The US commercial real estate (CRE) market is under significant stress, with CRE CLO managers buying back delinquent loans to avoid a market collapse, while China grapples with its own real estate difficulties, causing the Yuan to plummet.
The world is currently facing significant economic uncertainties, with two major risks at the forefront: the economic situation in China and the US commercial real estate market. These risks are not only persisting but escalating, impacting global financial markets. One indicator of these growing concerns is the observable downward bias in market interest rates, which suggests a shift toward lower growth and inflation expectations, and an increased demand for liquidity and safety.
Recent reports indicate increasing stress within the US commercial real estate (CRE) market. According to JPMorgan Chase & Company, firms repurchased a record $1.3 billion of delinquent loans in the past year. This unprecedented action is being taken by CRE Collateralized Loan Obligation (CLO) managers to protect the integrity of their structures. These managers are preemptively buying back bad loans to prevent losses from affecting the securitization structure, which could lead to market illiquidity and credit flow disruptions.
The "waterfall structure" of CLOs dictates that cash inflows are directed to senior tranches first, followed by mezzanine, and finally equity tranches. By using reserves to repurchase bad loans, CLO managers are attempting to mitigate the risk of market freeze-up that could occur should losses begin to hit equity holders.
Metrics from analytics firm Credit IQ show that the share of loans in CRE CLOs with payments over 30 days overdue decreased to 7.4% last month, a drop attributed to the proactive measures taken by CLO managers. Furthermore, Citigroup's measure of CRE CLO loan stress reached 4.8% in January, the highest since 2014. This suggests a significant amount of distressed loans are present in these CLOs, underlining the fragility of the CRE market.
China's economy is grappling with its own set of challenges, particularly in its real estate sector. The recent downward movement of the Chinese Yuan (CNY) reflects the lack of confidence in China's economic stability and its ability to manage the ongoing real estate crisis. The currency hit a low of 7.23 to the dollar, the lowest since November, suggesting that government interventions have yet to yield positive outcomes.
Reports have surfaced that major Chinese banks are providing syndicated loans to real estate developers, such as China Vanke, to facilitate the completion of stalled projects. However, these measures are not aiming to reflate the property bubble, but rather to manage its deflation in an orderly fashion. The goal is to enable developers to complete existing projects without causing further harm to property owners or the broader economy.
The downward bias in interest rates is not exclusively a reflection of central bank policy but is more closely associated with the aforementioned risks. Lower interest rates indicate market expectations of reduced economic growth and inflation, which are symptomatic of deeper systemic issues.
The recent rate cut by the Swiss National Bank, for instance, is seen as a response to the market's pricing in of lower inflation risks, a move expected to be mirrored by other central banks. This alignment suggests that the concerns factored into last year's bond market rally remain pertinent, and the post-rally pattern of interest rates confirms the persistence of these underlying fears.
The current state of the US commercial real estate market and China's economic difficulties are major concerns that continue to cast shadows over the global financial landscape. The use of reserves by CLO managers to purchase bad loans and China's efforts to stabilize its real estate market without inflating the bubble further are indicative of the severity of these issues. Moreover, the downward trend in interest rates is not a harbinger of stimulus but a sign of a market bracing for potential economic turbulence and seeking safety amidst growing uncertainty.
