NEW YORK – Big U.S. banks weathered a hypothetical 40% drop in commercial real estate (CRE) values as part of the Federal Reserve's annual health test, easing concerns about the banking sector as landlords struggle with prolonged periods of high interest rates.
Amid rising risks in the commercial real estate industry, investors have been focusing on the Fed's “stress tests” to assess how much risk U.S. lenders are exposed to as pandemic-era working practices leave office buildings empty and vacancy rates surge above record highs to 20%.
“In many ways, banks should feel reassured that they can weather a very nasty storm,” said Chris Marinak, director of research at Janney Montgomery Scott & Co. “But this doesn't mean the Fed thinks commercial real estate is out of the woods. It's still early days in this credit cycle.”
The Fed's emergency drills will test banks' balance sheets against a hypothetical severe economic downturn that would include a 36% drop in U.S. home prices, a 55% drop in stock prices and an unemployment rate of 10%.
All 31 of the largest U.S. banks passed the tests, showing they have enough capital to absorb losses of about US$685 billion (S$930 billion).
The results, released by the Federal Reserve on June 26, examine whether banks can continue lending to households and businesses in the event of a severe global recession.
It also shows how much capital a bank needs to be considered healthy and how much it can return to shareholders through dividends and share buybacks.
The Fed's disaster tests come more than a year after the failures of mid-sized financial institutions Silicon Valley Bank, Signature Bank and First Republic.
These failures led to criticism that the Fed failed to anticipate banks' vulnerability to rising interest rates. Instead, it assumed that interest rates would fall in a deep recession.
Commercial office space is in hot demand because $929 billion of the $4.7 trillion in outstanding commercial mortgages held by lenders and investors comes due in 2024, according to the Mortgage Bankers Association.
This looming maturity wall comes against a backdrop of falling property values and declining rental income.
Banks still face “significant concentration risks,” according to Moody's Ratings, and analysts expect this to pose a tough test for the commercial real estate industry.
Among banks surveyed, Goldman Sachs had the highest commercial real estate loan loss forecast at 15.9%, followed by RBC USA, Capital One and Northern Trust with losses of 15.8%, 14.6% and 13%, respectively.
One criticism analysts have of the Fed's stress tests is that they did not include regional banks, which hold the majority of CRE loans and are less heavily regulated than larger banks. Reuters