More Regional Banks May Fail as Commercial Real Estate Loans Struggle, Warns Pimco

Pimco, a leading investment management firm, is sounding the alarm about the growing troubles in the US commercial real estate sector, according to a new report out from Bloomberg.

The company believes that more regional banks could fail due to their heavy exposure to problematic commercial real estate loans.

John Murray, who leads Pimco’s global private commercial real estate team, said, “The real wave of distress is just starting” for lenders in this sector.

High borrowing costs and uncertainty about when the Federal Reserve will lower interest rates have caused property values to drop and defaults to rise.

As a result, lenders are stuck with assets that are hard to sell. Murray shared that his team has been buying commercial real estate loans from large US banks for the past year and a half.

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Regional banks are especially at risk because they increased their involvement in commercial real estate in recent years.

A March report by MSCI Real Assets pointed out that regional banks were the only lenders that didn’t require extra down payments from commercial property borrowers, making them more vulnerable to falling values.

The failure of several regional banks last year has kept investors on edge.

Even US Bancorp, the biggest regional bank, increased its provisions for credit losses to $553 million in the first quarter of this year.

While larger banks are not expected to collapse due to their reduced commercial real estate lending after the 2008 crisis, they are still lending less than they did in 2021 and 2022 because borrowers are having trouble repaying their loans.

Mortgage real estate investment trusts (REITs) are also facing their own challenges, which limits their ability to make new investments.

For example, Starwood Real Estate Income Trust recently made it harder for shareholders to pull out their money to maintain liquidity and avoid selling assets.

Meanwhile, Blackstone Inc.’s $59 billion property trust saw an increase in withdrawal requests.

According to Murray, lending volumes for major public mortgage REITs have dropped by 70% compared to 2021 levels.

Another worry is the more than $200 billion in loans made by US debt funds that will come due through 2025.

Many of these loans were made during the peak pricing period of 2021, often with a three-year term and a three-year rate cap. “The first catalyst for stress at the asset level is occurring right now, as assets will struggle to meet extension tests in this higher rate environment,” Murray said.

Pimco is also keeping an eye on how German banks handle their commercial real estate exposure.

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Murray summed up the situation, saying, “The combination of rising rates plus recessionary pressures creates real challenges for commercial real estate, from both a capital markets and fundamentals perspective.”