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Fed Chair Powell addressed upcoming regulatory changes regarding Bank capital requirements in his periodic congressional testimony this week. The upgraded changes were announced last year in the wake of the March 2023 sudden collapses of Silicon Valley Bank and First Regional Bank. Large regional banks would be required to retain more capital to protect against risk. Rising interest rates have devalued bank assets including commercial loan portfolios (along with office exposure) and substantial Treasury bond holdings. Powell, “I do expect there will be broad and material changes to the proposal.” Banks pushed back, telling policymakers the rules would “hurt Main Street” as banks would be forced to cut back on consumer credit and services. Some are saying that these rules intended to prevent another financial crisis could actually cause a crisis. That scenario assumes that less access to credit would accelerate drops in commercial real estate values and increase loan defaults in a spiral. Policymakers are wary of “fighting this battle” with the playbook that emerged from the “last battle” (the 2008 GFC). The revised regulations will be closely watched. Election year pressures on avowedly apolitical institutions like the Federal Reserve and FDIC may be distorting the process. Also, an upcoming Supreme Court decision may allow banks to litigate against Federal regulators in lower courts which could blunt the enforcement power of the FDIC and OCC.
Last year regulators released guidance urging banks to “work with good borrowers” on maturing loans aka “kick the can” or “pretend and extend.” Many loans that came due in 2023 received 1-year extensions (let’s do the math on when they come due shall we?). The Mortgage Bankers Association recently announced that 2024 CRE maturities have now ballooned from $659 billion (last year’s estimate) to $929 billion. That’s 20% of all outstanding US commercial real estate debt. Commercial banks are holding $441 billion of that total (note that the MBA did not break down US vs foreign bank loans).
Recent troubles at NY Credit Bank put the regional bank crisis issues back into the spotlight. NYCB took over Signature Bank’s loan portfolio after Signature’s March 2023 collapse. This came only 3 months after their December 2022 acquisition of Flagstar Bank. The sudden growth, rising rates, exposure to NY rent stabilized properties caused the stock price to plummet and liquidity concerns. This week’s 1 billion dollar cash infusion from private equity firms headed by ex-Treasury secretary Steve Mnuchin calmed investors (for now). Mnuchin’s group also is pushing for less “blend and extend” and a tougher stance on maturing loans.
Bottom Line: Bank troubles and CRE valuations are inexorably linked to the future path of interest rates which is dependent on inflation. Today’s jobs report indicated a still “warm but cooling” jobs market, lower than expected wage inflation and significant downward revisions of the hot December and January numbers. This week also saw weaker than expected Factory orders and a general “risk off” trade. The 10-year Treasury has dropped from 4.30 to 4.08 in the last 10 days. Next week’s CPI and PPI reports could be big market movers. Stay tuned…
By David R. Pascale, Jr., Senior Vice President at George Smith Partners.
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