US banks face higher exposure to property market decline: Morgan Stanley

Morgan Stanley has highlighted that heightened exposure of US banks compared to their European counterparts in the face of a potential property market downturn. According to analysts at Morgan Stanley, major European banks have reduced their lending to commercial property, effectively halving their exposure compared to US banks.

The commercial real estate (CRE) sector is currently witnessing its most considerable downturn since the 2008-2009 financial crisis. Factors such as rising borrowing costs and increased vacancy rates due to remote working arrangements have contributed to a decline in demand for office space.

In a research note, Morgan Stanley analysts pointed out that regional US banks and German regional lenders are particularly vulnerable due to their significant exposure to the commercial property market. Unlike larger European banks, which have been reducing their exposure to CRE, German regional banks have been increasing their exposure, adding to their vulnerability.

While Morgan Stanley does not foresee CRE-related issues leading to a systemic financial crisis, they anticipate that these challenges will have a manageable impact on earnings, primarily affecting a limited number of banks.

In a hypothetical stress scenario where property prices decline, leading to losses for banks and deteriorating credit quality for borrowers, European banks are expected to see a 3 per cent hit to earnings over three years. However, analysts deem this impact as "manageable," given the reduced exposure of European banks to CRE.

The contrast between US and European banks is striking. European banks have substantially decreased their exposure to CRE since 2022, with around 5 per cent of their loan books dedicated to commercial property. In comparison, US banks, including both large-cap and mid-cap lenders, face higher exposure levels, with mid-cap lenders particularly vulnerable.

Morgan Stanley's analysis also underlines differences in refinancing risks and vacancy rates between the US and European markets. The United States is set to grapple with approximately $660 billion in CRE debt maturing in 2024, far exceeding Europe's $150-$200 billion estimate.

The disparity in city office vacancy rates further highlights the divergence between the US and European markets. While vacancy rates in cities like San Francisco and Los Angeles exceed 20 per cent, European cities like London and Zurich maintain significantly lower vacancy rates.

(With Reuters inputs)