Commercial real estate’s link to smaller banks in the U.S. is vulnerable and has not gotten enough attention after recent strain in the banking system, according to Capital Economics.
“Lending to commercial property in the U.S. is dominated by the country’s small and mid-tier banks,” with smaller U.S. banks accounting for 70% of outstanding loans to the commercial real- estate sector, Neil Shearing, group chief economist at Capital Economics, said in a note Monday. A pullback in lending would likely add “downward pressure on capital values,” he said.
“But in a worst case scenario it’s possible that a ‘doom loop’ develops between smaller banks and commercial property, in which concerns about the health of these banks leads to deposit flight,” warned Shearing. That, in turn, would cause “banks to call in commercial real estate loans, which then accelerates a downturn in a sector that forms a key part of its asset base, which intensifies concerns about the health of the banks and thus completes the vicious cycle.”
Property-sector problems have figured into “the heart of major crises” historically, said Shearing, citing the global financial crisis of 2007 – 2008, the U.S. savings and loans crisis in the 1980s and 1990s, the U.K.’s “secondary banking crisis” of 1973-1975 and “the Great Crash of 1929.”
“If property is to be the source of deeper strains in the banking system, the place to look may be commercial real estate,” he said. “This has become a focus of concern in recent days, particularly in the U.S., but the linkages with the banking system – which is the real source of vulnerability – have not received sufficient attention within the debate.”
Pullback in lending?
The commercial real-estate market includes industrial and retail properties as well as offices and apartments, according to Capital Economics. In Shearing’s view, lending to commercial real estate may tighten as smaller banks experience pressure on their deposit base following the run on failed Silicon Valley Bank earlier this month.
“The immediate focus has been on the risk of deposit flight caused by concerns about the health of mid-tier banks in the wake of the collapse of SVB and worries about uninsured deposits in excess of the federally-insured limit” of $250,000, he said.
“But this has obscured a broader problem,” said Shearing, “which is that higher interest rates are causing a shift out of bank deposits and into money market funds as interest rates on short-dated securities rise faster than those on commercial bank deposits.”
Read: Bank ETFs fall amid concerns over SVB and ‘crack’ in financial system after rate hikes
That’s left banks “in a bind” that will probably lead to tightening of financing in the commercial real estate sector, according to the note. Banks will either need to raise their deposit rates “in line with money markets and try to maintain profits by increasing rates on loans that are due to refinance, or they shrink the asset side of their balance sheet in order to accommodate a smaller deposit base.”
Commercial-property lending accounts for about 40% of all loans by smaller U.S. banks, according to Capital Economics. Smaller U.S. banks are those defined by the Federal Reserve as being outside the 25 biggest by asset size, the note says.
Meanwhile, commercial real-estate prices in the U.S. have broadly fallen 4% to 5% from their peak in mid-2022 and Capital Economics expects a further 18% to 20% drop from here for a “peak-to-trough fall of around 22%,” according to the note. Office properties could see the worst of the decline, a chart in the note shows.
“Risks emanating from the property sector are very different from those 15 years ago, and the consequences are likely to be far less damaging to the real economy,” said Shearing. “But in the hunt for the next shoe to drop, commercial real estate – and its linkages to small and mid-tier banks – looms large.”
Shares of the SPDR S&P Regional Banking ETF
KRE
have tumbled this month, with a year-to-date drop of around 25% based on Monday morning trading, according to FactSet data, at last check.
The U.S. stock market was trading mostly higher late morning Monday, after booking gains last week. The S&P 500
SPX
was up 0.2% in late morning trade Monday, while the Dow Jones Industrial Average
DJIA
rose 0.6% and the technology-heavy Nasdaq Composite
COMP
fell 0.3%, according to FactSet data, at last check.
“A degree of calm has returned to markets over the past week, but some sense of nervousness persists,” Shearing said.
Read: There’s another looming cliff — the end of the student-loan repayment moratorium
stock could get hit by the trouble in the banking sector, one analyst says, earning the stock a downgrade.
The regional banking panic can impact any number of industries, including construction. That isn’t good news for companies that make and rent construction equipment, says Baird analyst Mig Dobre, who downgraded shares of
(ticker: CAT) and
(URI) to Sell from Hold. His Caterpillar price target dropped to $185 from $230 a share. Dobre’s United Rentals target went to $300 from $425 a share. Cat stock is down 1.6% in premarket trading to $213.50. United Rentals shares are down 1.2% to $366.37.
and
futures are both up about 0.5%.
