In the last several weeks a few regional banks in the U.S. have made headlines by facing a financial crisis. What has not yet made headlines are the number of other banks in the system that have major issues. All in all, it appears that the banking system is sound, but to what extent has the recent turmoil reached?
Uncertainty and Credit: JPMorgan analysts have noted that there are two major concerns that could keep economists up at night: uncertainty and credit. If the population believes that the banking system is unsound, the tendency could be to cut consumption and investment—two of the pillars of GDP. This uncertainty can impact consumer confidence not only in banking but in all markets in general. Credit problems can impact both business and consumer borrowers, as the extent of such crises can cause investors to sense higher risks, and consumers to put off purchases. The lack of financing can prevent businesses from growing or from staying afloat. However, in the current banking crisis, the fall of Silicon Valley Bank, uncertainty did not spread throughout the banking system. This might be due to the brevity of it and the hearty reaction by the FDIC, and the Federal Treasury to protect depositors.
Decline in Bank Valuations: Credit issues continue, however, as bank stocks have declined by more than ten percent globally. There appears to be a connection between falling bank stock prices and the declining dollar amount of new loans, restricting revenue growth. Further, banks that have deposit outflows that exceed inflows may need to cut back on lending altogether. This condition worsens if the bank reaches the need to obtain more capital. When it becomes publicly apparent that a bank needs more capital, the uncertainty card crops up, and a bank run could materialize. One of the crucial aspects in Silicon Valley Bank’s situation was the rapid speed of withdrawals of customer deposits fueled in part by a sudden awareness made public via social media. The decline in bank valuations has impacted the growth outlook of both American and European banks, but the harder hit has come to American banks. European banks, however, have a greater share of lending in their respective economies, and any pullback in the amount of lending would have a more far-reaching effect.
Empty Office Buildings: There is a clear trend away from the daily commute to the downtown central city for work in an office building complex. The amount of flex-time, stay-at-home work has declined somewhat with the end of Covid-19, but the return to the office is not anywhere near pre-covid levels. Coupled with higher interest rates, this has impacted valuations of numerous large properties that in turn can impact the viability of the banks that own the mortgages on them. Landlords are faced with fewer rent dollars being collected and more interest dollars being paid to lenders. Add to that the fear of an impending recession that could mean employers shrinking their workforces, particularly in these downtown zones. Widespread layoffs have not occurred yet, but when they do, it might force employers to move offices out of the high rent districts to smaller facilities in the suburbs, further aggravating the landlord’s ability to make ends meet for certain downtown high-rise properties. The commercial real estate situation is not confined to downtown office space. Warehouses have proliferated in some areas, and in an increasing number of cases they are left unoccupied. But the leveraged issue is office buildings as the trend away from them is not a cyclical phenomenon that could reverse itself when the economy picks up again. Some warehouses that are empty or unoccupied can expect to see an uptick in usage as the amount of commercial activity rises.
Other Financial Burdens: Commercial properties have other financial burdens that can pressure their profitability. Property taxes do not generally fluctuate directly with the amount of occupancy, especially in the downtown high rises. Therefore, with declining occupancy landlords do not always get a break on taxes. Certain metro areas appear to be hit worse than others. San Francisco has seen rental space offering rates decline by fifteen percent since pre-covid years. This may be due in part to a high number of tech workers working remotely. The fear is that increasing numbers of property owners may be in danger of being forced to roll over their upcoming property debt with the banks into new loans with higher interest rates, exasperating their profitability and making it harder to find refinancing. The danger to banks is that they could be forced to repossess an inordinately large amount of these once blue-chip properties and subsequently sell them at large discounts for liquidation. This repossession impact by banks would amount to a repricing of most, if not all, properties in a specific area, as valuations for certain properties are often influenced by comparisons to similar local properties.
Inflation Impact: Riding high over all these other factors is the inflation impact on the entire economy. The costs of converting unused downtown office property into other commercial or residential use has been elevated with inflation. Economic setbacks owing to financial reasons and aggravated by inflation can press banks into seeking new ways to create more income that might bring about greater risk taking. Greater risk taking in the form of riskier loans with higher interest rates during times of uncertainty could wind up being disastrous for banks if the economy does fall into recession. One scenario that provides a positive impact would be local governments stepping in and offering incentives to renovate or convert properties to more needed usages. The theory is that it is not in the government’s best interest for a section of a city to become blighted with unwanted buildings of the same genre.
Conclusions: If the trend of working away from the central city high rise continues, major revamping of urban landscapes will be forthcoming. Already in Chicago just west of downtown a new residential area has been born out of empty buildings. As the demand rises, more of the same could turn up in other central cities.
Sources: Clinging On, The Economist, April 1st, 2023.