.77 Tuesday, on what proved to be an all-around rough trading session for the stock market, with the S&P 500 Index
SPX
falling 0.06% to 4,567.18 and Dow Jones Industrial Average
DJIA
falling 0.22% to 36,124.56.
The stock’s fall snapped an eight-day winning streak.
Federal Realty Investment Trust closed $15.31 short of its 52-week high ($115.08), which the company achieved on February 2nd.
The stock demonstrated a mixed performance when compared to some of its competitors Tuesday, as Realty Income Corp.
O
fell 1.10% to $54.92, Kimco Realty Corp.
KIM
fell 0.05% to $20.54, and Regency Centers Corp.
REG
fell 0.89% to $64.55.
Trading volume (836,671) eclipsed its 50-day average volume of 669,268.
Editor’s Note: This story was auto-generated by Automated Insights, an automation technology provider, using data from Dow Jones and FactSet. See our market data terms of use.
Published: Sept. 7, 2023 at 1:52 p.m. ET
By Josh Beckerman
Shares of Sigma Additive Solutions rose 32% Thursday after it reported letters of intent to buy travel technology company NextTrip Holdings and sell intellectual property assets related to its quality assurance software for 3-D printing to an unnamed strategic buyer.
The stock recently traded at 29 cents and is down 28% for…
By Josh Beckerman
Shares of Sigma Additive Solutions rose 32% Thursday after it reported letters of intent to buy travel technology company NextTrip Holdings and sell intellectual property assets related to its quality assurance software for 3-D printing to an unnamed strategic buyer.
The stock recently traded at 29 cents and is down 28% for the year to date.
Sigma said it will buy 100% of NextTrip in exchange for shares constituting 19.99% of its outstanding common stock plus additional shares upon the achievement of post-closing milestone earnouts. It said the total transaction will have a starting valuation of about $48 million if all milestones are earned.
The transactions are expected to be completed in the fourth quarter, subject to conditions including negotiation and execution of a definitive NextTrip acquisition agreement. Sigma is expected to change its name to NextTrip.
Write to Josh Beckerman at josh.beckerman@wsj.com
Published: Aug. 18, 2023 at 5:26 p.m. ET
The numbers: Commercial and industrial loans — a key economic driver — fell $6.2 billion to $2.75 trillion in the week ending Aug. 9, the Federal Reserve said Friday.
This type of lending has been falling for four straight months, ever since the collapse of Silicon Valley Bank in mid-March.
Key details: Lending by large banks fell $6.3 billion…
The numbers: Commercial and industrial loans — a key economic driver — fell $6.2 billion to $2.75 trillion in the week ending Aug. 9, the Federal Reserve said Friday.
This type of lending has been falling for four straight months, ever since the collapse of Silicon Valley Bank in mid-March.
Key details: Lending by large banks fell $6.3 billion to $1.54 trillion in the latest week. It was $1.55 trillion in mid-March.
Lending by small banks rose $1.6 billion to $716.3 billion. It was $743 billion in mid-March.
Big picture: Federal Reserve officials are worried that tighter credit conditions on households and businesses since the collapse of Silicon Valley Bank could be a source of headwinds for the economy. Officials were still uncertain about the extent of these effects. The Fed is worried that banks will pull back on lending and raise standards so high that it will cause a credit crunch in the economy.
Market reaction: The S&P 500
SPX
suffered its third straight weekly loss, with bond yields moving higher as the Fed remains concerned about high inflation. The 10-year yield
BX:TMUBMUSD10Y
climbed for the fifth straight week to finish at 4.251%.
The capitulation of bearish investors seems to be a popular trend on Wall Street.
After months of unexpectedly strong stock market performance, more big-name investors have shuttered bearish bets or changed their dour tune—even as the stock market has begun to edge lower.
June and July short-covering was the largest over a two-month period in the past seven years among Goldman Sachs’ hedge fund clients, according to The Wall Street Journal.
Morgan Stanley strategist Mike Wilson, who has been sharply criticized for his negative views on the market, recently turned less bearish.
