Retail CRE debt has been crappy since 2017, and banks managed without collapsing. Now Office goes to heck. Multifamily, the biggie, is following.
By Wolf Richter for WOLF STREET.
First, the US Banking landscape.
There are 9,697 domestically-chartered banks, savings associations, and federally insured credit unions in the US. Of them, 4,135 were FDIC-insured commercial banks as of December 2022, with 71,190 branches, according to the FDIC’s year-end tally. Now minus three banks, in order of collapse date: Silvergate Bank, Silicon Valley Bank, and Signature bank. So, today maybe 4,132 banks.
All these banks, savings associations, and credit unions had $29 trillion in assets. Of them, the FDIC-insured banks alone had $23 trillion in assets. Of them, four held 40% of those assets:
- JP Morgan ($3.2 trillion in assets)
- BofA ($2.4 trillion in assets)
- Citibank ($1.8 trillion in assets)
- Wells Fargo ($1.7 trillion in assets).
Then there’s nothing for a long distance before we get to the fifth largest bank, US Bank, a regional bank, with $585 billion in assets. Silicon Valley Bank was the 16th largest bank at the end of 2022 with $209 billion in assets.
The 32nd largest bank had less than $100 billion in assets. The 132nd largest bank had about $10 billion in assets. The 2,050th-largest bank – the bank in the middle, or the median bank – had just $315 million in assets.
That’s important to understand when we talk about bank failures: If a few of these smaller banks collapse, few people outside of their community would even notice, though it could be a big blow to their community, especially in rural areas where this may be the only bank within miles.
Bank failures are kind of routine, but can spike.
As long as banks have existed, banks have failed, just like other companies have failed, even the most splendid ones. In the US, banks can’t file for bankruptcy (though their holding companies can). Failed banks are taken over by regulators and are “resolved.” This is a much quicker process than dismembering it in bankruptcy court, and it allows for most of the deposits to be returned to the economy in short order.
So far in 2023, among the FDIC-insured banks, there have been three bank failures, if you include Silvergate, which was forced to shut down. There were no bank failures in 2021 and 2022, but four in 2020 and four in 2019.
The gray insert shows the bank failures from 2015 through 2023 so far. The massive spike in the 1980s was the Savings & Loan crisis, which led to the prosecution and quality time in the hoosegow for a bunch of bank executives. Yes, those were the good old times. By contrast, during the Financial Crisis, no one even attempted to send anyone to the hoosegow.
CRE Debt by category.
Multifamily (apartment buildings, student housing, etc.) is by far the largest category. CRE debt outstanding by CRE category as percent of total CRE debt:
- Multifamily: 44.2%
- Office: 16.7%
- Retail: 9.4%
- Industrial (warehouses, etc.): 8.0%
- Lodging: 6.7%
- Healthcare (life sciences): 2.1%
- Other: 12.9%
Some CRE debt still in good shape, others are in trouble.
The data below on special servicing rates are from Trepp, which tracks CMBS. Special servicing rates are a precursor for potential defaults for CRE mortgages that have been securitized into CMBS. We can use these special servicing rates as an indication of the trends among overall CRE mortgages.
Note that retail has been in trouble for five years, and banks have managed their way through it. Lodging has been in bad trouble since 2020, and banks have managed their way through it. Dealing with bad debts is what banks do as part of their routine.
Industrial is still in good shape, with a special servicing rate of 0.4% in March, down from 0.6% a year ago.
Retail has for years been the worst category due to the brick-and-mortar meltdown that I documented here since 2017 that took countless retailers – from the largest such as Sears and Toys-R-Us to the smallest – to bankruptcy courts. And it still is the worst category, with a special servicing rate of 11.6% in March, worse than a year ago (10.9%). Banks have been managing this issue for years without collapsing.
Lodging became a nightmare during the lockdowns and travel bans, but has been getting less worse, so to speak, with a special servicing rate of 6.3% in March, down from 10.9% a year ago.
