New Trade: Exiting Our KRE Short as Shadow Liquidity Keeps Developers Afloat (For Now)
Today we are covering to close our short position in KRE, the regional bank ETF, due to a lack of follow-through tied to private credit and strength in the labor market.
Here are the details, with commentary to follow:
Buying to cover (fully close) short S&P Regional Bank ETF (KRE) at market price.
KRE showed signs of breakdown a few weeks ago, but then bounced back. As a result, our short position has been hanging around the breakeven level.
Digging deeper into the commercial real estate (CRE) situation, it appears the labor market — and with it multifamily real estate properties — might need to crack before regional banks truly feel the pain.
In the meantime, aggressive lenders in private credit markets are helping provide a stopgap.
A potential factor in the market's non-reaction to Federal Reserve rate hikes — at least so far — is trillions of dollars of liquidity sloshing around private credit markets.
In December 2023, BlackRock estimated that private equity managers, private (non-publicly traded) real estate funds, and private lenders had as much as $4 trillion worth of "dry powder" (assets under management waiting to be deployed) on hand.
The term "shadow banking system" refers to all the actors in markets who behave like commercial banks in terms of lending activity, but are not monitored or regulated like commercial banks.
Nobody can say for certain how large the shadow banking system is — part of the point is these assets are not officially tracked — but the total pool is huge.
Private credit is a part of the shadow banking system — a reference to capital loans provided, once again, by entities that act like banks but exist outside the banking system.
We are playing around with a new term, "shadow liquidity," to describe a macroeconomic force that is new to this business cycle: The ability of private credit flows to defy interest rate hikes, at least in the near term, because private lenders who need to generate a return on assets are willing to keep lending aggressively at the margins even as commercial banks, with their tighter regulations and strict leverage restrictions, are forced to turn away.
That brief rabbit trail applies to KRE — and our call to close the short position for now — because it looks like private credit loans are helping to stabilize the CRE situation.
High-profile office properties are indeed going bust. But outside the busted property deals hitting headlines when banks are forced to write them down, private credit lenders are apparently offering real estate bridge loans at high-but-tolerable finance rates.
This private credit flow won't be enough to stop a CRE reckoning — the lending rates are still too high to keep leveraged developers from going bust, and passing that pain to the banks, if property values don't bounce back.
But in the short term, the regional banks are getting a helping hand keeping their CRE losses under wraps, in part because desperate developers are hitting the bid on private credit loans as a last-ditch effort in the hopes things will turn around.
The availability of private credit likely also explains the large valuation gap between publicly traded real estate investment trusts (REITs) and values in the private market.
In a twist on the normal order of things, publicly traded real estate assets are trading at far lower valuations than their private market counterparts — which indicates one of the two is wrong, and it is probably the private side.
Our sense is that, for the gravity of the situation to really take hold, the labor market may need to crack.
That is because as long as the labor market stays strong, cash flow streams from rent payments could keep private credit lenders and developers in the game, or at least hanging on by their fingernails.
If the labor market cracks, however — with missed rent payments becoming a problem as unemployment rises — that could be the catalyst for the next leg down, as private credit lenders start getting hammered on their bridge loans and developers start throwing in the towel on more deals.
To sum up, shadow liquidity via private credit is lengthening the "extend and pretend" period by giving developers, and thus regional banks, a temporary lifeline. This could go on until labor markets start to crack, at which point it will become much harder (if not impossible) to keep defying gravity.
Until next time,
Justice Clark Litle Chief Research Officer, TradeSmith
TradeSmith is not registered as an investment adviser and operates under the publishers' exemption of the Investment Advisers Act of 1940. The investments and strategies discussed in TradeSmith's content do not constitute personalized investment advice. Any trading or investment decisions you take are in reliance on your own analysis and judgment and not in reliance on TradeSmith. There are risks inherent in investing and past investment performance is not indicative of future results.
Tidak ada komentar:
Posting Komentar