Carl Icahn, the activist investor, has decided that he, too, has wagered enough against the stock market advance. In a letter sent earlier this month to
(ticker: IEP) investors, he pledged to focus less on hedging stocks to express bearish views and more on what he is known for.
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“Activism is the best investment paradigm,” he wrote.
The market mob might delight in the difficulties of well-known investors. But schadenfreude is the wrong reaction—especially for those who, mostly through luck, were properly positioned for the 2023 rally.
Capitulation at the market’s highest levels is coinciding with a subtle shift in the market narrative: Many investors are increasingly fretting that corporate earnings are slowing, which should bode ill for stocks.
Oppenheimer strategist John Stoltzfus recently told clients that
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companies’ earnings seem weaker than expected for the second quarter thus far. He noted that earnings are down 7.8%, compared with an expected 6.4% decline.
Anyone who misses the significance of that surely understands this: Fitch recently downgraded the U.S. debt rating. Moody’s downgraded 10 regional banks and put others on notice that the same may happen to them. And 10-year Treasury yields have recently been above 4%, a level that has historically been bad for technology stocks, which have led the market higher this year. That’s because the discounted-cash-flow models used to value stocks are adversely impacted by higher interest rates.
Add to that the percolating financing troubles in the real estate sector and uncertainty about the odds of a recession, and you have the recipe for financial indigestion.
If you agree that the market narrative is changing—and you think it is premature that bearskin rugs are suddenly in vogue—consider protecting some of the extraordinary gains of 2023.
Hedging expenses remain reasonable. The
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or VIX, remains below its long-term average of 19. Michael Schwartz, Oppenheimer’s chief market strategist, has told clients to buy three S&P 500 November $4450 put options to hedge a $1 million portfolio. If the market falls 10%, he says the hedge would offset about 95% of any losses. (Puts give holders the right to sell a specified asset at a set price within a set period.)
Most bullish investors wait to hedge, or lock in profits, until they panic. The end of summer will bring many events that could prompt investors to sell stocks. The November expiration covers many key events that include the September and October trading months, which have historically delivered major market declines, several meetings of the Federal Reserve’s rate-setting committee, and loads of key economic data that will be parsed for clues on inflation.
If stocks rally into the fall, money spent hedging will be lost. Should that happen, of course, you can capitulate.
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Steven M. Sears is the president and chief operating officer of Options Solutions, a specialized asset-management firm. Neither he nor the firm has a position in the options or underlying securities mentioned in this column.
Email: editors@barrons.com
A raft of credit rating actions against more than two dozen U.S. banks by Moody’s Investors Service late Monday didn’t shock one buyer of distressed commercial real estate.
This is “more evidence of what is already known,” said Matt Windisch, executive vice president at Kennedy-Wilson, of Moody’s decision to cut it debt ratings on several small and medium size banks.
Moody’s, citing “profitability pressures” at banks and asset quality that “looks set to decline,” also placed ratings on six major U.S. lenders on review for downgrade.
“At this point, it feels like it’s specifically rates driven,” Windisch said Tuesday of pain felt by landlords and at banks from stress at commercial buildings. “But over time, if a recession hits, we’ll have to see.”
Beverly Hills-based Kennedy-Wilson Holdings
KW
made a splash in June with a private deal to buy a $5.7 billion construction loan portfolio from PacWest Bancorp
PACW
,
ahead of its sale to Banc of California
BANC
in July.
The firm paid about 95 cents on the dollar for the entire pool of construction loans and future funding commitments, mostly on multifamily properties and student housing. The average life of the loans in two years from purchase to maturity.
Kennedy-Wilson sees an opportunity to double the size of its roughly $7 billion commercial loan portfolio in the next few years, as rate shocks continue to reverberate through the commercial real-estate industry.
“We are obviously looking for other opportunities,” Windisch said, adding that the discount likely would have been greater if the loan book was backed by office or retail properties.
Unlike banks and lenders tethered to the U.S. banking industry, Kennedy-Wilson relies mostly on sovereign wealth and insurance company funding.
