Hello, and welcome to another episode of the Odd Lots Podcast. I'm Joe Wisenthal and I'm Tracy Alway. Tracy, there's two things that people well, there's all kinds that thinks people are like very attuned to these days. But I would say what's going on with regional banks has obviously become a huge focus, you know, with the collapse of Silicon
Valley Bank. And then what is going on with a commercial real estate We talked about that recently, and everyone knows like the office woes that are hitting major cities like New York. Two things that are like top of mind for many people. Well, and I think they started out sort of separate to each other because there were concerns about commercial real estate even before Silicon Valley Bank
went bust. But since then, and since we've had the turmoil in the banking sector, the posit flight, there is a concern that that is going to also start affecting the CRI outlook. And basically these two things are impacting each other and compounding each other at the same time, because of course regional banks have quite substantial exposure to commercial real estate, right so that was the interesting thing about SVB specifically, which is that there seemed to be
many problems there, but one thing it was not. It did not really seem to be about the credit quality of the assets. Is a rate story, is a deposit concentration story, but it wasn't about like, oh, they have some sort of like asset side exposure, just something troubled.
But then, as you point out correctly in the immediate way, a bunch of people like sort of stuck up their fingers like, oh, by the way, guys like these regional banks you're right about, they also are like sort of like disproportionately the funders of Yeah, well this is it. So there's two things here. So one, there's concern about the commercial real estate loans that some of these smaller regional banks hold. Are those actually going to default? Are
they going to come distressed in some way? Are they going to be able to refinance them in the current environment. And then secondly, as you get the stress in the banking system as you see deposits pulled from smaller banks, are they still going to be able to pour money into that sector? And those two things are sort of impacting each other. They go in both directions. As you as you sort of clarify there. And I think the other thing too, is like, you know, people like doom.
I mean I don't, but you know what I'm saying, Like people still like this is the exact type of thing that gets people going, and people post all these charts that most people you know, like don't aren't really an equipped to understand, including myself, Like, I don't really know. I'm a novice on this stuff, and so I think it's kind of important, like let's sort of get real, let's put some numbers and like how big of a
deal is this? Because there is a lot of like, oh, you know people, right, and I think people here, this is a twenty trillion dollar market and they think, oh, this is a very big deal. But of course, as we spoke about in a relatively recent episode with Rich Hill, it's not a monolithic market and a multi family you know, residential development is different to an office building in downtown New York that might be empty now. And also, you know, a big bank is going to have a different risk
profile to the sector than a smaller regional bank. So yeah, it's important to dive into the details. Yeah, totally. And you know there's office which we all know, because you could just pull up like a chart of like a big office rate like a tornado or something, and then there's medical would probably fine, and there's all the different categories.
So we really need to give in the interest. We really need to dive sort of like deeper into like, all right, let's talk about some of these exposures, let's talk about these relationships. Let's get some real numbers rather than just let's get granular, baby, let's get granular. All right, Well, we have the perfect guest to speak about this. We're going to be speaking to Jim Castillo, chief economist over
at msci's real Assets team. He was recommended to us by our recent guest, Ben Carlos type, and he said, this is the guy you wanted to talk about. That was a really good episode on New York City Residential. So I always love it when the guest recommends another guest, so that's usually a good sign. Jim, thank you so much for coming on. Odd Lots. Hey, great to be here.
