For a few brief days last spring, it looked like all hell was about to break loose in the banking sector.
A trio of influential, mid-sized banks wobbled and then went under in the wake of the Federal Reserve’s rate-hike campaign to curb inflation.
In the case of the most prominent of the three, Silicon Valley Bank, executives had made long-term financial bets based on the idea that the extremely low interest rate world of the 2010s and early 2020s would last forever.
Word of troubles at the bank, which had become a major lender to booming life sciences and tech companies, triggered an old-fashioned bank run that threatened to spread like wildfire.
The Fed stepped in and quickly doused the budding conflagration by lifting the $250,000 cap on insured deposits at both Silicon Valley and Signature Bank, ensuring customers would get most if not all of their money back and putting an end to the bank run.
Nearly a year later, a potentially bigger banking crisis is looming, this time centered on the troubled world of commercial real estate loans made on what are now half-empty downtown office towers across the country.
Tinder Waiting for a Spark?
The pandemic brought dramatic changes to everyday working life, including the now popular hybrid schedule of two or three days in the office, with the rest at home.
That has pushed office vacancy rates to levels previously only seen in bad recessions, and then some, while putting the owners of office properties under tremendous financial pressure and the threat of foreclosure.
Also feeling the heat are the banks and other lenders that provided the financing for to assemble investment portfolios of office buildings, often acquired in pre-pandemic days when available space was fairly tight and office rents – and therefore buildings’ prices – were high and growing.
Market conditions have been bad for a while now. It’s the equivalent of tinder piled high and just waiting for a spark to set it on fire.
And over the last week, a potential spark has appeared in the form of a suddenly very wobbly looking New York Community Bancorp.
The $116 billion-asset regional bank has taken a big, double-digit hit to its stock price after it reported an unexpected quarterly loss while revealing it is stashing away millions to cover looming commercial real estate losses.
Regional banks like NYCB are particularly vulnerable to the mounting woes of the commercial real estate market.
Seventy percent of all commercial real estate loans are held by regional or smaller banks, while small banks have quadruple the exposure to these now riskier lending deals, Reuters reported last fall, citing research by Citigroup and JPMorgan, respectively.
Good News, Bad News
The good news is that top federal regulators appear to be all over the problem.
Treasury Secretary Janet Yellen and Federal Reserve Chair Jerome Powell last week both chimed in publicly to say they are watching dismal CRE loan situation closely and prepared to take whatever action is needed.
But the bad news is that they are also clearly signaling the public, the business world, and the banking sector to brace for some turbulence ahead.
Yellen told a congressional panel that while the situation is “manageable,” she also believes “there may be some institutions that are quite stressed by this problem,” according to Reuters.
Local bankers, speaking on background, have offered a similar take, arguing that most financial institutions are confident they can manage the current and potential future volume of bad loans.
I think the key pair of words here is “most institutions,” for “most” very definitely does not mean “all,” and some institutions almost certainly will not survive ever more concerning CRE loan crunch.
Rough Ride, But No ’08
And for that sentiment, we can go directly to the head of the Federal Reserve, who was blunter in his assessment than Yellen of the risks facing banks as tower and office building owners start defaulting in even greater numbers on their loans.
In an interview with “60 Minutes,” Powell also called the problem of mounting commercial real estate loan woes a “manageable one.”
But he also made clear that while the problem may be manageable, not all lending institutions will make it through the wringer.
Powell told the popular investigative news program that some banks will either have to be merged “out of existence” or just outright “closed.”
But he also made clear that he does not see a repeat of the 2008 financial crisis on the horizon, when massive defaults on bad residential real estate loans – which had been repackaged as securities and sold on Wall Street – brought the global banking system to the brink of collapse.
That’s both reassuring and not so reassuring at the same time. For there is a lot of room between a scary, but relatively modest banking panic like the one we saw last spring, and the kind of cataclysmic, global financial system meltdown we saw back in September 2008.
Buckle your seatbelts. Either way, it’s going to be a rough ride ahead.
Scott Van Voorhis is Banker & Tradesman’s columnist and publisher of the Contrarian Boston newsletter; opinions expressed are his own. He may be reached at sbvanvoorhis@hotmail.com.