New York CNN —
It's no secret that commercial real estate (CRE) has been a source of stress for banks: If banks had known a pandemic was coming that would completely disrupt where people work, they would have been more cautious about lending to clients who rent out space in office buildings.
But now a tough timeline lies ahead: $2.2 trillion in commercial real estate loan payments loom over the next three years, according to data firm Trepp.
Office vacancy rates are at an all-time high as people continue to work remotely, putting office building owners in a bind, leading many to slash rents or sell properties at a loss.
All this can lead to big missed loan repayments as they come due. But the stress is not felt the same across all banks.
While the nation's largest banks owe hundreds of billions of dollars in loans to commercial real estate clients, smaller regional banks, which hold the most risk, are primarily bearing the brunt of the stress (more on that below). These banks account for about 80% of the total amount of U.S. bank lending to commercial real estate companies, according to Goldman Sachs economists.
Overall, commercial real estate accounts for 12.5% of the total loan portfolio of U.S. banks with more than $100 billion in assets, according to an analysis by S&P Global Ratings. But for banks with less than $10 billion in assets, the sector accounts for 38% of the loan portfolio.
That means big losses from commercial real estate loans could lead to the company's collapse, Fitch Ratings said in a December report.
Regional banks have been on high alert recently after New York Community Bancorp (NYCB) reported larger-than-expected future losses on commercial real estate loans.
Banks are required to hold a minimum amount of Tier 1 capital, a fund that can be quickly accessed in emergencies to cover loan and lease losses. Among the 100 largest U.S. banks by assets, NYCB subsidiary Flagstar Bank has the second-highest concentration (470%) of commercial real estate loan Tier 1 capital and loan and lease loss reserves, according to an analysis published by BankRegData using the most recent data available from banks and the Federal Deposit Insurance Corp., the regulator that oversees them. (Flagstar did not respond to CNN's inquiries.)
Morristown, New Jersey-based Valley National Bank (VLY) has the highest exposure to CRE, with lending to the sector making up 475% of its Tier 1 capital, which includes reserves for loan and lease losses.
A CRE exposure of more than 300% is one of the main indicators that a bank is at significant risk, according to guidelines the FDIC issued jointly with two other U.S. financial regulators in 2006. In a December advisory letter, the FDIC said it “continues to be concerned that financial institutions with concentrated CRE exposure may be more vulnerable to a real estate market downturn.”
In contrast, JPMorgan Chase & Co., which currently lends the most to commercial real estate clients, has a much lower exposure to the sector, at just 61%, according to BankReg data.
So why are smaller regional banks more reliant on commercial real estate?
To differentiate themselves from the largest national banks, smaller regional banks tend to focus on building relationships with local businesses and customers, which gives them a unique and deep understanding of the local economies in which they operate.
Michael Brokstein/SOPA Images/LightRocket/Getty Images
Valley National Bank has the greatest exposure to the commercial real estate market among the top 100 largest banks in the United States.
Fitch calls this practice a “community-based lending model” and says it contributes to its high exposure to commercial real estate.
Valley National Bank CEO Ira Robbins said in a statement to CNN that the bank has “been making relationship-driven commercial real estate loans for decades,” adding that the sector “serves as a key component of the economic vitality of our communities.”
After the Great Recession, banks with less than $250 billion in assets shifted much of their lending activity to commercial real estate away from construction and land development, which were the source of their biggest losses at the time, according to Fitch.
Fitch also noted that “as certain lending products, such as mortgages and credit cards, have shifted to larger players, smaller and mid-sized banks have been left focusing primarily on commercial, industrial and CRE lending.”
Commercial real estate doesn't just cover office space. It includes a variety of elements, including apartment complexes, rental properties, retail space, etc. However, of these subsectors, office real estate is the one with the highest vacancy rate and therefore the biggest concern.
The national office vacancy rate rose to a record 19.6% in the fourth quarter of last year, the biggest increase since the first quarter of 2021 and surpassing the 19.3% level recorded twice in the past 40 years, according to Moody's Analytics.
The FDIC said in 2007 that banks with high exposure to CRE could mitigate their risk by “diversifying their portfolios across property types.” In other words, banks whose CRE loan portfolios are more evenly diversified across subsectors, rather than heavily weighted toward one, may be less vulnerable to a downturn.
None of the nine subcomponents of Valley National Bank's $28.2 billion commercial real estate portfolio accounts for more than 25% of it. Office properties are one of the bank's smaller commercial real estate subcomponents.
“We remain pleased with our diversified and fragmented commercial real estate portfolio,” Valley National Bank's Robbins told CNN.
Carlos Barria/Reuters
Office real estate, while it is the one that worries banks and economists the most, is only one component of commercial real estate.
Additionally, Fitch found that smaller banks have fewer late-stage delinquencies and payment defaults than larger banks, despite their heavy reliance on commercial real estate lending. The ratings agency believes this is because smaller banks lend more to homeowners, who tend to make their loan payments in a more timely manner than, say, office building owners.
Still, the FDIC “strongly” encouraged banks with high exposure to commercial real estate, particularly in office lending, to set aside more capital “to ensure they are adequately protected against unexpected losses if market conditions were to deteriorate further.”