(Bloomberg) -- Property mogul Barry Sternlicht last week said there’s $1.2 trillion of real estate losses in offices alone and “nobody knows exactly where it all is.” Investors are growing alarmed that smaller banks might be on the hook for much of the wipeout.
Concerns mounted over the past two weeks after New York Community Bancorp, under pressure from a US watchdog, slashed its dividend to help stockpile funds in case commercial real estate loans go bad. And property values may have room to fall further, only adding to the pain for lenders: research firm Green Street estimated this week that appraised values of properties may need to drop another 10% to reach fair valuations.
The turmoil is a blow for landlords and bankers who were waiting for lower borrowing costs to ease the pain, embracing the mantra of ‘Survive Til ‘25.’ While that looked a good bet a couple of months ago, the robustness of the economy may cause the Federal Reserve to cut rates at a slower pace than markets had expected, increasing the risk of write downs at smaller lenders after they pushed into commercial real estate lending in recent years.
Here are six charts that show where we stand and how we got here:
Equity investors have been selling off regional bank shares since the NYCB surprise, but credit investors seem more sanguine, suggesting they see the issues as an earnings issue rather than a financial stability risk. In fact, risk premiums on bank bonds are narrowing more than the broader market, signaling banks bonds are performing better.
That said, CRE credit makes up more than 40% of some lenders’ loan books and the Fed is working with community and regional banks with concentrated exposures to commercial property. That includes coming up with a plan to work through expected losses, chairman Jerome Powell said in an interview with CBS’s 60 Minutes that aired Sunday evening.
One reason for that is higher capital charges made CRE loans less attractive to the largest banks after the financial crisis. Smaller lenders that faced fewer capital requirements saw a chance to boost market share and piled in, increasing their exposure just as interest rates began to rise.
The upshot now is that banks are by far the largest source of finance to the industry. With many of them hamstrung by losses, it will be harder for borrowers to refinance, increasing the risk of losses.
An additional complicating factor for lenders in the US is the amount of CRE lending that was interest-only, at least for mortgages bundled into bonds. While loan-to-value ratios may have been conservative, the decline in property values there has been so large it’s left bondholders vulnerable to losses in their commercial mortgage backed securities portfolios.
The troubles with CRE are by no means limited to the US. Real estate is the industry accounting for the largest amount by far of distressed bonds and loans globally, much of it from China which has been in a property downturn for more than three years. Distress has also spread to Germany and the Nordic nations, after a splurge using cheap borrowing turned bad as borrowing costs rose.
More than $220 billion of bonds and loans linked to property are currently distressed globally, according to data compiled by Bloomberg News. That’s a fall of just $11.4 billion since Powell said in mid-December that the interest-rate hiking cycle was essentially over and that discussion of possible cuts was coming “into view,” sparking a rally in a wide array of securities markets.
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Week in Review
- The troubles in the US commercial property market, which have already hit banks in New York and Japan, moved to Europe this week, elevating fears about broader contagion.
- For German banks at the forefront of the spreading US commercial property downturn, covered bonds and deposits can offer a lifeline, according to Barclays Plc.
- China Evergrande Group’s liquidation in Hong Kong gave US and European hedge funds a harsh lesson in the dangers of trying to bargain with the Communist Party in China.
- Buyouts of delinquent loans in CRE collateralized loan obligations recently reached record levels, according to JPMorgan.
- French bank Societe Generale SA is taking its collateralized loan obligation business in Europe up a notch, working to arrange new deals on its own.
- Junk-rated companies are struggling to secure lower interest rates on their outstanding loans since the Federal Reserve pushed back bets it will soon start easing policy.
- ING Groep NV sold an additional tier 1 bond in dollars — the market’s first in the currency since an issuance rush last year that followed a blockbuster issue by UBS Group AG.
- UBS sold dollar-denominated AT1 notes just a day after setting out plans to sell billions more of the risky securities in the coming years.
- A group of banks led by Morgan Stanley and Goldman Sachs Group Inc. priced an upsized $2.3 billion high-yield bond deal to refinance Ardonagh Group Ltd. debt, after winning part of the financing from direct lenders.
- Private-credit firms including Apollo Global Management Inc. and Blackstone Inc. are close to finalizing a $2 billion debt package that will help finance the buyout of Alteryx Inc.
- The days of investors pressing US companies to cut debt and shore up balance sheets as borrowing costs have risen may be ending, and the results could hurt corporate debt while boosting stocks.
- An uptick of missed payments on private debt by Chinese local government financing vehicles is spilling over into their bonds, potentially leading to a downward spiral.
On the Move
- Sumitomo Mitsui Financial Group Inc.’s US arm has recruited Clarke Adams and Matthew Burke as managing directors in its high-yield and leveraged finance teams.
- Piers Ronan has joined Truist Securities as a managing director in investment-grade debt syndicate in New York.
- Moelis & Co. hired Robert Mendelson from Venor Capital Management to improve its coverage of credit funds.
- Amundi SA has recruited Amelie Guillon as investment director to strengthen its private debt team.
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