Banks’ Exposure to CRE Loans by Bank Size

When CRE hits investors, fine, they were paid to take those risks. But we’re a little more squeamish when it comes to banks.

By Wolf Richter for WOLF STREET.

Commercial Real Estate loans amount to about $5 trillion. Not all CRE sectors are in trouble. At one end of the spectrum: Industrial is still in good shape. At the other end of the spectrum: office is in terrible shape. Somewhere in the middle: There have been some big defaults in multifamily, but the sector is in much better shape than office.

The 4,026 or so FDIC-insured commercial banks held $2.4 trillion of CRE loans at the end of 2023, according to FDIC data, amounting to roughly 10% of their total assets of $23.7 trillion. So banks hold a little less than half of CRE loans, and those loans are about 10% of their total assets.

The remaining CRE debt is held by investors via commercial mortgage-backed securities (CMBS), collateralized loan obligations (CLOs), mortgage REITs, PE firms, insurance companies, pension funds, foreign banks that piled into US CRE, and a big portion is held by US taxpayers who are on the hook for 55% of the $2 trillion in multifamily CRE loans. We’ve discussed this debacle for investors over the past two years, and we’ve documented numerous massive blowups that left us with the suspicion that banks securitized the riskiest and worst CRE loans and sold the CMBS to investors.

When CRE losses hit investors, fine, they were paid interest to take those risks, so it didn’t work out, and OK. Everyone acknowledges this risk was part of the deal.

But everyone gets squeamish when it comes to the banks because they’re like financial utilities for the economy, and they’re all tightly woven together into the US banking system, making it fertile grounds for contagion, and they’re by nature risky utilities (they borrow short and lend long). Three regional banks collapsed in 2023, but none of them because of bad CRE loans – or bad loans of any type. Another one was forced to self-liquidate and didn’t require FDIC deposit insurance. In addition, two tiny banks collapsed without making any ripples.

Banks’ exposure to CRE as % of their loan book, by size of bank.

A higher percentage means banks are specialized in CRE loans and are more heavily exposed to CRE problems. A lower percentage means banks hold many other types of loans, and CRE is only a small part of their total loan book (CRE loan data via Lipper Alpha):

Large banks: 6% of their loans are CRE loans. Each of these banks has over $250 billion in assets. There are only 14 of them, and they hold 56% of total banking assets. It’s those few big banks that matter to the financial system. If one of them fails, it can shake things up. If several fail, it’ll rattle a lot of nerves. On average, only 6% of their loans are CRE loans. If they take big losses on their CRE loans, it will dent their earnings and hurt their stocks, but CRE losses alone won’t topple the bank; they would have to have big other issues.

Mid-size banks: 17% of their loans are CRE loans.  These banks have between $10 billion and $250 billion in assets. There are 121 of these banks, 16 of them have over $100 billion in assets. If several of those bigger 16 topple, there would be some ripples across the financial system.  And we would notice it and write about it.

Small banks: 31% of their loans are CRE loans. These banks have between $1 billion to $10 billion in assets. There are about 700 of these banks. 31% of the loan book being CRE is huge exposure – with some banks being more exposed and others less exposed. CRE losses will likely pull the rug out from under some of those small banks over the next few years. And we’ll notice, but we’ll probably not write about it.

Tiny banks: 28% of their loans are CRE loans. These banks have between $100 million and $1 billion in assets. As a group, they’re hugely exposed to CRE, and there are thousands of those banks, and some of them, maybe dozens of them, will fail over the next few years. But these bank failures won’t even make ripples across the financial system. Locals will notice, they will lose perhaps the only bank in their small town, and that’s a problem for the town, but it’s not a problem for the financial system. If such a tiny bank fails, we won’t write about it just like we didn’t write about the two tiny banks that failed in 2023.

To the overall banking system, it doesn’t really matter if 50 tiny banks collapse, of the 4,026 commercial banks in the US, most of which are tiny banks. The big banks do matter, but they’re much less exposed to CRE. As their CRE loans go sour, they dent earnings and whack down stocks, but CRE alone won’t pull the rug out from under those big banks.

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  80 comments for “Banks’ Exposure to CRE Loans by Bank Size

  1. Modalita says:

    So I suspect the end result is even more consolidation of the banking industry. Just what we need. /s

    • Wolf Richter says:

      Yes, of course.

      Commercial banks will continue to vanish. In 2023, mergers took out 100 banks; bank failures and a self-liquidation took out 6 banks; but 6 new banks were started. The bank count has dropped from over 14,000 in the 1980s to 4,026. The vast majority of banks disappeared because they got bought out by other banks, not because of bank failures.

      • joedidee says:

        except for good ole RTC days

        • Wolf Richter says:

          Yes, those were the times, LOL. In the Resolution Trust Corporation’s (RTC) first year in 1989, the FDIC resolved 530 banks and it was the job of the RTC to get rid of the real estate that those collapsed S&Ls held. During the S&L crisis between 1983 and 1994, about 2,300 S&Ls were resolved. So that’s a lot. But it’s still only less than a quarter of the 10,000 banks that vanished between 1983 and now. You can see the S&L crisis years in the chart just above, when the curve steepened.