Still, Windisch said Kennedy-Wilson mostly plans to stick to multifamily and student housing in future loan acquisitions. That business also adds to the firm’s related lending platform, now with a national footprint since its purchase of the PacWest assets.
“These properties, themselves, don’t feel distressed,” Windisch said of a recent wave of landlords defaulting on or handing back keys to lenders on underwater multifamily properties. “It’s the capital structure that’s out of whack.”
The collapse of Silicon Valley Bank and Signature Bank in March sparked fears of broader stress at small and medium sized U.S. banks. The Federal Reserve has raised interest rates from nearly zero in the past 16 months, creating rate shocks at lenders with low coupon loans and bonds on their books, but also a flight of deposits from banks to other higher-yielding opportunities
PacWest in recent months had been subject to speculation that the bank might be vulnerable to collapse, before its sale to Banc of California.
Moody’s said on Monday that its slate of rating actions against banks comes as asset risks have been “rising, in particular for small and midsize banks with large CRE exposures.”
Small and medium size banks significantly expanded their commercial real estate lending in recent years, at ultralow rates when property values were sky-high, but many were caught off guard by the Fed’s fastest pace of rate hikes in decades.
Shares of the SPDR S&P Regional Banking ETF
KRE
were off 1.7% on Tuesday, following the rating actions by Moody’s. The S&P 500 index was 0.7% lower, while the Nasdaq Composite Index was off 0.7% and the Nasdaq Composite Index
COMP
was down 1%, according to FactSet.
Read next: Don’t wait for Fed rate cuts, says debt buyer to banks holding distressed commercial real estate
Published: Aug. 4, 2023 at 5:22 p.m. ET
Shares of Federal Realty Investment Trust FRT inched 0.77% higher to $103.42 Friday, on what proved to be an all-around rough trading session for the stock market, with the S&P 500 Index SPX falling 0.53% to 4,478.03 and Dow Jones Industrial Average DJIA falling 0.43% to 35,065.62.
This was the stock’s second consecutive day of gains.
Federal…
Shares of Federal Realty Investment Trust
FRT
inched 0.77% higher to $103.42 Friday, on what proved to be an all-around rough trading session for the stock market, with the S&P 500 Index
SPX
falling 0.53% to 4,478.03 and Dow Jones Industrial Average
DJIA
falling 0.43% to 35,065.62.
This was the stock’s second consecutive day of gains.
Federal Realty Investment Trust closed $11.66 below its 52-week high ($115.08), which the company reached on February 2nd.
The stock outperformed some of its competitors Friday, as Realty Income Corp.
O
rose 0.65% to $59.22, Kimco Realty Corp.
KIM
fell 0.40% to $20.00, and Regency Centers Corp.
REG
rose 0.41% to $66.25.
Trading volume (635,912) eclipsed its 50-day average volume of 624,600.
Editor’s Note: This story was auto-generated by Automated Insights, an automation technology provider, using data from Dow Jones and FactSet. See our market data terms of use.
With trillions of dollars of real estate-related debt coming due in the near future, commercial mortgage-backed securities (CMBS) are making headlines again. This has raised concerns about whether there’s a looming bubble ready to burst in a 2008-esque market crash. This time the case can be made that the CMBS market looks very different.
We learned a lot more from the 2008 financial crisis than is sometimes realized. Due to the way CMBS deals are structured today, there have not yet been significant losses of principal. While delinquent, foreclosed/REO loans have increased to 3.1% (based on reports by JPMorgan and analytics provider Trepp) from recent lows, they are still far below levels seen during the COVID pandemic.
Although adding all commercial mortgage loans together across sectors creates a daunting maturity wall, there’s roughly $100 billion in office CMBS loans coming due between now and 2026 (according to the CRE Analyst). That’s a manageable number for the market to digest. A high percentage of those loans are also likely to extend at the lower coupons they were struck at, compared to current commercial mortgage rates.
