Three major risks that have the banking industry on edge

Editor's note: This story was also published in CNN Business' Nightcap newsletter. Sign up here to receive it in your email.

CNN New York --

One month has passed since the collapse of Silicon Valley Bank, which triggered alarms in global finance halls.

The initial panic has subsided into a less severe state of tension. All of us can take a deep breath and know that our money is safe, and that the federal government has provided the necessary tools for banks to weather the storm.

Mike Mayo, a senior bank analyst at Wells Fargo, said that we are moving from flashing red lights towards flashing yellow lights. "I believe it's time to be hyper aware and vigilant to any other' that could further undermine confidence.

ADVERTISING

Investors and regulators are on alert. They don't need to look far to find things to be concerned.

Let's face it, SVB's red flags, including its rapid growth, poor risk management and excessive reliance on uninsured depositories, should have been obvious before the collapse. Everyone is now looking for the next danger hidden in plain sight.

Analysts are beginning to form a consensus around three areas that could lead to a systemic problem: commercial real estate, underwater bond portfolios and shadow banks, the industry with the highest metal moniker.

The WFH Era's toll

Julia Horowitz, Julia's colleague, reports that commercial real estate has been under significant pressure. Rich Hill, Cohen & Steers' head of real-estate strategy, said that commercial property valuations could drop by around 20% to 25% this year. The declines in office valuations could be even more severe, reaching 30%.

This is where office properties come in. According to data from Kastle security provider Kastle, the average office occupancy in the United States remains below half of March 2020 levels.

In 2023, approximately $270 billion worth of commercial real estate loans will be due. A third, or $80 billion, of this amount is for office properties.

There are more signs of strain. Trepp reports that the proportion of commercial mortgage borrowers who are in default on their payments is increasing. Trepp also provides data on commercial real property. High-profile defaults are making headlines. PIMCO, an asset manager, defaulted on almost $2 billion of debt to a landlord for seven office buildings in San Francisco, New York City, Boston, and Jersey City, New Jersey.

Banks could be facing problems due to their large lending to this sector. Goldman Sachs estimates 55% of US office loan balances are held by banks. 23% of the total is held by community and regional banks, already under severe pressure following the March failures at Signature Bank and Silicon Valley Bank.

Trepp's managing director Matt Anderson stated, "I'm more worried than I've ever been in a long while,"

Unrealized losses

US banks bought up mortgage-backed securities and long-dated Treasuries back when interest rates were low. This is a good move, as long as you hedge against the possibility of assets losing their value, which SVB did.

However, as central banks and the Fed have increased interest rates aggressively the value of these bonds has declined.

US banks currently have $620 billion worth of unrealized losses. This means that their assets are worth less than what they paid for them. This could make it difficult for the bank to sell these assets in a crisis, such as a bank run.

Experts believe that $620 billion is an optimistic estimate. It is not clear if these unrealized losses are scattered across the sector, or concentrated among specific types of lenders.

Shadow banks

Shadow banking, which we talked about last week, refers to financial institutions who lend money (like banks) but do not take deposits from customers.

They are a diverse group that includes investment banks and hedge funds, insurance companies and private equity funds.

This menacing nickname is easily interpreted. They are unregulated and therefore they are in the shadows. Are they, however, shady? Yes, and no. Yes and no. Hedge funds and private equity are often given a bad reputation, but they can also finance young businesses that cannot get financing from regular banks.

They are not subject to the same stringent rules as banks, so they can take on more risk. If the wheels begin to fall off, they don't have the government backing them up.

Bank-banks and other banks overlap in many real and perceived ways. When confidence is shaken on one side, panic can spread.

As Anna Cooban, my colleague, explains, the mere notion that the banking sector could be linked to a struggling bank could lead to a wider financial crisis.

Bottom line

One of the troubling lessons from the SVB scandal is that banks are large, sprawling operations managed by humans, who serve other human beings. None of them are rational. Although it might sound simple, this is especially true for an industry that relies so heavily on trust like banking.

Mayo states that 'This industry is not zero-defect. Mayo says that while this industry tries to minimize mistakes like other industries, the reality is that mistakes will still happen.

He said, "This is a time for banks to reinforce the importance their most important asset which is trust."