      • cas127 says:

        I won’t claim cause and effect, but I will venture an observation that the US seemed to have a healthier overall economy (1950-2000, not every year but generally speaking) when there were 2-3x the number of banks then there are today. There were implosions (S&L crisis) but they didn’t seem to affect the broader national economy as much.

        The last 20 years of ZIRP and bank consolidation seemed mirrored in an unprecedentedly volatile general economy (boom-bust-boom-bust).

        And, the performance of the TBTF banks in the run up to the 2008 MegaBust does not necessarily endorse the “Bigger Eggs in Fewer Baskets” perspective.

        • RationalHuman89 says:

          From my perspective, the adoption of the Internet and electronic trading is a more direct contributor to increased volatility and more booms and busts. The flow of information is much faster and readily available today for investors and businesses to react to and many assets can be traded with the click of a button.

    • tom10 says:

      That is correct.
      Small banks are were I and everyone else I know that own a business,
      had/have loans with.
      But no worries, it will not impact the big boys.

      • CCCB says:

        Yep, it seems bigger is better, smarter and safer … and more likely to get bailed out if the need ever arises.

    • eg says:

      Well, Canada has something like 6 major banks, so you’ve got plenty of room to consolidate.

      • cas127 says:

        Most other countries have a much, much more consolidated banking sector…but I don’t know that it has per se served them better.

        As a general rule, the US proclaims a preference for competition rather than oligopoly…why shouldn’t that apply to banks as well?

        Vast branch/ATM networks have already made the US banking sector pretty consolidated in deposit/asset terms (thus the origin of the term “Too Big to Fail”, ahem) – I don’t that much greater consolidation will lead to better results.

        • Chris says:

          I agree if you’re talking about consolidation of the big banks. On the other hand consolidation is definitely useful for the small banks. The world is moving more digital and small banks can’t afford to invest the tens/hundreds of millions a year in technology that is needed to compete

          Most people would be better off if the 4K tiny banks consolidated into <100 banks with meaningfully more scale so they could better compete

  2. Jonno says:

    I think “a little lass than half” should be “a little less than half”.

  3. MarMar says:

    Does the Lipper Alpha data give you any view into how much of the CRE data is in what sectors, specifically the office CRE that’s been hit so hard?

    • Wolf Richter says:

      No it doesn’t, in terms of the data that I have access to. So we don’t know based on this data which size-category of banks is more exposed to office.

      • CTD says:

        I worked in private banking for a large four and these numbers are skewed to the lower end of risk in the banking system. In private banking if the income to support a real estate loan came from non real estate income then the bank did not have to categorize the loan as real estate loan. But….. there are debt service coverage ratios that are tested quarterly based on the 10 yr treasury + 2.50%, even if the loan interest rate was fixed. In essence it was a margin loan. With long term rates up and down, the loans are in and out of default. The bank also has a right to reappraise the properties and the borrowers have 30 days to “right size” the loans. These loans are made to the wealthiest people and families. The shit storm is happening and banks have much more than what’s published and clients didn’t understand they had margin loans instead of real estate loans.

        • Wolf Richter says:

          “In essence it was a margin loan.”

          OK, so you are talking about margin loans backed by CRE. Margin loans are full recourse. With a margin loan, if the borrower defaults, the lender gets the collateral AND can go after the borrower for the deficiency. Banks rarely lose money on margin loans. But clients get wiped out when things go the wrong way. There are other margin loans like that, and we’ve discussed them here, such as securities-based lending (SBL) where the collateral can be all kinds of liquid and illiquid securities, not just publicly traded stocks.

          These margin loans are separate on a banks’ balance sheet, and they’re only a small portion of their loans, often labeled “other” or similar because they’re just not big amounts, in terms of the banks.

        • cas127 says:

          I still think the whole issue of whether or not bank (or other) lenders have the right to periodic collateral reappraisal baked into their loan agreements with CRE borrowers is a pretty big deal.

          If so, multi-year ZIRP-driven CRE overvaluations have exposed those CRE borrowers to tremendous risk – in that they can’t wait and hope the CRE mkt turns around in 4 or 5 years (maturity date of their loans)…they have to worry about their building collateral being re-appraised *downward* *dramatically* every 6-12 months (perhaps).

          Under this scenario, a CRE loan is more like a stock mkt margin loan – once the bank feels its 100% collateral protection might be threatened (per re-appraisal) the mechanism is in place for the bank to “call the loan” (more equity cash has to be put into deal) or the bank demands the keys (or demands a mandatory workout loan that captures a huge chunk of the landlord’s equity).

          I have not really seen this possibility discussed.