Moreover, leverage at the time of deal underwriting has been far more conservative than the pre-2008 deals, which are often referred to as “CMBS 1.0”. In fact, recent data from CoStar shows there is around a 65% loan-to-total-value in today’s deals, meaning even at these updated levels of net operating income, and assumed lower property valuations, there’s still more than 30% of equity in the average loan in today’s CMBS bond.
So, even within the office segment, where the average valuation decline is commonly expected to be about 30% (Barclays U.S. CMBS Research estimate, GSA CPPI Index), losses at the loan level underlying these deals should be limited. Investment-grade CMBS holders will further be protected by the credit enhancement at the trust level.
In addition, the structure of deals has required more credit enhancement for each ratings tranche than in the pre-Great Financial Crisis (GFC) period to achieve investment grade ratings. In the simplest terms, in order to get to a BBB or single-A rating, the rating agencies require far more cushion for loan losses. For example, many of today’s single-A conduit bonds have more than the 10% loss cushion, which used to garner AAA ratings pre-GFC. The average 2007-era CMBS “AJ” or AAA Jr. bond had a 10% loss cushion.
In many ways the 2008 experience may have been what has saved both CMBS and the securitized credit market from a much more punitive experience through COVID. Pulling the lens back on the sector and looking at occupancy trends there is no doubt that office vacancies increasing to 20% or more in major metropolitan markets is disconcerting. But there have also been “green shoots,” according to recent office data research from JPMorgan. Remote work has begun to decline and more companies are requiring more employees return to the office, at least a couple of days a week.
In retail, there had already been significant rightsizing both before and during COVID, and rent growth of the existing properties is a healthy 3%-4% (based on data from CoStar and JPMorgan). In multifamily housing, rents aren’t increasing at the unsustainable level of the past couple of years, but are still in a healthy low single-digit growth range (according to CoStar and JPMorgan research).
Which brings us back to what CMBS looks like today. There are many pieces of the CMBS “pie” besides office occupancy. The loan collateral backing the CMBS market is diversified across real estate subsectors. About 28% of CMBS conduit loans are comprised of office space. Almost three-quarters of the remaining loans are in other commercial real estate subsectors, for example retail, multifamily, industrial and hospitality, which have rebounded strongly since 2020 and whose fundamental outlooks remain supportive.
Loan performance of all subsectors outside of office have experienced improving delinquency and special servicing percentages since the beginning of 2021. Multifamily and industrial delinquency remain negligible while hotel and retail have seen loan delinquencies decline by 15% and 2%, respectively.
Investing in the CMBS market
While office space is driving headlines and much of the worry, there are many ways to invest in the CMBS market. For example, conduit deals with lower than average office exposure and most of the loans from other commercial real estate subsectors. Another approach is to look at single asset/single borrower deals that are 100% tied to one asset or one borrower, as well as select non-office in other commercial real estate (CRE) subsectors.
Even within the office CRE subsector the story is more nuanced, with the majority of office underperformance concentrated in older, lower-quality office stock. A recent national office study conducted by JLL found that about 90% of office vacancies are concentrated within just 30% of the overall U.S. office inventory. Adding to this point, the newer built (2015-present) U.S. office segment has recorded 103.2 million square feet of positive net absorption since 2019, offsetting negative absorption across all other vintage segments. The bifurcation within the office subsector is creating opportunities across the CMBS market.
There are, of course, elevated risks, as pricing suggests. These begin with the above-average volatility in the asset class and below-average liquidity compared to larger corporate-credit markets. Plus, there can always be losses of principal should the commercial real estate sector take a much deeper decline from already depressed levels. That said, many of those risks are currently priced in.
The CMBS market is often disccussed without talking about prices. In many investment-grade tranches below AAA, the price to enter a transaction is near the lowest level, and with the highest yields, that have ever been available since the 2008 Great Financial Crisis, compared to the lows experienced during the time of the COVID shutdowns.
You don’t have to be bullish to think there’s relative value in a single-A or BBB CMBS asset class at these discounts when they look cheap compared to some of the highest risk sectors of the corporate credit markets. Opportunity and risk is a balance, but the current CMBS credit environment has asymmetric upside compared to downside across markets.
