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Banking-System Challenges Reenergized by Commercial Real Estate Woes

Isaac Nuriani    |
Feb 9, 2024
  • Smaller regional banks hold 80% of commercial real estate loans.
  • U.S. commercial real estate troubles spreading to foreign banks.
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In March 2023, the world became reacquainted with a measure of the anxiety felt during the financial crisis, when the global banking system destabilized.[1]

Last spring, in a span of less than eight weeks, four regional U.S. banks closed when fast-rising interest rates sharply reduced the value of the U.S. Treasury securities into which they’d heavily invested. The financial institutions – Silvergate Bank, Silicon Valley Bank, Signature Bank and First Republic – were having difficulty meeting depositor withdrawal requests and were forced to liquidate the bonds at a loss.

A downward spiral quickly ensued, leading to the shuttering of each bank. Three of the four banks – Silicon Valley, Signature and First Republic – collapsed outright, becoming three of the four largest bank failures in U.S. history.[2]

Across the pond and at the same time, Swiss banking giant Credit Suisse also collapsed, although there is some debate as to how much its demise is attributable to the regional banking shocks that were upsetting the U.S. financial system during this period.[3]

Since then, the wave of notable bank collapses has subsided. Nevertheless, an uneasy feeling has persisted that underlying challenges and risks to the financial system continue to lurk.

As I mentioned, it is interest-rate risk that was responsible for much of the turbulence last year. And while rate risk remains a concern of banks and banking regulators, it now is being overshadowed by another peril: the ongoing downturn in the $20 trillion commercial real estate.

Last week, we were treated to just a foreshock of what many analysts fear could prove to be a significant seismic banking-system event triggered by commercial real estate weakness. Regional bank New York Community Bancorp – which, coincidentally, absorbed part of Signature Bank after its failure – reported suffering a wholly unexpected quarter-billion-dollar loss last quarter due largely to its struggling commercial real estate loans.[4]

Beyond sending shares of its own stock tumbling, news of the loss seemed to generate a ripple effect that resonated around the world.[5]

This week, we’re going to talk more about what happened – about what’s still happening – with New York Community Bancorp, including the associated impacts. And as part of the discussion, we’re going to take a broader look at the distress that marks the commercial real estate industry right now, with an eye to understanding how potentially vulnerable regional U.S. banks – and the banking system, overall – might be to that weakness.

New York Community Bancorp: Is It a “Canary in the Coalmine”?

As regional banks go, New York Community Bancorp (NYCB) is no slouch.

It’s the parent company of Flagstar Bank, one of the country’s biggest regional lenders. Flagstar has 420 branches in several regions throughout the country, with its biggest footprint is in the Northeast and Midwest. Additionally, NYCB is the nation’s second-largest lender against multifamily properties.[6]

The excitement began last week, when NYCB reported a stunning fourth-quarter loss of $252 million, which stands in sharp contrast to the $172 million profit posted in Q4 2022 as well as the $199 million in net income realized in just the prior quarter.[7]

The “tale of the tape” grows even longer. To cover loan losses, NYCB increased its provisions (the funds set aside by banks to cover anticipated losses) by a jaw-dropping 790% quarter over quarter in Q4, increasing that amount from $62 million in Q3 to $552 million. As for net charge-offs, which are debts written off as losses by creditors, NYCB listed $185 million of those in the fourth quarter, way up from the $24 million noted in Q3.[8] The principal culprits there are two co-op loans as well as an office loan.[9]

Which brings us to the fundamental reason for all the challenges: Distress in and among the lender’s vast commercial real estate loan portfolio.

As for consequences, there are more. NYCB cut its dividend from 17 cents to 5 cents to enhance its capitalization. Additionally, Moody’s cut the bank’s credit rating to junk earlier this week.[10]

And the stock price? It reacted the way you’d expect it to. Through this past Wednesday, it was down more than 50% from last week, resulting in a loss in market capitalization of roughly $4.5 billion.[11]

The public reaction – and even the investor reaction – to NYCB’s current misery is about much more than the bank itself. It’s about the possibility that it signals the official start to a widely anticipated and greatly feared wave of shocks to the financial system.

As Business Insider noted earlier this week, “Investors appear worried that NYCB could be a canary in the coal mine for regional banks and commercial real estate, and are bracing for the next domino to fall.”[12]

Next, we’ll talk more about that broader risk…and later on we’ll chat about a few overseas dominoes that are beginning to look a little wobbly.

Office Vacancy Rates of 25% Now Typical in Many U.S. Cities

For some time, the outlook for commercial real estate – and the banks that loan against it – has been worsening. One reason is the “macro” change in how we live and work since the advent of the internet along with persistent evolutions in personal technologies. The resulting rise in remote work as well as in the ability to shop for goods from personal devices has made bricks-and-mortar workplace and retail locations obsolete in many cases.

