Fed’s Williams says commercial real estate a ‘real issue’ for banks

Federal Reserve Bank of New York President John Williams

Federal Reserve Bank of New York President John Williams said bank supervisors are monitoring developments in the commercial real estate sector carefully.

Bloomberg

Federal Reserve Bank of New York President John Williams said the health of the office sector is a “real issue” for banks but not an immediate threat to financial stability.

Speaking at an event hosted by the Economic Club of New York on Tuesday afternoon, Williams said he and other bank supervisors are keenly focused on what falling commercial real estate values might mean for banks and their loan books.

“We are definitely monitoring that, analyzing it, but also paying very close attention to it in the supervision space around banks’ commercial real estate risk,” he said. “This is primarily focused on the office space, where you see some of the potential declines in values as businesses have seen people go to work from home or remote, that demand for office space has gone down in New York and other places.”

Commercial real estate valuations are a rising concern among financial market participants, according to its latest financial stability report, released Monday. More than half of those surveyed for the biannual report said the sector was a top concern for financial stability.

The report noted that valuations remain strong despite falling prices for commercial properties, rising vacancy rates and income levels for the asset class hovering around historic lows. But Williams said those figures may not tell the entire story. 

After the event, Williams told reporters that current data about the valuation of commercial real estate assets likely understates the problems in the sector, noting that most transactions in the market have involved higher end properties, thus skewing the data upward. 

While it is apparent that city center offices and retail spaces are being used less since the onset of COVID-19, he said, it is unclear just how much that trend has impacted their values. 

“As people have gone to work from home, partially remote or hybrid models, I don’t think we fully understand how that will settle out in terms of the underlying value of these properties,” Williams said. “Also, given that these properties often get revenue from the businesses, like restaurants and others that are associated with them. So I think we’ll get more information on that.”

Williams noted that while most banks have some exposure to commercial real estate loans, the concentration of those loans is not evenly distributed throughout the banking system. Some banks, he said, have more exposure to the sector broadly, and some have higher concentrations of potentially impacted assets than others.

He also said that because troubled real estate assets are not repriced until they are sold or refinanced, an event typically associated with the debt reaching maturity, it takes time for prices to fully correct. Because of this, he said, such changes are unlikely to be broadly destabilizing.

“The good news in this is that, typically, commercial real estate rolls over every five years or so, and depending on the loan or financing, so that takes time to happen. It all doesn’t come to market at the same time,” he said. “I definitely feel that it is a very real issue, especially in the office space and one of the risks to the outlook, not so much for financial stability, but more to the economy and, specifically, making sure that we have a good understanding of the banks’ exposures.”

Echoing sentiments shared by Fed Chair Jerome Powell last week, Williams said the banking system is strong and resilient. He said the outflow of bank deposits from regional banks to money market funds and large banks has been stemmed in recent weeks. Like Powell, he said his biggest concern going forward will be about how credit conditions react moving forward. 

Williams said credit has clearly become less available as of late, but said it is difficult to distinguish how much of that is driven by the banking crisis as opposed to the Fed’s tightening of monetary policy or other variables. 

“Even banks that are very healthy and strong are seeing the cost of their funding go up,” he said. “I’m sure that there are banks who are thinking, ‘Well, given what happened, I’m going to be more conservative,’ maybe hunker down and be conscious, and make sure they’re very strong for any other event that happens. I think that’s how that can spill over into the availability of credit.”

Going forward, Williams said his main takeaway from the episode is that the Fed, as a bank supervisory agency, must be prepared for issues to arise and play out at the speed of the Internet.

“The speed and magnitude of how people pull money away from banks, whether out of fear or concerns of insolvency, is just dramatically different,” he said. “I don’t think it’s just social media or the particular of the client base of Silicon Valley Bank. Maybe it’s relevant, but I think it’s more that we, as regulators and supervisors, all of us, not just the Fed, but others, have to make sure that banks are able to access liquidity, make sure they have the liquidity that they need if an event like this happens.”

Williams also touched on the outlook for consolidation of the banking sector through mergers and acquisitions in light of recent turmoil. He declined to comment on whether the stringency of the current merger review process has incentivized prospective buyers to wait for struggling banks to fail before making bids, but said the fact that the Federal Deposit Insurance Corp. was able to sell each of the three failed banks to other banks was a positive for the financial system.

He added that the Fed is focused on maintaining as many healthy banks of all sizes as it can.

“We don’t need to see blanket more consolidation or less consolidation. Our banking system, with community banks, with mid-sized banks, with larger banks, having all of that be healthy and strong actually serves the public, the businesses and household effectively.”

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