BANK REGULATORS EXPRESS CONCERN OVER REAL ESTATE RISK

The Financial Stability Oversight Council (FSOC) will increase scrutiny of banks’ exposure to the rising risk of commercial real estate loans defaulting, the agency said.

Small and regional banks hold more than 60 percent of the nation’s commercial property loans.

The proportion of late-paying loans in the sector remains low and banks remain “well-capitalized,” the FSOC said in a statement, but noted that vacancy rates are rising, especially in office buildings.

“Regulators are taking steps to emphasize risk management and examine exposures to commercial real estate loans at their regulated institutions,” the statement added.

The failure of First Republic, Signature, and Silicon Valley banks in rapid succession this spring has focused attention on weaknesses in the regulatory structure surrounding financial institutions.

“Washington watchdogs are under pressure to get out in front of any looming issues,” Bloomberg noted.

At a 14 June press briefing, U.S. Federal Reserve chair Jerome Powell said “we do expect losses” in commercial real estate and the bigger a bank’s exposure, the more it will lose.

The FSOC was established in the wake of the Great Recession and includes the U.S. treasury secretary, chair of the Federal Reserve, and chair of the U.S. Securities and Exchange Commission. 

TREND FORECAST: As evidenced, The Trends Journal was the first to forecast an Office Building Bust when politicians imposed draconian lockdown laws that forced people to work-from-home back in 2020. While office occupancy rates (which are at around 50 percent in the 10 major U.S. cities) will continue to climb, we forecast they will remain 35 percent to 40 percent below 2019 pre-COVID War levels. 

● “THE NEW LIFE OF LOCKDOWN” (19 May 2020)

● “REMOTE WORK = COMMERCIAL BUST” (2 Jun 2020)

● “SLIDING VALUE OF OFFICE SPACE HITS URBAN CENTERS” (11 Aug 2020)

● “WORK FROM HOME, CITY REAL ESTATE DOWN” (20 Oct 2020)

● “OFFICE WORKERS STAY HOME” (8 Dec 2020)

● “RETURN TO OFFICES POSTPONED: COMMERCIAL REAL ESTATE BUST?” (14 Sep 2021)

● “WORKERS STAYING HOME, COMMERCIAL REAL ESTATE DISASTER LOOMING” (19 Oct 2021)

● “COVID WAR KEEPING WORKERS OUT OF THE OFFICE” (16 Nov 2021)

● “NYC BUSINESSES: BYE, BYE NYC” (16 Nov 2021)

Facing the reality of our Office Building Bust trend forecast—which the business media ignored—The Wall Street Journal reported that “Share prices of the five largest real-estate investment trusts that concentrate on downtown office buildings were down 63 percent on June 15, on average, from the end of 2019.” And according to Columbia and New York University, it is estimated that the value of office buildings in U.S. cities has fallen 38 percent from their 2019 levels. 

BANKS PREPARING TO DUMP REAL ESTATE LOANS AT A LOSS

Although delinquency rates remain low, U.S. banks are preparing to sell some of their commercial real estate loans at a loss, according to the Financial Times.

“The fact that banks want to sell loans is coming up in a lot of conversations,” analyst Chad Littell at real estate research firm CoStar told the FT. “I’m hearing more about it than at any time in the last decade.”

PacWest Bancorp already is unloading “big chunks” of its construction loans at a loss, according to the FT. 

HSBC USA is selling hundreds of millions of dollars’ worth of commercial real estate loans, taking a 5-percent loss as it “winds down” direct lending to U.S. property developers, people familiar told the FT.

Through 2025, an estimated $145 trillion in commercial real estate loans will come due, many of which will need to be renegotiated.

The transition to remote work has forced office building owners to slash rents to attract tenants and keep old ones. At the same time, owners’ costs and interest rates have doubled or even tripled.

“I see people all the time who are panicked because they’re thinking ‘how am I going to pay off my loan when rates have now gone up way beyond what I can afford and rents are dropping?’,” real estate billionaire Jeff Greene told the FT.

TREND FORECAST: Smart bankers will screen their portfolios of real estate loans and create a priority list beginning with the riskiest and ending with the least likely to default.

Then, as opportunities and deteriorating economic conditions in the sector warrant, they can market the loans at an appropriate discount to get them off the books.

The most difficult part of the process is not the math.

Instead, it will be hardest for bankers, and their shareholders, to accept that diseased loans need to be amputated in a brisk and timely way to save the organism itself.

Taking a loss to rid themselves of bad loans will place more banks on a wobbly financial footing: deposits are migrating to institutions paying higher returns, many banks hold low-yield bonds they are unable to sell without a loss, and more banks are trying to hold more capital against the prospect of more loans turning sour in a weakening economy.

The combination of factors adds to the forces that will drive more banks to sell themselves to more stable competitors or face being shut down by regulators.

Marking down loans on office buildings also will publicly acknowledge the reality that the buildings have lost value, many significantly, making it even harder for owners to replace maturing loans with new ones.

Therefore, there will be massive foreclosures that will crash small and medium-sized banks that hold the commercial real estate loans and many businesses that depended on commuters will go out of business. Also, it is estimated by Green Street that the taxes on office buildings in major U.S. cities account for some 10 percent of revenue. Thus, the lower the tax revenue, the greater city debt loads along with a decline in public services and more firing of city workers. 

And as we have noted, the higher interest rates rise, the more it costs to service debt… which will in turn increase loan defaults:

● “TOP TREND 2023: OFFICE BUILDING BUST: OFFICE OCCUPANCYHALF OF WHAT IT USED TO BE” (7 Feb 2023) 

● “TOP TREND 2023, OFFICE BUILDING BUST: THE COMMERCIAL REAL ESTATE FACE OFF” (28 Mar 2023) 

● “SPOTLIGHT: OFFICE BUILDING BUST” (18 Apr 2023) 

● “TOP TREND 2023: OFFICE BUILDING BUST: PRICE OF HEDGING INTEREST RATES WALLOPS OFFICE LANDLORDS” (9 May 2023) 

● “SPOTLIGHT, TOP TREND 2023: OFFICE BUILDING BUST” (16 May 2023)

● “TOP TREND 2023: OFFICE BUILDING BUST” (13 Jun 2023)