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Here's the domino that could trigger another banking crisis

  • Smaller banks have a disproportionate amount of commercial real estate loans compared to other loans, according to Federal Reserve data.
  • Higher vacancy rates in commercial real estate following the COVID-19 pandemic have stifled demand in the sector, while high interest rates have driven up costs, putting developers at higher risk default, according to experts who spoke with the Daily Caller News Foundation.
  • “My view is that the commercial real estate market is a slow-moving train wreck that will have a significant negative effect on regional banks,” Desmond Lachman, a senior fellow at the American Enterprise Institute, told DCNF. “That, in turn, could derail the economic recovery and force the Federal Reserve to cut interest rates significantly.”

Small and medium-sized banks could face another crisis due to their overinvestment in the commercial real estate sector, which is struggling under the weight of lack of demand and high interest rates, experts said in the Daily Caller News Foundation.

Small banks, defined as those outside the top 25 in assets, hold only 36% of all loans, but own about 70% of commercial real estate loans. seconds to Federal Reserve data reviewed by the DCNF. The exposure of smaller banks to the struggling commercial real estate sector poses a significant risk in terms of triggering another banking crisis, as these banks depend on returns from indebted developers who may not be able to pay, experts told the DCNF.

“My view is that the commercial real estate market is a slow-moving train wreck that will have a significant negative effect on regional banks,” Desmond Lachman, a senior fellow at the American Enterprise Institute, told DCNF. “This, in turn, could derail the economic recovery and force the Federal Reserve to cut interest rates significantly. The core problem for the commercial real estate market is the high vacancy rates that have been caused by increase in the post-Covid trend for people to work at least part of the week at home rather than in the office.”

About $2.81 trillion in commercial real estate loans are expected to come through due until 2028, when companies will have to decide whether to pay the loan in full or refinance at a higher interest rate. A total of $544.3 billion in commercial real estate loans matured by 2023, the largest amount ever, prompting many developers to refinance under today's costly credit conditions.

Interest rates on commercial real estate loans are being pump up by increases in the federal funds rate by the Federal Reserve, which is currently in a range of 5.25% and 5.50%. Developers could soon see some relief with the Fed projecting that the federal funds rate will be cut to around 4.6% this year.

vacant rates Commercial real estate has risen due to a drop in demand as a result of the inertia of the COVID-19 pressures to work from home as well as online shopping. Office vacancies have seen the largest increase, rising from 13% in 2019 to 20% in the third quarter of 2023.

“Property prices are now expected to decline by about 40 percent,” Lachman told the DCNF. “That means a $3 trillion market will see about $1.2 trillion in value evaporate. That, along with high interest rates, will make it difficult for real estate developers to recoup the $500 billion a year in real estate loans maturing over the next two years. This will pave the way for a wave of home loan defaults. While the banking system as a whole will take a big hit, it will be regional banks that will be hurt the most.”

Commercial mortgage defaults are expected to rise from 2.25% in November 2023 to 4.5% in 2024 and 2.9% in 2025. seconds at Fitch Ratings.

More banks could follow the path of the now-defunct Silicon Valley Bank (SVB), which hit ended with a series of bank failures in early 2023 after depositors got excited and triggered a bank run, leading to the bank's collapse and a takeover by the Federal Deposit Insurance Corporation (FDIC). First Republic and Signature banks followed SVB as fleeing depositors also caused a collapse.

“We just saw the next death of the New York Community Bank, which appears to have been saved by deposit transfers from other banks,” said Peter St. Heritage Foundation economics researcher Onge to the DCNF on the possibility of more bank failures. “But absolutely, there is roughly $300 billion [commercial real estate] loans to regional companies, which represent around 30% of their balance sheets. Many have lost half or more of their value. So, absolutely, it's a live risk.”

New York Community Bank (NYCB) acquired Signature after its collapse, but recently issued a dismal earnings report showing losses related to the bank's huge exposure to commercial real estate. seconds in the New York Times. As a result, the bank's shares fell by almost two-thirds as investors saw the bank as a risky bet.

Some economists are more optimistic about the health of the banking system, with Norbert Michel, vice president and director of the Center for Monetary and Financial Alternatives at the Cato Institute, telling the DCNF that the banking sector's woes are overblown.

“There is no particular reason to think that the banking system is not well capitalized,” Michel told the DCNF. “That said, there's no way to know for sure whether any sector of the economy might suffer a shock. There's also no particular reason to focus on real estate right now — real estate shocks have caused problems for the banking sector for more than a century. The good news is that experts have predicted ten of the last two bank failures that were caused by real estate problems.”

The number of depositors at NYCB remained roughly stable after the announcement, preventing panic and a possible bank run, according to the NYT. Many depositors may have fled after the news, but money from other lenders may have propped up the bank's books.

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