(Bloomberg) — U.S. Treasury yields have risen since the end of last year, and the risk of commercial real estate trouble is once again weighing on the balance sheets of regional banks.
Most read by Bloomberg
Stocks are already reacting to higher borrowing costs. Shares of smaller banks have fallen about 8.2% since the end of November after the yield on 10-year bonds started to rise. The default risk for borrowers who bought office buildings before the pandemic sent values plummeting also increases when the cost of loans rises.
“Rising long-term yields certainly leave the banking system more fragile in the short term, although more profitable in the baseline economic scenario,” said Steven Kelly, associate director of research at the Yale Program on Financial Stability.
A rise in 10-year yields last year likely reversed most of the decline in unrealized losses on banks’ available-for-sale securities held to maturity in the third quarter, Federal Deposit Insurance Corporation President Martin Gruenberg said in a Dec. 12 speech. Even after rising last week following better-than-expected inflation data, the benchmark has since risen about 0.3 percentage points to around 4.58%, adding to the pain for lenders.
If borrowing benchmarks remain high, regional banks risk greater losses on commercial real estate because borrowers will have trouble refinancing, said Tomasz Piskorski, professor of finance and real estate at Columbia Business School. He and fellow researchers estimate that about 14% of the $3 trillion in US CRE loans are underwater, rising to 44% for offices.
Click here to listen to the Credit Edge podcast
Smaller lenders are more vulnerable to CRE defaults after demanding lower down payments from borrowers than their larger counterparts ahead of interest rate hikes starting in 2022. Now that office and multifamily values have fallen, lenders have less buffer before absorbing losses.
The office market has not yet stabilized “so we remain concerned and well-booked,” PNC Financial Service Group Chief Executive Officer Bill Demchak said during this week’s earnings call. The bank increased the reserves it set aside to cover bad office loans to 13.3%, up from 8.7% at the end of 2023, although this is a small share of their overall book.
On the positive side, the drop in the cost of deposits, thanks to lower federal funds rates, is helping stability. Steady deposit flows in the fourth quarter suggest there is little prospect that they could be quickly shifted to other banks, reducing the risk that lenders will have to sell hidden bonds. Duration risk also decreases as securities approach maturity.
For now, “investors are a little less concerned about unrealized losses, because it doesn’t look like there will be a forced sale like there was with the Silicon Valley bank,” said Scott Hildenbrand, head of fixed income deposits at Piper Sandler.
Terry McEvoy, banking analyst at Stephens Inc., agrees. The company has met with at least 30 bank investors in recent days and it was not a major area of discussion or concern, he said. The incoming Trump administration could also boost bank margins through deregulation, said Columbia Business School’s Piskorski.
Still, with borrowing benchmarks rising even as the Fed cuts interest rates, “we’re entering a very precarious position” and “instead of escaping this area of bank fragility, we’re moving into an increasingly larger area of bank fragility,” Piskorski said. .
Overview of the week
Six of the largest US banks issued corporate bonds or senior bonds this week, following the announcement of results. Issuance could rise in the coming sessions thanks to falling yields, after an inflation report implied that price increases could come under control.
It’s never been cheaper to trade corporate bonds, thanks to the boom in electronic trading that allows a wider range of investors to buy and sell large amounts of securities faster and more efficiently.
The first loan of the year to finance the leveraged buyout came Thursday, with JPMorgan Chase & Co. backed Silver Lake Management’s purchase of Endeavor Group Holdings Inc., a talent agency and controlling investor in WWE and the Ultimate Fighting Championship.
China Vanke Co. has rebounded from record lows in credit markets, as the struggling entrepreneur previously told some creditors it had enough cash lined up to pay off a local bond, people familiar with the matter said.
Recurring corporate bankruptcies in the US are happening at their fastest pace since 2020, as some companies still can’t recover even after debt relief.
Software manufacturer Databricks Inc. received more than $5 billion in financing from lenders including Blackstone Inc., Apollo Global Management Inc. and Blue Owl Capital Inc. in its largest debt increase to date.
At least eight large ailing Chinese companies, including a unit of China Evergrande Group, are set to defend themselves in court proceedings related to their debt problems over the next two weeks, in one of the busiest periods ever for such hearings.
Blackstone’s flagship private equity fund pulled a planned $500 million investment-grade bond sale that was expected to price on Tuesday due to administrative delays.
Goldman Sachs Group Inc. pulled out of a $1 billion deal to help Ecuador refinance its debt, citing internal risk management controls.
Creditors of Altice France are demanding the return of mixed assets and the right to vote in future board appointments as part of negotiations with the company over its 23.7 billion euro ($24.4 billion) debt pile.
Prospect Medical Holdings Inc., a once active buyer of cash-strapped hospitals, has filed for bankruptcy after struggling with debt piles and huge expenses.
On the go
Paul Goldschmid, who was one of the longest-serving partners at King Street Capital Management before leaving the $26 billion hedge fund last year, announced on LinkedIn the launch of his own long/short lending firm, Harvey Capital Partners.
Goldman Sachs Group Inc. promoted several key executives and merged teams to form the capital solutions group, a move that recognizes the growing importance of private markets. Pete Lyon, global head of the financial institutions group and financial and strategic investors group, and Mahesh Saireddy, global head of mortgage and structured products, will lead the new group.
Lloyds Bank has appointed James Brown as managing director, head of syndicated finance, leveraged finance and project finance. Brown joins from Mizuho in London where he led the debt capital markets business for five years.
Ares Management Corp. promoted financial industry veteran Kevin Alexander as co-head of Alternative Credit. He will work alongside current co-chairs Keith Ashton and Joel Holsinger.
Banco Bilbao Vizcaya Argentaria SA hired UBS Group AG’s head of structured credit and sustainable credit products for the Americas, Estanislao Fidelholtz, as managing director and head of the credit solutions structuring team in the US.
Man Group has consolidated its European and US CLO groups into a global syndicated loan business. Portfolio managers Joshua Cringle and Jonathan Newman will lead the new US-based platform with CLO issuance capacity.
Credit investor SC Lowy Financial HK Ltd. has laid off several staff members, according to the firm’s chief executive officer, as the firm pivots away from trading public securities and toward private loans.
