Trouble in the banking sector – the canary in the coalmine?

Over the space of a few days, financial news has been dominated by the difficulties of certain banks. These difficulties are associated with upheavals in the real-estate sector which are having a knock-on effect on the banking system. This awakens painful memories – first and foremost, of the subprime crisis.

Today, the crux of the problem can be found in the difficulties faced by commercial real estate in the US, a vast sector covering all real estate with the exception of individual housing and infrastructure. Shaken by a sharp rise in interest rates and a shift in usage patterns, the office segment is the epicentre of the earthquake. With the emergence of home-working and hotdesking, i.e. where a fixed office is a thing of the past, the demand for office space has still not returned to pre-Covid levels. This situation has resulted in record vacancy rates despite full employment. With reduced demand and the fixed nature of the supply side, logically, prices have fallen. Since March 2022, the price of office space in the US has fallen by an average of 21% based on the Green Street Commercial Property Price Index®. This has weakened the balance sheets of those exposed to the sector and worried the authorities. Janet Yellen, US Treasury Secretary, recently shared her fears of repercussions for the financial segment, initially for regional banks as the main lenders to the sector, and a few days later, for non-bank mortgage lenders which are subject to lower regulation.

Whilst this is a US earthquake, in a global economy, it has repercussions on other continents. This is the case in Japan, where the price of Aozora Bank lost a third of its value following the announcement of its highest annual loss since 2009 due to provisions on its US assets. This is also the case in Europe with concerns surrounding the German banks, Deutsche Pfandbriefbank and Aareal Bank, whose bonds are trading at discounts which could create refinancing difficulties. Once again, this is due to their significant exposure to US retail estate.

Viewed from afar, these shocks are worrying, albeit currently restricted to subsidiary players. In contrast, results published by the major banks have been generally reassuring, with little impact from this crisis. Better capitalised, better regulated, better supervised – the banking sector has changed a lot since 2008. It is not really surprising that weaknesses have appeared in players considered non-systemic by regulators. But they are a direct consequence of monetary tightening, which – when persistent – primarily affects sectors and players that are dependent on leverage.

The weakness of US commercial real estate and its collateral damage on the financial sector is contained for the moment. With vigilant authorities and central bankers who are quick to intervene to avoid any contagion of mistrust to the sector as a whole, this crisis looks more like a damp squib than the start of a collapse of the mine.

Final version of 9 February 2024 – Clément Inbona, Fund Manager, La Financière de l’Echiquier (LFDE).