Vacant Commercial Real Estate, Higher Interest Rates Could Create ‘Stress’ for Smaller Banks: Treasury Secretary Yellen

U.S. Treasury Secretary Janet Yellen testifies before a House Ways and Means Committee hearing on President Biden's proposed 2023 U.S. budget, on Capitol Hill in Washington, on June 8, 2022. Jonathan Ernst/Reuters

Treasury Secretary Janet Yellen told lawmakers on Feb. 8 that she is “concerned” that increased vacancy rates in the commercial real estate market combined with higher interest rates could create some “stress” for smaller banks.

Ms. Yellen told a Senate Banking Committee hearing that falling demand in commercial real estate—especially for office buildings in metropolitan areas— combined with soaring interest rates for refinancing loans could create a problem for smaller banks, particularly as real estate loans come due.

Roughly $325 billion of loan maturities are coming due, according to experts.

However, Ms. Yellen said she does not see the combination causing a systemic risk to the U.S. financial system as a whole.

“Metropolitan areas vacancy rates have gone way up, especially for other than Class A buildings, and of course, interest rates are substantially higher while valuations are falling and so it’s obvious that there’s going to be the stress and losses that are associated with this,” Ms. Yellen said.

The Treasury secretary said the multi-regulator Financial Stability Oversight Council (FSOC) has discussed commercial real estate risks at every meeting over the past year and has been comprehensively analyzing and working with bank supervisors to understand potential “exposures.”

She added that banking supervisors are also currently working with their banks to identify and manage this risk.

“I hope and believe this will not end up being a systemic risk to the banking system. The exposure of the largest banks is quite low, but there may be smaller banks that are stressed by these developments,” she said.

Focus on Non-Traditional Banking Institutions

Ms. Yellen also addressed the shift toward non-traditional banking institutions, when questioned whether this poses a risk to financial stability.

The FSOC is “very focused” on such non-banks, in particular non-bank mortgage companies, given that such institutions have a lack of access to deposits, tend to be more reliant on short-term financing, risk having their credit lines pulled in stressful times, and generally have limited loss-absorbing capacity.

Such institutions also do not have access to the Federal Reserves discount window, she noted.

“There is concern that in stressful market conditions, we could see the failure of one of these. This has become very, very significant in the mortgage market,” Ms. Yellen said.

The Treasury secretary’s comments came shortly after she praised federal banking officials for their fast actions in the wake of the collapse of Silicon Valley Bank at the start of last year.

Speaking during a hearing before the House Financial Services Committee on Feb. 6, Ms. Yellen said that officials did “everything we could to put together a package of measures that would stop what could have become a run on the banking system—to the huge detriment to our economy and to hardworking Americans and businesses.”

A screen displays the trading information for New York Community Bancorp on the floor at the New York Stock Exchange (NYSE) in New York, on Jan. 31, 2024. Brendan McDermid/Reuters

‘System Is Well Capitalized’

Her comments also come shortly after stocks of New York Community Bancorp (NYCB) plunged, and Moody’s Investors Service downgraded the bank’s long-term and some short-term issuer ratings to junk while warning of further downgrades.

The stock market sell-off came after the bank last week reported an unexpected fourth-quarter loss after building bigger provisions for potential commercial real estate loan defaults.

NYCB reported a $260 million net loss for the fourth quarter of 2023, down from a $164 million net income for the year-ago period. It also declared a lower dividend of $0.05 per common share, down from $0.17 in the fourth quarter of 2022. The combined effect caused the stock price to hit its lowest level in 25 years during Wednesday’s trade.

The bank has since attempted to reassure investors that it has enough finance to stay afloat with “strong liquidity and a strong deposit base,” according to its new executive chairman, Alessandro DiNello.

Ms. Yellen did not directly address the recent woes at NYCB during the Feb. 8, but told lawmakers in prepared remarks that when two regional banks—Silicon Valley Bank and Signature Bank—suddenly collapsed last March, officials “acted quickly to prevent contagion to banks with similar vulnerabilities and to maintain confidence in the banking system.”

“The council also increased transparency this year, issuing an analytic framework that for the first time provides the public with in-depth information on how it monitors, assesses, and responds to potential financial risks,” Ms. Yellen said.

The Treasury secretary concluded by noting that while there are some risks and some banking institutions that “will face stresses from commercial real estate” on balance “the system is well capitalized.”

Reuters contributed to this report.