“We see rising risks for rental/construction equipment [makers],” wrote Dobre in a Monday report. “A 2024 slowdown in U.S. nonresidential construction was already on the horizon, but now is increasingly likely given ongoing regional lenders’ turmoil and their sizable participation in commercial construction lending.”
Regional banks do a majority of the lending for commercial real estate, says Dobre. Tighter lending conditions mean less credit from banks which can mean fewer projects for construction companies.
As a result, he sees Caterpillar’s order book and backlog peaking and rental equipment supply rising while demand is moderating.
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His new price targets value Cat and United Rentals stock at about 11 times and 7 times Wall Street’s estimated 2024 earnings, respectively. That’s at the lower end of their historical ranges, which Dobre believes is appropriate given the mounting risks he sees for 2024 earnings.
A downgrade from Hold to Sell doesn’t change the Buy-rating ratio for a stock. About 39% of analyst covering Cat stock rate shares Buy after the downgrade, while the average Buy-rating ratio for a stock in the S&P 500 is about 58%.
A downgrade to Sell, of course, changes the Sell-rating ratio. Now about 21% of analysts covering Caterpillar shares rate them Sell. The average Sell-rating ratio for S&P 500 stock is less than 10%.
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For United Rentals, about 57% of analysts covering the company’s shares rate them Buy. About 13% rate them Sell.
United Rentals’ Buy-rating ratio has held steady over the past year. Caterpillar’s has fallen from about 50% to 39% over the same span. Wall Street has been getting a little more bearish on Cat stock in recent months.
Coming into Monday training, Caterpillar stock is down about 9% year to date and off about 3% over the past 12 months. United Rentals shares are up about 4% year to date and up about 2% over the past 12 months.
Write to Al Root at allen.root@dowjones.com
That’s Neel Kashkari, president and chief executive officer of the Federal Reserve Bank of Minneapolis, explaining the state of the banking system during a Sunday interview on CBS’s “Face the Nation.”
Jitters surrounding banks have raised some questions about the roughly $5.5 trillion U.S. commercial real estate debt market.
Rising interest rates can make it harder to refinance debt for property owners and overall values of debt tied to real estate have slumped, weighing on banks who have exposures. Small banks have become key players in commercial real estate over the past two decades.
The Fed president emphasized that the banking system “is resilient and it’s sound,” but cautioned that the troubles emanating from the banking sector may not be over.
“We know that there are other banks that have some exposure to long-date Treasury bonds, who have some duration risk, as they call it, on their books,” Kashkari said.
He said that current challenges with banks “definitely brings us closer” to recession but warned that it may still be too early to know the impact of troubled banks on the economy.
Kashkari said while large deposit outflows that some small to midsize banks have experienced in recent weeks have slowed, parts of the capital markets “have largely been closed” for weeks.
Last Wednesday, the Fed unanimously voted to raise its benchmark federal-funds rate by a quarter percentage point to a range between 4.75% and 5%, marking its ninth straight increase, and doing so despite lingering concerns about the health of the financial system amid troubles related to major lenders including Silicon Valley Bank, as well as international banks such as Credit Suisse
CS
and Deutsche Bank
DBK
DB
.
Rising interest rates have weighed on some lenders, at least partly, because banks are compelled to offer higher interest in the short-term on deposits, even as the interest rates that they collect on longer-term loans aren’t moving up as fast. Rate increases by the Fed are driving yields for short-term debt higher, but fears of economic recession down the road are driving yields, which move opposite to prices, lower.
That dynamic has weighed on the profits for financial institutions.
On top of that, not all banks have been managing risks effectively, with SVB, for example, obliged to sell assets at a loss to meet a deposit exodus.
Investors have been worrying that the failures of SVB and other banks could spread throughout the sector, and parts of the globe, if nervous customers continued to pull deposits from some, mostly smaller, lenders.
See: Emergency borrowing from Fed dips, a sign that bank stress may be easing
Kashkari is a 2023 voting member of the Fed’s rate-setting Federal Open Market Committee.
The Fed president’s comments come days after Fed Chairman Jerome Powell said the Fed remains focused on its fight against rising inflation, even as it acknowledged that the stability of the banking system has been on the Fed’s radar. Forecasts now show the Fed raising rates just one more time this year to a range of 5%-to-5.25% range.
Read: ‘Very unclear’: Powell’s press conference provided more questions than answers. Here are 4 big ones economists still have.
