by Michael Maharrey, Schiff Gold:
Problems in the commercial real estate (CRE) sector continue to bubble under the surface. This is a major stress point for US banks and could precipitate the next phase of the financial crisis.
A combination of high interest rates and declining tenancy is putting the squeeze on commercial real estate owners. As a result, banks hold a growing portfolio of delinquent CRE loans.
TRUTH LIVES on at https://sgtreport.tv/
As Reuters reported, “Weak demand for offices could trigger a wave of borrowers to default on their loans and put pressure on banks and other lenders, which are hoping to avoid selling loans at significant discounts.”
Anticipating this problem, banks reported big provisions for credit losses and chargeoffs in their latest financial statements.
For instance, Morgan Stanley set aside $134 million for credit losses in the third quarter. This was on top of a $161 provision for losses in Q2. The bank’s statement noted that the big reserve for chargeoffs was due to “deteriorating conditions in the commercial real estate sector.”
Wells Fargo reported an even bigger increase of $333 million in its allowance for credit losses.
Meanwhile, banks reported a growing number of non-performing and delinquent loans in Q3. According to Bank of America’s most recent financial statement, the total value of its non-performing loans (at least 90 days past due) increased to nearly $5 billion in the third quarter. That was up from $4.27 billion in Q2. The big increase was largely due to its CRE portfolio.
PNC’s non-performing commercial real estate loan balance more than doubled to $723 million in the third quarter. The bank’s chief financial officer said, “Pressures we anticipated within the commercial real estate office sector have begun to materialize,”
There is also a growing number of CRE chargeoffs. Wells Fargo reported $93 million in net CRE loan charge-offs in the third quarter. That was up from $79 million in the second quarter and $17 million during Q1.
Big banks can likely weather a CRE crash, but smaller regional banks can’t, and they hold the vast majority of commercial real estate loans. Small banks have more than 4.4 times the exposure to CRE loans than the major “too big to fail” banks. According to an analysis by Citigroup, regional and local banks hold 70% of all commercial real estate loans.
THE BIG PICTURE
The commercial real estate market might be the next thing to crack in this bubble economy due to the relatively high interest rate environment created by the Fed to battle price inflation. This could drag a lot of banks down with it.
The rampant money creation and zero percent interest rates during the COVID pandemic on top of three rounds of quantitative easing and more than a decade of artificially low interest rates in the wake of the 2008 financial crisis created all kinds of distortions and malinvestments in the economy and the financial system. It was inevitable that something would break when the Federal Reserve tried to raise interest rates in order to fight the price inflation it caused with its loose monetary policy.
Easy money is the lifeblood of the economy and the financial system. The Fed started draining that lifeblood away when it stepped in to fight the price inflation it could no longer write off as transitory. There was no way the central bank wasn’t going to break something.
The first crack in the dam was the failure of Silicon Valley Bank, Signature Bank, and First Republic Bank. The Fed rushed in to shore up the financial system with a bank bailout but problems continue to bubble under the surface. In August, Moody’s and S&P Global slashed the credit ratings of a number of banks. Along with the impact of rising interest rates on bank balance sheets, the S&P report also cited high commercial real estate (CRE) exposure as a reason for the downgrades.
