Lower Interest Rates Won’t Stop This Coming Disaster

Shah Gilani|December 15, 2023

We’re in a spectacular bond market rally. It just knocked the yield on benchmark U.S. 10-year Treasurys down from 5.021% to 3.95%.

And this week, markets celebrated the news that the Fed is looking to lower interest rates next year.

But it’s much too little, much too late to save the commercial property loan market.

Lower effective rates at the fed funds level and lower yields on fixed income securities don’t translate to commercial real estate because there’s no price discovery (setting a proper price on an asset), says New York real estate finance banker Daniel Hilpert.

Lenders haven’t budged on loan terms or refinancing rates… and they aren’t going to. Banks, insurance companies and real estate investors are afraid valuations have further to fall, so they’re pricing in a significant cushion for themselves on any deals they’re considering.

Office properties aren’t selling… because lenders would realize losses if they sold at today’s severely depressed prices.

Wells Fargo is a good example.

The bank is one of the nation’s largest commercial property lenders. It saw its past-due commercial property loans rise by more than 50% to $3.4 billion in the third quarter. That’s up from $400 million a year ago.

But Wells Fargo hasn’t forced many borrowers into default because selling busted loans or vacant, abandoned properties at big losses would severely impact the bank’s earnings.

But this hoary “extend and pretend” game that Wells Fargo and other banks are playing won’t last much longer.

Noting that Wells Fargo wrote off a tiny $91 million in commercial real estate loans in the third quarter, Mike Santomassimo, the bank’s chief financial officer, said, “We haven’t really seen any losses of significance yet, but we will.”

The frightening truth is that banks can delay the inevitable for only so long.

Rising delinquency rates will start forcing their hands in the first quarter of 2024.

The volume of past-due loans jumped 30% in the third quarter, according to industry tracker BankRegData.

Things are getting worse.

Leo Huang, head of commercial debt at Ellington Management Group, says, “Loan delinquencies are going to keep going up.”

And as delinquencies pile up, prices are sure to plummet.

Chris Whalen, head of Whalen Global Advisors, says if banks take back buildings, “Values can get cut in half.”

I’ve been warning investors that a commercial real estate reckoning is coming.

A 100-basis-point drop in interest rates won’t make an iota of a difference.

You’ve been warned.

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