In January, New York Community Bancorp (NYCB) announced a big loss in its commercial mortgage reserves, causing its stock price to fall by 70%. Shortly thereafter, financial analysts at Evercore ISI crunched the numbers and found that several regional banks were increasing their exposure to commercial loans, raising concerns for investors.
Their research suggests that the four banks face accelerating risks if the commercial sector continues to struggle.
Karen/Frost Banker
M&T Bank
Synovus Financial
Citizens Financial Group
John Pancari of Evercore, one of the analysts who has studied the issue, said that while loan defaults (or losses) have not reached the levels seen during the financial crisis, continued commercial losses could force at-risk banks to build up cash reserves. That said, Pancari doesn't think these banks are necessarily at risk of failure if commercial defaults rise.
“This isn't a liquidity or capital issue for banks, it's an earnings issue,” Pancari told Barron's.
That's good news for the economy because a second wave of community-bank closures like those that caused several banks, including First Republic Bank, to fail in 2023 could put investors and regulators on edge. But Evercore's analysis is still unwelcome news for shareholders of at-risk banks.
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How Evercore Breaks Down the Numbers
Evercore conducted an analysis looking at the amount of potential risk for regional banks compared to the amount of loan reserves — “rainy day funds” banks hold to offset losses in the event of a large loan default. Karen Frost Bank of Texas made the list because 35% of its loans are commercial real estate-related and its loan reserves are 1.45%.
A key factor in Karen Frost's favor is that the bank's average loan cash flow was 1.44 times its cost of debt, meaning many of its loans are in real estate that generates revenue and pays off debt. Next on the list is Georgia-based Synovus Financial, with 32% of its loans concentrated in commercial real estate and a reserve of 1.09%. But Synovus' CEO said the bank has few troubled loans and is limiting new commercial lending.
The story continues
Rhode Island-based Citizens Financial Group has 19% of its loans in commercial real estate and holds a 2.2% reserve. Citizens Financial Group's position is concerning because office loans make up a significant portion of its 19% loan exposure. The company also holds a 10.2% reserve against office loans, which is important because the office market is likely the most troubled sector within commercial real estate.
What are banks saying about loan balances?
M&T Bank, a Buffalo, New York bank, has 24% of its loans in commercial real estate and 1.9% in reserves. If the bank were to undergo a stress test like the ones the Federal Reserve administered to large banks like Wells Fargo after the 2008 financial crisis, the reserves would account for 22% of M&T's losses.
In a recent letter to shareholders, M&T noted that its outstanding commercial loan balances are at their lowest in 15 years, with a loan-to-property value ratio of 56%. On the company's most recent earnings call, M&T Chief Financial Officer Darryl Bible said, “We are very comfortable with our current reserve position. While we cannot promise that reserves will not increase in the future, we have conducted a thorough review of some of the higher-risk loan types in the (commercial real estate) space.”
Another reason to keep a close eye on this sector
Pancari ultimately believes a major default is unlikely to have a negative impact on depositors, but the potential impact on stock price movements is reason enough to keep a close eye on the banks under surveillance. It would be reasonable to expect Evercore's analysis to paint a rosy picture for all banks, but history has shown that it only takes one bank to fail due to bad loans to start a chain reaction and initiate a regional banking crisis.
With nearly $1 trillion in commercial mortgage debt maturing in 2024, many of the developers who owe it likely won't be able to refinance at interest rates that will allow them to keep their projects profitable. That will inevitably lead to defaults, and it's hard to imagine some regional banks not going under with bad loans. Overall, Evercore's analysis is another reason why investors should keep a close eye on this sector.
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This article, “These 4 Banks Could Be in Peril If Commercial Real Estate Keeps Slumping,” originally appeared on Benzinga.com.
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