US banks are facing a dilemma when it comes to commercial real estate. They want to reduce their exposure to this $5.6tn market. But they need interest from high-yield loans to finance the generous deposit rates required to attract savers.
Property values have been falling, depressing landlords’ equity and their willingness to service debt. Recent high-profile defaults in the US have involved the likes of Pimco’s Columbia Property Trust and a subsidiary of Brookfield Asset Management.
US banks, particularly smaller ones, have seen their funding costs go up sharply in the wake of the March banking crisis. To keep depositors from fleeing, many are paying higher deposit rates. Others have turned to pricey short-term borrowings from the Federal Home Loan Banks system.
Cumulative interest-bearing deposit betas, which measures the share of rate hikes passed on to depositors, increased by 8 percentage points to 34 per cent between the fourth and first quarter, according to Morgan Stanley. Expect the figure to increase further this year.
One way banks can offset higher funding costs is to make more loans and charge more for them. There is plenty of demand in the CRE market. Some $730bn of CRE loans are set to mature in 2023, according to Moody’s. Most were originated a decade ago. Banks now have the opportunity to refinance these borrowers at higher rates.
No bank wants to be seen as chasing revenue growth at the expense of credit quality. Office developers are the riskiest borrowers. But these make up just a quarter of the CRE loans due for refinancing this year. Apartment buildings and storage facilities — which have proved more resilient than offices — account for a bigger slice.
Overall, net charge-offs for CRE loans (excluding farmland) held by commercial banks remain low, at 0.07 per cent, compared to over 3 per cent in 2009, according to the FDIC.
For banks willing to separate the wheat from chaff, CRE may not be a such a bad place after all.
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