Let's just start with the sort of like key question that I see frequently asserted, which is that regional banks have more exposure to commercial real estate as a share of their assets than the big banks. Is this just like, is this a fact? And what does that mean? The thing that people have been highlighting is the fact that regional banks are a bigger share of bank lending to commercial real estate, and they've been taking that as a sign that maybe these regional banks are more of a
problem for commercial real estate than anything else. The challenges People are looking at the FED flow of funds number in a funny way, the FED flow of funds date dabase. It's a fantastic thing. There's a lot to dig into there, but if you're not careful, you can look at the wrong figures and people get hung up on the bank lending. But banks are not everything in the commercial real estate
lending world. Banks we have our own approach to getting at the lending universe, kind of working from the ground up, from every transaction and every building that's sold and figuring out who made the loan. From twenty fifteen to twenty nineteen, about forty eight percent of all commercial real estate loans in the university properties two point five million and greater that was in the banking realm, So already forty eight percent in the banking realm, and of that maybe sixty
percent was the local and regional banks. Now there's a difference there ten percent and sixty percent and seventy percent. There's a ten percent difference. And part of that comes into we're only tracking everything two point five million up the institutional universe. If you have a former gas station and two below Mississippi that's been converted to a barbecue shack, we're not tracking that. Okay, no institutional investor is really
interested in that kind of property. The FED from a regulatory standpoint, they have to think about all capital flows, so they're looking at everything that goes in there. But the key point is you can't just look at the banks. You have to look at the life insurance companies. You have to look at the debt funds, you have to
look at the CMBs, market clos everything. Right, So just on this point, maybe we can back up a bit and talk about what exactly the concern is here, because my impression is before the collapse of SVB, a lot of it was, well, these commercial real estate loans, you know, whether they're unsecured or secured via CMBs, there's a concern that they're going to be in trouble. They aren't going
to be able to refinance, they might default banks. I'd take your point about life insurers and other big investors, but there are a lot of banks who are heavily invested in CMBs. And then at the same time, now the concern seems to be that with the recent turmoil in deposits its, maybe banks start to tighten their lending standards. Maybe that cuts off some financing for commercial real estate. And so you have that aspect of it too. But what exactly is the worry here? Yeah, and banks have
been tightening their standards over the last three quarters. You look at the Fed's survey of senior loan officers, they're all getting more cautious even before the news NSCUB hit. And you know, Jay Pal's been saying that with this event, maybe they don't need to tighten as much because this is this turmoil is creating a little bit more constraint in the credit markets. That is helping them to limit
the kind of exhumert activity that was underway. Banks. We'll do it naturally, right, right, But it's a circular issue. If and the issue that we faced during the financial crisis was that you had cashline assets that couldn't get refinanced because lenders were afraid to issue a new loan, and so if somebody had to buy it, it was now available in a much lower price, which then got into the market data, and then the lenders see, oh well, prices are falling out want to be even more restrictive.
And it was a vicious downward spiral until all the federal regulators stepped in and put a floor under that negative decline. So that was the safety net that to put a floor under prices. But this time you have that dynamic and play to some degree with pressure on prices to fall. They have been falling recently, and it lenders becoming more restrictive when they do originate alane. It's
at lower LTVs than before, at higher interest rates. So you're not able to get the same kind of return expectation out of investment if you do that, which limits deal activity, which pushes volume down. So it is a little bit different than the two thousand and eight situation though, and this is the key thing every downturn that I've
been working through. There's this human behavior to always try and fight the last war, look at the last bad event, and you're looking at it that well, here's what happened. So I got to look out for those same things here, but conversely not just look out for the same bad things. A lot of the the estate people I talked to are looking for the best opportunities that come out of it.
Out of every downturn, everybody's always tried to use the playbook of the person who made money in the last downturn, and everybody wanted to be sam'zell for a bit, but there's only one Sam's Ll everybody wanted. At the beginning of the COVID crisis, they thought that we would have another downturn, just like the global financial crisis, and so buying all the distress debt like before was exactly the same way to make money. They were wrong then, too,
because there was different factors at play this time. There are some things at rhyme with the financial crisis, but going in we're in a much healthier place. We had loans that were being originated at more conservative terms than before. You know, it's not like, you know, you have all these toxic loans that were being made. The only challenge is that rates have gone up so much that things we're able to finance before they're going to have to
do something else when it comes up for refinancing. All right, I have a ton of questions, but to start off, like when it comes to the financing of commercial real estate, and I want to get into like the breadth that is commercial real estate and that it's not just like
office buildings in New York City. But when it comes to the financing of commercial real estate generally, is there something about the business model of the small slash regional banks that makes them more natural sources of financing to these projects than some of the you know, the really big two big to fail banks. There is regulatory shopping in the financial world, Okay. You have groups like the debt funds that they're really only regulated at the level
of the sec when they're raising capital. You know, they're making a private loan. There's no state bank regulator, no insurance regulator. You know, they're just doing their own thing. The local banks they don't have the same kind of restrictions placed on them as the large national banks. And
over time some of the restrictions have been eased a bit. Yeah, I know some banks have explicitly tried to keep their book a business below a certain levels so they don't get that regulatory burden because you know then there's extra costs that go into it, and just the administrative cost starts to rise at an exponential pace once you get
above a certain threshold level for those regulatory burdens. And really since around twenty fifteen when there were some tightening up of those standards and for the larger banks, the smaller banks started to gain more share of all the bank lending activity. There's a slight I've version, but I
actually am really curious about those administrative costs. You says they rise exponentially, and so I am curious, like what happened when a bank flips over to that larger size and they all want to avoid it and SVB tried to avoid getting these sort of larger designations, etc. But like what actually does happen internally in terms of the regulatory obligations and how that sort of changes the way the bank must operate at that point they have to hire a lot more risk management people and do a
lot more work on scenario planning around what happens to different FED scenarios that the FED will publish around the economy and potential changes to asset prices, not just in real estate, but other sectors, and it's a big administrative burden.
