U.S. Banks Pass Fed’s Stress Test Despite CRE Concerns

The Fed's rigorous health check evaluates banks' ability to endure a severe economic downturn

In a crucial confidence boost for the U.S. banking sector, major banks have successfully navigated the Federal Reserve’s annual stress test, demonstrating resilience against a hypothetical 40% drop in commercial real estate (CRE) values. This outcome eases concerns about the stability of banks amid escalating challenges in the CRE market, where landlords are grappling with sustained high-interest rates.

The Fed's rigorous health check evaluates banks' ability to endure a severe economic downturn, encompassing a 36% plunge in home prices, a 55% decline in equity prices, and a spike in the unemployment rate to 10%. Released on Wednesday, the results affirm that the 31 largest banks possess sufficient capital to withstand nearly $685 billion in potential losses, ensuring continued lending to households and businesses during a global recession. The successful stress test is timely, occurring over a year after the collapse of mid-sized lenders like Silicon Valley Bank, Signature Bank, and First Republic. These failures had sparked criticism of the Fed's oversight, highlighting vulnerabilities in banks’ defenses against rising interest rates. In contrast, the recent test focused on a scenario where interest rates decline amid economic turmoil.

As CRE faces intense scrutiny, the Mortgage Bankers Association notes that $929 billion of the $4.7 trillion in outstanding commercial mortgages will mature in 2024. This maturity wall coincides with falling property values and declining rents, signaling potential challenges ahead. Notably, Goldman Sachs recorded the highest projected loan loss for CRE at 15.9%, followed by RBC USA, Capital One, and Northern Trust at 15.8%, 14.6%, and 13%, respectively. However, analysts criticized the exclusion of regional banks, which hold the majority of CRE loans and are less regulated than their larger counterparts, from the stress test. This oversight suggests that risks in the CRE market may still pose significant threats to smaller lenders.