Magazine article Mortgage Banking

Potential Inflation Raises More Bank Concerns

Magazine article Mortgage Banking

Potential Inflation Raises More Bank Concerns

Article excerpt

A recent blip jump in 10-year Treasury yields has some industry analysts concerned about inflation and its impact on commercial real estate finance.

"It is hard to separate out how much the run-up in [10-year Treasury] yields is the reverse of the flight to quality, how much of the run-up in yields is about the budget deficit and how much of it is worries about inflation," said Mark Vitner, senior economist at Wachovia Economics Group, Charlotte, North Carolina. "Clearly, bond investors are concerned about all those things, and higher interest rates are going to make it tougher to refinance all of the loans that are maturing on commercial properties, which I think is going to continue to put downward pressure on prices," he said.

"So much money was put out at very low interest rates and, to me, that's a game of Russian roulette," said David Lynn, managing director of the research and investment strategy group at ING Clarion Partners, New York. "The money [the Fed] is printing--a lot of things seem to be conspiring for higher inflation, and [banks] are going to be stuck with very low interest rate loans that are going to be losing money."

However, Jamie Woodwell, vice president of commercial real estate research at the Mortgage Bankers Association, said MBA's forecast anticipates inflation reacting to the broader economy.

"The recession has been pushing down on consumer prices, and we are not likely to see significant inflationary pressures until the economy gets back on track," Woodwell said. "As an investment, commercial real estate is often seen as a good hedge against inflation, but that probably is not much of a factor at the current time."

Lynn said that even if banks recover and put their balance sheets in order, a full recovery for financial institutions could take time.

"[Higher interest rates] is a ticking time bomb," Lynn said. "Some of [the loans] were floating-rate, sure, but some of it was fixed-[rate] at very generous terms and at very high LTVs [loan-to-value ratios]. Those are the bombs waiting. Forget about the value declines, forget about financial distress; those [mortgages] are gigantic mines in this road ahead. If I were a lender, that would keep me up at night."

Lynn also expressed concern about residential mortgage markets moving from a low- to high-rate environment as well.

"It's helping the mortgage market right now but, to me, those [mortgages] are just going to be liabilities, and those liabilities will transfer over to RMBS [residential mortgage-backed securities] and RMBS will transfer over to the financial sector like it did in the run-up to the current [crisis]," Lynn said.

Vitner said inflation would most likely not become a concern for "a couple of years," and he forecasts future inflation to look more like 1971--closer to 4 percent--than Zimbabwe's current condition of hyperinflation. However, he also said inflation did not need to reflect Zimbabwe to become significant, because the dollar still lost more than 80 percent of its purchasing power in the past 38 years.

"Inflation is going to be a problem over the long run, longer term, but we need to quantify what we mean as a problem," Vitner said. "Some people are thinking that the U.S. will be the next Zimbabwe. That's not going to happen."

Historically, the inflation rate peaked at 14. …

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