While commercial real estate is often talked about as a problem for smaller banks, it is the larger banks that are bearing the most visible scars so far.
While commercial real estate is often talked about as a problem for smaller banks, it is the larger banks that are bearing the most visible scars so far.
But that's not what's happening in the stock market. Falling values of office, apartment and other commercial real estate are weighing on the stock prices of all banks, but especially smaller ones. The KBW Regional Bank Index is down about 12% this year, while the KBW Nasdaq Bank Index of large banks is up nearly 9%.
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But that's not what's happening in the stock market. Falling values of office, apartment and other commercial real estate are weighing on the stock prices of all banks, but especially smaller ones. The KBW Regional Bank Index is down about 12% this year, while the KBW Nasdaq Bank Index of large banks is up nearly 9%.
Regional, community and small banks account for more than a quarter of U.S. commercial and multifamily real estate debt, more than double the share held by the top 25 banks, according to a recent analysis by Moody's. But not all so-called CRE loans are created equal.
While something like a credit card loan is fairly standardized, real estate is more murky. Is it a new construction loan or a loan against an existing building? Is the borrower the primary tenant of the property or looking to rent out the building? Is it an office building, a medical facility, a shopping mall, or a warehouse? Is it a large loan split among banks or smaller loans held by one bank? And so on.
So it's important to dig into performance, not just exposure.Based on available data for the banking system, first-quarter regulatory filing figures recently compiled by S&P Global Market Intelligence showed a wide variation in the share of loans marked as delinquent or uncollected that banks don't expect to repay in full at maturity.
The problem is with large banks and lending to properties intended to be rented out to third parties. More than 4.4% of CRE loans on non-owner-occupied properties held by banks with more than $100 billion in assets were delinquent or unpaid in the first quarter, up more than 0.3 percentage points from the previous quarter. Meanwhile, all size categories of banks with less than $100 billion in assets, and owner-occupied loans at large banks, had delinquency rates below 1% in the first quarter.
The difference comes down to higher interest rates. Owner-occupied CRE loans tend to work well as long as the borrowing business itself is healthy and solvent, says Nathan Stovall, director of financial institutions research at S&P Global Market Intelligence. But rental properties are much more sensitive to interest-rate levels. A loan can get into trouble if property income, which is affected by occupancy rates and current rents, can't keep up with the costs of current loan payments or refinancing expiring loans.
The split could reflect geographic differences, like urban versus suburban, but it's not just big banks that are lending to downtowns. They could also be facing more near-term debt maturities in key areas. National banks held 29% of tracked office debt that matured last year and 20% of debt maturing this year, according to a March analysis by MSCI Real Assets. Regional and local banks' share was 16% last year and 13% this year.
CRE loans are often structured with balloon principal payments at the end of the term, and banks with approaching repayment dates will have to take a harder look at the repayment viability of these loans.
Many big banks have already set aside large reserves in anticipation of losses on office loans. The median first-quarter reserve ratio for office loans among banks tracked by Morgan Stanley analysts that have disclosed the ratio was 8%. That's well above the less than 2% loss reserve ratios for all insured banks and all loan categories, according to Federal Deposit Insurance Corp. data.
According to figures from S&P Global Market Intelligence, the net charge-off rate on non-owner-occupied CRE loans for banks with more than $100 billion in assets exceeded 1.1% in the first quarter, about a percentage point higher than the level for smaller banks but down more than 0.25 percentage point from the previous quarter.
Indeed, today's problems are also yesterday's risks, so the question is where the balance of risks lies now. If the real estate market downturn affects smaller or suburban properties more dramatically, or hits businesses more broadly, the most unpleasant surprises may come to the small or regional banks that hold such loans.
Conversely, smaller banks could fare better in a scenario where the economy stabilizes and interest rates stay high for a long time. In that case, there could be some value in these stocks lurking behind the headline concerns.
Write to Telis Demos at Telis.Demos@wsj.com
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