          Perhaps borrowers never agreed to periodic lender re-appraisal rights (although horny borrowers tend to agree to almost anything) but this isn’t the bank/lenders’ first goat slaughter – interest rate cycling/collateral valuation is the heart of their continual business. Bank lenders had to know that ZIRP was insanity and that huge resultant overvaluations were all over the place.

        • Wolf Richter says:

          When a CRE mortgage that had been securitized is sent to a special servicer because it’s in some kind of trouble, the first thing the special servicer can do is have the property re-appraised. The re-appraisal can be repeated. We’ve seen properties that were re-appraised several times, each time a lot lower than before, down to near-nothing. But that doesn’t happen until the mortgage is signaling some kind of trouble.

          What CTD was talking about was a non-mortgage loan backed by real estate similar to “securities-based lending” (SBL) that is backed by securities that may be illiquid debt instruments, non-traded equity, or whatever. They’re margin loans, with the bank having full recourse, and able to go after the borrower for any deficiency.

  4. John H. says:

    “The modern mind dislikes gold because it blurts out unpleasant truths.”
    — Joseph Schumpeter

    Love it or hate it, gold seems to be blurting now.

  5. Eric Vahlbusch says:

    I’d be interested in a list of the 14 banks in the ‘big’ category. I believe I’ve seen it before, but can’t find it this morning.

    • Wolf Richter says:
      Assets, billion $
      1 JPMORGAN CHASE 3,395
      2 BANK OF AMERICA 2,540
      3 WELLS FARGO & CO 1,733
      4 CITIBANK 1,685
      5 U S BANK 651
      6 PNC 557
      7 TRUIST 528
      8 GOLDMAN SACHS GROUP 521
      9 CAPITAL ONE 476
      10 T D BANK 367
      11 BANK OF NY MELLON 333
      12 STATE STREET 293
      13 BMO BANK 266
      14 CITIZENS FNCL GRP 222
    • Home toad says:

      I would think multifamily CRE loans would be in good shape, you write they are not ” big defaults”. These are rentals of 5 units or more, condos, appts. How could they possibly in trouble, unless they bought or built just recently ( last couple years).
      Rent prices up, land value up, building worth more? Curious

      • DownFed says:

        They can get into trouble if there is rent control. If the landlord needs to refinance, and runs into higher interest rates, they can’t raise the rent. There is some New York bank that has this issue.

        • ApartmentInvestor says:

          The “borrower” is in trouble if they can not refinance or raise rents due to rent control, but most “banks” should be fine (since VERY few multifamily values have dropped over 20% since the current loans were originated).

        • Home toad says:

          Rent control by the govt in
          New York? Who would have thought.

          government control is more in order, bigly, then much of this banking issue would be non existent., excluding the office CRE meltdown.

          Has this country’s woes ever been this dire…maybe?

          I bought an apple at Walmart, it costs 2.00, it wasn’t the big apple from new york, just an avg apple.

      • cas127 says:

        “How could they possibly in trouble, unless they bought or built just recently ( last couple years).
        Rent prices up, land value up, building worth more? Curious.

        Renters broke.

        Renters priced out.

        Renters vacate (perhaps with no alternative to roommate or street).

        Just because a landlord can get a mortgage based on some ZIRP-era nutso over-valuation, doesn’t mean he will be able to sustainably pass those costs onto economically-stagnant or distressed renters.

        The Applesway-Arbor fiasco in Houston is an excellent example of this – Google it, it is an interesting, scary-as-crap read.

        I know you mention that “more recent” mortgages might be problemmatic…but artificially low lending rates prevailed for 20 years…and truly delusionally low ones for 10.

        That all got baked into the LSD-laced cake of the real estate market.

  6. LongtimeLurker says:

    It seems like smaller banks and cities/counties that depended on overvalued office property taxes are going to hurt. Taxes might increase for non-office improvements. A funny thought I just had reading this is that the co-working model might actually work now that office properties have such huge markdowns. It is too late for WeWork though.

  7. Hubberts Curve says:

    Wolf, What percentage of the small and tiny banks would have to go bust ( get closed down) to cause trouble for the FDIC insurance pool?

    • Wolf Richter says:

      First, you have to keep in mind that banks have assets, and when they fail, the FDIC sells those assets, and the proceeds from the sales pay for most of the payouts of deposit insurance. If only the insured depositors get made whole, and the remaining depositors get some kind of haircut, the hit to the FDIC fund is relatively small, if any. But stockholders and preferred bondholders lose everything.

      100% of the tiny banks could fail, and it wouldn’t be an issue for the FDIC’s fund; except FDIC doesn’t have enough staff to spread out across the US like this, they’d have to go on a national hiring binge, and they did this before. These are well-paid temporary jobs. Friend of mine did that back in the day.

      With the small banks with $1 billion to $10 billion, the percentage would be smaller. Most of those banks have between $1-2 billion in assets, and that’s really small.

      Also keep in mind that the FDIC Deposit Insurance Fund, if depleted, borrows from the US Treasury, and then recuperates those funds with special assessments levied on the surviving banks and it eventually pays back the US Treasury. This is all pretty routine.

