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by  BlueBay Fixed Income teamA.Skiba, CFA Feb 13, 2024

BlueBay Head of US Fixed Income Andrzej Skiba discusses how investors are dealing with recent trouble spots within the US commercial real estate issues and how we’re dealing with the turbulence. 

'The weekly fix'

The weekly fix

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Watch time: 4 minutes, 19 seconds

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Welcome to the latest edition of the weekly fix. My name is Andrzej Skiba.

Commercial Real Estate (CRE) and regional bank fears resurfaced over the last few weeks. Unexpected losses on two property loans as well as a major step-up in provisioning in the CRE book sent New York Community Bank (NYCB) shares tumbling. Problems were not limited to US banks, with a Japanese Aozora Bank losing approximately a third of its market value following a profit warning triggered by a need for extra provisions in its US CRE exposure. Aozora is unique insofar it had close to 7% of its loan book related to US CRE, compared to an average of 0.1% for other major Japanese banks. In Europe, shares of Deutsche Pfandbriefbank also declined sharply, with the bank suffering from its large exposure to office real estate and close to 20% of the loan portfolio represented by US assets.

We remain of the view that CRE will continue to be a source of negative headlines for the market as we traverse through this year. Office occupancy has not recovered, transaction volumes have declined dramatically and prices are down approximately 20% for office and 10% for multi-family properties, with no recovery in sight.

Still, we do not believe this issue to be systemic. Yes, smaller US banks are likely to experience material losses over the years to come. We note however, that almost none of these have public bonds outstanding. In contrast, larger banks, i.e. those with assets above $150bn, were quick to address the deterioration in the office sector with collateral revaluations, moving troubled loans to criticized status, and establishing loss reserves where appropriate. For now, a clear majority of criticized office loans are still current on payment, which has not made them delinquent nor forced banks to charge these off. Some of this reflects the staggered maturities across the space which makes this an issue that banks will have to deal with over the next several years rather than being faced with a wall of maturities in coming quarter.

Across the broader regional bank space, the situation away from NYCB has stabilized since the failure of Silicon Valley Bank. While deposit pricing has increased due to higher rates, deposit flows have stabilized. Away from commercial real estate, banks’ asset quality has been good. Office CRE exposures are generally limited to 1-2% of loans. The move in rates since 3Q has benefitted almost all banks as the level of mark to market losses within their securities portfolio has improved which has led to fewer questions about regional bank capital levels. As of 4Q earnings, regional bank capital ratios remain robust with CET1 ratios close to 10%.

Across our portfolios, we see these periods of dislocation as ripe with investment opportunities for active managers. However, we also stress that there is no room for complacency and careful credit selection is of paramount importance.

Thank you for your attention.

Summary points

  • In our judgement, US commercial real estate (CRE) will be a source of negative headlines in 2024.

  • Several banks across the globe with significant US CRE exposure have reported increased provisioning.

  • Larger banks (>$150 bn in assets) have been quick to address the deterioration with collateral revaluations and establishing loss reserves where appropriate.

  • Periods of dislocation are ripe with opportunities, however careful credit selection is of paramount importance.

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