Pimco Predicts More Regional Bank Failures Due to Commercial Property Loan Strains

The investment firm Pacific Investment Management Co. (PImco) has raised concerns about the future of regional banks in the United States, anticipating a spike in failures linked to significant exposure to problematic commercial real estate (CRE) loans. Within Pimco's expansive $173 billion alternatives operation, the head of the global private commercial real estate team, John Murray, warns of impending distress within the lending sector, targeting a range of properties from shopping malls to office spaces.

The Underlying CRE Challenges

Current economic uncertainties, particularly regarding the Federal Reserve's interest rate decisions, have compounded the pitfalls facing the CRE sector. High borrowing costs have already begun to erode property values and prompt defaults, leaving banks saddled with assets that are difficult to liquidate. Murray points out that larger banks have strategically been offloading their more viable assets early on in a bid to mitigate losses.

As maturity dates approach for stressed loans, Murray expects banks to initiate the sale of these challenging loans to minimize their burden of troubled loan portfolios. He notes that Pimco has been proactively acquiring CRE loans that large banks have shed over the past one and a half years.

Regional Banks at the Epicenter of Concern

Regional banks have felt the tremors of the turmoil more acutely due to their increased investments in CRE, which now holds a fraction of the peak value. Incidents such as the unexpected dividend cut by New York Community Bancorp and the capital injection it precipitated, as well as heightened loan provisions by US Bancorp and scrutiny over Axos Financial Inc.'s property loans, underscore the growing pressure on smaller banking institutions.

Moreover, regional banks notably did not request additional down payments from commercial property borrowers in recent times, highlighting their sensitivities to devaluations. This year alone, banks are facing a daunting $441 billion in maturing property debt.

The Broader Banking Landscape

Larger banks, cautious from the 2008 financial crisis, are not expected to crumble under their CRE exposures. However, their lending has diminished since borrowers' defaults have increased. Real estate investment trusts (REITs) are also grappling with their challenges, with some, such as Starwood Real Estate Income Trust and Blackstone Inc.'s property trust, taking measures to safeguard liquidity due to rising withdrawal requests. Therefore, lending volumes from large public mortgage REITs have dropped severely compared to the previous year.

Outside of mainstream banks, debt funds in the US are also on the radar, with over $200 billion in loans set to mature by 2025. Many of these loans were secured during the peak of the market in 2021, carrying short terms and interest rate caps that might not withstand the current climbing rates.

Murray also emphasizes the forthcoming dilemma for assets failing to meet extension tests in this period of rising interest rates. Finally, he advises keeping an eye on the handling of commercial real estate exposure by German banks, as they too navigate the dual pressures of escalated rates and a threatening recession.

Pimco, banks, property