Markets ended last week higher, with the Dow Jones Industrial Average
DJIA
rising 1.2%, while the S&P 500
SPX
advanced 1.4% and the Nasdaq Composite Index
COMP
advanced 1.7%, according to FactSet data. The Dow snapped two straight weeks of losses, while the S&P 500 and Nasdaq each booked back-to-back weekly gains.
Also see: Why the worst banking mess since 2008 isn’t freaking out stock-market investors — yet
The transition from fossil fuels to renewable energy—a core theme in values-based portfolios for almost two decades—has been catapulted from a niche investment theme to the mainstream thanks to the passage of the most significant climate action legislation on record.
The Inflation Reduction Act (IRA), passed in August, is a profound inflection point in the evolution of climate policy that puts U.S. muscle behind the global push toward carbon-reduction goals. The bill, which dedicates $369 billion to climate provisions, is likely to elevate investor confidence in the clean-energy theme and open the door to new investment opportunities.
“The IRA will provide a huge boost to companies and projects, both proven and emerging, that enable decarbonization at scale,” says Justina Lai, chief impact officer at Wetherby Asset Management in San Francisco. “It provides much more policy certainty to companies and funds already investing in the energy transition and incentivizes laggards to catch up.”
The new legislation requires all emissions-producing sectors, such as transportation, agriculture, construction, and utilities, to reduce greenhouse gases, and provides a host of tax incentives to companies and individuals to make environmentally friendly choices, such as buying an electric vehicle and installing solar panels.
Lai expects more innovation in renewable energy, energy efficiency, electric vehicles, and batteries, along with nascent technologies in areas such as green hydrogen, direct air capture, carbon capture and storage, energy storage, and sustainable fuels.
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A goal to have net-zero carbon emissions by 2050—an agreed-upon target by many nations and the global scientific community—isn’t just a technology investment story. The carbon-reduction theme is intersecting with agriculture, construction, transportation, finance, and other industries.
In Kent, England, InspiraFarms creates modular cold rooms and packing-houses for agricultural use to reduce reliance on diesel generators and reduce food waste. Berlin-based Betteries upcycles electric-vehicle batteries and incorporates them in clean-power systems. In Lexington, Ky., Rubicon has developed software to help waste-management companies, businesses, and municipalities reduce carbon emissions.
“This is about investing across the entire value chain of this transition,” says Ian Schaeffer, global market strategist at J.P. Morgan Private Bank.
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While a major area of innovation is in slowing climate change, another is in addressing the needs of communities already struggling with the impact of rising global temperatures.
Source Global, a Scottsdale, Ariz., start-up, creates new solar-powered technology that extracts water vapor out of the air to make drinking water, eliminating the need for fossil-fuel-dependent methods for delivering drinking water to communities whose water supply is drying up due to climate changes.
“The beauty of the Inflation Reduction Act is that it opens the door to climate adaptation in underserved communities. That creates massive opportunity,” says Cody Friesen, Source’s founder and CEO.
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J.P. Morgan’s Schaeffer says investors should be looking toward the primary enablers of the transition to clean energy, and points to two important themes: green buildings and semiconductors.
“Buildings account for a staggering amount of carbon emissions,” he says. “We think there’s opportunity in sustainable construction materials, efficient air systems, incorporating smart systems, and digital infrastructure.”
Semiconductors are essential to modern technology and will play a big role in the transition of the automotive industry from internal combustion engines to electric vehicles, Schaeffer says. “This will require more powerful and efficient semiconductors. The demand for these will skyrocket in coming years.”
Opportunities are global in scope, and suited for long-term investors, he says. “This transition will be a long and bumpy but ultimately inevitable process likely to take us through the middle half of this century.”
This article appears in the March 2023 issue of Penta magazine.
Deposits in U.S. commercial banks dropped by about $100 billion for the week ended March 15, according to data posted by the Federal Reserve.
“There’s nothing alarming there, but the pace is a little bit greater than we might have expected,” says Carl Weinberg, chief economist at High Frequency Economics.
He added that bank deposits have been declining slowly for about a year, and it could be associated with the Federal Reserve’s quantitative tightening program.
“If the Fed sells a bond back to the market, then the banking system loses a reserve,” he says.
The latest information about bank deposits was included in the weekly H.8 banking data released by the Federal Reserve on Friday afternoon.
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The release comes as the banking sector has been in rocked by several high-profile blowups starting with the failure of Silicon Valley Bank on March 10. High interest rates caused SVB to record significant losses to its portfolio, sparking a rapid withdrawal of its deposits by customers.
One of the biggest worries among bank stockholders is the stability of bank deposits and whether there will be more bank runs, especially among regional banks. The Federal Deposit Insurance Corporation insures individual bank account deposits of up to $250,000.
