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The Fed Worries About Bank CRE Loans for a Good Reason
The Federal Reserve and other regulators have been focused of late on bank problems, and well they should. But concern is now spreading to commercial real estate and the possibility that interplays between CRE borrowers and lenders could, under current conditions, create a positive feedback loop that could increasingly hurt both. The signs are in two Fed reports.
In its May 2023 Financial Stability Report, the Fed looked at the exposure of financial institutions to CRE debt. The report acknowledged reduced demand for office space — and lack of understanding as to how that will ultimately play out — and vulnerability to higher interest rates that could prevent refinancing. "With CRE valuations remaining elevated … the magnitude of a correction in property values could be sizable and therefore could lead to credit losses by holders of CRE debt," they wrote.
Although that seems to run counter to the recent breakdown by Moody's Analytics, the Fed doesn't include multifamily mortgages "because the fundamentals of that sector are substantially different." Major devaluations of nonresidential CRE properties could then cause a big problem for banks that hold CRE debt. Plus, devaluations could likely trigger basic covenants, putting borrowers out of LTV requirements.
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