Some of the bank managers that I talked to, the presidents of some of these small local banks, you know, they've noted that when they were hiring during the aftermath of the financial crisis, they felt bad that they were hiring more were administrative workers then loan officers, not the folks who are going out and producing money for them.
And their worry was, if I go above that threshold, I'm gonna have to hire a lot more administrative folks to do all the CCR testing that they were talking about back in the day and run all these different scenarios and just more compliance people. Got it. And so if you're hiring a third of your people were in compliance and not income producing, you're going to try and
avoid that. Also, if you get really big, I think you start to get regulators who are situated on site in your bank right just to kind of monitor how things are going. You know, I don't know about that. I do know I was visiting one client once and all of a sudden, regulators came in sort of an announcement that morning they were coming in, and the atmosphere
in the place was suddenly very tense. So just on this regulation, no shit, It is true that commercial real estate has been on regulators radars collective radars as a source of potential risk for some time. What exactly was the concern there and can you kind of give us a quick synopsis of how that regulation has changed over the past few years. Well, in twenty fifteen, that was
a watershed for certain types of loans. The high volatility Commercial real Estate regulations came in HVC, so that the loans with shorter terms lenders had to hold more capital and reserve. So suddenly it became more expensive to originate loans like that. Construction lending was dead center for that activity because those are typically short term loans that just pay out very quickly once the construction projects done. And
we saw a distinct move in construction financing there. It used to be something like seventy percent of construction financing was bank driven, and that really declined to debt funds who didn't face any of that kind of regulatory burden. They really stepped into that and started originating more construction loans. Banks are still the question number too. Yeah, Like so it was seventy percent what's it done too, it's my recollection. It was like fifty two percent recently, so it's still
a majority bank financing. But the debt funds really aid into that business. And they know. Some of these lenders. When I talk with them, they complained about their competitors, how they're just so aggressive compared to them. And they kind of lifted the market in this period from twenty fifteen to twenty nineteen because they were originating loans at much higher LTVs, much lower interest rates, and with very few covenants out there, because they were underwriting differently than
banks banks. They underwrite a loan wanting to avoid in a foreclosure situation. They want to avoid what you call in the industry r EO, not the band, but you know r EO the real estate owned situation. They want to avoid that because you know, if I'm a big bank, what do I know about running an apart building? What do I know about managing an office building? I'd rather have the experts take care of that and I just collect a nice, stable yield. So I want to underwright
to avoid that. So I'll put covenants in there to make sure that if occupancy flow falls below a certain level, that there are scrapes of any revenue, so I make sure that I'm whole. So they put those kind of things in there. The debt funds they didn't do any of that because the debt funds a lot of them started as equity shops that have their own investments and own management in place, and you know, they viewed it
as an opportunity. It might be a situation where I have either any stable yield and I can help my investors that way. But if I had the tell situation where there's a foreclosure, I have this equity management shop on the side. I can just take the property to lower basis than before, and I know how to run a property and I could probably do it better than those people who were coming to me for a loan. So I'll put it into that shop and raise some
capital to stabilize that and I'll be good. So it's a different behavior, and it's you know, those were the folks who are the most aggressive and did some of the larger loans in that period of twenty twenty twenty twenty one when interest rates for so low, and typically they had short terms as well, So we have a wall of maturities coming in twenty twenty three through twenty twenty five, and those aggressive loans are the ones that
I think are going to see the most attention. This was exactly what my next question was going to be. But talk to us about what the maturity wall actually looks like at this point in time, because again, this is where a lot of the worry is stemming from, this idea that you have the sort of frontloaded wall that is coming due in the next year or two. And how are banks slash private investors to your point,
going to actually be able to refinance those loans. The originators of loans for them, their ability to refinance, you know, they have a certain cost of capital. They'll offer a bour Okay, we can refinance a loan, but it's at a lower LTV than before. The rate is higher. And if somebody bought a property back in twenty thirteen and the loan matures in twenty twenty three, you've had a