At the same time, consumer loans actually edged up to $1.867 trillion from $1.863 trillion during the week ended March 15. That surprised Weinberg, who was expecting a decline.
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Weinberg was concerned that banks had started to withdraw credit from the economy. But “there’s no evidence of that from this data,” he says.
No doubt, next Friday’s release will be closely monitored.
Write to Lawrence C. Strauss at lawrence.strauss@barrons.com and Karishma Vanjani at karishma.vanjani@dowjones.com
Published: March 23, 2023 at 4:26 a.m. ET
By Michael Susin
Seplat Energy PLC said Thursday that it has taken legal action against its former chair after terminating a consultancy agreement with its wholly-owned subsidiary and its co-founder with immediate effect.
The Nigeria-focused energy company said the termination follows repeated warnings about breaches of a material nature such…
By Michael Susin
Seplat Energy PLC said Thursday that it has taken legal action against its former chair after terminating a consultancy agreement with its wholly-owned subsidiary and its co-founder with immediate effect.
The Nigeria-focused energy company said the termination follows repeated warnings about breaches of a material nature such as “unilaterally making significant commitments on Seplat’s letterhead without prior board authority or knowledge”.
The company said that under the consultancy agreement, Mr. A.B.C Orjiako, acting through Amaze Ltd., was obliged to provide defined assistance with certain external stakeholder engagements following his retirement from the board.
The company has commenced legal action against Mr. Orjiako and Amaze Ltd. at the Federal High Court in Abuja, Nigeria.
Mr. Orjiako served in the company as chair and stepped down in May 2022.
Write to Michael Susin at michael.susin@wsj.com
Published: March 22, 2023 at 10:25 a.m. ET
By Michael Susin
Superdry PLC said Wednesday that it has signed an intellectual-property transfer agreement with South Korea-based Cowell Fashion Co. for the sale of its assets in certain countries within Asia Pacific for an upfront payment of $50 million in cash.
The British clothing brand said net proceeds from the deal are expected to be…
By Michael Susin
Superdry PLC said Wednesday that it has signed an intellectual-property transfer agreement with South Korea-based Cowell Fashion Co. for the sale of its assets in certain countries within Asia Pacific for an upfront payment of $50 million in cash.
The British clothing brand said net proceeds from the deal are expected to be around 34 million pounds ($41.5 million), which will be used to strengthen its balance sheet and to fund its ongoing working-capital requirements, including a significant cost-reduction program.
The company added that it is considering an equity issue as part of the turnaround program.
According to the deal, Cowell will own and use the Superdry brand in key APAC markets, starting with South Korea and extending to other countries including China.
Both Superdry and Cowell will work together to develop products relevant for those markets, the company said.
Following the completion of the sale, Superdry will provide certain support during the first two years and receive a further management fee of $1.0 million.
“Superdry believes that the partnership with Cowell will provide the best opportunities for the future growth of the Superdry brand in the APAC region and allows the company to focus on growing its brand and increasing sales in its more established territories where it has strongest expertise,” it added.
Shares at 1402 GMT were up 0.2 pence, or 0.2%, at 108.2 pence.
Write to Michael Susin at michael.susin@wsj.com
Published: March 22, 2023 at 3:16 a.m. ET
By Michael Susin
Superdry PLC said Wednesday that it has signed an intellectual property transfer agreement with South Korea-based Cowell Fashion Co. Ltd. for the sale of its assets in certain countries within Asia Pacific for an upfront payment of $50 million in cash.
The British clothing brand said that Cowell will own and use the Superdry…
By Michael Susin
Superdry PLC said Wednesday that it has signed an intellectual property transfer agreement with South Korea-based Cowell Fashion Co. Ltd. for the sale of its assets in certain countries within Asia Pacific for an upfront payment of $50 million in cash.
The British clothing brand said that Cowell will own and use the Superdry brand in key APAC markets, starting with South Korea and extending to other countries including China.
Both Superdry and Cowell will work together to develop products relevant for those markets, the company said.
Following the completion of the sale, Superdry will provide certain support during the first two years and receive a further management fee of $1.0 million.
“This agreement offers the Superdry brand a fantastic opportunity to expand its global reach, whilst providing additional funding to help deliver our turnaround program in the face of the challenging consumer landscape,” Chief Executive Julian Dunkerton said.
Write to Michael Susin at michael.susin@wsj.com
Published: March 21, 2023 at 4:45 p.m. ET
By Bob Henderson
AAR Corp. said Tuesday that third-quarter revenue rose 15% due to gains in its commercial segment, which continues to benefit from the ongoing recovery in air travel, while net income fell slightly because of higher interest expenses.