D.J. Lucey is senior managing director, senior portfolio manager, U.S. Total Return Fixed Income at SLC Management. SLC Management is the brand name for the institutional asset management business of Sun Life Financial Inc. This material contains opinions of the author, but not necessarily those of SLC Management or its affiliates.
Plus: The $1 trillion ‘wall of worry’ for commercial real estate that spirals through 2027
More: Fed no longer foresees a U.S. recession — and other things we learned from Powell’s press conference
Big-time landlords have begun surrendering office buildings and other struggling properties to lenders this year, when just a few years ago they were fetching sky-high values amid super-low rates.
Many consider it the start of a reckoning for the estimated $20.7 trillion commercial real-estate market, likely its biggest test of confidence since the 2007-2008 global financial crisis.
Brian Lane, the Well Fargo Investment Institute’s lead analyst for private credit, pointed to a $1 trillion “wall of worry” as a wave of commercial real-estate loans come due through the end of 2024 (see chart), in a Monday client note. The balance balloons to about $2.5 trillion through the end of 2027.
“Property owners are facing higher vacancy, reduced net operating income, falling prices and rising capitalization rates,” Lane wrote. “While valuations have started to decline in most property types, there is likely more downside.”
A recent McKinsey report pegged prices for office buildings as likely to fall as much as 42%,
Morgan Stanley analysts reiterated a call for overall commercial-property prices to drop 27.4% peak-to-trough through the end of 2024.
Lane expects many borrowers to resort to private-capital providers for loans, with banks and the commercial mortgage-backed securities market pulling back.
“We expect that private investors will be needed to provide debt financing, and that sponsors may be forced to infuse equity to protect holdings and right-size property deals.”
Furthermore, institutional investors in bonds haven’t given up on all commercial real estate.
Saira Malik, Nuveen’s chief investment officer, said that “nonoffice” commercial mortgage-backed securities that currently offer 10.6% yields look attractive relative to the roughly 5.5% yield on investment-grade corporate bonds and 3.87% 10-year Treasury yield
TMUBMUSD10Y
,
in a Monday client note.
Despite regional-bank failures and ongoing challenges in the office sector, Malik pointed to climbing delinquency rates of about 2% on loans in bond deals as well below the 9% rate of the global financial crisis some 15 years ago.
She also said investors might consider commercial real estate for its higher yields and total returns, given a backdrop where the Federal Reserve is expected to soon end its most aggressive cycle of rate hikes in decades.
Read: Do Not Disturb: Tenants brace for more office landlords to go belly up on their property debts
Stocks rose on Monday, with the Dow Jones Industrial Average
DJIA
up for its 11th straight session, ending at its highest level since February 2022, according to FactSet. The S&P 500 index
SPX
closed 5% below its record close on Jan. 3, 2022.
The U.S. economy isn’t the only thing unwilling to capitulate despite sharply higher interest rates.
Commercial real-estate prices have been heading lower in the wake of the pandemic and the Federal Reserve’s inflation fight, but the bulk of the pain still looks poised to come, according to Morgan Stanley analysts.
Prices for apartment buildings, offices properties and retail centers were pegged at about 8%-14% lower in May from peak levels (see chart), or less than Morgan Stanley’s initial estimates (blue line).
But the worst for property owners looks yet to come, according to Morgan Stanley’s REIT research team led by Ronald Kamden. The team reiterated its call for a 27.4% peak-to-trough price drop for all commercial property types through the end of 2024.
That compares with a 34.9% drop roughly 15 years ago during the global financial crisis, but also a subsequent period in which prices rose nearly 150% through the pandemic, according to Morgan Stanley data.
Prices have been heading lower overall, but with retail, industrial and office properties in the suburbs and central business districts, still facing the majority of their anticipated price declines “as transaction activity and distressed sales rise,” the team wrote in a Monday client note.
Up to 42% price drop?
Half-empty office buildings in the heart of financial districts in major U.S. cities are expected to be hit particularly hard by hybrid work, tighter credit and higher interest rates.
