Source: Brokerage China Author: Chen Ming

The latest news shows that Moody's, an internationally renowned rating agency, has included six US regional banks on its negative watchlist, and their credit ratings are at risk of being downgraded. Moody's said the above-mentioned banks have a large amount of exposure to commercial real estate loans.

Currently, US commercial real estate is under pressure, and small bank commercial real estate risk exposure is far greater than that of large banks. At the end of March this year, rating agency S&P Global downgraded the rating outlook of five US regional banks to "negative". In August of last year, Moody's downgraded the credit ratings of multiple US banks, which once triggered a sell-off of US financial stocks.

Moody's warning

On June 6 local time, international rating agency Moody's stated that at least six US regional banks with a large amount of commercial real estate loan exposure are at risk of being downgraded by debt rating.

Moody's included the long-term ratings of six banks, including First Merchants, Fulton Financial, Old National Bank, Peapack Gladstone Financial, Washington Federal Savings, and F.N.B.Corp., on a negative watchlist for possible downgrade.

Moody's stated that due to the high and persistent interest rate exacerbating the long-term risk, especially during the depression phase, regional banks with a large amount of exposure to commercial real estate loans face the continued pressure of asset quality and profitability.

Moody's pointed out that during the low-interest-rate period before the start of the Fed's rate hike cycle, many regional banks chose to establish and maintain a considerable commercial real estate exposure, and commercial real estate is an "unstable asset class". For example, as of March 31, commercial real estate accounted for 267% of Peapack Gladstone Financial's common stock equity.

Recently, New York Community Bank has been in turmoil. At the end of January this year, New York Community Bank unexpectedly published a quarterly loss and credit loss provision, causing market concerns about its commercial real estate (CRE) exposure, leading to a 60% drop in its stock price in 5 trading days; in early March, the bank exploded again due to the discovery of flaws in the loan review process. New York Community Bank reduced goodwill by $2.4 billion (about RMB 19 billion), resulting in a revised fourth quarter of 2023 loss of $2.71 billion (about RMB 21.2 billion), more than ten times higher than the original disclosed loss, and in the following two days, the bank's stock price plummeted by 43%. Since then, under the leadership of former US Treasury Secretary Steven Mnuchin, multiple private equity funds announced on March 6 that they would jointly invest $1.05 billion in equity in New York Community Bank to stabilize the market mood.

After that, investors began to pay close attention to US regional banks with a large amount of exposure to commercial real estate lending. In mid-March, the International Monetary Fund (IMF) warned that the banking industry's exposure to US commercial real estate is too high and may cause chaos similar to that caused by the collapse of Silicon Valley Bank last year. In addition, in April, the IMF's biannual Global Financial Stability Report showed that by the end of 2023, the proportion of non-performing commercial real estate loans in US bank investment portfolios had doubled from the same period last year, reaching 0.81%. The IMF also pointed out that banks continue to increase their provisions for bad commercial real estate loans.

Some industry insiders in the banking sector pointed out that with a large amount of real estate debt due in the next three years, more and more speculations believe that if the default rate of commercial real estate loans rises to an uncontrollable level, the US banking industry may be plunged into another major crisis. In the United States, commercial real estate loans are worth $2.7 trillion, accounting for about a quarter of the average assets of banks. In the low-interest-rate environment of the past decade, many loans have been issued at the lowest interest rate. Borrowers' painful experiences of repaying commercial real estate loans at significantly higher rates today have put huge pressure on US lenders.

In addition, the commercial real estate loaners have been further hit by factors such as economic slowdown, a strong preference for remote and hybrid work arrangements after the pandemic, etc., which not only led to a sharp increase in the difficulties of the US commercial real estate market, but also quite pessimistic about the prices of commercial real estate in the United States. According to Green Street's Commercial Property Price Index (CPPI), commercial real estate prices have fallen 7% in the past year and 21% since their peak in March 2022. Last year, the total amount of delinquent loans related to commercial real estate such as shopping malls, offices, and industrial units was estimated to be as high as US$24.3 billion, more than twice the US$11.2 billion in 2022.

Banks are being shorted.

On Tuesday (June 4, local time), an institutional investor shorted a regional bank. At that time, Landenburg Thalmann issued a report on the commercial real estate exposure and "excessive" valuation premiums of the regional bank Axos (AX.US), making Axos the latest closely watched bank. Landenburg Thalmann accused the bank of "relaxed lending standards" that will be affected by the sharply deteriorating US commercial real estate market.

On Tuesday, Axos's stock price plummeted more than 16% at one point and closed down 4%. In a statement, Axos said that Landenburg's report contained a series of untrue allegations. Axos said that nearly $5.2 billion of its commercial real estate special loan business is operated through fund partners, which provides the bank with strong joint protection in adverse market conditions.

The rise in interest rates has increased concerns about the risk of US commercial real estate, and one indicator shows a 21% drop in value since its peak in March 2022. Axos's report showed that its commercial real estate loans exceeded $5.9 billion as of the end of March, of which multi-family homes and hotels were its largest commercial real estate exposures.

Although Landenburg's report did not mention Trump, Axos has connections with the billionaire, helping refinance loans for Trump Tower and lending to a Florida resort. Last month, a federal court jury in New York found former US President Trump guilty in a hush money case, with all 34 charges against him being upheld, making Trump the first former president in the United States to be convicted.

The high cost of borrowing has hit real estate valuations, and uncertainty about Fed rate cuts has intensified the challenge. Josh Zegen, co-founder of lending firm Madison Realty Capital, said, "there are some cracks in the real estate industry that will grow more and more this year."

However, some alternative asset management firms see opportunities in this. A few days ago, Blackstone CEO Stephen Schwarzman said the investment giant is in talks with several regional US banks to explore purchases of their assets and issued loans. He said the pressure on these regional banks will not only come from the market, but also from regulators, which will reduce their ability to lend. Schwarzman said the regional banks' retreat from the business of lending to the broad economy will make Blackstone the beneficiary and a natural partner. Companies like Blackstone have the opportunity to fill this void.

Schwarzman said that the withdrawal of regional banks from the business of lending to the broader economy will make Blackstone the beneficiary and a natural partner. Companies like Blackstone have the opportunity to fill this void.

Blackstone manages nearly $1 trillion in assets and is the world's largest alternative asset management firm and a growing non-bank financier.

Editor/Lambor