Fed to Congress: Economy Improves, CRE Lending in More Trouble

Last week, the Federal Reserve had two opportunities to comment on the state of commercial real estate. In a regular report to Congress and minutes from the June Federal Open Market Committee, opinions on the overall economy seemed guardedly optimistic. CRE received a more cautious and negative reception, especially around implications for banking.

In the Monetary Policy Report to Congress, the high-level summary noted that inflation had reduced, though still wasn’t at the 2% goal the Fed holds, and that the benchmark federal funds rate has continued for the last year in the 5.25% to 5.50% range. Rate cuts won’t happen until the Fed has “greater confidence” that inflation is moving “sustainably” toward 2%. The labor market has remained strong, though added jobs per month are slowing, as is wage growth. GDP is growing moderately, with slowdowns due to volatile categories like net exports and inventory investment.

Commercial real estate comes into focus through loans and in association with credit cards and auto loans. Delinquency rates continued to increase during the first quarter of 2024, staying above long-run averages. As a result, part of banks’ CRE portfolios are under stress. Some banks are too reliant on uninsured deposits. The combination is of concern given last year’s closure of institutions like Silicon Valley Bank, Signature Bank, and First Republic Bank, in which a sudden fall of a significant asset source caused large depositors to rapidly transfer their money to other banks, challenging the solvency of all three. Equity prices for regional banks have declined in part because of concern over the quality of CRE loans.

The Fed said that CRE conditions have continued to deteriorate. Falling transaction prices are due to weak demand. They were presumably concerns over CRE risk while Treasurys could give investors reasonably high and safe annualized yields.

The Fed said in the minutes from the June FOMC meeting that credit was “largely available” for CRE outside construction and land development. Bank CRE loans “continued to increase” in April and May because of multifamily and nonfarm nonresidential loan demand.

That statement might sound strange to many CRE borrowers. The Fed has continued to report over an extended time that banks have continued to tighten underwriting standards. As widely reported in GlobeSt.com and elsewhere, higher rates have meant greater difficulty refinancing properties. There have been warnings about major loan maturity waves and extend-and-pretend strategies lenders have used to keep losses off their balance sheets.

However, the minutes included that “credit quality deteriorated further,” with CMBS delinquency rates rising in April and May, driven by office, hotel, and retail sectors, and that the credit quality of CRE borrowers weakened in Q1.

The level of information the Fed offers makes it difficult to reconcile these statements. Perhaps the growing bank CRE loans included carried forward balances from risky previously granted loans. Or maybe a smaller group of borrowers is getting significant loans with business fundamentals and assumptions far more conservative than was the case four to ten years ago.