US Big Banks Survive the Fed’s CRE Shock Scenario

The Fed’s annual stress test of the US banking system found that the largest US banks have enough capital to withstand severe economic and market turmoil – including any potential shock that a significant drop in commercial real estate values could deliver. Namely, the institutions survived a hypothetical 40% drop in values.

The 31 large banks tested showed they have sufficient capital to absorb nearly $685 billion in losses. The Fed also tested for a 36% decline in US home prices, a 55% drop in equity prices and an unemployment rate of 10%.

The commercial real estate component of the test had been closely monitored by the industry and regulators given the falling valuations, especially of office buildings, and elevated interest rates, which appear to  be in place for longer than expected. “Though this doesn’t mean the Fed thinks commercial real estate is out of the woods,” Chris Marinac, head of research at Janney Montgomery Scott told Reuters. “It’s still early innings in this credit cycle.”

Of the banks tested, Goldman Sachs had the highest projected loan loss for commercial real estate, at 15.9%. RBC USA, Capital One and Northern Trust followed, with projections at 15.8%, 14.6% and 13%, respectively.

This is not to say banks are unlikely to face any more fallout from problem commercial real-estate loans. But Moody’s says that when the Fed finally starts to roll back its interest rate hikes, a good bit of the pain could be alleviated.

“This is a financing problem,” said Stephen Lynch, senior credit officer at Moody’s Ratings, in a call with reporters on Wednesday, according to MarketWatch. “This is really an interest-rates story.”

Moody’s calculates that the biggest national, regional and community banks each own roughly a 10% to 13% share of overall CRE loans, but the biggest banks only have a 4.3% exposure as a portion of their overall assets.