tremendous amount of price growth along the way. Even though we've had some price declines recently, there's probably still enough that they might be able to refinance that at a higher rate and keep that alive, assuming that you don't have a problem on income. I'm gonna put that to the side for the moment because that's another challenge. But
just dealing with one challenge at a time here. Yeah, So, if you had a long term loan you're refinancing, Yeah, maybe you're not going to get the same proceeds as before,
but you might be okay. But if you had a loan that was originated in twenty twenty one, when we saw a record low interest rate environment and you had a very high LTV and a record low interest rate thinking that game would continue forever, you may have a bad day as you try to get that refinance because you're going to go to a lender who will offer you money, but it's going to be in a very low LTV comparative before and with a mortgage rate closer
to a seven percent than a three and a half percent, and so the numbers may not work for those folks and they're gonna have to have You know, there's three
options for some of these folks. Maybe it could do a cash in refinancing where they bring more equity to the table themselves in their own pocket, and they might want to do that just so they don't end up in a default situation if the property, if they still have an expectation of price growth ahead or income growth, or there's still some fees that make them whole and you know, they think of as a brand new investment at that point, or maybe they get some outside investor
to bring that cash in a preferred equity situation and that person gets some of the upside of the project moving forward, so that you the investor can at least still collect some fees on the project. And then another opportunity is to literally hand the keys over to the lender a jingle mail. I know we're making the point about how this might not be two thousand and eight, but these are all very oh eight type terms real estate owned and jingle Yeah, just in a different context.
But I wanted to you know, you mentioned setting aside the income question because we've been talking about raids, we've been talking about price appreciation. Can you break down like where is their income stress? Where is there not income stress within the commercial real estate world, and how are you thinking about that particular aspect of it right now? Yeah, the income stress is a bit of a challenge and there still is a lot of uncertainty around it. Let's
start with offices. You're saying earlier, Hey, everything's not Manhattan's offices, but let's talk about Manhattan. Okay, yeah, please. It's Wednesday today when we happen to be recording walking around the city. There's more people out today because it's a Wednesday, that's when more people are around. But if you're around on a Monday or Friday, it's usually pretty empty. And you know, so people see that and they see that, hey, there
are less people coming in. The subway ridership is at like sixty five per sent to the previous peak levels, so obviously the space is being utilized less. That said, the fiscal side of it, you know, the fiscal occupancy, the tenants who are still on the hook for the space.
There still is some good occupancy in that direction. You know, there's a lot of sublet space where firms are signaling that they want to get rid of it, but they still are pain and so there's a short term challenge that everyone knows that there's going to be a reduction to demand eventually, but right now there's still some income coming in, and so there's that there's a term in the industry walt weighted average least term and if you have a property that has a very long least term ahead,
even if people aren't using it as much. If you have some high quality tenants who are unlikely to default, that might seem like a safe investment. But if I've got a tenant who has one year left on the lease and I see that the building is half empty most days, I'm going to be concerned about what happens to income. They're moving forward, so it's a slow motion thing.
You know, everybody sees the direction it's going. That's one of the things about real estate forget about you know, I used to work with a bunch of economists in Boston. There's a lot of complex math we did, but forget about it all that the real estate market, there's all these sticky things. You just count the number of cranes and you can see whether you're going to have some construction challenges ahead. You just look at the number of people walking into a building and you can just get
a sense of what the potential demand is. All those kind of rule of thumb measures have been telling people that there's going to be some sort of reduction in demand, and we know that's coming, but nobody's really been able to fully quantify it yet it's something we just have to live through over the next few years before we see all the leases burn off. All right, but that was great. But what about the non Manhattan office? Yeah? And two, I guess sort of two interrelated questions. But
like Ridge Hill, the number he'side was twenty trillion. But when we think about that twenty and how much is this sort of like prime city office that might not ever come back to pre COVID levels. And then can you talk a little bit more about like are there other these other areas, medical, etc. Are they doing fine in terms of like income and income expectations. There's a
couple of things that are digests there. Yeah, the office market, most of the US office market is a suburban market, Okay, And that goes back to the nineteen seventies and nineteen eighties when we saw a surge in construction in those areas.
