Morning Wire XX
[0] U .S. banks continue to face intense financial pressure.
[1] The failures of First Republic Bank and Silicon Valley Bank are being followed up by massive losses at Pact West and other regional banks.
[2] One of the factors causing the instability is exposure to commercial real estate holdings.
[3] In this extra episode of MorningWire, we speak to an expert in the banking and lending sector.
[4] Thanks for joining us.
[5] It's Sunday, May 7th, and this is Morning Wire.
[6] Joining us to discuss the instability in the banking system and the commercial real estate sector is Mark A. Calabria, the former director of the federal housing finance agency and a senior advisor at the Cato Institute.
[7] Mark, thanks so much for coming on.
[8] I'm really delighted to, my pleasure.
[9] Now, we're starting to hear rumblings of trouble in the commercial real estate sector.
[10] Can you explain what's happening there and why some people like Charlie Munger are concerned?
[11] So there certainly is a number of legitimate concerns about the commercial real estate market.
[12] It's important to kind of separate it into different segments of the market.
[13] Post -pandemic, there are still a lot of cities and jurisdictions where you have a considerable amount of people who aren't back to work yet.
[14] And in many cases, offices and businesses have tried to adjust and have more flexibility.
[15] That's one aspect.
[16] But, you know, we've also been building more apartment buildings than we've been building since the late 70s.
[17] these early 80s.
[18] So you have increasing vacancies in office space because of remote work.
[19] You've had overbuilding this cycle in multifamily.
[20] And the pandemic has really changed the perspective in retail.
[21] And so you've had a lot of different sectors in the commercial real estate market that have come under stress.
[22] And of course, regional banks like signature, which failed a few weeks ago are big players in the commercial real estate space.
[23] So again, really big change in the cycle.
[24] Some of this is pandemic related.
[25] Some of this is overbuilding and just happens to be late cycle.
[26] So I agree with Charlie.
[27] There's a lot of reason to be concerned about commercial real estate right now.
[28] So just spell it out for us a little bit here.
[29] Do we have any sense of the number in terms of what percent of commercial buildings are close to or potentially not able to make their mortgage payments right now?
[30] It really is.
[31] is too early to tell at this point because most businesses, like retail, often tends to be a flat rent and then a percent of sale.
[32] And in many cases, the option for a landlord is you may try to get rid of that restaurant, but you're getting weak foot traffic because people aren't coming downtown.
[33] To work again, you're not really any better off replacing with another restaurant.
[34] I mean, we will see increased delinquencies.
[35] We've already seen increased delinquencies.
[36] and, of course, if we end up in a recession in a weaker economy, then that will get it even worse.
[37] So I think at this point, it's simply too early to tell what the magnitude is going to be at this point.
[38] But I expect to see delinquencies start to get above double digits in the commercial real estate space.
[39] Now, I understand that commercial real estate investments are typically considered to be safe investments by banks.
[40] What portion of banks' portfolios tend to be in commercial real estate?
[41] and how much of a risk is it for them if commercial real estate takes a dip?
[42] Very serious risk, but it differs a lot by banks.
[43] So with signature that failed recently in New York, you know, they were specialists.
[44] So you tend to have mid -sized, sometimes the regional banks, that become real estate specialist because it's really a specialized industry, not just any lenders, kind of like lend on a big office building.
[45] And, of course, the bigger lenders you think about the Bank of America, so the Chase is Wells.
[46] They're certainly very involved in commercial real estate, but it varies a lot by lenders.
[47] So one important takeaway is you really can't make generalizations across the entire banking sector.
[48] There are some lenders who do very little commercial real estate, and then there are others and the other end of spectrum who, what they predominantly do is commercial real estate.
[49] There are a handful of banks that are specialists in this area, and they're going to really take losses and they're going to come under a lot of stress.
[50] But it's not going to be a systemic issue that represents the entire real estate industry.
[51] I don't think anyone should take away from this that the entire industry is going to be threatened by this.
[52] Now, when we think of commercial real estate that was hit hard by COVID and the shift toward working from home, I think people primarily think of office buildings, but commercial real estate obviously includes other things.
