High interest rates and a bleak commercial real estate market are casting a shadow over the economy. The weight could become even heavier on regional banks as a short-term federal loan program is scheduled to expire on March 11.
Desmond Lachman, an economist at the American Enterprise Institute, observed, “A lot of what’s been going on is people didn’t want to recognize how serious the problem was, but now it’s becoming pretty obvious.”
Regional banks hold more than two-thirds of the roughly $2.8 trillion in outstanding loans for U.S. commercial real estate properties. According to the National Association of Realtors, the historically low vacancy rates witnessed throughout 2023 are not expected to improve anytime soon.
Tomasz Piskorski, a professor at Columbia Business School, noted that “everyone was playing the waiting game,” hoping interest rates would soon drop. However, with the latest Consumer Price Index report indicating inflation still above 3%, it seems less likely that the Federal Reserve will approve cuts in March. This will leave the current rate at 5.25% to 5.5%.
The Impact of High Rates
High rates have already wiped out about $2 trillion in asset value for banks, according to Piskorski. His recent paper, Monetary Tightening, Commercial Real Estate Distress, and US Bank Fragility, provides a deep dive into the number of properties where outstanding debts surpass listed values. Their research reveals that about 44% of all CRE loans are at risk of default. If that default rate were to reach 20%, over 380 banks would be on the brink of insolvency.
The End of the Bank Term Funding Program
The Federal Reserve recently announced that it will not be prolonging the Bank Term Funding Program, a short-term liquidity option for banks established in March 2023 in the aftermath of the Silicon Valley Bank crisis.
“A lot of what they tried to do after the SVB collapse was to create a perception that they, to an extent, will back the banking system,” Piskorski said. “It’s a confidence game at the end of the day.”
The system is currently holding steady due to this confidence, with regional bank customers refraining from mass withdrawals, unlike the trend seen last year.
‘Too slow to act’
Both Lachman and Piskorski agreed that the Federal Reserve’s focus on inflation at the expense of financial stability and its attention on big banks rather than regional banks are key issues. Regional banks could indeed benefit from higher capital minimums.
The Fed’s Vice Chair of Supervising, Michael Barr, admitted at a Columbia Law School Banking Conference last week that the Federal Reserve supervisors were slow to react.
“Federal Reserve supervisors did not identify issues quickly enough,” Barr conceded, “and when we did identify risks, we were too slow to act with sufficient force to change management behavior.”
In the meantime, the commercial real estate market and regional banks are left to navigate these turbulent financial waters.