And it's not just suburban New York. A lot of it is the development of the sun Belt states and as they entered the modern economy in that time and became service sector economies as opposed to agriculture and manufacturing, those office buildings in those areas they do constitute a large part of the office market Manhattan off top of head, I think it's about forty percent of all CBD office based in the United States. So that's why people like
to focus someone Happen because it's pretty significant. It's an indicator of where the whole c D office market is going nationally. But you know, that suburban market is a bigger market overall, and it's been bigger in terms of the deal vium recently, the last really since twenty fifteen, when the Chinese investors pulled back from investing in the US deal. Vilume fell off for the CBD locations, and the past had always been sort of half and half.
Half of all investment was in suburbs, half of all investment was in CBD locations, and that really started to turn a corner then when the prices hit a record low, and you know, there was just a very little upside left. So there's been a lot less transaction activity than the CBD locations even before all the central business essentially yeah sorry, yeah,
and so there's been a decline ever since. So it's it has been important, but it had been priced perfection back around twenty fifteen, so there Wasn't you know that that same push to continue to invest in it as
there had been for more suburban locations. I want to go back to what you were talking about when it comes to income deterioration and waltz, so you know, the weighted average lease terms and things like that, is the implication that the old extended pretend strategy, which you know, another blast from the past from two thousand and eight and the years after that, is the implication that that just won't work in the current environment, that at some
point you're not going to be able to refinance, or there will be some sort of catalyst on the income side that makes it impossible. Yeah, that is a good distinction. The extended pretend it worked for a simple reason. Everybody understood it was a temporary credit market challenge. You had otherwise cash flown properties, and if you know, the credit markets simply stabilized. Given that the some high quality cash flow,
you'd be able to refinance at reasonable rates. In fact, the folks who made a lot of money into the recovery period where folks who came in took buildings that were otherwise cash flowing, just with bad debt situations reposition the debt, put an appropriate debt structure in there, and then ride the wave of recovery as a debt market stabilized. This time through, you don't have that same opportunity of healthy cash flowing properties. You see properties that have uncertainty
around the income moving forward. So it's just not going to work out the same way we track distressed asset cells, and we don't have a lot of distressed asset cells yet. Again, everybody kind of sees this coming, but it's a slow moving, sticky market, and everybody knows there's some distress cells coming,
but it hasn't hit in a meaningful way yet. But when we do see some of the distress cells, when we disaggregate who was buying, it's a different type of buyer of the distress we've seen so far compared to the aftermath of the financial crisis. The aftermath of the financial crisis, there's a bunch of suits from New York, from private equity firms flying out to cities across the United States buying up these cash flowing assets, you know, repositioning the debt and flying home and just you know,
collecting a big get. Absolutely, and everybody sees that and thinks, Hey, I'm gonna be just like those folks this cycle. But the folks who have been buying these properties so far are local developer, owner operator types. It's people know how to swing a hammer. And that tells me that the distress is really more fundamental distress. It's not a cash flowing building in Nashville with a high quality credit tenant. It's a dead mall outside of Columbus with burnt orange
tile and brown carpet from the seventies. And you know, somebody has to reposition that, and it's going to take somebody who has relationships with local regulators. Every zoning board wants to get their hands involved in that to be able to change the use and bring it into the modern economy again. And so that takes a lot of elbow grease, both literally from the physical side and then figuratively just talking with local zoning boards and getting changes
and entitlements and land use regulation. There's a cre guy I follow on Twitter who goes by the handle repositioning play. That's what that means. It just clicked to me that that's what that means. That it's like some malls like, oh, maybe this could be like residential or maybe this could be like a big paintball sort of like thing. But that's what that means that you have to identify the
opportunity to like make it something other than it was. Yeah, and with those malls, a lot of malls that are positioned well relative to transit opportunities, yeah, for highways, and so some of them would be great for logistics and local distribution activity. However, that flies in the face of local zoning issues where you know, local city leaders feel that it's too beneath them. It's not bougie, it's not a consumption area. Plus, you know, we're not a low
class industrial town. We want them all we want, we want blooming deals because you know, we're high end. But they you know, the reality is the market doesn't believe that, and it's going to take a long time to get some local city leaders to kind of understand where they really sit. But there's another issue that in many states we have that those local city leaders want the retail because it generates more tax revenue without them having to
