The Banks Are Not Okay | Top of Mind Series

All right. Bob and Ben here with the Top of Mind episode for you. Are the banks okay? Are they not okay? You've been hearing about the commercial real estate crash and banks are in trouble. Let's find out.

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All right, well, welcome back to another episode. We're very excited to Home with you with another Top of Mind. These are shorter little segments on our podcast that are sometimes reacting to different things we're reading about the economy and the market, and sometimes more educational content. And today we saw a very interesting article titled The Banks Are Not Okay, right? And hey, that's very good clickbait and It's a recurring theme that we've heard over the past, you know, really year and last year when the big issue of the bond portfolios is the interest rates were going up and skyrocketing. It really impacted the bank's balance sheets and their bond portfolios. There's a big concern, right? We saw Signature Bank, you know, have a pretty big meltdown and Silicon Valley Bank, right? These are the banks that got all the headlines and, you know, kind of died down a little bit. You know, they changed some of the methodology on reporting and the hold-to-maturity, and it kind of alleviated. But now it's coming back. Banks are not okay. And why does this matter?

Right?

I think the big question is, why do I care? Well, if you look back and we're actually sharing the screen here, you can see a little chart. This is really, really interesting on the number of assets in banks on the problem bank list. So this is from the FDIC that monitors all the banks. And at the last, you know, big recession back at the Great Financial Crisis, there were a lot of issues in real estate, but it was really a banking crisis that caused and exacerbated this whole kind of global collapse. And so the banking system is such a lifeblood of our economy. And so it's a big, big issue. So Bob, tell us about it.

It's like the plumbing of the economy. It's like the plumbing and infrastructure. So Yeah. When you really have a systemic crisis is when a real estate crisis or other fiscal crisis becomes a banking crisis because banks are the financial plumbing. And so, yeah, so we've been reading about the commercial real estate crisis and it's a big deal. You're seeing office buildings especially. I mean, they've dropped as much as 50% in value. Well, if a bank loaned 70% of the value of that thing, they're going to take massive losses. And, you know, the article we're referring to was talking about New York Community Bank, whose shares closed down 44% yesterday based on loan loss reserves from their commercial real estate portfolio. So, all right, are we looking for a, you know, is this a massive banking crisis? And, and, you know, we can cut to the chase, right? Bottom line is it's not. And so showing you here, this is, this is the little chart from the FDIC and this is their problem bank list. And these are the list of banks. Now this is a private list. The FDIC does not share the names of the banks. They only share, you know, number of banks and, and the total assets of these banks. And they do that for obvious reasons. They don't want to cause a run on the bank. They don't want to be a problem, right? But you can actually infer what those banks are, and there is an official problem banks list. But the bottom line today is there's 44 banks that are problem banks. Back in 2009, it was approaching 900 problem banks. So we're not even close. The banks are actually quite healthy and have taken, you know, have taken, you know, taken precautions to make sure that they're, they're very healthy. But what, what I did like about the article is it was, it was saying how what's really, what's, what this is going to do is it's going to cause even more restricted lending. Yeah. And it says, which reduces the available financing and makes the industry more dependent on alternative funding sources like private equity with higher financing costs than commercial banks. That's 100% true. I mean, we're actually in the market, right? We're in the debt markets all the time. You know, Ben and I and our firm. And we're absolutely seeing that. I mean, the number of deals that are coming to us to fund has just exploded. And people that are desperate for even $500,000, $1 million just to complete a project, that's kind of no-brainers, right? But they cannot get funding for these things and they're willing to pay, you know, private equity type rates. So, so we're definitely seeing, you know, while it's not— we're not in danger of this becoming a systemic crisis, We're just not, it's a, it is a credit crisis that is, you know, a liquidity crisis that is creating a huge stress in the commercial real estate market.

Right.

Yeah.

And I mean, yeah, I've shared before, my background was actually in the banking industry. I was a commercial banker underwriter for a while. And, you know, it's interesting because I continue to have a lot of relationships with bankers. We work with a lot of bankers and You know, they are kind of putting pencils down right now, but they're not holding out for— which means what?

