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- An implosion of the US Commercial Real Estate space will have substantial economic ramifications
- US small bank loans to the commercial real estate sector account for c.7% of US GDP
- However, the likelihood of a GFC redux is low as banks today are better capitalised
- Average TCE/RWA ratio for large banks has improved markedly since GFC
A repeat of 2008 GFC contagion on the cards? Not likely. After the publication of our CIO Perspectives: US Commercial Real Estate – The Next Shoe to Fall (dated 25 April 2023), the questions one would naturally ask are:
- What if the shoe indeed falls and what are the economic implications?
- Will this be a repeat of 2008’s Great Financial Crisis (GFC)?
- What is the impact on global risk assets?
These are valid questions. With the challenges of a slowing economy, persistent inflation, and elevated bond yields, it is only right for portfolio allocators to tackle these issues head-on and prepare for potential economic/financial ramifications should the US commercial real estate (CRE) space implode.
Question 1: What if the shoe indeed falls and what are the economic implications?
- US regional banks will be the hardest hit should the CRE space implode. To determine the potential impact, we look at how exposed the US economy is to this segment.
- According to the St. Louis Federal Reserve, the percentage of total bank credit attributable to small domestically chartered banks (defined as all domestically chartered banks outside the top 25 by asset size) has grown over time, from c.20.4% in 1985 to 33.5% as at Apr-2023.
- US small bank loans to the CRE sector account for c.7% of US GDP and this is significantly above residential real estate (c.3.4%) as well as other commercial and industrial loans (c.3.0%).
- With small banks accounting for a third of total bank credit in the country, a tightening in lending conditions or even a liquidity freeze from these banks would therefore significantly impact the wider economy.
Figure 1: Small banks as % of total bank credit is on the rise 
Source: Bloomberg, St Louis Fed, DBS
Question 2: Will this be a repeat of 2008’s Great Financial Crisis (GFC)?
- Comparing the situation today with 2008, we believe that the probability of a GFC redux is low given that banks today are much better capitalised.
- A widely used gauge for banks’ financial health is the tangible common equity to risk-weighted assets (TCE/RWA) ratio. In the run-up to the GFC of 2008, the TCE/RWA ratio for US large banks (proxied by JPMorgan Chase, Citigroup, and Bank of America) deteriorated from 6.3% in Dec-2006 to 4.4% by Jun-2008 (right before the crisis).
- Banks operating on low TCE/RWA ratios run the risk of having their shareholders’ equity wiped out should liabilities spike, leading to insolvency. But post-GFC, banks’ equity position underwent a sea change. Average TCE/RWA ratio has improved markedly to 13.0% (as of Mar-2023), putting these banks in a better position to weather future shocks.
- Besides, US large banks no longer have the same outsized exposure to CRE and henceforth, they can continue to provide liquidity and funding to the economy should the former implode.
Question 3: What is the impact on global risk assets?
- The impact on equities, credit, rates, FX, and private assets can be found in the full report.
Download the PDF to read the full report.
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