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Stocks fell, with the S&P 500 up 19% year-to-date. This rise has some investors optimistic that another bull market may be upon us.
Wells Fargo Interest Rates Investment Property
However, investors should not let the recent move toward higher interest rates deter them from the potential risks associated with commercial real estate in particular. Interest rates are at their highest levels in decades, with the focus on office real estate and high financing costs.
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Wells Fargo (WFC -1.26%) is one of the largest commercial real estate (CRE) lenders in the country. It recently made billions of dollars in credit losses in the CRE group in the second quarter. Here’s what investors need to know about the bank’s move.
The commercial real estate industry has been under construction for several years, which has led to a slowdown in the industry. CBRE Group, one of the world’s largest commercial real estate companies, understands the factors that lead to a slowdown in the industry. The company’s CEO, Robert Sulintyk, highlighted three leaders in today’s industry:
Beginning in March 2022, the U.S. central bank raised the federal funds rate from 0% to 5.5%, the largest rate hike in decades. That change in interest rates contributed to SVB Financial’s decline in Silicon Valley bank in March, which was not prepared for interest rates to be as high as they are now.
The bank’s failure sent shockwaves through the industry and spread fears of contagion. In response, banks pulled funds, especially in riskier areas. Commercial real estate, especially office real estate, is a problem.
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Telecommuting for office workers has become widespread during the pandemic, with many companies sticking to it or switching to hybrid work arrangements. Many large technology companies have laid off employees en masse. As a result, companies need less office space, especially in specialized areas, and may choose to lease real estate.
With more than $154 billion in loans outstanding, Wells Fargo is one of the largest banks in CRE issuance. Of that amount, $33 billion is corporate debt.
On Wells Fargo’s earnings call, CFO Mike Santomasimo told investors that “the office market remains weak” and that “our CRE teams will focus on monitoring and scripting, which includes mitigating exposure and closely monitoring subprime loans.” Santomasimo also noted that Wells Fargo’s office announcements account for just 22% of its commercial real estate loans and 3% of its total loan book.
In the second season, things were not so bad. Wells Fargo’s commercial real estate loans had net income of $79 million, representing 0.2% of average loans. The bank also increased its loan loss provisions on corporate loans to $3.6 billion, or 2.35% of total loans.
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Banks accumulate loan loss reserves to prevent losses from borrowers who default on their loans. Setting aside reserves allows banks to absorb unexpected credit losses during economic downturns or turbulence, ensuring financial stability.
Backups don’t always mean there will be a crash. For example, during the pandemic, banks built up billions of dollars in reserves to prepare for an uncertain environment. Turns out the build was unnecessary, and their earnings rose in the quarter after they released that reserve. However, it is wise for banks to prepare for economic turbulence
We have not yet begun to see the full impact of the Federal Reserve’s rate hikes, which economists sometimes note have a “long and volatile lag.” According to Federal Reserve Bank of Atlanta President and CEO Rafael Bostic, it could take anywhere from 18 months to two years for interest rates to affect inflation and the economy. The Federal Reserve raised its first interest rate 16 months ago, and the next rate hike is likely to seep into the economy as early as next year.
In addition, the Federal Reserve recently completed its annual stress test, which evaluates banks to ensure they have enough capital to cover losses during severe recessions. This year’s test highlighted increased stress on the commercial real estate industry, with commercial real estate values falling by 40%.
Wells Fargo Raises Interest Income Forecast As Third Quarter Profit Beats Estimates
During the trial, the Federal Reserve revealed that Wells Fargo’s commercial real estate losses could exceed 9.7 percent of total debt. This puts it in the middle of the pack. Those with the highest exposure include Goldman Sachs (which could see a loss of 16% of its total loans), Morgan Stanley (13.7%) and Citizens Financial Group (12.4%).
Investors could bite into Wells Fargo’s earnings, and weakness in the commercial real estate market is likely to continue. For this reason, I am currently avoiding office-focused REITs such as SL Green Realty, Office Properties Income Trust and Vornado Realty Trust. These stocks are likely to face more volatility in the coming months as higher interest rates weigh on the industry and office property prices may take several years to recover.
For Wells Fargo, exposure to its office properties — the riskiest — is a small part of its overall investment. The bank also performed well during the stress test and is well capitalized to withstand any volatility in these markets. However, investors should be aware of challenges that are likely to reduce the bank’s earnings in the coming quarter.
Wells Fargo is an advertising partner for Ascent. SVB Finance provides credit and banking services to Motley. Courtney Carlsen has a position at Morgan Stanley. Motley has a view on Goldman Sachs Group and recommends it. The Motley Fool has a disclosure policy.
Wells Fargo & Co
Wells Fargo (WFC) Q3 2023 Earnings Call Record Missing This Bank’s Monster Profit Growth? Can Wells Fargo stock be bought? Will Wells Fargo Become the Leading Bank Stock Again? Despite high capital requirements, Wells Fargo remains in a good position to buy the stock
Invest better with The Motley Fool. Get stock recommendations, portfolio guidance and more from the Motley Fool’s premium services. Paul Centopani via Paul twitter PCentopani mailto paul.centopani@arizent.com Paul-Centopani November 9, 2018 at 12:10 pm. EST 1 min read
According to the National Association of Homeowners/Wells Fargo Housing Opportunity Index, both average home price growth and mortgage interest rate growth slowed in the third quarter.
The study found that 56.4 percent of new and existing homes sold between the beginning of July and the end of September were affordable to households with a median income of $71,900. This is a drop from 57.1% in the second quarter, which reached the lowest level of the index. Since the third quarter of 2008, before the real estate bubble burst.
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Continued limited inventory combined with increased demand has driven home prices higher. These factors, along with rising interest rates, are affordable.
“As home prices continue to rise and interest rates continue to rise and the labor force continues to grow, that drives housing affordability,” NAHB President Randy Noel of LaPlace, La., said in a news release. “Builders are increasingly focusing on managing home building costs to keep pace with rising wages.”
The national median home price rose to $268,000, up from $260,000 a year earlier and up from $265,000 in the second quarter. That was the highest average rate since NAHB and Wells Fargo began keeping data in 1991, and mortgage rates also rose to 4.72%, the highest level since the third quarter of 2010. The postseason margin increased by 4.67%.
“Continued job growth and the economy are creating a backdrop for housing demand amid the recent decline in affordability,” said NAHB Chief Economist Robert Dietz. “However, housing sustainability needs to stabilize to prevent a slowdown in momentum going into the new year.”
Review: Wells Fargo Home Mortgage
For the second consecutive quarter, Syracuse was the most affordable large housing market in the US, with 88.2 percent of new and existing homes sold affordable to households earning the metro area median income. Instead, San Francisco sold for the most affordable prices for the fourth straight quarter, with just 6.4 percent of homes sold being affordable to middle-income families. Donald Luskin, chief investment officer at TrendMacro, reacted to the rise in oil prices as an attack on Israel could heighten tensions in the Middle East.
Wells Fargo beat analysts’ estimates for third-quarter profit on Friday as it benefited from higher interest payments from customers and raised its forecast for annual interest rates.
The lender now expects net interest income (NII) – the difference between a bank loan and deposit payments – to be 16% higher in 2023 than a year ago. He had previously forecast a growth of 14 percent.
The fastest tightening of US monetary policy in 40 years has revived interest rates for banks aiming to revive sticky inflation.
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A man uses an ATM at a Wells Fargo bank branch
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