U.S. commercial real estate is thundering, and the banking crisis is not over

Text: Haitou-Global, ID: Haitou-Global

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The U.S. commercial real estate crisis and declining leasing demand put office properties at risk of loan default, and banks with large loan exposures could be hit hard.

"High interest rates drive up office vacancy rates and loan defaults"

With the US-based boom in home work, office leasing demand has not yet recovered to 2019 levels, and owners applying for variable-rate loans for commercial properties have begun to default on their debts on a regular basis. In a market environment of higher interest rates and tighter loans, office prices fell as they matured.

According to real estate services provider Cushman & Wakefield, the average U.S. office vacancy rate was 18.6% in the first quarter of 2023, 5.9 percentage points higher than in the fourth quarter of 2019.

According to Bloomberg data, more than 17% of office space in the United States was vacant in the first quarter, of which 4.3% was available for subleasing. These averages mask large disparities between major cities across the country, such as San Francisco, which has an office vacancy rate of nearly 25 percent. Cushman & Wakefield predicts that office vacancy rates will continue to rise in the second half of 2023; By 2030, the excess office space in the United States will reach nearly 330 million square feet (about 30 million square meters).

"Commercial property prices plummet, large number of loans coming due"

Commercial real estate, including office buildings, apartment towers, warehouses and shopping malls, saw prices fall 15% in the year to March 2023. The data shows that office prices have fallen more than other commercial properties because such buildings are typically purchased through high, variable-rate loans, and the cost of borrowing is rising as interest rates rise.

This decline is likely to last a long time. Cohen & steers, a US investment management firm, pointed out in a report that the pressure to work from home and stricter lending standards could reduce home prices by more than 20% to 30%, with office buildings falling the most.

In 2023 and 2024, when the economic environment is becoming more tense, a large number of loans in the commercial real estate sector will come due. According to Bloomberg, data from the Mortgage Bankers Association puts loans due at $92 billion in 2023 and $58 billion in 2024. The fall in house prices will add to the pressure on owners, who will demand more assets from owners who may choose to have their homes repossessed if they are of poor quality.

U.S. commercial real estate will see more debt defaults. In February 2023, Columbia Property Trust, a division of PIMCO, had defaulted on loans worth about $1.7 billion to seven of its iconic buildings; Brookfield Corp., one of the world's largest real estate investment ---firms, also defaulted on a $784 million loan for two skyscrapers in downtown Los Angeles.

"The banking crisis is still in turmoil, and the three banks have great exposure to commercial real estate loans"

Given the sharp drop in commercial property prices, banks that rely too heavily on commercial real estate loans could experience a run similar to that of Silicon Valley banks. Doubts about their health by bank customers can create a large demand for withdrawals. Banks may demand immediate repayment from borrowers, which will fuel panic and cause more depositors to flee.

JPMorgan defines banks with ≥1 commercial real estate loans/deposits as high-risk banks, with the three highest ratios as of April 4 being:

Valley National Bank (VLY) - 485%: With nearly $58 billion in assets at the end of 2022, Valley National has been performing well recently. However, the New Jersey-based bank's reliance on commercial real estate loans is worrying.

Data from the bank's 10-K financial statements showed a 485% ratio between commercial real estate loans ($25.7 billion) and tier 1 common equity ($5.3 billion). According to Barron's, the bank's commercial real estate portfolio has grown 73 percent over the past three years.

While Valley National increased its 2022 credit loss provision by 28% to $483 million, management remained optimistic, telling investors that "no factors have been identified that are unfavorable to the credit portfolio." As of April 18, Valley National's share price is down 25% in 2023 – the company's outstanding shares were shorted at a rate of 4.45% as of March 31.

East West Bancorp, headquartered in California, has also had a strong financial performance recently, reaching $64 billion in assets in 2022. But its commercial real estate loan exposure is also staggeringly high, with a ratio of 230% to Tier 1 common stock ($6.3 billion) according to its 2022 10-K report.

The good news is that East West Bank had a strong fourth quarter of last year, with revenue up 28% to $581 million; Its profit increased by 55% and its net profit margin reached 58%. In 2022, its loan loss provision increased by 10% to $595 million.

As of April 18, East West Bank's share price is down 20% in 2023. As of March 31, 2.6% of its outstanding shares were shorted, up 41% from February.

Synovus Financial (SNV) – 196%: $45 billion in assets at the end of 2022. Synovus Financial has seen little recent growth, but it has a high level of commercial real estate loans. According to its 2022 10-K report, the ratio between commercial real estate loans ($9.6 billion) and tier 1 common equity ($4.9 billion) was 196%.

In the fourth quarter of 2022, the bank's revenue increased by about 1% to $569 million, profit increased by 2.7%, and net profit margin was 36%. According to its 10-K report, its provision for credit losses increased 7% to $500.9 million in 2022.

As of April 18, Synovus' share price is down 19% in 2023. As of the end of March, the company's outstanding shares were shorted at 3.4%

The Silicon Valley Bank run shows that bank deposits can be lost quickly if things get out of hand. If the three banks report a significant increase in credit loss reserves in their first-quarter earnings, depositors are likely to panic, and the banking crisis could recur.

Resources:

1.Forbes，3 Banks With Big Commercial Real Estate Portfolios Could Face Trouble

2.Bloomberg，A Hedge Fund Trader Gained 119% Betting Against Malls. Now He’s Targeting Offices

3.Bloomberg，Brookfield Defaults on Two Los Angeles Office Towers

4. Vernacular Wall Street, Wall Street aggressively shorted U.S. commercial real estate

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