tax residents as much. And so that that's the other reason that it's a sticky issue keeping the market from converting the space to what it really needs to be. So this is really fascinating, just this idea that the buyers we're seeing show up in some of these distressed is not the people who just know how to like, you know, do a spridge. Yeah, that people who actually have to under have these sort of are sort of
like concrete connections. But I want to get back to some of the specific bank questions and specifically, like you know, let's say we talk about CBD office some of these areas that are income stressed, Like of the debt out there, how solid are the numbers in terms of like how much is bank how much is private credit funds? Like how is that broken down? I mean the originations we're tracking originations. Okay, we don't have a good measure of
the stock. We have some estimate some maturities. You know, given when we know all the loans were originated and the kind of terms that were in place, measures of stock gets get they get tricky because some loans, you know, it might default and we're not going to hear about that. So you know, I can give a perspective on on the share of originations. And in the boom period when interest rates were so low and everyone was excited about the fact that there were some yield on offer and
commercial real estate. Those debt funds were around thirteen percent of originations, and given that they had typically short term short terms associated with those loans, you know that's going to be a significant component of the maturities in the near term. Thirteen percent of the market was high LTV, low interest rate and a very few covenants from these aggressive lenders. Could be an interesting situation with those with
those deals. So, just on this topic, how do you see banks and private investors actually hedging their CRE exposure at this moment in time, if they're doing it at all, Because my impression of the space was it was always kind of a difficult one to hedge or go short. And you do have synthetic instruments like the CMBX, which is a derivatives index tied to not that many CMBs properties, I think, which makes it, you know, sometimes a not
perfect one for one hedge for this kind of exposure. Yeah, hedging the commercial estate market has been it's been the white whale for many folks in the industry over the last fifteen years. The firm I'm with now, they bought this company, Real Capital Analytics back in twenty twenty one, and Real Capital Analytics had been one of the folks trying to get a real estate DRIVTIS index going based on our commercial Property Price Index. We had licensed it out to a third party that was trying to get
that going. There a few of the folks trying to get that going, the trade organization Nate Creef, some folks are trying to trade routives on that. So there are a lot of folks trying to get that going, but it never really took off, and just they couldn't get enough buyers and sellers on opposite sides of a transaction
to make any of that work. Again, the market is highly predictable because there's so many sticky elements in the performance of the market that you know, if you just again forget about econometrics and forecasting, just very simple things talking to leasing brokers. Any deal that's going to be done in the next six months, they're working on it right now, and so you can get a sense of just future demand that way. So those kind of challenges.
Everybody saw that, so it's just been hard to make you know, a product like that, Wait, can I just press you on that point because since we're this is a fun episode for me because it's bringing up a lot of two thousand and eight flashbacks. But you know, if you wanted to go short residential real estate pre two thousand and eight, you use the ABX. Why is the commercial real estate market so different from the residential market that putting on that big commercial real estate short
seems to be much more difficult. Yeah, you know, I haven't gotten into that as much, the comparison in that direction. There are fundamental differences in the two product types. You know, there's much more of a subsized finance side on the residential market. The residential market is vastly larger than the commercial market. There's many more single family homes out there, So just more information availability becomes an issue. You can do a lot more. You go in the academic literature.
There's all kinds of folks doing stuff on residential real estate because that's where the data is. There's fewer folks doing work on commercial estate because it's just harder to get information. Interesting, Okay, I've been working in this sector since nineteen ninety six trying to help generate more transparency, more information, just better data sets for the sector, and
as much as we've improved since that time. When I talk to my public markets colleagues over at MSc EI, they're like, well, you guys are doing okay, well, all right, So again on this sort of like bank question. Part of the reason we're even having this discussion again is because in the wake of SVB, people are like, what are what are the landmines? I guess maybe that these banks could be stepping out or something. What's lurking on
the asset side of the bank balance sheets? And so when we sort of like, and I imagine there's no one model bank, obviously they're all going to be different. But when it comes to the various things that a theoretical bank could have on its balance sheet, you know, treasuries, agency mbs, you know, some sort of whatever, it is like, how significant is this really in terms of percentage of
their own exposure to commercial real estate? Or how do you think about answering that question, or how do you think about trying to dive into where this lives diving into that. The FDSC call sheets have a lot of information about some of the exposure sort of the stock of loans of different entities, and my colleague Tama up at Columbia. He did a study I think it was released on marks thirteenth of all days, and estimated that maybe two hundred banks face some challenges in that direction.
