Global Banks May See Large Losses On Commercial Property: Oxford Econ

The recent bank crisis will slow global growth, but no financial crisis is expected—yet. That was the takeaway from Oxford Economics‘ recent analysis on bank liquidity issues. Global liquidity isn’t as tight as it was 14 years ago, so the global research firm doesn’t see a 2008-like event soon. However, banks still potentially face large losses related to commercial real estate exposure.

It’s Not 2008, But It’s Not Risk Free Either

Let’s start with a point the firm emphasizes—a bank failure doesn’t mean a systemic banking crisis. There are safeguards in place to mitigate fallout from the risks, and it looks like it worked. Banks have failed before 2008, and they’ll fail long after this year. It won’t trigger a global crisis every time. Recent failures sound a lot like 2008, but Oxford Econ is amongst a large group of experts that don’t see a crisis.

It’s totally different. What happened in 2008? Banks experienced a liquidity crisis. Whereas last month, banks experienced a liquidity crisis. See? Totally different. We kid. 

A lack of liquidity is at the root of the issue in both cases, but leverage sets this one apart. Adam Slater, lead economist at Oxford Economics, argues leverage isn’t as extreme today. This will give institutions more room to maneuver, preventing system-wide chokes. He notes that leverage is elevated from typical levels, so we’re not in the clear. It just isn’t so extreme the system can’t handle the issue with ease.

Source: Oxford Economics.

That said, a recession can cause damage without a global financial crisis. Credit markets are expected to tighten in response, as de-risking follows losses. High inflation adds additional pressure, preventing central banks from flooding the market with cheap money. Creating any excess demand would contribute to further inflation. Do you want the economy to be crushed by a credit contraction or rising inflation? Central bankers’ choice. 

Regardless of which tool delivers the hit to the economy, Slater sees a “serious” hurdle to growth. His firm had already forecast little to no global economic growth this year, prior to the crisis. Now their forecast models are adjusting to lower growth, with risks slanted to the downside.

Banks May Get Stuck With Losses From Falling Asset Values, Especially Commercial Property

Shadow banking, falling asset values, and commercial real estate are all lingering risks. The report warns that shadow bank exposure isn’t fully assessed at this point. As for asset values, Slater’s firm warns banks can be sitting on unrealized losses equal to 3% of assets. Add to that commercial property is down 15%, and banks have significant exposure.

For example, their research estimates US banks have US$4.5 trillion in loan and CMBS exposure. In addition, they also carry additional exposure via short-term lending to non-bank lenders. If you haven’t been following this issue, commercial real estate has been a blood bath, and it’s not just a WFH issue. 

The number of mortgage defaults aren’t high, but the size of them challenge the GDP of small countries. Slater makes mention of the PIMCO-controlled US$1.7 billion Columbia Property Trust default as one massive example. Lloyds Bank in the UK selling a defaulted property at 40% below its 2014-purchase price also makes the list of panic inducing defaults. Then there’s Blackstone’s US$563 million default in Europe. We recently discussed Blackstone’s reverse-Midas touch in commercial property markets. 

Not a lot of growth potential when the world’s largest institutions are playing defense. Once again, not every bank failure means a 2008-like financial crisis is around the corner. However, a recession can do significant damage without a financial crisis.