[Why&Next] US Commercial Real Estate Shaking Japan and Europe... Will a Financial Sector Insolvency Bomb Explode?

'US CRE Loss' Japanese and Swiss Bank CEOs Resign
Commercial Real Estate Defaults Raise Financial Crisis Concerns
WSJ "Three Continents Hit"... Bloomberg "Pain Just Beginning"

Concerns are emerging that bank failures caused by the U.S. commercial real estate downturn could become a trigger for a financial sector crisis. On the 1st (local time), as banks in the U.S., Japan, and Germany announced losses related to U.S. commercial real estate loans, local U.S. media gave significant coverage, reporting that the commercial real estate crisis is spreading globally. The Wall Street Journal (WSJ) noted, "Three banks across three continents have been hit by commercial real estate losses," adding, "The pain from office real estate problems has only just begun." Bloomberg also reported, "From New York to Tokyo banks have been hit," stating, "The pain has only just begun."

Resignations of Japanese and European Bank CEOs Amid U.S. Commercial Real Estate Cooling

According to major foreign media, Japan's Aozora Bank, which announced losses on U.S. commercial real estate loans the previous day, revealed that its CEO plans to resign on April 1. This personnel change came as the bank recorded its first annual net loss in 15 years.

Swiss bank Julius Baer also announced that CEO Philipp Rickenbacher will step down amid the commercial real estate loan troubles. The bank reported that it may not recover $700 million in loans provided to the bankrupt Austrian real estate company Signa Group, causing net profits to plunge by more than 50%. As a disciplinary measure, the organization involved in the Signa Group loans will be dissolved.

The common background behind the resignations of Japanese and Swiss bank CEOs is the U.S. commercial real estate loan defaults. Since March 2022, aggressive interest rate hikes and the rise of remote work after the COVID-19 pandemic have caused vacancy rates to soar, leading to a rapid decline in U.S. commercial real estate values. For example, the Aon Center in Los Angeles (LA) was recently sold for $147.8 million, a 45% drop compared to 2014. Meanwhile, the benchmark interest rate surged from near 0% in early 2022 to a top rate of 5.5% currently. As borrowing costs soared and vacancy rates increased, the sales market froze, causing borrowers to start defaulting on principal and interest payments. The cooling of the U.S. commercial real estate market is now spreading to the financial institutions that supplied related loans.

Banks in the U.S., Asia, and Europe have been consecutively announcing losses related to U.S. commercial real estate loans. The day before, New York Community Bancorp (NYCB) reported a net loss of $252 million in Q4 last year. Although it had achieved a net profit of $172 million in the previous quarter, it turned to a loss within one quarter. The bank incurred $185 million in losses from two commercial real estate loans and set aside over $500 million in loan loss reserves to prepare for additional losses. Germany's Deutsche Bank also increased its loan loss reserves fivefold to $133 million compared to the end of 2022, fearing defaults on U.S. commercial real estate loans.

Bank stocks plummeted. NYCB shares fell 37.6% the previous day and dropped more than 11% again on the following day. Japan's Aozora Bank plunged over 20% on the Tokyo Stock Exchange the previous day, hitting the lower limit.

$2.2 Trillion in Maturities Due by 2027... "The Commercial Real Estate Crisis Is Just Beginning"

The problem is that as the commercial real estate crisis begins to be fully reflected in bank financial statements, it is spreading to financial sector insolvencies. Some in the market even fear a wave of bank failures due to loan defaults. This could lead to a repeat of the Silicon Valley Bank (SVB) collapse last March, which was triggered by a bank run caused by losses on U.S. Treasury investments.

According to market research firm Trepp, U.S. commercial real estate loans maturing by 2025 amount to $560 billion. The total loan maturities due by 2027 reach $2.2 trillion. Moody's, a global credit rating agency, forecasts that one in three commercial real estate loans maturing will face difficulties in extension or refinancing. Commercial real estate defaults lead to insolvencies of the financial institutions that supplied the loans. The U.S. commercial mortgage-backed securities (CMBS) market, which issues securities backed by banks' commercial real estate loans, is already showing signs of distress. Trepp reported that the delinquency rate in the $800 billion U.S. CMBS market rose sharply to 6% as of November last year, compared to 1.7% a year earlier.

As concerns over loan defaults grow, some banks have artificially delayed the exposure of bad loans by short-term extensions of maturing loans over the past two years. Guggenheim Partners' Chief Investment Officer (CIO) Ann Walsh said at the World Economic Forum (WEF, Davos Forum) held in Switzerland last month, "The pain from commercial real estate in the office sector has only just begun," adding, "Small and medium-sized banks will have to provide substantial loans to borrowers seeking refinancing within the next two years, leading to a 'rolling recession'." This points to the commercial real estate downturn leading to a banking crisis with a time lag.

In particular, such loan defaults are expected to concentrate in small and medium-sized banks rather than large banks with diversified portfolios. According to JP Morgan, U.S. small and medium-sized banks hold 28.7% of all commercial real estate loans, while large banks hold only 6.5%. Japan's Aozora Bank, whose CEO resigned due to exposure to U.S. commercial real estate losses, is also a medium-sized bank with assets of $55 billion.

The International Monetary Fund (IMF) warned that global commercial real estate prices could fall more sharply this year. In its Global Financial Stability Report released in October last year, the IMF predicted, "A vicious cycle potentially involving tighter financing conditions, falling commercial real estate prices, and bank losses could broadly impact macro-financial stability."

Justin Onuekwusi, CIO of St. James's Place Asset Management, stated, "It is clear that the correlation between commercial real estate and regional banks represents a 'tail risk' for 2024," forecasting, "Cracks could appear across the commercial real estate, housing, and banking sectors."