January 13, 2025 | Fannie Mae 6% 30-year MBS for February delivery traded below par last week as the 10-year Treasury rose above 4.75% in yield. Rational residential lenders are now writing mid-7% loan coupons for sale into FNMA 6.5s. As the rate cut narrative has been once again downgraded, the markets sold off and financials continue to give ground. But rising interest rates is causing a lot more damage than simply pushing down prices for publicly traded securities.
One big reason for the selloff in financials is the fact that delinquency in commercial real estate exposures continues to rise even as banks reduce unused credit available to the sector. Forbearance is now the order of the day, rendering bank financial statements more aspirational fiction that fact. Does this sound like 2010? Sure does. And, as yet, corporate debt spreads give no indication of trouble ahead.
“The largest Non Owner CRE lenders are Wells Fargo ($64.52B), Bank of America ($36.67B) and JPMorgan Chase ($35.79B),” notes Bill Moreland at BankRegData. “All three have elevated Non Owner NPL levels and all three are pivoting to historic loan modification levels (i.e. lowering payments so that borrowers can avoid delinquency).”
Moreland notes that CRE delinquency is not nearly at peak levels for this cycle, suggesting that 2025 could see some significant losses to banks from commercial exposures. Just as published delinquency levels for consumer exposures are understating losses significantly, commercial exposures like real estate are likewise heavily manipulated by banks with the full knowledge of federal bank regulators.
Commercial Real Estate | All Banks
Source: FDIC/BankRegData
“Frightening numbers, but perhaps the high is in?," Moreland muses. "Well, no. The gold chart on the right details the NOO CRE loan modifications where the payment has been lowered and the TDR has been left on accrual. They do this so that it avoids the NPL designation since NPLs are loans 90+ Days Due accruing Fee/Interest Income PLUS loans on Nonaccrual.”
After commercial real estate, one of the ugliest sectors in finance is private equity. Portfolio companies that were supposed to be sold in public offerings are festering in portfolios years after the hoped for sale date. And loans against these private portfolio gems are now likewise increasingly suspect. Do investors understand that most PE companies are distressed on day one? They do now!
When private markets had the wind of low interest rates behind them, private equity was easy. Buy the crap company, lever it up and do an IPO three years later. But in a higher-for-longer interest rate environment, PE is now toxic for institutional investors. If we assume that long-term rates will remain at current levels or even higher, what does this suggest for private equity returns? Or even better, private credit.
“Lenders and regulators are beginning ask if NAV loans on private equity fund stakes have materially overstated LTVs, and hence understated default-loss risks,” notes our colleague Nom de Plumber. He continues:
"After all, if a long-outstanding Private Equity Fund has been unable to IPO its increasingly stale portfolio companies, in hopes of repaying the highly leveraged loans which had financed their initial privatization buy-outs, then such portfolio companies are likely worth less than those loan balances (especially if below-expectation operating earnings, soft valuation multiples, and higher interest rates). In turn, that Private Equity Fund would have little or no residual value to repay any NAV loan. If an NAV loan has a reported 25% LTV, but the “V” is iffy at best, it may effectively be uncollateralized."
By no surprise, NDP reports that prudential regulators have begun to ask banks about their NAV loans to private equity fund Limited Partners----and any other financing transactions collateralized with private equity or private credit instruments. The larger phenomenon of forbearance has helped obscure PE related credits, but it is the lack of a market value that allows for malfeasance in reporting NAVs. Suffice to say that the estimates for loss provisioning against PE exposures at banks will be going up in Q4 and 2025.
Meanwhile, Bloomberg reports that Blackstone’s (BX) former global head of GP stakes, Mustafa Siddiqui, has launched SQ Capital, which will invest in private equity secondaries with a focus on the middle market. BX sold their clients a load of crap in the form of private equity, but now a former BX partner will buy them back at a discount! So thoughtful!
“Due to a dearth of initial public offerings and a gap in valuation expectations between buyers and sellers that has chilled some private equity deal activity,” Bloomberg reports, “the secondaries market has been particularly appealing to investors seeking liquidity.”
“SQ Capital estimates that a lull in exit volumes since 2021 has created a backlog of roughly 28,000 unsold companies, and around 40% of those have been in private equity ownership for at least four years. Private equity secondaries “is the most compelling area of the alternatives industry,” said Siddiqui, who likened the opportunity to the fat pitch he’s been waiting for. “It’s time to swing.”
As firms like BX position new platforms to buy losers from their private equity clients, the flight away from PE and private credit is gaining momentum. But don't tell this to David Solomon and his colleagues at Goldman Sachs (GS).
Coming off its huge success in managing a portfolio of white label credit cards for Apple Computer (AAPL), Goldman is creating a new business unit and elevating two executives in an effort to combat the growing competition from private credit funds. As we've noted to readers of the Premium Service, GS has the worst credit performance of the top-ten banks other than Citigroup (C). The abysmal GS credit performance against other investment banks is shown in the chart below.
Source: FFIEC
Part of the irony of the present predicament is that bond spreads are near record lows, suggesting that visible indicators of credit quality are at odds with the rancid fundamentals. Scott Carpenter of Bloomberg notes that spreads on collateralized loan obligations are at record lows, suggest that there may be a big adjustment in corporate loans and credit impending.
Now that Wall Street firms have bid up corporate assets to absurd levels to feed retail credit strategies, the stage is set for a massive selloff of debt, loans and also issuer equity as markets adjust to a world where interest rates may not decline below current levels. Just as PE managers expected to be taken out of portfolio positions in a falling rate environment, buyers of distressed debt where also anticipating a tail wind from falling interest rates. But maybe not.
As the credit losses from CRE and PE grow, the backlash against private equity investing is growing, even from established organizations within the financial community. "Statistically, there is an increased risk of failure with private equity ownership," note Alvin Ho and Janet Wong in a blog published by the CFA Institute ("Private Equity: In Essence, Plunder?"). "PE portfolio companies are about 10 times as likely to go bankrupt as non-PE-owned companies."
And commercial bankruptcies are on the rise. According to data from Epiq, commercial Chapter 11 filings increased by 20% in 2024 compared to the previous year, with overall commercial filings rising by 17%.
May 2025!
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