  8. fred flintstone says:

    As the chart shows since the laws changed the number of banks have decreased substantially over the years.
    This is probably not good in the long run. Reduced diversification in decision making and exposures.
    Hopefully most of the CRE issue will be handled over the years with intelligent write-offs.
    Probably one of the reasons the fed refuses to crush inflation. They can’t…….without risking a collapse in the mid to small banking industry.
    Hats off to Wolfe……again……for providing a site that provides such a clear understanding of the situation.

  9. JeffD says:

    Life insurers hold over half a trillion dollars of CRE loans, with no counterparty to pick up the loss. See page 44 of the Fed’s October 2023 Financial Stability report.

    • Hubberts Curve says:

      In the long run the life insurance industry is probably a dead-man-walking anyway. This industry fairs well in an era of growing population, growing real economic wealth and Increasing life expectancy. But as all those factors turn upside down the gig is up for them, A CRE smack down will just be icing on the cake.

    • Wolf Richter says:

      So what? The life insurance business — this is US and FOREIGN life insurers that plowed into US CRE — is huge and profitable. They can handle the loss. So they’re going to be less profitable. And maybe they’ll lose some money in some quarters, but a lot of investors are losing some money in some quarters. The Easy Money is over.

      And no one here cares about the losses of FOREIGN life insurers that gorged on US CRE, just like FOREIGN banks gorged on US CRE debt. You cannot lose money in real estate will have to be unlearned.

  10. HowNow says:

    Thank you, Wolf. This report gives outstanding perspective on the matter of CREs, and banking in the USA, in general.
    I’m still hopeful that your next book with be on “The principles of business and investing: For smarties” rather than on the auto industry. All your readers will buy at least one copy, then word will spread. It’ll be a “San Francisco Times Bestseller”!

  11. LouisDeLaSmart says:

    ///
    Cost of rent for office and lab space for development greatly depends on the Hybrid model. My data ,internally gathered, sais that the cost varies and depends on the number of employees, parking spaces and ammenities. It can be between 5-15% of the total yearly office expense (all salaries, bills, software licences, etc.)
    Generally companies have targeted 50% seating capacity but as of recent the trend is more towards 25% and below, since it is working just fine.
    ///
    Companies are now trying to sell work from home as a privilege, but since the market is still good, the sales pitch in not going well. Especially senior managers/engineers request a full remote position, and in return the company provides them a more modest salary.
    ///
    The hybrid mode is here to stay, COVID and post-COVID have shown it can function. Office space is now a negotiable and flexible category.
    ///

  12. Alex J. Pollock says:

    Wolf, Did you look at the CRE exposures relative to marked to market (real) capital? Best, Alex

    • Wolf Richter says:

      Yes, same thing. No problem for the big banks (their income and stocks might get dented), big problem for the tiny banks (rug-pull possible).

      Look, Wells Fargo just reported earnings. It made $4.6 billion in net income in Q1 and $15 billion in net income over the past four quarters, despite some credit losses. These banks are HUGELY profitable. This profit goes to capital. So if WFC loses $2 billion in EACH quarter on CRE – which it won’t because it doesn’t have that much – It will still make a net income of $8 billion a year. You need to wrap your brains around the immense profitability of these banks, which is why they can take the credit losses.

  13. Bagehot's Ghost says:

    I disagree with this: “banks because they’re like financial utilities for the economy”

    If they were regulated like power or water utilities, and they didn’t take on risk, then fine. If they were member-owned and stuck to consumer loans like Credit Unions, then fine.

    Banks aren’t like either of those. Banks are always, always, inevitably tempted to one-up each other for the sake of greater profits, such that they take on far more risk than their portfolios can accommodate without occasional massive blowups. They should pay for those blowups, but banks own way too much political power so they dump the losses on taxpayers. When that fails, they dump the losses on depositors. Somehow the shareholders rarely if ever see a price haircut, much less a dividend cut, and bondholders never see haircuts except in very rare cases.

    The SVB bailout, which flouted existing law and regulations on deposit insurance, might have killed SVB shareholders but it bailed out the entire rest of the industry in a way that precluded the creative destruction needed to rejuvenate the industry with small players with improved business practices.

    If banks want to play with CRE fire, or investment portfolio risks, those need to be walled off from the depository foundation and it needs to be made legally much more clear that it’s buyer beware in terms of the stock and bond ownership.

    Additionally, for commercial banks a different deposit insurance system should be set up, one that’s capable of absorbing SVB style losses and reducing the risk of bank runs – without contagion to the taxpayer.

    • Wolf Richter says:

      1. Most utilities, like banks, are investor-owned. California’s biggie, PG&E, is investor-owned and went bankrupt twice so far. But the lights stayed on. That’s what matters. In 2014, investor-owned Energy Future Holdings, parent company of TXU Energy at the time, and largest utility in Texas, filed for bankruptcy; and the lights stayed on. There are some utilities that are co-ops or government owned, but most, like banks, are investor-owned. Other utilities went bankrupt too.

