You gave the example of Lincoln Financial but indicated that this is not where the real risk is. But it would be helpful to know more about the risk of CRE exposure among insurance companies for the simple reason that this helps one move towards an actual shorting strategy. For example, an investor could simply buy long PUTS on Lincoln Financial and presumably other insurance companies as well.
But for your broader conclusion about the risk of CRE as a whole, and in particular as pertaining to regional banks, getting to an actual shorting strategy is considerably more difficult.
I wonder if hundreds of small banks will go down as you predict here.
It seems like the last sentence of this paragraph is doing a lot of heavy lifting here:
The total CRE market is $11 trillion, of which $4.5 trillion is the total outstanding debt. However, as we all know, the stress is visible only in the office space while the rest of the CRE market is resilient. Nevertheless, the situation might change if a hard landing ensues.
If office space blows up but overall CRE space is OK, is this still a systematic problem that will lead to 100s of bank failures?
I can't attach the image here, but as per GS regional banks account for 23% of the total office space debt. Now it depends on the region, for example in NY the hit will be maximum (overall default rates for CRE are already greater than 6%), so regional banks specific to particular area with highest concentrated lending towards office spaces will be fare the poorest. I got numbers for you for some banks (office space as % of total loan book): OZK (7%), SNV (5%), VLY (5%), NYCB (4%), CFR(4%) , EWBC(4%).
In US banking do the CRE loans carry higher risk weightage than other loan / bond category like BBB and higher bonds, residential mortgage loans, corporate loans, etc. If CRE loans r assigned higher risk weightage then the prescribed capital adequacy ratio must be ensuring that the banks are having sufficient tier-1 capital to cover for default loss from those loans
That's a good question. If I am not wrong, the CRE loans are in fact assigned higher risk weightage. The issue is that CET-1 ratio highly varies for large and small banks. As per Nov 2022 Fed report, the CET 1 ratio declined to pre pandemic levels due to the AFS losses on the bond holdings. Secondly, the Fed is aware of the CRE problems and high concentration in the smaller banks. you can read from page number starting 28, this is the Fed's own report from November 2022. https://www.federalreserve.gov/publications/files/202211-supervision-and-regulation-report.pdf
You gave the example of Lincoln Financial but indicated that this is not where the real risk is. But it would be helpful to know more about the risk of CRE exposure among insurance companies for the simple reason that this helps one move towards an actual shorting strategy. For example, an investor could simply buy long PUTS on Lincoln Financial and presumably other insurance companies as well.
But for your broader conclusion about the risk of CRE as a whole, and in particular as pertaining to regional banks, getting to an actual shorting strategy is considerably more difficult.
I wonder if hundreds of small banks will go down as you predict here.
100s of banks doesn't mean a systematic risk. There were 4236 FDIC insured commercial banks as of 2021.(check this link: https://www.statista.com/statistics/184536/number-of-fdic-insured-us-commercial-bank-institutions/).
Secondly, I don't recommend any shorts here. I just make a case that markets are looking in different direction, whereas actual risk lies elsewhere.
It seems like the last sentence of this paragraph is doing a lot of heavy lifting here:
The total CRE market is $11 trillion, of which $4.5 trillion is the total outstanding debt. However, as we all know, the stress is visible only in the office space while the rest of the CRE market is resilient. Nevertheless, the situation might change if a hard landing ensues.
If office space blows up but overall CRE space is OK, is this still a systematic problem that will lead to 100s of bank failures?
I can't attach the image here, but as per GS regional banks account for 23% of the total office space debt. Now it depends on the region, for example in NY the hit will be maximum (overall default rates for CRE are already greater than 6%), so regional banks specific to particular area with highest concentrated lending towards office spaces will be fare the poorest. I got numbers for you for some banks (office space as % of total loan book): OZK (7%), SNV (5%), VLY (5%), NYCB (4%), CFR(4%) , EWBC(4%).
In US banking do the CRE loans carry higher risk weightage than other loan / bond category like BBB and higher bonds, residential mortgage loans, corporate loans, etc. If CRE loans r assigned higher risk weightage then the prescribed capital adequacy ratio must be ensuring that the banks are having sufficient tier-1 capital to cover for default loss from those loans
That's a good question. If I am not wrong, the CRE loans are in fact assigned higher risk weightage. The issue is that CET-1 ratio highly varies for large and small banks. As per Nov 2022 Fed report, the CET 1 ratio declined to pre pandemic levels due to the AFS losses on the bond holdings. Secondly, the Fed is aware of the CRE problems and high concentration in the smaller banks. you can read from page number starting 28, this is the Fed's own report from November 2022. https://www.federalreserve.gov/publications/files/202211-supervision-and-regulation-report.pdf