It is nearing the first anniversary of the demise of Silicon Valley Bank and others, and the launch of a federal bank program in the US, which expires this month. As bank exposures to commercial real estate prompt awkward questions, we speak to a Swiss wealth manager about its views and positions.

"Beware the Ides of March," the soothsayer tells Julius Caesar in the eponymous Shakespeare play. And, as this month gets under way, it brings up the first anniversary of the collapse of Silicon Valley Bank and Signature Bank in the US, and the endgame of Credit Suisse in Switzerland.

So how worried should investors be about banking problems a year on, and what can they do?

Entering into the theater of worry, so to speak, is commercial property. The offices market, for example, is suffering from a large shift from office working, accelerated massively by the pandemic, and the rise in interest rates after 12 years of being on the floor.

There’s trouble brewing. Filings to the US Federal Deposit Insurance Corporation show that real estate loans have now overtaken loss reserves at a number of large US banks, highlighting the potential risk that markets could see another “SVB-style” event, or even a new subprime crisis, according to Switzerland’s Banque Eric Sturdza.

The possibility of an unforeseen, improbable “black swan” event such as a new bank failure/property crash has turned into a “gray” one, Eric Vanraes, head of fixed income asset management at the bank, told this news service.

“One year ago, just after the collapse of SVB and other regional banks, the Fed set up a Bank Term Funding Program to support some other banks if necessary. This BTFP program is supposed to end in March 2024 after one year of existence,” he said. “We hear a lot of comments around the odds of a Fed’s rate cut but I think that it is more important to follow closely Jerome Powell’s comments on the topic of BTFP.

“If it ends, as planned, it means that the Fed believes that NYCB and CRE loans are not a huge concern which could lead to a systemic risk in the banking sector.

“But if he [Powell] mentions that this program will be extended after March, this is proof that the crisis is deeper and has become a major concern. In this case, the black swan which turned already gray, will be white,” Vanraes said.

A rise in US official interest rates from zero to 5.5 per cent in the space of 18 months has hit a sector accustomed to cheap money.

“Sooner or later, you are going to have an accident,” Vanraes said.

Reflecting on the exposures of banks, Vanraes said the issue is mainly a US one, although a Japanese bank with commercial real estate loans may have problems, as might those in Germany.

A study from the Columbia Business School at the end of 2023 showed that 14 per cent of commercial real estate loans in the US were in negative equity at the end of the year.

What is to be done?
Vanraes, in his asset allocation to fixed income, had been holding high-duration paper, with some short-term paper too in a “barbell” approach with no exposures in between. “We recently decreased this strategy and started to buy five-year [US] notes,” he said.

If or when interest rates are cut, this will make the two-year sector more expensive, and quickly, so it makes more sense in valuation terms to buy the five-year sector as a more effective way of playing the shift in bond yields that is likely to come, Vanraes said.

“We are gradually increasing our exposure to the five-year area. We also buy five-year TIPs [index-linked US Treasuries],” he said, explaining that if US inflation is at, say, 2 per cent, then the yield gives more than 4 per cent – an attractive outcome for the level of risk.

New York drama
Late last week, commercial real estate lender New York Community Bancorp, which said it had discovered “material weaknesses” in the way it tracks loan risks, wrote down the value of companies acquired years ago and replaced its leadership. The stock plunged. The company expects to miss a deadline for filing an annual report as it shores up controls, reports said. The bank – a prominent lender to New York apartment landlords – acquired Signature Bank last year, which had collapsed in the same month as SVB.

The US Federal Reserve may not just try to ease conditions by cutting rates this year, Vanraes said. It could expand its balance sheet through asset purchases – quantitative easing. “There could be a liquidity crisis and the Fed may need to put liquidity back into the system. Last year in March, the Fed did a tremendous job and the cost was only $400 billion [to its balance sheet].”

If the problems seen from the likes of NYCB are idiosyncratic rather than systemic, handling this may cost the Fed’s balance sheet about $500 billion.

“Quantitative easing as a tool is not dead. It has become a conventional weapon,” he said.

Investors should remember that it took the wider financial system a decade to recover from the failure to stop the collapse of Lehman Brothers in September 2008, he said.

Central to understanding the problems of commercial property, he said, is that part of it is caused by the rise in rates, and another element comes from the shift to working from home since Covid-19.

Data suggests that worries about office occupancy rates might be overblown. The return-to-office trend gained steam in December 2023 when average visitation rates at 350 Manhattan buildings rose to 67 per cent of 2019 rates, according to the Real Estate Board of New York. This is a rise from 65 per cent in November.