      Utilities go bankrupt because they do risky things to pump up their stock prices, just like banks.

      2. Banks are very heavily regulated — maybe the regulations aren’t good, but the regulations are huge.

      3. Investors in the banks that failed in 2023 got wiped out. They were NOT bailed out. The banks were not bailed out either. They were shut down over the weekend, cut into pieces, and sold off as pieces.

      4. What the SVB collapse has taught the banking industry is that banks that get in trouble will be destroyed and sold off in pieces, investors lose everything, executives get fired on the spot, and some executives get sued. That’s how it went with SVB.

      5. What the SVB collapse has taught depositors (you and me) is that maybe there is deposit insurance beyond the official limits.

      6. This is wrong: “Additionally, for commercial banks a different deposit insurance system should be set up, one that’s capable of absorbing SVB style losses and reducing the risk of bank runs – without contagion to the taxpayer.”
      That’s wrong. The taxpayer didn’t pay for the SVB collapse. The Deposit Insurance Fund did, and to cover any shortage, it can borrow from the US Treasury. The FDIC then levies special assessments on the surviving banks to pay back the loan from the Treasury and refill the DIF. That’s routine.

      • HotTub says:

        So much for the ah hem, “regulators”. If the “regulators” actually did their job, Jaimie Dimon of JPMC would be rotting away in prison cell for the rest of his damned life.

        • Stanny1 says:

          Dimon has been manipulating the Silver market for decades.

        • Wolf Richter says:

          Stanny1,

          Looking at the price of silver, it seems he has been manipulating is UP 🤣

        • JimL says:

          We live in such sad times that people think that those who think differently than them should be “locked up”.

          It must suck to be so weak and fragile that contrary opinions trigger such a strong response.

      • Bagehot's Ghost says:

        We mostly agree.

        Regarding (1), there are two things that make Utilities different from banks. The first relates to your comment “But the lights stayed on. That’s what matters.” – when banks break down there’s a systemic risk that isn’t present in the utility system. The second is that most of the utility bankruptcies I’m aware of (including PG&E and at least one in Texas) were actually fallout from (de-)regulatory failures, not changes in the economy of the kind that tend to take down the whole banking system (and force law-breaking bailouts) every 10-20 years.

        Regarding (2), we agree, the regulations aren’t doing their job. Restoration of Glass-Steagall and as-originally-intended enforcement of the antitrust laws would do wonders to reduce systemic risk in the financial system. The point I was making is that banks are not regulated in a sound way, so there is systemic risk which is not present for power or water utilities.
        (BTW, we know antitrust law isn’t working for banks because they are not competing to offer reasonable market interest rates to depositors on existing accounts. They aren’t adequatey worried about losing their customers if they don’t compete.)

        Regarding (3) and (5), yes SVB investors got wiped out (and I mentioned that), but the bailout legitimized moral hazard for everyone else: depositors who had put their money legally at risk did not legally get bailed-in. The impact of the de-facto increase in deposit insurance limits means large depositors everywhere are free to abdicate their historical due-diligence responsibilities. Note that it was SVBs depositors who spotted the bank’s flaws, not the regulators! The lack of large-depositor due diligence is going to come back to haunt everyone.

        Regarding (4), no, it only taught the bankers that their most egregious members might get their heads cut off, the rest of the herd would always be protected. Considering that the regulatory agencies are typically in the pockets of the industry, lack of “depositor based regulation” also means there’s going to be a lot more risk-taking by bank managers with less to fear. The Fed gave the banking herd license to run wild, with only the most egregious outliers at risk of getting culled.

        Re (6), No, the taxpayers are on the hook, albeit indirectly. Any expense the Federal Reserve incurs that depletes their interest revenue remitted to the Treasury is a cost to the taxpayers.
        You have to follow the money trails there. Other than SVB and its failed fellows, the entire banking industry got an extra-legal freebie in the form of the Fed agreeing to carry their trashed Treasuries at par for up to 2 years, despite that being light-years above market value. On top of that, the Federal Reserve (and/or US Treasury through the Federal Reserve) also bailed out the FDIC last year. It’s true that will eventually get paid off by the banks, in the form of their depositors earning less in interest for years to come – more or less the same as taxpayers footing the bill; we won’t see bonuses or dividends cut now will we? Also, in the meantime isn’t it also true that as a result of its various policy changes to aid the banks, the Fed is foregoing interest that it should be earning and which belongs to the taxpayers (along with all other Fed profits)? For instance, interest on reserves is a recent Fed innovation to enable “raising interest rates” without actually tightening the monetary base to match. That was never a thing prior to the last few years, appears to be extralegal to the Fed’s mandate, and is a direct subsidy to the banks at taxpayer expense.