[53] It's malls, shopping centers.
[54] You mentioned restaurants, warehouses.
[55] How are other types of commercial real estate doing?
[56] Great question.
[57] Really across the board.
[58] So for instance, warehouses have done really well.
[59] We've all meant the last couple of years ordering things to be delivered to our houses.
[60] And so that's done actually pretty well for warehouse space.
[61] So warehouses is perhaps the exception going on.
[62] On the other extreme, in restaurants, it's still very much the case that the restaurant industry has not picked back up in the same way, at least for downtown and particularly a lot of restaurants also benefit from business travelers.
[63] And while a lot of business traveling is It's not back in the same way.
[64] Downtown office is the weakest in this sector.
[65] The flip side of the warehouse story where instead of buying from Amazon to you go down to the mall, particularly malls and big retailers, there's still a lot of weakness there.
[66] Of course, it's not as bad as it was in the pandemic, and you've got a lot of people going back into the bigger department stores again, the Home Depot's and such again.
[67] So there's more foot traffic than there was, but there's still a lot of softness there.
[68] But the bigger story is really location.
[69] And I should also emphasize, it's not just location in terms of urban suburban, it's location in terms of where in the country.
[70] You think about like, you know, the Boisys and Missoula's of the world where there was a lot of California emigration.
[71] That really helped the retail space in those areas.
[72] And that's turned around.
[73] A lot of people are, in fact, moving out of Idaho back to California.
[74] And, of course, some will stay.
[75] So it really is important to kind of look at this from a market by market.
[76] this really is kind of a two -coast story.
[77] What's going on in the southeast, very different than the rest of the country.
[78] How have the collapse and bailout of banks like Silicon Valley Bank and First Republic affected the overall stability of the U .S. banking system?
[79] So it's really important to keep in mind that what was going on on SVB was uniquely bad.
[80] But there are elements of it that is seen.
[81] So to be frank, I expect there probably to be another five or six regionals that get in trouble.
[82] But this is not something that is overall representative of the banking system, but there'll be more failures because, again, there are enough of this that's common.
[83] You're also seeing because of the troubles at SBB signature First Republic, the regulators are coming down real hard on commercial real estate lending.
[84] So any developer who's going to try to do a new project, even in someplace like Florida, where it may be sustainable, it's going to be a much tougher lending environment.
[85] So that's going to feed into the construction slowdown in that sector.
[86] Certainly going to make it tougher to refinance some of these properties that are coming up.
[87] The one uniformity is their regulatory environment absolutely getting tougher for commercial real estate lending.
[88] Now, is there a danger to having most of America's money tied up in just six large banks?
[89] Yes, short answer, yes.
[90] I would prefer that we saw a much more diversified system.
[91] I certainly don't want to suggest that the megabanks are seeing the same kind of problems.
[92] But again, diversification, you know, first principle of good finance, don't put all your eggs in one basket.
[93] You know, it might sound kind of hokey, but it's true.
[94] And one of the problems, of course, you know, we see this with the JP Morgan acquisition of First Republic is that you've got a limited number of these large institutions that are capable of assisting in a rescue.
[95] Because you've really only got five or six possible acquirers, you really get into problems and, you know, what kind of marriages or mergers can you do to, you know, run these problems?
[96] So, again, if there's another shoe that falls, could J .P. Morgan step in for that.
[97] So I am worried.
[98] I think we need to make sure that we've got a wide variety, even some non -banks, that could potentially come in and acquire any institutions that are in trouble.
[99] It's important to keep in mind, 4 ,000 plus banks we have in the U .S., 99 % of them are under 10 billion in assets, and many of them are under 100 million.
[100] So we do have still a very rich, small banking sector, but you have that kind of a hole in the middle.
[101] I think we're unfortunately going to see more consolidation there in the upper middle, if you will.
[102] All right.
[103] Well, Mark, thanks so much for coming on today.
[104] Really was my pleasure any time.
[105] That was Mark A. Calabria, senior advisor at the Cato Institute, and this has been a Sunday extra edition of Morning Wire.