Professor Glenn A. Okun
The FDIC and Fed have disagreed on the commercial real estate (“CRE”) loan problem facing the U.S. banking system. The FDIC has issued a more dire assessment, confirming the Rabid Capitalist’s view.
The Fed has characterized the CRE debt maturity paywall issue as manageable. The FDIC analysis has identified unmanaged exposures for the banks.
Mainstream assessments to date have concluded that the economy was facing a modest overall credit risk that would be concentrated in a limited number of small and regional banks. The large, systemically important, banks had small exposures.
The FDIC report contradicted this narrative. It found noteworthy exposure for the large banks. FDIC filings have shown that the average reserves at JPMorgan Chase, Bank of America, Wells Fargo, Citigroup, Goldman Sachs and Morgan Stanley have fallen from $1.60 to 90 cents for every dollar of CRE loans that were delinquent by at least thirty days.
FDIC data indicated an erosion in provisions for loan losses for the banking system as a whole. Current loan loss provision coverage of delinquent CRE debt declined to 140 percent from 220 percent last year.
Unfortunately, loan loss reserves have been based on historic loss rates for various loan categories. CRE debt has had a low loss rate based upon long term performance data.
The risk that Covid era CRE loan losses exceed these traditional loss rates is the threat facing the banks and the economy. Additional loan loss provisions would reduce banks’ earnings while the debt write downs would shrink the asset base and their lending capacity.
The FDIC data suggests that the Fed has arrived late to the bank supervision issues. This would be consistent with their mistiming interest rate moves to combat inflation that it had dismissed as transitory.
The Rabid Capitalist has been warning subscribers about the debt problem since July of 2023 (see https://therabidcapitalist.com/2023/07/25/bank-lending-diet-or-starvation/).
The banks and REITs should be avoided until the extent of these risks is well understood. Our business development company portfolio will benefit from this credit market disarray and is well positioned for intermediate and long-term performance.
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