Major US banks can withstand Fed’s commercial real estate shock scenario

NEW YORK: Major US banks survived a hypothetical 40 percent drop in commercial real estate values as part of the US Federal Reserve’s annual health check, easing fears for the banking sector as landlords struggle in a world of increasingly high interest rates.

As risks mount in the CRE sector, investors looked to the Fed’s “stress tests” to assess how vulnerable U.S. lenders are at a time when pandemic-era work habits continue to empty office towers, pushing vacancy rates past historic peaks to a record of 20%. per cent.

“In many ways, there should be a sense of comfort that banks can weather a very nasty storm,” said Chris Marinac, head of research at Janney Montgomery Scott. “Although this doesn’t mean the Fed thinks commercial real estate is out of the woods. It’s just the beginning of this credit cycle.”

The Fed’s emergency drill tests banks’ balance sheets for a possible severe economic downturn, which also brings a 36 percent drop in U.S. home prices, a 55 percent drop in stock prices and a 10 percent unemployment rate.

The results, released by the Fed on Wednesday, examine whether banks could continue lending to households and businesses in the event of a severe global recession. They also indicate how much capital banks should be considered healthy – and how much they can return to shareholders through dividends and buybacks.

The 31 major banks tested demonstrated that they had sufficient capital to absorb nearly $685 billion in losses.

The Fed’s disaster test comes more than a year after the collapse of midsize lenders Silicon Valley Bank, Signature Bank and First Republic. These failures led to criticism that the Fed had failed to assess banks’ vulnerabilities to rising interest rates; instead, the Fed thought rates would fall during a severe recession.

Commercial office space is being closely watched as $929 billion of the $4.7 trillion in outstanding commercial mortgages from lenders and investors will mature in 2024, according to the Mortgage Bankers Association. This looming maturity wall comes against a backdrop of falling property values and lower rents.

Analysts predict a painful reckoning for CRE, with banks still retaining “significant concentration risks,” according to Moody’s Ratings.

Of the banks tested, Goldman Sachs had the highest expected credit loss for commercial real estate at 15.9 percent. RBC USA, Capital One and Northern Trust followed, with forecasts of 15.8 percent, 14.6 percent and 13 percent, respectively.

One criticism from analysts of the Fed’s stress test was that it did not include the regional banks that hold the majority of CRE loans. Regional lenders are also less regulated than their larger peers.