That means they're not funding deals, right? They're just saying, I don't—

they're not putting new money out unless it's to an existing, you know, big-time borrower that they work a lot with. Maybe they'll do kind of a one-off deal. But, you know, I'm also asking, you know, how's your portfolio doing? Trying to get a, you know, inside scoop on, are you guys headed for a blowup? You know, what's, what's interesting about how banks work, which you may not understand, because this one's related to the loan loss reserve. So banks have to estimate their expected losses that they're going to incur from assets that they have to write down or that the loans that they're not going to fully collect. And that's just kind of part of their ongoing reporting. And if they underreport it and they have a big loss, well, that could impact as a surprise, which it did in this scenario. And what's really driving a lot of the concern, as you said, is the commercial real estate. But as we've talked about in many other episodes, the commercial real estate market, one, is not just one market, right? It's an amalgamation of hundreds of markets and also many different types of assets. Office kind of leads the charge on biggest hit to values and is usually what most people refer to when they're saying the commercial real estate market is in trouble. For obvious reasons, office is struggling and will likely continue to struggle. But multifamily, you know, it's a very mixed bag. Industrial, we're still pretty darn bullish on it. Retail, we're still very bullish on it, you know, and these different asset classes are going to perform very differently based on where they're at in the country and what type of product And so ultimately, you know, my expectation is we're going to see a lot of these, you know, little mini bubbles popping. You kind of coined that term mini bubble before and more in an idiosyncratic way, not kind of in a systemic, the whole system crashes, but there's pockets where there's higher concentrations, maybe at a bank with a lot of office, right? Or a lot of exposure to one certain asset class or one certain market that's getting hit pretty hard. And we're going to see some of those things start to kind of, you know, pop in the system. But it's hard to believe that it's going to be a systemic issue, especially with the data you're showing right here. I mean, the numbers— we had a little spike here in 2022, but, you know, that was really from, you know, likely Signature Bank, right? That was just kind of the assets in the problem banks spiked, but that got absorbed by, it was JP Morgan, right? And I wouldn't be shocked if we start seeing, you know, the number of banks on the problem list kind of tick up over the next few quarters because it's likely there's going to be issues, right? I think that's pretty obvious from the other things that we're seeing and reading that we shared. But I don't think it's going to spike by a factor of, you know, 10 times to the level we saw in the last financial crisis.

Yeah, it's, you know, and you know, look, commercial is under stress. There's also a lot of money sitting on the sidelines looking for these crazy good deals. So yeah, you know, again, it's not this freefall scenario where there's just no buyers and You know, a lot of people are waiting for these deals and we're just not seeing a lot of because the sellers are not yet willing to take those prices yet. So, you know, but bottom line is, you know, we're not going to see a banking crisis in 2024.

So I'll take the other side of this too. Yeah, there might be some issues of stress and I 100% agree. I think the biggest result of this is going to be banks continue to tighten, right? One, I think there's actually a portfolio constraint. I was talking with a banker just the other day. They can't lend on any more commercial real estate because their portfolio isn't paying off because interest rates are so much higher. So no one's selling. And so all the deals that they expected to be sold by now, so they had new money to lend, is still just sitting there, right? So it's kind of crazy. So this constant focus on their balance sheet.

That's a great point. So a bank has, you know, a certain percentage of its portfolio allocated to commercial real estate.

Yes.

And there's always turnover in their portfolio. So they get one of their loans gets refinanced out, they get paid off, that frees up capital to go lend somewhere else. But what's happening, because they're carrying all these historic loans at lower interest rates, the borrowers are not refinancing.

No.

So they're not getting paid off. So they're fully allocated.

So, so it's literally in our portfolio. I just sent out updates to our investors on all of our assets. We're at that point where we're kind of looking at, should we refinance? Should we sell? Well, selling right now is off the table because it's just not a good time to sell, right? The values are down and there's not a lot of buyers that are ready to move. And then refinancing, this is what's crazy to me. We, we've priced out several different properties on what a cash-out refinance would look like. And to pay interest-only loans with agency debt, that's, you know, usually lower interest rate than what you can get at regional banks and interest only, right? So you're just paying interest, not principal, is actually the same or more on a monthly payment basis than what we're paying right now on some of our amortizing loans at low interest rates. Right. And it's like, that doesn't make any sense. Right. So I'm just going to keep holding and we'll just continue to wait. I think that's what that's happening. And so you have that issue. And then on top of that, as there is more stress that starts to kind of percolate through different banks, I think that will cause a further tightening because now they're even more reticent where they previously just couldn't. Now it's even reticence on top of that. And I think that's creating this pretty incredible opportunity right now we're seeing in the private credit space, which we've talked about and have been playing in for a while. We're seeing continual deal flow where Good deals, good properties, and you can come in with pretty incredible positions in the capital stack with lower risk and charge a premium because there's no other capital available. And so really, really interesting time in the market. And hope this was interesting to you. If you're enjoying it, please subscribe and share with a friend. And thanks so much for listening. Tune into our next show. Thanks so much.