The roiling of banking has generated shockwaves that are hitting other industries, like CRE. At first, it was a question of whether rent payments would come in from the tech startups doing business with Silicon Valley Bank. Then concern about what the Fed might do about interest rates came in. A consortium of large banks saving First Republic promised even more volatility. Credit Suisse became COD Suisse and needed a quick rescue, which happened when UBS took it over.
Enough discombobulation? Don’t you bet on it. Today’s new concern is real estate-based bonds. Whether MBS or CMBS securities could get the legs swept out from under them, taking a lot of value with them, came up in a Wall Street Journal article.
The short take is that some of the banks — SVB, of course, but probably others — had loaded up on not just 10-year Treasurys but real estate-based bonds, like MBSs issued by the agencies, Fannie Mae and Freddie Mac, as well as CMBSs. If those bonds hit the market, suddenly getting written down in value and then on top of that dumped in a fire sale, the glut, whatever the size, could push down the value of all similar bonds. And they may well hit the market because, when a bank like SVB gets closed down and goes into federal receivership, the FDIC is required to get back as much value as possible, which includes selling off the bonds.
Take SVB for a moment. According to the bank’s 2022 annual report, by the end of last year, it had $6.6 billion in agency-issued MBS, another $678 million in agency collateralized mortgage obligations (CMO), and about $1.5 billion in CMBS. That may not sound bad, but that was the available-for-sale, or AFS, category. The ones regularly marked to market.
The troublesome aspect and the held-to-maturity, or HTM, securities: $57.7 billion in MBSs, $10.5 billion in fixed-rate CMOs, $79 million in variable-rate CMOs, and $14.5 billion in CMBS. That’s $82.7 billion.
“For sure there will be sharks that smell blood in the water and will buy discounted assets for cheap,” Brad Werner, a partner and leader in assurance, accounting, and tax consultancy Wipfli’s CRE group, tells GlobeSt.com. “Regional banks will for certain tighten as oversight autocorrects and interest rates continue to rise.”
The real pain has already started in CMBS. “The market for commercial mortgage-backed securities is actively seizing up,” Werner adds. “CMBS is a significant portion of the office financing market and February sales volume of those securities just dropped 85%. The most distressed sector is likely to be Class B office buildings going forward, particularly those that have floating rate adjustable loans, which have essentially made the assets unprofitable relative to operating yields as rates have increased. Yields have been impacted negatively by the staying power of remote work and the flight to quality Class A assets. When you add that smaller domestic banks finance approximately 67% of commercial real estate deals and are under increased pressure in the wake of the SVB debacle, that adds for a pretty scary environment in commercial office real estate.”