        P.S. Interest on Reserves is also a likely reason why 5% interest rates aren’t actually inducing financial tightening. 5% interest rates aren’t constraining lending because reserves are abundant. And in fact that 5% in Fed-mandated interest is spraying money all over the economy like gas on a fire. The 5% is multiplied across trillions of dollars in reserves as well as trillions more in T-bills and other debt rollovers. Back in the 1970s, if the Fed wanted 5% or 10% interest rates, it had to do a lot more than issue a press release and pay bankers for their reserves. Since the system today doesn’t function the way that it did in the 1970s and 1980s, one shouldn’t expect the same superficial policy changes to have the same effects.

        • Tom S. says:

          Another difference is that the big banks operate nationwide, where most utilities are regional. I think regulation wise you’d have a different apparatus.

        • Bailouts4Billionaires says:

          Well said. Other depositors and taxpayers are definitely propping up the remaining banks with BTFP. Not to mention the compounding moral hazard.

    • John H. says:

      Bagehot’s Ghost-

      You said: “The SVB bailout, which flouted existing law and regulations on deposit insurance, might have killed SVB shareholders but it bailed out the entire rest of the industry in a way that precluded the creative destruction needed to rejuvenate the industry with small players with improved business practices.”

      I agree with the spirit of your statement, and would add this general statement, in memory of your namesake:

      “Any aid to a present bad Bank is the surest mode of preventing the establishment of a future good Bank.”
      —Walter Bagehot, Lombard Street

  14. roddy6667 says:

    Insurance companies have reinsurance. The risk is always spread around. This is provided in the banking industry by FDIC and securitization, but it looks like many banks don’t do enough. The insurance companies make sure they are protected. If I ran a bank, I would insist that they never hold risky assets that are more than X percent of total. Silicon Valley Bank is a good example. Tech startups are notoriously fickle. They should have been bundled into securities before the ink wass dry on the contract. Back in the Eighties when I was a Realtor, the loan officer I did the most deals with told me: “As long as they make two payments, we’re good. Then we get the cash back to lend out again” That bank never had any problems.

    • Tom V. says:

      Right. The commercial banks got into trouble this past year by going naked-long on interest rates and got the trade wrong. This is why Glass-Steagall needs to be re-implemented. Trades like this need to be the domain of investment banks, not commercial banks.

  15. vinyl1 says:

    You analyze by the size of the bank, but not by the quality of the loans. I have found that in general, the closer you are to the borrower the better you are able to evaluate risk. This would imply that the worst loans are held by retail investors and foreign banks. Local commercial banks carefully investigate the leases, the types of lessors, the capital structure, and the quality of the building for each loan they make. I doubt if overseas banks and retail investors, or for that matter pools of private capital, are in the position to do this, and in any case that is not their style. They allocate capital by general categories – US real estate, US stocks, US bonds. That don’t analyze each building, each stock, each bond.

    • Wolf Richter says:

      Yes, as I mentioned in the article, 3rd paragraph:

      “We’ve discussed this debacle for investors over the past two years, and we’ve documented numerous massive blowups that left us with the suspicion that banks securitized the riskiest and worst CRE loans and sold the CMBS to investors.”

      And these CMBS are stuffed everywhere, including in retail bond funds.

      • John H. says:

        “banks securitized the riskiest and worst CRE loans and sold the CMBS to investors…..And these CMBS are stuffed everywhere, including in retail bond funds.”

        Is there an ethical or legal issue here? Seems almost parallel to predatory lending.

        Good for the banks balance sheet, but bad for the unwary bond fund investor, especially 401k participants.

        • vinyl1 says:

          Yes, if you’re an investor, you have to watch what you’re investing in.

          I see three types of investor:

          1. The investor who carefully investigates each security he buys – what is their business model? How do they make money? What is the quality of their management? What is their capital structure, where is the risk?

          2. The investor who admits he doesn’t know anything, and buys a broad index of stocks and bonds, including both the good and the bad.

          3. The investor who thinks that he can get a 10% dividend from a sure thing, and that everyone else is a dummy for taking 4%. He likes leveraged CEFs that invest in leveraged lenders who lend to leveraged customers. What could possibly go wrong?

          Is it unethical that financial houses offer products that the third investor will buy? Well, they say these products are designed for sophisticated purchasers only, and put all kinds of disclaimers in the prospectus. Did you read the prospectus? OK, then you have only yourself to blame.

  16. Pants_Relief says:

    Hey Wolf, did you happen to read that Wall Street Journal piece back in February about investors such as Ian Jacobs coming to San Francisco, looking to buy distressed, cheap Office towers?

    The article mentions a similar play in 1977, in which a family acquired eight Manhattan buildings on the cheap, banking on a CRE rebound that yielded billions for them in the years that followed.

    As an SF local who is highly educated on CRE, do you think this type of play can actually work in 2024, given the CRE mortgages are underwater, the popularity of Work From Home, soaring vacancy rates which are even worse in older buildings, etc?

    Who are the Office sellers that would even be able to sell to a cash buyer, given their principal loan balances exceed the values, and no one wants to lease that space?