But what do we mean, like, because that's arrange it things right, It's like they're gonna like take losses, They're gonna have write down as verses like people are worried about like insolvencies, etc. So like, how seriously do you view the stress not to the commercial real estate market, but to the banking system from the exposure that they have. Sorry, can I just tack on to the end of that, wouldn loan loss provisions actually look like for CR because
you would expect that. You know, again, this has been sort of on people's radar for some time. Yeah, I'm not sure what the loan loss provisions were. I don't have insight to that. I just know when they made the loan sort of the high the terms there. This is a challenge that is out there for the sector. You know, as much as we've tried, there are still many things that are known unknowns. It's still an opaque sector. On performance, I'm in the office every day and part
of that is every day. I use it as a base of operations, and I'm going around the city. You'll have a few meetings every week just talking to people because you pick up so much information that's not in a database, that's not easily accessible. Because you just have a conversation with somebody, you get a few observations in
sort of a sense of direction. Momentum is a challenging sector in that direction, and just in terms of like the seriousness that a CIRI weakness poses two banks themselves, Like, what is your judgment on that. Everybody saw what happened with Silicon Valley Bank. You know they had all this rmbs on their balance sheet. You know it was a it seemed like a safe product. You know it was thrown off yield. But in a rising interest rate environment, you know, the acid value needs to be written down.
Other entities have the same kind of thing on their balance sheet. The question that I would be digging into is how many of them have actually taken those write downs so far and have they been able to replace that capital in other ways. Before the bank runs started SVB, they were trying to bring in other assets. They were trying to raise capital to shore up their balance sheet. What I'd be looking at is have other banks been
ahead of the curve there? Have they been able to start to step that up, and you know where do they stand. That's what I would be looking for, because anybody who held those kind of securities realistically, if they're marketing it to market, they're not worth what they were back when interest rates were so low. And this is the challenge of the medicine that the FED has to deal with inflation. The last time the FED raised the FED funds rate at such a rapid pace was in
the early nineteen seventies. You know, they's just they had to put the pedal to the medal here to fight inflation. But it had unintended consequences. You know, back in the seventies, you didn't have these complicated structured products like rmbs. It just it wasn't something that banks held, and the financial environment was largely a bank and a life company market.
You didn't have debt funds in the United States. They had a structure like that in the UK, but not here as much, and you didn't have CMBs didn't exist at all, So you didn't have complicated products on the balance sheet. So when rates were raised, you know, you didn't have as much of an immediate shock to the banks this time through. I don't know if they were thinking about the fact that you have a more complicated financial environment today than the early nineteen seventies, with more
unintended consequences. What are you hearing from the banks themselves? I mean, give us some color, because as you pointed out multiple times, this is a very opaque market. It is difficult to get a handle on whether or not people are writing stuff down what the capitulation point actually is. That is something that I always like, like I knowed walking around the city, just go visit clients, talk to people.
You pick up a lot that way. Yeah. Since mid March, it's been very quiet, no meetings and just no conversations with our clients there or with the regulators either, Not that I didn't want to talk with them, it's just they've been busy elsewhere. Interesting. Yeah, one of my favorite forms of cell side research is when they send all
the analysts to go shopping like a mall. Yeah, but now it's going to be when they send analysts to just walk around downtown New York and observe how many people are going in and out of office buildings, you're like, how many people are in line at a Starbucks or just like those charts which I would share, like and
everybody's still monitoring those like MTA usage. I just want to go back again, and I think outside of you know, this sort of non office, non central business district real estate, I guess malls, there's some issues, but by and large, is this still more about like a rate pressure than it is an income pressure, Like is there income stress showing up in other parts? Yeah, the income stress has mostly been a story of properties where the previous economic
justification from is evaporating. Okay, Malls we've been dealing with for a long time, right, Like that's a pre COVID story for a long time. An office is now are kind of where malls used to be, where everybody saw there was a change. They weren't sure how long it was going to take, but it's going to be there.