Multifamily is now slithering into trouble, with a special servicing rate of 3.0% in March, up from 1.7% a year ago.
Office is going to heck. The special servicing rate has risen to 4.8%, up from 3.15% a year ago. Collateral values have collapsed. The issue is structural. Years of hogging office space by companies that they didn’t need and couldn’t use collided with a shift to working from home, and downsizing, and flight-to-quality that is leaving older office towers vacant. But given the size of these deals, everything is slow-moving. I discussed yesterday some of the recent deals, price cuts, and foreclosures sales, with haircuts ranging from 36% for the lucky ones to 100% for unlucky CMBS holders. Nearly all of the bag-holders were investors, not banks.
Banks’ exposure to CRE debt.
The data below is from a report by investment manager Cohen & Steers [CNS], citing data from the American Mortgage Bankers Association, the FDIC, and the Federal Reserve.
The size of CRE debt. CRE-related debts fall into different categories:
- $4.5 trillion: CRE mortgages on income-producing properties, meaning properties that are completed and have tenants – the CRE mortgages that everyone is talking about when landlords default.
- $467 billion: construction loans.
- $627 billion: owner-occupied property loans that the FDIC classifies at “commercial mortgages.”
- Plus: Revolving lines of credit, senior unsecured bonds, and warehouse facilities (extended by banks to nonbanks to temporarily fund their mortgage issuance until they can be securitized).
Banks held $1.73 trillion (38.4%) of the $4.5 trillion CRE mortgages of income producing properties. Investors and government entities held or guaranteed the remaining 61.6%, according to the Cohen & Steers analysis. In other words, $1.73 trillion in CRE debt is spread over 4,132 banks.
- Banks and thrifts: 38.4% ($1.73 trillion)
- Government-backed Agency, GSE, and MBS: 20.8%
- Life insurers: 14.7%
- CMBS, CDOs, and other ABS: 13.7%:
- Other: 12.5%
In the broader sense, including construction loans, banks hold 45% or $2.25 trillion of all CRE mortgages:
- Top 25 banks held $700 billion (14%) of CRE debt, about 4% of their total assets
- Next 110 banks (assets $10 billion to $160 billion) held $800 billion (16%) of CRE debt.
- The 4,000 smaller banks held $750 billion (15%) of total CRE debt.
Regional and smaller banks, the last two categories accounting for 4,110 banks, are relatively more exposed to CRE. On average, their CRE exposure amounts to 20% of their total assets.
But office mortgages account for 3% of their total assets, according to Cohen & Steers. So in general, it’s not going to be office CRE that will cause them trouble; office CRE is too small, though it could cause a few heavily exposed small banks to topple. Anything can.
For a bank with $1 billion in assets, CRE exposure of 20% means that the bank would sit on $200 million in CRE loans. This would be composed of all kinds of CRE loans. On average, this bank would also be exposed to office mortgages amounting to 3% of its assets, or about $30 million. This makes for a huge diversity of small local players that know their local markets.
A few small banks are hugely exposed. But a “handful” of the 4,000 small banks have exposure to CRE that exceed 50% of their assets, and if they run into CRE trouble, they may be added to the chart of failed banks above. This is called “concentration risk” in banking. It’s not good.
The top 25 banks have relatively little exposure to office loans, with office mortgages accounting for less than 1% of their total assets, according to estimates by Cohen & Steers. So with them, defaulting office CRE would cause some hits to earnings but not an existential crisis.
It’s investors that are taking the biggest hit on office mortgages – not banks.
There will be some bank failures.
We will see the number of bank failures rise. CRE debt will take down some of them. Other banks will be taken down by other factors. Credit risk, interest-rate risk, and concentration risk – it’s a bank’s job to manage them, and those that didn’t will get strung out. Banks will report crappy earnings for years. Investors have been taking big losses on CRE equity and debt already. And that will continue and get worse. Everyone will learn all over again that you can lose money in real estate.
But CRE is unlikely to lead to the next big banking crisis. It’s just not big enough for the banking sector.
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