"US Commercial Real Estate Slump May Accelerate Bank Sector Pivot"

National Financial Center Report
"Systemic Crisis Spread Possibility Low but Caution Needed"

Before the Federal Reserve's (Fed) pivot (monetary policy shift) fully takes effect, it has been suggested that the sluggishness in the Commercial Real Estate (CRE) market could increase volatility in the financial markets, warranting close attention. There is also an analysis that if contagion in the banking sector intensifies, the pivot could be accelerated.

According to the International Finance Center on the 12th, since 2022, CRE values have sharply declined due to high-intensity tightening, the expansion of remote work, and structural changes such as the increase in e-commerce, raising concerns about mortgage defaults. Large-scale CRE loan maturities (10-20 years), which occurred on a low-interest-rate basis after the 2009 financial crisis, are concentrated from this year through 2027, raising fears of simultaneous defaults among lending institutions such as banks.

Source=International Financial Center

If CRE prices fall further, losses could expand mainly among small and medium-sized regional banks with large CRE exposure relative to their capital. This is because banks hold half of the CRE loans among U.S. financial institutions, and 70% of those loans are concentrated in small and medium-sized banks. Moreover, 73% of real estate development loans, which carry relatively higher default risks, were executed by small banks.

However, the possibility of this spreading into a systemic crisis appears limited. Even if some small banks close due to CRE loan defaults, the consensus is that a systemic crisis like the 2008 financial crisis will not occur. Researchers Park Mijeong and Hwang Wonjeong from the International Finance Center added, "If the pressure of deposit withdrawals increases at regional banks due to CRE instability, there remains a possibility that the Fed's Bank Term Funding Program (BTFP) operation plan could be changed. Recent efforts by U.S. financial authorities to strengthen CRE information disclosure requirements for small banks and to mandate borrowing through bank discount windows are also expected to help contain the spread of the crisis."

Nevertheless, demand for commercial real estate is unlikely to recover in the short term, making it difficult for banks with large related exposures to restore profitability, which could intermittently act as a factor increasing volatility in the financial markets.

In its recent report titled "U.S. Commercial Real Estate Market Trends and Banking Sector Impact," the International Finance Center explained, "Weakening economic activity in the first half of the year and the establishment of hybrid work are expected to continuously constrain overall office demand throughout this year, with office vacancy rates projected to peak at 19.8% (CBRE) this year. Given the difficulty of office demand recovering in the short term, there is a possibility of additional price adjustments and sporadic regional bank instability due to deteriorating profitability."

It further noted, "Due to U.S. CRE instability, credit costs are increasing for major country banks such as those in Germany, Switzerland, and Japan. In particular, attention should be paid to the growing possibility of contagion in Europe through small German banks."

According to the report, if the Fed begins its monetary policy shift after mid-year and the economic downturn does not worsen, the CRE market tightening outside the office sector could gradually ease from the second half of the year. At the same time, if contagion from commercial real estate to the banking sector expands, there is also an analysis that the Fed's policy response could be strengthened and the pivot could be brought forward.

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