Offices today are in some cases much like the malls in the past, But you know, the other property types, it's not as extreme on sort of the income and certainty some elements of hotels, with some of the convention center locations still not where they were in expensive urban markets you don't see as much activity and some of those although the nature of it has changed much more tourism and talking with hotel experts, there's sort of been a change in the patterns of daily room rates because
there's many more folks who are not doing the come in the middle of week for a conference or to see clients. It's many more tourists, So it's changed in nature of some of those hotels, but you know, it's largely all about the change in the economic justification of some of the some of the assets. Jim Castello, thank you so much for coming in. This is like such a big topic and this was so helpful in terms of sort of understanding the various dynamics out there. So, yeah,
that was really great. Thanks for coming out, Old One. Yeah, great to be here, Tracy, I thought that was really great. Obviously a lot there, but this idea that like for the most part, and this it speaks to why we really need to do a sort of like office to Resie episode turn and the challenges there that this is not going to be a situation which the money is accrued to like people who know how to like read a spreadsheet or enter numbers, into a model and sit
behind a computer in New York. But someone who knows about like actual construction and zoning and relationships, I think it's like a really interesting Yeah, this is not the least absolutely, And also the parallels between where shopping malls were in say twenty fifteen, and I mean I remember writing those stories from a CMBs perspective of you know, what are we going to do with all the shopping malls and some of them are going to become like
multi family living centers and things like that. Yeah, and the parallels with the office space now. And the other thing I thought was really interesting was this idea and I'd never thought of it before, but the idea that the local authorities might want to hold out for you know, retail because they get higher tax income than for resie.
That was really interesting to me. And then also just the point about why extend and pretend won't work in that environment, In an environment where you know, the cash flow the income is actually in doubt, it's not just a matter of refinancing again, you know, I think obviously for understandable reasons, there are these concerns about regional bank
exposure to this space. But I do think that like people need to remember that there is like a diversity of what's meant by commercial real estate, and that like a lot of like the risky stuff, like the sort of like fast money, the riskiest stuff, especially in this sort of like low interest rate period with like the worst covenants or the sort of like the worst investor protections. The fastest time to REFI was by the sort of
like private debt funds. Was a really interesting point. Yeah, and like the older people who have money invested in those private debt funds, like they're probably not going to do great. I would assume they're gonna like take some heads, but like that seems better than like having all those like losses be borne by like the banks themselves. I
have these like sort of like key infrastructure groups. Well, I mean the good news is, to some extent, that's what a lot of the recent regulation was trying to encourage, which was, you know, banks are more conservative on risky CRI, and there was a lot of recognition that was an area of worry in recent years and that some of that risk would be pushed out into non banking entities such as large debt funds. But I guess now we
get to see well whether or not that was a strategy. Yeah, and then still the point that like part of the reason the regional banks have this exposure is because of the Yeah, they're less less burdened than the large banks in terms of the types of risks that they can take.
So clearly still risks out there for multiple parties. I do want to do an episode though, on why commercial real estate seems to be so difficult to short or to hedge, Oh, because this has been a sort of it's a little geeky or wonky, but this has been a perennial talking point in the industry at various points in time. You see people come out with very creative ways of going short, but there hasn't been an obvious industry standard other than CMBX, which is definitely not a
perfect hedge for a long time. So we should do an episode on that. Yeah, that is interesting because I think people just sort of imagine that, like and I remember these even go back take two thousand and two thousand and nine, like just with like credit default two. Yeah, and people like imagine you just like go like log into your brokerage, right and like by a CDs or like whatever as if like it's like buying a stock.
It's like, why don't you put on a hedge? It's like, well, it was someone willing to sell you a hedge for this, yeah, yo, sided. It's sort of this idea that like there is just that always a hedge out there that someone could have bought, sort of like this sort of naive fantasy about how these markets work, right, or the idea that everyone has like an ista agreement up there sleeve. Yeah, okay, shall we leave it there? Let's leave it there. This has
been another episode of the Old Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway. And I'm Joe Wisenthal. You can follow me on Twitter at the Stalwart. Follow our guest Jim Costello. He's at Jim Costello cr E. Follow our producers Carmen Rodriguez at Carmen Arman and Dash Bennett at Dashbot. Follow all of the Bloomberg podcasts under the handle at podcasts, and for more odd Lots content, go to Bloomberg dot com slash odd Lots.
We have transcripts a blog. Tracy can have a newsletter and hang out with other listeners on the odd loads Discord. It's really fun. I'm spending more on word time there. People talk about all the topics we discussed on the show. Go to Discord dot gg slash odd LODs Yeah, twenty four seven odd LODs chat what could be better? Thanks for listening.