Dive Overview:
Treasury Secretary Janet Yellen said Tuesday that commercial real estate losses could put financial institutions under “significant stress” as loans come due, vacancy rates in some cities remain high and interest rates remain at 23-year highs. Federal regulators are working to ensure that banks struggling to lend to commercial property owners have sufficient liquidity, can cut dividends and build loan loss reserves if necessary, Yellen said in testimony before the House Financial Services Committee. “The rising interest rate environment and, in some cases, particularly for office buildings, changes in work patterns due to the pandemic and vacancy rates in some cities that are quite high, as many commercial real estate loans come due and require borrowing or refinancing, will put significant stress on owners of these properties,” Yellen said. “And so our regulators are very focused on helping banks get through this.”
Dive Insights:
A top U.S. regulator warned in December that the commercial real estate market was the biggest risk to financial stability this year, citing rising vacancy rates, falling office property values, high interest rates and the possibility of a slowing economy.
“CRE is the largest loan category for nearly half of U.S. banks, and more than a quarter of U.S. banks have large CRE loan portfolios relative to their capital holdings,” the Financial Stability Oversight Council said in its annual report.
“The office sector faces the most severe challenges as demand for office space remains weak, particularly in the largest US markets,” the council said.
Cleveland Federal Reserve Bank President Loretta Mester said Tuesday that the banking system is stabilizing after the failure of three banks in March, but parts of the system could face further disruption because of vulnerabilities to commercial real estate.
“Since March, many banks have diversified their liquidity sources, making them less vulnerable,” Mester said in her speech, “but we could see renewed stress for banks that continue to rely on unsecured deposits for funding and have significant exposure to CRE assets that will need to be revalued at higher interest rates.”
Yellen stressed regulators' focus on risk but said banking regulators could probably limit disruptions to banks linked to commercial real estate.
“I am concerned,” she said in response to questions from lawmakers. “Some agencies may be under significant stress, but I believe it is manageable.”
As the work-from-home trend reduces demand for office space, many commercial property owners who borrowed at near-zero interest rates nearly a decade ago are now being forced to refinance at much higher rates.
Yellen said the strain on the balance sheets of some financial institutions was significant.
“Many banks, especially smaller and regional banks, are concentrating their lending on commercial real estate,” she said. “Office properties in some cities are of particular concern as vacancy rates rise and property values fall.”
New York Community Bancorp on Jan. 31 reported a fourth-quarter loss and cut its dividend, rekindling concerns about turmoil at regional banks.
NYCB announced that it was recapitalizing itself by purchasing the assets and liabilities of Signature Bank, one of three banks that failed in March. The purchase brings NYCB's total assets to more than $100 billion and makes it subject to stricter capital and liquidity regulations.
“The bank purchased Signature's assets, which moved the bank into a higher category that is subject to greater oversight and higher capital requirements,” Chicago Federal Reserve Bank President Austan Goolsby said Monday.
“Right now, we're not seeing a commercial real estate explosion or anything like that happening,” Goolsby said in an interview on Bloomberg Television. “But of course we're watching,” he said, adding that “the job of the central bank is to watch and be prepared for anything that could go wrong.”
Federal Reserve officials are among the regulators who serve on FSOC.