See: San Francisco’s office market erases all gains since 2017 as prices sag nationally: chart
New York magazine recently wrote how big Manhattan office landlords are looking to shed buildings now worth less.
The hardest-hit cities could see demand for office buildings tumbling by as much as 38% from 2019 levels, according to a McKinsey Global Institute report from earlier in June. The report also pegged office prices as falling about 26% on average in a moderate scenario through 2023, but skidding 42% in a severe scenario.
BofA Global researchers led by Alan Todd also said that pressure in the office sector could “spill over” into other property types, including hotels and retail, by making refinancing more difficult.
“For example, to the extent airline costs remain elevated, flight cancellations remain a common problem, or corporate belt tightening limits fly-to in person meetings, we see it as a headwind for hotel revenues, which can fluctuate significantly with the public’s ability or willingness to travel,” Todd’s team wrote, in a weekly client note.
The Dow Jones Equity REIT index
DJDBK
was up 3.1% on the year through Monday, according to FactSet. Stocks have punched higher in 2023 in the wake of a resilient U.S. economy, despite the Fed already having raised rates by about 500 basis points to a range of 5%-5.25%.
Fed officials indicated that two more rate hikes could still be in store this year, likely with another 25 basis point rate increase expected later this month. The S&P 500 index
SPX
was up about 17.8% on the year through Monday, while the Dow Jones Industrial Average
DJIA
was 4.3% higher and the Nasdaq Composite Index
COMP
was up 36%, according to FactSet.
Related (February): Losing the trophy? A $45 billion mortgage bill is coming due for some of America’s signature commercial properties
Read next: Do Not Disturb: Tenants brace for more office landlords to go belly up on their property debts
Opinion: How much pain could commercial real estate heap on U.S. banks? A lot.
Commercial real estate is in trouble. There are several reasons why.
First, higher interest rates put pressure on commercial real estate operators who financed their acquisitions with debt at historically high property values and low interest rates. Many of these loans mature in the next couple of years and may have to be refinanced at much higher rates potentially resulting in maturity default.
Second, recent technology-sector layoffs and a potential U.S. recession could lead to a significant decline in the demand for commercial properties, adversely affecting their valuation.
Finally, the shift in workplace culture to more hybrid and remote styles is putting significant pressure on office properties, which constitute a sizeable share of all commercial real estate. As of July 2023, just half of U.S. workers had returned to the office on an average day relative to pre-pandemic levels.
The signs of commercial real estate distress are already visible, especially in the office sector. In the first quarter of 2023, the office vacancy rate reached 18.6%, 5.5% higher than it did in first quarter 2020 when the pandemic began. This is a larger trough-to-peak increase than the 4.6% increase during the Great Recession.
The shares of real estate holding companies (REITs) focused on the office sector declined by about 60% since the beginning of pandemic, implying more than 30% decline in the value of their office buildings. While the overall delinquency rate on commercial mortgages is still relatively low, it has been quickly rising, especially in the office sector. Several deep-pocketed investors including PIMCO and Blackstone recently defaulted on their office loans.
But how big of a threat is the commercial real estate decline? The subprime mortgage crisis that started in 2007 eventually launched the 2008 Great Recession. Many economists aren’t yet seeing the ties between empty office buildings and the future of U.S. banks.
My new research with Erica Jiang, Gregor Matvos, and Amit Seru explores bank-level data to assess the commercial real-estate distress risk for each of 4,844 of U.S. banks — accounting for about $24 trillion of assets in the aggregate. As I explain below, the news is mixed: the risk is not as big as sometimes portrayed, but is real.
Commercial real estate (CRE) loans are an important portion of bank assets, accounting for about a quarter of assets for an average bank and $2.7 trillion of bank assets in the aggregate. Most of these loans are held by smaller- and midsize banks. So, banks indeed have a very significant exposure to commercial real estate loans.
To assess the banks’ ability to withstand the CRE credit distress, we consider a range of CRE stress-test scenarios ranging from 10% to 20% of commercial real estate loans defaulting at each U.S. bank. We assume that in the case of a default the banks can recover about 70% of outstanding face value of their loans, which is in line with the historical data. Notably, delinquencies on bank-held commercial real estate loans reached almost 10% during the Great Recession.
