Commercial real estate defaults, a banking crisis reoccurrence? Barclays: The risks of individual cases have been overestimated.

Last week, New York Community Bancorp suddenly suffered a major loss in performance due to bad debts in commercial real estate loans, causing its stock price to plummet and the market to panic. Concerns arose that NYCB's situation could indicate a repeat of last year's "SVB Financial crisis" in regional banks.

However, Barclays strategist Ajay Rajadhyaksha and his team believe that the market's reaction is excessive, and that NYCB is just an isolated case and will not evolve into a crisis for the entire industry.

NYCB's exposure to residential mortgages is not the same as office buildings

Many analyses point out that with the prevalence of remote work after the pandemic, the vacancy rate of office buildings in the United States has continued to rise, leading to a sharp decline in expected returns on commercial real estate, making commercial real estate loans a hidden threat in the US banking industry.

Barclays points out that NYCB's situation is different. Although 44% of the bank's assets are commercial real estate loans, about four times higher than its peers, over one-third of these loans are multi-family apartments, totaling approximately $37 billion.

Multi-family apartments, as residential buildings, are not affected by the work-from-home culture. However, compared to the peak of the US housing market during the pandemic, the market has relatively softened, with prices falling 20% from the peak at the end of 2022, and returns being squeezed due to rising interest rates.

But Barclays emphasizes that from a fundamental perspective, office buildings are facing a structural transformation. A significant proportion of Americans are working from home, and the vacancy rate of office buildings has already exceeded the level during the global financial crisis. Office buildings are not easily repurposed, and when the demand for office space shrinks, owners have almost no choice but to exit if the expected returns decline and the rent is insufficient to cover the loans.

On the other hand, the current situation of multi-family apartments remains robust. Compared to pre-pandemic levels, multi-family apartment rents have increased by 20%, and the vacancy rate is roughly the same. This means that unlike office buildings, there is no risk of vacancy in apartment buildings. Even though the pace of rent growth has slowed down, it is still increasing overall.

In addition, NYCB faces another unique situation - the bank's multi-family apartment loans are mainly concentrated in Manhattan, New York, and more than half of them are subject to rent control. Rent control means that landlords cannot freely raise rents to offset the rising interest rates. However, this is a problem limited to a few areas such as New York.

The analysts wrote:

Based on the loan performance of Fannie Mae small balance transactions, we estimate that the delinquency rate for rent-controlled properties in New York is 9%, while the delinquency rate for market-rate apartments is 1%. Most states in the United States do not have (or allow) any form of rent control, but it does exist in some states, including large states such as New York and California. However, New York's laws are the strictest, so we believe this is a highly localized issue.

The multi-family housing market is currently facing temporary difficulties, but there won't be major issues

Barclays emphasizes that there is another major difference between the multi-family housing loan market and the office building loan market - government entities' participation, which provides counter-cyclical funding sources for the multi-family housing loan market.

In the United States as a whole, the commercial real estate loan market is worth $5.6 trillion, with multi-family housing being the largest component, exceeding $2 trillion. Of this, approximately $1.2 trillion is guaranteed by government-sponsored entities such as Fannie Mae, Freddie Mac, and Ginnie Mae. The remaining credit risk outside of government guarantees is about $1 trillion, with approximately $700 billion within banks and the rest shared by bond investors, insurance companies, and mortgage real estate investment trusts.

Overall, analysts believe that in recent years, a large number of multi-family residential apartments have been built, intensifying market competition and leading to an increase in vacancy rates. Cash flow growth for multi-family housing this year may remain flat or even experience negative growth.

However, this market has not undergone a structural transformation similar to that of office buildings, and cash flow remains relatively stable. Considering that the Federal Reserve may shift towards easing this year, multi-family housing owners are more likely to overcome short-term pressures.

The bank believes that in the worst-case scenario, the cumulative losses of the US banking system on multi-family housing loans would be around $45-50 billion, which has a very small macro impact. Therefore, the downside risk of multi-family housing loans to the US economy and financial system is manageable.

Barclays also added that last week, the Japanese Aozora Bank, which also suffered from bad debt performance in the US commercial real estate sector, has a very different situation from NYCB. Due to the low transparency of the US commercial real estate market, it is currently unclear whether the risks faced by Aozora Bank involve US multi-family housing loans. Barclays believes that Aozora Bank is likely involved in office building loans.