"Expansion of US Commercial Real Estate Loan Defaults... Small and Medium Banks to Fail or Merge"

Bank of Korea, Report on 'Current Status and Characteristics of US Commercial Real Estate Loans'

[Image source=Reuters Yonhap News]

The Bank of Korea has assessed that the defaults on U.S. commercial real estate loans may continue to increase as they intersect with the remote work and high interest rate environment, and that additional bankruptcies and mergers could occur among small and medium-sized banks experiencing severe management deterioration.

In its report titled "Current Status and Characteristics of U.S. Commercial Real Estate Loans," published on the 2nd in the Overseas Economic Focus, the Bank of Korea stated, "Some small and medium-sized banks with a particularly high proportion of office loans in their loan assets may face bankruptcy due to worsening management."

According to the report, unlike residential real estate, which has recently seen a price rebound, U.S. commercial real estate prices have continued to decline by more than 10% from their previous peak, and transaction volumes have shrunk by 80%. Especially following the March Silicon Valley Bank (SVB) crisis this year, where the decline in bond prices held by banks led to the failure of a major bank, concerns about the deterioration of bank-held assets have heightened, bringing commercial real estate-related risks to the forefront of market attention.

Commercial real estate loans account for 24% of bank loan assets, so defaults related to these loans could significantly impact the soundness of banks' assets. Although the proportion of commercial real estate loans within bank loans had somewhat decreased following the 2008 global financial crisis, banks have increased their lending since 2013 to secure profitability under low interest rates, resulting in a rising share.

The size of commercial real estate mortgage loans is $4.5 trillion and has steadily increased since the global financial crisis. Under the low interest rate environment, commercial real estate has shown high returns, with a 10.1% year-on-year increase in the second quarter of last year, marking the highest growth rate since 2008.

Breaking down commercial real estate mortgage holdings by institution, banks hold 39%, government-sponsored enterprises 21%, insurance companies 15%, and Commercial Mortgage-Backed Securities (CMBS) 13%. Among these, banks have the highest proportion, with commercial real estate loans accounting for 25% of their loan assets.

Maturity of U.S. Commercial Real Estate Loans Concentrated This Year and Next Year

Unlike residential real estate loans, which are mostly long-term fixed-rate, commercial real estate loans have a high proportion of variable-rate loans, close to 50%, and this share has rapidly increased since the 2008 financial crisis. This characteristic is not a major issue in a low interest rate environment but can lead to a sharp increase in interest burdens during periods of monetary tightening like the current one.

Moreover, the maturity of commercial real estate loans is concentrated in this year and next year, with the amount maturing by next year reaching $1.1 trillion. The concentration of commercial real estate loans in small and medium-sized banks also raises concerns. When looking at the share of commercial real estate loans by bank size, small and medium-sized banks with assets under $180 billion account for 70%.

In 2004, the proportions of commercial real estate loans between large and small-to-medium banks were similar, but after the global financial crisis, large banks subject to strengthened regulations reduced their share to 30%, while small and medium-sized banks' share increased to 70%.

The report analyzed, "While defaults on U.S. commercial real estate loans, especially office-centered ones, may continue to increase, strong demand for non-office commercial real estate, improved financial stability, and a gradual pace of loss occurrence are expected to limit the possibility of systemic risk across banks. Considering the past case in the 1990s savings and loan crisis, where 37 banks were consolidated into 4, it is likely that banks unable to endure long-term profitability deterioration and regulatory tightening will be absorbed by larger banks."

This content was produced with the assistance of AI translation services.