    • Wolf Richter says:

      I think those are the three options, depending on what kind of tower it is, and they’re good options, and I’m looking forward to some of them get worked out, but this stuff takes years:

      1. To make the purchase of an office tower work, anywhere just about, you need to buy VERY CHEAP. Then you can put the space on the market at half price in terms of rents (in SF that’s still expensive), and maybe fill the tower with non-glamorous tenants; but that’s a gamble. You might not be able to fill it, even at half price.

      2. Or you can buy it for land value, tear it down, and build residential.

      3. Or you can buy it for land value, and spend a gazillion converting it to residential, if even possible (few towers are suitable for conversion; often it’s just cheaper to tear them down and start over, and end up with a better product).

      The going rate in SF now is 60% to 75% off the prepandemic price, which makes some things possible.

      “Who are the Office sellers that would even be able to sell to a cash buyer…”

      The office sellers have been banks (Wells Fargo, US Bank) that owned the towers free and clear for their own office space. Other sellers are the lenders that end up with the tower after a foreclosure or deed in lieu. There have been very few transactions so far. Another deal was made with seller financing, and so that wasn’t really a sale; that was just a lease, essentially.

      • Pants_Relief says:

        Thank you for the thorough answer, Wolf!

        Regarding Option #1, are you seeing that cheap office rent = businesses lease space again, and work from homers get called in?

        It seems like you are saying high office rent intersects with allowing work from homers to have their way. But once rent is crazy cheap, the businesses are more inclined to return to the old model.

  17. JimL says:

    “But everyone gets squeamish when it comes to the banks because they’re like financial utilities for the economy, and they’re all tightly woven together into the US banking system, making it fertile grounds for contagion, and they’re by nature risky utilities (they borrow short and lend long). ”

    Unfortunately the repeal of Glass-Stegall buried the idea of banks as public utilities. If they were public utilities they would not be allowed to make the risky bets that many if them make. Instead, they are now held in some dual-quasi status of having the protections of a public utility, while being allowed to take on massive risk in the name of higher pay for those that engage in such risk. Heads they win, tails, they get bailed outout.

    I am not a big fan of government regulation, especially when it involves hiring an army of regulators to try and oversee bankers who are far smarter (and higher paid) than the regulators.

    A better system involves something more simple like Glass-Stegall, where entities that want to act like public utilities are given huge benefits (leverage through fractional banking), but must restrict their activity to a few shallow, well known markets (lending). Those that want to engage in gambling can do so on their investors dime. Win, they make lots of money, lose, they go bust.

    The reason this is is because the regulators can never stay ahead of the banks. For one, the bankers are just too smart. For two, the bankers will just grind away at bribing lawmakers to pass laws that reduce the power of regulators.

    It is an impossible situation.

    Just make it easy, if you want to engage in fractional banking, you must restrict yourself to a few easy to understand markets. If you want to gamble, then put up your own money.

    • eg says:

      You are, of course, correct. In essence, the notion that commercial banks are somehow “private sector actors” is frankly a sham. But you are also correct that the regulatory agencies and your elected representatives are either ideologically captured or simply bought off, or both. So nothing will change.

  18. SpencerG says:

    Another really good article Wolf. I remember stumbling across this site years ago during QT1 when I was trying to understand the Fed’s balance sheet. It continues to educate me.

    Question: Have you decided to deemphasize guest writers? They used to be another source of mind opening articles.

    • Wolf Richter says:

      I’d like to have John McNellis’ articles, CRE guy, his stuff is often great. He’s funny too. But he wanted me to publish everything he writes; problem is that some of it is political advocacy, and I don’t publish that. So he worked out a deal with the San Francisco and Silicon Valley versions of the Business Times, which publishes whatever he writes. But then if I want one of his articles, I’d have to wait until the print edition appears before I can publish it. I didn’t even know they still had a print edition. I did that once, my version of the article was like three weeks out-of-date by then. It’s just silly. So I’m not doing that anymore under those conditions. I’ve given up on the others, they’re too much work, and not enough return (this is not ZH, and I don’t just publish whatever).

      • SpencerG says:

        Yeah my impression of the better articles was that they were intermittent from the various authors. You don’t need a steady stream of mediocrity or whatever from a few authors… instead a few GREAT articles from a variety of experts works best for this site. They have to be educational in nature to really fit well with what you do. Like this article from McNellis from five years ago…

        https://wolfstreet.com/2019/11/16/meals-on-broken-wheels-uber-eats-grubhub-doordash-postmates/

        which has one of the best/funniest opening lines I have ever read on ANY website.

        “What do DoorDash, GrubHub, Postmates and Uber Eats have in common with Lassie? Nothing. They’re dogs; Lassie’s a superstar.

  19. Tyler says:

    I myself bank with what’s considered a tiny bank, and sometimes I worry that one day the bank will see circumstances that don’t bode well for it. I just remember that my deposits are protected by the FDIC.

