Concerns over systemic risk are mounting among fund managers as warning signs emerge in property markets worldwide. According to Bank of America Corp.’s latest Global Fund Manager survey, about one in six respondents views a potential credit event as the most significant tail risk facing markets, up from one in eleven in December. The deepening unease in US commercial real estate (CRE) and Chinese property markets has propelled this fear to the third position among respondents, trailing only concerns about higher inflation and geopolitical tensions.
Hopes for relief from the Federal Reserve through interest rate cuts to alleviate pressure on the real estate sector were dampened by stronger-than-expected inflation figures. Traders now anticipate fewer interest rate cuts this year, with expectations slashed by nearly half since January. Additionally, the looming refinancing or property sale needs of over $900 billion in US commercial and multifamily real estate debt, a 40% increase from previous estimates, further exacerbate concerns amid declining building values.
Bruce Richards, Chairman of Marathon Asset Management, cautioned that smaller banks are headed towards default rates of 8-10% in their CRE loan portfolios. These lenders, having significantly increased their exposure to CRE in recent years, are particularly vulnerable to the downturn. In contrast, larger banks are viewed as more resilient.
A 10% default rate on CRE loans could result in approximately $80 billion in additional bank losses, according to a research paper published in December, potentially putting over 300 smaller regional banks at risk of solvency issues.
Omar Eltorai, director of research at Altus Group, expects distress levels to continue rising, albeit with a delay before significant impacts are felt, sometimes measured in years. To address potential losses, the Fed is collaborating with lenders heavily exposed to CRE on strategies to manage expected losses, according to Treasury Secretary Janet Yellen.
The BofA survey revealed that nearly 40% of fund managers view US CRE as the most likely source of a credit event, with an additional 22% identifying Chinese real estate as the primary threat. The turmoil has already manifested in the market, with New York Community Bancorp reducing dividends and bolstering reserves due to weakness in office and multifamily markets. German lenders with exposure to US CRE have also felt the ripple effects, with Deutsche Pfandbriefbank AG facing further downgrades following S&P Global Ratings’ assessment of its high exposure to the troubled market.
Despite these challenges, the credit market continues to attract significant inflows, shielding investors from negative scenarios. US banks are increasing purchases of mortgage-backed securities and collateralized loan obligations after years of cutbacks. Furthermore, strong demand for insurance products used for retirement funding is driving demand for corporate debt and commercial mortgage bonds.
Amid these developments, financial institutions are making strategic moves. Citigroup Inc. has appointed John Witherspoon from JPMorgan Chase & Co. to bolster its real estate investment-banking team, while Alberta Investment Management Corp. is expanding its presence in New York to enhance its private credit investing efforts. Such moves reflect the industry’s proactive response to the evolving landscape of systemic risks and market turmoil.
