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Fund managers are increasingly worried that problems in the commercial real estate sector could trigger a credit crunch in the U.S., according to a new survey from Bank of America.
About 16% of global fund manager survey respondents identified a “systemic credit event” as the top risk to markets in February, compared to just 11% the previous month. It represented the third largest tail risk to markets after ongoing inflation and geopolitics.
The fund managers believe the most likely source of a credit event is the commercial real estate market.
Other possible sources include shadow banks or non-bank financial institutions that are not subject to regulation, including hedge funds, private equity funds, investment banks and mortgage lenders, as well as U.S. corporate debt.
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A “Wall Street” sign in New York City on January 27, 2023. (Photographer: John Taggart/Bloomberg via Getty Images / Getty Images)
About $1.5 trillion in commercial mortgage debt is due by the end of 2025, but higher borrowing costs, coupled with tighter lending conditions and a decline in property values driven by remote work, have increased the risk of default.
About $929 billion in commercial real estate loans are expected to come due this year, according to the Mortgage Bankers Association. Borrowers may have no choice but to refinance at significantly higher interest rates or sell their properties at a large loss.
In response to soaring inflation, the Federal Reserve raised interest rates to their highest level since 2001. Rates are likely to remain elevated for some time as policymakers have signaled they are unwilling to begin cutting rates until they are more confident that inflation has returned to 2%.
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Making matters worse, small and regional banks are the largest source of credit for the $20 trillion commercial real estate market, holding about 80% of the sector's outstanding debt. Regional banks were at the epicenter of upheaval in the financial sector last year following the collapse of Silicon Valley Bank, and there are concerns that the turmoil could sharply tighten lending standards.
| ticker | Security | Last | Change | Change % |
|---|---|---|---|---|
| NYCB | NEW YORK COMMUNITY BANCORP INC. | 4.90 | -0.04 | -0.81% |
During a credit crunch, banks significantly increase their lending standards, making it difficult for businesses or households to obtain loans. Borrowers may have to agree to more stringent conditions such as high interest rates as banks seek to reduce financial risk on their side.
Those fears were reignited earlier this month when New York Community Bank cut its dividend and reported an unexpected quarterly loss on office and residential real estate loans. Since then, the shares have lost about half of their value.
Treasury Secretary Janet Yellen has sought to downplay growing problems in the commercial real estate sector and their potential impact on the banking system.
Traders work on the floor of the New York Stock Exchange during morning trading on March 13, 2023 in New York City. (TIMOTHY A. CLARY/AFP via Getty Images / Getty Images)
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When Yellen testified before the Senate Finance Committee two weeks ago, she said she expects additional bank stress and financial losses due to weakness in the commercial real estate sector, but believes it ultimately will not pose a “systemic risk to the banking system.” The risk for the largest banks is quite low, but there may be smaller banks that will come under pressure from these developments.”