    Anyways, after COVID there is more stress on the CRE environment due to work from home becoming more popular. I’m sure some commercial real estate can be rezoned by a city to be residential and the real estate can be converted into lofts and what not. All this takes time though. If it does stay as commercial though the banks might just have to eat the loss. A building can always be demolished to make something else. Land can sometimes be more valuable than the building itself! Especially in a crowded city.

  20. Tom S. says:

    The 10-yr leap back towards 5% sure changes the tenor of any debt restructuring conversation. No doubt there are investors betting on something breaking in the banking sector lined up to buy treasuries which puts a ceiling on that yield, though.

  21. greg S elmlinger says:

    Great article Wolf – useful data and well-presented. That data suggests that there are probably at least a few banks (albeit not large ones) that literally have over 100% of their equity invested in office CRE. Will be interesting to see what happens when those banks inevitably go under – especially if it happens at a time when the market is in “risk-off” mode.

  22. Charles Clarke says:

    Sometimes I wonder if the Fed is slow walking QT so that collateral has time to inflate into better LTVs so borrowers are more likely to keep paying, managing and extending. The money received may be worth less, but it would be received instead of lost through short sales or REOs.

  23. Nick Kelly says:

    ‘These banks have between $100 million and $1 billion in assets. As a group, they’re hugely exposed to CRE, and there are thousands of those banks’

    Amazing. If an entity with a 100 million in assets wants huge exposure to CRE, it should just be another company selling stock, not one taking deposits from the public with a Fed guarantee.

    Let’s look at context: it wasn’t long ago that Yellen under pressure from
    bank failures, felt she had to raise publicly a possible Fed guarantee of ALL deposits, regardless of size. This is an indication of a flaw in the system. The banking sector should not be running to mum every time it skins a knee.

    Pleasantville, pop 31, 403, does not need its own bank. It needs a branch of a much larger bank serving many places, that can absorb shocks.

  24. Ken Miller says:

    Good piece on an important topic. Thanks Wolf. I’m not sure anybody knows, within, say 200%, how big is the private CRE debt market, though. Estimates of the total size of outstanding CRE loans differ by roughly $1T from various meaningful sources. Below is TREPP (sourced largely from the Mortgage Bankers Assoc, I think), saying that total CRE debt market is approx $5.8T. I suspect that the $800b difference from your approximation above, Wolf, is definitional? Personally, I don’t think that private beneficiary debt combined with closed-end CRE debt funds totals less than $400b. One way to look at this: I can make a list and add up the stated AUM of closed-end debt funds and come up with more than $200b, I don’t know anywhere close to the total universe of those funds. There’s a $100mm private debt fund on seemingly every street corner in America. https://www.trepp.com/trepptalk/commercial-real-estate-debt-universe-grows-in-q2-2023.

    • Wolf Richter says:

      Yes, as you suspected, there are several big definitional issues: if you widen the definition, the number gets a lot bigger. There appears to be no consensus on how to present this, so you’ll see a lot of different numbers.

      I’m going to give you roughly current numbers below. The Trepp article you linked, was for Q1 2023, a year ago, and the totals have gone up since then. Trepp’s figure in the article is $5.9 trillion for what it calls the “universe commercial mortgages.”

      1. Construction loans. There is a distinction between construction loans and loans on “income-producing” properties, such as finished office and apartment buildings that generate rental revenues for the landlord. Not including construction loans, CRE debt is close to $5 trillion; and construction loans amount to an additional $500 billion or so. So that brings the total to close to $5.5 trillion.

      Construction loans are often not included in CRE loans, but in other types of loans, because they’re different; they’re special types of loans that get paid off when the project is finished and starts producing rental income, at which point the developer can take out a regular CRE mortgage to pay off the construction loan.

      2. Then there’s the $600 billion or so in mortgages on owner-occupied properties that the FDIC classifies as “commercial mortgages.” Some people exclude those from their total, and others include them. I’m in the camp that wants to exclude them.

      3. Other types of CRE-related loans are usually not included in CRE loans but in other types of loans. I don’t have a figure for that. But it’s not nothing. These loans include: 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).

      So under the narrowest definition of CRE loans, you’d have about $5 trillion. A broader definition that includes construction loans, will get you to about $5.5 trillion. And an even broader definition that includes the FDIC’s figure on mortgages on certain owner-occupied properties would bring the total to over $6 trillion. If you include the other types of CRE-related loans (#3), you go even higher.

      • Ken Miller says:

        Thank you for your thoughtful reply. I’m going to noodle on that and I may chime in further with other observations and data. *** I think this is a very big topic as, I think anyone should have just derived from your answer: there may be a lot more CRE debt exposure out there than just what’s on the books as direct loans or securities held (the latter being CMBS of course). *** The definition of “warehouse line” has morphed back to its latitudinarian use pre GFC. The definition you give, is, of course, correct for residential mortgages and for CMBS issuance, private or agency. When a closed end fund gets a “warehouse line,” it’s just some pool of loans getting, say, a three-year term loan to juice the equity returns. Regards, Ken

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