Entrepreneur Tom Ellsworth believes “a crisis is about to happen” in the U.S. banking system — and there are two competing issues battering the foundation.
One-fifth, or $929 billion, of the $4.7 trillion of outstanding commercial mortgages held by U.S. lenders and investors will come due in 2024, according to the Mortgage Bankers Association (MBA)’s 2023 Commercial Real Estate (CRE) Survey of Loan Maturity Volumes.
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This spells trouble for America’s small- and medium-sized commercial banks and private mortgage lenders feeling the strain of America’s high interest rate environment.
“The Fed just said the rates will be higher longer. Uh-oh!” Ellsworth said on a recent episode of the PBD podcast. “There’s going to be bank failures and there’s going to be commercial real estate that goes into receivership.”
Is he right that the U.S. banking system and CRE sector is teetering on the brink?
Banks are ‘stressed’
As the high interest rate environment prevails, there is concern that some small lenders and regional banks will dip below their minimum capital requirements set by the Federal Reserve.
Small lenders and banks — those with less than $10 billion in assets — are “stressed,” but not necessarily “close to insolvent, Brian Graham, co-founder and partner at consulting firm Klaros Group, told CNBC.
While Klaros Group recently reported that 282 of 4,000 U.S. banks are facing challenges around the double-threat of maturing CRE loans and losses resulting from higher interest rates, Graham doesn’t foresee a repeat of 2023, which saw the catastrophic failures of Silicon Valley Bank, Signature Bank and First Republic Bank.
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Instead, he thinks there will be “fewer bank failures” because banks have prepared for these situations — and learned from what happened last year — but he also admitted Americans could still “get hurt by that stress.”
Reacting to that relatively upbeat analysis on the PBD podcast, Ellsworth said: “What do you mean ‘fewer bank failures’? That’s like saying: ‘Hey, when the hurricane just passes by, there will be less rain,’ but it’s still raining!”
The coming storm
So, what makes maturing CRE loans and the Federal Reserve’s “higher-for-longer” interest rate regime such a perfect storm for private lenders and regional banks in the U.S.?
Higher-for-longer interest rates have exposed some vulnerabilities at banks worldwide, according to the International Monetary Fund.
A blog posted by the IMF explains: “Loan losses may … increase as both consumers and businesses now face higher borrowing costs — especially if they lose jobs or business revenues. Besides loans, banks also invest in bonds and other debt securities, which lose value when interest rates rise. Banks may be forced to sell these at a loss if faced with sudden deposit withdrawals or other funding pressures.”
Theoretically, if these smaller lenders and regional banks suffer liquidity issues as a result of higher interest rates, the amount of available debt for new CRE borrowers would evaporate, potentially leading to massive defaults.
The scale of that issue could be significant, considering the MBA’s projection that $929 billion of CRE mortgages are maturing (and out for shopping) this year. But according to Moody’s Analytics, the CRE sector’s reliance on regional bank lending “has been largely overstated or misstated” and the diversification needed to keep the sector stable is there.
It’s also important to consider that banks must pass the Federal Reserve’s stress test, which assesses whether they are sufficiently capitalized to absorb losses during stressful conditions, such as this conjunction of high interest rates and CRE debt maturity.
The potential for bank failure is mitigated somewhat by this government oversight, but these banks still need to be prepared to withstand the pressure.
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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.