Getting caught in the interest-rate trap
The low interest rates set by central banks in recent years have led to a real estate boom in the U.S. and Europe, but as interest rates begin to rise rapidly, banks and real estate companies may become insolvent. The commercial real estate market is in shock and transactions are not as frequent. The high prices of real estate will have to fall until rental yields are in line with interest on debt. This will result in losses for investors and investment vehicles lured into the market by low interest rates. The situation is particularly dire in Europe, where interest rates are even lower than in the United States.
Real estate companies are experiencing financial difficulties, with the Stoxx 600 Real Estate Index losing 40% last year. Many companies' bonds are now trading as junk, despite having investment-grade ratings. Germany's Vonovia is one such company, with a rental yield of just 3% and refinancing costs of over 5%. This means that the company is paying more to refinance its debt than it is earning in rental income, which is not sustainable in the long term.Many real estate funds are also affected, including Blackstone's B-REIT, which has seen significant redemption requests.
Banks are also in trouble because they have a lot of loans to commercial real estate companies that are unlikely to be repaid. They also have a problem with residential mortgages, because if property values fall and people lose income in a recession, they may not be able to pay back their loans. In addition, people are moving their savings out of banks and into government bonds and money market funds that offer higher interest rates, putting banks in a difficult position.
Bad news:
The banks are completely caught in the interest rate trap: if they raise deposit rates to keep savers, their already measly interest margin shrinks and they lose money every day. If they do not raise deposit rates, the bank run continues and they risk becoming illiquid like Silicon Valley Bank and Credit Suisse. So it looks like another credit crunch similar to the 2008 financial crisis. Banks are cutting back on new lending, which is causing lending to fall sharply and exacerbating the credit crunch among over-indebted companies. This, in turn, increases the likelihood of bankruptcies and forced sales. Interest premiums on new loans and bonds rise, leading to a self-reinforcing downward spiral. The eventual demand for government and central bank intervention will ultimately be paid for by the general public.
The bottom line:
It feels like the financial sector is lurching towards a new crisis, lured into the trap of more than a decade of measly interest rates and years of bad investments of capital. In my view, shares of banks from all former low-interest countries are currently not worth investing in, no matter how favourable their valuations may look. The extent of the damage can hardly be estimated at the beginning of the crisis and total losses are imminent. But also stocks of other companies, which have more or less fixed income for a longer period of time and have to finance themselves on the capital market at higher interest rates in the short term, are red-hot - above all real estate companies or infrastructure investments.
Real estate companies are experiencing financial difficulties, with the Stoxx 600 Real Estate Index losing 40% last year. Many companies' bonds are now trading as junk, despite having investment-grade ratings. Germany's Vonovia is one such company, with a rental yield of just 3% and refinancing costs of over 5%. This means that the company is paying more to refinance its debt than it is earning in rental income, which is not sustainable in the long term.Many real estate funds are also affected, including Blackstone's B-REIT, which has seen significant redemption requests.
Banks are also in trouble because they have a lot of loans to commercial real estate companies that are unlikely to be repaid. They also have a problem with residential mortgages, because if property values fall and people lose income in a recession, they may not be able to pay back their loans. In addition, people are moving their savings out of banks and into government bonds and money market funds that offer higher interest rates, putting banks in a difficult position.
Bad news:
The banks are completely caught in the interest rate trap: if they raise deposit rates to keep savers, their already measly interest margin shrinks and they lose money every day. If they do not raise deposit rates, the bank run continues and they risk becoming illiquid like Silicon Valley Bank and Credit Suisse. So it looks like another credit crunch similar to the 2008 financial crisis. Banks are cutting back on new lending, which is causing lending to fall sharply and exacerbating the credit crunch among over-indebted companies. This, in turn, increases the likelihood of bankruptcies and forced sales. Interest premiums on new loans and bonds rise, leading to a self-reinforcing downward spiral. The eventual demand for government and central bank intervention will ultimately be paid for by the general public.
The bottom line:
It feels like the financial sector is lurching towards a new crisis, lured into the trap of more than a decade of measly interest rates and years of bad investments of capital. In my view, shares of banks from all former low-interest countries are currently not worth investing in, no matter how favourable their valuations may look. The extent of the damage can hardly be estimated at the beginning of the crisis and total losses are imminent. But also stocks of other companies, which have more or less fixed income for a longer period of time and have to finance themselves on the capital market at higher interest rates in the short term, are red-hot - above all real estate companies or infrastructure investments.
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