Gillian Tett at the FT scared the hell out of everyone in the holiday week by arguing that it’s finally time to worry about commercial real estate.Why?
Because banks have been playing “extend and pretend” by extending the terms of loans that can’t be refinanced, never mind that the value of buildings has plummeted and vacancy rates are high.
Tett argues that rising interest rates will now make extend and pretend impossible, which will force the banks to start taking write-offs. And that will clobber some smaller banks that aren’t Too Big To Fail.
But here’s the good news:
Compared to the residential real-estate problem, this is small potatoes.
According to the Institute for International Finance, about $375 billion of CRE loans in the US are currently delinquent and about $1.4 trillion have to be refinanced by 2014 (unless they are extended). You would need a very high percentage of those loans to be a total write-off to threaten the big banks and, therefore, the financial system.
Here’s Gillian’s conclusion:
If [all these loans aren’t refinanced smoothly], that will hurt many small and medium-sized US banks. Moody’s, for example, estimates that US banks have barely recognised half their CRE losses, far less than for residential mortgages. Defaults could also damage European financial institutions. Last month the Bank of England’s financial stability report observed that a third of all UK banks’ global corporate loans were to CRE – and many of those loans have also been “evergreened”. (Apparently, “30 per cent of UK companies made insufficient profits to cover their interest payments in 2009”, the FSR observes.) DTZ Research estimates that there is a potential gap of $54bn between the value of UK CRE loans maturing and the amount of new debt that could be raised over the next three years. “Ireland and Spain also have large estimated CRE funding gaps,” the Bank adds. That could hit plenty of other European banks too.
Now, I am not suggesting that these woes could deliver anything like the shock that occurred from subprime, or that might yet emanate from sovereign debt; a “mere” $54bn funding gap – or a $375bn pile of distressed loans – is still manageable for the system as whole.
But if nothing else, these numbers could hurt some banks.
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