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Financial sector exposure to commercial mortgage backed securities (CMBS) has come under increased scrutiny in recent weeks. Not only are mid-sized banks a primary lender for commercial real estate projects, but they hold a significant amount of CMBS on their balance sheets. These securities are often not marked to market. Surging interest rates throughout the last year have not only depressed prices of CMBS, but raised the costs associated with servicing mortgages that were originated with an adjustable rate.

Delinquency rates are beginning to rise more quickly for securitized commercial mortgages, which could hurt banks’ balance sheets, as well as their ability or willingness to lend to more commercial real estate projects. This would have negative implications for the broader economy.

Related ETFs & REIT: iShares CMBS ETF (CMBS), Financial Select Sector SPDR Fund (XLF), SPDR S&P 500 ETF Trust (SPY)

Though large unrealized losses on banks’ US Treasuries, meant to be held to maturity, have been widely cited as a key factor drying up liquidity at America’s banks, mortgage-backed securities (MBS) are playing a significant role as well. As an example, a quick look at the now defunct Silicon Valley Bank’s (SVB) Q4 2022 earnings report shows that its fixed income portfolio was most heavily weighted toward MBS – particularly agency MBS issued and guaranteed by US government agencies. 55% of SVB’s $117 billion fixed income portfolio alone was comprised of agency RMBS with another 13% being agency commercial MBS. The share of CMBS in the portfolio was only slightly smaller than that of US Treasury Securities.

Risk is quickly rising in the CMBS space and that can be seen in the types of commercial mortgages coming to market. Per Bloomberg data, Sales of CMBS deals without government backing have fallen more than 80% this year. The Real Deal notes that leading commercial real estate firms including CBRE, JLL, Colliers and Cushman & Wakefield, and others are moving forward with cost-cutting measures, including layoffs.

Per Wall Street Journal data, Charles Schwab makes up the largest share of agency MBS security holders among mid-sized US financial institutions, carrying $237 billion of securities – $159 billion of which is designated as held-to-maturity and is not marked to market prices. This is likely why Schwab attracted the attention of bearish traders and speculators last week, causing credit default swaps (CDS) on Schwab to nearly double from their 2023 lows. This is not to say Schwab will definitively face any real liquidity troubles, but investors are clearly weighing the risks posed by an ongoing downturn in the MBS market more heavily, even within the agency tier of these securities.

Commercial real estate and the CMBS market plays a critical role in the performance of the US banking sector, considering mid-sized banks – lenders with less than $250 billion in assets – account for 80% of commercial real estate lending, according to Goldman Sachs data. In a recent…

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