The Wood Dale, Ill.-based aviation services provider reported net income of $21.8 million,…
By Bob Henderson
AAR Corp. said Tuesday that third-quarter revenue rose 15% due to gains in its commercial segment, which continues to benefit from the ongoing recovery in air travel, while net income fell slightly because of higher interest expenses.
The Wood Dale, Ill.-based aviation services provider reported net income of $21.8 million, or 62 cents a share, for the three-month period ended Feb. 28, compared with a profit of $22.5 million, or 63 cents a share, in the same quarter a year ago.
Adjusted for certain-one time items, AAR said that per-share earnings were 75 cents. Analysts surveyed by FactSet were expecting earnings of 70 cents a share.
Total sales were $521.1 million, up from $452.2 million last year, compared with analyst estimates of $487 million.
The company said sales to commercial clients increased 28% from a year ago, primarily because of the further recovery in air travel, while sales to government customers decreased 3% due to the completion of contracts that occurred in the last fiscal year.
“We are encouraged by the optimism we see from our airline customers regarding the recovery in air travel and this continues to drive demand for our services,” Chief Executive John Holmes said.
Profit was hit by higher interest expenses, which were $3.5 million for the quarter, up from around $600,000 in the prior year.
Write to Bob Henderson at bob.henderson@wsj.com
11 commercial REIT stocks loved by analysts, who see upside of up to 47%
As if concerns over banks’ liquidity weren’t enough to rattle investors, analysts have been raising concerns about the U.S. commercial real-estate market, especially for office buildings. Below is a screen of real-estate investment trusts that concentrate on commercial real estate, highlighting the 11 analysts expect to fare best through 2024.
A REIT is a company that owns property, makes loans or invests in mortgage-backed securities and distributes at least 90% of its earnings to shareholders as dividends, in return for tax advantages. Most dividends received by REIT investors are taxed as ordinary income.
On Monday, a group of analysts at BofA Securities led by Camille Bonnel wrote that REITs that own office buildings had declined 70% in value “as public markets have been pricing in secular headwinds and tight lending conditions” since the beginning of the Covid-19 pandemic in 2020.
On Monday, Adam Posen, president of the Peterson Institute for International Economics, said the commercial real estate space was heading into a “real mess,” in part because office occupancy was down 30% to 40% since the pandemic began.
Back on March 7, analysts at Keefe, Bruyette and Woods predicted “no soft landing for CRE,” especially in particular markets, including San Francisco, New York, Washington D.C., Seattle, Austin, Texas, and Phoenix. In a report highlighting risks for REITs and banks, the KBW analysts added: “With $400bn of annual loan maturities, we expect increasing credit issues as borrowers evaluate capital and lenders become defensive; our framework implies 1-3% loan losses.” They expect office building values to decline 30% or more, with those values “30 to 50% into correction.”
The BofA analysts provided some comfort for REIT investors: “Most REITs tend to own top-quartile properties and follow an active, hands-on ownership model. Historically, public REITs outperform within their markets particularly in tougher market conditions like today.”
CRE REIT screen
To highlight which REITs focused on commercial real estate (CRE) might fare best, we began with the 180 REITs in the Russell 3000 Index and then narrowed the list.
First, there is a distinction between equity REITs, which own properties and rent them out, and mortgage REITs, which are lenders and investors in mortgage-backed securities.
And now for the cuts:
AFFO is adjusted funds from operations — a non-GAAP calculation. In the REIT industry, FFO adds depreciation and amortization back to earnings, while subtracting gains on the sale of property. Adjusted FFO goes further, netting out expected capital expenditures to maintain the quality of property investments. For commercial mortgage REITs, FFO isn’t typically calculated, so we looked at EPS instead.
Among the remaining 53 companies, 11 are rated “buy” or the equivalent by at least three-quarters of the analysts covering them. Here they are, sorted by the upside potential implied by consensus price targets among analysts polled by FactSet:
ARE
REFI
STWD
CTO
AMT
CHCT
REXR
VICI
PLD
GLPI
IRM
Click on the tickers for more about each REIT. If you are interested in any individual stock, it is best to do your own research and form your own opinion about how successful a company is likely to be over the next decade at least.
Read Tomi Kilgore’s detailed guide to the wealth of information available for free on the MarketWatch quote page.
Don’t miss: 11 stocks in the S&P 500 expected to form an exclusive growth club for investors
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