The result has been plummeting occupancy rates in commercial space, a problem which seemed to grow exponentially as the global health crisis unfolded and businesses were forced to make remote work a manageable reality.[13] At the end of 2023, the national vacancy rate for U.S. office space was slightly more than 18%, with some cities – including Denver, Detroit, Houston and Seattle – at or near a 25% vacancy rate.[14]

Vacancies certainly are a big component of the commercial real estate mess, but not the only one. There’s also the matter of all the cheap money gobbled up between the time of the global financial crisis and the pandemic, which is now in the process of maturing over the next several years. Loans that can’t be paid off must be refinanced, which means, in the current rate climate, they’ll be getting refinanced at a cost significantly higher than what was paid when the loans were issued initially.

As former International Monetary Fund economist Desmond Lachman recently put it, “Not only will these developers have declining revenues as a result high vacancy rates, they will now need to pay interest rates at least 5 percentage points higher than the rates they were paying on their original loans.”[15]

Smaller Banks Hold Roughly 80% of Commercial Real Estate Loans

This could be particularly bad news for America’s regional banks. Overall, U.S. banks are holding $2.7 trillion in commercial real estate loans, with about 80% of that sum held by the smaller regional institutions. Of that, roughly $2.2 trillion comes due between now and the end of 2027, according to the commercial real estate analytics firm Trepp.[16]

The threat to regional lenders stems from more than the outsized percentage of commercial real estate loans they hold. A recent Bloomberg report notes that it’s also due to the fact that more modest-sized lenders don’t have nearly as significant exposure as bigger banks to the credit card or investment banking lines of business that can help minimize the impact of a downturn in commercial real estate.[17]

“This is a huge issue that the market has to reckon with,” said Harold Bordwin of Keen-Summit Capital Partners LLC in New York, a real estate firm specializing in restructurings. “Banks’ balance sheets aren’t accounting for the fact that there’s lots of real estate on there that’s not going to pay off at maturity.”[18]

Also casting an eye to the near-term future, David Aviram, principal at Maverick Real Estate Partners, a private equity fund manager that “traffics” in commercial loans based in New York City, said recently, “The percentage of loans that banks have so far been reported as delinquent are a drop in the bucket compared to the defaults that will occur throughout 2024 and 2025. Banks remain exposed to these significant risks, and the potential decline in interest rates in the next year won’t solve bank problems.”[19]

And while the data, at first glance, suggests the risks to commercial real estate loans are borne primarily by regional banks in the U.S., they are by no means exclusive to smaller domestic lenders. In fact, at the same time regional banks are facing this looming crisis, there are signs that problems with commercial real estate are effectively being exported overseas to large foreign banks, further underscoring the banking-system contagion threat posed by a possible crisis.

Foreign Banks Suddenly Feel Pressure from U.S. Commercial Real Estate Problems

As news about New York Community Bancorp was unfolding last week, two foreign lenders reported significant challenges stemming from their exposure to the U.S. commercial real estate sector.

Japan’s Aozora Bank said bad loans on U.S. offices were largely responsible for its projected loss of nearly $200 million last year, the first loss suffered by the bank in 15 years.[20]

Aozora reduced the value of its nonperforming loans against U.S. offices by nearly 60%. The bank additionally cut its revenue forecast by 35% and its annual profit forecast by 52%.[21]

Also last week, Germany’s Deutsche Bank revealed that it raised its loan-loss provisions in Q4 2023 to $133 million, a more-than-400% increase year over year and nearly twice the amount set aside in Q3.[22]

And earlier this week, another German lender, Deutsche Pfandbriefbank AG (Deutsche PBB), saw its shares and bonds tank over concerns about its exposure to America’s commercial real estate market.[23]

Deutsche PBB said it was upping its loan-loss provisions because of what it called “persistent weakness of the real estate markets.” The bank also suggested the current state of the U.S commercial real estate market represents “the greatest real estate crisis since the financial crisis.”[24] Deutsche PBB said it’s exposed to the U.S. commercial real estate market to the tune of 15% of its overall portfolio.[25]

Somewhat echoing the grave assessment of Deutsche PBB, Bloomberg suggested in a report earlier this week that “if the CRE losses spread to Europe through smaller German banks, that would have an echo of the 2008 global financial crisis.”[26]

And even a mere “echo” of that fateful economic event likely is something that investors would prefer reverberates through their portfolios with as little impact as possible. One option some might choose to help mitigate the potential effects of portfolio volatility generated by banking-system instability is to own assets highly regarded for their potential to hedge against a wide variety of uncertainty.

