Commercial Real Estate Could Cause Thousands Of Banks To Fail

Our latest article on bank safety, titled "Commercial Real Estate Could Cause Thousands Of Banks To Fail."

If you follow our banking work, you have probably noticed that we have published quite a lot of articles on commercial real estate lending. In fact, this segment is in such bad shape now that it could likely trigger a major financial crisis, which could be worse than the Great Recession. In this article, we discuss some new data that underpins our very negative view of this lending segment.

First, the FDIC, which is usually very optimistic about the banking sector and prefers to ignore red flags, has recently made the following statement:

Looking more closely at commercial real estate portfolios, we are beginning to see concerning trends in non–owner–occupied property loans. The volume of noncurrent non–owner occupied CRE loans increased by $4.1 billion, or 36.4 percent, quarter over quarter. In addition, these loans had a noncurrent rate of 1.31 percent in the third quarter, up from 0.96 percent last quarter and 0.54 percent a year ago. This is the highest noncurrent rate reported for this loan portfolio since third quarter 2014.

The chart below shows that the latest noncurrent rate for the CRE space is indeed the highest since 3Q14.

Second, Moody’s Analytics has recently reported that, according to the latest data, 19.6% of office space in the U.S. is not leased. This is the highest rate since at least 1979, when Moody’s began to track these numbers. Obviously, such a huge rate looks very bad for the CRE lending space and, eventually, for banks that are exposed to this sector.

Finally, researchers from USC, Columbia, Stanford, and Northwestern have published a working paper on commercial real estate lending in the U.S. Importantly, this is an independent analytical paper, and, in contrast to investment banks and rating agencies, academic researchers do not generally have conflicts of interest.

According to the paper, due to higher interest rates and the adoption of remote working, 14% of all CRE loans and 44% of office-related loans appear to be in "negative equity." In other words, the current values of properties, which serve as collaterals for these loans, are less than the outstanding loan balances. In addition, the paper said that around one-third of all CRE loans and the majority of office-related loans may encounter substantial cash flow problems and refinancing challenges. As a result, the researchers concluded that the banking industry could face a range of 10% to 20% default rates on CRE loans, i.e., levels that are comparable to or even higher than those seen during the Great Recession.

A 20% default rate would result in $160B in losses for U.S. banks. According to the paper, given such a huge loss and the weakening ability of U.S. banks to withstand defaults, 482 banks would have their mark-to-market value of assets below the face value of all their non-equity liabilities. If half of insured depositors decide to withdraw their savings, 31 banks would become insolvent, and this number is in addition to the 340 banks that would become insolvent due to higher interest rates. If all depositors decided to withdraw their savings, 385 banks would become insolvent. The most shocking conclusion from this paper is that those 385 banks are in addition to the 1,799 banks facing insolvency risks just due to higher interest rates.

To sum up, in a worst-case scenario, higher interest rates and a crisis in the CRE space could lead to the failures of 2,184 U.S. banks.

Bottom line

We have been warning our readers about major issues in the CRE space for the past 18 months. The situation in this segment continues to deteriorate and could trigger a crisis that would be worse than the Great Recession.

I want to take this opportunity to remind you that we have reviewed many larger banks in our public articles. But I must warn you: The substance of that analysis is not looking too good for the future of the larger banks in the United States, details for which are here.

Moreover, if you believe that the banking issues have been addressed, I'm sorry to inform you that you likely only saw the tip of the iceberg. We were able to identify the exact reasons in our public article which caused SVB to fail, well before anyone even considered these issues. And I can assure you that they have not been resolved. It's now only a matter of time.

At the end of the day, we're speaking of protecting your hard-earned money. Therefore, it behooves you to engage in due diligence regarding the banks which currently house your money.

You have a responsibility to yourself and your family to make sure your money resides in only the safest of institutions. And if you're relying on the FDIC, I suggest you read our prior articles, which outline why such reliance will not be as prudent as you may believe in the coming years.

It's time for you to do a deep dive on the banks that house your hard-earned money in order to determine whether your bank is truly solid or not. Our due diligence methodology is outlined here.