A council of federal financial regulators chaired by Treasury Secretary Janet Yellen stated in their 2022 Annual Report released today: “the commercial real estate (CRE) and residential real estate sectors have the potential to increase risks to U.S. financial stability significantly.” (Treasury Department news release and PoliticoPro, Dec. 16) 

A Top Concern 

• The Financial Stability Oversight Council (FSOC) identified CRE among its top market and credit concerns heading into 2023, given rising interest rates and borrowing costs. (FSOC Annual Report, pages 18-20)
  
  
• Among the FSOC’s report conclusions:
  
  
  • “Rising interest rates, uncertain economic conditions, continuing weakness in urban commercial real estate, and the possibility that some post-pandemic changes in demand for CRE will become permanent have heightened concerns about CRE.”
    
    
  • "The Council recommends supervisors and financial institutions continue to monitor CRE exposures and concentrations, ensure the adequacy of credit loss allowances, assess CRE underwriting standards, and review contingency planning for a possible increase in delinquencies.” 

• “In extreme cases, CRE credit losses can lead to outright bank failures, particularly for banks with high exposure to CRE loans,” according to the regulators’ report. 

Office Markets & Remote Work 

• The Council emphasized that the office property market may face the most uncertainty, with the prospect of weak future demand as return-to-office plans evolve and users decide how much space they need.
  
  
• The 2022 Annual Report notes that office property demand may take time to stabilize as tenants navigate remote work decisions and adjust leasing decisions. The FSOC also reports that a slow return to densely populated urban office centers could reduce the desirability of office properties and nearby retail space.
  
  
• “This may be especially true for older, less desirable office spaces with fewer modern amenities,” the report acknowledges.
  
  
• The report also notes, “structural changes in the demand for office space can lead to weaker credit quality for loans secured by office properties over the long term.”
  

The Fed’s Influence

• FSOC regulators also caution that more aggressive action by the Fed—either in its interest rate decisions or changes in its holdings of mortgage-backed securities—could lead to further increases in mortgage rates that could negatively affect financial stability. (FSOC 2022 Annual Report and PoliticoPro, Dec. 16 ) 

The Council's mission is to identify risks to the financial stability of the United States, promote market discipline, and respond to emerging risks to the stability of its financial system. (FSOC website) 

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