The good news is that direct losses to banks due to CRE distress are not that large. At a 10% to 20% default rate, the direct losses on banks’ CRE loans relative to their book value amount to about $80 to $160 billion. If CRE distress would manifest itself early in 2022 when interest rates were low, not a single bank would fail, even under our most pessimistic scenario. This is because the losses due to CRE distress are less than 10% of aggregate book value of equity in the banking system — which was about $2.3 trillion at the beginning of 2022 — and banks were sufficiently capitalized to withstand them.
The bad news is that we are in 2023, and interest rates are much higher. Banks engage in maturity transformation: they finance long maturity assets with short-term liabilities — deposits. Banks operate with high financial leverage, with a typical bank funding itself with 90% of debt, consisting of mostly deposits. As interest rates rise, the value of a bank’s assets can decline, leading to bank fragility and insolvency risk.
Read: The $1 trillion ‘wall of worry’ for commercial real estate that spirals through 2027
As we show in our other related work, following recent monetary tightening the U.S. banking system’s market value of assets is about $2.2 trillion lower than suggested by their book-value accounting for loan portfolios held to maturity. Consequently, about half of U.S. banks (2,315) with $11 trillion of assets have a lower value of their assets compared to the face value of their debt liabilities.
This does not mean that half of U.S. banks are insolvent. Banks primarily fund themselves with deposits so they could survive these asset value declines if they can pay low rates on their deposits and their depositors do not flee.
However, about half of deposits are uninsured, accounting for about $9 trillion of bank funding in the aggregate. Unlike insured depositors, uninsured depositors stand to lose a part of their deposits if the bank fails, potentially giving them incentives to run in response to the decline in bank assets values following an increase interest rates.
We show that if half of uninsured depositors would withdraw their money, 186 banks would fail. If there is a widespread run by uninsured depositors, more than 1,600 banks could fail with aggregate assets of close to $5 trillion. In sum, higher interest rates combined with high leverage has made the U.S. banking system extremely fragile and eroded the banks’ ability to deal with credit distress.
The commercial real-estate distress would add up to an additional $160 billion of losses and a $2.2 trillion decline in the value of bank assets due to higher rates. While losses due to commercial real estate distress are an order of magnitude smaller than the decline in bank asset values associated with a recent rise of interest rates, they would impact a sizable set of banks.
Due to these losses, up to 580 additional banks with aggregate assets of $1.2 trillion would have their mark-to-market value of assets below the face value of all their non-equity liabilities. If half of uninsured depositors decide to withdraw, the losses due to CRE distress would result in up to 58 smaller regional banks becoming insolvent in addition to 186 banks that would become insolvent just due to higher rates.
Importantly, the news about commercial real estate default and banking losses could be a trigger for a widespread run on the banking system by uninsured depositors, unraveling a fragile equilibrium in the banking system. Moreover, commercial real estate distress could also lead to a credit crunch adversely affecting the U.S. economy and increasing recession risk.
What can be done? As long as interest rates remain elevated, the U.S. banking system will face a prolonged period of significant insolvency risk. In the near term, the creation of the Bank Term Funding Program in March 2023 together with other policy responses to the recent banking vulnerabilities may put a pause on the crisis and reduce the risk of acute deposit runs across the banking system.
However, these are temporary measures that do not really address the fundamental insolvency risk, which our analysis indicates could involve hundreds of banks.
A near-term solution is a market-based recapitalization of the U.S. banking system. Longer-term, banks could face stricter capital requirements, which would bring their capital ratios closer to less regulated non-bank lenders that retain more than twice as much capital buffers as banks. Increased capital buffers would make the U.S. banking system more resilient to adverse shocks to their asset values.
Tomasz Piskorski is the Edward S. Gordon Professor of Real Estate at Columbia Business School.
More: Commercial mortgage-backed securities are in the spotlight again, but this isn’t 2008
Plus: San Francisco’s push to turn office buildings into homes hinges on this simple idea
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