Stress among banks, commercial, residential real estate, saw biggest upticks in expected risk in Fed survey

Banking sector stress and commercial and residential real estate (CRE, RRE) showed the largest growth in anticipated risk to U.S. financial stability, according to results of a survey by the Federal Reserve of conducted earlier this year of market experts.

Contained in the Fed’s Financial Stability Report, issued late Monday, the survey results showed 56% of those surveyed — which included researchers, academics, and market contacts – cited stress in banking, exemplified by the recent failure of three, large regional banks, as a top risk. In November, in a similar survey, only 12% of the experts cited trouble among banks as a big risk.

In March, federal financial regulators closed two banks: Silicon Valley Bank of Santa Clara, Calif., and Signature Bank of New York, N.Y. Just more than a week ago, the agencies shut down First Republic Bank of San Francisco. At the core of the issues for the three banks: large amounts of uninsured deposits being withdrawn from high net-worth customers.

Meanwhile, 52% of those surveyed cited CRE and RRE as risks. In a similar survey conducted in November, only 12% of the experts said the real estate areas showed risk.

The shift toward telework in many industries has dramatically reduced demand for office space, which could lead to a correction in the values of office buildings and downtown retail properties that largely depend on office workers,” the report states . “Moreover, the rise in interest rates over the past year increases the risk that CRE mortgage borrowers will not be able to refinance their loans when the loans reach the end of their term .”

The report asserts that, with CRE valuations remaining elevated, the “magnitude of a correction in property values could be sizable and therefore could lead to credit losses by holders of CRE debt.”

As for RRE, the report stated that valuations in the sector remained elevated despite weakening activity. “A model of house price valuation based on prices relative to owners’ equivalent rent and the real 10-year Treasury yield remained near historically high levels despite having fallen somewhat in the first quarter,” the report states. “Another measure based on market rents also pointed to stretched valuations, although to a lesser extent. Similarly, while price-to-rent ratios have declined across a wide distribution of geographic areas since the November report, the median price-to-rent ratio remained above its previous peak in the mid-2000s.”

Other “salient risks” outlined in the stability report included:

  • Persistent inflation, monetary tightening with 56% of experts seeing risk (that’s down from November, when 62% rated it as a top risk).
  • S.-China relations, with 52% citing risk (up from 42% in November).
  • Russia-Ukraine war, with 52% seeing it as a top risk (down from 62% in November).

Financial Stability Report, May 2023