THIS WEEK'S
REPORT:
The BAN Report: CRE Funding Gap / The Higher New Normal / CRE Concentration by Bank Size / Boeing Boardroom Shakeup / Ohtani's Wires-3/28/24
CRE Funding Gap
PGIM this week published a report on the funding gap for CRE debt coming due this year, estimating it to be $150 billion.
Over the course of 2024, the commercial and multifamily mortgage sector is expected to face a significant increase in debt maturities, with figures set to reach $929 billion (Exhibit 1). This marks a substantial 28% rise from the $729 billion that matured in 2023, and accounts for 20% of the $4.7 trillion in outstanding debt, according to data from the Mortgage Bankers Association.
This spike, originally estimated at $658.6 billion, has been revised upward due to deferred loan repayments. The bulk of this increase is in loans held by banks and commercial mortgage-backed securities (CMBS), both of which continue to wrestle with constraints on new lending. Banks, holding nearly half (48%) of loans due in 2024, now face $440.7 billion in maturities, reflecting a 35% rise from previous estimates. Similarly, loans in CMBS, which account for 25%, now amount to $234 billion, a marked increase from earlier projections.
By property type, loans against multifamily assets continue to dominate as the single largest sector, comprising 28% of maturing loans in 2024, consistent with previous estimates. Meanwhile the office sector, which comprises 22% of this year’s volume, has seen the largest uptick from earlier estimates as it adapts to changing work patterns, rising to $206 billion. Loans associated with sectors categorized as “other,” which encompasses healthcare, hotels, and unspecified types, have also been revised up to $283.6 billion and now account for 30% of loans due in 2024 (Exhibit 2).
In short, due to extensions on loans that should have matured last year, we have a pile-up of loan maturities this year approaching $1 billion.
The challenge of refinancing the $929 billion worth of debt maturing in 2024 is that lending policies have tightened; new loan LTVs have fallen, debt service requirements are stricter, and lenders are demanding higher yields to compensate for increased risks. The combination of these factors leads to an estimated funding gap of $150 billion in 20244, with variations across property types exacerbating the situation (Exhibit 5).
The gap, defined as the delta between the maturity volume and new debt availability, is largest for the office sector. Next is loans against “other” followed by multifamily, then retail. Industrial is the only sector that does not have a funding gap. Sector-specific nuances add another $10 billion to the funding gap, bringing the total to $158.9 billion.
Commercial real estate borrowers often have substantial assets, but limited liquidity. If a borrower has say five loans coming due this year, she may only have enough liquidity to right-size one or two of those loans. The banks that right-size her loans first will be at a distinct advantage over the banks that wait. There are sources of capital out there to provide rescue capital, preferred equity, etc., but those sources need double-digit returns and borrowers will likely wait until they are forced to seek out these options.
The Higher New Normal
According to the WSJ, mortgage rates may not fall as much as expected due to widening spreads between MBS and Treasuries.
Interest rates are likely to come down later this year, with the Federal Reserve on track to start cutting rates. But mortgage rates might not follow as quickly.
That is because mortgages, and mortgage-backed bonds, just aren’t as in demand in financial markets as they were in the years before the Fed began to start to tighten in 2022. And they might not be for a while.
The extra yield over Treasurys—or spread—demanded by investors to own mortgage-backed securities issued by government-sponsored enterprises such as Fannie Mae or Freddie Mac, known as agency MBS, has come down a bit from the highs touched last year. But it still hasn’t narrowed back to historical levels. Wider spreads appear to be a new normal for the mortgage market. That in turn means homebuyers for now can expect to keep paying relatively higher rates.
The yield gap between mortgage bonds and Treasurys is still around 1.5 percentage points, according to figures compiled by Bank of America. The typical spread a few years ago was around 1 percentage point.
“There is further room for tightening spreads,” says David Finkelstein, chief executive and chief investment officer of Annaly Capital Management, a real-estate investment trust that invests in mortgage bonds and other strategies across residential mortgage finance. “But we don’t believe we’re going back to pre-2022 levels.”
One crucial driver of a new baseline is that the Fed seems increasingly unlikely to return to the market as a buyer of agency MBS. Even if the Fed does end quantitative tightening sooner than anticipated, many observers expect it to continue to allow mortgage bonds to mature or pay off and leave the balance sheet at the same pace, while adjusting how quickly the Treasurys part of the portfolio declines.
One Fed governor, Christopher Waller, said in a speech at the beginning of March that he “would like to see the Fed’s agency MBS holdings go to zero,” alongside a desire to shift the Fed’s portfolio to have a larger share of shorter-term Treasury bills.
“The historical [spread] level is from an environment in which the Fed was buying mortgages,” says Jeana Curro, head of agency MBS strategy at Bank of America. “We’ve had to recalibrate what is normal.”
Banks, too, hardly seem poised to return to big buying. There are still scars from last year’s crisis, which was sparked in part by banks sitting on piles of longer-term bonds such as agency MBS that plunged in value. Not only will banks’ investors probably discourage them from loading up on bonds, but regulators are considering measures such as higher capital and liquidity requirements that could have a similar effect.
So, unless the banks pick up the slack, there will simply be less investor appetite for Agency MBS, which means yields must be higher for the bonds in order to sell them. Consequently, underlying mortgage rates won’t fall as much.
CRE Concentration by Bank Size
Bill Moreland of Bank Regdata did some analysis of bank CRE concentration by asset size and had an interesting take.
