26 February 2010
'The next shoe to drop' in the credit crisis. That's how analysts have been describing losses in US commercial real estate for months, says John Mauldin on Investors Insight.com. And now the Congressional Oversight Panel (COP) warns that "a wave of commercial real-estate loan failures" could threaten the "already-weakened" US financial system.
Careless lending and a deteriorating economy are the chief culprits, says Wirtschaftswoche. American commercial property prices have fallen by around 43% from their 2007 peak, according to Moody's. The office vacancy rate nationwide is 16% and rents have plummeted – in New York they are down 45%. Moreover, loans have also been "rolled up and sold on" to investors in the form of commercial mortgage-backed securities (CMBS). All told, there is around $3.5trn of commercial real-estate debt outstanding, according to a government estimate. Banks and insurers are sitting on around half of it, with CMBS investors owning around a fifth.
The trouble is that, between 2010 and 2014, around $1.4trn of loans (half of which are in negative equity) will reach the end of their terms and need refinancing. But banks are busy deleveraging and demanding much tougher terms. Plus they are unable to sell loans on now that the CMBS market has "practically dried up", says Gary Halbert of Profutures. So it looks a tall order. Deutsche Bank reckons that around 65% of the loans due in the next few years will struggle to get refinanced.
The upshot, according to the COP, is that "losses at banks alone" could reach $200bn-$300bn. The most exposed banks are small- and medium-sized lenders. These were never subject to the 'stress tests' applied to their major counterparts, which in any case only covered capital reserves up to the end of 2010.
Bank lending is already declining. But now that losses on commercial property threaten to bankrupt smaller banks, making them even more reluctant to dole out credit, the crunch could worsen. Widespread bank failure would undermine the recovery and "extend an already painful recession", says the COP. And it's not just American banks that have dabbled in US commercial property, says Wirtschaftswoche. Markets could be in for "the property crisis, part II".