“Performance During Times of Crisis” Is a Key Driver of Gold Demand Among Central Banks  

Precious metals are examples of such assets. A recent study by Sprott Asset Management determined that through seven crisis periods over the last decade and a half – including the financial crisis itself – gold, on average, outperformed popular, “mainstream” assets by a significant margin.[27]

It’s worth noting, too, that the world’s central banks are especially fond of gold for its potential to hedge. Central banks have been net purchasers of gold for the past 14 years, setting a new all-time calendar-year record for gold demand in 2022 and nearly matching it in 2023.[28] According to the council’s 2023 Central Bank Gold Reserves Survey, among the most prominent reasons why central banks are buying so much gold is its “performance during times of crisis” and its efficacy as an “effective portfolio diversifier.”[29]

Individual investors will have to decide for themselves if central banks and/or asset managers such as Sprott are on to something with their high regard for precious metals as hedge “tools.” If they agree, they might seek to acquire metals assets using tax-advantaged account options such as a gold IRA, which is similar to the “regular” IRAs and 401(k)s that remain popular with retirement savers throughout the country.

Without regard to just how an average person decides to move forward in addressing potential fallout from growing uncertainty in the commercial real estate sector, he or she might want to seriously consider doing something. Even though Federal Reserve Chair Jerome Powell suggested last Sunday that the problem “doesn’t appear to have the makings” of another global financial crisis, he did say, “It feels like a problem we’ll be working on for years,” adding:

“It’s a sizable problem.”[30]

For many smart investors, that’ll be all they need to hear before pulling the trigger on alternative assets like gold and silver, including within gold IRAs.





[1] Kimberly Amadeo, The Balance, “Causes of the 2008 Financial Crisis” (December 13, 2022, accessed 2/8/24).
[2] Matthew Goldberg, Bankrate, “The 7 largest bank failures in US history” (May 1, 2023, accessed 2/8/24).
[3] Elliot Smith, CNBC.com, “The Swiss claim the U.S. banking crisis ultimately toppled Credit Suisse. But are they right?” (March 24, 2023, accessed 2/8/24).
[4] Nicole Goodkind, CNN Business, “Wall Street is worried about another regional banking crisis” (February 6, 2024, accessed 2/8/24).
[5] Patrick Clark, Natalie Wong and Diana Li, Bloomberg.com, “A $560 Billion Property Warning Hits Banks From NY to Tokyo” (February 1, 2024, accessed 2/8/24).
[6] Flagstar.com, “About Flagstar” (accessed 2/8/24).
[7] Theron Mohamed, Business Insider, “NYCB’s slide sparks fears of more banking and commercial real estate turmoil” (February 7, 2024, accessed 2/8/24).
[8] Ibid.
[9] Steve Dickson and Bre Bradham, Bloomberg.com, “NY Community Bancorp Plunges as Real Estate Risks Jolt Market” (January 31, 2024, accessed 2/8/24).
[10] Mohamed, “NYCB’s slide sparks fears.”
[11] Nicole Goodkind and Elisabeth Buchwald, CNN Business, “New York Community Bank stock turns positive after lender says deposits increased” (February 7, 2024, accessed 2/8/24).
[12] Mohamed, “NYCB’s slide sparks fears.”
[13] Desmond Lachman, The Hill, “The regional bank crisis is not over” (November 20, 2023, accessed 2/8/24).
[14] Evelyn Jozsa, Commercial Edge, “U.S. Office Market Closes 2023 With $34 Billion in Sales, 60% Below the Volume Recorded in 2022” (January 23, 2024, accessed 2/8/24).
[15] Lachman, “The regional bank crisis is not over.”
[16] Emily Yue, “CRE Mortgage Maturities & Debt Outstanding: $2.81 Trillion Coming Due by 2028” (December 21, 2023, accessed 2/8/24).
[17] Clark, Wong and Li, “A $560 Billion Property Warning Hits Banks.”
[18] Ibid.
[19] Ibid.
[20] Giulia Morpurgo, Tasos Vossos, and Neil Callanan, Bloomberg.com, “US Commercial Real Estate Contagion Is Now Moving to Europe” (February 7, 2024, accessed 2/8/24).
[21] Steve Goldstein, Morningstar, “Not just NYCB: Japanese bank issues warning on U.S. offices, as Deutsche Bank increases provisions” (February 1, 2024, accessed 2/8/24).
[22] Harry Wilson, Bloomberg.com, “Deutsche Bank Warns of Potential US Property Losses” (February 1, 2024, accessed 2/8/24).
[23] Tom Sims, Reuters.com, “German bank PBB says it can cope with US real estate troubles as shares slide” (February 8, 2024, accessed 2/8/24).
[24] Morpurgo, Vossos and Callanan, “US Commercial Real Estate Contagion Is Now Moving to Europe.”
[25] Sims, “German bank PBB says it can cope.”
[26] Morpurgo, Vossos and Callanan, “US Commercial Real Estate Contagion Is Now Moving to Europe.”
[27] Sprott.com, “The Case for Gold in Crises” (accessed 2/8/24).
[28] World Gold Council, “Gold Demand Trends Full Year 2023” (January 31, 2024, accessed 2/8/24).
[29] World Gold Council, “2023 Central Bank Gold Reserves Survey” (May 30, 2023, accessed 2/8/24).
[30] Goodkind, “Wall Street Is Worried.”

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