Michelle Conlin
NEW YORK (Reuters) – Big U.S. banks weathered a hypothetical 40 percent drop in commercial property prices as part of the Federal Reserve's annual real estate 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, head 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%.
The Fed's findings, released Wednesday, examine whether banks could continue lending to households and businesses in the event of a deep global recession. They also show how much capital banks would need to be considered healthy and how much they could return to shareholders through dividends and share buybacks.
The 31 largest banks surveyed were found to have enough capital to absorb losses of about $685 billion.
The Fed's failure tests came more than a year after the collapse of mid-sized financial institutions Silicon Valley Bank, Signature Bank and First Republic, which prompted criticism that the Fed failed to anticipate banks' vulnerability to rising interest rates, instead assuming that interest rates would fall in a deep recession.
Commercial office space is in the spotlight 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. The looming deadline comes against the backdrop of declining property values and shrinking rents.
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 projected commercial real estate loan losses at 15.9%, followed by RBC USA, Capital One and Northern Trust at 15.8%, 14.6% and 13%, respectively.
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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 lenders.
(Reporting by Michelle Conlin and Deepa Babington Editing by