According to experts, small and mid-sized banks could be facing another crisis in the near future, due to their outsized investment in the commercial real estate sector, which is struggling due to lack of demand and high interest rates.
According to Federal Reserve data, small banks hold only 36% of all loans, but own around 70% of commercial real estate loans. There are concerns that their exposure to the struggling commercial real estate sector poses a significant risk and could trigger another banking crisis, as those banks rely on returns from developers that may not be paid out.
“My view is that the commercial property market is a slow-moving train wreck that is going to have a major adverse effect on the regional banks,” Desmond Lachman, a senior fellow at the American Enterprise Institute, told the Daily Caller. “That, in turn, could derail the economic recovery and force the Federal Reserve to cut interest rates in a big way. The basic problem for the commercial property market is the record high vacancy rates that have resulted from the increased post-COVID trend for people to work at least part of the week at home rather than at the office.”
Between now and 2028, approximately $2.81 trillion in commercial real estate loans are set to come due, forcing firms to decide whether to pay off the loan in its entirety or refinance at a higher interest rate. In 2023 alone, $544.3 billion in commercial real estate came due, the largest amount in history. This led many developers to refinance under current credit conditions, which are abnormally costly.
Interest rates for these loans are being increased by hikes to the federal funds rate by the Federal Reserve, which is currently sitting in a range of 5.25% and 5.50%, but may decrease to around 4.6% this year, leading to some relief for developers.
Following the COVID-19 pandemic, increases in work-from-home practices and a push to online shopping led to increased vacancy rates for commercial real estate, due to a significant drop in demand. Office vacancies have seen the biggest increase, rising from around 13% in 2019 to 20% in the third quarter of 2023.
“It is now expected that property prices will decline by around 40 percent,” Lachman told the Daily Caller. “That means that a $3 trillion market will see some $1.2 trillion in value evaporate. This, together with high interest rates, will make it difficult for the property developers to roll over the $500 billion a year in property loans that fall due over the next two years. That will pave the way for a wave of property loan defaults. While the banking system as a whole will take a big hit, it will be the regional banks that will be the ones that are most damaged.”
Delinquencies in Commercial mortgage-backed securities are projected to rise from 2.25% in November 2023 to 4.5% in 2024 and 2.9% in 2025, according to Fitch Ratings.
There are concerns that more banks could follow the path of Silicon Valley Bank, which collapsed and led to a string of bank failures in early 2023, after depositors panicked and triggered a bank run. The Federal Deposit Insurance Corporation (FDIC) acquired the bank, but two other banks, First Republic and Signature, followed SVB, as fleeing depositors triggered collapses in those banks as well.
Signature was acquired by New York Community Bank (NYCB) following its collapse, but the latter bank recently unveiled a dismal earnings report showing losses related to the former bank’s huge exposure to commercial real estate, according to The New York Times. The bank’s stock has declined by nearly two-thirds, and investors now view the bank a risky investment.
“We just saw the near-death of New York Community Bank, which appears to have been saved by deposit transfers from other banks,” Peter St. Onge, research fellow in economics at the Heritage Foundation, told the Daily Caller about the possibility of more bank failures. “But, absolutely, there are roughly $300 billion of [commercial real estate] loans at regionals, making up about 30% of their balance sheets. Many have lost half or more of their value. So, absolutely, it’s a live risk.”
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