Could COVID-19 Cause A Banking And Commercial Real Estate Crisis?

Twelve years after the housing and mortgage markets’ collapse threw the United States into financial distress not seen since the Great Depression, market watchers are again on the lookout for a possible new banking crisis spawned by upheaval in the U.S. commercial real estate sector.

COVID-19 has caused urban flight, hollowing out cities by catalyzing the surge in working from home, shopping online and not traveling far from one’s residence. That’s been a huge blow to commercial properties of almost all descriptions.

“This is something that could make a bad situation worse,” Adam Slater, lead economist for Oxford Economics in London, told The Washington Post. “What we don’t want is to get really nasty stresses and strains in the financial system from something like this.”

What he and other concerned parties are looking at are the growing reserves that U.S. banks are setting aside to prepare for future losses on some $2 trillion in commercial real estate loans.

Adding to the problem, the Post reported, is the fact that the looming threat of bankruptcies and defaults has already caused banks to tighten lending. That’s made it more difficult for ailing commercial borrowers to access the loans and refinancing they need to weather the storm.

No Quick Fix

Even if a COVID-19 vaccine is finalized in the next few months, that wouldn’t provide immediate relief to New York City’s comatose $4 billion hotel mortgage sector, the Financial Times reported. The paper said the Big Apple’s overbuilt hotel market currently has a huge glut of vacant rooms, and four out of five properties backed by hotel mortgage bonds are showing signs of strain.

Vijay Dandapani, chief executive of the Hotel Association of New York City, told the FT that if only half of the city’s 640 hotels survive, that will be a “great” outcome.

More Than Just Hotels Are in Trouble

It’s not just tourism-related properties that are feeling the punch. The COVID-led commercial real estate crunch is also having a major impact on retail properties.

Earlier this month, the owners of two portfolios consisting of 130 shopping malls filed for bankruptcy after a spate of stores and restaurants either closed or couldn’t pay their rent.

Missouri-based commercial real estate broker John John told local media that the pandemic was the final push for a sector that had already been in a decline.

“The retail market has been under stress for several years, because of, you know, online sales and that sort of thing. And I think this has just moved it very much faster forward,” John said.

According to Statista, vacancy rates across the U.S. retail sector hit an average of 20 percent in the second quarter, up from 9 percent when 2020 began. Vacancy rates have soared as shopping malls and freestanding stores suffered a particularly heavy blow from the pandemic.

The Government’s Response

For banks, second-quarter charge-offs saw their biggest percentage increase in a decade amid a quadrupling of loan reserves.

Bank regulators and overseers have been tracking the problem since the outbreak’s onset. The Post reported that the Federal Deposit Insurance Corp. (FDIC) currently considers 356 banks to be “concentrated” in commercial real estate based on the ratio of CRE loans they hold.

The Post noted that a 2019 study that economist Pablo D’Erasmo conducted for the Philadelphia Federal Reserve found that banks exceeding the FDIC’s “concentrated” criteria are three to four times as likely to fail than those that don’t.

“In the event of another such crisis, most banks would be affected, and many might fail. … And the CRE sector remains a potential source of instability for the banking sector,” D’Erasmo wrote.

Variables factoring into what happens next include the pandemic’s eventual length, the degree to which banks can absorb losses and whether Congress approves another round of government stimulus.

But Oxford’s Slater said it’s a situation that can’t be ignored.

“Could the coronavirus crisis lead, via the commercial property sector, to long-term problems for the banking and financial systems?” Slater wrote in a recent report. “We think it is a genuine concern.”