Major U.S. Banks Could Survive the Worst CRE Scenario

For those who have been worried about the banking system, the Federal Reserve brings news of its “annual bank stress test, which demonstrates that large banks are well positioned to weather a severe recession and continue to lend to households and businesses even during a severe recession.” Even if commercial real estate experiences a massive decline in value.

The Fed’s annual bank stress tests how lenders would do against a 40% decline in commercial real estate values, among other scenarios. The 23 banks examined hold approximately 20% of office and downtown retail CRE loans, and their average projected CRE loan loss rate was 8.8% of average loan balances, compared with 9.8% last year. Goldman Sachs Group had the highest CRE loan loss rate of 16% of average loan balances, followed by Morgan Stanley at 13.7% and Citizens at 12.4%.

“Today’s results confirm that the banking system remains strong and resilient,” Vice Chair for Supervision Michael S. Barr said in prepared remarks. “At the same time, this stress test is only one way to measure that strength. We should remain humble about how risks can arise and continue our work to ensure that banks are resilient to a range of economic scenarios, market shocks, and other stresses.”

All of the banks tested “remained above their minimum capital requirements during the hypothetical recession, despite total projected losses of $541 billion.”

The tested stress factors also included a severe global recession, substantial increase in office vacancies, and 38% housing price decline. Unemployment increased to 10% under the scenario and “economic output declines commensurately.”

Large banks would experience “heavy losses” but would still be able to lend. “The banks in this year’s test hold roughly 20% of the office and downtown commercial real estate loans held by banks,” the Fed said. “The large projected decline in commercial real estate prices, combined with the substantial increase in office vacancies, contributes to projected loss rates on office properties that are roughly triple the levels reached during the 2008 financial crisis.”

But with all that, there’s much unsaid. First is the constant very human practice of reacting to what previously happened instead of knowing what might occur next. The banking system has felt stress of late, and it was the midsize-but-still-pretty-big banks that weren’t among the very biggest and so had been excused from the additional stress testing through 2018 legislation. Expand outward to the thousands of banks also not required to undergo stress testing, and you have the all the ones that hold roughly 80% of office and downtown CRE loans.

It’s also wise to remember that the stress tests, originally required by the Dodd-Frank legislation that was a reaction to the Global Financial Crisis, didn’t consider the large and rapid increases in interest rates due to inflation that actually did happen and caused the problems with those banks that didn’t receive stress testing.