“There seems to be a preoccupation in the media with the ratio and what it says about the Community Bank sector. Certainly, a higher ratio is indicative of possible future risk, however, I believe many are misinterpreting this table:
The conclusion here is that the larger banks are safer and the concern should be with the elevated community banks. In the video I walk through several reasons why the table may not be what we think it is. I also think we might be well served to focus on current actual problems with large bank CRE portfolios.
Several of the largest banks have serious CRE issues right now and I believe many of them are no where near being well reserved. “
In a great video, Bill walked through this further. He points out that, while the CRE concentrations are higher in the banks between $1 to $100 billion, the largest banks have more nonperforming loans. Of course, this could partly be a function that the largest banks are more aggressive with their borrowers. Another thought is the largest banks have large CRE borrowers and these borrowers are more likely to walk away from bad deals.
Nevertheless, the data is compelling. Thirty-two banks have basically two-thirds of the CRE NPLs with less than 1/3 of the CRE exposure. We have talked to multiple regional banks that, while there are seeing increased in NPAs, they are not seeing material spikes.
So, why is all of the attention on the regional banks? My theory is that short sellers have an easier time beating up the regionals than banks that are perceived as too big to fail.
Boeing Boardroom Shakeup
Embattled Boeing, perhaps the saddest company in American business, cleaned house this week and fired a lot of people.
Boeing abruptly said on Monday that it was overhauling its leadership amid its most significant safety crisis in years, announcing sweeping changes that included the departure of its chief executive, Dave Calhoun, at the end of the year.
The aircraft maker has been under mounting pressure from regulators, airlines and passengers as the company struggled to respond to the fallout from an incident in early January in which a panel blew off a Boeing 737 Max 9 plane midair during an Alaska Airlines flight.
The incident has roiled the company, considered by many to be a prized American institution, and renewed concerns about its commitment to safety and quality five years after two crashes of 737 Max 8 planes killed a total of nearly 350 people.
In addition to Mr. Calhoun’s departure, Boeing announced that Stan Deal, the head of the division that makes planes for airlines and other commercial customers, would retire immediately. He will be replaced by Stephanie Pope, Boeing’s chief operating officer, the company said in a statement.
Boeing also said that its chairman, Larry Kellner, would not stand for re-election. This weekend, the board elected Steve Mollenkopf, an electrical engineer by training and the former chief executive of Qualcomm, as its new chairman. In that role, he will lead the process of choosing Boeing’s next chief executive.
Another ex-GE executive bites the dust. To David Calhoun’s credit, he did take responsibility. In his letter to his employees, he stated that Boeing “must continue to respond to this accident with humility and complete transparency. We also must inculcate a total commitment to safety and quality at every level of our company.”
Boeing is a classic example of a large company that seems more focused on financial engineering than their product and quality control. Perhaps, instead of relocating their headquarters to DC, they should return back to Seattle and management should be closer to the engineers. If Boeing doesn’t fix things fast, they run the risk of becoming a distant second to Airbus.
Ohtani’s Wires
As MLB’s regular season starts next week, the gambling scandal involving LA Dodgers star Shohei Ohtani and his interpreter, Ippei Mizuhara, has been center stage. There are number of lingering questions, most notably, how could someone receive $4.5MM in wires without the account holder’s knowledge?
1. How were the payments made?
ESPN reported last week that at least $4.5 million in wire transfers was sent from Ohtani's bank account in California to the bookmaker. ESPN also reported that it had viewed bank information that showed Ohtani's name connected with two $500,000 payments as recently as September. Each transaction was marked as a "loan."
"We had to add a description for the wire," Mizuhara told ESPN. "I think [Bowyer] might have told me to just put 'loan.' You had to put something."
It's worth noting that Ohtani has claimed to have no knowledge of Mizuhara's gambling or gambling debts, and that he did not authorize the transfers. In turn, Ohtani and his lawyers have accused Mizuhara of committing theft, which raises another question.
2. Is it unusual for an interpreter to have access to bank accounts?
Although interpreters are often perceived as having one function -- to help the player bridge language gaps with their teammates and coaches -- many of them come to serve in greater roles for their players. That can include handling non-baseball responsibilities that grant the interpreter access to sensitive information. In this particular case, Mizuhara had been at Ohtani's side dating back through the beginning of his MLB career; it's probably fair to assume that there was a high degree of trust between the sides.
Don't take our word for it. ESPN's Daniel Kim, a former interpreter himself, tweeted about his experiences on Tuesday.
"I had to assist the players on just about every aspect of their daily lives," Kim shared. "These include: opening bank accounts, taking them to [the] DMV to get licenses, and setting up utilities. I also carried their check books on the road for clubhouse dues."
I asked the LinkedIn community of bankers on how these transfers could be made without his knowledge and the general
consensus is yes. A wire room manager from a regional bank said, “My guess is he was set up with online banking and had wire capabilities, and the interpreter used his log in and credentials and sent out the funds. Depending on security procedures built into the usage agreement, the wire could go out without secondary verification of any kind.”
Consider me a skeptic. Ohtani is now starting a $700MM contract with the Dodgers, and he was paid $42MM from his previous team. It seems hard to believe that you would not notice $4.5MM in missing funds. Moreover, if these bets were made on credit, the bookmaker presumably must have believed Ohtani was the source of the funds, not someone making less than $100K / year. Perhaps, the interpreter is taking the fall for Ohtani, knowing Ohtani has far more to lose than he does.