McCaig
We've written a lot about CRE lending and its impact on U.S. banks. Another side to this story is that a significant number of CRE loans are packaged into debt securities called CMBS (Commercial Mortgage Backed Securities). There has been some interesting news that has led to some notable movement in the CMBS market.
First, according to KBRA's CMBS Trend Watch, CMBS issuance has reached $43.7 billion so far this year, which is already 11% higher than the $39.3 billion expected for all of 2023. This large increase in new CMBS is likely due to a significant deterioration in asset quality in the CRE lending segment, forcing banks to more aggressively sell CRE loans off their balance sheets. Clearly, the large supply of new CMBS is putting pressure on prices.
Second, according to Trepp, which tracks CMBS delinquencies, the overall U.S. CMBS delinquency rate rose 38 bps month-over-month to 5.35% in June, while the office CMBS delinquency rate rose more than 60 bps month-over-month to 7.55%. More importantly, variable-rate office CMBS has a higher delinquency rate of 24%. About 40% of all office loans packed into CMBS are variable-rate, according to Trepp.
According to a KBRA analysis, an estimated 31% of all CMBS office loans are in trouble, and it is very likely that these delinquency rates will rise in the future.CMBS holders are working hard to extend the maturities of these loans because they know how large their losses are if borrowers default.
For example, in May, holders of a $308 million CMBS bond secured by a mortgage on a Manhattan office building lost money when the building was sold for $185.9 million. Of note, the CMBS bond was the highest rated (AAA), so this was the first time investors lost money on a AAA rated bond since the Great Recession. The technical default on the bond officially occurred in 2022 when Blackstone stopped making interest payments on the mortgage. It is also interesting to note that Blackstone originally paid over $600 million for this Manhattan building in 2014, so its price has fallen by almost 70% since then.
Therefore, despite efforts by CMBS holders to extend the maturities of the loans packed into these derivatives, it will only be a matter of time before these problematic loans start to default, and the respective buildings will be sold at deep discounts.
If we look at U.S. banks' direct exposure to CMBS, it's pretty low. As of the end of May, banks held $95.4 billion in non-government guaranteed MBS, some of which is likely residential MBS. When compared to the more than $3 trillion in CRE loans on U.S. bank balance sheets, the exposure looks especially low.
So CMBS is a much bigger problem for insurance companies, pension funds, private equity, and other similar companies that are buying these derivatives. Importantly, it's also a problem for companies that have very conservative investment strategies because AAA rated CMBS are defaulting. A lot of these companies get their credit lines primarily from the big banks. So when they start taking losses on their CMBS holdings, some of these companies may not be able to repay their bank credit, which will have a negative impact on the banks. So all these CMBS related issues indirectly have a negative impact on the big banks.
Conclusion
The negative data streaming out of the CMBS market is a reminder that whereas the 2007-2009 financial crisis had one primary issue that caused banks to fail at the time, we are now moving toward an environment where many banks have multiple overlapping problems on their balance sheets.
So I would like to take this opportunity to remind you that we have reviewed many of the big banks in our public articles. But let me warn you: the essence of that analysis is that it doesn't bode well for the future of the big U.S. banks. You can read about that in previous articles we wrote. And as these issues worsen, the risks continue to grow.
Additionally, if we believe the bank's problems have been resolved, I think New York Community Bancorp (NYCB) is a reminder that we are likely only seeing the tip of the iceberg. And the exact reasons why SVB failed were identified in public articles long before these issues were even considered. And I can guarantee you these issues have not been resolved. It is only a matter of time before the rest of the market starts to take notice. By that time, it may be too late for many bank depositors.
After all, we are talking about protecting your hard-earned money, so you need to do your due diligence on the bank where you are currently depositing your money.
You have a responsibility to yourself and your family to only put your money in the safest institutions. And if you rely on the FDIC, we encourage you to read our previous article, which outlines why such reliance may not be as wise as you think in the coming years. One of the main reasons is the banking industry's desire to move toward a bail-in. (And if you don't know what a bail-in is, we encourage you to read our previous article.)
It's time to thoroughly research the bank you're entrusting your hard-earned money to determine if it can truly be trusted. Use the due diligence techniques outlined here to help.