The half-empty offices could be the next big risk for banks

The American Commercial Real Estate Market is Facing: Banks and Wall Street are Infavorably Doing Business in Times of Financial Crises

The work-from- home era has shown the presence of vacant offices in places like Dallas and Minneapolis, to name a few. But clear desks and quiet break rooms aren’t just a headache for bosses eager to gather teams in person.

The downturn in the US commercial real estate market is being seen as a sign of trouble in the financial system, which investors and regulators are on high alert for.

Signs of strain are increasing. A rising proportion of commercial office mortgages are behind with repayments, and high-profile defaults are making headlines. Earlier this year, a landlord owned by asset manager PIMCO defaulted on nearly $2 billion in debt for seven office buildings in San Francisco, New York City, Boston and Jersey City.

“Although this is not yet a systemic problem for the banking sector, there are legitimate concerns about contagion,” said Eswar Prasad, an economics professor at Cornell University.

The US market is vulnerable. As the outlook for prices gets worse, the European Central Bank and Bank of England have warned of the risks of commercial real estate.

The signs of strain are increasing. The proportion of commercial office mortgages where borrowers are behind with payments is rising, according to Trepp, which provides data on commercial real estate, and high-profile defaults are making headlines. Earlier this year, a landlord owned by PIMCO defaulted on nearly $2 billion in debt for seven office buildings in San Francisco, New York City, Boston, and Jersey City.

The CEO of America’s largest bank told CNN he didn’t know whether more banks will fail this year. Yet he was quick to point out that the current situation was very different to the 2008 global financial crisis, when there were “hundreds of institutions around the world with far too much leverage.”

Commercial real estate — which spans offices, apartment complexes, warehouses and malls — has come under substantial pressure in recent months. Green Street said that prices in the US were down 15% in March from their recent peak. The rapid increase in interest rates over the past year has been difficult to swallow as large loans are used to finance purchases of commercial buildings.

This is a particular pain point for office properties. The average occupancy of offices in the United States is still less than half their March 2020 levels, according to data from security provider Kastle.

“You have fundamentals under pressure from work from home at a time when lending is less available than [it has been] over the last decade,” said Rich Hill, head of real estate strategy at Cohen & Steers. A decline in valuations is the result of those two factors.

Signature Bank

            (SBNY) had the tenth biggest portfolio of commercial real estate loans in the United States at the start of the year, according to Trepp. First Republic, which got a $30 billion rescue last month from several major banks, was the ninth largest. Both had more assets tied up in real estate than Wells Fargo, the leading US lender to the sector.

A total of $270 billion in commercialreal estate loans will come due in the next few years. Roughly $80 billion, nearly a third, are on office properties.

Banks may prefer that option to kickstarting drawn-out, expensive foreclosure processes. But it puts them in the difficult position of owning depreciating properties.

“That is a scenario we will see now very often,” Christian Ulbrich, chief executive of global commercial real estate services giant Jones Lang LaSalle (JLL), told CNN. The question, he continued, is what lenders will do in that situation, and whether banks are sitting on such sizable loan portfolios that they need to take “significant losses.”

But bank-banks and non-banks overlap in all kinds of real and perceived ways, and when confidence is eroded on either side, that creates a potential for panic to spread.

The financial crisis: from flashing red lights to flashing yellow lights: the solution to the financial crisis a la Ulbrich, Ms. Stanley Wealth Management

“There’s always a risk for self-fulfilling prophecies here, but I would still be fairly optimistic things will play out in a digestible way,” Ulbrich said.

Stress has historically harmed the landlords and the bankers that lend to them, according to a note to clients this month by the chief investment officer at Morgan Stanley Wealth Management. She said that related businesses and investors may also be hurt.

The initial panic has settled into a more tolerable state of tension. We can all take a deep breath, knowing our money is safe and that banks have the tools they need, courtesy of the federal government, to weather the storm.

“We’re going from flashing red lights to flashing yellow lights,” Wells Fargo’s senior bank analyst Mike Mayo told me recently. “I think it’s time for hyper awareness and vigilance to anything else” that might further undermine confidence.

It should have been easy to spot these red flags before it collapsed. Now, everyone’s looking for the next risk hiding in plain sight.

A consensus is forming around three key areas that analysts fear could create a systemic problem — commercial real estate, underwater bond portfolios, and the industry with the most metal moniker ever, shadow banks.

US banks are now sitting on an estimated $620 billion in unrealized losses — their assets are worth less now than they paid for them, making it a problem if the bank is forced to sell those assets in a crisis (like, say, a bank run).

As we discussed here last week, shadow banking refers to financial institutions that lend out money (like a bank) but don’t take deposits from customers.

Nightcap Banking Red Flags: When Banks Come to a Resurrection, They Might Be Misunderstood

They’re a large and diverse cast that includes investment banks, hedge funds, insurance companies, private equity funds, all manner of Wall Street power players.

The menacing nickname can be used to mean anything. They’re in the shadows because they’re unregulated, sure. But are they, like shady? Yes and no. Hedge funds and private equity types get a bad rap that is sometimes deserved, but they also provide financing to young firms that can’t get the time of day from regular bank-banks.

The key thing to remember is they’re not subject to the same strict rules as banks are, meaning they can take on more risk. The government backstop doesn’t help them if the wheels start to come off.

The mere perception that the banking sector might be connected to a struggling non-bank could spark a broader financial crisis, as my colleague Anna Cooban explains.

One of the many troubling reminders to emerge from the SVB debacle is that banks are big, sprawling operations run by human beings, in service of other human beings, none of whom are entirely rational. That might seem straightforward, but it is relevant in an industry reliant on trust as banking is.

Source: https://www.cnn.com/2023/04/10/business/nightcap-banking-red-flags/index.html

All Nightcap: A Zero-Defection Insight into a Small Industry, and a Big Profit (or Big Bang, Big Bang)

There is a zero-defection industry. “This is an industry that tries to minimize losses of mistakes, just like any other industry…The reality is that there are going to be mistakes.”

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